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Shoney's Wall St. woes

On March 26th of this year, Shoney's CEO Steve Lynn met with his shareholders in the fifth floor auditorium of the First American Center in Nashville. It was the company's annual meeting and the mood was anything but joyous. Virtually every person in the standing-room-only crowd, Lynn included, had watched his or her personal wealth decline as Shoney's share price plummeted. That Wednesday morning, a single share of the company's common stock could barely buy you a trip to the breakfast bar. There was a time it could have easily treated the whole family.

Hired two years earlier to fix the troubled company, Lynn, a gentlemanly, respectful man with a deep sense of spirituality, did his best to build confidence in those in the room, a task that could not have been easy. Lynn himself had grown impatient with Shoney's lackluster performance. The turnaround was taking longer than even he had imagined.

He persisted nonetheless, telling the group that they must attack their problems head-on. We know what's wrong with Shoney's, Lynn's message said, and we believe we know how to fix it.

But others had their own fix-it plan. What Lynn did not know at the time—what almost nobody in the auditorium knew (until now)—was that only three days earlier a Tennessee law firm presented to its Nashville client a document outlining a way to wrest control of the Shoney's board, replace its management team, and install the client as Shoney's new chief executive.

That client was Ray Danner, co-founder, former chairman, and still the single largest stakeholder in Shoney's.

The months that followed would prove excruciating for Shoney's managers, shareholders, employees, even some of its customers. For, though Danner did not act on his secret plan to gain control of Shoney's, less than three months after the shareholders meeting somebody else did: Ray Schoenbaum, the son of Danner's longtime partner and Shoney's other founder, the late Alex Schoenbaum. Just as Lynn's team was saying it had drawn a bead on how massive their fight to turn the company around truly was, they were unexpectedly jolted into a different type of combat altogether—a proxy battle with one of its founder's sons.

That messy fight started in June and was over by September when, in exchange for Schoenbaum dropping his initiative, Shoney's agreed to add Schoenbaum and his and Danner's allies to its board. Also, Lynn, Schoenbaum, and two other directors now form an Operations Committee that has "oversight responsibility for the day-to-day operations of the company."

But the whole episode definitely cost the company: Schoenbaum's very public airing of Shoney's woes (he said the restaurants' food is terrible and that management was ruining the company his father started) torpedoed Lynn at a time when he surely needed to build confidence in his team, out in the field, among shareholders and customers, and in the financial community. Furthermore, the proxy contest itself cost the company untold man hours and about $6 million in legal and consulting fees alone before it was over. This at a time when the debt-ridden Shoney's, whose restaurants sorely needed upgrading, had precious little cash on hand to improve them.

Schoenbaum's proxy fight might be over for now, and Danner's may never have begun, but make no mistake: These continue to be highly charged times at Shoney's. Now armed with board-member status, Schoenbaum, who lives in Atlanta, flies to Nashville about once a week. There he meets not just with Shoney's people to discuss company operations but with his ally Danner, whose office is but a five-minute drive from Shoney's headquarters.

Together Danner, Schoenbaum, and his mother, Betty, own nearly 17% of the company. Add to this the notion that, as Danner tells it during an interview in his office, had his proxy battle, not Schoenbaum's, gone forward, "I would not have backed down," and it's enough to unnerve most any CEO. Certainly one with the kind of task ahead of him that Lynn has.

Schoenbaum is taking an active role in Shoney's, to be sure, and his insights on how to improve operations are largely viewed positively, even by Lynn. In fact, the two are generally in accord as to how things need to be improved. And that begins with customer satisfaction.

But that could turn out to be quite a knotty challenge. Shoney's core customers, the ones who also have been turning away from the concept, are between 25 and 65 and have a family income of $40,000. Looking toward 1998 and beyond, the plan is to tighten the core customer group to between 29 and 59, and ratchet the family income up above $40,000.

More important, and perhaps more alarming, the company has discovered that Shoney's customers are driven by two things principally: price and convenience. Since you could say basically the same thing about fast food, that's not a good sign for a full-service operation like Shoney's, whose average check, like fast food's, has been stuck in the high $5 range for some time.

"The only thing that's been getting them through the door is our deals and our convenience," says COO Robert Langford. "For example, over the years we have devalued our breakfast bar; it's worth a lot more than what we charge but we've told the customer it isn't by the way we've priced it."

And how. When the price of the breakfast bar was raised 30¢ at company stores last year, and without any change in the food items, sales went south in a big way, in the double digits. It took three quarters before the company recovered from the decline.

Late last month, Shoney's began testing an "enhanced breakfast bar" in five different markets, to see if that might work instead. Priced between its current $3.99 price point and $4.59, the idea is to provide a better product at a higher price and begin the long road toward establishing Shoney's as a value rather than a deal provider. In the bargain, hopefully breakfast—as well as the other dayparts—will become more profitable than they are now.

But breakfast, which accounts for 28% of Shoney's sales, isn't the only time of day that Shoney's relies on its bar. In fact, fully 60% of every dollar spent at Shoney's is driven off the bar. Lynn says that Shoney's is "addicted to the bar business," and that it shouldn't be. "We have to become more menu-driven," he insists. During lunch with Lynn recently, in a prototype Shoney's in Nashville, the addiction was quite evident, as the waitress steered us not to the menu but to the bar. "She makes the same tip either way, so it's easier for her to push the bar," Lynn observes.

Lynn's team is in the early stages of exploring Shoney's Friday and Saturday night $8.99 all-you-can-eat seafood buffet. They've recently begun to consider offering a Captain's Platter sampler those nights instead, with an accompanying, enhanced soup-and-salad bar. This would allow stores to offer better-quality food than they currently serve, a key concern among Shoney's brass. It would also make a huge statement about the company's commitment to getting customers away from the bar and back ordering off the menu.

Alex. Brown analyst David Trossman says that while the enhanced breakfast bar "makes sense," the seafood move could be risky if it's ever attempted. "That's a lot tougher to implement than an enhanced breakfast buffet because it's more of a change for Shoney's," says Trossman. "It's also a whole lot of marketing and a whole lot of message to convey to the customer."

Still, something must be done to increase sales, boost profits, and ultimately break away from the dead-end track Shoney's has been traveling these past few years. "There's still a price point we can compete in effectively and that's probably in the $7 range," says Schoenbaum over breakfast at a Shoney's in Nashville. "Casual dining's in the $9-$10 range and fast food's at $5 or $6. We've been in the high five's for a long time but we can go higher than that—and we should."

The idea, according to Lynn, is to shore up Shoney's core customer base by giving them better food and service, and then gradually attracting those people who prefer to eat at Applebee's or Cracker Barrel.

But it's here where Schoenbaum has been most critical of Lynn. "The plan to come back to our core markets, though it makes sense, was a financially oriented plan, not an operations-driven plan," Schoenbaum argues. "This company didn't have an operations-oriented direction before we got here. Don't forget, we've taught people to go to the bar because our menu items aren't very good.

"The other problem is that our focus may be on the bar, but our bar can't compete with somebody like Golden Corral's bar. If we decided to go with bigger, better bars, that would require bigger restaurants and bigger volumes. We can't do that, so we have to get back to the menu, and with better menu items."

Schoenbaum even goes so far as to suggest that many of the company's new initiatives, like enhancing the breakfast bar, redoubling efforts to improve menu items, and becoming known as a value leader, are the result of his finally having a voice now that he's on the Shoney's board of directors.

Asked about these claims, Lynn characteristically refrains from fanning further controversy. "I don't care where good ideas come from," he says. "I don't have to take credit for a single idea. I will say, however, that Raymond and I are saying much the same things but with a different way of expressing our passion about it.

However schoenbaum's presence (and perhaps Danner's in the background) may have a downside as well. "What you have is confusion at the top," says Morgan Keegan analyst Craig Weichmann, a longtime Shoney's follower. "Who's in charge? Whose plan are we following?" Those sentiments run deep right now, and only time will determine their impact on the company going forward.

But moving the company forward is Lynn's job—at least it is right now. And it's not an easy one at that. Lynn must show improvements at the store level—soon—and he knows it. The Captain D's fast-food fish concept is in pretty good shape, but the flagship family restaurants aren't. Same-store sales at company-owned Shoney's restaurants have been declining for years, even with frequent price hikes. For the first three quarters of this year alone, company-owned Shoney's stores were down another 3.5%, and that's with a 2.4% jump in prices. Lynn won't comment on how the Shoney's stores are faring in the fourth quarter, but insiders suggest that same-store sales are not recovering and may in fact be down further.

If that's true, expect more doom-and-gloom rhetoric when fourth-quarter numbers are released next month, not to mention further loud criticism of Lynn and his team. However, once you get past that, it seems pretty clear that Shoney's turnaround, no matter who's sitting in the corner office, is a longer-term play that will take more than a few quarters to determine. "We lost credibility in the market by stating our timetable for the turnaround once," says Lynn. "I don't want to make any predictions this time."

Indeed, this was supposed to be the year when things might get a little better. After joining Shoney's from Sonic in 1995, Lynn quickly determined that the family chain had grown beyond its abilities geographically, and that it must concentrate instead on improving performance in the states where it was strongest. "There was a well-defined mission," says Weichmann. But, he adds, the mission wasn't as well executed as it might have been.

"Lynn had spent a long time putting a team together, and I believe they were very close to maybe seeing some fruit," Weichmann says. What threw Shoney's off course, says the analyst, was an acquisition that should not have been.

In September 1996, already hundreds of millions of dollars in debt, Shoney's borrowed another $100 million to acquire TPI Enterprises, a franchisee with 176 Shoney's and 67 Captain D's, for $164.4 million. The idea: Shut down TPI's pricey West Palm Beach headquarters and its two distribution centers, thereby shaving $10-12 million in overhead costs alone. In the bargain they hoped to pick up all those restaurants—and all those sales—while still sticking to the Lynn plan calling for clustered restaurants in strong Shoney's markets.

Trouble was, TPI's restaurants were doing even worse than the company's, about 20% worse. And that, says Weichmann, screwed up an otherwise sound recovery plan. "The TPI acquisition was a major interference that caused a fairly well-articulated plan to not be executed," he says. "They lost the franchise income, and captured more debt, to take on a low-revenue, low-margin operation."

Shoney's executives won't say they should not have bought TPI; Lynn still argues that he bought the franchisee "at the right price," and that Shoney's "picked up the synergies we'd planned and more." But management is surely aware of the toll it's taken on the company. "TPI had a profound impact on us," says Robert Langford, who was once a franchisee himself. "It required a great deal of management's time," he says, time that might better have been spent elsewhere.

Time isn't exactly Steve Lynn's friend right now, what with Shoney's stock price (around $5) and shareholder patience running pretty low. Nonetheless, there's a job to do and Lynn, a devoutly religious man who speaks as effortlessly of his "spiritual journey" as of his professional one, is working hard to prove his critics wrong. He continues focusing on the 13-state core market initiative—renovating tired stores in these markets to help boost sales—but he says there's more to the plan than that. "Improving our quality is a key part of our strategic focus. All I want is for our customer to be well taken care of, our sales to go up, and our shareholders to get increased value. All of that begins with taking care of our customer."

The massive job ahead of Shoney's is in no small way at the mercy of finances. The company owns about 900 restaurants and generates over $1 billion in annual revenues, but it's also got more than a half-billion dollar's worth of debt. Up until now just about all the company's cash flow—and all the money it's raised from selling off unwanted restaurants—has had to go toward reducing the debt, and that's prevented Shoney's from plowing the cash into operations.

Shoney's will get some relief next year, but not much. It recently refinanced up to $375 million of its debt, retiring a straitjacket of a bridge loan that demanded that every penny raised from selling assets (and the company has targeted $100 million worth of assets it wants to sell) go toward debt reduction.

The new terms, principally bank debt maturing over four years, requires minimal payments over the first two years and is structured so that as store performance improves, both the company and the bank essentially share the cash flow. The new terms also will free up an additional $20 million of investment capital each year, says chief financial officer W. Craig Barber. "The idea is to free up cash flow to put back into the restaurants," Barber explains. "This way, the pinch isn't on to sell assets. We're still selling the assets, though; that hasn't changed. We'll just have more money available for operations."

Barber says the extra $20 million in cash per year "will make an impact" on operations, though others aren't quite so sure of that. "It's a drip to a company Shoney's size," says Weichmann. "Being extremely conservative, you've got to need $15 million for normal maintenance alone."

J.C. Bradford & Co.'s Gary Dean figures things are a little worse than that. "They're still in a difficult situation," Dean argues, "because their business probably requires $25-30 million in maintenance." To make matters more difficult, Dean says that Shoney's asset-sale initiative, which should raise $35 million this year and hopefully $65 million in '98, hasn't gone as well as planned. "They haven't been able to sell the assets at prices they wanted," he says, "and that's only highlighted their financial crisis."

Still, $20 million is more than Shoney's has had to work with recently and Lynn hopes to make the most of what he's got. Roughly 20% of company stores that haven't already been remodeled will get a facelift in '98, at an average cost of $140,000 for Shoney's and $80,000 for Captain D's. So far, 86 Shoney's restaurants have the new look that Lynn says he likes—a brighter, more open and cleaner feel, a visible kitchen—but his team is still tweaking the prototype some before committing to it entirely. Carpeting may be replaced by tile, for instance; merchandise displayed near the check-out is too cluttered; game machines near the entrance detract from the overall experience (though right now the cash they generate is too good to pass up).

Whatever package Lynn ultimately decides on, most everybody agrees that a chain of Shoney's restaurants that are operationally sound and well-run can once again thrive. Shoney's is a powerful brand in the Southeast, right up there with McDonald's in name recognition. "If everything is done right you could start seeing results in six months and get to maximum performance in two years," says Schoenbaum.

The challenge isn't lost on Lynn's team, either. Shareholders and Wall Street are looking for "clear, sustainable, positive same-store sales growth; one quarter won't do it," Barber acknowledges. "Clearly," he adds, "the belief here is that the fundamentals are good. We're in that tough time when we have to focus on the fundamentals; it's the heavy-lifting stage."

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