Friday, February 27, 2009

Evaluating Western Sizzlin's restaurant operations under Sardar

Sardar was appointed to Western’s board in November of 2005 and was elected Chairman in March 2006. Here’s the 2005 shareholder letter:

Excerpts from the letter:
“Our 2005 return on capital was dismal. The five company-owned stores achieved same-store sales growth of .33%. The franchise system achieved same-store sales growth of .25%. While same-store sales are not the only, preferred, or most important figure, we do like to see the figures climb as long as profits keep pace and the capital that generated those gains results in a healthy return on invested capital.
The more important factor is the cash return on invested capital.” (emphasis supplied).

Let’s look at the cash return on invested capital from just before and since Sardar has gotten control. All amounts are in dollars.

Year 2008 (9 months) 2007 2006 2005
Income from operations 57,920 350,257 733,122 1,426,119
D&A 786,676 1,063,017 1,057,492 1,072,334
Lawsuit/claims settlement expense (1) 162,820 741,287 289,109201,000
Gain on claims (1) - - - (1,166,683)
Maintenance capital expenditures (22,505) (30,006 annualized)(35,493)(492,107)(312,532)
Pre-tax cash from operations 984,911 (1,292,728 annual) (4) 2,119,068 1,587,606 1,220,238
Invested capital at the start of the year (2) (3) 15,706,703 16,388,887 16,885,941 17,907,831
Pre-tax cash ROIC (4) 8.23%12.92%9.4%6.81%

Note the numbers for 2005. The business was earning a pre-tax return of 6.81% on invested capital with debt financing a part of that capital at 10%. Little wonder then that Sardar moved to pay down the debt first. The improvement in return on invested capital was achieved despite overall revenues declining from about $19.3 million in 2005 to $17.25 million in 2007(they declined further in 2008). The boost to cash flows came from reducing expenses from about $19.11 million in 2005 to about $16.2 million in 2007 and from slashing capital expenditures to what is essentially a bare minimum maintenance level. The invested capital in the business was lowered as well as Western went from a working capital surplus of about $2 million in 2005 to a working capital deficit of about $1.6 million in 2007. Of course, none of these improvements can go on forever. It’s reasonable to assume that this is about as well as the company owned stores and the franchises will do, for now.

A note on the 2008 numbers. These are skewed by a couple of items:
a. The departure of Jim Verney from Western Sizzlin Franchise Corp. resulted in severance expense of $250,000.
b. Sub-leased property expenses increased by $355,000 for the first 9 months of 2008 as compared to 2007. These lease arrangements will cease at the end of 2008. I won’t miss them.

Contrast these operations with the joint venture Wood Grill Buffet in Harrisonburg. The cash return on invested capital ($3.9 million) in 2007 for that restaurant amounted to 18.6%. These are very good numbers in absolute terms and about 1.5 times better than the rest of Western’s restaurant operations in 2007, on a pre-tax basis. Interestingly, from the figures presented by Sardar on pg. 4 of the 2007 letter, the tax expense on the joint venture’s pre-tax income of $315,063 in 2007 amount to a piddling $62. For the first 9 months of 2008, there was an income tax benefit of $6,683. This makes me wary of using after-tax numbers for the JV and I am surprised that Sardar used them in his presentation in the 2007 letter.

Here's how the cash ROIC numbers look for the JV. All amounts are in dollars.

Year 2008 (9 months)2007
Pre-tax earnings 294,488315,063
Interest 160,421223,574
D&A 152,131200,869
Maintenance capital expenditures (17,864) (estimated from information on JV operations from fiscal 2008 3rd qtr 10-Q) (12,995)
Pre-tax cash from operations 589,176 (785,568 annualized) 726,511
Invested capital at the start of the year (5) 3,678,571 3,534,960
Pre-tax cash ROIC21.36% 20.55%
Cash distribution to Western150,000-

Here are Western’s cash flows as they pertain to the JV:

Late 2005: Cash outlay of $300,000.
No cash flows in 2006 and 2007.
3rd quarter of 2008: Cash receipt of $150,000 with decent prospects for cash flows ahead. I’d take this deal every day of the week and thrice on Sundays. Of course, given the amount of leverage involved, it’s hard to imagine scaling on these returns on equity.

From the numbers above, it is clear that Sardar is walking the talk at Western. Admittedly, the bar wasn’t set very high (understatement) when he got control but it’s good to see progress nonetheless. What is also clear is that the restaurant operations (excluding the JV) aren’t worth owning on a long-term basis unless the cash from those operations are redeployed into (much) higher return opportunities elsewhere.

Often wrong but seldom in doubt,

Notes to calculations:

1. Cash flows were adjusted for one-time gains/losses. Sardar makes the same adjustments when presenting restaurant operations’ performance in the 2007 letter: (pg 2).

2. Invested capital in restaurant operations was calculated as the total of all assets that were financed by either debt or equity, less cash, marketable securities, equity in the joint venture and all non-interest bearing current liabilities. This means tax and insurance receivables were ignored as were accounts payable (financed by suppliers) and accrued expenses. Also, franchise royalty contracts (what essentially amounts to goodwill when franchises are reacquired by the company) were not amortized for the purposes of calculation of invested capital.

3. Western’s operating leases weren’t converted to their debt equivalents for the calculation of invested capital.

4. 4th quarter pre-tax operating income was assumed to be the same as 1st quarter pre-tax operating income, before lawsuit charges. These 2 quarters are relatively weak as compared to the 2nd and 3rd quarters.

5. Cash was included in the calculation of invested capital since, unlike at Western, there are really no redeployment opportunities in the JV. Regardless, it is clear that this JV has highly-desirable economics.

Friday, February 6, 2009

Management changes at Premier

A couple of weeks after Sellers Capital delivered sufficient shareholder consents to elect their nominees to Premier's board, Premier acknowledged their election:

Arnie Geller has been terminated as CEO, although he is still on the board, a position that leaves me feeling uncomfortable. Sellers will serve as non-executive chairman without compensation, as promised. One of the elected directors, Christopher Davino, will serve as Interim President and CEO, for a period of between 4-6 months. He comes from XRoads Solutions Group, a corporate restructuring management consulting company. Meanwhile, the newly constituted audit committee will continue to investigate the Sarbanes Oxley violation allegations, allegations that were withheld from Sellers Capital at the time that it discussed bringing back Geller as CEO for a second term.

I am glad though that this consent solicitation is over and we have management in place that Sellers chose. I haven't always found myself nodding in agreement with Sellers during the consent solicitation process but the outcome, which was critical, turned out alright. It is vital for Sellers to address the looming liquidity issues with shareholders. Previous management had said that they'd be ok till the middle of 2009. Their available line of credit, down from $10 million to $7.1 million at the end of the last quarter, goes down with deteriorating operational performance. 

The change in management will lead to a much greater focus on better aligning costs with declining attendances, better corporate governance and more transparent and conservative accounting. Sellers, in my opinion, has essentially staked his legacy on this position. We'll see how it pans out for him and the rest of Premier's shareholders.

Often wrong but seldom in doubt,