7373 North Scottsdale
DenAmerica Corporation operates 200 full-service family restaurants, most of them branded, in about 25 states. The company is the largest franchisee of Denny's restaurants in the nation, with 99 Denny's restaurants in 18 states. These 24-hour-a-day units offer traditional, family-style fare and are perhaps best known for their popular breakfast menu. DenAmerica also owns 101 Black-Eyed Pea restaurants in 13 states, including 73 in Texas, Oklahoma, and Arizona. Black-Eyed Pea units are known for their home-style menu, which includes pot roast, chicken-fried steak, and roast turkey entrees.
1990s Origins from a Reverse Merger
DenAmerica Corp. was formed in 1996 when DenWest Restaurant Corp. of Scottsdale, Arizona, acquired Georgia-based America Family Restaurants in a reverse merger. American Family, which had gone public in 1994 with an initial offering of 2.9 million common shares, operated 78 Denny's and 56 non-branded restaurants at the time of the merger. American Family's annual sales had increased about 47.4 percent, from $72.5 million in 1993 to $106.9 million in 1995. DenWest had more than doubled its restaurant sales during the same time period, from $32.6 million to about $75 million, and had acquired an additional 26 Denny's restaurants in 1994 for a total of 72 Denny's units west of the Mississippi. Combined, the two companies operated more than 200 restaurants in 27 states and accounted for about ten percent of Denny's U.S.-based system.
The decision to merge was driven by both companies' need to decrease overhead expenses and by each one's appetite for growth. Consolidating into a single headquarters shaved millions off annual operating expenses and allowed for other efficiencies, such as eliminating staff, closing some regional offices, and installing more efficient insurance and purchasing programs.
Prior to the merger, each company had pursued a somewhat different growth strategy. American Family Restaurants, which had been in existence since 1986, under the direction of its chairman and chief executive officer, Jeffrey Miller, had focused on acquiring smaller regional chains of family restaurants which it then converted to the Denny's concept. DenWest, formed by the 1995 consolidation of several related companies under the stewardship of Jack Lloyd, pursued the acquisition of existing Denny's from other operators and constructed entirely new units.
Under the terms of the merger agreement, shareholders of the privately held DenWest received almost seven million common shares of American Family, $24.3 million in bonds and warrants, and control of DenAmerica's board of directors. American Family shareholders controlled another approximately six million shares of DenAmerica Corp. Even before the deal had closed, news of the organizational change resulted in improvement in the share price of American Family. The companies, too, felt optimistic about the new entity and worked to strengthen its market position. Within a month of the announcement of merger in mid-1995, DenWest acquired 25 properties in Texas, Oklahoma, Colorado, Alabama, Virginia, Florida, Georgia, and North and South Carolina from Kettle Restaurants, Inc. and began implementing its plan to fill in the gaps in its southeast base, thereby strengthening DenAmerica's position in one of its existing areas of operation. Days later, American Family acquired 11 Mr. Fable's Restaurants in western Michigan for approximately $2.7 million. Taken together, these acquisitions increased the soon-to-be-created DenAmerica's overall restaurant base by almost 17 percent and brought its number of restaurants to somewhere in the vicinity of 250. Four months after the decision to merge had been announced, American Family's stock had risen 44 percent.
Going Beyond the Denny's Concept
According to Jeffrey Miller, the new president and chief executive officer of DenAmerica, the new company chose to target the family-dining segment because this portion of the dining-out market was fragmented and underdeveloped at the time. It picked the 1,600-unit Denny's because this particular restaurant concept had a national presence but relatively sparse market penetration. Denny's units typically yielded higher sales and operating margins than the company's smaller, lesser known brands. Following the merger, DenAmerica strategically focused its efforts upon limiting the number of chains that it franchised and narrowing its geographic base. It also undertook a store-by-store review, with the aim of maximizing the return on investment from each restaurant.
As a result of this refocusing and reevaluation, the company made the decision in 1996 to sell 23 Ike's restaurants and Jerry's restaurants in Ohio, Indiana, Kentucky, and Illinois for $4.6 million and to convert 22 of its non-branded restaurants to the Denny's concept. It also sold 33 of its non-branded restaurants. Shortly thereafter, in a move conceived as a means of growing beyond the Denny's concept, DenAmerica purchased the Black-Eyed Pea restaurant chain, the 92nd-largest family dining chain in the nation, from Unigate P.L.C., a British food manufacturer and distributor, for $65 million in early 1997. The Black-Eyed Pea chain consisted of 130 restaurants, 30 of which were franchises, in Texas, Oklahoma, Georgia, and Washington, D.C. The acquisition boosted the number of restaurants operated by DenAmerica to more than 300.
The Black-Eyed Pea restaurant acquisition added about $75 million in revenues to the company for fiscal 1996, generating an earnings increase in the vicinity of $11.5 million before administrative expenses, interest, taxes, depreciation, and amortization were taken into account. DenAmerica's overall net income for 1996 was $1.1 million compared with only $200,000 for the year before. Restaurant sales for 1996 were $241.5 million, considerably more than the $74.7 million totaled for 1995. Good times notwithstanding, however, Miller made the decision in July 1996 to leave DenAmerica to pursue other business interests. The company was next led by Jack Lloyd and Bill Howard as president and executive vice-president, respectively.
Streamlining Denny's, Expanding Black-Eyed Peas
The company's revenues continued to rise--39 percent throughout the first nine months of 1997--but then sales plummeted $9.1 million in the third quarter of the year. By mid- to late-1997, same-store sales were suffering across the board at DenAmerica, down 4.6 percent at the Black-Eyed Pea and down 5.8 percent at Denny's; the company's share price had tumbled from $5.25 to $2.25. DenAmerica, which then ranked tenth among the nation's restaurant franchisees based on revenue, closed out the quarter ended July 2, 1997, with a loss of $350,000. This turn of events prompted the management to sue the former owner of the Black-Eyed Pea for damages that included loss of franchise royalties and the lessening of business value, claiming that it had supplied DenAmerica with false and misleading information at the time of the purchase. By the end of the third quarter, DenAmerica reported a loss of $408,000 on revenues of $227.79 million compared with a gain of $1.31 million on revenues of $163.77 million for the year before. The company finished the year with a net loss of nearly $21 million, although this upset was due in part to reserves taken in preparation for the upcoming sale of some of its properties.
Management responded to the downswing in DenAmerica's fortunes by reexamining its position. The company had recently fallen out of compliance with certain of its debt covenants, and although it received waivers to defer interest from bondholders, it began to sell more Denny's to alleviate its debt. In a July 1997 move to reduce the number of its Denny's inherited from American Family, DenAmerica sold off two other non-branded restaurants and 14 non-performing Denny's units east of the Mississippi where the chain had been underperforming. DenAmerica also made plans to sell another ten non-branded restaurants and 61 Denny's formerly owned by American Family Restaurants. Since Denny's units in the western United States and Florida were performing well, the company planned to expand the chain in those regions at the same time that it launched an expansion of its Black-Eyed Pea chain.
In 1998, DenAmerica sold 71 of its lowest-volume restaurants, including 63 Denny's, to Houston-based Olajuwon Holdings for $28.7 million. With the completion of this sale, which enabled DenAmerica to pay off more of its still remaining $60 million debt, DenAmerica now operated 103 Denny's and 104 Black-eyed Peas restaurants, and licensed three Black-eyed Peas. Since the 1996 merger, DenAmerica had sold 145 restaurants, most of them Denny's. DenAmerica then went ahead to purchase nine formerly franchised Black-Eyed Peas, adding to the four new units it had built in 1997. During 1998, same store sales at DenAmerica's Denny's gained about three percent in the first nine months, while Black-Eyed Pea sales decreased 1.5 percent for the year.
DenAmerica appeared to be suffering in large part from challenges specific to franchising. Denny's parent firm, Flagstar Cos., was itself emerging from a Chapter 11 bankruptcy reorganization in 1998 as the newly formed Advantica. Having been beset by 12 years of over-leveraging and racial discrimination claims, Flagstar had not had the time to devote any of its resources to marketing Denny's. Nor did it appear to be making Denny's its priority. Instead, Advantica opened units of its Coco's and Carrows chains, direct competitors in the family dining-out market, within close proximity of many Denny's restaurants. When Advantica initiated a price-slashing campaign as part of its effort to market Denny's, DenAmerica initially refused to go along with the strategy, insisting that Advantica's "value-priced" menus conflicted with the Denny's concept's focus on providing full service to customers. Pressured from above, however, DenAmerica eventually had to comply with Advantica's plan.
DenAmerica entered 1999 determined to continue to do business as usual, improving sales, investing where profitable, and selling off underperforming properties as needed. Its liabilities totaled $169 million compared with assets of $170 million, and its revenues had declined $44.6 million to $256 million in 1998 with a net loss of $4.7 million. However, management derived optimism from the fact that the company's same store sales at both its Denny's and Black-Eyed Pea restaurants were improving, with its Denny's units as a group outperforming those of Advantica. The company even had made plans for building another four new restaurants. Yet, at the same time, DenAmerica was considering the possibility of a buy-out. After the failure to complete a purchase offer of $158 million by the New York computer company, Tech Electro, DenAmerica secured $17.1 million in new financing of which 7.5 million went to repay debt, including some failed senior debt covenants.