Restaurants: hungry for growth & profits; Success in the restaurant industry hinges on delivering profits to stakeholders by serving more customers, adding locations and controlling costs--in innovative ways.

U.S. Secretary of the Treasury John Snow, who got one of his first jobs in a restaurant, lauded the industry recently for being a "cornerstone" of the U.S. economy. "As the nation's largest private-sector employer, the restaurant industry has a tremendous impact on this nation's economy," he told National Restaurant Association (NRA) members at their September 2004 Public Affairs Conference.

[ILLUSTRATION OMITTED]

[ILLUSTRATION OMITTED]

The rise of dual-career, more-affluent families is driving more people to eat out, more people are working in the industry and more revenue is being generated. Yet, restaurants, like other consumer-driven businesses, are in a perpetual race to grow and serve up more profits for shareholders--by serving more customers, adding locations and controlling costs--in new and innovative ways. "You have to have new news, new products and new approaches," says Kerrii B. Anderson, CPA, executive vice president and CFO of Wendy's International Inc.

It's been said that successfully operating a restaurant is one of the hardest--if not the hardest--of businesses. At the same time, industry statistics report that in 2004, 878,000 restaurant and food-service outlets, employing 12 million, will serve more than 70 billion "meal and snack occasions" with a tab of $440.1 billion--up 1.5 percent over 2003 in inflation-adjusted terms. And, these numbers do not include other industries that are affected. The NRA says that looking at all restaurant meals served, the sales generated in related industries will impact the overall U.S. economy by an estimated $1.2 trillion in 2004.

While every industry is concerned with issues related to risk, controls, costs, margins, profits, cash, revenues and taxes, for restaurants, other areas of concern include: food safety, the supply chain, employees, government regulations and frivolous lawsuits--to mention a few.

Financial Executive Managing Editor Ellen M. Heffes asked financial executives at three different categories of restaurant chains to discuss how they maintain success in their niche in this highly competitive industry. The three are:

* Wendy's International Inc., the Dublin, Ohio-based number three burger-maker in the "quick-service restaurant (QSR)" sector.

* Brinker International Inc., the Dallas-based owner and operator of five distinctly branded "casual-dining" concepts, including its flagship Chili's Grill & Bar[R].

* Privately held Morton's[R] Restaurant Group Inc. of New Hyde Park, N.Y., the largest steakhouse chain in the "fine dining" category.

Dave Thomas was the face of Wendy's beginning in 1969--as its founder and leader, as well as its national advertising spokesperson--so one might've worried about what would happen when he passed away in 2002. "In many ways, nothing's changed," says Anderson. "He really did establish the culture, and we focus on making sure the legacy of Dave continues to be how we execute this brand every day."

[ILLUSTRATION OMITTED]

[ILLUSTRATION OMITTED]

She says she loved his attitude and passion, recalling interviewing with Thomas prior to accepting her job in September 2000. "He asked if I was a CPA. I said: 'I am a CPA, and an MBA from Duke,' to which he said, 'Oh, Kerrii, you can't think like an accountant; you have to think like a business partner.'" She says that really stuck with her, as it was the approach she had always taken in her career--that accounting provides the information to make better business decisions.

"The organization is much more diversified than it was even three years ago," says Anderson, with its business primarily in North America (the U.S. and Canada), in nearly 9,500 units, generating 2003 revenues of more than $3.1 billion system wide.

Wendy's, the enterprise--the 8th largest U.S. restaurant company--is the owner of three key brands and an investor in a few smaller concepts, and employs about 53,000. Flagship Wendy's Old Fashioned Hamburgers[R] (Wendy's) also owns a bakery that produces buns for company-owned and franchise locations.

The second largest brand, Tim Hortons[R] ("Tim's"), is a Canadian-based coffee-and-baked-goods chain that began in 1964 and merged with Wendy's in 1995. Through vertical integration, a Branford, Ontario-based bakery provides baked goods to the franchisees, and a coffee roaster in Rochester, N.Y., provides about a third of the coffee for the system. Tim's--with about 70 percent of the quick-service coffee and baked-goods market in Canada, and 20 percent of the overall QSR in Canada--makes Canada the only country where McDonalds is not the number one QSR, Anderson reports.

A third brand, the 305-unit Baja Fresh[R] Mexican Grill, acquired in June 2002, serves the fast-casual Mexicanfood segment. Additionally, Wendy's holds a 70 percent interest in Cafe Express[TM], an American bistro concept (about 18 units around Texas) and a 25 percent interest in Pasta Pomodoro[R], a fast-casual Italian concept in California. A majority of the locations are franchised--about 80 percent of Wendy's, 99 percent of Tim's and about 50 percent of Baja Fresh.

In the casual-dining sector, Brinker's five diverse concepts have prompted its being referred to as the "mutual fund of restaurants." In 1975, Brinker International Inc.'s Norman Brinker was already a trend-setting restaurant operator. By the early '80s, he bought Dallas-based Chili's, then a small chain of restaurants with 28 locations primarily in the Southwest that offered a simple menu of hamburgers, tacos and chili, along with beer and maragaritas. The menu grew and diversified over the years to include sizzling fajitas, baby back ribs and much more.

The company went public, and in 1991 was renamed "Brinker International Inc." to reflect the additional restaurant concepts that had been added to its portfolio. Over the years, the company has had partnerships with various individuals and entities that have provided other concept ideas that Brinker purchased and developed, says David Doyle, CPA, senior vice president and controller.

In total, Brinker either owns, operates, franchises or is involved in the ownership of more than 1,500 restaurants (about 1,200 company-owned) in more than 24 countries. The 1,000 Chili's locations accounts for about 60 percent of the sales and approximately 75 percent of pre-tax profits.

The other brands--Romano's Macaroni Grill[R] (developed by Phil Romano, has 211 company-owned and 9 franchises); Maggiano's Little Italy[R] (30 company-owned) and Corner Bakery Cafe[R] (83 company-owned, 3 franchises), purchased from the Lettuce Entertain You group; and On the Border[R], purchased from a Dallas company--are part of the corporate-owned structure (approximately 80 percent company-owned and 20 percent franchised, and moving toward 75/25, primarily by "refranchising some existing areas with significant development agreements," mostly for Chili's). Brinker also has a less-than-50 percent partnership in Rockfish Seafood Grill[R] in Dallas.

Brinker employs nearly 100,000 people. Its 2004 revenue is projected at $3.7 billion, up from $3.3 billion in 2003; close to $4 billion in sales is expected in 2005.

When it comes to fine dining, what may likely come to mind is the thought of a big, juicy steak served in the comfort of a luxurious decor--kind of like having both the sizzle and the steak! That's just what you'll find at any one of the 65 Morton's locations--whether in the U.S., Canada, Hong Kong or Singapore--says Thomas J. Baldwin, CPA, executive vice president and CFO of Morton's Restaurant Group Inc. All Morton's locations are owned and operated by the company itself. Baldwin views owning and operating restaurants as a major competitive advantage, citing better quality control.

[ILLUSTRATION OMITTED]

With an average tab of $75 per person (including beverages), the typical Morton's customer is either on an expense account or at a social event, and is looking for high, yet affordable value, explains Baldwin. The chain also features private dining facilities in its "boardrooms," which are fully equipped with sophisticated telecommunication and audiovisual equipment and are especially useful to certain clients.

Morton's was founded in 1978 in Chicago (Morton's of Chicago) by Arnie Morton and Claus Fritsch. Morton sold his interest in 1987, and Fritsch currently serves as vice chairman of Morton's of Chicago. And, like other restaurant companies, Morton's seems to be extending its marketplace. It's acquired four Bertolini's[R] Trattorias--moderately-priced northern Italian cuisine restaurants.

Morton's has an unusual structure--its equity is privately held, but the debt is publicly held--"an ideal capital structure for our company, as well as our investors," Baldwin says. It was a New York Stock Exchange-listed public company for 10 years, and went private in 2003. After considering strategic alternatives to enhance shareholder value, he explains, its partner, private equity firm Castle Harlan, purchased the company and took it private. However, since it holds public debt, it is subject to Securities and Exchange Commission (SEC) regulations and filing requirements, such as The Sarbanes-Oxley Act and publishing its financial results.

Morton's employs about 4,000 and generated revenue of $259 million in 2003. There's a large seasonal component to the business, says Baldwin, with the highest sales volume coming in the fourth quarter. He sees "fundamental strength in the business this year," as the first half of 2004 has generated $138 million in revenue.

The Number-Crunchers

Doyle says the restaurant industry is "a fun industry to work in [where] you can go out and see it, touch it, taste it, every day." There aren't many businesses "where you can actually go out and get a feel for the operations side."

Doyle's career began in the audit side of public accounting in Dallas, where he focused for 12 years on both public and private retail companies, including working on the Brinker account, from the mid-1980s to '90s. In 1994, he was offered a director position in Brinker's accounting department. He was promoted to vice president in '97, and became senior vice president and controller in 2003. He says it was quite an adjustment, "going from public accounting's very competitive, top-down approach, to the more team-oriented/people-oriented environment," and that it has worked just fine for him. He oversees the accounting and tax functions and, naturally, external financial reporting.

Anderson also began her career in public accounting, with KPMG. "I learned to ask the right questions and apply what I knew from my disciplines--accounting, finance, strategy--to that specific business," she says. Coming to Wendy's with 12 years of CFO experience in a homebuilding company certainly represented an industry change. She describes the switch from a production cycle of 60 days (for lower-priced homes) to "building a burger in 60 seconds!"

Baldwin started at Morton's in his first CFO job in 1986. Prior to that, he worked for two years in a large corporate banking environment, with Citicorp, and for seven years in various finance and accounting positions with Kraft General Foods. He's had several promotions, and currently serves on the board of directors--with he and the chairman as the only two insiders on the company's 11-member board.

Growth, Competition: Food Fights?

No matter what the sector of the industry, growth is imperative, and most companies are growing through a combination of ownership, franchises, acquisitions and partial ownership as a way to test the waters for new brands.

Growth is on Morton's' plate. Baldwin says its "prudent" growth strategy involves re-investing in the business and growing cash flow and earnings in the 10 percent range, through the combination of new restaurants, prudent restaurant growth and raising comparable restaurant revenue (or "same store sales"). Through the first half of 2004, comparable restaurant growth was over 10 percent; last year, it was 4.3 percent for the entire year.

Of course, Baldwin notes, last year's growth represented the rebound from the earlier weakened 2002 economy, following 2001's "profound events," when business softened due to the decline in business travel and hotel occupancy.

Many Morton's are in upscale hotels--in Singapore, Hong Kong, Toronto and Beverly Hills--while most are in leased premises, although the company owns six properties. Not surprisingly, notes Baldwin, a "strong economy is definitely a major factor in our success."

Substantial growth opportunities exist, asserts Baldwin, with much of it coming from "rounding out existing markets." For example, when he joined the company, there was just one Morton's in the Washington, D.C., metro area. The seventh is scheduled to open in that market in January. Besides that one, five other new locations are planned to open next year.

Growth for Brinker comes primarily from its existing restaurant base, through sales growth as well as new restaurant development, explains Doyle. Brinker expects to add between 143 and 161 new stores system-wide this year (mostly Chili's). Going forward, he says, its long-term business model targets restaurant growth of about 10 percent.

[ILLUSTRATION OMITTED]

Doyle says Brinker has always been "an operations-focused business, emphasizing innovation, choice and high-quality overall experience to each of our guests," and that value is the focus in everything the firm does. In the casual-dining sector, which is growing at approximately 7 percent annually, he believes the company is well-positioned, in that it offers a number of brands that are "complementary, rather than competitive."

For Wendy's, growth is governed by a strategic plan, which its board of directors tasked senior management with developing in 2000, with a focus on long-term earnings growth. Anderson says the rate of growth on a compound annual growth rate has consistently been around 12 percent per year since 2000. Wendy's is continually reinvesting in the business--building new stores and renovating current stores.

Comparable-store sales and new units are the two big drivers that form the core focus for both Wendy's and Tim's. The current 6,500 Wendy's restaurants (5,800 in the U.S) are expected to expand to between 8,500 to 9,500 locations. And Tim's current 2,300 restaurants in Canada are expected to grow to between 3,000 and 3,500. Additionally, Tim's U.S. (with 200 locations) is poised for growth, with the recent acquisition of a 42-unit chain in the Rhode Island/Connecticut area for conversion to Tim's. Growth is also on tap for Baja. The strategic plan includes continuing to look for other vertical-integration opportunities for Wendy's, the enterprise.

[ILLUSTRATION OMITTED]

Business Challenges

With certain issues common to the industry, it's Doyle's belief that all competitors are affected equally. So, he says the strategy at Brinker is to "focus on things that we can control." The industry was affected by the summer's terrible weather in Florida--a big market for Brinker--but he says, "Luckily we didn't have extensive damage." Brinker, like others, has also felt the impact of recent commodity price increases and forecasts for year-over-year increases; some restaurant-level price increases are "running about 2 percent year-over-year, to help offset that impact" on its bottom line.

Besides running the business, in his control capacity, Doyle expresses angst about "government intervention" issues he says the company has to deal with. One relates to a tip-reporting dispute with the Internal Revenue Service, which he says is reported in the firm's recent 8-K filing. "That's taking up a lot of my time, as I'm coordinating that effort," he says. "We feel very confident about our case, and feel that what the IRS has done is not right, so we're spending a lot of time and effort--internally and externally," dealing with it.

How does Anderson believe Wendy's stacks up to the numbers one and two in its "burger" category? "Even though we look at others in the industry, the truth is we worry our ourselves--What is Wendy's doing? What is Tim's doing? And how do we get better tomorrow than we are today--as an organization, both financially and operationally?" are questions she asks. What's important, she asserts, "is to be known as the number one in quality and meeting consumer needs."

One big consumer need over the past several years relates to nutrition and diet. Anderson says extensive firm-led research shows that consumers are focused on several elements: they are more stressed, have less time, want fast food that is fresh and want their definition of "healthy." Also, they want their meals in a less-hectic environment. Basically, they want nutritional choices, and the information to make those choices. So, nutritional information is available on Wendy's Web site--from caloric count, to grams of fat and more. And, while Wendy's is associated with hamburgers, she notes, "actually, only one-third of our products are hamburgers."

At Brinker, its Nutrition Advisory Council helps it "evaluate current menu initiatives and develop our long-term strategy around that," Doyle notes. The company continues to "emphasize choice to our guests so that they can order products that meet their dietary requirements."

Baldwin says the biggest challenge at Morton's is commodity cost rises--particularly beef (several public companies are reporting significant price increases), which accounts for 80 percent of its menu items. Since its inception, he says, the business has been consistently centered on three elements: extraordinarily warm, friendly service, fine food (it specializes in USDA prime--that costs Morton's $18 per pound) and high-end decor.

How has Morton's fared in the diet fads of recent years? Baldwin says he hasn't seen a decline in the demand for beef in the company's 26 year-history, because of "perceived health concerns, nor did we see a bump because of the protein or some of the other fad diets," he says. "Morton's is not a fad," he argues, calling it the most consistent high-end restaurant chain. Indeed, he indicates that in each year of the 15-year period ending in 2000, Morton's had comparable restaurant increases.

Baldwin maintains that dining at a Morton's is a "reward" and an "affordable luxury," and current demographics trends support growth. Interestingly, he notes, Morton's' overall menu mix has not changed in its history.

The Turnover Factor

A big concern for restuarants, the nation's largest private-sector employer, is employees; industry statistics report that turnover at the crew level--which employs primarily college students--is often 250 percent a year. Doyle says Brinker's "people-focused culture, that is vibrant and very progressive" enables it to attract and retain the best people. "We're hiring a lot of people," he says, and that "it's up to managers in the field to hire good people, incent them and motivate them." At the manager level, he notes, turnover is around the mid-20 percent level--probably one of the best in the industry.

Baldwin says that 80 percent of Morton's management team comes from internal positions, so, by industry standards, it's "significantly lower" than the general turnover.

Compared to industry levels, employee turnover at Wendy's at the crew level, at 180 percent a few years ago, didn't sound too bad. However, Anderson says efforts were made to improve those numbers with its "People Excellence" initiatives--which includes training in both English and Spanish. Turnover is now at around 125 percent.

Besides restaurant menus, pricing and ambiance, another area of competition in the industry is competing for real estate, sometimes among a company's own brands. Doyle says it typically takes around 18 months to find and develop a new restaurant, after detailed demographic efforts determine which brand fits best in particular areas, based on the local competition set. As new areas develop and people move in, "you have the same group of big chains looking at the good locations and competing for those." In addition, he notes that "everybody is fighting for 'A' spots."

In particular locations, Brinker leaves the development to the franchise partner, and all of its international locations are franchised. With real estate and construction in certain areas very challenging due to expense and local laws, he says, "We let partners who are more familiar with that in their local markets deal with it."

Franchising is often a quicker route to a market. Brinker recently signed an agreement with Athens, Ga.-based Bonnaroo Restaurant Group to develop up to 15 Chili's locations in Georgia and South Carolina. "By selling to Bonnaroo, Brinker will begin receiving royalties sooner than it could generate revenues by developing on its own," says Doyle.

As noted earlier, Wendy's is bringing Tim's to the U.S. through franchise arrangements. For Wendy's, the enterprise, the value of its large number of franchise partners is clear. Anderson recalls that on her second day on the job, her CEO told her to join him in the boardroom to meet "the most important people you'll meet at Wendy's." The group was the Franchise Advisory Council. Indeed, she says, communicating with this group is probably her biggest challenge. One innovation was initiating cyber-chat to share information with and respond to questions from franchisees. "We try to make sure they understand opportunities from a business perspective--tax law changes, risk management issues, etc." Quoting Dave Thomas, she says, "When their business is successful, so is ours!"

Editor's note: The financial executives featured in this profile are all FEI members.

RELATED ARTICLE: Restaurant Industry 2004: Facts to Chew On

878,000 restaurant locations

U.S. sales should hit $440.1 billion; 4.4% increase over 2003

Typical day average sales: over $1.2 billion

Sales equal 4% of the U.S. GDP 

Employs approximately 12 million--almost 9% of the U.S. workforce

Critical issues: minimum wage, food safety, IRS tip audits

Eating-and-drinking places employ more minority managers than any other industry

Source: National Restaurant Association

www.restaurant.org