Friendly Ice Cream's Retro Action

With debt trimmed and comps rising, it's back to the future at Friendly's.

By David Farkas, Senior Editor -- Chain Leader, 4/1/2003

Friendly Ice Cream Corp. CEO John Cutter (r.) and CFO Paul Hoagland.

When a visitor at Friendly Ice Cream Corp. headquarters muses that the aging restaurant company was likely The Cheesecake Factory of its time, CEO John Cutter responds enthusiastically, “Absolutely! And it can be again.” To be sure, the 549-unit family-dining chain has remained justly famous for creamy desserts and savory sandwich melts since its founding in 1935. In contrast, 25-year-old Cheesecake Factory, which operates 61 restaurants, is a mere upstart. But shares of CAKE currently trade at 30 times earnings, light years ahead of FRN’s meager multiple of 9.

“The market needs to see two things before we’re going to get a higher multiple,” Cutter says, sounding more restrained. “One is consistent earnings growth from quarter to quarter to quarter. The other is top-line growth.”

Achieving both has been his goal since joining Friendly’s as president and COO in 1999. But it wasn’t a priority until last year, when the company rolled out new a remodel program, new menu items and a slew of family-focused TV and radio ads. That was when Wilbraham, Mass.-based Friendly’s emerged from a period of retrenchment.

During that time, the 58-year-old executive shuttered 150 underperforming units and fired staff. The company used the proceeds to pay down debt that, besides squeezing profits, restricted its ability to update restaurants and improve operations.

Meanwhile, Cutter and CFO Paul Hoagland, 50, struggled to refinance some $264 million in outstanding debt. It was a grueling and time-consuming process, the officials concede, but it eventually paid off by allowing Friendly’s to escape covenants that were severely limiting capital spending. “There was a lot of stuff we had to get done before we could go after growth,” says Cutter, who got his start in restaurants with Saga Corp. after graduating from Stanford University.

“Recapitalization was critical,” declares analyst Andrew Ebersole of KDP Investment Advisors, who follows the company. “It took a long time, and they executed a number of transactions, but once they accomplished [the refinancing], operations began to stabilize.”

Fighting the Good Fight
With debt since trimmed, Cutter and Hoagland are confident the $233 million Friendly’s still owes banks and bondholders will no longer hamper their objectives: driving sales and earnings. “Refinancing doesn’t ever free you of covenants, but we are performing so well now, they are not an issue,” Cutter says.

All things considered, last year was a good one for the company. All-important same-store sales climbed a respectable 6 percent, dragged down only by a weak fourth quarter (1.5 percent). In all, the company’s 389 restaurants have scored eight consecutive quarters of comparable gains. Cutter claims franchisees, who control 160 outposts, have done even better, though Friendly’s doesn’t release the numbers.

The rise in comparables drove up earnings, from 50 cents to 84 cents per share in ’02. Positive comps have pleased investors, who’ve boosted Friendly’s stock 192 percent over the last two years. By that metric, Friendly’s is way ahead of The Cheesecake Factory (up 14 percent) and other industry high fliers.

Good as those results are, Friendly’s still must scrap for every customer given a bleak economy, persistent competition and declining traffic counts among family-style restaurants. According to NPD Foodworld, consumer demand dipped 3 percent last year for the category.

Worse yet, management can’t count on development to help pull it through rough times. Friendly’s is opening just two corporate restaurants this year, franchisees a half dozen. It still needs 20 to 30 new units, for example, to make TV advertising worthwhile in the lucrative New York-Pennsylvania DMA. Four franchise units will open there this year.

An Old New Look
Instead of opening new units, Cutter is pouring money from the recap, about $34 million, into a new remodeling program. He expects to update 60 to 70 units this year and in each of the following years until the system is completed; 36 were overhauled in ’02. He’s also produced a campaign of sentimental commercials aimed at the heartstrings of moderate and heavy users to remind them to come back as soon as possible. Plans to ramp up company-store growth will remain on hold for another year or so.

Cutter, who was appointed CEO in February, set about transforming existing restaurants after research showed customers wanted Friendly’s to return to its heritage. He hired Chicago-based Aumiller Youngquist, whose back-to-the-future design helped raise weekly comparable sales 9 percent in remodeled restaurants.

Principal Bill Aumiller remembers seeing a chain in conceptual disarray. “Over the years Friendly’s had responded to a lot of market trends. We tried to take them back to their roots,” recalls the designer, who was given a per-unit budget of about $170,000. The chain’s latest remodeled restaurants resembled living rooms, replete with carpeting, valances, fireplaces, ceramics and print wallpaper.

The retro interiors of the remodeled units contrast sharply with Friendly’s current look. “I had trouble with it,” Cutter admits. “It was so dramatically different that initially it was a shock. As you live with it, you warm up to it and understand it.”

Counter Points
Aumiller Youngquist created an adult-oriented soda fountain, featuring a counter with stools, black-and-white tile floors, dark wood dividers between booths, beige tabletops and walls painted in soft ice-cream colors. Outside, the look is classic New England: a cupola with widow’s walk, deep red awnings and unpainted brickwork. In a way it was a homage to founders S. Prestly and Curtis Blake, who had opened a counter-service shop on Boston Road in Springfield, Mass., 68 years ago.

The designers also moved the busy walk-up window to the side of the building after focus groups griped about it. “At the window you were looking down prep aisles and at the floor. The customer experience no longer felt like a soda fountain,” Aumiller says. Moving the window to one side solved another problem: The restaurant didn’t look as if there were a long wait to customers driving past.

A more upscale decor might also lure adult couples at dinner who are not necessarily there to order ice cream. Industrywide, the supper daypart has been growing recently, and last year it was the only one to show traffic growth (1 percent), says NPD Foodworld. Friendly’s R&D meanwhile whipped up a new line of dishes, called American Classics, to help snag diners. Comfort foods—Yankee Pot Roast and Country Fried Steak (both $8.49), for example—were on the menu this winter. To top them off, the meals were bundled with a free hot fudge sundae. This month, the company begins promoting its signature SuperMelts.

Dad Ad
Despite the emphasis on adult-style grub, families with kids continue to be the focus of Friendly’s TV and radio spots, which air in 16 DMAs. The current batch, created by Chicago-based Laughlin/Constable, play up togetherness. The tagline is “You and me and Friendly’s.”

“Our positioning is really kind of a formula,” Cutter explains. “Friendly’s equals ice cream, burgers and melts equals families with kids equals good times and good memories.” He reasons that with 68 years of history, Friendly’s is part of many people’s lives; hence, there are strong emotional ties to the brand.

The ads play up the connection in ways that make a visit to the chain seem almost routine. The 30-second commercials show stereotypical typical family situations, all of which culminate in a visit to Friendly’s. One particularly moving example is of a young father attending a school open house. While there, he discovers drawings on a board that reads, “What I Want To Be When I Grow Up.” His son has scrawled “Dad” on his. Cut to eight seconds of food before returning to smiling father and son now at Friendly’s.

“When the economy gets tough or the environment is uncertain like it is now, Friendly’s offers stability. We are positioned to take advantage of that,” Cutter says.

Fingers Crossed
Whether that will be enough to keep up the momentum remains a big question. Ebersole predicts comparable sales will likely drop into the 2 percent to 3 percent range this year, figuring last year’s comparisons are simply too tough to maintain in such an unstable economic environment. In fact, Cutter alluded to recent soft sales in a Feb. 26 conference call. He blamed bad weather. Profits may therefore be harder to come by.

Ebersole adds that EBITDA, $60 million in ’02, will grow by about $1 million by the end of this year.

A big variable is cream, the major ingredient in ice cream, which accounts for 8 percent of costs and 35 percent of total sales. In 1999 the per-pound price of cream rose to historic levels, and analysts downgraded Friendly’s shares as earnings were rocked. Prices climbed again in 2001, though management hedged with option agreements.

“We’re getting smarter as we learn to deal with cream,” Hoagland says. “Last year we started building an [ice cream] inventory of four to six weeks. We also buy option agreements that allow us to protect pricing.” He says the company can still be profitable if the price goes up to $1.25, but not more. That hasn’t been an issue so far this year, as cream has been near historic lows ($1.09 a pound in early March).

Cutter says ice cream is decreasing as a percentage of sales in the restaurants, a smart strategy given Friendly’s vulnerability on the cream side. “It’s still a key component,” he says. “But if we were just in the ice-cream business we wouldn’t be here today.” Note to R&D: Lay off the banana splits.