Up for the Challenge
CEO Bob Hartnett has prepared Houlihans to survive economic issues.
By David Farkas, Senior Editor -- Chain Leader, 12/1/2007
 Houlihan’s prototype, which has a $2.2 million price tag, features an upmarket look.
WEB EXCLUSIVE: CEO Bob Hartnett tells how he secured an investment to rebuild Houlihan’s.
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Casual-dining concepts are being doubled-whammied. Macro-economic factors like rising energy prices and falling home values are flattening sales while nearly identical brand formats are sending diners in search of a unique experience.
The danger of that predicament is abundantly clear to Bob Hartnett, who joined Leawood, Kan.-based Houlihan’s Restaurants as chief executive and an owner in late 2002. Hartnett, who had only recently turned around Golden, Colo.-based Einstein Noah Restaurant Group, has since revamped menus, opened 11 new prototypes and added the new design to 30 existing units.
Today, diners nosh on ahi tuna tacos while sipping Brazilian Wax cocktails, a mix of cachaça, orange-flavored liqueur and pineapple juice, in subtly lit dining rooms. It’s a long way from the ’80s-era, clutter-filled eateries that still make up much of the system.
Still, trendiness comes at a price. New Houlihan’s, with their open floor plans, high ceilings and display kitchens, cost $2.2 million for building and FF&E. The amount is justified, Hartnett insists, by the additional $750,000 in sales the new units produce over the system average of $2.8 million.
Until August, comparable sales remained positive at the 90-unit chain, Hartnett says. Since then, they’ve tailed off as headwinds have hampered sales and guest counts throughout the category. "What’s going to happen in the future, I don’t know," he concedes.
Others are confident Houlihan’s can withstand the challenges. "Bob and the team have a handle on things," offers lender Rod Guinn of Wells Fargo Foothill. "They are approaching operations and their financial plan in a way that they will manage through [the challenge]."
Hartnett spoke to Chain Leader in early November about the issues facing the privately held chain and the plan in place to deal with them.
Is the current economic climate causing you to pull back on growth?
No, we are trying to ramp up our growth. We opened about 16 this year; six of them corporate restaurants. Next year, we’re planning on 16 or 17. But we are finding it takes longer to get them open. Two years ago we thought we could do it in a year-and-a-half, but today it’s more like two years. It’s the same thing for our franchise partners.
What’s lengthening the process?
It is not a fact of capital. It’s finding quality sites and permitting. The real-estate process is taking longer than we anticipated.
Describe the ideal site for Houlihan’s.
On the Houlihan’s side, we’re looking to be in power centers with multiple big-box tenants. If we can be on the same site with P.F. Chang’s—that kind of quality restaurant—then that’s where we’d like to be. We need the lunch daypart and evenings and weekends. It’s pretty much the same thing everyone else is looking for.
What do year-to-date comparable sales look like?
We do not give out actual numbers. I can say we’ve had four years of sales that have been from excellent to good by industry averages. I’m comparing them to public companies.
Describe recent sales trends.
We are seeing softness in the last eight weeks that we haven’t seen in the last four years, quite frankly. It is difficult and won’t get any better for the next year to 18 months.
Is it because of gas prices and adjustable rate mortgages?
Oil is a psychological factor. It’s really adjustable rate mortgages. I expect another couple of rounds [of increases] to come. Once those rates adjust, it is going to be hundreds of dollars a month.
Is there a region of the country where sales are dipping faster than in others?
No, not really. We opened our first restaurant in San Antonio six months ago. It’s done very well, and we opened in Dallas about 90 days ago. We have only two restaurants in Texas, and it’s a corporate market.
What do you like about Texas?
I lived there for a long time, so I know the state. I like it because it has a good consumer base. I like the business environment. Tip credit is still $2.13, which makes it much more economical than other states where tip credit is higher. It just has a vibrant economy with consumers.
Where does the brand stand today with consumers?
It really depends on [which era] restaurant you go into. We are a 35-year-old company. We have repositioned from where you might remember it prior to 2001. What you see in Strongsville, Ohio, for example, is the total branding package: food, uniforms, music, menu format and environment. It is the end result of how we repositioned Houlihan’s and what we are building going forward.
But the older restaurants make up the bulk of the system.
In our existing restaurants, which have an ’80s or ’90s feel like a lot of other casual diners, where we really get credit is the quality of the food. It’s a scratch kitchen for the most part. We have a menu with some interesting things and some traditional things. The more interesting things are the ahi tuna tacos. If you are a more traditional eater, there’s traditional casual-dining food on the menu.
Have you used focus groups to discover what customers think of the new prototype?
Last year we did them with customers going into the new prototype and the older [restaurants]. People liked the look and feel of the new place. We have three key elements: a big patio, big bar and a dining room with display cooking. We get all dayparts there because people use the restaurant many different ways.
What else do you get credit for?
Universally people like the food. If we get any kind of negative feedback from an experiential viewpoint—and I don’t want this to sound wrong—it is around service. When we stumble, we typically stumble in the service arena and not the food arena.
Have brand icons changed?
What we really changed is the personality of the brand to something that probably didn’t exist before. Now there’s a real sense of irreverence and sophisticated humor, for example, in the way we describe the wine and food on the menu.
What existed before?
How I can say this? It was kind of bland. Houlihan’s had always been known for having scratch cooking and interesting food, but [the brand] needed to be reawakened.
What have you changed?
One difference is the way we treated the ceiling. We changed some colors and we lowered the walls so the people on the elevated piece could see all the way to the bar. Last week in Dallas we were going through lighting to get exactly the right feel when the sun goes down.
Are enough prototypes open to accurately predict the investment?
Pretty much. It depends on whether it’s a union or non-union market. Non-union, it ranges from about $2 million to $2.2 million for building and FF&E. That’s curb-in with no site work involved.
What’s the system average sales volume?
It’s roughly $2.8 million to $2.9 million. The prototypes are averaging $750,000 above the average store base. Even fully capitalized with the lease we are above 1 times on a sales-to-investment ratio basis.
Speaking of investments, I’d like to know more about your approach to the balance sheet.
After taking two companies out of bankruptcy, it is pretty conservative. There’s always temptation to lever a company up or to grow at a rate to beat competition. You will not always deploy capital the right way, and you can’t avoid making a few mistakes along the way. But you’ve got to make sure the mistakes are more like stubbing your toe instead of something that puts you in the hospital.
What was the capital structure after Houlihan’s emerged from bankruptcy in 2002?
The five banks [that controlled the company] converted their debt into a $30 million preferred equity, which had a "pick" to it. There was also $12 million in term debt. We [management] bought 51 percent of the common equity from the bank group.
And the debt picture?
Over the years we got rid of the term debt. The preferred continued to accrete, and Goldner Hawn came in and bought all of it from the banks with the exception of GE. The equity attached to the preferred—the 49 percent that we didn’t own. The recap effectively converted that preferred into common stock, which retired the preferred and turned it all into equity.
Did the management team take money off the table?
No, we had no desire to. What we really wanted to do was get a more traditional capital structure and a balance sheet that made sense. And to bring on a partner that could help us to grow. We kicked some options around at the time, however.
What’s the company’s capital structure look like now?
We have $15 million term debt on our company today, and our coverages are significantly better than that. We have a revolver when we need it. But we are really growing out of our internally generated cash flow.
How is company ownership divvied up?
On a fully diluted basis, Goldner Hawn is probably at 70 percent. Management has 25 percent and GE Finance has the difference.
When did Goldner Hawn step in?
About a year ago. [Management] had built up equity value prior to Goldner Hawn coming on board. We now had real incentive to grow equity and protect what we built. It’s not like we got a bunch of options and said, "Let’s just roll the dice and see what happens. If it doesn’t work, it’s someone else’s problem because it’s not our money."
How did you determine the appropriate mix of debt and equity?
We were looking for a balance sheet to allow us to grow at a reasonable rate and not put us in a position where, if the economy or we stumbled, we’d be in trouble. That helps because you’re so far out on lease commitments these days. We were looking [to operate] a low-leverage company that wouldn’t keep us awake at night. Instead, we could stay awake thinking about how to grow the business.
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