The bagel debacle.
"One of the most immediately disastrous acquisitions in American business" is how The Wall Street Journal described Quality Dining's purchase of the Bruegger's Bagel Bakery chain.
A year after the bagel business was sold, CEO Daniel Fitzpatrick is busy rebuilding his Mishawaka company's image and his reputation as one of the best operators in the restaurant industry. The turnaround is slowly taking shape, as reflected by Quality Dining's fiscal 1998 figures. Sales have dropped to $232 million, similar to the volume before the acquisition. But the company showed a profit of $113,000, small but significant when compared to 1997's net loss of $196.5 million. Fitzpatrick is back to basics, looking more like what he was before 1997: a 1996 Indiana "Entrepreneur of the Year" whose company was ranked sixth on Forbes magazine's list of "200 Best Small Companies in America."
The magnitude of the mistake Quality Dining made in purchasing and then attempting to expand Bruegger's too rapidly is evident in two ways. First, Quality Dining took a huge financial hit, incurring $200.5 million in charges after the company announced it would sell Bruegger's back to its founders less than a year after the acquisition.
Second, some say the CEO had too many things on his plate. Fitzpatrick now is dedicated and cautious in the way he rebuilds Quality Dining and positions for success the remaining restaurants he owns and operates.
Fitzpatrick has refused to grieve the loss of the bagel business. Focusing on the negatives would be unproductive, and what happened to Bruegger's happened to chains everywhere, he says. Not a single player in the bagel industry went unscathed when the relatively small industry unpredictably boomed and supply began exceeding consumers' demands.
If Fitzpatrick seems to have taken a low profile since the Bruegger's derailment, he says it's because his most productive day is spent focusing on customers and shareholders, not talking to the media or worrying about whether analysts think Quality Dining can recover.
The company operates 38 Grady's American Grill restaurants, four Papa Vino's Italian Kitchen restaurants, four Spageddies Italian Kitchen restaurants, 70 Burger King restaurants and 28 Chili's Grill & Bar restaurants "If analysts say this company has not yet reached its potential and has not yet succeeded, that's why I came to work today," Fitzpatrick explains. "I get frustrated responding to those expectations. The events of 1997 were a very difficult time for our company and we had some business problems. From an imagery standpoint, we got beat up probably more than we should have been. We've been solely focused on running our restaurants, optimizing our cash flow and reducing our bank debt. I don't mean to be emotional about it. All we can do is play the game on Saturday and try to win."
Dan Fitzpatrick is a hard-core, roll-up-your-sleeves kind of restaurant operator. He got his start in restaurants at an earlier age than most. Fitzpatrick was only 14 when he became a busboy in an Italian restaurant in Toledo, Ohio, starting work to help support his family because his father had health problems.
"Early in life, the Fitzpatricks were told that there was no money in the till and they were going have to do hard work to get what they needed," explains Craig Weichmann, an analyst with Morgan, Keegan & Co. in Memphis, Tenn., and one of the few analysts still following Quality Dining.
At 16, Fitzpatrick began his career in fast food at a Burger Chef restaurant. He quickly moved up the ranks to assistant manager, and after high school graduation, he secured a job with Burger King restaurants. Burger King would become the foundation of his future. He acquired two Burger King restaurants in the Detroit area in the early 1980s, and he also bought into the franchise in the South Bend/Mishawaka area, where he eventually built his company, Quality Dining.
The "hamburger tycoon," as Fitzpatrick was pegged in the media, established Quality Dining in 1991. At the time, Fitzpatrick owned and operated more than three dozen Burger Kings and his new company purchased the franchise rights to Chili's restaurants for the states of Indiana, Michigan and Ohio.
He took Quality Dining public in early 1994, and national attention followed. When the company's common stock began trading on the Nasdaq, he had more than 40 Burger King restaurants and five Chili's restaurants in his portfolio. In the early- to mid-1990s, Fitzpatrick was building his reputation as a good, solid restaurant operator - sales grew from $42.6 million in 1991 to $105.3 million in 1995 - and Wall Street was taking notice, with analysts regarding Quality Dining as one of the strongest restaurant stocks.
EXPANDING INTO NEW TERRITORY
Quality Dining began operating licensed units of Bruegger's Bagel Bakery in 1994. The initial feedback Fitzpatrick heard about his first bagel store in Grosse Pointe, Mich., and others that followed, was good. Very good. As bagels surged in popularity with health-conscious consumers, Fitzpatrick continued building bagel stores mainly in Michigan, Indiana and Ohio for the Burlington, Vt.-based chain.
"The units they opened were doing extremely well," WeIchmann affirms. "Volumes at their openings were way above the average. Bruegger's was becoming a focal point."
In 1995 and early 1996, opportunities started pouring in. Fitzpatrick, who was still a franchisee and operator of Burger King, Chili's and Spageddies restaurants, purchased the Spageddies chain from Brinker International Inc. of Dallas along with Grady's, a group of casual-dining restaurants.
His company's annual sales were expected to double, increasing more than $100 miLlion that year. Fitzpatrick knew Grady's was fuzzy in consumers' eyes, but he envisioned a 100-unit concept and a $250 million business with some nurturing.
But another major business development would soon take the front burner. With Quality Dining's bagel stores doing so well, the company completed an acquisition of Bruegger's in June 1996 for $142 million in stock. Bruegger's founders Nordahl Brue and Michael Dressell joined Quality Dining's board, as did Stephen Finn, Bruegger's president and CEO.
Fitzpatrick doesn't spend time today talking about why he bought the bagel business. "Why we bought it is well known; why we sold it is extremely well known," he says. But about two years ago, the faith he had in the concept was clear. "We think Bruegger's will become to the bagel business what Starbucks has become to the coffee side," he said in an interview months before the merger was final. At the time, Bruegger's was the country's largest bagel chain, with nearly 400 outlets, but it had accumulated more than $10 million of losses in four years of aggressive growth. Fitzpatrick thought Bruegger's had the potential to be a 2,000-unit system in four years.
"We're going to operate this business with a heck of a lot of experience going in," he said at the time. "This is not a new business to me. I didn't buy a nuclear power plant. I didn't buy a mobile home park. I didn't buy a medical technology or computer technology company. I bought something I really know."
But no one knew how the changing dynamics of the industry would alter the scope of what companies like Quality Dining intended to do with bagels. At the time, Fitzpatrick had no reason not to believe the bagel business would be anything but promising.
"We're going to stub our toe, but we've got 10,000 people working in this company and more coming in the advent of the merger," he said before the deal closed. Of the potential he saw with Bruegger's: "It's truly national in scope. It'll be a huge, huge business for us."
MISTAKES ARE MADE
Quality Dining's first mistake was leaving Grady's in the lurch, Weichmann says.
"He bought Grady's then turned right around and bet the bank on buying Bruegger's, which created huge dilution, huge financial commitments and quickly it got out of control," he says. "They got into a capital crisis and they forgot who they were."
Quality Dining could have sold Grady's at a small loss for transaction costs and put the capital toward feeding Bruegger's growth, Weichmann says. An operator cannot park a concept in the restaurant business and figure he can come back to it later. It's important to stay focused, and Fitzpatrick "got distracted," he says. "He had too many things on his plate."
Fitzpatrick made a second mistake with his decision to put Bruegger's into too many major U.S. markets too quickly. It was a huge tactical error, Weichmann believes. Fitzpatrick himself agrees that expansion was a problem from the beginning, but adds that the momentum was already in place when he took over. "There was too much expansion in too many markets with regard to Bruegger's that was all started before we bought the business," Fitzpatrick says. "It's a very difficult thing to overcome."
DISSIDENTS FORCE QUALITY DINING TO SELL
Months after the merger, Bruegger's co-founders Brue and Dressell began worrying about their investment in Quality Dining. Grady's was experiencing double-digit declines in average unit volumes. The average weekly volumes at some Bruegger's stores, too, started falling short of the mark Quality Dining wanted to hit. And the supply of bagel shops across the country started exceeding demand.
Bruegger's moved its headquarters from Burlington, Vt., to Mishawaka, where Quality Dining had a new building under construction. Until the new building opened, executives worked in tight temporary quarters, forced to share offices, phones and computer equipment. Space was at such a premium following the bagel deal that some of the 27 Bruegger's execs coming to Indiana from Vermont had to delay their moves until the building was finished. And some of Bruegger's management quit rather than make the move.
Meanwhile, Quality Dining's stock, which traded as high as $39.50 a share on the day shareholders approved the acquisition, lost more than half of its value by the end of 1996. It continued to slide in 1997.
The final blow was the internal strife within Quality Dining which made financial news. Brue and Dressell, who owned nearly 26 percent of Quality Dining's stock, resigned from the company's board of directors in February 1997. They rejoined the following month, but reported in a March 17 filing to the Securities and Exchange Commission that they had hired the investment banking firm Gleacher NatWest Inc. to try and maximize shareholder value.
In other words, they wanted to break up Quality Dining.
They suggested a number of options, including a sale of the company's non-bagel operations (with the proceeds used to reduce the company's debt and expand the bagel business), a spinoff of those operations, a recapitalization of the company and a sale or merger of the company. Fitzpatrick responded that Quality Dining was not for sale.
Brue and Dressell criticized Quality Dining in the SEC report, saying they had become "increasingly concerned with the operations of the company as a whole, including the declining market prices of the company's common stock." In their judgment, "management of the company does not have a viable plan to grow, or to finance the growth of its business as owner, operator and franchiser of Bruegger's Bagel Bakery," according to the SEC filing. Further, they alleged, "the company lacks strategic direction."
Just a few days later, in an amended SEC filing, Brue and Dressell mentioned plans to auction off the company, based in part upon their belief that "the company's management has proved itself incapable of managing and growing these various businesses in a successful manner."
Then Finn, Bruegger's president and CEO, left Quality Dining. Finn became chief executive at Leann Chin, a Chinese food restaurant chain in Bloomington, Minn. When reached for comment for this story, Finn said he had "nothing to contribute."
Ultimately, Quality Dining sold the chain back to Brue and Dressell. Fitzpatrick made the announcement in May 1997: Quality Dining would divest its Bruegger's bagel businesses - acquired less than a year before. The sale, valued at just $45 million, was completed in October 1997.
"We looked at our future and decided that in the best interest of optimizing long-term shareholder value, owning the bagel business was not going to help us achieve our goals," Fitzpatrick says. "That was a complicated issue, one I will tell you we gave a lot of thought to."
LIFE AFTER BRUEGGER'S
What's next for Quality Dining? For the past year, Fitzpatrick has tried to stay out of the spotlight to focus on restaurant basics. Expansion came to a screeching halt and Fitzpatrick took excess cash flow to pay down the high debt he had accumulated. And it has worked.
Fitzpatrick has taken the $141 million long-term debt the company reported during the third quarter of 1997 and reduced it to about $115 million. And in one year's time, Quality Dining may not be reporting big earnings, but it continues to generate cash. Reducing overhead is another tangible result that is improving the health of the business. At the end of fiscal 1998, the company reported total revenues of $232.2 million, a decrease of 23 percent from fiscal 1997. The decrease, the company reported, was primarily a result of the divestiture of its bagel-related businesses. The company has returned to profitability, but recovery in the company's stock price still has a long way to go, with 1998 trading ending at $2.63.
Fitzpatrick says the lessons he has learned from the Bruegger's merger are not necessarily profound. "I don't want to be philosophical, but the people in this building did not sit around and cry for a long time," he says.
The disappointing aspects of the Bruegger's deal have motivated and re-energized Quality Dining's commitment to success, he says. "Challenges, problems, mistakes, whatever you want to call them, they're there for a purpose," Fitzpatrick says. "We've never focused in a non-positive way on our problems because that isn't very productive. That's not always easy."
Chuck Chapman, Bruegger's executive vice president and chief operating officer, talks about the lessons his company has learned. "If you're going to enter a marketplace, make sure that you can be the dominant player, then dominate that market," Chapman says. "Focus on Main Street, not Wall Street." And at a time when many bagel operators are getting away from their core bagel products, he says "stick to the roots of what you're good at. Don't try to be something you're not."
Between 1995 and 1997, the bagel industry was growing at 500 percent a year, Chapman says. It has slowed down to a 10 percent annual growth rate, since the bagel industry has been consolidating. Chains that have proven themselves profitable - with strong underlying economics and business plans - are surviving, and Chapman watches as others are closing, selling or trying to restructure themselves.
As for Quality Dining, the Burger King segment is strong. Weichmann gives Chili's mixed reviews - it isn't bad, it isn't great. The Chili's brand is growing, but Weichmann thinks margins are still off. The Italian division, which remains small, seems to be doing very well.
But to be a vibrant company again, Quality Dining must turn Grady's around, Weichmann says. "I have spent more time on Grady's than the others," Fitzpatrick acknowledges. "It was a business that I think has good opportunity for us and one I wanted to get a little closer to over the past 12 months and I've done that."
Many people believe Grady's has lost too much momentum to become a strong force in the restaurant industry, Weichmann says. But the yield Fitzpatrick would get from selling Grady's today would be very low, so it makes more business sense to hang onto it and make it healthy.
That's exactly what Fitzpatrick intends to do. Fortunately, Fitzpatrick has a core business that has stayed healthy during the past few years: Burger King, the rock the company was built upon. "Properly focused, he has an opportunity where he owns two brands, and he's got some franchise opportunities and heritage in running restaurants," Weichmann says. "But he also has some battle scars."
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|Title Annotation:||Quality Dining's purchase of Bruegger's Bagel Bakery chain|
|Author:||Wieneke, Heidi Prescott|
|Publication:||Indiana Business Magazine|
|Article Type:||Cover Story|
|Date:||Jan 1, 1999|
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