Advantica Restaurant Group, Inc.

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Advantica Restaurant Group, Inc.

203 East Main Street
Spartanburg, South Carolina 29319-9966
U.S.A.
(864) 597-8000
Fax: (864) 597-8780

Public Company
Incorporated: 1979 as Trans World Corporation
Employees: 85,000
Sales: $2.6 billion
Stock Exchanges: NASDAQ
Ticker Symbol: DINE
SICs: 5812 Eating Places; 6794 Patent Owners & Lessors; 6719 Holding Companies

Advantica Restaurant Group, Inc., is one of the largest restaurant companies in the United States, operating 3,300 restaurants. In the late 1990s its moderately priced chains included Denny’s, Coco’s, Carrows, and El Pollo Loco. Originally part of a much larger and more diverse conglomerate, Advantica, formerly known as Flagstar, was formed through a series of corporate mergers and divestitures, which ultimately produced a company focused on restaurants. The company’s legacy of corporate restructuring, however, left it with large debts, and it went through Chapter 11 bankruptcy reorganization in 1997.

Company Origins

Flagstar emerged in the early 1990s from the Trans World Corporation, which was created in 1979 as a holding company for Trans World Airlines (TWA), Hilton International hotels, and the Canteen Corporation, a contract food-services company. Later that year Trans World acquired Century 21 Real Estate and Spartan Food Systems, which owned the restaurant chain Quincy’s Family Steakhouse and is the largest franchisee of Hardee’s restaurants. In the mid-1980s Trans World moved to streamline its diverse operations, spinning off TWA to its shareholders and selling Century 21 to the Metropolitan Life Insurance Company.

In 1986 Trans World’s profits declined sharply after its purchase of American Medical Services, a nursing home operator in poor financial shape. As a result of this acquisition, the company’s stock price dropped dramatically, attracting the attention of corporate raiders, who sought to buy up the inexpensive shares of Trans World stock, take over the company, and sell off its other valuable constituent parts for a profit. To ward off such hostile takeover attempts, Trans World was forced to restructure. The company’s stock was liquidated on December 31, 1986, and new stock, for a company called TW Services, Inc., was issued. This new entity included the assets of Canteen, Spartan, and American Medical Systems, along with other businesses.

The following year TW Services moved to consolidate its operations further, and it sold its hotel operations, Hilton International, to Allegis, Inc. At the same time, TW Services expanded and strengthened its restaurant operations, purchasing Denny’s, a restaurant chain with 1,200 outlets, and El Pollo Loco, another chain of 70 eateries specializing in chicken. After this process of corporate restructurings, TW Services emerged as an operator of chain restaurants and other food services. The company’s five principal food-oriented businesses included Denny’s, Hardee’s, Quincy’s Family Steakhouse, El Pollo Loco, and the Canteen Corporation.

Early History of the Canteen Subsidiary

The oldest of TW Services’ units was Canteen, founded in July 1929 by Nathaniel Leverone and two other partners. Just before the onset of the Great Depression, Leverone acquired the Chicago Automatic Canteen Corporation, the vending operations of an American Legion chapter in Chicago. The company oversaw the operations of 100 five-cent candy bar machines stationed throughout the Chicago area. In 1930 Leverone changed the name of his company to the Automatic Canteen Company of America, and he began to seek out franchise operators, who would be given an exclusive contract to operate Canteen machines in different areas of the country. By 1931, 15 different franchises had been established.

Wartime shortages in the early 1940s challenged the abilities of Canteen’s franchise operators. At the end of the war, however, a sharp increase in the manufacture of consumer goods proved a boon to Canteen operators, since many of their machines were located in factory lunchrooms. The company thrived throughout the 1950s, and in 1960 its operations were expanded with the purchase of Nationwide Food Service, which also provided food services for people in their workplace. In the mid-1960s American Canteen shortened its name to the Canteen Corporation. Three years later the company was purchased by International Telephone and Telegraph (ITT).

Under ITT, Canteen’s operations continued to expand, as it moved into the fields of hospital and college campus food services. In 1973 Canteen was sold to the Trans World Corporation, and over the next several years Canteen became involved in running food services for the National Aeronautics and Space Administration (NASA), as well as concession stands in national parks and at convention centers, sports arenas, and massive entertainment complexes.

Early History of Denny’s

The second oldest of the TW Services restaurant units was Denny’s, founded as a doughnut stand in Lakewood, California, in 1953. Originally called Danny’s Donuts, the shop was opened by Harold Butler, who planned to offer coffee and doughnuts 24 hours a day. By the end of its first year in operation, Butler’s doughnut stand had garnered profits of $120,000. In 1954 Danny’s Donuts became Danny’s Coffee Shops, and Butler began expanding his operations, opening additional stores. Five years later the chain of coffee shops became Denny’s restaurants, and doughnuts were phased out of the menu.

In choosing locations for his restaurants, Butler concentrated on major highway and freeway exits, where travelers would be plentiful at all hours of the day and night. The expansion of a national network of interstate highways during this time prompted increasing numbers of Americans to travel by car, and Denny’s restaurants became a rapid success.

In 1967 Denny’s opened its first foreign restaurant, located in Acapulco, Mexico, and eventually established additional outlets in Mexico as well as Hong Kong. In 1969, in an effort to streamline and centralize its food production, Denny’s bought Delly’s Food, changing the name of that concern to Proficient Food Company. This subsidiary was responsible for running warehouse and distribution operations to keep the company’s restaurants supplied. Four years later Denny’s opened its own food processing facility, called Portion-Trol Foods, in Mansfield, Texas. In the mid-1980s Denny’s was purchased for $800 million by a group of investors in a leveraged buyout. Two years later these investors sold the company to TW Services for $843 million.

Early History of Spartan Food Systems

TW Services also owned and operated the largest franchisee of Hardee’s, one of the units of Spartan Food Systems. The first Hardee’s franchise was opened in October of 1961 in Spartanburg, South Carolina. A second Hardee’s franchise outlet was soon opened in another area of Spartanburg. This restaurant, which was a walk-up operation rather than a drive-in, was owned and run by Jerry Richardson and four other investors, who contributed a total of $20,000 and called their enterprise Spartan Investment Company.

Offering hamburgers, french fries, and beverages priced between 10 and 15 cents, the franchised Hardee’s was a success, and the Spartan investors soon opened other outlets. Within five years they were running 15 different Hardee’s restaurants. In 1969 the partnership changed its name to Spartan Food Systems and began to offer stock to the public. In 1976 Spartan was listed on the New York Stock Exchange for the first time.

The following year, with the money raised from this stock offering, Spartan purchased the Quincy’s Family Steakhouse chain, founded in 1973 as the Western Family Steak House, a single restaurant located in Greenville, South Carolina. By 1976 nine Western Family Steak Houses were in operation, and the company’s name was changed to Quincy’s, in honor of co-founder Bill Brittain’s grandfather. By 1978 the number of Quincy’s restaurants had almost tripled, and this rate of rapid growth continued after Spartan was purchased by Trans World in 1979. Over the next five years, an additional 189 Quincy’s steakhouse restaurants were opened throughout the Southeast.

TW Services also acquired El Pollo Loco, Spanish for ’ The Crazy Chicken,” a company that got its start in Mexico in 1975. Francisco Ochoa opened a modest restaurant by the side of a road in the small town of Gusave, serving flame-broiled chicken that had been marinated with his family’s recipe of fruit juices, herbs, and spices. Ochoa’s operation expanded rapidly in Mexico, as 90 outlets in 20 cities were opened during the 1970s.

At the end of 1980 the company opened its first restaurant in the United States, on Alvarado Street in Los Angeles, and within three years 16 more American restaurants were established. In 1983 the Ochoa family sold its American restaurants to Denny’s, retaining the El Pollo Loco Mexican operations. Under its new owner, the American El Pollo Locos were expanded to include several new outlets in California and Nevada, before being purchased by TW Services in 1987.

With a stable group of food service properties in place, TW Services announced in 1987 that it planned to invest $700 million in expanding and improving its operations in an effort to strengthen its presence in the food services industry. Toward this end the company cut back the administrative staff at Denny’s headquarters and simplified the chain’s menus, improving the company’s profitability.

Hostile Takeover in Late 1980s

Before other efforts had begun to take effect, however, TW Services found itself in the midst of another corporate takeover battle in the fall of 1988. Coniston Partners, an investor group known for breaking up and selling off parts of other big corporations, sought to buy TW Services for $1.14 billion. In response, the company put in place a “poison pill” defense intended to make it extremely expensive for any outsider to buy more than 20 percent of its stock. Coniston challenged this move in court, while continuing to purchase increments of TW Services stock. By mid-December 1988, 85 percent of TW Services’ stock had been purchased by Coniston, and by the middle of the following year the deal had been completed. Coniston bought TW Services for $1.7 billion. The company’s new owners planned to keep its food services units and sell off its less profitable nursing home unit.

In 1990 American Medical Services was divested, along with two other smaller units, The Rowe Corporation and the Milnot Corporation. In addition, the company consolidated the administration of all of its restaurant chains, moving the headquarters of TW Services from Paramus, New Jersey, to Spartanburg, South Carolina, where its Hardee’s franchises were based. In the months following, the headquarters of Canteen was moved from Chicago to Spartanburg as was Denny’s administrative staff, which transferred from Irvine, California. Only El Pollo Loco, whose restaurants were located exclusively in the western states, retained its headquarters outside the new central company facilities.

These moves were intended to help TW Services run more efficiently, to offset its high debt, and to stem its losses, which reached $67.8 million in 1990. The transfer of operations was completed in 1991, but the company still finished 1991 with losses of $67.6 million. Help for the beleaguered company came in 1992, when TW Services cut a deal with the venture capital firm Kohlberg Kravis Roberts & Company, which contributed $300 million in capital to TW Services, in return for a 47 percent stake in the company.

Denny’s Discrimination Problem in the Early 1990s

Hope for financial improvements was offset, however, by disturbing news on another front: African-American customers at Denny’s restaurants in California began to complain that they had been discriminated against and denied service. Specifically, the customers alleged that some Denny’s restaurants either refused adequate service or forced them to pay in advance for their meals, while white customers in the restaurants were not asked to do the same.

As the U.S. Justice Department began an investigation into Denny’s, TW Services began an effort to control the public relations damage to its reputation. The company apologized to customers, made contact with civil rights groups, fired or transferred problematic employees, and implemented a cultural relations team designed to educate employees on issues of race. Negotiations with the Justice Department continued throughout 1992. In March 1993, TW Services signed a consent decree with the Justice Department that called for an end to prejudicial practices. The company agreed to initiate improved training guidelines for employees and to allow for the spot testing of Denny’s restaurants for compliance with its nondiscriminatory policy.

Nevertheless, the company’s legal troubles continued, as aggrieved customers pressed lawsuits. Moreover, in May 1993, six African-American Secret Service agents sued Denny’s, claiming that they had been denied service at a restaurant in Annapolis, Maryland. The charges received extensive media exposure, as critics charged that Denny’s employees exhibited such consistent racist behavior that it constituted a part of the company’s culture.

In the midst of these image problems, TW Services changed its name in June 1993. Shedding all vestiges of its past association with Trans World, the company took Flagstar as its new moniker. Flagstar also hired its first African-American executive, a human relations administrator who vowed to tackle the problems at Denny’s.

One month later, Flagstar announced an ambitious minority advancement program developed in conjunction with the NAACP. To demonstrate its good faith in its effort to stamp out racism, Flagstar announced that it would double the number of Denny’s franchises owned by minorities to 107, hire 325 African-American managers, and pledge $1 billion to be earmarked for goods purchased from minority-owned contractors over a seven-year period. Moreover, the company promised to maintain a policy of designating 12 percent of its purchasing budget, ten percent of its marketing and advertising budget, and 15 percent of its legal, accounting, and consulting budget, exclusively for minority-owned firms.

Financial Trouble in the Mid-1990s

Flagstar continued to suffer financial difficulties. Surveys showed that the customer traffic in its Denny’s chain, which contributed the bulk of its revenues, was down by seven percent. In an effort to draw more people into its restaurants, Denny’s inaugurated an all-you-can-eat promotion, which had to be canceled in the summer of 1993 when it became too expensive. By the end of the year the company’s losses had reached $1.7 billion, which included a $1.5 billion write-off of goodwill and other intangible assets. In addition, in January 1994, Flagstar announced that it would take a $192 million restructuring charge to close or franchise 14 percent of its restaurants, primarily Denny’s outlets. The company also announced that it would embark upon a modernization program for its 1,000 company restaurants, installing new facades and menus, additional lights, and contemporary logos in facilities that, in many cases, had not been updated in 20 years.

The company’s poor financial performance prompted the layoff of 300 employees in March 1994. Although the company had announced in February an 18-month program for gradual downsizing, it considerably accelerated the plan. The eliminated positions were primarily in support staff, particularly clerical, payroll, and building services.

In June 1994 Flagstar announced that it had completed the sale of the Canteen food and vending operations to London-based Compass Group PLC for $450 million. At the same time Flagstar began searching for buyers for its Volume Services and TW Recreational Services divisions. These efforts reflected the company’s decision to focus on its restaurants, Flagstar’s core business.

By December 1995, Flagstar had agreed to pay a total of $54 million to plaintiffs in three class action lawsuits against Denny’s. This sum represented the largest and broadest settlement ever made in such suits. With this move, the company hoped to settle 4,300 claims against it, contained in legal proceedings taking place in Maryland, Virginia, and California. At the same time, the company renewed its commitment to improving race relations at Denny’s, setting up discrimination testing programs and monitoring employee behavior.

Flagstar CEO Jerry Richardson brokered the settlements and hired Ron Petty to take over as president of Denny’s, with clear instructions to solve the chain’s race relations problems. Richardson faced other problems, however, namely $2.3 billion in debt and five straight years of losses by the end of 1994. In January 1995 he was replaced as CEO by Jim Adamson. Adamson moved decisively to change the company’s environment of racial discrimination. He instituted diversity training for his employees, set up management training programs to help minorities rise into executive positions, increased recruitment of minorities for both company positions and for franchise ownership, and sought out minority suppliers.

The company’s financial problems proved more difficult to overcome. In 1995 Flagstar lost $55 million on revenues of $2.6 billion. Struggling with a poor image and with annual interest payments of $230 million, the company had lost Wall Street’s confidence; the stock price had fallen to a low of $2.88 in 1995. The company’s mainstay, Denny’s, had begun to recover in 1994, with revenues up 35 percent. That growth stalled in 1995 as Flagstar sold 45 company-owned restaurants to franchisees, resulting in Denny’s revenues dropping from $1.55 billion in 1994 to $1.49 billion in 1995. Hardee’s was also a drain in 1995, as revenues fell almost six percent to $660 million. Hardee’s same-store sales showed a depressing decline of 8.6 percent.

Adamson tackled the company’s problems on several fronts. Flagstar already had begun refocusing on its restaurant businesses; Adamson completed that task by divesting all of the company’s nonrestaurant businesses by mid-1996. To offset competition at Denny’s from fast food restaurants, he lowered prices, introducing five morning meals under $2 to supplement the chain’s popular $1.99 Grand Slam breakfast. In addition, Denny’s added a “value” lunch menu, with meals from $2.99 to $4.99. To regain Hardee’s customer base, Adamson ordered a cut in burger prices and an increase in burger size. In addition, he brought in a new president, Craig Bushey, to rejuvenate the 580-store chain.

In May 1996 Flagstar acquired two family dining chains, Coco’s and Carrows, hoping to add more consistent performers to its stable of restaurant chains. Unable to continue under its staggering burden of debt, however, Flagstar spent 1997 reorganizing under Chapter 11 bankruptcy protection. The company finished the year with revenues of $2.61 billion, a slight increase over 1996, but reported yet another net loss, this time of $134.5 million.

In January 1998, Flagstar emerged from Chapter 11 with a new name, Advantica Restaurant Group, and a debt load $1.1 billion lighter. Adamson remained CEO, but the company had a new board of directors and newly issued common stock trading over NASDAQ. In February Advantica signed an agreement to sell its Hardee’s franchise subsidiary to CKE Restaurants, Inc. The $427 million deal comprised $381 million in cash and $46 million in debt obligations. Soon after, Advantica sold its Quincy’s Family Steakhouse chain as well. Advantica planned to use the cash from the two transactions to further reduce its debt and to invest in its other restaurant chains. Not only was Advantica in a more hopeful financial position in mid-1998, it was receiving recognition for its dramatic turnaround in race relations. Fortune magazine named Advantica the number two best company in the country for Asians, African-Americans, and Hispanics. With a rejuvenated balance sheet and image, Advantica hoped to complete a solid turnaround by the end of the decade.