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DENVER –Quiznos, the franchise chain famous for its toasted sandwiches, announced just past noon today that it has filed for voluntary Chapter 11 bankruptcy protection.
Quiznos falling systemwide sales shrank to such a level that the franchisor was unable to pay the interest on its $570 million in debt. This came just two years after the troubled system skirted bankruptcy – in 2012 creditor Avenue Capital Group, which focuses on distressed company investments, emerged as majority owner in a restructuring of $860 million in unpayable debt that was chiseled down to $570 million and swapped for an equity deal for the cash-poor franchisor. Senior lenders have now voted overwhelmingly in favor of a "pre-packaged" restructuring plan that will reduce Quiznos' debt by more than $400 million. In order to implement this pre-packaged plan, Quiznos today voluntarily filed to reorganize under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court in Wilmington, Delaware.
Quiznos franchise owners first learned of their franchisor's bankruptcy when the company issued a press release just minutes ago. A teleconference call has just been announced for franchise owners at 1:30 p.m. EST.
The asset-light franchisor, with nearly 100 percent of its restaurants franchised, had built a franchise system of some 5,100 U.S. restaurants by 2006. Those were the heady days in which there was brazen talk that one day Quiznos sandwich shops might challenge the very supremacy of Subway, with its 27,000 U.S. franchise locations. The problem was that the franchisor, with few units of its own, seemed to lose touch in understanding its strengths and hearing what the market and its stores needed. Quiznos units started to dwindle as complaints of franchise churning began to emerge and lawsuits exploded. The company brought in a "dream team" of some of the industry's brightest executives, anticipating that they would prepare the franchisor for an initial public offering. But all the king's horses and all the king's men could not put this firm back on the road to prosperity again. The toasted hoagie sandwich shop rapidly imploded to some 1,200* U.S. franchises today. Hundreds of those numbers are nontraditional units at Hess gas station convenience stores.
Franchise owners, analysts and insiders have explained to Blue MauMau that at the heart of the chain's problem is the poor economics of making a Quiznos sandwich shop run profitably. Franchise owners say store costs are too high. They estimate that it has high product markups of 30 percent or more. They argue that the franchisor's wholly-owned supply management subsidiary, American Food Distributors, has taken too heavy of a toll from the shops' bottom line, essentially killing the goose that laid the golden egg. After years of litigation, the Quiznos Franchisee Association was created as a result of one of the most expensive settlements with franchisees in restaurant history, valued at $206 million. The representative body for the chain's largely mom-and-pop franchise owners has pleaded in vain with Quiznos and its parent company Avenue Capital to forsake their vendor kickbacks and set up a franchisee purchasing cooperative similar to competitor Subway and its Independent Purchasing Cooperative. There franchised store owners, not the franchisor, own and direct the system's product purchases, product distribution and supply chain management. That eliminates kickbacks to the franchisor at the expense of franchisees and shrinks store cost of goods as it provides cost transparency to franchise owners.
For years that franchisee message has gone unheeded by the franchisor. Quiznos likely needed every bit of cash it could obtain if it were to pay its debts and bills. Meanwhile, its franchise units continued to dwindle as franchise owners struggled to sell or even give away what was left of their restaurants.
"The actions we are taking are intended to enable Quiznos to reduce our debt, execute a comprehensive plan to further enhance the customer experience, elevate the profile of the brand and help increase sales and profits for our franchise owners," said Stuart K. Mathis, Quiznos chief executive officer. "We look forward to continuing to work with and support our global network of franchise owners, who are the backbone of our business." The franchisor points out that the independently owned sandwich shops that dot the country's 50 states are not part of the Quiznos bankruptcy.
What does the insolvency of Quiznos and the franchisor's attempt to return to profitability mean to the franchise owners currently operating restaurants under the brand?
Franchisee attorney Carmen Caruso of Chicago-based law firm Caruso & Roeder LLC thinks the franchisor's crisis may actually be an opportunity for franchise owners. Their franchisee association could give them a seat at the table if played right. "Although no franchisee wants to see its franchisor fail, the silver lining in this cloud is that the filing of the bankruptcy is likely to give the franchisees and their association a substantial increase in their leverage to either cut a better deal with the debtor or the trustee, if one is appointed, or possibly to break away from the failed system under the auspices of the court."
Some bewildered and hurting Quiznos franchise owners are pondering whether they should shutter their stores and withhold royalty payments to Quiznos, despite the danger of such activities breaching the terms of their franchise contracts. There is also the danger of customer visits significantly dropping as news of the bankruptcy spreads to the sandwich eating crowd. Avenue Capital will likely use its current public relations firm Crossroads to handle the crisis and soothe customers. The sandwich shop chain has worked with a string of public relations firms one after another in hopes of calming the waters of public perception during tough times – the present Crossroads, the earlier Coltrin & Associates, and Shift and Ogilvy Public Relations further back.
Franchisee attorney Caruso explains how current lawsuits from franchisees against the franchisor could be affected by the bankruptcy. "All of the lawsuits pending in the United States are, of course, subject to the automatic stay provisions in the bankruptcy code, meaning that the bankruptcy court judge will have to decide if and when these cases can proceed," says Caruso.
Quiznos has received a commitment for $15 million in debtor-in-possession ("DIP") financing from its senior lenders, which, subject to court approval, will be available to support its ongoing operations during the Chapter 11 proceedings. The company's distribution centers are open and fulfilling orders, and Quiznos has been in touch with its key suppliers to help ensure that products will continue to be delivered to franchisees in a timely fashion. Because the company has already received the requisite approvals for its pre-packaged restructuring plan from the necessary creditor groups, it expects to execute the plan and emerge from the court-supervised process on an accelerated basis.
*Note: This is Blue MauMau's best guess. The 1,200 stores is estimated from a Quiznos press release from its public relations firm Crossroads on February 28. Its 2013 franchise disclosure document has not yet been published. Its 2012 FDD numbers published in March of 2013 show roughly 2,000 units in the United States.