February 13, 2016 8:00 a.m.
Crain’s Detroit Business
If the past year is any indication, the future of Bagger Dave’s Burger Tavern is anything but in the bag.
The Southfield-based restaurant chain suffered the indignity of two rounds of restaurant closings in 2015. The first came in August, when parent company Diversified Restaurant Holdings Inc. shuttered three locations, all in Indiana, gnawing $1.8 million in writedowns off the corporate books.
Then in December, eight more locations closed, at a loss of about $10.7 million for writedowns and other costs. One of them was its downtown Detroit location. The others were in Indiana.
The Detroit restaurant had been open for two years. One of the Indiana restaurants didn’t last 10 months; two more barely made it to the one-year mark. The oldest of the Indiana restaurants, the one in Indianapolis, was just 3 years old.
Anyone looking for more upbeat signs than these should avoid cracking open Diversified’s quarterly reports of the past year.
The reports start rosily enough. The first, released in March, predicted between 47 and 51 stores by the end of 2017. (There were 24 at the end of 2014.) These numbers steadily fell in subsequent reports. By the time November’s third-quarter report came around, the company had stopped making any predictions at all.
“We will not commit to any further development of Bagger Dave’s,” the company said in the report, released seven weeks before the December closings.
That doesn’t mean the company had given up on Bagger Dave’s. It opened five last year, including one in Centerville, Ohio, as recently as November, its first in that state. Another is set to open near Cincinnati in late March. But that and the 18 Bagger Dave’s (16 in Michigan, one in Ohio and one in Indiana) that survived the closings — and employ 670 people — will be the last for the foreseeable future.
This is a marked about-face for a company normally hell-bent on growth. It opened six Bagger Dave’s in 2014 and seven in 2013. And that pales to its Buffalo Wild Wings franchise operations, the largest in the country. Last year alone, Diversified added 20 more restaurants, 18 of which came from the $54 million purchase of Buffalo Wild Wings restaurants in the St. Louis area. That brought the number of Buffalo Wild Wings locations under its umbrella to 62.
From the end of 2011 to the end of last year, Diversified increased the total number of its restaurants across the two brands from 28 to 80. This year, though, it plans to add just three — the Bagger Dave’s near Cincinnati and two more Buffalo Wild Wings locations.
Bagger Dave’s has struggled before. Sales took a hit after Diversified embarked on an aggressive growth plan in 2012, opening or buying 16 stores across its two brands. It listed on Nasdaq the following year.
The pace distracted management from everyday operations, and it was the Bagger Dave’s side of the business that took the hit in sales.
To mend things, Diversified beefed up Bagger Dave’s marketing, launched a corporate training program, brought in an employee-assessment firm and began hiring professionals from national chains such as Red Robin. It brought in consultants from the Disney Institute to go over employee retention and recruitment and rolled out new menus — the first one in early 2014 and another last year. The final rollout wrapped up last September.
It included adding more burgers and removing sandwiches that weren’t selling well, switching from a two-patty burger to an 8-ounce one and adding a grilled chicken breast sandwich. Fries are included in the price of a burger instead of added on. The menu’s marketing pitch changed to tell customers about certain points of company pride, such as how it uses prime rib and sirloin in its burgers and carefully sources its food.
“I’m much, much more connected to Bagger Dave’s now,” CEO Michael Ansley said last April in a Crain’s interview.
Things appeared to pay off. In a conference call for last year’s second-quarter results, Ansley said sales at Bagger Dave’s stores open at least two years had increased 2.5 percent compared with the same quarter a year earlier and 4 percent year to date.
Ansley talked about encouraging positive signs showing in things like Facebook “likes” and “net promoter scores,” which measure customer satisfaction. Investments in technology — tabletop ordering tablets, a mobile app, a gift card program, a “RockBot” jukebox app — promised to further brighten the picture.
Nevertheless, Ansley had to acknowledge struggles. “Despite the positives, we fully appreciate the missteps we have made in the past with respect to the brand,” he said.
One initiative has proved costly. Management was determined to maintain a base staffing level at Bagger Dave’s restaurants, even if sales were low. This policy was done to bolster service and coax repeat visits out of customers.
But this, along with minimum wage increases, pushed up the company’s year-on-year compensation costs by more than 25 percent in the second quarter of last year. This came on the heels of a $2 million spike in compensation costs that brought its tally for 2014 to $9.2 million.
Minimum staffing practices like this are rarely used in the restaurant industry, said Darren Tristano, president of Technomic Inc., a Chicago-based restaurant industry research company.
“There’s nothing financially efficient about it,” he said. “You end up with staff standing around.”
In a conference call on Nov. 5, Ansley and CFO David Burke expressed frustration with the slow pace of results. Burke described Bagger Dave’s as a “Dr. Jekyll/Mr. Hyde concept” because of the changes it had undergone.
There were signs of improvement coming out of investments in the menu and training, but “you don’t see an immediate impact in sales from that,” he said.
The financial picture
Diversified’s breakneck growth comes with a heavy capital burden.
Estimated capital expenditures last year were about $30 million. It spent $36 million the year before.
The buildout of a Bagger Dave’s costs $1.1 million to $1.4 million, according to company financial statements. A new Buffalo Wild Wings costs $1.7 million to $2.1 million. Updates to older restaurants cost between $50,000 and $1.3 million.
A listing on Nasdaq in 2013 raised $31.9 million. But much of the company’s expansion has been financed by debt. Total debt rose from $61.8 million at the close of 2014 to $123.9 million at the end of September, pushed up because of the acquisition of the St. Louis stores.
The company’s share price opened at $2.57 the day the closure of the eight stores was announced. The stock was trading just above $1.50 last week.
A pair of lawsuits last year further strained finances. The two cases, brought by the same attorney, alleged employees who work for tips were made to do the work of non-tipped employees who earn a higher hourly rate. The settlement and related expenses cost the company $1.9 million.
For the first three quarters of last year, Diversified booked a net loss of $6.6 million, compared with an $85,000 profit for the same period in 2014. The company lost $1.3 million overall in 2014. The company does not believe it made a full-year profit in 2015. (Annual results are expected to be released in March.)
Preliminary financial estimates for 2015 show revenue growing 34 percent to $172.5 million from $128.4 million in 2014, in line with the company’s guidance.
Same-store sales increased 2.8 percent at Buffalo Wild Wings and 1.3 percent at Bagger Dave’s from 2014 to 2015, but they decreased 7.8 percent year-over-year in the fourth quarter at Bagger Dave’s and increased just 0.8 percent at Buffalo Wild Wings.
The Buffalo squeeze
The 18 Bagger Dave’s stores that remain don’t appear to be on much better ground.
The eight stores shuttered in December generated $5.5 million in revenue, or $687,500 per restaurant, through the first three quarters of last year and had a pre-tax (EBITDA) loss of $600,000. But the other 18 locations brought in $14.1 million, or $783,333 per restaurant, and had a pretax profit of $700,000. That comes to less than $52,000 per restaurant on an annualized basis, a growth rate of 5 percent.
The revenue per restaurant on an annualized basis comes to $1 million, well below the target revenue per store of $1.7 million, the goal stated in a presentation to investors in January.
A profit margin of 5 percent is low, especially for company-owned stores, Tristano said. Franchisee-owned stores typically hit at least 10 percent because of the fees to the franchisor they must pay.
“They’ve got to be doing better than 5 percent to pay down their debt,” Tristano said.
The obvious question that arises is, were the closures enough?
All Bagger Dave’s restaurants are company-owned. (Plans to franchise the brand several years ago were scrapped.) With a massive Buffalo Wild Wings operation cranking away, the Bagger Dave’s “baby brand,” as Ansley has called it, has had a hard time getting the attention it needs.
Diversified has a contractual obligation with Buffalo Wild Wings Inc. to open 42 restaurants by 2021 and has 15 more to go. The company says it’s ahead of schedule.
Ansley also points out that failing to make that obligation bears only a weak cost: Diversified only has to pay Buffalo Wild Wings $50,000 for each store it does not open — far less than the millions it costs to open one. “With our relationship with Buffalo Wild Wings, I doubt they’d charge us the $50,000,” Ansley said.
In any case, the moves Bagger Dave’s has made demonstrate the pressure on Diversified to stay focused on the much stronger Buffalo Wild Wings side of the business.
“In the year ahead, we plan to focus our resources primarily on growing our BWW portfolio, which represents the overwhelming majority of both our revenue and adjusted EBITDA,” the company said in its third-quarter report.
The move toward Buffalo Wild Wings is smart because it’s a more proven brand than Bagger Dave’s, which is “a good brand but not that broadly differentiated,” Tristano said.
“The reality in our industry is that there’s no shortage of optimism. We hear about these ambitious goals, but very rarely do we see brands meet those goals.”
Last year’s closings, which included one Buffalo Wild Wings restaurant in Florida besides the Bagger Dave’s spots, were the first for the company. But they were a long time coming.
“Bagger Dave’s has given us some fits,” Ansley said in an interview. “We knew we had issues with it two years ago. We made a lot of changes — I can’t even count the changes.”
These changes came too quickly and were confusing for guests and employees. “We were too aggressive. That was the problem, and we learned it the hard way,” Ansley said.
Casual dining chains face intense competition throughout the country, not just from each other but also from fast-casual restaurants like Chipotle Mexican Grill and Five Guys Burgers and Fries. The parent of the Max & Erma’s chain closed eight metro Detroit locations in January.
To counter this trend, Diversified needs to do a better job of marketing Bagger Dave’s by doing things such as telling people of premium ingredients that are mostly sourced in Michigan, Ansley said.
He also is heartened to see interest in properties of the shuttered locations. This includes the one in downtown Detroit, which has garnered “a lot of offers,” he said.
The company is holding the line on the minimum staffing levels that have driven up compensation costs. “There will be a little deleveraging from” the minimum staffing levels that drove up compensation costs but “nothing substantial,” Ansley said.
No more Bagger Dave’s locations will be closed, Ansley said. If the prototype stores do well for the rest of the year, “then we will start expanding again,” he said.
The 18 remaining Bagger Dave’s restaurants are profitable, said Ansley, who is especially encouraged by the performance of “prototype” stores. These stores have the new menus and have been redesigned to be smaller and “hipper.” They are in Grand Blanc, Birch Run, Grand Rapids, Chesterfield Township and Centerville, Ohio.
The three analysts who cover Diversified’s stock are encouraged. They express concern at the company’s debt but agree that the Bagger Dave’s changes are on the right track.
“We think much of the ‘noise’ of the past few quarters is behind the company and management can focus on restaurant operations,” wrote Mark Smith, analyst at Minneapolis-based Felt & Co.