Why Don't Chain Restaurants Talk More About Their Franchises' Finances?

It’s interesting to note that chain restaurants don’t talk much about their franchisees financial performance.

Oh, I know, these are separate corporations and financial entities, and the franchisor model (and advantages therein) is somewhat known. But if you think about these chains and how they are increasing franchising, and reliant on franchisees to stay in business and expand, the financial analyst in me says: say something, at least.

80-100% of these chain’s (DIN will hit 100% at some point) units are franchised and the franchisees have different unit level margins, G&A and debt cost metrics, versus the larger company operators.

Company operated unit trends are more of less discussed to some length, but consider this February 2009 sampling of McDonald's (MCD), Yum (YUM), Burger King, (BKC), DinEquity (DIN) and Dominos (DPZ) earnings calls, all reporting or having analyst days in the last month, regarding franchisee performance:

• MCD: (Q4, 2008, Jan 26, 2009): nothing directly mentioned
• YUM (Q4 2008, Feb 4 2009): nothing directly mentioned
• DIN (Q2 2009, Feb 25 2009): nothing directly mentioned.
• DPZ ( Feb 25 2009): Company did note it had graded franchisees into A through F ratings earlier, and Greg Badishkanian of CITI asked good questions.
• BKC (Analyst day, Feb 26 2009): page 171 of 184 did show a bar chart showing franchisee ratings/grades in the European Zone, see chart below:

click to enlarge

While this would have to be voluntary (and non-GAAP, of course), as a thought for the future, what if the companies revealed:

-whether franchisee profits were tracking at or below the company margins, or in the same direction

-franchisee unit level economics versus company

-what percentage of the franchisees were on track to expansion goals

Disclosure: Pacific Management Consulting Group is an analytically focused restaurant management consultancy and has no stock positions.

Comments

[trayton:]

Franchisors often own some of their own franchises, and for this reason alone, they should divulge at least some basic information, because profits & l from franchises relate directly to their bottom line.

Mar 01 12:49 PM

[johnheiders...:]

I think that specific financial claims regarding franchisees are required to be made in a UFOC and for that reason the quarterly earnings releases don't say much in that regard.

Mar 01 05:52 PM

[stronzo:]

Dominos Pizza Europe - House of Cards ?
Openings and sales are progressing well but behind the fanfare things are not as rosy as they seem at Dominos Pizza Europe ... the franchisees can't pay their bills!
The annual report 2007 shows trade receivables at the consolidated level (almost exclusively food and royalties from franchisees) of A$27 million, or about 49 days on Revenues of A$200m (see attached). This does not seem to concern the auditors who attest (note 7) that "the average credit period on sales of goods is 30 days". The same note reveals however that, since the acquisition of the Europe master franchise, consolidated trade receivables has shot up from $5.4m to $27m. In comparing the $27m consolidated trade receivables figure to the company one (A$7.4m) we must indeed suppose that this difference is driven by the Europe acquisition.
Analysis of the French statutory accounts confirms this. Trade receivables in France as at 30/6/2007 stand at 9.498 million (A$15.077 million) or 127 days sales (versus €6.747 million 1 A$10.710 million or 116 days at the end of 2005). Now, a large part of the 2005 receivables were either written off or converted into debt, hence the €3325k (A$5278k) "other receivables" that we see in 2007. If we therefore look at combined trade receivables and other receivables for France of €12823k (A$20335k) we arrive 171 days of franchisee debts ... just under 6 months! Another way of looking at this is to say that the French franchisees owe t equivalent of 3 times the 2007 group consolidated operating cash flow of A$ 6.976 million!
Now, not all Dominos Franchisees in France are unable to pay their debts. A number have been around for years and are doing fine. Fine, that is, until they have to move to Dominos new contractual terms of 6.5% royalty in addition to paying 5.5% national marketing contribution to pay for the television campaign which has unfortunately not yielded sufficient sales uplift to pay for the investment.
The bigger problem is the franchisees who are opening new units. In addition to paying the 12% of sales on royalty and marketing, the sales levels of openings are simply not high enough to pay the food (between 25% and 30% of sales for the franchisee, depending on the level of price discounting). It is these new franchisees who are causing the debts to accumulate ... from A$ 11.8 million at end 2005 to A$20.3m as at end June 2007.
French law requires that payments to food suppliers be made within 45 days, which is clearly not the case for many of the French franchisees today.
In addition, the French authorities generally take a dim view of big corporations (particularly foreign ones) using their financial muscle to attack their small independent entrepreneurs. One can imagine the conclusions they will come to when they look at the heavy price discounting behind Dominos highly publicised "High Volume Mentality" coupled with the rapidly accumulating Franchisee debts.

Mar 02 07:39 AM

[stronzo:]

funnynews.free.fr/foru...: Domino's Pizza France

Mar 02 07:43 AM

[stronzo:]

Domino’s Pizza France – Belgium – Holland – Monaco
From living a true dream to dealing with drumming bill payable accounts, leading by way of consequence to a true accounting drama!

Stating the facts: a little Enron-y goes a long way…


Dear Sir or Madam,
The reason you’re getting this e-mail is because the information we disclose hereby may be of great interest to your company.
In case you don’t feel concerned, please forward the document to anyone likely to be interested.
Best regards.




Many of you have been asking for explanation about the risks that the managers for Domino’s Pizza France – Belgium – Holland and even Monaco are bringing upon themselves. Let’s try and answer that question, though we still lack information to give you a thorough/ an exhaustive overview.





I) Management fees

II) Measures being undertaken by the managers…

A) …to expand the existing network (opening new stores)
1) Marketing expenditures and direct expenses
2) Direct financing
3) Indirect financing

B) … considering the sales made in existing stores
1) customer debts / customers’ account-receivable
2) stores being on the look-out for bank /debt financing
3) financing through a DPF subsidiary

III) Possible consequences

A) The financing bank and Domino’s Pizza France

B) Forgiveness of debts

C) The managers and possible fraudulent use of corporate property


I) Management fees

You’ll get relevant information by checking Domino’s Pizza Australia website, with a focus on the following hypertext link:
http ://dominos.com.au/_upload... ;
We should first examine the case of the CEO of Domino’s Pizza France, which is a wholly-owned subsidiary of Domino’s Pizza Australia (DMP).
Following that report, page 39 (out of 136), Mr. Andrew Rennie was given / got 210,000 stock-options, worth 2,2 Australian dollars each.
This long-term stock-based compensation is provided for by the ESO plan, which defines the stock-options allotment.
When it comes to Andrew Rennie, his stock-options portfolio / plan depends on a 10% growth of the company earning per share and on the operating results in Europe.

Within the group of head officers, Mr. Andrew Rennie has got the biggest number of stock options, thus being level with Don Meij, who’s the founding President for Domino’s Pizza Australia. It says a lot about the importance attached to Mr. Andrew Rennie and the responsibility lying on his shoulders.

These stock-options aren’t the only fees paid to the managers: they also get a fixed compensation and a variable incentive compensation based on the company performance and on the value creation for shareholders, depending on short term and long term indicators (STI and LTI, refer to page 42 out of 136).
The medium term incentive compensation is being calculated according to a key performance indicator (KPI).

Mr. Andrew Rennie is supposed to reach an astoundingly ambitious goal: 50 to 60 new stores should be set up each year; the profits made by Domino’s Pizza Europe should soar (and up to now, there’s always been nothing but an operating deficit, managed by Domino’s Pizza USA); how could it be possible to get such operating results when royalties have to be paid to Domino’s Pizza US, as planned in the Master Franchise Agreement (without taking into account the two-year delay to pay it off as it seems).

Since it’s hardly possible to take up that challenge, they’ll have to resort to using rough-and-ready methods, which is indeed quite risky.

N.B.: Mr Andrew Rennie actually took up 112,500 options in 2007, worth 2.2 Autralian dollars each, with an actual price of the day of 3.60 per share…which emphasizes how strong the faith in Andrew Rennie actually is!
According to the chart displayed page 52 out of 136, there were 250,000 options more to take up; the actual price of the shares has to remain the same no matter what, so that Mr. Andrew Rennie doesn’t lose money. That’s what we’re about to unfold…




II) Management decisions carried out by the CEO, Mr. Andrew Rennie:

A) …to expand the existing network (opening new stores)

1) marketing expenditures and direct expenses

New franchisees should be recruited to speed up the growth, leading to the opening of 50 to 60 new stores; a marketing strategy emphasizing the opening of new stores should be implemented instead of focusing on financial marketing: that’s the statement released the stock exchange markets.
Intrusive media planning, making a big fuss about the profitability and power of Domino’s Pizza – the pizza world leader – and their methods; who cares about the cost of all this? We only care about results!
Yet, there’s nothing to be done: there’s little return on investment, as the new candidates don’t seem to jump at this – supposed – opportunity, and when they do so and open new stores, Domino’s Pizza has to increase expenditures to try and succeed to make him stay and keep opening more stores.
That’s all the more true when the banks that are lending some money don’t back the franchisees up, or stop supporting them.

2) direct financing

This candidate is going to be well taken care of, he’s going to be pampered and spoon-fed, on an economic point of view.
What if the bank doesn’t approve of the loan application?
That’s no problem; the earnings report will be rigged so that it meets the bank requirements.

Their personal financial contribution is too low?
That’s no problem; a subsidiary structure of Domino’s Pizza France will take part in the financial set-up, and both Domino’s Pizza France and the financial structure will become surety for the franchisee.

The bank is still refusing to grant a loan of the franchisee?
How dare they?
That’s no problem; a subsidiary structure of Domino’s Pizza France will finance the increase of the financial contribution, in return for interest, and will become a surety for the franchisee.

The franchise candidate is a salaried employee and can’t make a contribution of any kind?
That’s no problem; Domino’s Pizza France will buy the store and the store will be run through lease management.

Business premises need to be bought to settle the store of the former Domino’s Pizza manager?
That’s no problem; Domino’s Pizza will indulge this franchisee-to-be any of his desires: they will buy the premises and will then let them for rent to the worthy franchisee who won’t make more than about 10,600 euros a week (with a break-even point set at 13,800 euros, as this is the Roll’s Royce of all stores), the first 14 weeks of 2007!

A store is in danger of falling down?
That’s no problem; Domino’s Pizza France will rescue the failing franchisee (and then assert that this franchisee was incompetent, as he didn’t comply with the management rules set by Domino’s Pizza which have proved their worth worldwide), by buying the store out and having an elite manager run the store (by the way, the Bordeaux store supposedly doubled its turnover overnight, once run by the new franchisee…(sic)).
And if you evoke the boundary changes that have been made, you’ll be told you’re being very picky!

This is the usual device used by Domino’s Pizza to make sure that a Goodwill will appear when the accounts are audited:
Domino’s Pizza is now managed by highly competent professionals, and this well-known competence explains why there is a positive Goodwill worth several million Euros.


3) indirect financing

The bank guarantee that has been given by Domino’s Pizza to banks that are fond of company financial involvements - a guarantee they can by no means get rid of – allows to finance whimsical projects; but more than that it allows to open new stores that will be counted when the time to exercise stock-options comes.

Domino’s Pizza CEO may from time to time resort to another creative accounting technique: the forgiveness of debt.
For instance, the forgiveness of debt in the Domino’s Pizza store in Bourges means that 30,000 euros were given to the franchisee in return for … well nothing special indeed, at least officially. But in reality, the money is financing the personal contribution for new stores that the Bourges manager is supposed to open, and it’s also given in return for his silence about the very low profitability of his business, though the store has been existing for 10 years by now.
Is there a good reason for SRTF Inc, Domino’s Pizza Bourges, declaring 46,521 euros earnings before taxes, to benefit from forgiveness of debt worth 30,000 euros?

Beside questioning the lawfulness of the reciprocal accounting entries between Domino’s Pizza and SRTF, that auditors can’t have missed (rfcomptable.grouperf.c...), we may wonder whether all the franchisees have benefited from the same treatment or not. Can they all expect such a 30,000euros worth forgiveness of debt?
+130*30,000 = 3,900,000 euros
We know the answer to our question and the answer is NO!
In fact, the amount granted by means of the forgiveness of debt - without having to promise anything in return –, as well as the payment periods, is the franchisee financial contribution to set up a new store.



B) … considering the sales made in existing stores

Domino’s Pizza urges the franchisees to increase their sales, without paying any attention to their actual profitability (this question is off the point in Domino’s Pizza’s world). These sales are improving fictitiously the profit made by Domino’s Pizza France, as the company doesn’t declare doubtful accounts or conceal them by means of intermediary structures that have not been taken into account by full consolidation or netting, subsidiaries which don’t even have the same balance sheet date (HVM is thus going to close the books on Dec.31st 2008, whereas DPF has just closed the books in June 2008).
No wonder the auditors will enjoy doing their job, especially when it comes to the Goodwill!


1) franchisees debts

As we already know, Domino’s Pizza doesn’t make it compulsory for their franchisees to pay their Food bills, royalties and NAF in due course.
These payment periods will allow some of the franchisees to build up capital and get a sufficient contribution to open new stores.

2) stores being on the look-out for debt financing

But there’s a limit to that device, when the franchisees debt reaches an outrageous amount, which looks weird in the accounts.
What’s the next solution? Let’s do a bit more creative accounting, with the help of two French banks, the Bred and HSBC.
The following mechanism is set up: money is loaned to the franchisees (with a reduced interest rate – 5 to 6% - and a security interest, the franchisee business guarantying his loan - but most importantly Domino’s Pizza guarantee) who will later pay back Domino’s Pizza.
Domino’s Pizza head officers are then going to go round the country and visit the franchise stores, to convince the franchisees to take loans to pay off their debts.
Yet, the Domino’s Pizza Franchisee is not that gullible and quite wise indeed: he got it he wouldn’t let the company head officers bump them off twice:
- once by paying interest where credit should be free
- Second, by giving everything in.

Client accounts need to be provisionally cleared and it won’t be the case, but that will be for another time.
We need to stress on the fact that neither HSBC nor the Bred Banque Populaire banks care about the fact they’re lending money to franchisees who keep showing day after day an ongoing deficit, with no hope to make any profit anytime soon, and it seems like it doesn’t matter that the loans concern operating losses whereas loans be granted to carry out investments.
In reality, the only reason the loan exists is because Domino’s Pizza France is committed as a guarantee.

3) financing through a DPF subsidiary

What if the banks refuse to lend money to so-called lame ducks? Whatever! Domino’s Pizza subsidiaries will loan them the money.
No one’ll be any the wiser: these loans will be mentioned on later balance sheets, so that the Auditor will have nothing to do but certifying the accounts.




III) Possible consequences

A) The financing bank and Domino’s Pizza France


One thing needs to be stressed on: French banks are eager to grant loans to the franchisees facing a “very concerning financial situation (negative owner’s equity, carry back in deficit, book loss the ongoing fiscal period, important indebtedness)”, even though the loans aim at financing huge debts. The bank hides the truth when they grant a loan at a time when there is no way out of the situation for the franchisees; it even tends to perpetuate operating losses. The bank is liable and could be sued as this is a criminal offence, in so far as the bank is not complying with their obligation to act with judgment, as it’s been explained by doctrine and decided over by courts of law, thus setting a precedent. Article L313-12 of the finance code states that the bank is allowed to stop lending money to the debtor straight away as soon as the debtor finds himself “irreparably in jeopardy”. By extension, it was decided by court that the bank is liable if they have granted a loan that “aimed at financing an operation that is not viable” (Com. Jan.7th 2004) or “out of proportion with the debtor’s capacity to pay off their debt” (Caen, Oct 11th 2001).
What about the Frejus case? The franchisee wasn’t capable of paying off her debt; she had to fill out a loan application to the same bank, and to take out a loan in her name that time, so that she could pay back her delayed scheduled payments due to the first loan taken out to finance the store.

What about Domino’s Pizza ? Is the company liable too? Indeed, Domino’s Pizza was the one organizing this financial set-up, therefore being liable for abusive extension of credit (besides, the company didn’t ask for their issued bills to be paid). In 2003, thecommercial section of the “Cour de Cassation” (equivalent to the US Supreme Court), decided of the joint and several liability of a bank and its parent company since they had both organized a financial set-up to help their subsidiary (Com. March 25th 2003).


B) Forgiveness of debt

For further information on the forgiveness of debt, you can refer to the following website:
rfcomptable.grouperf.c...

If we only pay attention to the comments made by the owner of the Domino’s Pizza franchise store in Bourges, we may believe that it’s a wonderful world, and that he will for sure make profit.
What about the relevance of a forgiveness of debt worth 30,000 euros (granted by Domino’s Pizza France to SRTF, the Bourges franchisee) then?


The auditors have already certified the accounts of these two companies (Domino’s Pizza France), without reservation.
They were probably shown accounts with a satisfying financial set-up, but we still need to know if it was a commercial forgiveness of debt or a financial one.
Was it a mixed one?
Anyhow, the situation is not supposed to get better anytime soon, and this is much concerning regarding the survival of the Bourges Domino’s Pizza store.

C) The managers and the possible fraudulent use of corporate property

You should look at the following Wikipedia links to get further information:
- fr.wikipedia.org/wiki/... or
- Or fr.jurispedia.org/inde...);
- And, more precisely www.legifrance.gouv.fr...

Let’s try and define the problem we’re dealing with:

We shall refer to the Commercial Code, Article L241-3, which has been modified by the edict of September 19th 2000, article 3 - Ordonnance n°2000-916 du 19 septembre 2000 - art. 3 (V) JORF 22 septembre 2000 en vigueur le 1er janvier 2002 –
(The legal text below is in blue):

A person can be held liable and sentenced to a 5 year imprisonment or fined up to 375,000 euros if:
1° the person has fraudulently over-assessed a contribution in kind;
Is the subsidiary valuation relevant indeed, in the light of the significant risk not to collect franchisees debts?
Is the Goodwill, as shown in the accounts of Domino’s Pizza Australia, truly justified? If you look at the figures stated in the Week 23 charts (which was the top week regarding sales, the average turnover on a longer period being notified as well), more than half the Domino’s Pizza France franchisees network hasn’t reached the break-even point. (We’re facing similar results when it comes to Domino’s Pizza Belgium, where no more than 2 stores are making profit).

2° the fact, for managers, to share fictitious dividends between the partners, without making any inventory or by means of fraudulent inventories.
Could there truly be profit, allowing sharing dividends, if the balance sheets were taking into account a badwill, allowances for doubtful accounts, with a significant risk for a call to guarantors? The dividends, once shared, would become stock dividends, according to a very interesting plan for managers (of course!).
3° The fact for managers, even if there are no dividends to share, to show their partners annual financial statements which do not give, for each fiscal period, an accurate picture of the fiscal-year earnings, of the financial state and of the company property by the end of that period, with the intent to conceal the actual situation of the company;
See the DIP report (Document d’information précontractuel – Pre-contractual information document): the balance sheet mentioned in this report is used as an enticing argument for the recruitment of new franchisees, though the figures displayed are false (exactly the same as in 2°)
4° the fact, for managers, to use business property or credit in bad faith, being well aware that it goes against the interest of the company, out of self-interest or to favour a third party Company or business in which they have a direct or indirect interest;
Stating the facts :
- the Orleans stores were purchased and then they happened to be run through lease management, with no hope to be profitable anytime, but with the purpose to prove the shareholders that the development plan has been carried out (though this plan is pretty whimsical indeed)
- Domino’s Pizza bought some franchisees stores that were in the utmost deficit (Paris 13, Paris 15, Issy les Moulineaux, Annecy and other ones), with the intent to conceal uncollectible, the non-existing profitability of the new franchisee stores, and to keep pretending that whimsical development plan has been carried out.
- Domino’s Pizza bought Domino’s Pizza Chatou premises, to give a hand to its former manager (though he had a 15-year experience managing pizza delivery stores – including Pizza Hut and Domino’s Pizza – ). Yet this manager keeps on struggling to reach the break-even point.
The objective of doing so was to make sure no risk would be taken (such as the former manager revealing unlawful methods used by Domino’s Pizza) and to rely on the former manager’s relationships to destabilize the competitors by hiring away their employees (including Pizza Hut managers and franchisees of all existing pizza delivery networks) so that they could set up more franchise stores.
What is more, the former manager will become a « Wonder recruiting officer », being very convincing thanks to his long experience and having a lot of contacts in the business. He’ll thus be responsible for developing the brand image in what should be considered as the nicest Domino’s Pizza store in France.

The franchisee candidates will be tempted until they get to know the real accounts.

Eventually, he’ll be the one in charge of handling the crisis, which has only consisted in a unique press release that was useless and short enough not to mention fraudulent actions.
Silence gives consent
Qui ne dit mot consent.
5°the fact, for managers, to use their powers or their votes in the company in bad faith, being well aware that it goes against the interest of the company, out of self-interest or to favour a third party Company or business in which they have a direct or indirect interest.
We shall still verify the whole DPF joint venture, including HVM, DPEU and other subsidiaries, which help to keep accounts, that won’t be publicly released, unveiled.
No doubt the Auditors, well aware of the situation, will now do their job properly.

Mar 02 07:44 AM

[User 370594:]

Why don't you post your net worth online?

Mar 05 05:08 PM

[User 372956:]

Domino's Pizza hasn't been concerned with the health of it's US Franchisees for years. Their main focus is simply finding more ways to get dollars out of it's franchisees. They've forced the use and purchase of an already out of date POS system that must be purchased through Domino's Pizza at an almost 50% premium over what the hardware is available for. They have forced all stores to be open for lunch to promote sandwiches, but there are many many stores that deliver solely to residential areas that do very little lunch business regardless of the menu. In a small operation like a Domino's Pizza, extra labor costs to run that shift can be backbreaking to a franchisee. Domino's Pizza doesn't care because they will squeeze a few more royalty dollars on the extra $200 worth of business one of these struggling stores MIGHT generate during lunch. Regardless of what the CEO might say, offering sandwiches and small pizzas in all stores (as opposed to making them an optional item for stores that have the proper audience for them...i.e. colleges, business parks, etc.) hasn't increased top line sales, but HAS managed to lower their average ticket price without accomplishing the necessary increase in order counts to offset the price drop. Check their 4th quarter sales and you will see that they had negative sales for the quarter while having a huge new product introduction. Those negative sales results are now two years running through what is historically the busiest time of the year for Domino's Pizza. Domino's Pizza's other issue is a lack of a committed operational message. A year ago they terminated their entire store inspection team and turned their heads from any operational issues...now they are bringing a new team on which will give them the opportunity to pressure franchisees and get rid of any they don't want in the system. It's all set up to be in their favor...the success or failure of their franchisees is way down their list of priorities.

Mar 09 09:31 PM