🍴Declining Restaurant Trends Ripple Through (Short Dinnerware)🍴

There are a number of trends that are taking hold currently that may be disruptive to a company that manufactures and distributes glass tableware (i.e., shot glasses, tumblers, stemware, mugs, bowls, etc.) and ceramic dinnerware products (i.e., servicing utensils and trays) to food service distributors, mass merchants, department stores, retail distributors, houseware stores, breweries and other end users of glass container products. First, people don’t go to department stores or houseware stores anymore (in case you hadn’t heard, check out the stock performance of every department store in the US and, for good measure, Bed Bath & Beyond ($BBBY)). Second, millennials aren’t drinking as much as Generation Z did. Third, people are ordering food more frequently and cooking and hosting dinner parties far less often than they did prior to VC-subsidized companies like UberEats ($UBER), Postmates and Caviar coming along. Indeed, per the company’s most recent report:

In U.S. foodservice, restaurant traffic for Q3 as reported by Black Box was down 3.6% compared to down 1.3% in Q3 of 2018.

All of these things are headwinds to a company like Libbey Glass ($LBY), an Ohio-based company founded in 1888. The longevity of the business is uber-impressive, but the year is currently 2019, and sh*t is unforgiving out there: Libbey is starting to look a bit troubled.

The company reported Q2 numbers back in August and revenue was down across all segments: food service and retail. The company cited “intense global competition” and trade headwinds (in both Mexico and China) as major factors. Net sales were $206.2mm, down 3.5% YOY, and the company reported a net loss of $43.8mm in the quarter (primarily due to a non-cash impairment charge). Notably, business was particularly bad in EMEA: $5.5mm decline. It was the second straight quarter where the business performed poorly on a year-over-year basis.

On the August 1 earnings call, the company noted:

“We do…continue to see declines in U.S. & Canada foodservice traffic, as has been reported by third-party research firms Knapp-Track and Blackbox every quarter since 2012. Our U.S. & Canada foodservice channel is currently performing in-line with market trends. Management expects these trends, and the challenging environment experienced during 2018 and the first half of 2019, to continue for the remainder of the year.”

In particular, one disturbing trend is takeout and delivery:

While this channel continues to adapt to the new norm of takeout and delivery, we've seen our focus on new products and differentiated service begin to pay dividends. In addition to these ongoing efforts, we are adapting our approach and resource deployment to expand into growing and/or underpenetrated segments of the channel, like health care and hospitality. As previously mentioned, we also see a significant opportunity to leverage digital tools to reach end users and further support our distribution partners.

Sure, they did. And they certainly needed to: a quick look at their numbers shows that the second quarter is typically the business’ strongest. This didn’t portend well for Q3 performance.

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🥑#BustedTech: Munchery Filed for Bankruptcy.🥑

Short VC-Backed Hyper-Growth

What kills a business is a lack of cash. What causes a business like meal delivery (kit or prepared) to run out of cash are broken unit economics. Munchery's Chapter 11 reveals they still don't understand the impact of customer churn (inverse of retention) https://t.co/HFi8MIQhAk

— Tren Griffin (@trengriffin) March 6, 2019

We've previously discussed the process of an assignment for the benefit of creditors and posited that, as the private markets increasingly become the public markets, (later stage) "startups" will be more likely to file for chapter 11 than go the ABC route. Our conclusion was based primarily on three factors: (a) a number of these startups would have highly-developed and potentially valuable intellectual property and data, (b) more venture-backed companies have "venture debt" than the market generally recognizes, and (iii) parties involved, whether that's the lenders or the VCs, would want releases with respect to any failure and subsequent chapter 11 bankruptcy filing. Given continuing low — and as of this week, lower — yields and a system awash in capital looking for alternative sources of yield (read: venture capital), there's been a dearth of high profile startup failures of late. And, so, technically, we've been wrong. 

Yet, on February 28th, Munchery Inc. filed for bankruptcy in the Northern District of California (we previously noted the failure here and again here in a broader discussion of what we dubbed, “The Toys R Us Effect”). Munchery was a once-high-flying "tech" company founded in 2011 with the intent of providing freshly prepared meals to consumers. It made and fulfilled orders placed on its own app and also had a meal kit subcription business where customers received weekly kits with recipes and ingredients. Its greatest creation, however, might be its shockingly self-aware first day declaration — a piece of work that functions as a crash course for entrepreneurs on the evolution and subsequent trials and tribulations of a failing startup. 

Interestingly, the meal kit business wasn't part of the original business model. This represented the quintessential startup pivot: originally, the company's model was predicated upon co-cooking (another trend we've previously discussed) where professional chefs would leverage Munchery's kitchens (and, presumably, larger scale) to sell their products directly through Munchery's website and mobile apps. Of late, the co-cooking concept — despite some recent notable failures — has continued to gain traction. Apparently, former Uber CEO, Travis Kalanick, is very active in this space (see CloudKitchens). 

At the time, "food delivery was in its early stages." But local restaurant delivery has exploded ever since: Grub Hub, Seamless, Door Dash, Postmates, Caviar, and Uber Eats are all over this space now. Similarly, in the meal kit space, Blue Apron inc. ($APRN), Plated, Hello Fresh and SunBasket are just four of seemingly gazillions of meal kit services that time-compressed workaholics or parents can order to save time. 

As you can probably imagine, any company worth anything — especially after nearly a decade of operation and tens of millions of venture funding — will have some interesting proprietary technology. Here's the company's description of its tech (apologies in advance for length but it marks the crux of the bankruptcy filing): 

"The team’s early focus was to develop a proprietary technology platform to operate and optimize the entire process of making and delivering fresh food to customers. The technology developed and deployed by the company included: a front-end ecommerce platform, which allowed the company to post items daily and consumers to select, purchase and pay for meals through the company’s website and native apps; the production enterprise resource management (“ERP”) system, which enabled the company to develop and launch new recipes, manage the supply chain for fresh ingredients and supplies, produce the meals through batch cooking, and plate individual meals; the logistics and last-mile platform, which enabled the company to accurately and quickly pack-and-pack individual items and assemble orders using modified hand scanners, distribute orders via a hub-and-spoke system where refrigerated trucks would transport orders to specific zones and hand-off the orders to the assigned drivers; and, a driver app that assisted in managing and routing orders to arrive in the windows specified by customers. All of this was managed through a set of proprietary tracking and administrative tools used by the teams to monitor and mitigate operational issues—and connected to a customer relationship management platform. The team later developed algorithms to optimize the various aspects of the service to scale operations, increase efficiency, and improve the quality of the service. In addition, the company developed over three thousand meal recipes, including descriptions, nutritional information, and photographs. Over the life of the business, the company invested significantly in its technology capabilities, believing that the company’s ability to efficiently scale its operations leveraging technology would be a competitive advantage in the food delivery market."

All of that tech obviously required capital to develop. The company raised $120.7mm in three preferred equity financing rounds between 2013 and 2015. Investors included Menlo Ventures, Sherpa Capital, and E-Ventures. The company also had $11.8mm in venture debt ($8.4mm Comerica Bank and $3.4mm from TriplePoint Venture Growth BDC Corp.). 

The bankruptcy filing illustrates what happens when investors (the board) lose faith in founders and insist upon rejiggering the business to be operationally focused. First, they bring in a new operator and relegate the founders to other positions. With new management as cover, they then cut costs. Here, the new CEO's "first action" was to RIF 30 people from company HQ. Founders generally don't like to lose control and then see friends blown out, and so here, both founders resigned shortly after the RIF. This, in turn, gives the investors more latitude to bring in skilled operators which is precisely what they did.

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What to Make of the Credit Cycle. Part 9. (Long Summer Associate Programs)

Milbank Tweed Gives Summer Associates A Dose of Reality

Welcome to Part 9 of our ongoing series “What to Make of the Credit Cycle.” You can view previous parts here, here, here, here, here, here, here, and here (some paywall, some not…roll the dice).

Around a year ago, a partner at a major law firm shared his view with us that a clear-cut sign of a market top is when biglaw associate salaries go up. Subsequently, per CBS, this happened:

Some lines of work pay more than others. While Americans have largely seen lackluster wage growth during the past year, the roughly 500 associates laboring at Milbank, Tweed, Hadley & McCloy just drew a large bump in pay, putting the law firm at the top of the legal heap in terms of salaries paid to attorneys just starting out.

A spokesperson for the 690-lawyer firm confirmed that it is hiking associate salaries by $10,000 to $15,000, bringing a first-year associate's salary to $190,000. A second-year associate at the firm will now make $200,000, while an eight-year associate will pull in $330,000.

The prior high mark had been set two years ago by Cravath, Swaine & Moore, which upped starting pay by $20,000 to $180,000, an industry standard that was quickly matched by Milbank and multiple other firms.

Not to be over-powered in the ever-feverish stampede for the next generation of, cough, ”legal talent,” multiple firms (got bent and) fell in line, upping associate pay to match (or exceed) Milbank’s salary raise. Count on Abovethelaw for some added color:

Summer 2018 has really been the summer of money for Biglaw associates. Milbank got the party started by finally bringing NY (and its other offices) to $190K. Simpson Thacher upped the ante just two days later by matching the new salary scale and adding in special summer bonuses. And just a few days after that, Cravath reasserted its dominance as the firm that sets the market standard by increasing the standard base salary for senior associates over what was set by Milbank. 

And yet, elsewhere in the broader macroeconomy, economists everywhere are wondering why there are underwhelming wage increases (maybe because corporate legal bills just went up?!? 🤔). Per Forbes:

Wages rose 2.7% from a year earlier in June, below the 2.8% increase economists had expected and the increase may make little difference because inflation is also picking up and could soon outpace wages, meaning many workers have no real increase in buying power.

Bloomberg adds:

There are currently 6.7 million job openings — a record high. And the rate at which workers are quitting their jobs is higher than it was before the onset of the Great Recession. But wage growth is still noticeably slower than many economists and analysts expect (despite all the stories about employers desperate for workers).

Meanwhile, after a 5% salary increase prior to even working for a single (billable) hour, entering Milbank associates be like:

Source: Giphy

(PETITION Note: hopefully those associates don’t ever run the hourly calculation).

Law students looking forward to these new riches need to work hard this summer to ensure that they get an offer at the end of their respective summer associate programs. Indeed, they need to not screw up this:*

Nothing gives a realistic snapshot of life as a biglaw attorney like axe throwing, escape the room(s), the Olympics, cooking classes, and spectacular rooftop views. We’re serious.

Really. We are.

Having the aggressiveness, discipline and vigilance of an Olympic athlete is needed to navigate the halls of a biglaw firm (PETITION Note: sadly, they don’t teach you inter-office politics in law school). Knowing how to throw an axe may actually help lawyers wade through the morass. In fact, if we were associates, we would go on a shopping spree at Best Made and hang some dope-looking axes on the wall to leverage the intimidation factor.

Escape the room? Junior associates will want to do that every Friday evening to avoid the inevitable partner phone call asking for an “urgent!!”memo on some esoteric legal question that more-likely-than-not will NEVER come up. By Monday morning, of course. (Hot PETITION tip: the likelihood of said partner reading that memo on Monday morning — let alone by the end of the following week — is roughly about 1.27%).

Cooking classes? Sh*t. The closest you’ll get to cooking once you’re making that sweet $190k is receiving someone else’s via Seamless, UberEats or Caviar. In the office. Of course.

Rooftop views? Awesome. There’s nothing more lit than having a bird’s eye view to thousands of New Yorkers living their lives eating drinking and being merry while you’re stuck in the office. Those views are a double-edged sword, broheim. Make no mistake about that.

So, again, kudos to Milbank for giving its summer associates a realistic view of practice.

*Milbank “promoted” this tweet, by the way, which means that it wanted the world to know that we’ve once again reached peak-summer-associate. We’re old enough to remember when the earth exploded and summer associate offers were reneged or deferred starting dates. This will end just as well.

Is Delivery Killing Fast Casual Too? (Long Busted Narratives)

Zoe's Kitchen is Latest Restaurant Showing Signs of Trouble

Fast casual is supposed to be a bright spot for restaurants. But as the segment has grown in recent years, there are bound to be winners and losers. Zoe’s Kitchen Inc., a fast casual Mediterranean food chain with 250 locations in 20 states ($ZOES), is increasingly looking like the latter.

Last week the company reported sh*tty earnings. Comp restaurant sales declined by 2.3% despite rising prices pushed on to the consumer. The decline is attributable to the usual array of externalities (e.g., weather) but also location cannibalization. Apparently, the company’s growth strategy is pulling consumers from previously established locations. Moreover, the company noted “inflationary pressures in produce and freight costs, that are expected to impact cost of goods sold for the balance of the year.” Wages also increased 3.3%, an acceleration from the 2.9% realized in Q4 ‘17. Accordingly, adjusted EBITDA decreased 30.9%. The net loss for the quarter was $3.6mm or -$0.19/share. The company lowered guidance. The stock tumbled.

Before you get too excited, note that this is a debt-light company: it currently has a ‘22 $50mm revolving credit facility with JPMorganChase Bank NA, of which $16.5mm is outstanding (with $3.7mm of cash on hand, net debt is only $12.8mm). It also, believe it or not, has covenants — leverage and interest coverage, among others — and the company is in compliance as of April 16, 2018. It also plans to continue its expansion: in the sixteen weeks ended 4/16/18, the company opened 11 company-owned restaurants with a plan to open approximately 25 (inclusive) over the course of fiscal year ‘18. That said, it does intend to rationalize existing locations (and expects some impairment charges as a result), cut G&A and take other operational performance improvement measures to combat its negative trends. There’s a potential opportunity here for low-to-middle-market FAs and real estate advisors.

For our part, we found this bit intriguing (unedited):

We are definitely seen more competitive intrusion, more square footage growth in some of those smaller kind of mid to kind of large markets where we've been there for some time now that's a little bit of what we're seeing in those markets.

We've also seen more competitive catering competition as every ones ramped up catering. And also the value and discounting as we spoke to in the call, in the prepared remarks we've seen that $10 check with that single user kind of moving around and we think that's so from the new competition square footage growth, the value and discounting and then the delivery interruption, we've seen or felt that in many of our markets.

There’s a lot to unpack there. Clearly competition, as we noted upfront, is increasing in the $10-check size cohort of fast casual. Catering is always a competitive business for restaurants like this too. But, the point that really got out attention was that about delivery. The company says pointedly, “We also believe that disruption from delivery and discounting has created headwinds.” The company further states,

Digital comps were 26% positive in Q1 as we leverage improvements from last year's investments in web and mobile platforms to build greater convenience for our guests. Early in Q2, we relaunched and upgraded our loyalty program, which is expected to help drive traffic by making it easier and clearer for our guest to earn and redeem rewards. Delivery sales grew in both our non-catering and catering businesses by 155%. And we have a clear plan to build out the channel for more profitable growth in 2018.

The impact of mobile food ordering and the need for delivery cannot be overstated. Companies need to act fast to activate delivery capabilities that makes sense to a mobile consumer who, more and more, goes to Postmates, Caviar, UberEats and other food delivery services for discovery. This is precisely why Shake Shack ($SHAK) is now on Postmates and Chipotle Mexican Grill Inc. ($CMG) is now available on Doordash. Others, like privately-owned Panera Bread are taking a step farther by building out its own delivery infrastructure in an attempt to own all its data and deliver without owing a cut to a middleman. Query whether this is far too much dependence on the likelihood of people to go directly to Panera’s app when they’re hungry…?

It sounds like the Zoe folks are increasing their focus on delivery. The question is whether they can execute fast enough to offset in-store dining declines. And whether they can do it on their own.