Selections Newsletter - Spring 2017

April 2017

Restaurants-Selections-News-Spring-2017_pic-x679.jpg

Download PDF Version


Table of Contents

 


Mapping A Route Through Industry Saturation

By Dustin Minton and Vince Stasiulewicz

At times, learning how to manage in an oversaturated market can feel like trying to drive on a crowded highway during rush hour. In the moment, roadblocks and traffic may slow you down—but what matters most is that you ultimately reach your destination.


Pump the Breaks

Market saturation in the industry is limiting same-store sales growth despite macroeconomic positives like job growth. According to BDO’s The Counter, same-store sales decreased on average through Q3 2016, with public companies reporting same-store sales decreases of 0.1 percent. As a result of capacity growth and labor constraints, expect 2017 to see a continued softening of same-store sales and higher labor costs driven by minimum wage hikes and the rising cost of benefits. While this may seem like a reason to flash your hazards, remember outliers working to overcome recent setbacks may be temporarily keeping segments down.


Merge with Caution

Just because traffic is slow doesn’t mean you shouldn’t travel at all. Instead, use your blinker to find your space in the flow. Keeping your restaurant relevant shouldn’t require a huge spend; start by implementing little changes. When’s the last time you refreshed your menu? Simple changes to menu selection—such as healthier ingredients— can be a cost-effective way to encourage customers to keep coming back.

Other often-overlooked areas for improvement can be found in staffing and technology upgrades. Ensuring your staff is as competent as possible can be the difference between a one-time and repeat customer. Additionally, switching outdated technology for upgrades like tabletop tablets can add efficiency to the business and excitement to the customer’s visit. For many, it’s about the experience as much as it’s about the food, so if the visit is not exceptional, consumers may not be willing to pay a premium price—or any price at all.


Find Your Fast Lane

Perhaps you’ve already found your perfect menu, and the service can’t be beat. So what’s your differentiator? Rather than staying on cruise control, it’s time to take advantage of what sets your restaurant apart.

When looking at examples of success stories, think about chains that are filling underserved niches or departing from industry norms. Pret a Manger, for example, stands out as a result of its promise of always being natural, fresh and “ready to eat.” That, combined with consistently friendly staff, keeps customers loyal. Additionally, Blaze, the fast casual pizza chain, sets itself apart by fast-firing custom pizzas in 180 seconds at a lower price point than traditional pizza chains. Though these strategies may not be a perfect fit for your business, these are just a couple of examples of how carving out your role in the industry can set you up for success.

The fast casual segment is currently the most optimistic in the industry and, often, traits that make fast casuals trendy provide a unique opportunity to create a niche by nature. The generally better price points, fresher and higher quality food options, improved efficiency and better user experiences are bringing the customers in, so why should they come back? Discover your differentiator to get through the bottleneck.


Arriving Safely

When the industry feels like a congested highway, take a step back and evaluate your business for ways to improve. Look for built-in differentiators to take your restaurant to the next level while keeping in mind that little changes can result in big improvements. Much like being stuck in a traffic jam, if you focus on arriving safely versus the bumps in the road, you’ll get to your destination in no time.

This post originally ran on Fast Casual.
 
Dustin Minton is an audit partner and co-leader of BDO’s Restaurant Practice. He can be reached at dminton@bdo.com.

Vince Stasiulewicz is an audit senior manager in BDO’s Restaurant Practice. He can be reached at vstasiulewicz@bdo.com.

 


What Impact Do Lower Grocery Store Prices Have On Restaurants?

By Dustin Minton and Ron Reed, Jr.

Falling food prices are driving grocery store prices to decline. And this has some questioning the long-term impact of a price gap between grocery store and restaurant prices. According to the US Bureau of Labor Statistic’s December 2016 Consumer Price Index Summary, prices on food away from home increased 0.2 percent, while prices for food at home declined by 0.2 percent. This represents the eighth consecutive month food at home has experienced a decline, with an overall decrease of 2 percent in 2016. All major grocery store food group indexes decreased last year.

While the restaurant industry has also benefited from lower food costs, menu prices are trending upward, with labor expenses on the rise.

“Restaurants tend to have a higher mix of labor-to-food costs than grocers, so the cost of labor is overshadowing the benefit restaurants are seeing from lower commodity costs,” says Adam Berebitsky, co-leader of BDO’s Restaurant Practice.

As the price gap widens between eating at home and at restaurants, are consumers noticing and shifting their food dollars away from restaurants?

According to industry results through Q3 2016 reported in BDO’s most recent issue of The Counter, the answer seems to be yes. On average, public companies reported same-store sales decreases of 0.1 percent. The fast casual segment, specifically, also posted a decrease in same-store sales through Q3, a divergence from the 4.9 percent growth reported for fiscal year 2015. These findings signal that Chipotle’s sales decline is working against the segment average as the brand looks to repair its reputation and loyal customer base. Most industry observers agree that the price gap between restaurants and grocery stores is a contributing factor to the restaurant traffic declines seen during 2016, leading to softening same‑store sales.

Restaurant Research LLC recently conducted a survey of 1,500 consumers to examine whether the general public has noticed the pricing gap and, if so, how they’ve reacted. More than 28 percent of respondents answered that they do not pay attention to price differences, and nearly another 22 percent said that grocery store prices don’t seem cheaper. Meanwhile, just over 4 percent said they were unaware of the price gap as a result of great deals at restaurants. Therefore, more than half of the survey’s respondents admit they either don’t pay attention or have yet to notice the price gap. Another 14.4 percent have noticed the decline of grocery store prices, but have not changed their buying behavior in response.


Restaurants-Selections-News-Spring-2017_chart-1-x679.jpg

That’s good news for restaurants. But what about the other 31.6 percent? These survey respondents say they have noticed that grocery store prices are cheaper—either by a little or a lot—resulting in a change in behavior geared toward eating at home more frequently. For a closer look at how consumers responded, click here for Restaurant Research’s full report, sliced by demographic.

This post originally ran on Fast Casual.
 
Dustin Minton is an audit partner and co-leader of BDO’s Restaurant Practice. He can be reached at dminton@bdo.com.

Ron Reed is a tax senior manager in BDO’s Restaurant Practice. He can be reached at rreed@bdo.com.

 


Income Tax Basis of Accounting vs. GAAP

By Kari Maue

Once again, it’s time for annual financial statements to be compiled, reviewed or audited and presented to comply with bank covenants. Banks and investors generally require year-end financials to be in accordance with generally accepted accounting principles (GAAP). While GAAP requirements are geared to best serve investors as users of financial statements, many private company users include bankers and owners who care about cash flow and ability to repay debt.

When deciding whether to employ income tax basis financial statements and GAAP, there are some key differences to consider. The basis of accounting will change based on your auditor’s opinion, but the type of opinion will stay the same. For the restaurant industry, differences between the two approaches are most noticeable with:
  • Lease accounting
  • Tenant improvement allowance
  • Closed store reserves
  • Gift card recognition
  • Depreciation
  • Goodwill
  • Purchase accounting
For example, the income tax basis of accounting requires the recognition of rent, paid or to be paid. Conversely, GAAP recognizes rent expense on a straight-line basis over the term of the lease, thereby resulting in a liability, or deferred rent, on the balance sheet for the difference between rent paid and rent expensed. Overall, the adjustments required under GAAP result in non-cash adjustments to the books of record and a thorough understanding of the technical literature.

If you’re leaning toward income tax basis of accounting, a few benefits to consider include:
  • A review or audit is less expensive for clients and easier to prep for, as less accounting assistance is needed from the CPA firm
  • Results are often better aligned with EBITDA as it excludes non-cash transactions and focuses on the cash outflow as well as the ability to meet debt servicing requirements
  • The P&L results better reflect the operating cash flow of the company by excluding non-cash transactions for continuing operations
  • It has minimal impact on sales, cost of sales, labor
  • The balance sheet will only include liabilities with cash outlay requirements
On the other hand,
  • Results of income tax basis accounting will not include adjustments for impairment or closure of stores; however, disclosures will be made in the notes to financial statements
  • Re-evaluation of debt covenants may be necessary; most banks allow for the non-cash element of deferred rent to be backed out of calculations
  • In many private equity deals, GAAP financial statements are preferred
If you’re still not sure which accounting method will work best for your business, consult your owner, banker, investor or accounting professional. 

Kari Maue is an audit senior manager in BDO’s Restaurant Practice. She can be reached at kmaue@bdo.com.
 


Impairment of Long-Lived Assets: GAAP and Tax Treatment

By Giselle El Biri

As restaurant operators well know, things do not always go as planned. For instance, areas where restaurants are operating can become saturated with competition, demographics and target audiences can evolve, or management’s plans may simply change, resulting in a decision to close a location.

Under generally accepted accounting principles (GAAP), these situations each represent examples of triggering events which require the performance of an asset impairment test. While the asset impairment test may result in write-downs related to poor performing stores and stores that are expected to be closed, the results may have a different effect on your tax return.

Let’s look at an example: Management of Company A has been watching a group of poorly performing stores and decides further analysis is required. GAAP requires a projection of future cash flows for these stores, which is then compared to the net book value of the related long-lived assets. The calculation of future cash flows involves projecting earnings before interest, taxes, depreciation and amortization for each year through the remaining obligated lease term. However, if any of those locations were owned versus leased, then projected future cash flows should be calculated over the remaining economic life.

In this example, the results of management’s calculations show that the undiscounted cash flows are less than the net book value of the long-lived assets. Company A must then determine the fair value of the long-lived assets, and record an impairment charge for the difference between the fair value and the net book value. If Company A determined that the fair value was less than the carrying value by $600,000, then it would record an impairment charge of $600,000.   

How do you allocate the impairment charge? You must first determine what can be sold or used in other stores. For example, leasehold improvements cannot typically be moved to another location nor sold, therefore the net book value of these assets would be perhaps more significantly impaired, and the remaining impairment charge should be allocated to the remaining equipment. Note that the total impairment charge is typically recorded as a reserve and not a direct write-off against the assets in order to retain historical information for tax and other purposes. However, the reserve is applied against the carrying amount when determining future depreciation. Any depreciable value is the remaining carrying value of the assets and not the original gross value.

The income statement effect of the impairment is part of continuing operations and should not be presented “below the line” or in “other expense.” However, it can be separately presented so that an investor or banker can segregate it from any analysis performed on your company.

Many restaurants are confused about how impairment is treated on the tax return. Under the tax law, a company may not record losses until the asset is actually written off. Therefore, in our example above, if the impairment was recorded in 2016 but management did not physically close the location until 2018, the tax law would not permit Company A to deduct these losses until 2018 when the location physically closes or if the assets were sold.

Under GAAP, since the location closed and will not operate in 2018, the impairment reserve, related assets and accumulated depreciation will be written off and any remaining difference recorded as loss on disposal of assets on the income statement at that time.  

The impairment of goodwill will also impact the financial statements differently from the tax return. Under GAAP, goodwill is tested for impairment at the reporting unit level. A reporting unit is typically a business unit that is one level below the operating segment level. At least annually, or earlier if a triggering event has occurred, much like in the example above, the entity must perform a goodwill impairment test. Note that under the private company alternative, a goodwill impairment test is only required upon a triggering event. Under the guidance, the entity can elect to perform a qualitative test, a likelihood of more than 50 percent that the fair value of the reporting unit is less than the carrying value. If the qualitative test proves there is a likely impairment, then the fair value of the reporting unit must be calculated and compared to its carrying value of the assets and liabilities. Alternatively, the entity can choose to skip the qualitative analysis and move straight to the quantitative test. In either case, if the carrying value is more than fair value, an impairment charge is recorded similar to the above example. For tax purposes, goodwill is not written off until the reporting unit is sold or otherwise closed.

Giselle El Biri is an audit director in BDO’s Restaurant Practice. She can be reached at gelbiri@bdo.com.
 

 


Negotiating Tips On Debt Covenants and Personal Guarantees

By Dustin Minton

Non-compliance with debt agreement financial covenants can be costly, time-intensive and distracting to your business. Once you are out of compliance, lenders typically charge significant waiver fees, and the process to return to compliance often requires weeks of back-and-forth negotiations between your company’s chief financial officer/controller, the bank representative and the underwriter.

Therefore, when initially negotiating debt funding with your lender, it is important to understand the financial covenants your lender expects you to uphold and the variables that could prevent compliance. In addition, be sure to know the risks you assume when personally guaranteeing debt obligations.

Two common financial covenants typically included in a debt agreement are fixed-charge coverage ratio and funded debt to EBITDAR. Many variables should be considered when negotiating these covenants to ensure you can comply, including:
  • Negotiate the exclusion of new debt proceeds received for the construction of a new store or remodel from covenants until the new location is open or the remodel is complete, as the total EBITDAR will not reflect the EBITDAR expected to be contributed from the new or remodeled store.
  • Negotiate the definition of what income taxes may be excluded as there are many state taxes that may not be characterized as an income tax but rather as gross receipts or business use tax. Determine whether these other state taxes can be excluded.
  • Negotiate the definition of non-recurring charges to exclude such items as pre-opening expenses, impairment charges or losses from discontinued operations. Ensure these items are clearly defined in the agreement.
  • Negotiate the definition of rent to back out the non-cash portion representing the straight-line adjustment and tenant improvement allowance accretion required by GAAP. Rent should be reflective of the cash paid out.
Most lenders also will require a personal guarantee on the debt if the amount of equity is not significant or a limited history exists. A personal guarantee puts the individual’s personal assets at risk should the business not succeed and the underlying sale of assets fails to cover the debt owed. This risk can be mitigated through personal guarantee insurance, which may allow the guarantor to insure up to 70 percent of potential liability should the lender require the guarantor to make the debt obligation whole.

Debt negotiations can be difficult and time consuming; however, energy exerted upfront to clearly spell out the expectations and variables included in the financial covenant calculation can save significant time and money down the road, and allow you to focus on the growth of the company instead of continually negotiating with the lender to get back in compliance with the debt agreement.
 
Dustin Minton is an audit partner and co-leader of BDO’s Restaurant Practice. He can be reached at dminton@bdo.com
 

For more information on BDO USA’s service offerings to the restaurant industry, please contact:
 
Adam Berebitsky
Tax Partner and Co-Leader of the Restaurant Practice
   Dustin Minton
Assurance Partner and Co-Leader of the Restaurant Practice

 
Dana Zukofsky
Director