Equity Analysis & Valuation - Mark E. Moore

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Equity Analysis & Valuation

Analysts David Barr - [email protected] Mario Santos - [email protected]

Trent Fell - [email protected] Sean DePriest - [email protected]

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Table of Contents Executive Summary for Cracker Barrel Inc.…………………………………………….……..9 Industry Summary……………………………………………………………………………11 Accounting Summary………………………………………………………………………..13 Financial Summary……………………………………………………………………………14 Valuation Summary…………………………………………………………………………..16 Overview of Cracker Barrel…………………………………………………………………………..17 Industry Overview……………………………………………………………………………………….20 Five Forces……….…………………………………………………………………………………….….22 Rivalry Among Existing Firms……………………………………………………………..23 Industry Growth………………………………………………………………………24 Industry Concentration……….……………………………………………………29 Degree of Differentiation………………………………………………………….32 Switching Costs………………………………………………………………….…...32 Economies of Scale………………………………………………………………....33 Fixed-Variable Costs………………………………………………………………...35 Excess Capacity and Exit Barriers…………………………….…………….....36 Conclusion…………………………………………………………………………….…37 Threat of New Entrants………………………………………………………………….…..37 Scale of Economies.............................................................….....38 First Mover Advantage………………………………………..……………………39 Relationships/Distribution Access………………………………………………39 Legal Barriers………………………………………………………………………….40 Conclusion………………………………………………………………………………41

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Threat of Substitute Products..……………………………………………………………41 Relative Price and Performance…………………………………………………42 Buyer‟s Willingness to Switch…………………………………………………….42 Conclusion………………………………………………………………………………44 Bargaining Power of Customers…………………………………………………………..44 Switching Costs………………………………………………………………………..45 Differentiation………………………………………………………………………....46 Importance of Product for Costs and Quality……………………………....47 Number of Customers..………………………………………………………….….48 Volume Per Buyer……………………………………………………………….…...49 Conclusion…………………………………………………………………………….…50 Bargaining Power of Suppliers………………………………………………………….….50 Switching Costs…………………………………………………………………….….51 Differentiation……………………………………………………………………….…51 Importance of Product for Cost and Quality…………………………..…...52 Number of Suppliers………………..………………………………………….……52 Volume Per Supplier…………………………………………………………….…..53 Conclusion…………………………………………………………………………….…54 Five Forces Conclusion ……………………………………………………………………….54 Key Success Factors for Value Creation………………………………………………..55 Cost Leadership………………………………………………………………………..56 Economies of Scale and Low Input Costs……………………….…56 Efficient Production and Simpler Product Designs………………56 Differentiation………………………………………………………………………....57

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Superior Product Quality, Variety, and Customer Service…….57 Investment in Brand Image……………………………………………..58 Firm Competitive Advantage Analysis……………………………………………………59 Efficient Production & Economies of Scale………………………………..…59 Simple Product Designs…………………………………………………………….60 Low Cost Distribution.……………………….……………………………………..60 Superior Product Quality……………………………………………………………61 Investment In Brand Image………………………………………………………61 Superior Product Variety & Flexible Delivery..………………………………62 Superior Customer Service…………………………………………………………63 Conclusion…………………………………………………………………………………………63 Accounting Analysis…………………………………………………………………………….……..63 Type 1 Key Accounting Policies……………………………………………………..…..66 Superior Product Variety……………………………………………….…………66 Investment in Brand Image………………………………………………………67 Efficient Production Methods…………………………………………………….69 Type 2 Key Accounting Policies………………………………………….……………….70 Operating Leases……………………………………………………………………..70 Potential Accounting Flexibility…………………………………………………………………….72 Operating Leases……………………………………………………………………….………72 Actual Accounting Strategy……….………………………………………………………….………73 Operating Leases……………………………………………………………………………….74 Quality of Disclosure…………………………………………………………………………………....75 Introduction……………………………………………………………………………………...75

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Type 1 Accounting Policies…………………………………………..…….………..……....75 Superior Customer Service/Product Quality……………….………..…..……75 Superior Product Variety…………………………………………………..………...76 Low Cost Distribution/Flexible Delivery....................................….....76 Sales Manipulation Diagnostics..……………………………………………………………77 Net Sales/Cash From Sales………………………………………….………………77 Net Sales/Accounts Receivable…………………………………………………….79 Net Sales/Unearned Revenue……………………………….………………………82 Net Sales/Inventory……………………………………………………..……………..83 Conclusion…………………………………………………………..……………………..85 Expense Manipulation Diagnostics…………………………….…………………………....86 Asset Turnover…………………………………………………………………………....86 Cash Flow From Operations/Operating Income………………..………….….90 Cash Flow From Operations/ Net Operating Assets…………………….…...91 Total Accruals/Sales……………………………………………………..…………….…95 Conclusion…………………………………………………………….………………….….96 Potential Red Flags……………………………………………………………….……………………….….97 Operating Leases………………………………………….……………………………………...…97 Cash Flow From Operations………………………………………………….………………....98 Undo Accounting Distortions………………..……………….………………………………….…..……98 Operating Leases………………………………………………………………………………..…..98 Trial Balance………………………………………….…………………………………….…..….…103 Financial Ratio Analysis, Financial Forecasting, and Cost of Capital Estimation………...107 Financial Ratio Analysis…………………………………………………………….………………….…...107

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Liquidity Ratios………………………………………………………………………………..……..108 Current Ratio……………………………………………….……….………………………108 Quick Asset Ratio……………………………………………....…………………………110 Working Capital Turnover………………………….……………………………………112 Accounts Receivable Turnover…………………………………….…….……………113 Days Sales Outstanding…………………………………………………………….……115 Inventory Turnover…………………………………………………..……………………116 Days Supply of Inventory……………………………………………………….………118 Cash to Cash Cycle……………………………………………..…...……………………120 Conclusion……….……………………………………….……………………………….…121 Profitability Ratio Analysis………………………………………………………….………………………122 Gross Profit Margin..……………………………………………………………….………………123 Operating Profit Margin…………………………………………………..………………………124 Net Profit Margin…………………………………….………………………………………………125 Asset Turnover……………………………………………………..…………..…….……………..126 Return on Assets……………….…………………………………………………………….……..128 Return on Equity…………………………………………….………….……………………………129 Conclusion...........................................................................................…...130 Capital Structure Ratios…………………………………………………….…………………..………….131 Debt to Equity………………………………………………………………………………..………131 Times Interest Earned..……………………………..……………………………………………133 Debt Service Margin…………………………………………….…………………….……………134 Altman‟s Z-Score………………………………………………………………….…………………136 Conclusion……………………………………………………………….……….……………………138

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Firm Growth Ratios…………………………………………………………………………………………..139 Internal Growth Rate………………………………………..……………..……………………..140 Sustainable Growth Rate……………………………………………………………….…..……141 Conclusion……………………………………………………………………………………………...142 Financial Statement Forecasting…………….……………………………………………..……………142 Forecasted Income Statement…………………………….……………………………………143 Forecasted Restated Income Statement………………..…………………….…………….149 Forecasted Balance Sheet………………………………………………………………………..153 Forecasted Restated Balance Sheet………………..………………………………………..157 Forecasted Statement of Cash Flows……………………………………………….…….….160 Estimating cost of Capital……………………………………………………….…………..…………….163 Cost of Equity…………………………………………………………………….…………………..163 Size Adjusted Cost of Equity………………………………….……….………………………..167 Alternative Cost of Equity Estimation…………………….………………………….………167 Cost of Debt………………………………………………….………………………………………..168 Weighted Average Cost of Capital………………..……….……….…………………………171 Valuation Analysis……………………………………………………..…………………………..…………174 Method of Comparables…………………………………………………………………………..174 Trailing Price/Earnings (P/E)………………..……………..…….…………………..175 Forecasted P/E…………………………………………….………………………….……176 Price/Book (P/B)…………………………………………………..……………………...177 Dividends/Price (D/P)….……………………………………………..…………………178 Price Earnings Growth…………………………….………………….…………………179 Price/EBITDA………………..…………………….……………………………………….180

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Price/Free Cash Flow…………………………………………………..……………..181 Enterprise Value/EBTIDA………………..………………………..………………..183 Conclusion……………………………………………….…….…….…………………..184 Intrinsic Valuation Models……………………………………….…...………..…………….184 Discounted Dividends Valuation………………………..…….…………………..185 Discounted Free Cash Flows…………………………….…….……….…………..187 Residual Income…………………….…………………………………….…….………189 Abnormal Earnings Growth……………………………………………………………192 Long Run Return on Equity Residual Income………………..……….……….195 Analyst Recommendation……………………………………………………………………….199 Appendices …………………………………………………………………………………………………….202 Liquidity Ratios………………………………………………………………………………………202 Profitability Ratios……………………………………………………………………………………204 Capital Structure Ratios……………………………………………………………………………206 Operating Leases Restated Financial Statements………………………………………..208 Regression Analysis…………………………………………………………………….…………..210 Method of Comparables…………………………………………………………………………..225 Intrinsic Valuation Models………………………………………….…………………………….227 Works Cited……………………………………………………………………..………………………………235

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Executive Summary for Cracker Barrel

Investor Recommendation: Overvalued, SELL (11/2/09) CBRL-NYSE (11/2/2009) 32.74 52 Wk Range Revenue Market Cap. Shares Outstanding

Current Market Share Price (11/2/2009) 32.74

$11.64-$36.60 2.37 Billion 743.9 Million 22.72 Million As Stated Restated

Book Value Per Share Return on Equity Return on Assets

$5.97 71.08% 5.02%

$5.53 66.70% 3.42%

Financial Based Valuations As Stated Restated Trailing P/E 36.42 31.03 Forward P/E 31.32 26.06 Price to Book 15.9 14.74 P.E.G Ratio 30.9 13.31 Price to EBITDA 33.02 27.25 EV/EBITDA 4.13 -23.8 Price to FCF 32.57 Dividends to Price 26.67 26.67

Cost of Capital Estimated 3 Month 1 Year 2 Year 5 Year 10 Year Published Beta Estimated Beta Backdoor Cost of Cap: Backdoor Cost of Equity: Cost of Debt WACC (BT):

RSquared 0.1745 0.1747 0.1747 0.1736 0.1731 0.89 0.98 10.30% 11.27% 5.42% 10.30%

Beta

Ke

1.522 0.9842 0.9847 0.981 0.9787

0.1128 0.1127 0.1128 0.1125 0.1123

Intrinsic Valuations

Discounted Dividends Free Cash Flows Residual Income Abnormal Earnings Growth Long Run Residual Income

As Restated Stated 18.26 76.24 19.07 16.59 22.71 20.11 7.68 7.47

Altman Z-Score Initial Scores Revised Scores

2005 4.09 2.83

2006 2.66 1.92

2007 2.74 1.95

2008 2.64 1.97

2009 2.8 1.95

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Industry Summary Cracker Barrel Old Country Store, Inc. specifies itself in the casual dining sector of the restaurant industry. The company operates within two separate industries which helps aid it in surviving in a highly competitive market. Cracker Barrel‟s restaurant services make up eighty percent of its revenues and the remaining twenty percent is delegated to sales from the retail store within the restaurants. Cracker Barrel‟s financials have been negatively affected due to the recent recession, however the firm has not made any drastic efforts to change the business or its strategy. The company has maintained consistent with its strategy because it operates within a highly differentiated niche of the restaurant industry. Cracker Barrel competes with five other firms which include Brinker International, Bob Evans Farms, Inc., Darden Restaurants, Inc., Denny‟s Corporation, and DineEquity, Inc. Competitive Force

Degree of Competition

Rivalry Among Existing Firms

High

Threat of New Entrants

High

Threat of Substitute Products

High

Bargaining Power of Customers

High

Bargaining Power of Suppliers

Low

The casual dining industry is a highly competitive market similar to all other restaurant business niches. Even though the restaurant industry is so highly saturated, new businesses are always arising. This is due to such a large demand for restaurant services and creative strategies developed by new entrants. In addition, large casual dining companies must also compete with local businesses. Between choosing direct

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competitors, local fare, and eating at home, consumers have a wide variety of options when it comes to food. Not only do companies in the industry have to worry about the other firms they directly compete with, they must also deal with several consumer trends such as the recent shift towards healthier dining choices. This massive healthy eating trend, which has been in effect for several years, coupled with the recent recessionary period has caused many restaurants to add more healthy options to their menus as well as lower prices. What this implies is that consumers have a high bargaining power and greatly influence the items on the menu and the price for these items. One area in which the casual dining industry does have some bargaining power is with suppliers. There are many suppliers of food and because of this many restaurant companies engage in hedging activities that allow them to purchase goods at lower prices. In addition with the large bulk orders these companies must make, suppliers give discounts for purchasing their goods. Firms become price makers because of the numerous methods they can employ to save money when purchasing goods. While operating within the casual dining industry, it is crucial to enlist both a differentiation approach and a cost leadership approach in company business strategies. Because of this there are many key success factors in which competitors in the industry can procure. In the cost leadership bracket firms can make use of economies of scale, low input costs, simpler product designs, and efficient production. All of these strategies are designed in order to cut any unnecessary spending. Under the differentiation approach competitors in this industry can make use of investment in brand image, superior product quality, variety, and customer service. Where as cost leadership is designed to cut spending these traditionally promote additional spending to set companies apart. As mentioned earlier, casual dining competitors must operate under both a differentiation approach and a cost leadership approach to create competitive advantages. Cracker Barrel is no different when it comes to making use of the key success factors listed above. Some of the methods in which the company achieves their

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success factors may be different, but for the most part the strategies in this industry are very similar. Accounting Summary Companies utilize several methods in which accountants distort their real performance therefore the purpose of the accounting analysis is to identify any potential distortions of value. There are several steps that must be taken to properly assess any distortions. First, the type 1 and type 2 Key Accounting Policies need to be identified. The type 1 KAPs directly correlate with the identified Key Success Factors which drive value where as the type 2 KAPs recognize any items in which accountants are allowed flexibility in reporting. Next, the quality of disclosure in the firm‟s annual reports needs to be assessed. This is done by means of a qualitative and quantitative analysis. The qualitative analysis is an opinion based analysis which states our opinion of the level of disclosure in regards to Key Accounting Policies. The quantitative analysis on the other hand is based off of reported data. Revenue manipulation and expense manipulation diagnostic ratios are performed to properly analyze if there are any potential distortions or “red flags” in financial data. The last step included in the accounting analysis is to undo any accounting distortions. To do this, a trial balance sheet needs to be created by taking the annual reported balance sheet data and adding back operating leases, goodwill, and research and development. The purpose of creating a trial balance sheet and adding back these items is to view the company with the additional assets, liabilities, and owner‟s equity initially avoided. Cracker Barrel is a high disclosure company when it comes to information regarding its questionable key accounting policies. There was only one key accounting policy identified that we needed to adjust which was operating leases. We found that 99.9% of all reported leases are operating leases. This rate is exceedingly high for this industry and restating these operating leases as capital leases was necessary to properly value Cracker Barrel. In this section, we break down how we capitalized these operating leases. 13

Financial Summary The purpose of financial analysis is to evaluate the performance of a company by comparing it to industry averages. Ratio analysis allows analysts to compare ratios of a company over numerous years and to ratios of similar firms in an industry.1 When a company‟s ratios are compared to those of industry competitors it allows analysts to evaluate a firm‟s strengths and weaknesses. The three types of ratios that will be used in this analysis are liquidity, profitability, and capital structure. Liquidity ratios measure a company‟s ability to meet its liability obligations in the short run. Banks and creditors also use these ratios to determine if a firm is risky, or in other words able to cover their obligations with their assets. In our financial analysis we used the following liquidity ratios: current ratio, quick asset ratio, working capital turnover, day‟s supply of inventory, receivables turnover, day‟s sales outstanding, inventory turnover ratio and cash-to-cash cycle. From our liquidity ratios, we determined Cracker Barrel‟s liquidity to be slightly below the industry average. This is caused by the high levels of inventory that Cracker Barrel keeps for the retail business. Profitability ratios measure how effective a firm is at creating income as well as minimizing expenses in order to maximize their profits. The profitability ratios that we used in our financial analysis are: gross profit margin, operating profit margin, net profit margin, asset turnover, return on equity, and the return on assets. Based on our findings, Cracker Barrel outperforms a majority of its industry competitors. This means that Cracker Barrel is underperforming in its ability to create sales from its assets. Capital structure ratios are used in examining how a firm finances the purchases of new assets. Companies can finance operations by either debt or equity. Unlike the previous two types of ratios, capital structure ratios don‟t measure performance, but let analysts measure a company‟s default risk. The capital structure ratios that we used in our financial analysis are: debt/equity, times interest earned, debt service margin, and 1

palepu

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Altman‟s Z score. We found that Cracker Barrel has an average credit risk, this means that they are healthy enough to withstand a recession and grow during normal economic climates. We must also look at potential growth rates when performing the financial analysis. In order to do so we can use sustainable and internal growth rates. The sustainable growth rate is the maximum rate that a company can grow without increasing financial leverage. The internal growth rate is the maximum growth rate that a company can grow without acquiring any additional funds. Cracker Barrel outperforms a majority of its competitor‟s growth rates, meaning that the company can continue to grow without the use of additional funds. Next, to value the current position of the company, we must forecast financial statements. In order to forecast financial statements we relied on trends, growth rates, and financial ratios. We first forecasted the income statement, as stated and restated, by using estimations based on our forecasted sales growth. Then we forecasted the balance sheet, as stated and restated, using the asset turnover ratio, accounts receivable turnover, inventory turnover, and current ratio. Finally we forecasted the statement of cash flows; this is the hardest statement to forecast due to the fact that there is no link to any of the other statements. We used the CFFO/Sales and CFFI/Change in Non-current assets to forecast out the statement of cash flows. Finally, the cost of capital must be estimated in order to properly value a firm. Since the leverage of a firm affects return to investors we must find the weighted average cost of capital (WACC). The WACC is derived by taking the weighted average cost of equity and adding the weighted average cost of. In order to calculate the WACC you must first find the cost of debt and the cost of equity. We derived the cost of equity by using the capital asset pricing model (CAPM). The cost of equity is the minimum return required for an investor to invest in a company. CAPM is the company‟s beta multiplied by the market risk premium (MRP) plus the risk free rate. We found Cracker Barrel‟s cost of equity to be 11.27%. The cost of debt gives insight 15

into how easy or expensive it is for a company to borrow money. The cost of debt is a weighted average of Cracker Barrel‟s debt outstanding and its interest rates, which we found to be 5.42%. We found the WACC before tax to be 10.5% as stated and 10.3% restated. Then we found the more appropriate before tax WACC using the back door method, which was 15.6% as stated and 10.3% restated. We chose the restated before tax WACC using the back door method as the WACC to use in our valuations. Valuation Summary We separated the valuation analysis into two sections: the methods of comparables and intrinsic valuations. The method of comparables utilizes the industry average to compute a resulting price for each approach. Components of the ratio were found on Yahoo Finance on November 2, 2009. Most of the results we found using these methods showed that Cracker Barrel‟s current market price is overvalued. Although this is a popular method in calculating the share price of a company, it is not supported by any theories or analyst opinions. This flaw hinders the effectiveness of the results. For this reason, we did not make any valuation decisions based on the method of comparables. Intrinsic valuation models are much more reliable because they are supported by theory and include analyst opinions. This allows for a more accurate valuation of the firm. Because of this, we based our final decision according to the intrinsic valuation model calculations. The models used were: discounted dividend model, discounted free cash flow model, residual income model, long run ROE residual income, and the abnormal earnings growth. According to the models, Cracker Barrel is overvalued in all but the discounted free cash flow model. The discounted free cash flow model only takes into account dividends and leaves out capital gains. Also, it only has an explanatory power between 10-20% so it was not considered in the valuation.

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Overview of Cracker Barrel The Cracker Barrel Old Country Store was founded along a Tennessee highway in 1969 with the lone mission of “pleasing people.” The goal was to give travelers a largeportioned, country home-style meal at a fair price while making them feel as if they were part of the family. Cracker Barrel has since expanded into one of the largest restaurant chains in the United States. In addition to serving country-style food, Cracker Barrel maintains a retail store in each location. The retail stores are stocked with an extremely wide variety of items such as toys, country music, gifts, foods, and their trademark rocking chairs. The retail section is a unique part of the experience and sets Cracker Barrel apart by providing customers the ability to “treasure hunt” within the depths of the store‟s odd trinkets. The firm‟s commitment to providing an enjoyable customer experience has been recognized by numerous awards, including “being named “Best in Family Dining” by Restaurants and Institutions magazine‟s “Choice in Chains” consumer survey for the 18th consecutive year.”2 Today, Cracker Barrel remains an icon in consistency and quality; a place where the customer experience is put above all else. Founder Dan Evins began his vision in Lebanon, Tennessee, and 40 years later the Corporate Headquarters are still located there. Over the years Cracker Barrel has expanded throughout Southeast America and into 41 states, with stores as far reaching as Vermont and Idaho. However, most of its 588 restaurants are located in the southeastern part the United States where their country food is most loved. Roughly 85% of stores are located along highways as a continued strategy to make Cracker Barrel a roadside stop for families and travelers. In turn, 40% of its customers are travelers. Each store seats 215 customers in a 10,000 sq. ft. building. Around 100 employees serve an average of 7,350 customers per week. Cracker Barrel boasts 2

Cracker Barrel Fact Book. May 27, 2009. Corporate Profile.

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impressive turnover rates for the restaurant industry, as yearly turnover is below 80% for hourly employees and 20% for management. This keeps expenses from hiring and training new employees at bay and is a testament to the company‟s reputation for treating its employees with respect and creating an enjoyable work environment. The retail store is supplied from a lone distribution center located with the headquarters in Lebanon, Tennessee. Each Cracker Barrel is designed so that the customer must walk through the retail store to enter the restaurant, and back through the store once more to pay the bill. This results in 32% of customers purchasing retail in addition to their meals. The retail store also features many items used as door busters to attract customers to the restaurant. Cracker Barrel has recently done exclusive CD releases for Dolly Parton, Montgomery Gentry, and The Zac Brown Band. In addition, they offer exclusive releases for child‟s toys aimed at bringing families to the restaurant. Recently the Cracker Barrel retail store was the exclusive retailer of a new design of the popular kids‟ toys, Webkinz. The retail section not only acts as a way to increase sales to customers coming for the food, but also as a reason for customers to come in the first place. The Lubbock store‟s general manager, Terry Edwards, compares Cracker Barrel‟s retail section to the competitions bar. The vastly different retail is very important to Cracker Barrel‟s profits. Although Cracker Barrel‟s tagline is “Half Restaurant. Half Store. All Country.”, Cracker Barrel really only derives around 20% of its total revenue from sales in the retail store.

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The following chart shows the percentage of revenue generated from the retail component of the business over the past 5 years:

Percentage of Total Revenue from Retail 24 23.5 23 22.5 22 21.5 21 20.5 20 2004

2005

2006

2007

2008

% of Total Revenue from Retail

The next graph illustrates Cracker Barrels total assets from 2003 to 2008. For the most part total assets have remained flat. In 2008, Cracker Barrel had approximately 1.3 billion dollars in total assets.

Total Assets (in millions) 1800 1600 1400 1200 1000 800 600 400 200 0 2004

2005

2006

2007

2008

Cracker Barrel

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As of September 14th, 2009, Cracker Barrel Old Country Store had a market capitalization of $725.62 million at a stock price of $32.09. The market value is calculated by multiplying the number of shares outstanding times the current per share price. Market value can be used as a way to show the relative size of a firm, but is subject to massive swings as stock prices change. That being said, Cracker Barrel‟s market cap is well above the restaurant industry average of $175.62 million. The following graph illustrates the recent decline in Cracker Barrel‟s market value.

2015663.4

End of Year Market Value (in thousands) 1643508.55 1402733.64

769456.84 461092.46

2004

2005

2006

2007

2008

Industry Overview Cracker Barrel conducts business in two distinctly different industries. Based on the EDGAR Filings, the primary Standard Industrial Classification code for Cracker Barrel is “5812 Eating Places.” The secondary SIC code is the “5947 Gift, Novelty & Souvenir.” 3

Notably the main industry for which Cracker Barrel operates is the restaurant

industry. The potential profitability of the firm to co-integrate the different lines of businesses into one strategically positioned competitive business is important. In the case of Cracker Barrel, the decomposition of revenues indicates that 71% of its revenue

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http://www.answers.com/topic/cbrl-group-inc 20

stream is based on the dining (food service) aspect of the business, while the other 29% is derived from the retail (gift shop) component. A specific list of competitors for Cracker Barrel is provided in Table 1. This list does not encompass all of the firms that operate within the restaurant industry. Instead, these firms are more of a direct rival than an indirect rival. For example, McDonalds, a very well known fast food chain, also operates in the restaurant industry. However, McDonalds would be considered more of an indirect competitor because drive-through windows and casual dining provide substantially different eating experiences than the sit-down style Cracker Barrel provides. The indirect competition is important, but for the purpose of this analysis it would be more fruitful to examine the peers that are more closely related. Table 1 illustrates the five specific peers that compete directly with Cracker Barrel. Table 1: The Competition Brinker International Bob Evans Farms, Inc. Darden Restaurants, Inc. Denny‟s Corporation DineEquity, Inc. Darden Restaurants, Inc. has a large variety of restaurants underneath its umbrella. More specifically, they operate: Red Lobster, Olive Garden, LongHorn Steakhouse, The Capital Grille, Bahama Breeze, Season 52, Hemenway‟s Seafood Grille, Oyster Bar, and The Old Grist Mill Tavern. The sheer size of Darden Restaurant‟s, Inc. imposes significant competition upon Cracker Barrel. Darden Restaurants provides competition because their restaurants also embrace a specific dining environment. In this analysis, the term “operate” is used loosely because each firm is slightly different. For example, Cracker Barrel operates its stores, whereas Darden Restaurants, Inc. operates and franchises their restaurants. Brinker International also operates and franchises its restaurants. Another major competitor is Brinker International. Brinker International has three very distinct brand names under its oversight: Chili‟s Grill and 21

Bar, On the Border Mexican Grill and Cantina, and Maggiano‟s Little Italy. Arguably, Cracker Barrel‟s most related competitor is Bob Evans Farms, Inc. because both businesses comingle the restaurant with a novelty / gift shop. Bob Evans Farms, Inc. oversees Bob Evans Restaurants and Mimi‟s Cafes. The fourth peer on our list is DineEquity, Inc., which operates the International House of Pancakes (IHOP) and Applebee‟s Neighborhood Grill and Bar. Furthermore, according to Terry, the general manager at the Lubbock restaurant, Denny‟s and IHOP are the two most significant competitors for Cracker Barrel. However, he also emphasized the importance of the local market for direct comparison. The focus of Denny‟s, IHOP and Cracker Barrel is to attract the “breakfast crowd.” However, all three restaurants also serve lunch and dinner. According to the Technomic, “DineEquity Inc.‟s International House of Pancakes, the category leader, has an estimated 7.3% share of U.S. sales in the segment, followed by Denny‟s Corp. with 6.8%, Cracker Barrel Old Country Store Inc. with 5.6% and Bob Evans Farms Inc. with 3%.”4 The list of competitors chosen does not encompass all of Cracker Barrel‟s potential competitors, but the comparisons will provide insight into the many intricacies of the highly competitive restaurant industry. Five Forces The industry structure and firm profitability are analyzed from the two dimensions of the five factor model outlined by Palepu & Healy. The first dimension evaluates the magnitude of competition and examines the level of competitiveness by decomposing the intensity of competition into three different subcategories. The first subcategory examines the current market share and the competitiveness of the restaurant industry. The second subcategory examines the barriers to entry for the industry and the ability for firms to enter and exit the market. The last subcategory evaluates the sensitivity of consumers demand for the product. The second dimension 4

Gibson, Richard. “A New Recipe” The Wall Street Journal. July 13, 2009.

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explicitly evaluates the competitive nature of the business in both the input market and the output market. In summary, the analysis scrutinizes the restaurant industry structure for which Cracker Barrel Old Country Store operates and their potential profitability in the context described above. The following graph represents the overall competition and power of the impending forces upon the company. Competitive Force

Degree of Competition

Rivalry Among Existing Firms

High

Threat of New Entrants

High

Threat of Substitute Products

High

Bargaining Power of Customers

High

Bargaining Power of Suppliers

Low

Subcategory 1 - Rivalry Among Existing Firms The rivalry among existing firms is evaluated by looking at the industry growth, concentration, differentiation, switching costs, scale of economies, learning economies, fixed cost, variable costs, excess capacity, and exit barriers of the industry. Depending upon the level of competition that exists within the industry, firms will either compete along the pricing dimension or on the non-pricing dimension. In order to set prices, and be competitive, a firm needs to operate in an industry where the number of rivals is relatively small. The higher the level of concentration, the higher the prices the restaurants will be able to charge. The lower the level of concentration, the more competitive the price strategy will have to be. In conclusion, the restaurant industry is highly competitive and moderately concentrated. The large number of rivals drives competition to cut cost, innovate, and establish branding image. In summary, the 23

investigation of the rivalry among existing firms enables us to shed light on the actual and potential competition that exists within the restaurant industry. Industry Growth Industry growth reflects how fast an industry can expand and contract. The restaurant industry growth can be evaluated from two very different expansion paths. One expansion path enables a firm to acquire market share from a new pool of potential consumers, while the other expansion path requires the firm to compete among its rivals for market share among existing customers. Logically, most firms that compete within the restaurant industry want to attract new customers, while stealing away customers from the other firms. The most challenging aspect for Cracker Barrel is that their competitors in the industry are running specials and posting coupons on their website. Other firms in the industry have also not followed their competitors in hopes that name brand and the unique atmosphere will carry them through these tough times. Julie Jargon wrote in the Wall Street Journal that the restaurant industry is struggling during these difficult economic times. She also indicated that parents are now deciding to leave their children at home when they go out to eat, which inevitably reduces the average restaurant sales ticket. Julie said, “The industry is scrambling to counter a tendency by recession-pinched parents to leave their children at home when they go out to eat. Restaurant visits among groups with kids fell 5% in the 52 weeks ended June 30 compared with a year earlier, according to researcher NPD Group.”5 The current economic downturn has inevitably increased the competitiveness of firms within the restaurant industry, because the number of consumers who are going out to eat is on the decline. The following analysis examines the restaurant industry growth rate from two different angles: annual sales growth, and number of new restaurants.

5

Jargon, Julie. “Restaurants Look Beyond Chicken Fingers.” Wall Street Journal. September 1, 2009.

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The industry‟s annual sales growth seems to outpace the annual growth rate in the U.S. Gross Domestic Product. The annual sales growth rate for the restaurant industry has averaged approximately 6% per year over the five year sample period (2003 to 2008). Over the course of the sample period, the annual sales growth rate was lowest in 2005 (at 4.44%) and highest in 2008 (at 12%). The growth rate for 2008 is misleading because in 2008, DineEquity, Inc. completed its merger with Applebee‟s Neighborhood Grill and Bar. The annual revenue growth rate for the industry was 5.74% ignoring DineEquity, Inc.‟s growth rate for 2008. This result is not reported in the table below. Table 2: Peer 2003 Cracker Barrel 1,923,545 Darden Restaurants, Inc. 4,655,000 Brinker International 3,285,390 Bob Evans Farms, Inc. 1,091,337 DineEquity, Inc. 404,805 Denny's Corporation 950,945 Total Sales

comparison of total $ sales in thousands. 2004 2,060,463 5,003,400 3,541,005 1,197,997 359,002 960,006

2005 2,190,866 4,977,600 3,749,539 1,460,195 348,023 978,725

2006 2,219,475 5,353,600 4,141,291 1,584,819 349,560 994,044

2007 2,351,276 5,567,100 4,376,900 1,654,460 484,559 939,368

2008 2,384,521 6,626,500 4,235,223 1,737,026 1,613,628 760,271

12,311,022 13,121,873 13,704,948 14,642,789 15,373,663

17,357,169

Table 2 suggests that over the last 5 years restaurant sales have been on the rise. The result of DineEquity, Inc.‟s merger with Applebee‟s is apparent in the above table. In 2007, DineEquity, Inc. had total sales of $484,559,000 and was the smallest contributor to industry sales. After the completion of the merger with Applebee‟s, DineEquity, Inc.‟s sales jumped to $1,613,628,000, which is significantly higher than the previous year. DineEquity, Inc. is no longer the smallest contributor to industry sales. They have jumped up one spot and have almost caught up with Bob Evan‟s Farm.

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Annual Industry Sales 20,000,000 18,000,000 16,000,000 14,000,000 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 0 2003

2004

2005

2006

2007

2008

This increase in sales growth is easier to interpret by looking at Table 3. In addition, Table 3 reports the annual sales growth rates for each firm within our defined industry.

Table 3: Peer comparison of Annual Sales Growth 2004 2005 2006 2007 Cracker Barrel 7.12% 6.33% 1.31% 5.94% Darden Restaurants, Inc. 7.48% -0.52% 7.55% 3.99% Brinker International 7.78% 5.89% 10.45% 5.69% Bob Evans Farms, Inc. 9.77% 21.89% 8.53% 4.39% DineEquity, Inc. -11.31% -3.06% 0.44% 38.62% Denny's Corporation 0.95% 1.95% 1.57% -5.50% Industry 6.59% 4.44% 6.84% 4.99%

2008 1.41% 19.03% -3.24% 4.99% 233.01%* -19.07% 12.90%*

Annual sales growth rates for each firm i, in year t, is calculated using the following equation: 𝑆𝑎𝑙𝑒𝑠 𝑖,𝑡

𝐴𝑛𝑛𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 𝐺𝑟𝑜𝑤𝑡𝑕 𝑅𝑎𝑡𝑒𝑖,𝑡 = (𝑆𝑎𝑙𝑒𝑠

𝑖,𝑡−1

− 1) ∗ 100.

The following graph illustrates the industry growth rate. The industry growth rate has been relatively flat over the last few years. The last value is misleading because the large increase in the industry growth rate stems from the fact that DineEquity, Inc. 26

merged with Applebee‟s. Excluding DineEquity from 2008 decreases the industry growth rate to 5.74% for 2008.

Industry Revenue Growth Rate 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 2004

2005

2006

2007

2008

Industry

Table 4 shows the total number of stores that each firm in the industry operates. Table 4: Total number of restaurants. 2004 2005 2006 Cracker Barrel 504 529 543 Darden Restaurants, Inc 1,311 1,398 1,443 Brinker International 1476 1588 1622 Denny's Corporation 1638 1603 1578 Bob Evans Farms, Inc 558 683 689 DineEquity, Inc 1165 1186 1242

2007 562 1,665 1801 1546 694 1302

2008 577 1,683 1888 1541 703 3320

Total Restaurants

7570

9712

6652

6987

7117

There are three noteworthy findings from this table. First, all of the firms in the industry have opened up new stores every year since 2004 except for the Denny‟s Corporation. The number of Denny‟s restaurants has been on the decline since 2004. Second, the combination of IHOP and Applebee‟s has led to a larger number of stores

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for DineEquity, Inc. Third, the industry on the aggregate has seen a steady increase in the number of stores that are operated. The following figure compares the growth rate in the number of stores for the industry. This time series graph is slightly misleading because the large increase in the number of restaurants operated and franchised in 2008 is mainly due to DineEquity, Inc.‟s merger with Applebee‟s.

Percentage Change in New Stores 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 2005

2006

2007

2008

In summary, the provided evidence suggests that industry annual growth rate in sales has been relatively flat over the last several years and the annual increase in the number of new restaurants has been on the rise. These findings are interesting because the increase in stores, in theory, should also increase the amount of revenues that are generated. This preliminary evidence suggests that the slow increase in revenues is mainly attributable to an increase in the number of stores. More importantly, the flat growth rate in sales has the potential to increase the rivalry among existing firms in the restaurant industry.

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Industry Concentration Industries that are highly concentrated are more likely to refrain from engaging in destructive competitive pricing. Instead, these firms will implicitly coordinate their prices in such a way that enables each to earn a profit. Industries that exhibit low levels of concentration are more likely to engage in competitive pricing behavior because these firms will have a much harder time coordinating and signaling pricing information to their competition. The restaurant industry is moderately concentrated. The four-firm concentration ratio for the restaurant industry exceeds 80% for the period 2003 - 2008, assuming that the industry is defined by the selected firms. Obviously, the sample of firms does not encompass the entire restaurant industry; however, these firms are representative of the significant players. Moreover, the concentration of an industry can have significant implications for the potential profitability of the firm. Table 5 illustrates the annual industry concentration results. There are two significant conclusions that can be drawn from this table. For starters, Cracker Barrel and Denny‟s are the two most noticeable firms that have been losing market share over the last five years. Next, DineEquity, Inc. is the only firm that has seen a significant increase in market share. Undoubtedly, this large increase in market share is derived from their merger with Applebee‟s. The other three firms (Darden, Brinker and Bob Evans) have maintained their market share throughout this period of time.

Cracker Barrel Darden Restaurants, Inc. Brinker International Bob Evans Farms, Inc. DineEquity, Inc. Denny's Corporation Industry

Table 5: Annual Industry Concentration 2004 2005 2006 15.70% 15.99% 15.16% 38.13% 36.32% 36.56% 26.99% 27.36% 28.28% 9.13% 10.65% 10.82% 2.74% 2.54% 2.39% 7.32% 7.14% 6.79% 100.00% 100.00% 100.00%

2007 15.29% 36.21% 28.47% 10.76% 3.15% 6.11% 100.00%

2008 13.74% 38.18% 24.40% 10.01% 9.30% 4.38% 100.00% 29

The following figure provides a graphical representation of Table 5.

Annual Industry Concentration 45.00% 40.00% 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 2004

2005

2006

2007

Cracker Barrel

Darden Restaurants, Inc.

Brinker International

Bob Evans Farms, Inc.

DineEquity, Inc.

Denny's Corporation

2008

The following exploding pie chart represents the industry concentration for the fiscal year 2008. Industry concentration is the total percentage of sales of each individual firm within the industry. The percentages are based on the total sales of the firm within a particular year divided by the total number of sales for the industry during the same year.

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Industry Concentration - 2008 Cracker Barrel

Darden Restaurants, Inc.

Brinker International

Bob Evans Farms, Inc.

DineEquity, Inc.

Denny's Corporation

9%

4%

14%

10%

25%

38%

The above pie chart illustrates that Darden Restaurants, Inc. and Brinker International represent more than 50% of the total industry. Cracker Barrel‟s market share is small, 14%. However, Cracker Barrel ranks third out of all of the firms within the industry. In summary, the evidence suggests that the market share is heavily concentrated among the top four firms. This result implies that the industry is dominated by two firms, Darden Restaurants, Inc. and Brinker International. Moreover, the four-firm concentration ratio in 2008 was 86%. The evidence suggests that the restaurant industry is moderately concentrated. This implies that the firms will not engage too heavily in destructive price wars and the firms will try to signal to the other participants the prices that they are setting for a particular meal. The firms in the industry implicitly price signal other firms in the market by posting some version of their menu online. These menus all contain prices for the meal. Although the price signaling is prevalent among these firms, they are also engaging in a recognizable price war. Some of the restaurants are running specials, while others are posting coupons on their websites to attract customers in a down economy. Interestingly, Cracker Barrel is not participating in this price war. There are no coupons or food specials on their website.

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Degree of Differentiation Product differentiation enables a firm to distinguish itself from the competition. The degree of product differentiation in the restaurant industry comes from three sources. The main difference between restaurants is the type of food they are serving whether it be: Mexican, Italian, Steakhouse and Japanese. This would explain why many of the firms within the industry choose to have multiple chains under their supervision. This enables them to cover a large range of potential customers. The type of restaurant will play a role in where customers choose to eat. However, this method of differentiation will be minimal because most of the firms in the industry have more than one style of restaurant. The restaurant environment and dining experience is another source of differentiation. This element is important because the array of restaurants in the industry all have a particular environment they are trying to achieve. For example, On the Border Mexican Grill aims to provide a fun, Mexican style atmosphere, while Cracker Barrel attempts to create the home-away-from-home feel. The final two sources are quality of the food and customer service. Clearly, poor food quality and customer service can cause customers to seek out alternative eating destinations. Alternatively, great customer service and high food quality can create a loyal customer base. All of the restaurants consider customer service as one of the most important aspects of their business. In conclusion, the restaurant industry exhibits a moderate level of product differentiation. Switching Costs Switching costs refer to the cost associated with allocating the company‟s assets to a different business venture. The switching costs for a restaurant can be relatively low. For example, the restaurant can be easily transformed into a different style of restaurant. The reason for the low amount of switching costs is because very little switching is required of the capital already in place. A basic remodel of the restaurant 32

will more than likely suffice. The switching costs significantly increase if the restaurant transforms into anything other than another restaurant. For example, the restaurant facility could be transformed into an office building or another retail store. The reason why switching costs will be significantly higher for those firms that choose to change industries is because much of the capital used in the restaurant industry is industry specific. New capital would have to be obtained and the existing capital would have to be sold. In conclusion, the restaurant industry exhibits a high level of switching costs, assuming the restaurant is not transformed into a different restaurant, which increases the degree of rivalry among existing firms. Economies of Scale Economies of scale contribute to the degree of competitiveness of the firms within the industry. Economies of scale imply that as the firms grow larger and larger their average unit costs decline. Firms that do business in an industry where economies of scale are possible will find it beneficial to increase the size of their firm. “In such situations, there are incentives to engage in aggressive competition for market share” (Palepu & Healy). The restaurant industry is not identified as an industry that exhibits significant economies to scale. The following table and graph illustrate the total assets of the key firms in the restaurant industry.

Cracker Barrel Darden Restaurants, Inc. Brinker International Bob Evans Farms, Inc. DineEquity, Inc. Denny's Corporation Industry

Table 6: Peer comparison of total assets in millions. 2004 2005 2006 2007 1435.7 1533.2 1681.2 1265 2780.3 2937.8 3010.2 2880.8 2211.7 2156.1 2221.7 2318 853.3 1150.9 1185 1196.9 821.6 771 768.8 3831.1 499.3 511.7 444.4 377.4 8,602

9,061

9,311

11,869

2008 1313.7 4730.6 2193.1 1207 3361.2 347.2 13,153

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Table 6 shows that the total assets for the industry are on the rise. More importantly, the total assets of the restaurant industry have almost doubled in 4 years‟ time. Although the industry has been growing, the increase in growth has done little to reduce the average unit cost of the meal that is produced. The unit cost of the goods that is produced by the restaurant industry is heavily dependent upon food prices and energy prices. The following graph shows the total assets of the industry in millions of dollars.

Total Assets of the Industry (in millions) 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 2004

2005

2006

2007

2008

Industry

34

The following graph shows the total assets of each firm in the industry by year.

Total Assets (in millions) 5000 4500 4000 3500 3000 2500 2000 1500 1000 500 0 2004

2005

2006

2007

Cracker Barrel

Darden Restaurants, Inc.

Brinker International

Bob Evans Farms, Inc.

DineEquity, Inc.

Denny's Corporation

2008

As seen in the above graphs, the total asset value for the restaurant industry is on the rise. This would suggest that the firms are attempting to increase their balance sheets. However, a closer examination of Table 6 suggests that most of the firms in the restaurant industry have experienced little to no growth in their total assets. The main contributor to the increase in total assets is DineEquity, Inc. The results suggest that the restaurant industry is moderately concentrated. This implies that a few key companies dominate the market, which makes it difficult for a small firm to compete on a national or global scale. Fixed - Variable Costs Firms that have high a fixed-to-variable cost ratio are more inclined to engage in aggressive pricing strategies. Alternatively, firms that exhibit a low fixed-to-variable cost ratio are more concerned with the monitoring of their variable costs. The restaurant industry has a relatively low amount of fixed costs. The fixed costs include 35

industrial grade ovens and refrigerators. In contrast, the restaurant industry has high variable costs. The variable costs include labor costs, supplies, energy costs, food costs, and rent costs. Cracker Barrel Bob Evans Dennys Darden Brinker International

2004 -0.19

2005 -1.16

2006 0.87

2007 -1.73

2008 0.59

2009 -0.92

-0.25 -1.17 1.39 -0.31

-0.12 3.14 1.18 0.81

-0.40 -0.51 -5.27 -0.38

-0.51 0.07 -1.92 -0.21

-0.42 2.25 1.58 -0.64

-0.30 1.63 -0.26

The restaurant industry has a fixed to variable cost ratio that is less than one. We computed this by taking all the positive fixed to variable cost ratios of Cracker Barrel‟s competitors, not including companies with negative variable costs, and computed an average of .39. A low fixed to variable cost ratio means that the store is not highly leveraged, and they can cut stores and cut capacity easily. This also means that firms cannot reduce this ratio by increasing the demand for their product. Excess Capacity and Exit Barriers When the demand for the product exceeds the supply, firms are encouraged to raise prices to eliminate shortages. On the other hand, firms have incentive to reduce the prices of the products when the demand for the product is less than supply. Excess capacity motivates restaurants to offer specials, discounts and coupons. Interestingly, excess capacity only comes in one dimension in the restaurant industry – empty seats. The current economic climate has increased the probability of excess capacity in the restaurant industry. The threat of excess capacity has undoubtedly increased the rivalry among existing firms. Palepu and Healy state: “Exit barriers are high when the assets are specialized or if there are regulations which make exit costly.” The restaurant industry has specialized assets – the industrial ovens, grills, deep-fryers, and refrigerators. However, there is no

36

discernable regulation which makes exiting the industry costly. Thus, exit barriers in the restaurant industry are low. Conclusion The evidence above suggests that the rivalry among existing in the restaurant industry is high. The relatively flat industry growth rate indicates that firms are competing for existing customers. They are able to compete through different pricing strategies and the degree of product differentiation. The firms exhibit a moderate level of product differentiations. Furthermore, most of the differentiation is derived from the restaurant environment, quality and customer service. The firms also exhibit a significantly high level of switching costs, assuming they are not transforming their existing assets into different restaurant. These higher switching costs increase the rivalry among existing firms. The restaurant industry exhibits a low level of economies of scale, which enables them to reduce some per unit costs as they grow larger. The restaurant industry has a low fixed-to-variable cost ratio, which implies that the fixed costs are lower than the variable costs. Most of the restaurant expenses are derived from the variable costs. Lastly, the current economic climate has reduced demand for eating out, which also has increased the rivalry among existing firms. With relatively low exit barriers, it is possible that some of the firms may go out of business. Subcategory 2 - Threat of New Entrants Firms all over the world have many threats they must anticipate in order to be successful and remain profitable. These threats range from other existing firms to unpredictable events. Such events would be new firms and new products that are not currently in production. When the industry has positive economic profits to be had, the industry is in constant threat of new entrants until each firm makes zero economic profits. Each new entrant takes a share of the market away from the existing firms; therefore, the threat of new entrants is a problem for all existing firms in that market. In certain industries firms do not have to worry as much about new entrants because of 37

significant entry barriers such as: scale of economies, first mover advantage, distribution access, relationships, and legal barriers. All of these barriers help to determine the degree of a threat from new entrants. Even though firms may have a specific set of other firms they see as direct competition, in the restaurant industry every restaurant can be considered a possible threat. For example, an American food restaurant may not see an Asian food restaurant as a direct threat, but it could be considered a threat to their dinner crowd if it opened up shop next door. These threats make the industry very competitive by nature, because there are so many restaurants in each city. Scale of Economies Scale of economies is the idea that the larger a firm gets and the more it produces, the cheaper the next item is to produce. This creates a cost advantage for the pre-existing firms because they will have a lower cost than a new start up firm. This idea also considers that the larger firms become the more bargaining power the firms get over suppliers. If a firm has many suppliers willing to sell them goods they are not bound to one supplier. This means if a supplier thinks that a firm is one of their largest customers, they are willing to negotiate prices to keep the firm‟s business. The larger the firm is the more bargaining power it receives. This is attributed to the economies of scale. Although most restaurants do receive some benefits from the scale of economies, it is not a huge threat to new entrants. The new firms will not get to enjoy the cost saving advantages in the first few years, but as long as they break-even they can increase their customer base and eventually their bargaining power. For this reason the scale of economies is not significant enough to prevent other companies from taking market share.

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First Mover Advantage The first firm in an industry always has a competitive advantage over firms that enter later. They learn more about the industry and what their consumers want. If the firm knows what their customer wants, then fulfills those wants, they will bring the customers back into their shops. Firms use this advantage to build brand image and consumer loyalty. The first firm in a market also sets certain standards. In the restaurant industry, these are prices, serving sizes, customer service, and whether or not there are free refills on sodas or free chips. The problem in the restaurant industry is that when a new restaurant opens most people are willing to try it out. This can cause problems for the existing restaurants because all of the sudden their tables are empty during the grand opening of a new restaurant. If the new restaurant doesn‟t fulfill its customer‟s wants, then they will go back to what they know. However, if they do satisfy their customers, it means a new firm has just entered the market. For this reason the first mover does not have a huge advantage over other firms in this industry. Therefore, the first mover advantage proves to be a relatively small barrier of entry. Relationships/Distribution Access Relationships and distribution access tend to be a large barrier to entry in most industries. These two categories go hand in hand because most distributors want to build a relationship with their customers in order to keep their business. These relationships help both sides because the supplier learns what exactly the customer is looking for, and vice versa. Through these relationships they can make deals with the distributors to get lower prices. This is an advantage for the earliest firms in the market because they can form relationships with suppliers. This poses as a potential problem to new firms that have all the machinery to produce a product, but no inputs because suppliers are not willing to work with them.

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In the restaurant industry this problem does not pose a huge threat because of the vast number of suppliers. These include grocery stores, Sysco, Wal-Mart, SAMs, and other distributors. These suppliers are located in most major cities that have restaurants. Another key factor about these suppliers is that they do not require a company to form a relationship to get reasonable prices. Although a large company will get slightly better prices, it is not enough to keep competition from entering the market. Therefore, relationships and distribution access do not present a large barrier to new firms wanting to enter the market. Legal Barriers There are many legal barriers that can restrain new entrants from entering the market. In every industry there are laws and restrictions that must be followed. In certain industries firms may have to obtain special licenses in order to operate their business. These legal barriers vary from state to state if it is a local industry and by country if it is international. Most of these permits and licenses take months or even years to acquire. The restaurant industry is no different. Regulations vary in each state, but most states require firms to have certain permits and licenses just to open. According to Lorri Mealey, a writer for About.com, most states require an “entertainment permit, sign permit, seafood permit, seller‟s license, liquor license, insurance, and a number of other permits and license” just to open a business.6 In the Texas area restaurants are required to have a health inspector permit, alcohol license (if the firm serves liquor), smoking permit (if smoking is allowed in the facility), building inspection, occupancy permit, fire inspection permit, zoning license, and a sales tax id. The legal barriers are the toughest barriers a new firm faces when trying to open a new business. If a firm fails to get any one of these permits it could jeopardize their chances of opening or being successful.

6

Mealey, Lorri “Restauranting FAQs” About.com http://restaurants.about.com/od/openingarestaurant/a/Restaurant_FAQs.htm

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Conclusion Overall the threat of new entrants into the restaurant industry is very high. This is because the barriers that keep firms out are comparatively low in the restaurant industry. The hardest barrier new firms must overcome are the legal issues involved in acquiring permits and licenses. The first mover advantage does give the first entrants an edge, but it is not nearly enough to keep competitors out of the market. In today‟s economy, suppliers are constantly looking for new customers; this allows new firms to enter the market relatively easily. The scale of economies can help certain firms in the restaurant industry, but it does not necessarily hurt the smaller firms and keep them out. In summary, entry barriers are very low in the restaurant industry. Subcategory 3 - Threat of Substitute Products Substitute products have an indirect threat to businesses in all industries, as it is indicated by Porter‟s Five Forces Model. Although a substitute product may not have as big a threat as relevant products, it is still important to consider the risk a substitute product poses to a firm‟s primary product line. A substitute product does not have to be of the same form of an existing product, but simply an alternative product that performs the same function and gives consumers the same benefit. Full-service restaurants are highly competitive within their own industry. Food, in general, is not a unique commodity; it can virtually be found anywhere. Therefore, the full-service restaurant industry faces the threat of substitutes from other food industry segments, as well as consumers‟ choice to dine at home. Due to the competition between restaurants in the industries, they must compete based on menu prices and performance to attract and retain customers. Because there is such a wide variety of choices consumers have in the food industry, consumers essentially have a low switching cost.

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Relative Price and Performance Full-service restaurants face steep competition in the segmented food industry. In the full-service restaurant segment of the industry many restaurants compete for market share, while also indirectly compete with the fast-service restaurants, limitedservice restaurants, and cafeterias. “In the current year through June, according to the U.S. Department of Agriculture, sales of food away from home fell by just 2.5 percent from the previous year.”7 With restaurant industry sales still slumping, it is important for industry competitors to compete on relative price and performance to increase profits and gain market share. In such a highly competitive industry, the restaurant industry has to find ways to stay competitive while still remaining profitable. Many restaurants are currently offering discounts and promotions to attract customers as they try to increase revenue. For example, DineEquity‟s International House of Pancakes and Denny‟s restaurants are now offering menu items starting at $5.99 to try to increase clientele, due to negative quarterly revenues of 17.6% and 18.1% respectively.8 Input prices for the industry have an effect on relative overall pricing. Restaurants try to balance increasing ingredients cost with menu and price adjustment, while trying to maintain consumers that have diminished purchasing power. “Up to August, wholesale food prices went up 8.7 percent on top of a 7.6 percent rise in food items the previous year. In contrast, menu prices went up this year on the average by only 4.2 percent.”9 With an overall price increase in restaurant menu prices, customers have to decide whether to pay a premium for a higher quality of food, or switching to a lower cost substitute. Buyers’ willingness to switch The food industry has a low switching cost, meaning that consumers in this industry don‟t have to remain brand loyal. Other segments in the food industry offer an

7

Brett Arends. “Will the Recovery Boost Restaurant Stocks?” Wall Street Journal, August 13, 2009 http://finance.yahoo.com/q/co?s=CBRL 9 http://www.allheadlinenews.com/articles/7012830379#ixzz0RHTmJRL8 8

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array of low cost substitutes, but the full-service restaurant industry offsets the threat with the use of strong branding. This includes marketing techniques such as higher quality menu items, differentiated atmospheres, and outstanding quality of service. In both the full-service restaurant industry and food industry, switching costs are low because consumers can compare prices with relative ease; information about menu prices can be obtained easily through the internet or advertisements. In the fast-service industry, many competitors offer “value menus” which are a threat to full-service restaurants because consumers can obtain a similar benefit at a lower cost. The threat of consumers substituting going out to eat with eating at home is directly correlated with the success of the economy. In an economic recession, consumer spending on restaurant dining is one of the first areas to take a hit. The following chart shows the answers of over 1300 consumers when asked if they will be spending more or less money on restaurants over the next 90 days.

Percentage of Restaurant Spending 60 50 40 30 20 10 0 Sep Nov Jan Mar May Jun Aug Sep Nov Jan Feb Apr May Jul Aug Sep Nov Dec '06 '06 '07 '07 '07 '07 '07 '07 '07 '08 '08 '08 '08 '08 '08 '08 '08 '08 Spending Less

Spending More

This chart uses information from ChangeWave Research Company.10

10

http://seekingalpha.com/article/114572-consumers-show-little-appetite-for-restaurants

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The consumers‟ answers are split almost 50/50 for the first year (2006), while the economy was rising. When the stock markets began to crash in late 2007, spending less shot up into the 30‟s, 40‟s, and even 50‟s while consumers‟ plans to eat out over the next 90 days plummeted to single digits. When faced with a need to cut spending costs, consumers will immediately look towards alternative ways of eating rather than dining at restaurants. Conclusion The threat of substitute products in the full-service restaurant industry is relatively high. With a high degree of competition within the food industry, consumers demand for food is elastic. Consumers can easily switch to substitute products, like eating at home, because of the low cost to switch between substitutes in the industry. In times of economic recession consumers can trade down to lower cost substitutes such as fast-service restaurants, limited-service restaurants, or choose to just dine at home. This fact is demonstrated by recent Wall Street Journal Article, by Katy McLaughlin. She wrote, “Casual dining sales overall are down 6% to 7% this year as more customers eat at home or turn to fast food to economize, said Technomic, a Chicago restaurant consultant.”11 Subcategory 4 - Bargaining Power of Customers The bargaining power of customers determines the price setting ability of restaurants in the industry. If customers are exuding a relatively strong level of bargaining power, then the industry will be forced to be more of a price taker. On the other hand, if customers lack bargaining power, then the industry will have the luxury of being more of a price setter from the output side of production. The purchasing decisions and the elasticity of consumer demand is dictated by the amount of bargaining power the consumer has in the output market. Firms will earn lower profits in a market where the consumer does have power. Furthermore, customers will be 11

Katy McLaughlin. “Macaroni Grill’s Order: Cut Calories, Keep Customers.” Wall Street Journal. Wednesday, September 16, 2009.

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more willing to go to different restaurants when the firm increases their price. In essence, the consumers will be able to substitute other products rather easily and thus their demand curve will be relatively more elastic. This means they are more sensitive to a change in prices. The large number of close substitutes in the restaurant industry provides a plethora of choices for the consumer. Firms in the industry are inherently aware of this market complexity. This reduces their ability to set prices. In general, firms are price takers from the output side of this market. Therefore, restaurants that tend to make profits strive to keep their prices competitive. To further explain the bargaining power of customers‟ analysts need to know the switching costs, differentiation, importance of product for costs and quality, number of buyers, and the volume per buyer. Switching Cost Switching costs are the costs associated with customers switching from one restaurant to another. For example, if it is expensive for a customer to switch restaurants, then they have high switching costs. By contrast, if it is cheap for a customer to switch between restaurants, then they have a low switching cost. With so many restaurants to choose from, customers are never obligated to stay loyal to just one restaurant. The inherent problem with the restaurant industry is location, location, location. Most restaurants tend to set up shop relatively close to other restaurants. This increases the number of restaurant choices without increasing the cost of switching from one restaurant to another. The amount of fuel consumption for switching between restaurants is negligible. The only non-monetary cost would be a consumer‟s taste and preference. For example, Joe really likes eating at restaurant “X” because he enjoys the live music and quality of the food. Joe may not like having to switch to another restaurant because the opportunity costs of switching are high. The “average Joe” is not the same as the Joe in this example, which means that the opportunity cost of switching between goods is minimal at best. According to the example, the consumer‟s switching costs are low to 45

non-existent. This increases the customer‟s bargaining power because they can implicitly dictate what price they are willing to pay. If a restaurant increases their prices, or competitors lower their prices, the customers will go elsewhere at relatively no expense to them. Differentiation Every firm wants their product or service to standout from other firms in their industry. This is accomplished through product and service differentiation. The degree of differentiation is crucial to repeat customers. The customers that go to Denny‟s definitely do not expect to be able to browse intricate trinkets and CDs. The service and the food quality of the two restaurants are vastly different. Michael Woodhouse reports in the annual report that Cracker Barrel has scored reasonably well in market surveys and has won several awards for quality. “PeopleMetrics, a research firm that tracks consumer markets, surveyed 1,250 customers about their experiences at nine major restaurant chains. Cracker Barrel Old Country Store scored high in customer engagement, which means: 1) the customer feels valued; 2) there‟s an engaged employee who‟s creating the experience; and 3) there is a clean environment and hot food.”12 In the restaurant industry the main differentiation between eateries comes in the form of quality and environment. If the restaurant is noticeably different, in a positive manner, then the customers will be more likely to return. At a certain level of product differentiation, the restaurants will be able to mitigate customer bargaining power because consumers will be looking for a particular experience. One of the closest substitutes is Bob Evans. Bob Evans also has a gift shop in its restaurants. The heterogeneous products enable firms within the industry to attract a particular demographic of customers. Firms in the industry that offer unique services have a slight advantage over customers‟ bargaining power when compared to other restaurants like Denny‟s and Applebee‟s.

12

2008 Annual Report. Cracker Barrel Old Country Store.

46

Importance of Product for Costs and Quality Customers see costs and quality as some of their top priorities when choosing where to dine out. In the current economic conditions consumers are looking for the lowest possible prices while maintaining high quality. Firms are choosing to compete for existing customers to maintain an ample revenue stream. The main source of competition is through pricing tactics, which encompasses discounts and specials. Notably, restaurants who neglect to compete or follow the industry have potential for a significant loss of customers. Although the reduced prices have a tendency to decrease potential profits, the pricing promotions have the ability to sustain customers in a down economy. Firms who choose to compete in this manner need to be aware of the potential downside risk. Reducing profits to sustain revenues has the potential to reduce a profitable firm to an unprofitable firm. Furthermore, these promotional activities have the potential to upset customers. In a recent Wall Street Journal article, Diana Ransom wrote “A recent KFC promotion actually sparked protests among customers.”13

Interestingly, Cracker

Barrel restaurants do not offer price discounts on their menu items. The only discount that the restaurant offers is a tourist special. “Our country Coach Service offers several benefits to tour groups.” In contrast, many of the major competitors are offering substantial discounts on their food. For example, Applebee‟s is offering the “Pick „N Pair” lunch special starting at $5.99 and Denny‟s is running a “Build Your Own Grandslam” for $5.99. Furthermore, Denny‟s also provides a senior citizen discount. In order to keep customer‟s coming back to their restaurants, restaurants attempt to keep their prices competitive and their food quality high. While most stores are offering specials and discounts, Cracker Barrel keeps their prices as static as possible, and they find other ways to cut cost. For example, instead of serving bread to everyone before their meal, they ask customers what type of bread they want with their meal. This reduces the potential waste of bread that companies like Olive Garden have, 13

Ransom, Diana. “Can They Really Make Money Off the Dollar Menu?” Wall Street Journal. May 21, 2009.

47

when they bring a basket full of bread before the meal. Some restaurant managers have even started “using less costly cuts of meat…offering less free bread and cutting back on condiments,” according to Carla Norfleet Taylor, a Fitch Ratings analyst. 14 Every time one restaurant lowers their prices and cuts quality, it creates a ripple effect through the industry which in turn changes consumer‟s options. In the end, these options are allowing customers to have more bargaining power. Number of Customers The restaurant industry generated $17,357,169,000 in sales in 2008. The amount of customers that is served on a daily basis is significant. The size of the customer basis is inversely related to the level of customer bargaining power. This means that as the number of potential customers increases the amount of bargaining power decreases because the restaurants are less concerned with customers switching to other restaurants. The main variable that may influence this hypothesis is the decomposition of the customer base. Each restaurant may have a particular demographic of customers for which they are trying to curtail their restaurant around. This is especially true for Cracker Barrel, whose customer base is mostly citizens over the age 50. Over 64% of their clients are over 50 years of age and only 11% are between the ages of 18 and 34.

14

Arends, Brett. “Will the Recovery Boost Restaurant Stocks?” Wall Street Journal. August 13, 2009.

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Customer Sales Percentage by Age 18-34

35-49

50-64

65+

11% 32% 24%

33%

The pie graph illustrates that only 35% of Cracker Barrel‟s customers are under the age of 50, whereas Denny‟s is targeting 18-24 year olds. When Denny‟s releases new items on the menu they announce this through Twitter and MySpace.15 From the industry‟s perspective this could pose as a threat to restaurants because in order to get new, younger customers they might have to surrender even more bargaining power to their customers. Old, retired customers tend to have a more elastic demand than younger customers. This means that older people are more sensitive to a change in the price of the food they are serving. The restaurant industry needs to consider the price sensitivity and recognize that this gives their average customer more bargaining power. Volume Per Buyer In general the volume per buyer plays a large role when determining a customer‟s bargaining power. The more that a single customer buys, the more bargaining power he wields. So, if in a specific industry there is a relatively small amount of customers, firms are flexible for those individuals. Therefore, the customers have more bargaining power. On the other hand, if an industry has a vast amount of customers then firms are not as flexible towards a single customer‟s preferences. This means that the industry has more bargaining power over customers. 15

Jargon, Julie. “Denny's Tries Night-Owl Vibe.” Wall Street Journal. June 30,2009.

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Thousands of customers visit a single restaurant on a weekly basis. The average check per person in the United States is $6.51.16 When comparing Cracker Barrel, who averages a check of $8.93 per person, and Olive Garden, who averages a check per person of $1517, analysts can see a significant variation from the U.S. average. This variation allows analysts to assume that each firm has a different amount of bargaining power over their customers. Conclusion In conclusion, restaurants are generally price takers on the consumer side of the market. Although they do gain some bargaining power through product differentiation it is not enough to overtake the consumers‟ low switching cost. The restaurant industry gives up even more bargaining power when they start competing on the cost and quality of their menu items. The number of customers and volume per buyer should give the restaurant industry more bargaining power because the number of customers is high, and the check per person is low. Although this is the case, the restaurant industry cannot capitalize on this power because the market is extremely competitive. If they do not cater to each customer then they start losing shares of the market to their competitors who do cater to each customer. Inevitably, the low switching cost forces restaurants in the industry to be extremely competitive and give most of the power to its customers. Although each individual firm has a different amount of bargaining power, it is not enough for the industry to become a price giver. Subcategory 5 - Bargaining Power of Suppliers The bargaining power of suppliers is dependent on the overall concentration of the industry. The less concentrated an industry is the more influence a supplier has over the negotiation of the terms of a deal. The higher concentrated an industry becomes more options become available, shifting the negotiating power over to the buyers. 16 17

Dougherty, Connor “Restaurant Traffic Declines Worldwide” Wall Street Journal. August 25, 2009 “The Darden Menu” Fast Company. July 1, 2009

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In the restaurant industry there are many companies for food suppliers to do business with. Food can be produced locally by farmers, or it can be imported if it is a specialty food. In this industry there is low price sensitivity when it comes to suppliers due to the nature of competitiveness. Furthermore, the low barriers of entry in this industry lead to strong price competition among food suppliers. Due to the high competition of this industry most of the suppliers will be price takers, which forces them to price their goods at a competitive market price. Switching Cost The switching cost is determined by two key factors; the concentration of an industry and the uniqueness of a product. The switching cost for suppliers the restaurant industry with a low concentration is low because there are many buyers demanding the product. The only exception is for suppliers that provide a specialty good. The less unique a commodity is the lower the switching cost is for a supplier because of a larger market and higher demand for that product. Food suppliers are made up of thousands of domestic and international farmers. Food is a common commodity, giving a low switching cost to suppliers because they don‟t have to sell to just restaurants. Suppliers find a high concentration of food demand locally and abroad from restaurants, grocery stores, hospitals, and other businesses. If a supplier or a farmer has a type of food that is widely demanded such as beef, chicken, or pork, the switching cost is relatively low because the market for these products is much larger and demanded by a larger number of consumers. Differentiation Suppliers can increase their bargaining power over customers by setting themselves apart from the competition. Differentiation can be achieved through quality, perception, reliability, and uniqueness. Suppliers that deal with a common commodity have to differentiate in order to be successful because customers will naturally search for cheaper substitutes. 51

Food that is produced domestically is virtually the same as the food that is produced internationally. All chicken and beef tastes the same. Food suppliers in the food industry must differentiate their product in a different ways than the product itself. One way of doing so is to provide a higher quality commodity. Suppliers can provide bigger chickens or thicker steaks, but it is up to the customer to conclude if this value added by the supplier is worth paying a higher price for. Food suppliers also differentiate themselves by having a strong, reliable relationship with the customer. Great operational management is key for suppliers to surviving in this industry. Since supplier products are undifferentiated in the industry their bargaining power is low. Importance of Product for Cost and Quality In order for a supplier to have more bargaining power they must deliver a product that is of high quality for a low cost. If the product is undifferentiated, such as produce, then buyers are more price sensitive. When firms demand a lower cost, suppliers have to compete on price. Let us take a look at this relationship in the restaurant industry. Restaurants search for suppliers that can deliver low prices so that the profit margin of its own products does not shrink. Distributors of restaurants have low bargaining power because they are forced to be price takers in this industry. In order for the distributers to be profitable it must either increase sale amounts to restaurants, or tighten up on cost control. In order for restaurants to maintain great quality of their products at a reasonable price for consumers, it is essential to have suppliers that consistently deliver great quality products at a low price. Number of Suppliers The concentration of the industry is a determinant of how much bargaining power suppliers have. If there is a low concentration of suppliers then buyers are left with fewer choices, which increase supplier bargaining power. Alternatively, an industry

52

with a high concentration of suppliers makes buyers more price sensitive and shifts bargaining power over to the buyer. There is so much competition in the restaurant industry that suppliers have lower bargaining power. When dealing with a restaurant that has a strong market share, suppliers are price takers. Local suppliers are obliged to the contractual terms that firms set for its suppliers. The high level of competition for suppliers gives the bargaining power in this market to large restaurants because it sets the standards for its suppliers using contracts. According to Cracker Barrel‟s 10k,“Approximately 75% of [their] food commodities are under contract for the remainder of fiscal year 2009 as of November 24.”

18

This type of contract setting is an example of how most firms in the industry

manage supply chains. Volume Per Supplier In any industry, the volume of products that suppliers produce can equate to bargaining power. If a supplier produces a high volume of a certain company‟s inventory, suppliers have more bargaining power because a company is dependent on them. Rather, when the supplier‟s volume of a product is relatively low then the power shifts to the buyer because dependability and switching cost of suppliers are lower. In the restaurant industry, buyers are not dependant on any single source of supplies or raw materials because of the low concentration of suppliers. In order for restaurants to maintain a consistent quality of their food nationwide they must acquire food products and other items from reliable suppliers. When prices of products are uncertain in the future restaurants may enter into purchasing contracts or buy supply in bulk to ensure that their expenses do not increase, and also that quality is assured. Since firms are usually not dependant on a single source of raw material, suppliers ultimately have low bargaining power.

18

http://investor.crackerbarrel.com/faq.cfm?expand=true

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Conclusion Ultimately, suppliers of firms in the restaurant industry are price takers in the market. Suppliers have low switching costs because of the low concentration of firms in the restaurant industry. Because suppliers in this industry have undifferentiated products their bargaining power is relatively low. In order for restaurants to keep cost low they are price sensitive when it comes to choosing suppliers. The low concentration of suppliers gives the bargaining power to the firms in the industry. Finally, the volume each supplier contributes to firms in the industry determines the bargaining power. High volume suppliers have higher bargaining power. Alternatively, lower volume suppliers have a lower bargaining power. As a result of these factors suppliers in the industry have relatively low bargaining power. Five Forces Conclusion Competitive Force

Degree of Competition

Rivalry Among Existing Firms

High

Threat of New Entrants

High

Threat of Substitute Products

High

Bargaining Power of Customers

High

Bargaining Power of Suppliers

Low

Analysis of the five forces within the industry portrays a substantially high level of competition and consumer power over prices. The restaurant industry is a very aggressive market because the only real barriers faced by new entrants are permits and licenses. The other entry barriers faced by new firms in this industry are relatively nonexistent, due in part to the vast amount of suppliers who are willing to offer their products at a minimal rate. Rivalry amongst the industry‟s suppliers creates high 54

bargaining power for the casual dining industry‟s firms. This is caused in part by the large amount of suppliers in the restaurant industry. Numerous firms within the restaurant industry create a very competitive market. In order to remain a strong competitor, firms must have adequately low prices, high quality, and an established brand image. If these strategies are not used, home cooked meals and fast food are readily accessible to the industry‟s consumers. This entails that the customers play a large role in dictating prices within the industry. In times of economic pitfalls this can be seen through forced discounts and incentives given to consumers. This in turn, provides customers the option of going out to dine over staying home. From the five forces model it is safe to derive that the degree of competition in this particular industry is significant. Key Success Factors for Value Creation When analyzing a firm, there are two strategies involved in creating a competitive advantage within an industry. Companies can obtain competitive advantages through a cost leadership approach, a differentiation approach, or a mix between the two. A cost leadership approach is used when there are other companies who are producing the same or similar products. This form of strategy is highly dependent on the competitive prices of items produced as well as the cost of purchased goods. Efficient production and distribution are also essential when considering a cost leadership strategy. The differentiation approach is desirable when firms are offering unique products or services. Some of the operating methods that classify this approach consist of investment in brand image and research and development, more flexible delivery, and superior customer service (Palepu & Healy). Both the cost leadership and differentiation approaches are designed in order to maximize profits within a company. In the casual dining industry, businesses must be highly competitive and are typically forced into a cost leadership method of running their operations. Even though competition may be fierce, some businesses within the industry have still been able to segment themselves out into acquiring both strategies. 55

Cost Leadership In an industry where cost leadership is widely used, it is important to be especially frugal in times of economic downturn. There are many uncontrollable factors that can negatively impact the industry and the best defense for surviving in such a market is to have high economies of scale and scope, efficient production, simpler product designs, lower input costs, low-cost distribution, and small research and development expenses. Economies of Scale & Low Input Costs Economies of scale are highly desirable in lowering costs because the demand in the casual dining industry is highly elastic or sensitive to a change in prices. Economies of scale occur when productivity and proficiency increase. As a result of this productivity increase, the average cost per unit decreases. Companies can achieve economies of scale in many ways. Purchasing products in bulk can have a great effect on lowering the average cost per unit because typically incentives or discounts are given to companies purchasing in this manner. In addition, businesses have the option to have their purchased products fully specified to their needs in order to lower waste expenses. When approaching operations using this method, not only will the company lower waste expenses, but they will increase their economies of scale. Efficient Production & Simpler Product Designs It is essential within the restaurant industry that meals be prepared in a timely manner. This can be achieved in many ways. As mentioned earlier, companies can have their suppliers carry some of the burden by having them cover more of the manual preparation. Not only does this cut costs, but it simplifies the preparation as well as saves precious time between the time ordered and served. Cracker Barrel Old Country Store, Inc. has “found that when [they] deliver [the customer‟s] food in 14 minutes or

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less, guests are more likely to return and recommend [their] restaurant over others.”19 Given this example, it is essential to have efficient and timely production in order to remain in the dining industry. Another common method of speeding up production is by automating certain jobs through mechanical devices. This method is gaining ground with some companies because it allows for quicker service and streamlining the man power required. Differentiation The casual dining industry is immensely competitive, so any form of differentiation can help alleviate some of the financial strain put upon the business. Differentiation when defined to the industry is simply creating something of value that is unique or “different” from all other products or services in that market segment. In regards to the restaurant sector, there are a few methods in which a company can distinguish itself including superior product quality, variety, and customer service. Investment in the brand image can also be highly desirable in such a highly competitive market. Superior Product Quality, Variety, and Customer Service A restaurant‟s product quality, variety of items available, and customer service play a vital role in adding value to its operations. These points of differentiation have the ability to make or break a firm in the casual dining industry. Superior product quality is essential when competing in this industry. The consumer almost always expects a high quality product when dining out, unless they are expecting to be excessively stingy with their budget. The variety of items available also has the ability to create value. When there are more products available to be purchased, the customer is given a greater chance for being satisfied. In a highly competitive market, having a larger variety of products can allow a business to more readily adapt to changes such as recent healthy choice trends. According to the Wall Street Journal, “A study last 19

Annual Report 2008. Cracker Barrel Old Country Store.

57

month by market research firm Mintel International Group Ltd. found that parents are looking for healthier alternatives to the standard kids' fare of chicken fingers, grilled cheese sandwiches and macaroni and cheese”(Julie Jargon). Without being able to adapt to market demands, a firm can severely limit its survivability. Quality customer service within the industry, although it isn‟t necessary, can play a large role in consumer satisfaction as well. The design of customer service is to tend to any needs and wants of the customer. This concept adds value by allowing an employee to ensure contentment in the customer‟s experience. Investment in Brand Image The Brand Image can be invested in through several different methods. Purchasing advertising to be displayed on billboards and T.V. or presented through radio are some very common methods of investment. Investing in the brand image is beneficial because it allows consumers to both be better informed as well as create awareness of the business. In addition, promotions in brand image can create customer preferences within the market which stimulates a consistent customer base.

Advertising to Sales Ratio 0.05 0.045 0.04 0.035 0.03 0.025 0.02 0.015 0.01 0.005 0

Cracker Barrel Bob Evans Dennys Darden Dine Equity Brinker International 2005

2006

2007

2008

2009

The chart above gives insight into how much advertising as a percentage of sales is spent for each firm in the industry. This information is helpful to analysts because it allows them to see how much each firm spends on advertising in relation to their 58

competitors. The firms in the casual dining industry range from 1.8% to 4.4% with the exception of Dine Equity which has been dramatically increasing its spending on advertising in recent years. Firm Competitive Advantage Analysis Since Cracker Barrel Old Country Store, Inc. is in such a highly competitive market, the company must operate to some extent within the cost leadership strategy. What sets Cracker Barrel apart from most firms in the casual dining industry has been the ability to adopt a strong differentiation approach through its retail store as well. The company prides itself in being one of the most differentiated firms in the casual dining industry and has managed to be a massive competitor because of it. Both of these strategies allow the company to create a stronger competitive advantage within the market. This in turn increases the business‟s survivability and willingness to stay in the market. Efficient Production & Economies of Scale Cracker Barrel uses both the economies of scale and efficient production strategies in their operations. Economies of scale, as defined in the previous section, occur when lowering the average cost per unit through minimizing the time it takes to produce more goods. Cracker Barrel elicits this strategy by forcing their suppliers to tailor the products to Cracker Barrel‟s specifications. This not only saves money on waste expenses, but increases efficiency and reduces production time in the kitchen. Currently, Cracker Barrel is working at applying their “Best of the Barrel” strategy to their menus nationwide. The new menu is designed to “highlight higher-margin, easyto-prepare selections and to eliminate slow-moving, low-volume items.”20 What this strategy promotes is a more streamlined variety of products that they must supply which ultimately lowers food preparation time.

20

2008 Annual Report. Cracker Barrel Old Country Store.

59

Another tactic in which Cracker Barrel has taken to speed up production is their “Seat to Eat” concept. This concept includes both passing off some of the preparation time to the suppliers, as mentioned earlier, and researching in more efficient kitchen layouts and equipment. During Cracker Barrel‟s 2007 Thanksgiving Day Special, they “saved over $500,000 through reduced overtime just related to preparing for that one day.”20 This concept creates a large competitive advantage by lowering both time and monetary costs. Simple Product Designs When competing in the food industry, consumers expect efficient and timely service. Cracker Barrel achieves this through simpler product designs. Most of Cracker Barrel‟s offered products require minimal preparation time. This includes both the items in the retail store which require no preparation and the food items which are on the light end of time spent on creation. The “Seat to Eat” strategy mentioned earlier is designed to find new ways to make preparation both simpler and more time efficient by passing off some of the work. This plays as a large advantage to Cracker Barrel, and value is added through speedy preparation. Low-cost Distribution In order to lower additional costs, Cracker Barrel has placed distribution centers in six different regions across the nation. Having these centers spread into separate regions allows for efficient and well-organized distribution to all of their stores. In addition to these distribution centers allowing for quicker delivery of goods, they allow their suppliers to be significantly closer to the Cracker Barrel stores within the region. This strategy decreases the opportunity for products to spoil during transport, i.e., the less time it takes food products to get from the supplier to the stores to be sold, the better minimization of wasted goods.

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Superior Product Quality Maintaining high standards in product quality is crucial in the casual dining industry. Cracker Barrel is able to uphold this core competency through shorter transportation time of goods and having significant power over their suppliers. The business does not compete by reducing product quality in order to cut prices or increase profits. They feel that it is their responsibility to sustain their standards and continue to offer a product in which customers will be satisfied. According to Terry Edwards, a Cracker Barrel manager, the quality of their inputs from suppliers is what keeps customers returning. The reason Cracker Barrel‟s product quality remains high is due to their belief that there is considerable value in product differentiation. Investment in Brand Image Another method in which Cracker Barrel differentiates itself is through investing in their brand‟s image. Cracker Barrel relies heavily on advertising by means of billboards. Because eighty-five percent of Cracker Barrel restaurants are located along interstate highways and forty percent of their business derives from travelers, this is a highly effective method of investment.21 Due to Cracker Barrel‟s recent interest in building more off-interstate locations, the company is looking at investing in more conventional methods of advertising such as TV, radio, and newspaper. All of Cracker Barrel‟s advertising is directed towards promoting their “down-home,” “genuine,” and “authentic country cooking” image. In advertising their special country flair, they are creating a valuable competitive advantage by differentiating themselves into a stylized niche.

21

Cracker Barrel Fact Book. May 27, 2009.

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Advertising to Sales Ratio 0.05 0.045 0.04 0.035 0.03 0.025 0.02 0.015 0.01 0.005 0

Cracker Barrel Bob Evans Dennys Darden Dine Equity Brinker International 2005

2006

2007

2008

2009

The advertising to sales ratio is calculated by dividing advertising by sales. On average Cracker Barrel‟s advertising to sales ratio remains stable around 1.8%. Although the company has one of the lowest advertising to sales ratios, investment in brand image is a necessary component for competitors in the casual dining industry. With forty percent of Cracker Barrel‟s customer base consisting of travelers it is safe to assume that their advertising methods are highly effective and efficient in bringing in new customers. Superior Product Variety & Flexible Delivery In the retail portion of Cracker Barrel, a wide variety of products are offered for the customers to purchase. These products are designated to give the optimum value in the customer‟s full country experience. Cracker Barrel offers such items as exclusive popular country artist CDs all the way to rocking chairs, jelly, and apparel. All of Cracker Barrel‟s retail items are sent to their warehouse located in Lebanon, TN and distributed to the stores from there. Because their retail system operates on a differentiation standard, it is a much more time flexible system of delivery compared to their food delivery process.

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Superior Customer Service One of the main traits associated with the country image is southern hospitality. In an authentic country cooking strategy, it is no surprise that Cracker Barrel tries to instill this trait within its employees. Through their innovative “Rising Stars” program, “Cracker Barrel is now below 100% turnover among [their] hourly restaurant employees, hiring 1/3 fewer people in fiscal 2008”(CBRL Group, INC. 2008 Annual Report 27). This program entails finding the more dedicated employees and training them to a higher degree. Employees are able to feel more reward and value in their work which ultimately creates happier employees. In turn, moods of customer service employees can play a large role in customer satisfaction. Conclusion When faced with the highly competitive environment of the casual dining industry, businesses must incorporate elements of cost leadership and differentiation that stiffly control cost of supplies, minimize product preparation time, respond to the changing demands of the market, produce superior quality of goods, promote a clearly focused image in advertisement, and offer a wide variety of marketable goods. Businesses must streamline conditions for obtaining supplies while providing a widely desirable product in a positive environment. Cracker Barrel Old Country Store, Inc. has optimized their opportunities for success by enlisting all of these strategies. This company doesn‟t leave anything to chance in its plan to create value and a strong competitive advantage within this industry. Accounting Analysis There are many ways firms can legally manipulate information to portray accounting figures in a favorable light. Managers and board members may have personal incentives, such as management compensation bonuses, to manipulate 63

accounting figures. Therefore, the extensive evaluation of a firm‟s financial statements and accounting policies is an important step in the firm valuation process. A thorough accounting analysis will provide an in-depth look at the underlying business components that hide behind the reported numbers. This analysis consists of 6 important steps. The first step is to identify the Key Accounting Polices (KAPs). Key Accounting Policies are the accounting measures that most directly relate to the underlying value of the company. KAPs are split into two categories: Type 1 and Type 2. Type 1 Key Accounting Policies are linked to the Key Success Factors presented in the Business/Industry analysis section. Type 2 KAPs are associated with certain items on the financial statements that managers have the ability to distort. The second step is to assess the amount of flexibility that managers in the firm have when choosing accounting policies and estimates. These choices can range from depreciation and inventory policies to whether or not a firm will expense marketing investments. The level of flexibility relates to how informative the accounting numbers are to analysts. This step focuses more on Type 2 Key Accounting Policies. After assessing the amount of flexibility in the firm, the next step involves evaluating the firm‟s accounting strategy. This involves identifying how conservative or how aggressive a company is in reporting Type 2 Key Accounting Policies. Looking into the firm‟s choices can reveal the actual strength of the company and whether or not managers are hiding results. This includes comparing the firm‟s accounting policies to other firms within the industry. Moreover, this step involves checking if the firm has made any policy or estimate changes, as well as, whether or not the firm‟s policies and estimates have been accurate in the past. The fourth step in the accounting analysis calls for an evaluation of the quality of disclosure within the firm‟s annual reports (financial statements). The evaluation will include looking at adequacy of footnotes in financial statements and the amount of specific information in the letter to shareholders. If a business is segmented, then the analysis needs to examine how the firm breaks up reporting of the multiple lines of business or if the firm simply combines them all into one segment. The amount of

64

disclosures from management that are above and beyond minimum requirements and the way bad news is presented are also examined. Following the examination of the degree of information transparence, the next step in the accounting analysis methodology requires that the financial statements are scoured for red flags that could potentially mask questionable accounting. These red flags are typically seen when companies are struggling or when firms make unsubstantiated transactions that increase profits. Red flags may also be found in writeoffs, fourth quarter adjustments, decreasing cash flow while net income remains the same, and accounting changes that are unexplained. When a red flag is discovered, “the analyst should examine certain items more closely or gather more information on them.” (Palepu & Healy). The final step is to undo the accounting distortions that may have been found in the previous five steps. Next, the analyst must restate the financial statements to the best of their ability when accounting policies and practices are discovered that may have resulted in misleading figures. An examination of the statement of cash flows and financial statement footnotes will aid in determining the closest possible estimate of the firm‟s accounting figures. Key Accounting Policies As mentioned above, Key Accounting Policies (KAPs) are the policies and estimates a firm uses that are most directly related to Key Success Factors and have the most effect on the underlying value of the firm. Identifying the KAPs of a firm is the first step in the Accounting Analysis. Managers‟ choices in reporting practices concerning Key Accounting Policies will have the most effect on the perception of the firm‟s value. Noise and distortion in accounting figures can result from firm managers dressing up the financial numbers. Therefore it is important to analyze all aspects of the firms‟ financial statements. However, specifically examining the Key Accounting Policies will have the greatest effect on an analysts‟ valuation of the firm because these policies are most closely related to what drives the firm‟s value. Key Accounting Policies will be separated into two categories: Type 1 KAPs and Type 2 KAPs. Type 1 policies are those that relate directly to the Key Success Factors identified for the firm in the Business 65

Analysis and relate to activities that drive value. They will show how the company reports information concerning its core competencies and the aspects that drive firm value in the industry. This might include how the firm utilizes Economies of Scale or how the company is a leader in controlling input costs. Type 2 policies relate to asset or liability items that managers have flexibility in reporting and may significantly influence the market value of the firm. For example, a firm may intentionally report Goodwill, Defined Benefit Plan liabilities and operating and capital leases in a way that is opaque to the average reader. However, a comprehensive analysis of these items can help us shed light on the parlor tricks that managers may employ. Type 1 Key Accounting Policies As mentioned above, Type 1 Key Accounting Policies relate to the Key Success Factors that drive firm value. For Cracker Barrel, these core policies are their superior product variety, investment in brand image, and the use of efficient production methods. Superior Product Variety Cracker Barrel maintains its position in the restaurant industry by providing superior product variety in its stores. The retail store attached to all Cracker Barrel restaurants is a significant part of the customer experience and contributes approximately 20% of the total annual revenues for the firm. Notably, Cracker Barrel does not segment the reporting of results from the two operating activities. Because of their close proximity, “the operating expenses of the restaurant and retail product lines of a Cracker Barrel unit are shared and are indistinguishable in many respects.”

22

Cracker Barrel reports operating results from two different industries in one report, as opposed to most competitors, which are only involved in the restaurant industry. Bob Evans Farms, Inc. operates similar retail type stores within some of its restaurants and

22

Cracker Barrel 10 – K. 2004-2009.

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segments the reporting of revenues and expenses for the restaurant and retail portions of their business. Investment in Brand Image Another way Cracker Barrel generates value is through their investment in the Brand Image. This is done primarily through the use of highway billboard signs. The signs are uniform and highly recognizable and remind travelers that Cracker Barrel‟s “home-away-from-home” feeling is close by. This is critical to the success of the restaurants as over 40% of customers are travelers. Payments for these signs are recognized as advertising expenses separate of operating leases maintained for store locations. The notes to the consolidated financial statements specifically outline the difference between advertising costs and operating leases for restaurant locations. The following chart shows the total amount of advertising expense over the past 3 years and the amount of that expense composed of billboard leases. The bar graph of the dollars spent on advertising expenses and billboard rent expenses indicate that these expenses have been steady with little growth over the last three years.

Investment in Brand Image Advertising Expense 41133

23374

2005

38274 24938

2006

Billboard Rent Expense

40522

25204

2007

42160

25177

2008

42371

25950

2009

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Cracker Barrel has traditionally stayed away from more mainstream advertising methods such as radio and television advertising. The firm has little information as to whether the additional advertising would be beneficial and believes the additional costs might negatively affect results from operations. Other firms in the industry spend a relatively higher amount of their net sales on advertising expense. The following chart show a time series plot of the percentage of net sales recorded as advertising expense for each firms‟ last 5 reported years. It is clear that Cracker Barrel does not employ as aggressive advertising strategies as its competitors. The firm has traditionally had a conservative approach to advertising and will continue as long as it experiences success. DineEquity‟s acquisition of Applebee‟s resulted in a significant increase in advertising expenses. Applebees‟ employs a heavy dose of television advertising. Darden operates a multitude of restaurant chains, each of which may require a different advertising budget.

Advertising Expense / Sales 0.05 0.045 0.04 0.035 0.03 0.025 0.02 0.015 0.01 0.005 0 2005 Cracker Barrel

2006 Darden

2007 BobEvans

2008 DineEquity

2009 Denny's

Brinker

Note that DineEquity and Denny‟s Corp have not reported 2009 numbers yet. Cracker Barrel finds itself among the firms in the industry that spend a small percentage of their net sales on advertising. This is partly a result of the fact that 68

Cracker Barrel does not employ an aggressive television and radio advertising strategy. However, accounting policy has an effect on this number as well. Cracker Barrel records all rent expense for operating leases for billboards under advertising expenses. These billboards are the primary way that Cracker Barrel advertises. Because no tangible operating revenues come from the billboards, they are not classified under operating leases. However, the payments are not like normal advertising costs that would be one time, sunk costs. The leases account for recurring advertising costs for the length of the billboard contracts. Efficient Production Methods Cracker Barrel also utilizes efficient production methods to provide quality food at a relatively low price. This includes tactics such as having suppliers do portions of the meal preparation before shipping foods to the restaurant locations. Additionally, reducing input costs ensures Cracker Barrel can provide food as cheaply as possible. Notably, Cracker Barrel has a relatively low amount of disclosure when it comes to input information. The 10-K merely states that Cracker Barrel uses a “contract with an unaffiliated distributor with custom distribution centers.”23 Cracker Barrel makes use of standardized kitchen and store setups to ensure that each new location carries the same amount of efficiency as existing stores. Menus are standardized across the nation as well. Raw food materials are bought mostly locally, with few if any products relying on a single source.24 However, Cracker Barrel affords little disclosure when it comes to the purchase of materials for production. Examining the Gross Profit Margin ((Net Sales – Cost of Goods Sold)/Net Sales) can serve as a useful tool in identifying firms that are operating efficiently. The following graph shows the Gross Profit Margin for Cracker Barrel and its competitors in the restaurant industry over the past 5 years.

23 24

Cracker Barrel 10 – K. 2004-2009. Cracker Barrel 10 – K. 2004-2009.

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Gross Profit Margin 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 2005

2006

2007

2008

Cracker Barrel

Bob Evans

Denny's

Darden

DineEquity

Brinker

2009

It is clear that Cracker Barrel is one of the leading firms in the industry when it comes to maximizing the profits from each sale. Cracker Barrel, Brinker, and Bob Evan‟s have relatively large market capitalizations for the industry and can utilize economies of scale. Type 2 Key Accounting Policies Firm managers have the most impact on adjusting numbers within type 2 accounting policies. Distortions in reporting can result in misleading figures represented on the balance sheet and income statement. Operating Leases As of September 22, 2009, Cracker Barrel operated 591 restaurant locations. Of these, 192 are leased under either capital or operating leases. A firm‟s choice to classify leases as operating or capital can have a significant effect on the financial statements. 70

Operating leases allow the firm to record rent payments under operating expenses on the income statement. Firms are essentially renting the property with no benefits or risks of ownership, although they may intend to renew the lease over and over again. Capital leases incorporate an interest payment into the rent payment so that the firm slowly paying for the asset. As a result, the firm maintains the benefits and risks of ownership of the asset. This includes recording depreciation expenses for the asset over its useful life. In addition, the liabilities from future principal and interest payments are represented in the balance sheet. As of September 22, 2009, Cracker Barrel operated 591 restaurant locations. Of these, 192 stores were leased under either capital or operating leases. Firms will generally lean towards operating leases as opposed to capital leases because it allows them to keep a large chunk of liabilities off of the balance sheet. In addition, depreciation and interest expense are not recorded, which can understate the firm‟s expenses. This leads to balance sheets that may not be an accurate representation of the firm‟s position. Using primarily operating leases will understate liabilities and assets, in turn overstating equity. This will lead to an overstatement of net income as well, which affects many key financial ratios. Cracker Barrel follows the industry trend in that almost all of its leases are classified as operating leases. The disclosure on the details of such leases is relatively low. Cracker Barrel lists a very low amount of $60,000 as its capital lease obligations in the fiscal year 2009. Minimum capital lease payments through 2011 are as low as $22,000 a year. The results from using operating leases mentioned above will be demonstrated in Cracker Barrel‟s financial statements and will continue as they plan to renew operating leases when available. This is the accounting policy that most distorts Cracker Barrel‟s accounting figures. Cracker Barrel reports no amount of Goodwill in its financial statements. This is primarily due to the fact that they have had no major acquisitions in recent years. When purchasing Logan‟s Roadhouse in 1998, Cracker Barrel did not pay a significant premium to the market value of the firm, so no Goodwill was accounted for.

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Foreign currency exchange rates do not affect Cracker Barrel because they only deal internationally with China. The Chinese yuan has been a peg to the U.S. dollar, meaning that its value is set in proportion to the dollar. Thus, changes in the strengths of the dollar are mirrored by the yuan, causing little effect to Cracker Barrel. Potential Accounting Flexibility All U.S. based firms deal with various degrees of flexibility in their accounting policies. This is due to the abundant methods in which firms are capable of creating value and GAAP‟s (Generally Accepted Accounting Policies) allowance for firms to use their own judgment in recording a few specific items. These items include goodwill, operating leases, defined benefit plans, medical benefit plans for retirees, research and development, and foreign currency risk. When in a competitive market, it is important for companies to report positive earnings. Because of this, managers often create distortions in the company‟s value through their firm‟s allotted accounting flexibility. The ultimate goal of reporting positively to investors can then be accomplished by reporting the firm‟s effectiveness in creating value through their key success factors. Cracker Barrel Old Country Store, Inc. has one distinct area in which it is allotted some flexibility in its accounting policies, the use of operating leases instead of capital leases. Operating Leases Accounting for operating leases instead of capital leases has great potential to distort the actual value of a company. GAAP allows for flexibility in whether a firm can report its leases as capital or operating, which further aids companies in hiding losses with greater ease. Under capital leasing, a company will report its leases as assets and will incur liabilities from rent expenses. This form of leasing allows firms to stay true to their actual company value. Firms find the use of operating leases desirable because they allow any liabilities or obligations in regard to their leased assets to be hidden from the balance sheet. For instance, because the leases are not regarded as assets, firms 72

can avoid the interest expenses that would accumulate if these assets were reported. The table below breaks down how the balance sheet and income statement could be affected through using operating leases in comparison to capital leases. Assets would be understated because the leases are withheld from the books, and liabilities and equity would be overstated in proportion to assets. Because the additional interest expense is avoided and there is no effect to revenue, Net Income will have potential to be overstated. With 99.9% of Cracker Barrel‟s leases being operating leases, this could have a drastic effect on the firm‟s actual value.

Assets

Liabilities

Equity

Revenue

Expenses

Net Income

U

O

O

N

Avoided

O

Actual Accounting Strategy When evaluating the actual accounting strategy of a firm, it is important to first compare the firm‟s accounting policies and their quality in disclosing them to those of its competitors. A firm‟s quality of disclosure reflects greatly on the overall image of the firm. If managers are given incentives in reporting positive earnings, it is much more likely that they will choose accounting policies which distort the firm‟s actual earnings when the company is suffering. For instance when managers own a large amount of stock in the firm, they will be inclined to overstate earnings because they will be rewarded monetarily for the increased share price. When the quality of disclosure is lacking, there is a greater likelihood that managers are distorting the actual value of the company through accounting policies. The overall goal of an analyst is to make sure that the company being evaluated is providing a proper outlook to how the company is doing. What this entails is deciphering from the company‟s information whether they exercise aggressive, conservative, or typical accounting policies for the industry. Aggressive accounting

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policies are characterized by reporting the company‟s income higher than it should be stated, whereas conservative accounting indirectly leads companies to report lower incomes. When comparing a firm‟s accounting approaches to other firms in the industry, the firm‟s overall approach to accounting can then be revealed. Operating Leases Cracker Barrel, as mentioned earlier, has a mixture of capital and operating leases with the majority being operating leases. By reporting a majority of operating leases, the company is taking advantage of GAAP‟s flexibility in regards to leases. Cracker Barrel‟s 10-K states that the total present value of the future capital lease expenses are $562,000 where as the total present value of the future operating lease expenses are valued at $765,144,000. This means that 99.9% of all of Cracker Barrel‟s leases are operating leases and are not stated as assets. In 2009, Cracker Barrel incurred $34,464,000 of rent expenses tied to operating leases. This is a significant amount of assets to be hidden from the balance sheet and could be a large factor in determining the actual success and value of the firm. Even though the use of operating leases is considered to be an aggressive accounting policy, in comparison to the rest of the casual dining industry Cracker Barrel is right in line with its competitors. Every one of Cracker Barrels competitors have a large portion of its leases recorded as operating leases. This is significant because it gives some perspective to the common accounting policies of the industry. This also indicates that Cracker Barrel is not manipulating its accounting policies any differently than anyone else in the industry. Even though its policies are similar, Cracker Barrel is still regarded to be even more aggressive than its competitors from operating leases. Not only do they have an excessively large percentage of its leases reported as operating leases, but the firm also is active in sale-lease backs. This is considered to be a very aggressive strategy because it sells and leases the properties they build and is blatant that they are avoiding having these stores hidden from their assets.

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Quality of Disclosure Introduction To evaluate a firm effectively it is important to analyze the managers accounting discretion in order to decide whether a company‟s financial statements truly reflects all inside information. GAAP requires that a firm discloses a certain amount of information as regards to its accounting policy and accounting strategy. Since managers have intimate knowledge about the firms‟ business, they are expected to reflect that knowledge in the financial statements in order to give investors and creditors a transparent view of the company‟s business. If a manager discloses information beyond what is required by GAAP then the quality of the company‟s disclosure gives outside users a more accurate view of the company, which increases the businesses value by making its financial statements more reliable. On the other hand, managers have an incentive to manipulate the quality of disclosure by making biased assumptions. If a company‟s chooses not to disclose certain information then the reliability of its accounting quality decreases because it does not capture the reality of the business.25 Throughout this section an analysis of Cracker Barrel‟s quality of disclosure compared to its top competitors will be reported. Type 1 Accounting Policies Superior Customer Service/Product Quality We begin analyzing Cracker Barrel‟s disclosure of type 1 key accounting policies by taking a look at how they address their superior customer service and product quality. These are two of their main core competencies, and it is supported by their mission statement which is “Pleasing People.” Cracker Barrel discusses in their 10-K the

25

Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.

75

process that they follow in order to deliver outstanding service, consisting mainly of attentive service and consistent food quality. Looking under their “Guest Satisfaction” section of the 10-K, they thoroughly explain that they are committed to staffing experienced managers and employees, and training them on the importance of their mission statement and culture. The company also explains how they manage customer complaints by engaging in surveys, restaurant visits, and providing internet services for customers to make comments and suggestions.26 Overall, Cracker Barrel has good disclosure of their process of maintaining excellent customer service. Superior Product Variety Cracker Barrel differentiates itself from competitors by offering a variety of products. Unlike most restaurants, Cracker Barrel has a wide selection of retail items that contribute to approximately 21% of the company‟s business. They fully disclose the types of menu items offered, and also discuss the type of products that are offered in the retail section by breaking them down into five categories: Apparel, food, seasonal, home, and toys. However, the company does not segment their reporting of results from the two types of operating activities, meaning that the expenses from the two operating activities are “shared and indistinguishable in many respects.”27 Because they don‟t segment their reporting, Cracker Barrel has a moderate rate of disclosure for its superior product variety. Low Cost Distribution/ Flexible Delivery The ability to have low cost distribution and flexible delivery of products is a key core competency for the value of a firm. Cracker Barrel does not fully disclose their distribution method, perhaps to keep information hidden from its competitors. They only mention their contracts with “unaffiliated distributors” and the locations of their 26 27

Cracker Barrel 10 – K. 2004-2009. Cracker Barrel 10 – K. 2004-2009.

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distribution centers. According to their 10-K, these unaffiliated distributers are also responsible for placing the food orders, warehousing, and delivery of products. Cracker Barrel also mentions that approximately 42% of their retail purchases for 2009 came from the republic of China, but fails to disclose specific vendors it contracts or the specific retail items purchased from China.28 Due to this Cracker Barrel has a low quality of disclosure of its low cost distribution. Sales Manipulation Diagnostics Sales manipulation ratios help analysts compare competing firm‟s financial statements. By comparing inventory, cash from sales, and accounts receivables to net sales it allows analyst to find credibility of the sales that are reported. With the knowledge of these ratios, analyst can find distortions in a company‟s financial statements. These distortions are seen though drastic changes in the ratios, from one year to another. The distortions seen in the ratios help to point out “red flags” which will increase or decrease the value of the information presented by the firms. We will compare Cracker Barrel‟s ratios with their competition in order to verify if ratios are related to the industry. With this knowledge you can easily identify problems and concerns within the financial statements. Net Sales/Cash From Sales In order to find cash from sales you must subtract the change in accounts receivable from net sales. Then to find this ratio you simple divide net sales by cash from sales. The purpose of this ratio is to measure the correlatation of net sales to their cash from sales. The ratio should be 1 for a pure cash business because net sales will equal the total cash from sales. When a company has Accounts Receivable they do not recognize the cash from the sale and it raises their ratio in one year and lowers it

28

Cracker Barrel 10 – K. 2004-2009.

77

when they receive the cash the next year. When there are increases in sales and Accounts Receivables stays the same the ratio increases. Following is a graph that represents the relations.

Net Sales/ Cash From Sales (RAW) 1.2 1.15 Cracker Barrel 1.1

Bob Evans Dennys

1.05

Darden Dine Equity

1

Brinker International 0.95

Industy

0.9 2004

2005

2006

2007

2008

As you can see the ratio stays very close to 1. This means that it is mostly a cash industry. There is a large spike in Dine Equity‟s ratio. This is due to their acquisition of Applebee‟s in 2007. On the other hand Cracker Barrel is consistently close to 1, which shows their revenues are very closely related to their cash.

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Net Sales/Cash From Sales (CHANGE) 2.5 2 Cracker Barrel

1.5

Bob Evans

1

Dennys

0.5

Darden 0 -0.5

2004

2005

2006

2007

2008

-1

Dine Equity Brinker International Industy

-1.5 -2

This measures the correlation between sales and cash from sales. When the correlation is negative it means the sales are not related to the cash from sales. In summary most of the company‟s ratios remain relatively close to 1, except for Dine Equity. This means there is a positive correlation between the sales and cash from sales. Dine Equity had a sales increase in 2006 but a cash decrease; this causes the spike in 2006 and in 2007 they purchased Applebee‟s. The industry average also remains close to 1, except for the years in which Dine Equity‟s correlation spikes. Since there are no distortions in Cracker Barrel‟s ratios, there are no signs of any “red flags.” Net Sales/Accounts Receivable This ratio is found by dividing net sales by accounts receivable. It shows the relationship that accounts receivable have with net sales. If a company‟s sales show a minor increase and their accounts receivable go down it will increase the ratio. This ratio should remain relatively static throughout the years. If there are any distortions, or major spikes, it could be a “red flag.” If the ratio jumps it means the firm recognized too many revenues from its accounts receivable that year. Following is a graph of Cracker Barrel and its competitors in the industry.

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Net Sales/Accounts Receivable 300 250 Cracker Barrel 200

Bob Evans Dennys

150

Darden Dine Equity

100

Brinker International 50

Industy

0 2003

2004

2005

2006

2007

2008

This graph indicates that there is a possible “red flag” for Cracker Barrel between 2004 and 2005. It could be that they changed how much of their receivables they were recording as revenues each year, based on their bad debt expense percentage. Although, since the industry average dipped that year it should not be a major concern, or a “red flag.” Most of the other firms remained fairly constant through-out the 6 year period.

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The following graph shows the change in net sales over accounts receivable.

Net Sales/Accounts Receivable (Change) 3.5 3 Cracker Barrel

2.5

Bob Evans 2

Dennys Darden

1.5

Dine Equity 1

Brinker International Industy

0.5 0 2004

2005

2006

2007

2008

This graph allows analyst to see the change in net sales relative to the change in accounts receivable. As you can see the change stays within 1 point of its original ratio, this means that there is a correlation between sales and accounts receivable. This is achieved by maintaining good account collections and maintaining a steady accounts receivable increase relative to sales. This is true for everyone but Darden, which shows that there is a “red flag” for Darden. Most firms in the industry have a negative ratio which could mean they are taking on aggressive accounting techniques. This is true for Cracker Barrel as well except, they were not negative for consecutive years. Therefore, it should not pose as a major “red flag.”

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Net Sales/ Unearned Revenue The ratio of net sales/unearned revenue describes how much of a company‟s net sales are contributed by its unearned revenue. This is an important measure in the restaurant industry, where companies are faced with the liability of unused gift cards. There is no specific number in measuring this ratio, just keep in mind the industry norm.

Net Sales/Unearned Revenue (RAW) 160 140 120

Cracker Barrel

100

Bob Evans

80

Darden

60

Dine Equity

40

Brinker International

20

Industy

0 2003

2004

2005

2006

2007

2008

As the chart above displays, companies in the restaurant industry operate their net sales/unearned revenue at different levels. Note, Dine Equity fails to disclose information on unearned revenue before 2007, and Bob Evans fails to disclose information previous to 2006. The charts shows that most companies in the in the industry have a downward sloping ratio, meaning that unearned revenue is increasing more than net sales. While normally this would raise a “red flag” of sales manipulation, the industry norm suggest that it is a trend between most of the companies. The change in net sales/unearned revenue is a measure of the correlation between a firms‟ net sales and unearned revenue. If the change in ratio is positive, it implies that the company‟s unearned revenue is increasing as sales increase, which is a common trend. However, if the change ratio is negative, it implies that net sales and

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unearned revenue are moving in opposite direction. Keep in mind that only positive and negative values are important in analyzing the change ratio.

Net Sales/Unearned Revenue (CHANGE) 200 100

Cracker Barrel

0 -100

2004

2005

2006

2007

-200 -300 -400 -500

2008

Bob Evans Darden Dine Equity Brinker International Industy

-600

As the chart above explains, most of the companies are relatively close to one another; with the exception of Cracker Barrel during 2005 and 2007. For those two years Cracker Barrel‟s sales and unearned revenue had negative correlation with one another. This is not necessarily a bad sign because it means that the company received more cash up front, as opposed to writing down a liability. It could, however, be a cause of concern that sales may have been manipulated. Looking closer at Cracker Barrels financial statements, their sales decreased from 2004 to 2005 by 7.98% and increased by 5.95% during 2006-2007, with unearned revenue staying relatively constant. Given this information, the negative correlation between the two accounts is explained by fluctuating payment styles by consumers. Net Sales/Inventory This ratio is found by dividing net sales by inventory. It shows the relationship between net sales and inventory. Since, inventory is directly related to sales it should correlate, meaning if sales raise so should the amount of inventory. Any spikes in this

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ratio show that inventory was not properly accounted for in that period. Following is a graph of the industries net sales over inventory ratio.

Net Sales/Inventory 500 450 400 Cracker Barrel

350

Bob Evans

300

Dennys

250

Darden

200

Dine Equity

150

Brinker International

100

Industy

50 0 2003

2004

2005

2006

2007

2008

As you can see most companies stay fairly static over the 6 year period. The exception is Dine Equity who kept low inventory until they acquired Applebee‟s in 2006. In the future analyst should expect to see Dine Equity show the same consistency as the other firms in the industry. The industry average is also offset by Dine Equity‟s ratio.

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Following is the graph of change in net sales over inventory.

Net Sales/Inventory (CHANGE) 300 200 Cracker Barrel

100

Bob Evans 0 -100

2004

2005

2006

-200

2007

2008

Dennys Darden Dine Equity Brinker International

-300

Industy

-400 -500

This graph better illustrates the changes in the net sales over inventory ratio. According to this graph Cracker Barrel had a major distortion in 2005 which could point to a “red flag.” This shows that they did not have a direct correlation between net sales and inventory. Although, the industry average decreased so it could be considered an industry trend and not considered a “red flag.” The same cannot be said for Denny‟s because they have a huge distortion in 2006. This has huge implications on the accounting policies that Denny‟s used. Conclusion In conclusion, Cracker Barrel‟s ratios stayed fairly consistent throughout the time period, with respect to industry averages. The only major exception was in 2005 with their net sales over inventory ratio. This could mean they changed their inventory methods, or just had a really good year on retail sales at the end of the period. Either is possible because the next year the inventory ratio went back to normal. This leads me to assume that there is only one “red flag” for Cracker Barrel and that was in 2005 with relation to their inventory. 85

Expense Manipulation Diagnostics Expense diagnostics use line items from the financial statements to check for any manipulations. They are helpful in determining if companies are overstating expenses for the purpose of understating net income. These ratios take the line items from the financial statements and measure the connection between them. The three financial statements that will be used for the expense ratios are the income statement, the balance sheet, and the statement of cash flows. The ratios will be compared to competitors in the restaurant industry in order to uncover any irregularities from the industry norm. Asset Turnover The turnover ratio is calculated by dividing the firm‟s net sales over their total assets. This ratio is a lag ratio, meaning that net sales are divided by the total assets of the previous year. It measures how efficiently a firm is utilizing its resources.29 In the restaurant industry there are companies of all sizes, and the asset turnover ratio allows for the comparison of the amount of sales produced for each dollar amount of assets for different size companies. For example, if the ratio is high it means that a company is making more sales with the assets on hand.

29

investopedia

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The following is a graph showing the firms asset turnover ratio.

Asset Turnover (RAW) 3 2.5 Cracker Barrel 2

Bob Evans Dennys

1.5

Darden Dine Equity

1

Brinker International 0.5

Industy

0 2003

2004

2005

2006

2007

2008

As you can see most firms in the industry remain relatively consistent, and the industrial average also remains consistent. Dine Equity‟s ratio is smaller than its competitors, signaling that the company operates with a higher amount of assets. According to this graph Cracker Barrel jumped from 2006 to 2007. This spike is caused from the discontinuance of Logan‟s Steak House in 2006. For this reason, there is no “red flag” for Cracker Barrel.

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The following graph shows the change in asset turnover for the industry.

Asset Turnover (CHANGE) 4 3

Cracker Barrel

2

Bob Evans Dennys

1

Darden 0 -1 -2

2004

2005

2006

2007

2008

Dine Equity Brinker International Industry

-3

The graph above shows the change in total assets and sales over a five year period. Most of the companies in the industry have a positive asset change ratio, which means that total assets and sales are positively correlated. The asset turnover change ratio shows that for the year 2005 Cracker Barrel‟s change in sales were negatively correlated with the change in total assets. In fact, Cracker Barrel had an increased amount of total assets which produced a lower amount of sales compared to the year before. Cracker Barrel for the most part has a positive asset turnover change ratio which would not raise any concerns of manipulation. Denny‟s and Dine Equity begin with negative change ratios in 2004, but then rise to a positive ratio which raises no “red flags.”

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The following graph shows Cracker Barrel‟s Asset Turnover in relation to the trial balance worksheet.

Asset Turnover (RESTATED) 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0

As Stated Restated Industry Average

2004

2005

2006

2007

2008

2009

The result from this graph allows the user to see that the restated financials reduced the total assets of Cracker Barrel. This caused the ratio to be lowered and shows that Cracker Barrel is under the industrial average. This is not a huge concern because all of the other companies in the industry have operating leases which would lower their assets as well. This would cause Cracker Barrel to stay close to the industry average. Note, the last year of the industrial average was unattainable due to the fact that not all companies have posted their 2009 10-Ks.

As Stated

Restated

Industry Average

2004

1.66

1.42

1.47

2005

1.43

1.11

1.43

2006

1.32

1.02

1.48

2007

1.86

1.45

1.54

2008

1.82

1.45

1.54

2009

1.90

1.42

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Cash Flow from Operations/Operating Income The ratio is calculated by taking the cash flow from operations and dividing it by the operating income for a given period. The ratio links the income statement with the statement of cash flows and gives a measure of the correlation between operating income and cash flow from operations. It is a useful ratio in determining if a company is deferring expenses. When interpreting this ratio the correlation between operating income and cash flow from operations must be analyzed with the industry norm to check for any irregularities.

CFFO/OI (RAW) 2 1.5

Cracker Barrel

1

Bob Evans

0.5

Dennys

0

Darden

-0.5 -1 -1.5

2003

2004

2005

2006

2007

2008

Dine Equity Brinker International Industy

-2

Over the past five years, most of the firms in the industry have experienced some stability in their CFFO/OI ratio, with the exception of Dine Equity. The trend of the industry CFFO/OI ratio seems to be declining over the years, meaning that operating income is increasing faster than cash flow from operations. Dine Equity had a major drop off in 2007, which was caused by a negative operating income for the years 2007 and 2008. Cracker Barrel‟s ratio was relatively constant from 2003-2006, but then dropped after the sale of Logan‟s Steakhouse in 2006. After examining their financial

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statements, Cracker Barrel had a bigger decrease in cash flow from operations than in operating income, which explains the decrease in their CFFO/OI ratio. The change ratio for CFFO/OI should be positive because operating income and cash flow from operations should be positively correlated. On the other hand, if the change CFFO/OI ratio is negative, it should raise a red flag of accounting manipulation because it is implying that cash flows are not being attributed from operating income.

CFFO/OI (CHANGE) 10 5

Cracker Barrel

0 -5

Bob Evans 2004

2005

2006

2007

2008

Dennys

-10

Darden

-15

Dine Equity

-20

Brinker International

-25

Industy

-30

The chart above explains the change in CFFO/OI ratios over the past five years. It shows that Cracker Barrel had a negative CFFO/OI in all years except for 2006. This raises a red flag for Cracker Barrel because the change ratio is explaining that operating income is negatively correlated with cash flow from operations. This should cause concern if Cracker Barrel is misrepresenting expense numbers to try and manipulate net income. In 2007 Cracker Barrel‟s CFFO/OI ratio decreased dramatically due to the sale of Logan‟s Steakhouse during 2006. Cash Flow from Operations/ Net Operating Assets This ratio links the statement of cash flows with the balance sheet. Net operating assets are a company‟s property plant and equipment minus any depreciation. This ratio is helpful in measuring the correlation between a company‟s cash flow from

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operations and its net operating assets. It is useful in determining if a company is correctly depreciating its assets or writing off expenses, and it allows for analyst to check for any irregularities due to these accounting manipulations.

CFFO/NOA (RAW) 5 3

Cracker Barrel

1

Bob Evans

-1

Dennys 2003

2004

2005

2006

2007

2008

-3

Darden Dine Equity

-5

Brinker International

-7

Industy

-9

As the chart above shows, most of the companies in the restaurant industry are fairly close to one another. Cracker Barrel‟s CFFO/NOA ratio stays relatively constant with the industry norm, except for a sudden drop in 2006. The decrease in Cracker Barrel‟s CFFO/NOA ratio is not a “red flag” because the sale of Logan‟s Steak House increased current assets for the year. Due to the sale of Logan‟s Steak House, Cracker Barrel had negative net operating assets for the year. The negative net operating assets are the reason for the big drop during 2006. The CFFO/NOA ratio change should be positive, implying that an increase in assets should generate more cash flow. If a firm has a negative change ratio it is implying that they may be distorting expenses. It raises a “red flag” that the company may not be appropriately expensing their operating assets. The only thing important in the graph is the value sign of the ratio.

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CFFO/NOA (CHANGE) 10 8

Cracker Barrel

6

Bob Evans

4

Dennys

2

Darden

0 -2

2004

2005

2006

2007

-4 -6

2008

Dine Equity Brinker International Industy

-8

As you can tell by the graph Cracker Barrel has a relatively constant CFFO/NOA ratio change compared to the industry norm. Bob Evans and Darden have negative change in 2006, raising a “red flag” that the two companies may not be depreciating their assets appropriately, or that expenses were not written off correctly. The same can be said about Denny‟s in the year 2005.

93

The following graph shows Cracker Barrel‟s CFFO/NOA ratio with respect to the trial balance sheet.

CFFO/NOA (RESTATED) 2 0 2004

2005

2006

2007

2008

2009

-2

As Stated

-4

Restated Industry Average

-6 -8 -10

This graph allows the user to see that capitalizing the operating leases does not significantly impact the CFFO/NOA ratio in 2004 or2005. It does however balance out the sale of Logan‟s Steak House in 2006. Without the sale of Logan‟s Steak House in 2006, the industry average would be much closer to the restated ratio. The 2007-2009 ratio is impacted and lowered, this would happen to all companies that capitalized their operating leases. Note, the last year of the industrial average was unattainable due to the fact that not all companies have posted their 2009 10-Ks.

As

Restated

Stated

Industry Average

2004

0.22

0.17

0.22

2005

0.24

0.18

0.16

2006

-8.31

0.60

-1.24

2007

0.54

0.22

0.10

2008

0.91

0.32

1.03

2009

0.81

0.36

94

Accruals/ Sales In order to calculate total accruals you must subtract operating income from cash flow from operations, and then divide that by sales. This ratio measures the relationship between the company‟s accruals and sales. There is no ideal ratio number, it is only a measure that should be compared to the industry in order to test for any irregularities from the norm. This is another useful ratio in checking for any expenses manipulations. For example, If the ratio is dropping over time it means that a company is reporting more accruals, in which they may be deferring expenses.

Total Accruals/Sales (RAW) 1.2 1

Cracker Barrel Bob Evans

0.8

Dennys

0.6

Darden 0.4

Dine Equity

0.2

Brinker International Industy

0 -0.2

2003

2004

2005

2006

2007

2008

The chart above shows the total accruals/sales ratio for Cracker Barrel and its competitors over the past five years. Most these restaurants in this industry have a stable accruals/sales ratio over the years. However, in 2006 Dine Equity has a spike, which is of cause of concern. The increase in Dine Equity‟s ratio may have been attributed to the acquisition of Applebee‟s that year, or it could be a “red flag” that the company overstated its expenses during the year and decreasing accruals. Cracker Barrel has a ratio close to zero, which is not uncommon in the restaurant industry because companies operate mostly with cash transactions instead of having accounts receivables.

95

Now we will observe the total accruals/sales ratio change in order to test the relationship between the two accounts. Basic theory suggests that if sales increase then so should the number of accruals. If the change in ratio is of negative value, then it is implying that sales and accruals are not positively correlated. When looking for “red flags” it is only significant to consider if the ratio value is positive or negative.

Total Accruals/Sales (CHANGE) 6 4

Cracker Barrel Bob Evans

2

Dennys

0

Darden 2004

-2 -4

2005

2006

2007

2008

Dine Equity Brinker International Industy

-6

As the chart above displays, there are three companies that have negative change in ratios: Cracker Barrel, Denny‟s, and Brinker International. Looking more closely, we see that Cracker Barrel and Denny‟s had negative change ratios for two consecutive years. The negative change ratios point out that accruals and sales had no correlation for the two years, which should raise a “red flag.” Examining Cracker Barrel‟s statements of cash flow more closely, there is a decrease of cash flow from operations of -24% from 2005 to 2006 and -44.5% for the following year. It raises a “red flag” that the company may have been overstating expenses during the two years. Conclusion Expense manipulation diagnostics are important in analyzing a company‟s financial statements. They are useful tools in aiding analyst decipher any expenses manipulations that effect could affect net income. Comparing these ratios among

96

competitors in a given industry helps to point out potential “red flags.” Cracker Barrel‟s asset turnover, CFFO/IO, and CFFO/NOA ratios were consistent with the norm of the industry, except for differences in 2006 from the discontinuation of Logan‟s Steak House. Finally, Cracker Barrel‟s accruals/sales change ratio had “red flags” in two consecutive years. The negative correlation of the change ratio was caused by a decrease in cash flow from operations, which may have been an affect from an overstatement of expenses during the two years. Potential Red Flags Part of an analyst‟s job when valuing a firm is to identify potential red flags in the company‟s financial statements. Red Flags are defined as misrepresentations of financial data which can distort the real value of the company‟s performance. When a red flag is presumed it is important to decipher why there is a significant change in the company‟s reports. From there, the analyst needs to decide whether or not the numbers related to the red flag should be corrected. Operating Leases Cracker Barrel‟s key concern for a red flag is held in reporting operating leases. The present value of future operating lease payments for 2009 is $453,544 and longterm debt is $638,040. This would cause the present value of its operating lease payments in proportion to their long-term debt to equal 71%, meaning present value of the company‟s operating lease payments has been found to exceed ten percent of its long-term debt. This is the main indicator of distortions in the company‟s actual value. When the firm reports their leases as operating leases, a significant portion of their assets and liabilities incurred from these assets are removed from their books and in addition net income and equity could potentially be inflated. From these effects it is reasonable to assume Cracker Barrel is signaling a red flag and their books must then be restated. 97

CFFO Decreases in CFFO(cash flow from operations) may be a bad sign for the overall health of a firm. Companies may begin complete more credit sales and have less cash to show for total revenues. Cracker Barrel‟s CFFO decreased slightly in the fiscal year 2006 and even more sharply in the year 2007. However, this is due to the firm‟s divestiture of Logan‟s Roadhouse. The company recorded a loss from discontinuing operations under CFFO in both years due to this divestiture. Therefore it is not a significant sign of danger that the change ratio of Total Accruals to Sales was negative in years 2006 and 2007.

Undo Accounting Distortions The purpose of finding “red flags” is to ultimately undo any accounting distortions in the financial statements. This allows analyst to properly value firms without the biased accounting techniques used by managers. When undoing distortions, the balance sheet is properly reflected, giving viewers a transparent view of the statements. This allows investors and creditors to create what is called a trial balance sheet. The trial balance sheet restates assets and liabilities by adding back in operating leases, goodwill, and research and development. These restated sheets help to properly value the firms. Their operating leases created a “red flag” which ultimately affected their financial statements. To give users a better view the operating leases will be capitalized and restated in the financial statements. Operating Leases Cracker Barrel‟s Operating leases amounted to a present value of over 10% of its long term debt. This means that the operating leases must be capitalized and added into their financial statements. By doing so, it properly valuates their assets and 98

liabilities onto the financial statements. To find the present value we first had to come up with the interest rate to discount their future payment obligations. This was achieved by finding the internal rate of return of their future cash flow payments from their capital leases. Then, we assumed that Cracker Barrel will exercise all future renewal on operating leases and that all leases are 20 year leases. The first five payments were given in Cracker Barrels 10-K and we found the last 15 payments by dividing the sum of their later years by 15. Below is the table created to properly amortize operating leases for years 2004-2009.

99

0.0729 Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 0.062 Year 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

Ol Payment t 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 t 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

PV Factor PV Payment 30156 0.930233 28052 29856 0.865333 25835 29754 0.804961 23951 29798 0.748801 22313 29688 0.696559 20679 19571 0.647962 12682 19571 0.602755 11797 19571 0.560702 10974 19571 0.521583 10208 19571 0.485194 9496 19571 0.451343 8833 19571 0.419854 8217 19571 0.390562 7644 19571 0.363313 7111 19571 0.337966 6614 19571 0.314387 6153 19571 0.292453 5724 19571 0.272049 5324 19571 0.253069 4953 19571 0.235413 4607 Ol Payment 241168 PV Factor PV Payment 30174 0.943396 28466 29947 0.889996 26653 29934 0.839619 25133 30190 0.792094 23913 30376 0.747258 22699 38195 0.704961 26926 38195 0.665057 25402 38195 0.627412 23964 38195 0.591898 22607 38195 0.558395 21328 38195 0.526788 20120 38195 0.496969 18981 38195 0.468839 17907 38195 0.442301 16893 38195 0.417265 15937 38195 0.393646 15035 38195 0.371364 14184 38195 0.350344 13381 38195 0.330513 12624 38195 0.311805 11909

Loan Amortization Table BB Interest Payment 2005 1 241168 17833 30156 2006 2 232304 16935 29856 2007 3 219383 15993 29754 2008 4 205622 14990 29798 2009 5 190814 13910 29688 2010 6 175037 12760 19571 2011 7 168225 12264 19571 2012 8 160917 11731 19571 2013 9 153077 11159 19571 2014 10 144665 10546 19571 2015 11 135639 9888 19571 2016 12 125956 9182 19571 2017 13 115567 8425 19571 2018 14 104420 7612 19571 2019 15 92461 6740 19571 2020 16 79630 5805 19571 2021 17 65863 4801 19571 2022 18 51093 3725 19571 2023 19 35246 2569 19571 2024 20 18244 1330 19571 Loan Amortization Table BB Interest Payment 2006 1 432682 26826 30174 2007 2 429334 26619 29947 2008 3 426006 26412 29934 2009 4 422484 26194 30190 2010 5 418488 25946 30376 2011 6 414059 25672 38195 2012 7 401536 24895 38195 2013 8 388236 24071 38195 2014 9 374113 23195 38195 2015 10 359113 22265 38195 2016 11 343184 21277 38195 2017 12 326266 20229 38195 2018 13 308300 19115 38195 2019 14 289220 17932 38195 2020 15 268958 16675 38195 2021 16 247438 15341 38195 2022 17 224585 13924 38195 2023 18 200315 12420 38195 2024 19 174540 10821 38195 2025 20 147167 9124 38195

EB Change In Loan Depreciation Total CL Exp CL-OL 232304 -12323 12231 30065 -91 219383 -12921 12231 29166 -690 205622 -13761 12231 28224 -1530 190814 -14808 12231 27221 -2577 175037 -15778 12231 26142 -3546 168225 -6811 12231 24992 5420 160917 -7308 12231 24495 4924 153077 -7841 12231 23962 4391 144665 -8412 12231 23391 3819 135639 -9025 12231 22777 3206 125956 -9683 12231 22119 2548 115567 -10389 12231 21414 1842 104420 -11147 12231 20656 1085 92461 -11959 12231 19844 272 79630 -12831 12231 18972 -600 65863 -13766 12231 18036 -1535 51093 -14770 12231 17033 -2539 35246 -15847 12231 15956 -3615 18244 -17002 12231 14801 -4771 3 -18241 12231 13561 -6010 EB Change In Loan Depreciation Total CL Exp CL-OL 429334 -3348 21634 48460 18286 426006 -3328 21634 48253 18306 422484 -3522 21634 48046 18112 418488 -3996 21634 47828 17638 414059 -4430 21634 47580 17204 401536 -12523 21634 47306 9111 388236 -13299 21634 46529 8335 374113 -14124 21634 45705 7510 359113 -15000 21634 44829 6635 343184 -15930 21634 43899 5705 326266 -16917 21634 42911 4717 308300 -17966 21634 41863 3668 289220 -19080 21634 40749 2554 268958 -20263 21634 39566 1371 247438 -21519 21634 38309 115 224585 -22853 21634 36975 -1219 200315 -24270 21634 35558 -2636 174540 -25775 21634 34054 -4141 147167 -27373 21634 32456 -5739 118097 -29070 21634 30758 -7436

100

0.046 Year 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 0.046 Year 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027

Ol Payment t 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 t 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

PV Factor 35634 0.956938 36021 0.91573 36130 0.876297 35076 0.838561 35014 0.802451 43723 0.767896 43723 0.734828 43723 0.703185 43723 0.672904 43723 0.643928 43723 0.616199 43723 0.589664 43723 0.564272 43723 0.539973 43723 0.51672 43723 0.494469 43723 0.473176 43723 0.4528 43723 0.433302 43723 0.414643 Ol Payment PV Factor 29044 0.938967 29178 0.881659 27917 0.827849 27697 0.777323 27666 0.729881 31311 0.685334 31311 0.734828 31311 0.703185 31311 0.672904 31311 0.643928 31311 0.616199 31311 0.589664 31311 0.564272 31311 0.539973 31311 0.51672 31311 0.494469 31311 0.473176 31311 0.4528 31311 0.433302 31311 0.414643

404063 PV Payment 34100 32986 31661 29413 28097 33574 32129 30745 29421 28154 26942 25782 24671 23609 22592 21619 20688 19798 18945 18129 533056 PV Payment 27271 25725 23111 21530 20193 21459 23008 22018 21069 20162 19294 18463 17668 16907 16179 15482 14816 14178 13567 12983

Loan Amortization Table BB Interest Payment 2007 1 532573 24498 35634 2008 2 521437 23986 36021 2009 3 509402 23433 36130 2010 4 496705 22848 35076 2011 5 484477 22286 35014 2012 6 471749 21700 43723 2013 7 449727 20687 43723 2014 8 426692 19628 43723 2015 9 402597 18519 43723 2016 10 377394 17360 43723 2017 11 351032 16147 43723 2018 12 323457 14879 43723 2019 13 294613 13552 43723 2020 14 264443 12164 43723 2021 15 232884 10713 43723 2022 16 199874 9194 43723 2023 17 165346 7606 43723 2024 18 129229 5945 43723 2025 19 91451 4207 43723 2026 20 51936 2389 43723 Loan Amortization Table BB Interest Payment 2008 1 393892 18119 29044 2009 2 382967 17616 29178 2010 3 371406 17085 27917 2011 4 360573 16586 27697 2012 5 349463 16075 27666 2013 6 337872 15542 31311 2014 7 322103 14817 31311 2015 8 305608 14058 31311 2016 9 288355 13264 31311 2017 10 270308 12434 31311 2018 11 251431 11566 31311 2019 12 231686 10658 31311 2020 13 211032 9707 31311 2021 14 189428 8714 31311 2022 15 166831 7674 31311 2023 16 143194 6587 31311 2024 17 118470 5450 31311 2025 18 92608 4260 31311 2026 19 65557 3016 31311 2027 20 37261 1714 31311

EB Change In Loan Depreciation Total CL Exp 521437 -11136 26629 51127 509402 -12035 26629 50615 496705 -12697 26629 50061 484477 -12228 26629 49477 471749 -12728 26629 48915 449727 -22022 26629 48329 426692 -23035 26629 47316 402597 -24095 26629 46256 377394 -25203 26629 45148 351032 -26362 26629 43989 323457 -27575 26629 42776 294613 -28844 26629 41508 264443 -30170 26629 40181 232884 -31558 26629 38793 199874 -33010 26629 37341 165346 -34528 26629 35823 129229 -36117 26629 34235 91451 -37778 26629 32573 51936 -39516 26629 30835 10602 -41334 26629 29018

CL-OL 15493 14594 13931 14401 13901 4607 3594 2534 1426 266 -946 -2215 -3542 -4930 -6381 -7900 -9488 -11149 -12887 -14705

EB Change In Loan Depreciation Total CL Exp CL-OL 382967 -10925 19695 37814 8770 371406 -11562 19695 37311 8133 360573 -10832 19695 36779 8862 349463 -11111 19695 36281 8584 337872 -11591 19695 35770 8104 322103 -15769 19695 35237 3926 305608 -16494 19695 34511 3200 288355 -17253 19695 33753 2441 270308 -18047 19695 32959 1648 251431 -18877 19695 32129 818 231686 -19745 19695 31260 -51 211032 -20654 19695 30352 -959 189428 -21604 19695 29402 -1909 166831 -22597 19695 28408 -2903 143194 -23637 19695 27369 -3942 118470 -24724 19695 26282 -5030 92608 -25862 19695 25144 -6167 65557 -27051 19695 23955 -7357 37261 -28296 19695 22710 -8601 7664 -29597 19695 21409 -9903

101

0.059 Year 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 0.055 Year 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029

Ol Payment t 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 t 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

PV Factor 30294 0.943396 30504 0.889996 29083 0.839619 29073 0.792094 29307 0.747258 33038 0.704961 33038 0.665057 33038 0.627412 33038 0.591898 33038 0.558395 33038 0.526788 33038 0.496969 33038 0.468839 33038 0.442301 33038 0.417265 33038 0.393646 33038 0.371364 33038 0.350344 33038 0.330513 33038 0.311805 Ol Payment PV Factor 36890 0.947867 35601 0.898452 35668 0.851614 35980 0.807217 36401 0.765134 38974 0.725246 38974 0.687437 38974 0.651599 38974 0.617629 38974 0.585431 38974 0.554911 38974 0.525982 38974 0.498561 38974 0.472569 38974 0.447933 38974 0.424581 38974 0.402447 38974 0.381466 38974 0.361579 38974 0.342729

385083 PV Payment 28579 27148 24419 23029 21900 23290 21972 20728 19555 18448 17404 16419 15489 14613 13785 13005 12269 11575 10919 10301 364848 PV Payment 34966.81363 31985.78965 30375.36815 29043.66766 27851.64273 28265.44751 26791.89466 25395.15879 24071.22559 22816.35362 21626.87935 20499.41208 19430.71699 18417.71518 17457.56157 16547.45006 15684.8084 14867.1033 14092.03531 13357.38295

Loan Amortization Table BB Interest Payment 2009 1 368862 21763 30294 2010 2 360331 21260 30504 2011 3 351086 20714 29083 2012 4 342717 20220 29073 2013 5 333865 19698 29307 2014 6 324256 19131 33038 2015 7 310349 18311 33038 2016 8 295622 17442 33038 2017 9 280026 16522 33038 2018 10 263510 15547 33038 2019 11 246019 14515 33038 2020 12 227497 13422 33038 2021 13 207881 12265 33038 2022 14 187108 11039 33038 2023 15 165110 9741 33038 2024 16 141814 8367 33038 2025 17 117143 6911 33038 2026 18 91017 5370 33038 2027 19 63349 3738 33038 2028 20 34049 2009 33038 Loan Amortization Table BB Interest Payment 2010 1 455080 25029 36890 2011 2 443219 24377 35601 2012 3 431995 23760 35668 2013 4 420087 23105 35980 2014 5 407212 22397 36401 2015 6 393208 21626 38974 2016 7 375860 20672 38974 2017 8 357559 19666 38974 2018 9 338251 18604 38974 2019 10 317882 17483 38974 2020 11 296391 16302 38974 2021 12 273719 15055 38974 2022 13 249800 13739 38974 2023 14 224566 12351 38974 2024 15 197943 10887 38974 2025 16 169857 9342 38974 2026 17 140225 7712 38974 2027 18 108964 5993 38974 2028 19 75983 4179 38974 2029 20 41189 2265 38974

EB Change In Loan Depreciation Total CL Exp CL-OL 360331 -8531 18443 40206 9912 351086 -9244 18443 39703 9199 342717 -8369 18443 39157 10074 333865 -8853 18443 38663 9590 324256 -9609 18443 38141 8834 310349 -13907 18443 37574 4536 295622 -14727 18443 36754 3716 280026 -15596 18443 35885 2847 263510 -16516 18443 34965 1927 246019 -17491 18443 33990 952 227497 -18523 18443 32958 -80 207881 -19615 18443 31865 -1172 187108 -20773 18443 30708 -2330 165110 -21998 18443 29482 -3555 141814 -23296 18443 28185 -4853 117143 -24671 18443 26810 -6228 91017 -26126 18443 25355 -7683 63349 -27668 18443 23813 -9225 34049 -29300 18443 22181 -10857 3020 -31029 18443 20452 -12586 EB Change In Loan Depreciation Total CL Exp 443219 -11861 22754 47783 431995 -11224 22754 47131 420087 -11908 22754 46514 407212 -12875 22754 45859 393208 -14004 22754 45151 375860 -17347 22754 44380 357559 -18301 22754 43426 338251 -19308 22754 42420 317882 -20370 22754 41358 296391 -21490 22754 40237 273719 -22672 22754 39056 249800 -23919 22754 37809 224566 -25235 22754 36493 197943 -26622 22754 35105 169857 -28087 22754 33641 140225 -29631 22754 32096 108964 -31261 22754 30466 75983 -32981 22754 28747 41189 -34795 22754 26933 4481 -36708 22754 25019

CL-OL 10893 11530 10846 9879 8750 5407 4453 3446 2384 1264 82 -1165 -2481 -3868 -5333 -6877 -8507 -10227 -12041 -13954

102

Trial Balance When restating financial statements it is important to construct a trial balance of each year‟s financial statements. The trial balance will make sure that debits and credits match up after proper yearly adjustments. First we created an amortization schedule for the operating leases Cracker Barrel currently has. From this table we were able to come up with the adjustment numbers to show accrued depreciation and interest on the capitalized leases. This allowed us to formulate restated balance sheets and income statements for years 2004-2009. Restating the financial statements shows a more realistic view of Cracker Barrel‟s position. The following pages show the adjusted trial balance sheet.

103

CBRL GROUP, INC. TRIAL BALANCE SHEET (In thousands except share data) ASSETS 2004 As Stated Current Assets: Total current assets

Debits

Credits

2004 Adjusted

2005 As Stated

Debits

Credits

2005 Adjusted

203040

203040

190483

190483

298233 662682 3289 315512 193859 28739

298233 662682 3289 315512 193859 28739 241168 1743482

328362 709730 3289 359533 228859 34275 1664048

328362 709730 3289 359533 228859 34275 432774 2096822

383741

445750

445750

1118573

1359741

1218298

1651072

93724 20367

93724 20367

93724 30767

93724 30767

1435704

1676872

1533272

1966046

Current Liabilities: Total current liabilities

242235

242235

295345

295345

Long-term Debt Capital lease obligations (net) Interest rate swap liability Other Long-term Obligations Deferred Income Taxes

185138 0 0 36225 98770

185138 241168 0 36225 98770

212218

Total Long Term Liabilities

320133

561301 803535.732

367939

800621 1095966

Total shareholders' equity

873336

873336

869988

870080

1435704

1676872

1533272

1966046

Property and Equipment: Land Buildings and improvements Buildings under capital leases Restaurant and other equipment Leasehold improvements Construction in progress Assets Under Capitalized Lease Rights (Net) Total

241168 1502314

Less: Accumulated depreciation and amortization of capital 383741leases Property and equipment - net Goodwill Other Assets Total

445005

12231

LIABILITIES AND SHAREHOLDERS' EQUITY

Total

2004 As Stated 2380947 785703 1595244 880617 0 405139

241168

Debits

Credits

Total revenue Cost of goods sold Gross profit Labor & other related expenses Impairment and store closing charges Other store operating expenses Op. Lease Expense Depreciation Expense, Operating Leases Store operating income 309488 General and administrative 126501 Operating income 182987 Interest expense 8444 Interest income 5 Income before income taxes 174548 Provision for income taxes 62663 Income from continuing operations 111885 Income from discontinued operations net of tax 0 Net income Trial Balance Test

12323 0 48411 107310

2004 2005 Adjusted As Stated 2380947 2567548 785703 847045 1595244 1720503 880617 939849 0 0 405139 447506

Debits

12231

111885 241167.7 241167.7

445005

309488 126501 182987 8444 5 174548 62663 111885 0

333148 130986 202162 8693 96 193565 66925 126640 0

111885

126640

17833

212218 432682 0 48411 107310

2005 Adjusted 2567548 847045 1720503 939849 0 447506 30156 -30156 12231 351073 130986 220087 26526 96 193657 66925 126732 0

Credits

126732 487392

487392

104

ASSETS 2006 As Stated Current Assets: Total current assets

Debits

Credits

2006 Adjusted

2007 As Stated

Debits

Credits

2007 Adjusted

653830

653830

200281

200281

277605 651643 3289 315867 149061 17909

277605 651643 3289 315867 149061 17909 489788 1905162

287873 687041 3289 336881 165472 19673 1500229

287873 687041 3289 336881 165472 19673 353459 1853688

432870

481247

481247

982504

1472292

1018982

1372441

0 44963

0 44963

0 45767

0 45767

1681297

2171085

1265030

1618489

Current Liabilities: Total current liabilities

330533

330533

274669

274669

Long-term Debt Capital lease obligations (net) Interest rate swap liability Other Long-term Obligations Deferred Income Taxes

911464 0 0 55128 81890

911464 508074 0 55128 81890

756306 0 0 67499 62433

Property and Equipment: Land Buildings and improvements Buildings under capital leases Restaurant and other equipment Leasehold improvements Construction in progress Assets Under Capitalized Lease Rights (Net) Total

511422

21634

1415374

Less: Accumulated depreciation and amortization of capital 432870leases Property and equipment - net Goodwill Other Assets Total

380088

26629

LIABILITIES AND SHAREHOLDERS' EQUITY

3348

511422

11136

380088

756306 368952 0 67499 62433

Total Long Term Liabilities

1048482

1556556 1887089

886238

1255190 1529859

Total shareholders' equity

302282

283996

104123

88630

1681297

2171085

1265030

1618489

Total

2006 As Stated 2219475 706095 1513380 832943 5369 384442

Total revenue Cost of goods sold Gross profit Labor & other related expenses Impairment and store closing charges Other store operating expenses Op. Lease Expense Depreciation Expense, Operating Leases Store operating income 290626 General and administrative 128830 Operating income 161796 Interest expense 22205 Interest income 764 Income before income taxes 140355 Provision for income taxes 44854 Income from continuing operations 95501 Income from discontinued operations net of tax 20790 Net income Trial Balance Test

Debits

21634

26826

2006 2007 Adjusted As Stated 2219475 2351576 706095 744275 1513380 1607301 832943 892839 5369 0 384442 410131 30174 -30174 21634 299166 304331 128830 136186 170336 168145 49031 59438 764 7774 122069 116481 44854 40498 77215 75983 20790 86082

Credits

116291

98005 563230

563230

Debits

26629

24498

2007 Adjusted 2351576 744275 1607301 892839 0 410131 35634 -35634 26629 313336 136186 177150 83936 7774 100988 40498 60490 86082

Credits

162065

146572 442351

442351

105

2008 As Stated Current Assets: Total current assets

Debits

Credits

2008 Adjusted

2009 As Stated

Debits

Credits

2009 Adjusted

220639

220639

198325

198325

299608 711030 3289 359089 183729 15071

299608 711030 3289 359089 183729 15071 325535 1897351

286161 686736 3289 379459 200704 16089 1572438

286161 686736 3289 379459 200704 16089 416718 1989156

526576

570662

570662

1045240

1370775

1001776

1418494

0 47824

0 47824

0 45080

0 45080

1313703

1639238

1245181

1661899

Current Liabilities: Total current liabilities

264719

264719

264962

264962

Long-term Debt Capital lease obligations (net) Interest rate swap liability Other Long-term Obligations Deferred Income Taxes

779061 77 39618 83147 54330

779061 334382 39618 83147 54330

638040 60 61232 89610 55655

Total Long Term Liabilities

956233

844597

Total shareholders' equity

92751

1290538 1555257 83981

Property and Equipment: Land Buildings and improvements Buildings under capital leases Restaurant and other equipment Leasehold improvements Construction in progress Assets Under Capitalized Lease Rights (Net) Total

345230

19695

1571816

Less: Accumulated depreciation and amortization of capital 526576leases Property and equipment - net Goodwill Other Assets Total

435161

18443

LIABILITIES AND SHAREHOLDERS' EQUITY

Total

1313703 2008 As Stated 2384521 773757 1610764 909546 877 422293

Total revenue Cost of goods sold Gross profit Labor & other related expenses Impairment and store closing charges Other store operating expenses Op. Lease Expense Depreciation Expense, Operating Leases Store operating income 278048 General and administrative 127273 Operating income 150775 Interest expense 57445 Interest income 185 Income before income taxes 93515 Provision for income taxes 28212 Income from continuing operations 65303 Income from discontinued operations net of tax 250 Net income Trial Balance Test

10925

345230

56783 393969

393969

435161

638040 426690 61232 89610 55655 1271227 1536189 125710

135622

1639238 1245181 2008 2009 Debits Credits Adjusted As Stated 2384521 2367285 773757 764909 1610764 1602376 909546 916256 877 2088 422293 421594 29044 -29044 19695 19695 287397 262438 127273 120199 160124 142239 18119 75564 52177 185 0 84745 90062 28212 24105 56533 65957 250 -31

65553

8531

1661899 2009 Debits Credits Adjusted 2367285 764909 1602376 916256 2088 421594 30294 -30294 18443 18443 274289 120199 154090 21763 73940 0 80150 24105 56045 -31

65926

56014 483898

483898

106

Financial Ratio Analysis, Financial Forecasting, and Cost of Capital Estimation In order to give a proper evaluation of the company‟s performance we will examine the firm by analyzing financial ratios, forecasting financial statements, and estimating the cost of capital. Each of these tasks involved in the financial analysis are essential in estimating the value of the firm. The financial ratio section is designed to give an outlook on a firm‟s liquidity, profitability, and capital structure. This section also states these qualities in an absolute and relative manner by comparing the firm‟s ratios to those of its competitors. The financial forecasting section is used to portray how the company will look up to ten years in the future. The forecasts use estimated growth rates based off of data trends from five years previous. In addition, it gives a ten year forecast of financial data after restating for any significant distortions. The final section of the financial analysis is a cost of capital estimation. When estimating the cost of capital the weighted average cost of capital (WACC) formula is used. The WACC formula gives the rate at which the firm must pay off its financing from both debt and equity. Financial Ratio Analysis Examining a company‟s financial ratios offers a simple, uniform way to assess the performance of a firm. In addition, Palepu and Healy state that “Ratio analysis...provides the foundation for making forecasts of future performance.” 30 Investors and analysts can use these ratios to compare firms at their current positions as well as into the future. This allows for another angle at assessing the value of the firm.

30

Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.

107

Liquidity Ratios Liquidity ratios are representative of the company‟s ability to take care of debts in the short run. These ratios can also show how efficiently a firm is running. Carrying mostly assets that are not able to be converted relatively quickly into cash (illiquid assets) can pose a risk when companies do not generate expected cash flows and short-term liabilities come due. Illiquid assets generally create more long term cash flows, but liquidity is key in times of economic downturn or unexpected events when firms must find alternative ways to generate cash for debt payments. The following ratios will be used to evaluate Cracker Barrel and compare the firm to competitors in the industry. Liquidity Ratios: -

Current Ratio

-

Quick-Asset (Acid Test) Ratio

Operating Efficiency Ratios: -

Working Capital Turnover

-

Days‟ Supply of Inventory

-

Receivables Turnover

-

Days‟ Sales Outstanding

-

Inventory Turnover Ratio

-

Cash-to-Cash Cycle

Current Ratio The current ratio is a quick and easy way to determine if a company has sufficient resources to satisfy next years‟ current liabilities. The current ratio is found by dividing all current assets by all current liabilities. In general, a current ratio lower than 108

one means that a firm would not be able to pay off all its liabilities if they came due and could be in a bad financial position. In contrast, a ratio above one indicates that the firm would be able to cover its debts with its current assets. For this reason, banks typically like to lend to firms with a ratio greater than two. However, it is important to remember that different industries carry different standards, so an industry wide comparison is essential. In some cases, firms try to keep their ratio just around one. If a company has long term stability, it can borrow against future cash flows in order to cover current liabilities.31

Current Ratio 2.5 2

Cracker Barrel Bob Evans

1.5

Denny's Darden

1

Dine Equity 0.5

Brinker International Industry

0 2004

2005

2006

2007

2008

2004

2005

2006

2007

2008 Five Year Average

Cracker Barrel

0.84

0.64

1.98

0.73

0.83

1.00

Bob Evans

0.33

0.30

0.52

0.51

0.22

0.37

Denny's

0.32

0.42

0.46

0.44

0.50

0.43

Darden

0.51

0.39

0.37

0.51

0.41

0.44

Dine Equity

1.82

1.14

1.22

1.14

1.06

1.28

Brinker International

1.06

0.73

0.49

1.21

0.87

0.87

Industry

0.81

0.60

0.61

0.76

0.61

0.68

31

“Financial Ratio Analysis” http://www.nd.edu/~mgrecon/simulations/micromaticweb/financialratios.html

109

Cracker Barrel maintains a 5 year current ratio average of almost exactly 1, about .33 above the industry average. This indicates Cracker Barrel would be able to cover its short term debts with its short term assets. However, closer examination of the numbers reveals an aberration in the year 2006, when Cracker Barrel sold its ownership claims in Logan‟s Roadhouse, Inc. Cracker Barrel received a notable consideration of cash and other assets in the sale. Around $400,000,000 from the sale was represented as “assets from discounted operations” on the balance sheet for the fiscal year 2006. This caused the current ratio to spike to more than double what it was in any of the four other years. Without the year 2006, Cracker Barrel maintains a current ratio average of .7614, much nearer to the industry average. The restaurant industry as a whole is able to generate cash rather quickly (as most sales are cash sales), so Cracker Barrel‟s low current ratio is not necessarily a sign of danger. Quick Asset Ratio The quick asset ratio, also known as the acid test ratio, is a measure of a firm‟s ability to pay off current liabilities using only assets that can quickly be turned into cash. The main difference from the current ratio is that the quick asset ratio excludes inventories. Excluding inventory allows for a glance at the current liability coverage a firm has should it stop selling its product. It is used in many cases instead of the current ratio because it provides a more conservative look at a firm‟s liquidity position. Inventories may build up during economic downturns and represent a large portion of current assets that might not be able to be quickly sold to cover current liabilities. It can be used as a disaster measure to see what liabilities the firm could cover in the event that the business has to shut down.

110

Quick Asset Ratio 2 Cracker Barrel 1.5

Bob Evans Dennys

1

Darden Dine Equity

0.5

Brinker International 0

Industy 2004

2005

2006

2007

2008

2004

2005

2006

2007

2008 Five Year Average

Cracker Barrel

0.25

0.16

1.59

0.20

0.24

0.49

Bob Evans

0.19

0.17

0.34

0.37

0.12

0.24

Dennys

0.26

0.36

0.40

0.39

0.45

0.37

Darden

0.22

0.16

0.17

0.31

0.22

0.22

Dine Equity

1.81

1.13

1.22

1.10

1.02

1.26

Brinker International

0.96

0.61

0.41

1.15

0.80

0.79

Industry

0.69

0.49

0.51

0.66

0.52

0.57

With the exception of 2006, Cracker Barrel‟s quick asset ratio consistently ranks near the bottom of the industry. Upon looking at Cracker Barrel‟s 10-K, it is clear that this is because such a large portion of their current assets is made up of inventories. Inventories consistently comprise around two thirds to three quarters of total current assets (69% in the most recent year). These inventories inflate the current ratio and indicate that Cracker Barrel may have more trouble covering current liabilities than previously thought. However, Cracker Barrel acknowledges this fact and claims that the purchasing and holding of retail inventories are “aided by rapid product turnover of the restaurant industry.”32 Investors can expect this trend to continue; as long as Cracker Barrel maintains the retail portion of its stores, their quick asset ratio will continue to rank near the bottom of the restaurant industry. For these reasons, Cracker Barrel‟s low quick ratio does not cause us concern. 32

CBRL 10-K, 2009

111

Working Capital Turnover Working capital turnover is defined as the amount of sales divided by working capital (WC=CA-CL). Working capital is the amount of current assets left after covering for current liabilities that can be invested into business growth. It is the net investment into the companies‟ cash-to-cash cycle. Working capital turnover represents the productivity of those investments. In general, the higher the WC turnover, the better, as this indicates a firm is operating more efficiently with the amount of money invested. A WC turnover nearing zero or one that is negative may be an indication that a firm is in serious financial trouble and may go bankrupt soon.

Working Capital Turnover 200 150

Cracker Barrel Bob Evans

100

Dennys

50

Darden Dine Equity

0 2003

2004

2005

2006

2007

2008

Brinker International Industy

-50 -100

2004

2005

2006

2007

Cracker Barrel

-60.74

-20.89

6.87

-31.61

-54.10

-27.50

Bob Evans

-12.18

-11.11

-20.56

-16.76

-6.80

-14.45

Dennys

-10.36

-11.28

-13.62

-12.76

-14.17

-10.78

Darden

-14.84

-8.28

-7.72

-10.52

-9.92

-11.23

7.49

39.93

24.47

9.26

92.66

17.22

170.40

-32.05

-16.28

39.18

-59.82

27.68

28.10

-4.56

-6.74

1.68

0.39

1.69

Dine Equity Brinker International Industry

2008 Five Year Average

112

At first glance, it seems as though almost every company in the industry is headed for bankruptcy. However, a negative working capital turnover is actually quite common in the restaurant industry. Recalling from the current ratio section, almost all firms had a current ratio of less than one. This implies that current assets are less than current liabilities, which in turn creates negative working capital. This negative working capital plugged in to the WC turnover equation yields the negative working capital figures shown above. Because cash is received at the point of sale, the firms can easily and quickly raise cash should they need to cover liabilities immediately. In many cases, firms in the restaurant industry sell food inventories to customers before they even pay their suppliers for the foods. Still, when analyzing Cracker Barrel it is important to remember that the company also holds retail inventory, which does not enjoy the quick turnover that restaurant inventory does. This means that Cracker Barrel may be in more danger operating with a working capital deficit than other restaurants in the industry. Accounts Receivable Turnover Accounts receivable turnover is a representation of a firm‟s ability to collect payments from customers. A low ratio can indicate that a company may be too liberal with the credit policies they extend to customers. A high ratio implies that a firm is either efficient with collecting accounts receivable or operates in a mostly cash industry. Receivables turnover is found by dividing net sales by accounts receivable. As mentioned previously, the restaurant industry is dominated by cash sales at the point of transaction. Sales are made at such a high rate and at such a low cost that there is no need for firms to extend financing to customers. Even in the case of Cracker Barrel‟s retail sector, sales are still made with cash or third party credit. Because companies in the restaurant industry maintain such low accounts receivable balances, the receivables turnover ratio can be expected to be high and is not very relevant in assessing the health of a firm.

113

Receivables Turnover 300 250

Cracker Barrel

200

Bob Evans Denny's

150

Darden 100

Dine Equity Brinker International

50

Industry

0 2004

2005

2006

2007

2008

2004

2005

2006

2007

242.88

159.50

194.11

199.98

176.84

194.66

Bob Evans

89.32

99.29

98.25

80.65

87.06

90.91

Dennys

77.58

58.16

68.25

69.15

50.20

64.67

Darden

165.36

144.57

134.82

122.62

95.35

132.54

8.09

7.97

7.67

4.20

13.68

8.32

97.74

86.01

79.01

87.80

80.97

86.31

87.61

79.20

77.60

72.88

65.45

76.55

Cracker Barrel

Dine Equity Brinker International Industry

2008 Five Year Average

As expected, ratios are extremely high across the board with the exception of DineEquity, who maintains receivables for income from franchised locations.33 Cracker Barrel is consistently the industry leader in receivables turnover. However, as previously stated, this ratio does not have much relevance in an industry where receivables numbers are so low.

33

DineEquity 10-K, 2008

114

Days’ Sales Outstanding Days‟ sales outstanding represents how many days it takes a firm to collect money from a sale. It is calculated by dividing 365 days in a year by the receivables turnover. Because a component of days‟ sales outstanding is the receivables turnover, the explanations of the restaurant industries‟ quick cash collection shown in the receivables turnover section will again be prevalent in the days‟ sales outstanding. However, now the quickest collecting firms will be represented by the lowest numbers. Cracker Barrel leads the industry in collection efficiency, with a five year average of 1.91 days to collect cash from sales.

Days Sales Outstanding 100 90 80

Cracker Barrel

70

Bob Evans

60

Denny's

50

Darden

40

Dine Equity

30

Brinker International

20

Industry

10 0 2004

2005

2006

2007

2008

115

2004

2005

2006

2007

Cracker Barrel

1.5

2.3

1.9

1.8

2.1

1.9

Bob Evans

4.1

3.7

3.7

4.5

4.2

4.0

Dennys

4.7

6.3

5.3

5.3

7.3

5.8

Darden

2.2

2.5

2.7

3.0

3.8

2.8

45.1

45.8

47.6

86.9

26.7

50.4

3.7

4.2

4.6

4.2

4.5

4.3

12.0

12.5

12.8

20.8

9.3

13.5

Dine Equity Brinker International Industry

2008 Five Year Average

Inventory Turnover Inventory turnover is an indication of a firm‟s ability to efficiently manage its inventory. It is calculated by dividing the cost of goods sold by inventory. If a firm sells the same inventory over and over and keeps restocking it, the cost of goods sold will rise while inventory remains constant, increasing the ratio. A higher ratio means that a company is restocking its inventory more times. A lower ratio can represent dormant inventories. This is a sign of trouble and can hurt the company when prices drop while inventory is held. As with other ratios, it should be compared within the industry as different industries maintain different size inventories. The restaurant industry holds low amounts of inventories relative to cost of goods sold because the inventories are turned over so quickly.

116

Inventory Turnover 200.00 180.00 160.00 Cracker Barrel Without Retail

140.00

Cracker Barrel With Retail

120.00

Bob Evans

100.00

Dennys

80.00

Darden Dine Equity

60.00

Brinker International

40.00

Industry

20.00 0.00 2004

2005

2006

2007

2008

2004

2005

2006

2007

Cracker Barrel Without Retail Cracker Barrel With Retail

16.69

13.93

18.52

17.25

5.54

5.02

5.50

5.15

4.96

5.24

Bob Evans

17.52

18.15

16.74

16.81

16.51

17.15

Dennys

91.09

94.97

95.35

120.55

104.51

101.29

Darden

19.63

17.40

22.28

20.32

23.71

20.67

1541.68

395.88

526.43

22.98

98.88

517.17

26.89

21.79

28.79

41.87

33.94

30.65

339.36

109.64

137.92

44.51

55.51

137.39

Dine Equity Brinker International Industry

2008 Five Year Average 19.72

17.22

Cracker Barrel‟s inventory turnover ratio is far below the rest of the industry. This is a result of Cracker Barrel‟s retail sector, which causes the firm to hold much larger inventories than the rest of the industry. In the most recent year, Cracker Barrel‟s inventory was $137,424,000, of which $108,412,000 were retail inventories. If in the 117

most recent year the retail inventories are taken out of Cracker Barrel‟s inventory and inventory turnover is recalculated (reducing COGS by 25% as this is what portion of sales are retail sales), Cracker Barrel has an inventory turnover of 19.77. This is much more on par with the industry average, and indicates Cracker Barrel is able to generate restaurant sales as well as its competitors. DineEquity‟s extremely large ratio is due to the fact that they franchise almost all their locations and do not include the inventory of the franchised locations in their inventory numbers. However, they do include the cost of goods sold from the franchises, and this severely inflates the numbers. The efficiency represented by a higher ratio translates into a higher level of liquidity for the firm. Days’ Supply of Inventory The days‟ supply of inventory represents how long it takes a firm to turnover its inventory. It is calculated by dividing 365 days in a year by the inventory turnover ratio. It has a relationship with the inventory turnover rate much the same way that days‟ sales outstanding has a relationship with the receivables turnover rate. The higher the receivables turnover rate, the lower the days‟ supply of inventory. A low DSI is generally seen as more desirable as it represents less days that inventories are unsold and less days that the company could lose money from market prices for inventories dropping.

118

Days Supply of Inventory 80.00 70.00

Cracker Barrel Without Retail

60.00

Cracker Barrel With Retail

50.00

Bob Evans

40.00

Dennys

30.00

Darden

20.00

Dine Equity

10.00

Brinker International

0.00

Industry 2004

2005

2006

2007

2008

2004

2005

2006

2007 21.16

2008 Five Year Average 18.51

Cracker Barrel Without Retail

21.87

26.20

19.71

21.49

Cracker Barrel With Retail Bob Evans

65.88

72.68

66.32

70.82

73.57

69.86

20.83

20.11

21.80

21.71

22.11

21.31

Denny’s

4.01

3.84

3.83

3.03

3.49

3.64

Darden

18.59

20.98

16.38

17.96

15.39

17.86

0.24

0.92

0.69

15.89

3.69

4.29

Brinker International

13.58

16.75

12.68

8.72

10.75

12.50

Industry

11.45

12.52

11.08

13.46

11.09

11.92

Dine Equity

Cracker Barrel has the highest days‟ supply of inventory of any of the firms at 69.85 days. This is different from the industry average for the same reasons the inventory turnover was different. However, applying Cracker Barrel‟s inventory turnover excluding retail to the days‟ supply of inventory formula yields a five year average of 21.29 days. While still higher than the industry average, it is much nearer than the roughly 70 days with retail. Retail items hold far greater shelf lives than food inventories used for the restaurant section of the stores. While there is room for improvement, Cracker Barrel‟s days supply of inventory does not cause us much

119

concern. The retail section of Cracker Barrel stores is a key part of its success and this must be considered when analyzing the high ratios it can cause. Cash -to-Cash Cycle A firm‟s cash-to-cash cycle represents the amount of time it takes for cash received from customers to be free for use by the firm. Accounts receivable represent cash from a sale already made that is not collected and therefore unable to be used. Inventories also tie up cash because the company must back up sitting inventories with cash. Therefore the ratio is calculated by adding days‟ sales outstanding and days‟ supply of inventory. A lower ratio indicates that the firm is able to use cash received from sales in investing activities sooner than a firm with a higher ratio. A lower ratio is a good sign and has been linked to improved earnings per share.34

Cash to Cash Cycle 120.00 Cracker Barrel Without Retail

100.00

Cracker Barrel With Retail 80.00

Bob Evans

60.00

Dennys

40.00

Darden Dine Equity

20.00

Brinker International

0.00

Industry 2004

34

2005

2006

2007

2008

Ward, Peter. Cash-to-Cash is What Counts. Via http://www.vitalentusa.com/learn/cash_to_cash.php

120

2004

2005

2006

2007

Cracker Barrel Without Retail

23.37

28.49

21.59

22.98

2008 Five Year Average 20.57 23.40

Cracker Barrel With Retail Bob Evans

67.39

74.97

68.20

72.65

75.63

71.77

24.92

23.78

25.52

26.23

26.31

25.35

Dennys

8.71

10.12

9.18

8.31

10.76

9.42

Darden

20.80

23.51

19.09

20.94

19.22

20.71

Dine Equity

45.38

46.74

48.28

102.76

30.37

54.71

Brinker International

17.31

21.00

17.30

12.87

15.26

16.75

Industry

23.42

25.03

23.87

34.22

20.38

25.39

Due to Cracker Barrel‟s high DSI, they have the highest average cash-to-cash cycle. Using the DSI without Cracker Barrel‟s retail section yields a much more average cash-to-cash cycle. However, the retail portion is more relevant in the cash-to-cash cycle than in the other ratios, as Cracker Barrel must account for the retail inventories it holds with cash that could be used for financing. The retail inventories tie up a significant amount of cash received from Cracker Barrel‟s sales. Cracker Barrel‟s inventory represents nearly 20% of its cost of goods sold, while no other company even reaches double digits. As a result, Cracker Barrel has less of its cash from sales to use toward financing daily activities than its competitors. This may be viewed as a credit risk by lenders as less cash available for investing also means less cash available to cover short term debts. Conclusion In conclusion, Cracker Barrel‟s liquidity can be measured as slightly below average relative to the industry. Although Cracker Barrel‟s restaurant operations run efficiently, the amount of inventory represented by retail puts the firm at a disadvantage to other firms in the industry in terms of liquidity. The only area that 121

Cracker Barrel performs above the industry average is in receivables turnover and days‟ sales outstanding, which in the restaurant industry are volatile numbers because of the extremely low amount of accounts receivable. Investors can expect these ratios to remain somewhat the same as the retail sector of Cracker Barrel restaurants is a key component that drives their value.

Ratio

Performance

Trend

Current Ratio

average

increasing

Quick Asset Ratio

average

stable

Working Capital Turnover

below average

decreasing

Accounts Receivable

above average

decreasing

Days’ Sales Outstanding

above average

increasing

Inventory Turnover

below average

decreasing

Days’ Supply of Inventory

below average

increasing

Cash-to-Cash Cycle

below average

increasing

Turnover

Profitability Ratio Analysis A profitability ratio analysis is key in figuring out how effective a firm is at creating income as well as minimizing expenses in order maximize their profits. The system in which to go about this analysis is to evaluate the firm‟s operating efficiency, asset productivity, and rate of return on assets and equity. The main ratios involved in the process are: 

Gross Profit Margin



Operating Profit Margin 122



Net Profit Margin



Asset Turnover



Return on Assets



Return on Equity

To properly assess a firm‟s profitability, an analyst must compare the firm‟s ratios it is inspecting to those of its competitors and an industry average. For each ratio, the higher a firm‟s percentage the more profitable it is. This form of information is important to investors so that they can get a full and comparable track record of how well the firm is operating. Gross Profit Margin A firm‟s gross profit margin can hint at two things: either a superior price premium on its goods and/or the efficiency in its production processes. Gross profit margin is a measurement of basic product profitability and can be calculated by dividing a firm‟s gross profit by its sales revenue. In order to find gross profit, the cost of goods sold needs to be subtracted from the company‟s revenues. Gross profit is considered to be the income in excess after the cost of sales has been taken out.

Gross Profit Margin 0.8 0.7 Cracker Barrel

0.6

Bob Evans

0.5

Dennys

0.4

Darden

0.3

Dine Equity

0.2

Brinker International

0.1

Industry

0 2004

2005

2006

2007

2008

123

This table breaks down how Cracker Barrel relates to the rest of the competitors in its industry as well as the industry average. As seen in the chart, one can notice that Cracker Barrel maintains a relatively high gross profit margin in comparison to several of its competitors in the industry. On average, the company‟s GPM lies around 67.7%. This is indicative of both the price premiums in its retail store as well as its cost leadership strategy in its restaurant business. Brinker International‟s high GPM can mostly be attributed to price premiums on its food, but it is no surprise that Bob Evans has a similar track record in its GPM because of its highly comparable market strategy of selling both retail and food. The industry average stays rather stable around 44% and the large gap between Cracker Barrel‟s GPM and the industry average suggests a stellar performance. Operating Profit Margin Operating profit margin is a measurement of a company‟s day to day business profitability. Some analysts like this measurement because it allows them to see a company‟s performance before taxes have been taken out. In a sense it is a raw form of performance before the government affects income. A firm‟s operating profit margin is derived from dividing operating income by sales. Operating income is found by taking the gross profit mentioned earlier and subtracting operating expenses, e.g. salaries and selling and administrative expenses.

124

Operating Profit Margin 0.7 0.6

Cracker Barrel

0.5

CBRL Restated

0.4

Bob Evans

0.3

Dennys

0.2

Darden

0.1

Dine Equity Brinker International

0 -0.1

2004

2005

2006

2007

2008

Industry

-0.2

In the last five years, Cracker Barrel‟s operating profit margin has been on a decline from 7.7% in 2004 to 6% in 2009. This decline is in line with the industry‟s steady fall from 8.7% in 2004 to 2.1% in 2008. Although the industry average is much higher in 2006, it is mainly due to a radical year for Brinker International. From the chart we can see that Cracker Barrel has been performing below the industry average for a few years, but has managed to outperform the industry in more recent years. This is mainly due to Cracker Barrel‟s much slower rate of decline than the industry average. After the restatement of operating leases, Cracker Barrel‟s trend for operating profit margin in 2005 through 2009 has been on a moderately steady decline. From 2005-2007 the company performs beneath the industry average. Even so, in 2008 the company manages to outperform the industry average due to a slower rate of decline. Net Profit Margin Net Profit Margin is a measurement of the excess money a firm actually receives per dollar of sales. It is calculated by dividing net income by sales. Net income is defined as the income received after all expenses and taxes have been taken out. The

125

graph below is a visual aid to show how Cracker Barrel‟s net profit margin relates to its competitors.

Net Profit Margin 0.15 Cracker Barrel

0.1

CBRL Restated

0.05

Bob Evans Dennys

0 2004

2005

2006

2007

2008

-0.05 -0.1

Darden Dine Equity Brinker International Industry

-0.15

From 2004 to 2006 Cracker Barrel has remained relatively stable with a net profit margin of around 5%. In 2008 and 2009 their NPM was steady around 2.7%. The recent years NPM of 2.7% give insight into Cracker Barrel‟s performance under recessionary time periods. Overall, Cracker Barrel‟s net profit margin has managed to remain above the industry average in all years except 2006. When restated after capitalizing their operating leases, Cracker Barrel shows to consistently be only slightly below its as stated net profit margin. The restated company manages to stay above the industry average as well. Asset Turnover Asset Turnover is a measure of how well a company utilizes its assets in the creation of revenues. Asset turnover is considered to be a lag ratio. What this means is that when it is calculated by dividing sales by total assets, the total assets in the

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denominator of the ratio need be the previous year‟s total assets rather than the current year‟s assets.

Asset Turnover 2.5 Cracker Barrel

2

CBRL Restated Bob Evans

1.5

Dennys 1

Darden Dine Equity

0.5

Brinker International Industry

0 2004

2005

2006

2007

2008

Taken from a five year average, Cracker Barrel has a 1.61 asset turnover. When compared to a five year industry average of 1.53, Cracker Barrel represents a strong competence in outperforming a majority of its competitors. In 2008 and 2009 the company shows a 1.88 and 1.8 asset turnover. The past two fiscal years represent how they have remained strong in recessionary time periods. According to the restated financials, Cracker Barrel consistently sits below the industry average. In 2008 and 2009 Cracker Barrel has an asset turnover of 1.47 and 1.44 which is moderately close to the industry average. The restated asset turnover from 2005-2007 is shows a different story about the company however. With the additional assets on the books from capitalizing operating leases the asset turnover is lowered below the industry average and runs nearly parallel to the as stated company. This information is significant because it shows an underperforming company compared to its competitors.

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Return on Assets The return on assets ratio is very similar to the asset turnover ratio except that it takes the revenues after all expenses and taxes have been taken out. The equation for calculating the return on assets is net income divided by total assets. In addition, the return on assets ratio is a lag ratio. This means that to properly calculate the ratio, the total assets in the denominator need to be taken from the previous year.

Return on Assets 0.15 Cracker Barrel 0.1

CBRL Restated Bob Evans

0.05

Dennys Darden

0 2004 -0.05

2005

2006

2007

2008

Dine Equity Brinker International Industry

-0.1

From 2004 to 2007 Cracker Barrel went from an 8.4% to a 9.6% return on assets. Due to recessionary times their return on assets dropped to around 5.2% in 2008 and 5% in the following year. This means that Cracker Barrel has become less effective at generating net income from their assets in more recent years. Compared to the industry average, Cracker Barrel has managed to consistently outperform the industry average. This is substantial in evaluating a company‟s performance because it allows analysts to see how effective the company is at turning their assets into profit. Cracker Barrel‟s return on assets shows similar trends with both as stated and restated financial statements. In 2008 and 2009 their ROA is observed at 3.5% and

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3.4% respectively. In comparison to the industry average, Cracker Barrel‟s restated return on assets are relatively close to this average. Return on Equity Similar to return on assets, return on equity measures how well a firm generates profit. In addition to monitoring how well the firm creates profit from its assets, it is just as important to monitor how well the firm creates profits from shareholder‟s invested money. Return on Equity is a lag ratio as well and is calculated by dividing net income by the previous year‟s owners‟ equity.

Return on Equity 0.7 0.6

Cracker Barrel

0.5

CBRL Restated

0.4

Bob Evans

0.3

Dennys

0.2

Darden

0.1

Dine Equity

0 -0.1

Brinker International 2004

2005

2006

2007

2008

Industry

-0.2

From 2004 to 2006, Cracker Barrel‟s return on equity hovered around 14%. In 2007, the company experienced steep growth and has managed to grow substantially in following years. The 2007, 2008, and 2009 return on equity of Cracker Barrel far exceed any of the other firms in the industry and showed rising rates of 54%, 63%, and 71%. The reason for this sudden jump is that the company has been substantially decreasing the amount of shareholder‟s equity. Although they are being more

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productive with the equity they have, it has potential to worry an analyst because the company could be changing the makeup of the company. With the restatement, in 2007 through 2009 there is an upward spike in return on equity similar to what was observed with the as stated returns. The ROE increases nearly right in line with those of the as stated rates showing 51.6%, 64.1%, and 66.7% in 2007, ‟08, and ‟09, respectively. Both the as stated and restated return on equity yield high rates which more than surpass any of the rates represented by any other firm. Conclusion From the profitability ratio analysis it can be concluded that Cracker Barrel is outperforming the majority of its competitors in gross profit margin, net profit margin, asset turnover, return on assets, and return on equity. In addition, Cracker Barrel has managed to stabilize at all of these rates except for return on equity in which it is increasing. To the average investor this would be great news, but when the firm‟s financials are restated the data tells a slightly different story. With a financial restatement for operating leases, there is only one significant difference between the as stated and restated profitability ratios. This occurs with the asset turnover ratio. The restated asset turnover ratio shows to be below the industry average in several years. This is significant information to investors because it shows Cracker Barrel to be underperforming in its ability to create sales from its assets.

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Ratio

Performance

Trend

Gross Profit Margin

Outperforming

Stable

Average

Stable

Slightly Outperforming

Stable

Asset Turnover

Outperforming

Stabilizing

Return on Assets

Outperforming

Stabilizing

Return on Equity

Outperforming

Increasing

Operating Profit Margin Net Profit Margin

Capital Structure Ratios Capital structure ratios are used in examining how a firm finances the purchase of new assets. In analyzing these ratios one can assess how leveraged a company is. When a company is highly leveraged, it is borrowing large sums of money to invest in capital now in order to increase future cash flows. The more leveraged a company is, the more it has potential for growth. However, more leveraged companies are also exposed to higher risk levels as they could face bankruptcy if they are unable to meet debt payments on the loans. Three ratios are used to analyze a firm‟s capital structure: the debt to equity ratio, times interest earned ratio, and debt service margin. In addition, the Altman‟s Z-Score method will be used to further assess the firms‟ health. Debt to Equity The debt to equity ratio is a simple way to measure the amount of debt a company holds versus the amount of equity they have issued. It is an easy way to identify the preference of a firm in financing the purchase of new assets. The ratio is calculated by dividing total debt by stockholder‟s equity. A high ratio represents a firm that can be deemed risky. This can lead to large future gains or serious financial

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trouble. Typically any ratio over 2.0 can be viewed as very risky and may cause a firm to have higher interest rates on its debt.35

Debt/Equity 50 45 40

Cracker Barrel

35

Cracker Barrel Restated

30

Bob Evans

25

Denny's

20

Darden

15

Dine Equity

10 5

Brinker International

0

Industry

-5

2004

2005

2006

2007

2008

2004

2005

2006

2007

Cracker Barrel

0.64

0.76

4.56

11.15

2008 Five Year Average 13.16 6.06

Cracker Barrel Restated

0.92

1.26

6.64

17.26

18.52

8.92

Bob Evans

0.38

0.81

0.68

0.70

0.97

0.71

Denny's

-2.89

-2.92

-2.98

-3.07

-2.99

-2.97

Darden

1.37

1.31

1.45

0.87

2.36

1.47

Dine Equity

1.42

1.62

1.66

-4.89

77.59

15.48

Brinker International

1.23

0.96

1.06

1.88

2.69

1.56

Industry

0.30

0.36

0.37

-0.90

16.12

3.25

-10

Cracker Barrel‟s debt to equity ratio is dangerously high. However, when examining the firm‟s financials it should be noted that Cracker Barrel has aggressively repurchased stock in the past 5 years. Since 2003, they have repurchased over 25 million shares to go from 47,872,542 shares in ‟03 to 22,722,685 shares in 2009. When

35

Machon, Michael. “Banking on Financial Ratios” http://www.bdo.ca/library/publications/agriculture/articles/Accounting_Financial_Ratios.cfm

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firms repurchase stock, the stock is subtracted form shareholder‟s equity at the purchase price. However, the originally issued shares show up at par value on the balance sheet.36 This can cause a debt to equity ratio to be abnormally high, as is the case with Cracker Barrel. Adding the share repurchases back into the denominator significantly reduces the ratio. Times Interest Earned When determining a firm‟s capability to meet its debt obligations, it is useful to use the times interest earned ratio. The times interest earned ratio represents how many times a firm would be able to pay interest payments on its debt using its income from operations. It is calculated by dividing operating income by the interest expense charged on debt. A high ratio, while representing protection against possible bankruptcy, may be a red flag to some investors as it could indicate that the company has a low amount of debt and is not planning on growing. A low ratio is a much more severe red flag that indicates a firm is not making enough income to cover debt obligations. It is important to compare a firms TIE ratio to competitors and the industry as a whole when assessing the results of the ratio.

Times Interest Earned 50 45 40

Cracker Barrel

35

Cracker Barrel Restated

30

Bob Evans

25

Denny's

20

Darden

15

Dine Equity

10 5

Brinker International

0

Industry

-5

2004

2005

2006

2007

2008

-10 36

Durell, Philip. “Using the Debt to Equity Ratio”. Motley Fool Inside Value. December 2006.

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2004

2005

2006

2007

Cracker Barrel

0.64

0.76

4.56

11.15

2008 Five Year Average 13.16 6.06

Cracker Barrel Restated

0.92

1.26

6.64

17.26

18.52

8.92

Bob Evans

0.38

0.81

0.68

0.70

0.97

0.71

Denny's

-2.89

-2.92

-2.98

-3.07

-2.99

-2.97

Darden

1.37

1.31

1.45

0.87

2.36

1.47

Dine Equity

1.42

1.62

1.66

-4.89

77.59

15.48

Brinker International

1.23

0.96

1.06

1.88

2.69

1.56

Industry

0.30

0.36

0.37

-0.90

16.12

3.25

Cracker Barrel‟s times interest earned ratio is well above the industry average. This is good in an industry that is very susceptible to damage during a recession. In addition, the ratio is still low enough to indicate that Cracker Barrel is investing in future growth. However, the ratio is showing an increasing trend over the past few years, and investors should keep an eye out to make sure it does not become too high. Debt Service Margin The debt service margin measures a firm‟s ability to pay off its current debts. It is a lagged ratio, meaning it is calculated by dividing cash flow from operations by the current portion of long term debt from the previous year. A higher ratio means that a company will be able to pay off its current debts and have extra cash flow to invest.

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Debt Service Margin 2500 2000

Cracker Barrel Bob Evans

1500

Denny's Darden

1000

Dine Equity 500

Brinker International Industry

0 2004

2005

2006

2007

2008

2004

2005

2006

2007

2003.65

1218.841

831.8762

11.93593

Bob Evans

34.13975

32.51275

37.063

37.876

4.663912

29.25108

Denny’s

0.544965

10.66915

4.959368

4.020062

3.338168

4.706343

12.95

3.627247

18.93361

Cracker Barrel

Darden

40.22359

2008 Five Year Average 15.2064 816.302

Dine Equity

11.68749

9.471766

3.315222

24.57174

12.26155

Brinker International

27.67946

23.50191

260.6465

220.7542

205.3038

147.5772

Industry

18.51292

23.27583

76.49603

60.0344

54.23328

42.54595

Cracker Barrel‟s debt service margin is off the charts in the first few years. This is primarily due to Cracker Barrel having extremely low current portions of long term debt in those years in addition to a large cash flow from operating activities. After the divestiture of Logan‟s in 2006, Cracker Barrel‟s CFFO decreased and they took on more debt, radically lowering their ratio. Investors can expect to see a ratio similar to the past two years in the future. Cracker Barrel has a healthy debt service margin and easily makes enough cash flows to cover its current debts.

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Altman’s Z Score The Z-Score is a method of combining many different elements into a number that represents the probability of a firm going bankrupt in the next two years. It can also be used in assessing the credit risk of a company. The z-score is computed as follows: 1.2(Net Working Capital / Total Assets) +1.4(Retained Earnings / Total Assets) +3.3(EBIT / Total Assets) +1.0(Sales / Total Assets) +0.6(Market Value of Equity / Book Value of Liabilities)

=

Z-Score

A firm with a z-score greater than or equal to 3.0 is considered healthy and not at risk. A z-score between 1.8 and 3.0 is considered to be in the “gray area”, not healthy but not in deep trouble yet. A firm with a calculated z-score of less than 1.8 has a high probability of going bankrupt in the next two years. CBRL Z Scores

2005

2006

2007

2008

2009

1.2(WC/TA)

-0.08

0.23

-0.07

-0.04

-0.06422

1.4(RE/TA)

0.79

0.25

0.12

0.12

0.188039

3.3(EBIT/TA)

0.43

0.31

0.43

0.37

0.376964

1(Sales/TA)

1.42

1.32

1.85

1.81

1.901157

0.6(MVE/BVL)

1.51

0.54

0.39

0.36

0.40229

Z-Score

4.09

2.66

2.74

2.64

2.804232

Cracker Barrel‟s z-score dipped from a healthy level in 2005 to the gray area in 2006 and has stayed there through the present. However, it is on the higher side of the 136

gray area. Cracker Barrel should not be seen as a risk to go bankrupt, but the z-score should be closely monitored over the next few years as it is not completely healthy. One factor to keep in mind is that most of the restaurant industry purposefully operates with a negative working capital. This makes the WC/TA portion of the z-score negative and significantly brings down the end z-score. CBRL Restated Z Scores

2005

2006

2007

2008

2008

1.2(WC/TA)

-0.06

0.17

-0.05

-0.03

-0.04

1.4(RE/TA)

0.61

0.19

0.09

0.10

0.14

3.3(EBIT/TA)

0.24

0.13

0.16

0.16

0.14

1(Sales/TA)

1.11

1.02

1.45

1.45

1.42

0.6(MVE/BVL)

0.91

0.39

0.29

0.28

0.29

Z-Score

2.83

1.92

1.95

1.97

1.95

Cracker Barrel‟s restated z-score has a more stressful outcome. The z-score is in the gray area in all 5 years and over this last 4 years has not even made it over two. This is not a very good sign, but one must still remember that the restaurant industry wants to operate with negative working capital so the z-score is a little smaller compared to comparable firms in other industries.

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Z-Scores 6.00 Cracker Barrel 5.00

Cracker Barrel Restated

4.00

Bob Evans

3.00

Denny's

2.00

Darden

1.00

Dine Equity Brinker International

0.00 2005

2006

2007

2008

2009

Industry

2005

2006

2007

2008

Cracker Barrel

4.09

2.66

2.74

2.65

2009 Five Year Average 2.80 2.99

Cracker Barrel Restated Bob Evans

2.83

1.93

1.95

1.98

1.96

2.13

2.92

3.79

3.51

3.00

3.22

3.29

Denny's

0.21

0.90

0.79

0.00

Darden

3.19

3.06

2.52

2.28

Dine Equity

2.23

2.32

0.50

0.60

Brinker International Industry

4.23

5.05

3.95

3.28

3.50

4.00

2.56

3.02

2.25

1.83

3.02

2.37

0.48 2.35

2.68 1.41

Cracker Barrel is right around the industry average for Altman‟s z-score. Denny‟s has a very high probability of going bankrupt within the next two years. Cracker Barrel‟s z-score has been stable for the past 4 years, so it looks to be in no real danger of heading towards bankruptcy. Conclusion These capital structure ratios give the investor a good idea as to how a firm is financed and how prepared they are to cover their obligations. Cracker Barrel‟s debt to

138

equity ratio is far above average and will continue to be as long as they continue their recent trend of consistently repurchasing stock. Their times interest earned ratio is also above industry average, a contributing factor to their stability through the current economic recession. Over the past 3 years, the TIE ratio has been steadily increasing, and investors should watch to make sure it doesn‟t get too high, which can represent lack of future growth. Their debt service margin has stabilized over the past few years and the firm has a comfortable margin to cover its debts. Cracker Barrel‟s z-score is primarily in the gray area, but the strength of their other ratios and the tendency of the restaurant industry to have lower z-scores makes this not of much concern. Overall it can be said that Cracker Barrel has an average credit risk and is healthy enough to withstand a recession and grow during normal economic climates. Capital Structure Ratio

Performance

Trend

Debt to Equity

above average

Increasing

Times Interest Earned

above average

Increasing

Debt Service Margin

above average

Stable

Z-Score

average

Stable

Firm Growth Ratios Considering the growth rates of a company aid in evaluating whether the firm can maintain its growth in the future without having financing from outside sources. A firm that is able to grow based on internal funds has an advantage over firms that use external sources for funding. Also, understanding the growth rates of a company allow analysts to enhance predictions of future expansions by the company. A company with excess internal funds is more willing to expand than a company that has to be externally funded. In the following section we will be discussing the internal growth rate and sustainable growth rate for Cracker Barrel and its competitors.

139

Internal Growth Rate A firm‟s internal growth rate is defined as the largest amount of growth it can get without using financing from outside sources. The IGR is important to analyze because it allows for insight into the highest growth a business can get from using only the firm‟s resources. In times where interest rates are high this plays a vital role in how well a firm can maintain positive growth. To calculate the internal growth rate, multiply the return on assets by one minus the dividend payout ratio. The dividend payout ratio can be found by dividing dividends by net income.

Internal Growth Rate 0.12 0.1 0.08 0.06 0.04 0.02 0 -0.02 -0.04 -0.06 -0.08 -0.1

Cracker Barrel Bob Evans Dennys Darden 2004

2005

2006

2007

2008

Dine Equity Brinker International Industry

From 2004 to 2006, Cracker Barrel‟s internal growth rate has been stable around 6.2% on average. In 2007, a spike in their growth rate occurs and settles back down around 3.8% in 2008 and 2009. Again, it is possible 2008-09 are at lower rates due to the recent recessionary period and may not be fully indicative of Cracker Barrel‟s typical internal growth rate. Compared to the industry average, Cracker Barrel manages to outperform several of its competitors.

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Sustainable Growth Rate The sustainable growth rate indicates the maximum rate in which a firm can grow without borrowing any additional funds. In finance lingo, borrowed funds are commonly referred to as financial leverage. SGR can be calculated by multiplying the internal growth rate by one plus financial leverage. Financial leverage calculated by dividing debt by equity.

Sustainable Growth Rate 1.2 1

Cracker Barrel

0.8

Bob Evans

0.6

Dennys

0.4

Darden

0.2

Dine Equity Brinker International

0 -0.2

2004

2005

2006

2007

2008

Industry

-0.4

(Chart excludes Dine Equity‟s SGR for 2008) In order to get a better view of Cracker Barrel and the industry average‟s SGR, the SGR for Dine Equity needed to be removed. During 2008 Dine Equity acquired Applebee‟s which caused the company‟s net income to be highly negative. Because of this, Dine Equity observed a -500% sustainable growth rate, significantly distorting the industry average. In 2007 there is a large spike in Cracker Barrel‟s sustainable growth rate. The main explanation for this is that in 2006 Cracker Barrel sold off Logan‟s and a substantial amount of equity was removed from their books. This made the following year‟s SGR inflate significantly. After 2007, it appears the company has been working to put more equity onto their books and as a result their sustainable growth rate has been

141

falling back to normal levels. In all previous years Cracker Barrel‟s sustainable growth rates have outperformed its competitors and as a result the company has been able to continue to grow at a considerable level without the use of further borrowing of funds. Conclusion Cracker Barrel is one of the top companies when it comes to internal and sustainable growth rates over the past five years. Their internal growth rate stays positive over the five year span, and it is also outperforms the industry average. The sustainable growth rate for Cracker Barrel was the highest out of the entire industry. Based on the internal and sustainable growth rate, we believe that Cracker Barrel is more likely to have future expansion than its competitors. We also expect their firm growth rates to remain above its competitors in the future. Internal Growth Rate Sustainable Growth Rate

Outperforming

Decreasing

Outperforming

Decreasing

Financial Statement Forecasting Forecasting a company‟s financial statements is important in the valuation process because it attempts to fairly estimate future performance. In order to forecast, we analyzed historical data over the last five years for trends, growth rates, and financial ratios that will help in the forecasting process. The three financial statements that will be forecasted are the income statement, balance sheet, and the statement of cash flows. The stated and adjusted income statements are the first financial statements to be forecast because they are the most reliable. The stated and adjusted balance sheets are the next financial statements that are forecasted. The income statement provides forecasted numbers that are required to forecast out the balance sheet. The final financial statement that is forecasted is the cash flow statement. This

142

statement is the hardest to forecast, and is the most unreliable statement because you cannot correctly predict a company‟s future cash flows. Forecasted Income Statement When you begin to forecast it is important to start out with the income statement. This is the first financial statement that we will forecast because it will be used to forecast the balance sheet and the statement of cash flows by the assumptions made from the income statement. The overall valuation of the firm‟s future financial performance relies on the accuracy of the income statement‟s forecasts. Because of the interdependence of the income statement and the other financial statements, it is crucial to make these forecasts as accurate as possible. In this section we will discuss the steps taken in forecasting the income statement. We began the forecasting of the income statement by forecasting future sales. In order to forecast sales, we examined Cracker Barrels historical performance and looked for a relative growth trend to estimate future revenues. Also, when predicting future sales it is important to take into account the current condition of the economy, which could impact growth of sales. Looking at historical data we figured out an average of about .182% sales growth rate over the last five years. The growth average was affected by the recession in year 2008 and 2009, as well as the disposition of Logan‟s Steakhouse in 2006. We excluded those three years and recalculated the average and came up with a growth rate of 5.1% based on sales and assumed a growth rate of 5%. Since we believe that it could take approximately two to three more years for the recession to end, we took a conservative approach and grew our sales at a lower rate than the assumed 5%. We began the sales forecasting by growing sales by 1% in 2010, 3% in 2011, and 4% in 2012 considering a staggered increase in demand as the recession comes to an end. Then from 2013-2019 we grew our sales by 5% annually, assuming that Cracker Barrel returns to its normal growth rate from before the recession.

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The second step taken in forecasting the income statement is to calculate the gross profit. In order to calculate Cracker Barrel‟s gross profit, we measured their historical gross profit as a percentage of sales over the past five years. We calculated a historical gross profit average of 67.68%, but decided to assume a gross profit of 68.2% because we believe that it is more indicative of the gross profit/sales percentage before the recession. Next, we took our assumed gross profit percentage of 68.2% and multiplied it by our forecasted sales for the years 2010-2019 in order to forecast gross profit for each year. The third step is to forecast the company‟s cost of goods sold. Since we already have an assumed gross profit percentage, we can use the gross profit method to calculate cost of goods sold. Gross profit is found by subtracting cost of goods sold from net sales. The gross profit method is used by accountants to quickly estimate cost of goods sold. This is accomplished by multiplying sales by the gross profit percentage to come up with gross profit for a given year, and then subtracting the gross profit from sales to back into the cost of goods sold calculation. In order to forecast cost of goods sold, we subtracted our forecasted gross profit from the forecasted sales step for each year. The fourth step taken in forecasting the income statement was to forecast labor and other related expenses. In order to forecast this expense, we calculated labor and other expenses as a percentage of sales. We found an average of 37.83% over the last five years. The percentages were relatively stable over the past five years, so we decided to forecast Cracker Barrel‟s labor and other related expenses at an assumed rate of 38.5% of sales. This is indicative of the percentage trend over the three most recent years. We then multiplied our forecasted sales for each year by 38.5% to calculate the labor and other related expenses for that given year. The fifth step in forecasting the income statement is to forecast other store operating expenses. A percentage of the expense was taken by dividing other store operating expenses by sales. It is important to note that any item that does not follow a 144

trend is not able to be forecasted. An average of 17.35% was calculated, which was reflective of the other store operating expenses/sales percentage over the last few years. We assumed a percentage of 17.6% based on the average of the percentages, and also considered the three most recent years to be a more precise measure. The other store operating expenses were forecasted for the next ten years by multiplying our assumed percentage of 17.6% by the forecasted sales of each year. The sixth step in forecasting the income statement is to forecast store operating income. In order to do so, we calculated the percentage of store operating income compared to sales. Over the last five years there was an average of 12.45%, but we choose to assume a conservative percentage of 11% for store operating income. Next, we multiplied each year‟s forecasted sales by 11% to forecast operating income for the next ten yeas. The seventh step taken to forecast the income statement is to forecast general and administrative expenses. We divided general and administrative expenses by sales to calculate a percentage over time. There was a relatively stable trend in this percentage and we assumed a general and administrative expense/sales percentage of 5.2%. General and administrative expenses were forecasted by multiplying each year‟s forecasted sales by 5.2% The eighth step taken in forecasting the income statement is to forecast operating income. Operating income was divided by sales over the last five years, and an average of 7.03% was derived. We came to a conclusion of 6.5% for operating income/sales because the most recent years‟ percentages were lower than the average. Operating income for the next ten years was forecasted by multiplying each future year‟s forecasted sales by our assumed operating income/sales percentage of 6.5%. The ninth step in forecasting the income statement is to forecast interest expense. We divided interest expense by sales for each of the last five years, and calculated an average of 1.48%. In assuming a percentage to forecast interest expense, only the three most recent years‟ percentages were considered relevant. An 145

assumed percentage rate of 2% was chosen, and interest expense was forecasted for the next ten years by multiplying each year‟s forecasted sales by the assumed percentage of 2%. The final step in forecasting the income statement is to forecast net income. The net profit margin was used to forecast net income. The net profit margin equals net income divided by sales. Net profit margin was calculated over the last five years and an average of 4.6% was derived. Our assumed net profit margin of 3% was calculated by looking at the trend of the net profit margin over the three most current years. The reason why only the three most current years were considered is that Cracker Barrel had a higher net profit margin from 2004-2006, which was before the disposal of Logan‟s Steakhouse. To forecast net income, we simply multiplied each year‟s forecasted sales by the assumed net profit margin of 3%.

146

147

148

Forecasted Restated Income Statement In order to properly value a company, we must restate its income statement to include any expenses that may be of significance. Cracker Barrel‟s income statement must be restated to capitalize operating leases. Capitalizing an asset reports the proper liabilities previously not included in financial statements by a company‟s use of operating leases. The first adjustment made to the income statement is to include the depreciation expense for the newly capitalized operating leases. Earlier, we calculated the new depreciation expense in the operating lease schedule. The new depreciation expenses calculated in the operating lease schedule for 2005-2009 are $12,231, $21,643, $26,629, $19,695, and $18,443 respectively. We included these expenses on the income statement for the years 2005-2009 to make the proper adjustment. The next adjustment made to the income statement was the reduction in rent expense for operating leases. Because operating leases only show up as an expense on financial statements, we must reduce Cracker Barrel‟s rent expense on operating leases for the last five years. Cracker Barrel‟s 10-K includes a schedule of rent expense for past years, and the rent expense given for each year was the amount of rent expense reduced.37 In order to forecast the reduction of rent expense, we calculated rent expense as a percentage of sales over the past five years. The result was an average of 1.47%. We chose to assume a rent expense/sales percentage of 1.5%, which is above the average. Cracker Barrel‟s rent expenses have increased each year since the disposition of Logan‟s Roadhouse in 2006, so we felt this figure was appropriate. To forecast the reduction in rent expense we just multiplied each year‟s forecasted sales by 1.5%, and reduced each year‟s operating expenses by the amount calculated. The third adjustment made to the income statement was to adjust the interest expense. Since we capitalized all of Cracker Barrel‟s operating leases, we must make an adjustment to the amount of new interest realized. Looking back at the operating lease 37

Cracker Barrel 10 – K. 2004-2009.

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schedule, we have calculated new interest expenses for the years 2005-2009 to be $17,833, $26,826, $24,498, $18,119, and $21,763 respectively. Adjustments for interest expense were made by taking the interest expenses given by Cracker Barrel in their 10-Ks for the years 2005-2009, and adding to the stated interest expense the interest expense calculated in the operating lease schedule.38 After adjustments to depreciation expense, reduction in rent expense, and interest expenses were made, operating income and net income were affected. Because of these changes, we recalculated operating profit margin and net profit margin accordingly. Operating income was higher after adjustments were made, so we adjusted our assumed operating profit margin from 6% to 6.5%. Net income was lower after adjustments, so we changed our assumed net profit margin from 3% to 2.5%. Next, we multiplied the new operating profit margin and the net profit margin by the forecasted sales over the next ten years to forecast operating profit and net income.

38

Cracker Barrel 10 – K. 2004-2009.

150

151

152

Forecasted Balance Sheet After forecasting the income statement the balance sheet needs to be forecasted. The balance sheet reports a company‟s assets, liabilities, and owners‟ equity. The main equation of the balance sheet is Assets= Liabilities + Owners‟ Equity. It is very important that this equation is in balance, because if it is not there are errors in the financial statement. This financial statement allows investors to view and compare various accounts needed in many important financial ratios. It is important to note that the balance sheet can be manipulated by managers in a firm. This means accounts like receivables, goodwill, and inventories all have various reporting methods and can be impaired. These impairments lead to distorted ratios and poor quality financial information. In order to forecast the balance sheet, it is important to start with forecasting assets. The accounts receivable turnover is used to forecast out the accounts receivable. This ratio is used because it relates net sales to accounts receivable. This ratio is calculated by dividing the net sales from the forecasted income statement by the accounts receivable turnover. We found the receivables turnover to be about 190 over the past 4 years. So we took the forecasted net sales for 2010-2019 and divided it by 190 to forecast each year‟s accounts receivable. Next, the inventory is forecasted by using the inventory turnover ratio. This ratio also relates inventory to the net sales. To forecast the inventory the net sales is taken from the forecasted income statement and divided by the inventory turnover. We found our inventory turnover to be 5.2 over the past 6 years. We used this ratio to divide the forecasted net sales for 2010-2019 to forecast out the inventory. One of the most important forecasts on the balance sheet is the total assets. This is forecast out by using the asset turnover ratio. The total assets are forecast by taking the net sales and dividing them by the asset turnover ratio. We found our asset turnover to be 1.75 based on the past two years, which seems to be stable after the sale of Logan‟s Roadhouse. We then used this number to forecast out the total assets 153

the same way we did the inventory and accounts receivable. Once the total assets are forecast, it allows for the current assets to be forecast. The current assets are not forecasted out with a turnover ratio. Instead, they are forecast out by using a percentage, based off of prior years, of current assets to total assets. We found current assets to be equal to about 15% for the past 5 years, except in 2006 when they had a large amount of current assets due to the sale of Logan‟s Roadhouse. After finding the current assets, the current liabilities are easily found by using the current ratio. The current ratio is current assets over current liabilities. We found the current ratio to be .75 over the past 3 years since the sale of Logan‟s Roadhouse. We then took the forecasted current assets and divided it by .75 to find the forecasted current liabilities. Next, the retained earnings are forecast out by taking the prior year‟s retained earnings plus the current year‟s net income minus the dividends paid for the current year. We found these numbers on the forecasted income statement and forecasted them out with that calculation. We then found the stockholders‟ equity the same way, taking the previous year‟s stockholders‟ equity and adding net income minus the dividends for that year. Finally, the total liabilities are computed by taking the total assets minus the stockholders‟ equity minus the current liabilities. This forecast is not very reliable because it is distorted. Either the stockholders‟ equity is distorted or the total liabilities are distorted. It is much more important to have the stockholders‟ equity than the total liabilities, so we chose to distort the total liabilities.

154

155

156

Forecasted Restated Balance Sheet Since Cracker Barrel has operating leases we must restate the financials to include them on their balance sheet. The restated financials change the total assets, total liabilities, net income, and operating income. These adjustments also change the ratios used to forecast out the balance sheet. The asset turnover ratio is changed from 1.75 to 1.4. We chose 1.4 to be the new asset turnover because it is consistent with the past two years for Cracker Barrel. This lower ratio means that the total assets are going to increase when net sales are divided by the new ratio. The total asset increase means the total liabilities, long term assets, and long term liabilities are also going to increase. The total assets increase because the operating leases are put into the property, plant, and equipment account. The property, plant, and equipment account is forecasted out by a new percentage of total assets. The new percentage that we found is 84% instead of 80%. We found it to be around 84% of total assets based on the previous years, excluding 2006 because current assets were high in that year with the sale of Logan‟s Roadhouse. We then took the new percentage and multiplied it times the adjusted forecasted total assets. The total liabilities also increase because we added a capital lease obligation account to the long term liabilities to balance out the equation. The retained earnings and stockholders‟ equity are also affected by the adjusted financial statements. These accounts are decreased because the net income has decreased in our adjusted income statement. The net income has decreased because we are including the interest expense and depreciation expense into the financials. We also added back the rent expense that is incurred by the operating leases. Although this expense is added back, the other expenses (interest expense and depreciation expense) were greater than the amount of rent expense so the net income decreases. This decrease affects retained earnings because the net income minus dividends paid is added into retained earnings each year.

157

158

159

Forecasted Statement of Cash Flows The final financial statement to forecast is the statement of cash flows. It is forecast last because it is the hardest financial statement to forecast. The reason it is the hardest to forecast is because of its limited association to the other financial statements. The three parts of the cash flow statement that we forecast are the cash flow from operations (CFFO), cash flow from investing (CFFI), and cash flow from financing (CFFF). The first step in forecasting the statement of cash flows is forecasting the cash flow from operations. We tried three methods to forecast CFFO. The methods used were CFFO/Sales, CFFO/Net Income, and CFFO/Operating Income. The most stable of these ratios was the CFFO/Sales method. The average of the past five years was 7.2% and we made the assumption of 7.5% based off of years prior to the recession. To forecast CFFO we took 7.5% and multiplied it by the forecasted sales for the next ten years. The second step in forecasting the statement of cash flows is forecasting the cash flow from investing activities. We tried two methods to forecast CFFI. These methods were the CFFI/Change in Non-Current Assets and CFFI/Change in Operating Equipment. The most reliable ratio was CFFI/Change in Non-Current Assets. The average of this ratio was 2.27; however, we assumed 2.4 based off of years after the sale of Logan‟s Roadhouse in 2006. To forecast CFFI we took forecasted sales and divided it by 2.4. The final step in forecasting the statement of cash flows is forecasting the cash flow from financing activities. We used the dividend payout ratio to forecast this method. We found the average dividend payout ratio to be 19.8%. We assumed a rate of 19% by removing years that were associated with the recession. In order to forecast CFFF we multiplied our forecasted net income by 19% for each of the ten years.

160

161

162

Estimating Cost of Capital The cost of capital is the opportunity cost of financing because it is the minimum return that an investor requires. For creditors, this is the interest rate required on loans. For the company, it is the minimum return that the company should make on its own investments.39 In this section we will estimate the cost of equity using the Capital Asset Pricing Model (CAPM), the size-adjusted CAPM, and the back door method. Cost of Equity According to Charles Jones, publisher of Investments: Analysis and Management, the cost of equity is the “minimum expected return necessary to induce an investor to purchase the stock.”40 The cost of equity is higher than the cost of debt because there is more risk associated with equity; this is due to the fact that stock holders are lower on the priority of claims than creditors. In order to calculate cost of equity we used the Capital Asset Pricing Model (CAPM). The CAPM “provides investors with a method of calculating a required return for a stock.”41 This equation defines the cost of equity as:

The first part of this equation is the risk free rate. The risk free rate is based off of treasury bills because the U.S. government is viewed as a riskless investment. We determined the risk free rates by using the ten year treasury constant maturity rate from the September 2009 St. Louis Federal Reserve.42 The market risk premium (MRP) is the “amount that investors demand for bearing beta risk.”43 The market risk premium equation is defined as:

39

Modigliani, F.; Miller M. (1958). “The Cost of Capital, Corporation Finance and the Theory of Investments. American Economic Review 48 (3) 261-297 40 th Jones, Charles. Investments: Analysis and Management. 9 Ed. 2003 41 th Jones, Charles. Investments: Analysis and Management. 9 Ed. 2003 42 Economic Research Federal Reserve Bank of St. Louis http://research.stlouisfed.org/fred2/series/GS10?cid=115 43 Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.

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The beta of a firm “reflects the sensitivity of its cash flows and earnings (and hence the stock price) to economy-wide market movements.”44 It measures the systematic risk of the company, which is the risk that cannot be diversified away. The beta is found by using a linear regression analysis. In order to find an appropriate beta for Cracker Barrel we ran linear regressions for five points on the yield curve. We used the risk free rates for the three month, one year, two year, seven year, and ten year to find the five points of the yield curve. We used the monthly return for the S&P500 for the return on the market. We determined the monthly risk free rates by using the St. Louis Federal Reserve. With both of these numbers we were able to calculate the monthly MRP. We then performed linear regression analysis on a 72 month, 60 month, 48 month, 36 month, and 24 month horizons in order to find the most useful beta. The regression outputs were then broken down by their adjusted R^2. The higher a regression‟s R^2, the more explanatory power the beta has. The linear regression analysis tests the stability of beta over time. The regression analyses that we ran are as follows: 3 Month Treasury Bill Beta

Adjusted R2

B ub

B lb

Ke

Ke low

Ke Up

72

0.90092

0.14006

1.40785

0.39399

0.10607

0.06552

0.14663

60

0.98494

0.17458

1.52196

0.44793

0.11280

0.06983

0.15576

48

0.95320

0.15996

1.56147

0.34493

0.11026

0.06159

0.15892

36

0.86592

0.15189

1.51866

0.21317

0.10327

0.05105

0.15549

24

0.86571

0.13517

1.70329

0.02814

0.10326

0.03625

0.17026

1 Year Treasury Bill Beta

Adjusted R2

B ub

B lb

Ke

Ke low

Ke Up

72

0.90092

0.14033

1.40731

0.39452

0.10607

0.06556

0.14659

60

0.98422

0.17469

1.52065

0.44779

0.11274

0.06982

0.15565

48

0.95220

0.16001

1.55974

0.34467

0.11018

0.06157

0.15878

36

0.86480

0.15183

1.51682

0.21277

0.10318

0.05102

0.15535

24

0.86536

0.13529

1.70225

0.02846

0.10323

0.03628

0.17018

44

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2 Year Treasury Bill Beta

Adjusted R2

B ub

B lb

Ke

Ke low

Ke Up

72

0.90227

0.14061

1.40890

0.39564

0.10618

0.06565

0.14671

60

0.98466

0.17474

1.52125

0.44807

0.11277

0.06985

0.15570

48

0.95237

0.16000

1.56003

0.34471

0.11019

0.06158

0.15880

36

0.86480

0.15171

1.51710

0.21251

0.10318

0.05100

0.15537

24

0.86651

0.13538

1.70426

0.02877

0.10332

0.03630

0.17034

7 Year Treasury Bill Beta

Adjusted R2

B ub

B lb

Ke

Ke low

Ke Up

72

0.90094

0.14009

1.40782

0.39406

0.10608

0.06553

0.14663

60

0.98101

0.17359

1.51759

0.44443

0.11248

0.06955

0.15541

48

0.94947

0.15919

1.55692

0.34201

0.10996

0.06136

0.15855

36

0.86193

0.15057

1.51454

0.20932

0.10295

0.05075

0.15516

24

0.86677

0.13486

1.70623

0.02731

0.10334

0.03618

0.17050

10 Year Treasury Bill Beta

Adjusted R2

B ub

B lb

Ke

Ke low

Ke Up

72

0.89918

0.13974

1.40573

0.39262

0.10593

0.06541

0.14646

60

0.97869

0.17310

1.51486

0.44252

0.11230

0.06940

0.15519

48

0.94734

0.15879

1.55424

0.34043

0.10979

0.06123

0.15834

36

0.85999

0.15012

1.51213

0.20784

0.10280

0.05063

0.15497

24

0.86563

0.13458

1.70478

0.02648

0.10325

0.03612

0.17038

The Capital Asset Pricing Model (CAPM) says that beta is relatively stable over time. The company has a relatively stable beta, meaning that this is the type of company that investors would buy and hold. This shows that it covers a wide range of investor horizons.

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After running these regressions we determined the beta for our company by finding the highest adjusted R squared. The adjusted R squared is the percentage explained by the market; the rest is firm specific risk. The highest adjusted R squared that we found was on the 2-Year Treasury bill at the 60 month time period, which was 17.474%. Once identified, we were able to determine the beta for our company which is .98466. Compared to the published beta on Yahoo Finance of .89, the beta we derived is higher, meaning that it is riskier. The fact that the beta is below 1 means that the firm‟s cash flows and earnings are less sensitive to economic changes.45 The market risk premium is 8% and the risk free rate is 3.4%. These numbers came from the St. Louis Federal Reserve. Now that we have derived the risk free rate, the market risk premium, and the beta we are able to determine the cost of equity.

After computing the cost of equity we can determine how certain we are that it is 11.3% by using the 95% confidence levels. The confidence levels are found by calculating the upper and lower bounds of cost of equity. We found that the lower 95% confidence level was 6.9% and the upper 95% confidence level was 15.6%. This means that we are 95% sure that the estimated cost of equity is between 6.9% and 15.6%. We found these percentages by replacing the beta with the Upper Bound (Ub) and Lower Bound (Lb) from the regression analysis as follows:

Size Adjusted Cost of Equity

45

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We used the CAPM model in order to estimate our cost of equity, but there is evidence that the model is incomplete. There are “factors beyond just systematic risk that seem to play some role in explaining variation in long-run average returns.”46 For this reason, we calculated the size adjusted CAPM. In order to calculate the size adjusted CAPM we used a table comparing average stock returns for U.S. firms varied across size deciles form 1926 to 2005.47 The size deciles range from 1 to 10, 1 being companies with the smallest market value and 10 being companies with the largest market value. The firms with size deciles closer to one have a larger size premium and the firms with size deciles closer to ten have a smaller size premium. We found that the market value of Cracker Barrel is 743.9 million. This means that Cracker Barrel falls in the third decile, which has a size premium of 2.3%. We then recalculated CAPM, which we found to be 13.6%, with a size premium of 2.3% as follows:

Alternative Cost of Equity Estimation An alternative method in estimating a firm‟s cost of equity is the back door method. This method can be calculated as follows: 𝑀𝑎𝑟𝑘𝑒𝑡𝑒 𝑅𝑂𝐸 + 𝐾𝑒 = 1+ 𝐵𝑜𝑜𝑘𝑒 𝐾𝑒 − 𝑔 𝑀𝑎𝑟𝑘𝑒𝑡𝑒 = Market Value of Equity or Market Cap 𝐵𝑜𝑜𝑘𝑒 = Book Value of Equity 𝑅𝑂𝐸 = Return on Equity 𝑔 = Historical Sales growth rate 𝐾𝑒 = Cost of Equity

46 47

Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008. Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.

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Cracker Barrel‟s market to book ratio as of November 2nd has been found to be 5.485398. This was found by dividing the market value of equity by the book value of equity. We calculated the market value of equity to be 745,940,700 by multiplying the number of shares outstanding by the current price as of November 2, 2009. We got the book value of equity of 135,622,000 from Cracker Barrel‟s 2009 10-K. The Return on Equity is .710784789, which was calculated earlier in the profitability ratio analysis. The growth rate used was our assumed growth rate for sales in the forecasting section, which was 5%. Solving for the as stated Ke we found the backdoor cost of equity to be 17.1%. To find the restated Ke you must use the restated book value of equity, which is 125,710,000, and the restated Return on Equity, which is .666984. Then you must solve for the restated Ke, which equals the restated backdoor cost of equity. The resulting Ke was 11.3%. The back door cost of equity calculated is very close to the cost of equity derived using the CAPM, which was 11.277 %. The following is a table comparing as stated and restated backdoor cost of equity. Back Door Cost of Equity

Cracker Barrel Cracker Barrel Restated

ROE

Growth Rate

P/B

Cost of Equity

71.1%

5%

5.485

17.1%

66.7%

5%

5.918

11.3%

Cost of Debt Figuring the cost of debt, 𝐾𝑑 , is useful for finding out the rate at which a firm must pay off its liabilities, as well as how risky a firm is. The cost of debt is important for analysts to investigate because it gives some insight into how easy or expensive it is for a firm to borrow money. It is calculated by taking a weighted average of all liability accounts multiplied by the interest rates which apply to them. The process in which this 168

calculation is achieved is to divide the amount in a single liability account by total liabilities to get the weight of the account. After that, multiply the weight just found by the rate in which the company pays interest on the account to compute the weighted rate. This process is done to all liability accounts. When all of the weighted rates have been calculated, the cost of debt is found by adding together all of the weighted rates for all accounts. The table below breaks down the rates, weights, and values used in calculating Cracker Barrel‟s cost of debt. Interest rates placed on accounts are the most important in estimating the cost of debt because they are the only potentially variable items involved in the estimation. Some firms don‟t fully disclose the rates they pay on certain items. All Cracker Barrel‟s liability accounts were able to be properly identified from their 10-k except for “Taxes withheld and accrued” and “Deferred Income Taxes.” For these two accounts an outside source had to be used. Because both of these accounts dealt with taxes, a riskless rate was used for the interest rate. This riskless rate originated from the September 2009 St. Louis Federal Reserve 10 year treasury constant maturity rate of 3.4%48. After adding the weighted rates for all accounts, we found Cracker Barrel‟s cost of debt, 𝐾𝑑 , to equal 5.42%.

48

Economic Research Federal Reserve Bank of St. Louis http://research.stlouisfed.org/fred2/series/GS10?cid=115

169

Cost of Debt Weighted Amount

Rate

Weight

Rate

Source

92,168

0.18%

8.31%

0.01%

Cracker Barrel 10-k

7,422

7.07%

0.67%

0.05%

Cracker Barrel 10-k

32,081

3.40%

2.89%

0.10%

10 year Treasury Constant Maturity Rate

49,994

2.88%

4.51%

0.13%

Cracker Barrel 10-k

32,633

2.88%

2.94%

0.08%

Cracker Barrel 10-k

Deferred revenues

22,528

2.88%

2.03%

0.06%

Cracker Barrel 10-k

Accrued interest expense

10,379

2.88%

0.94%

0.03%

Cracker Barrel 10-k

Other accrued expenses

17,757

2.88%

1.60%

0.05%

Cracker Barrel 10-k

638,040

6.80%

57.50%

3.91%

Cracker Barrel 10-k

60

6.50%

0.01%

0.00%

Cracker Barrel 10-k

61,232

5.57%

5.52%

0.31%

Cracker Barrel 10-k

89,610

6.50%

8.08%

0.52%

Cracker Barrel 10-k

55,655

3.40%

5.02%

0.17%

10 year Treasury Constant Maturity Rate

𝑲𝒅

5.42%

Current Liabilities: Accounts payable Current maturities of long-term debt and other long-term obligations Taxes withheld and accrued Accrued employee compensation Accrued employee benefits

Long-term Liabilities: Long-term Debt Capital lease obligations Interest rate swap liability Other Long-term Obligations Deferred Income Taxes Total Liabilities

1,109,559

170

Weighted Average Cost of Capital (WACC) The weighted average cost of capital is the average expected return from a firm‟s investors. A firm‟s assets are financed by debt and equity, so the weighted average cost of capital is the weighted average cost of debt plus the weighted average cost of equity. The weighted average cost of debt is calculated by first taking the market value of a firm‟s debt and dividing it by the market value of a firm‟s asset. The weight is then multiplied by the cost of debt. The market value of a firm‟s liabilities is unknown, so the book value of liabilities is used. The weighted average cost of equity can be found by dividing the market value of equity by the market value of assets, then multiplying the weight by the cost of equity. In order to find the market value of equity, you multiply the current price of the company‟s stock by the number of shares outstanding. Because a firm‟s assets equal its liabilities plus owners‟ equity, the market value of assets is the market value of its liabilities plus the market value of its equity. The following is the equation for calculating the weighted average cost of capital before tax:

𝑊𝐴𝐶𝐶𝐵𝑇 =

𝑀𝑉 𝑜𝑓 𝐷𝑒𝑏𝑡 𝑀𝑉 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 ∗ 𝑟𝑑 + ∗𝑟 𝑀𝑉 𝑜𝑓 𝐴𝑠𝑠𝑒𝑡𝑠 𝑀𝑉 𝑜𝑓 𝐴𝑠𝑠𝑒𝑡𝑠 𝑒

Using the formula above, we came up with a WACC before tax of 10.5% and a WACC before tax for the adjusted statements of 10.3%. The WACC before tax for our adjusted statements is lower because of the capitalization of operating leases. This caused our MVL/MVA to increase and our MVE/MVA to decrease because the market value of liabilities increased, while the market value of equity stayed constant. We also calculated the WACC before tax using our backdoor and the WACC before tax size adjusted. The WACC before tax using our backdoor came out to be 15.6%, and the adjusted WACC before taxes using our backdoor came out to be 10.3%. The average stock returns for U.S. from 1926-2005 for firms with a market value between 586.4 and 872.1 million averaged stocks returns between 16.6 and 17.5 %.We decided to go with 171

the WACC before tax using the back door because Cracker Barrel has a market value of 743.9 million, which falls into the third decile of table 8-1 in the text book “Business Analysis & Valuation Using Financial Statements.”49 The following tables and chart explain the above.

Weighted Average Cost of Capital Cost of Debt

𝑊𝐴𝐶𝐶𝐵𝑇

5.4%

𝑊𝐴𝐶𝐶𝐵𝑇 𝐴𝑑𝑗𝑢𝑠𝑡𝑒𝑑 5.4%

MVL/MVA

Cost of Equity

MVE/MVA

WACC

13%

11.3%

87%

10.5%

17.1%

11.3%

82.9%

10.3%

Weighted Average Cost of Capital (Using Backdoor Ke) Cost of Debt

𝑊𝐴𝐶𝐶𝐵𝑇

5.4%

𝑊𝐴𝐶𝐶𝐵𝑇 𝐴𝑑𝑗𝑢𝑠𝑡𝑒𝑑 5.4%

49

MVL/MVA 13% 17.1%

Cost of Equity 17.1% 11.3%

MVE/MVA

WACC

87%

15.6%

82.9%

10.3%

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172

Weighted Average Cost of Capital (Using Size Adjusted Ke) Cost of Debt

𝑊𝐴𝐶𝐶𝐵𝑇

5.4%

𝑊𝐴𝐶𝐶𝐵𝑇 𝐴𝑑𝑗𝑢𝑠𝑡𝑒𝑑 5.4%

MVL/MVA

Cost of Equity

MVE/MVA

WACC

13%

13.6%

87%

12.5%

17.1%

13.6%

82.9%

12.2%

TABLE 8-1 STOCK RETURNS, VOLATILITY, and FIRM SIZE

Size Decile

1-smallest

Market Value of Fraction of total largest market value company in represented by decile in 2005 decile in 2005 (%) ($ millions)

Average annual stock return, 1926-2005(%)

Size Premium Beta, 1926-2005

(return in excess of CAPM-%)

265

.8

21.6

1.41

6.4

2

586.4

1

17.5

1.34

2.7

3

872.1

1.3

16.6

1.28

2.3

4

1281

1.7

15.6

1.23

1.7

5

1728.9

2.4

15.3

1.18

1.7

6

2519.3

3.2

14.9

1.16

1.5

7

3961.4

4.7

14.3

1.13

1.1

8

7187.2

7.6

13.8

1.10

.9

9

16016.5

14

13.2

1.04

0.7

10-largest

367495.1

63.3

11.3

.91

-.4

Source: Ibbotson and Associates, Stocks, Bonds, Bills, and Inflation (2006).

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Valuation Analysis The purpose of valuation is to estimate the value of a firm‟s assets and equity.50 There are two approaches in valuing a firm: market based valuation and intrinsic valuation. Market based valuation is a ratio and consensus based valuation that has no support from theories. On the other hand, intrinsic valuation values a firm using theory, models, and personal opinion. This adds value in the valuation process. For this reason, we will put more emphasis on intrinsic based valuations to value Cracker Barrel. We will be using the method of comparables for market based valuation and popular valuation methods for intrinsic valuation. Method of Comparables The method of comparables is a basic screening tool used by analysts to value a firm. “The primary reason for the popularity of this method is its simplicity.”51 These methods don‟t use theory and rely on the market for most of their inputs. The only reason why these methods are accepted is because they are consensuses based. These methods allow us to compare firms in the industry despite different operational levels. These methods are valued because people have faith in them, such as fiat money like the U.S. dollar. In this report we will be using a 10% analyst perspective. This is a conservative approach to valuing a company, and it also has a higher likelihood of being correct if a firm is misvalued. On November 2, 2009, Cracker Barrel‟s price per share was $32.74. This means that any valuation above $36.01 is undervalued and any valuation below $29.47 is overvalued; any computed price in between $36.01 and $29.47 is considered fairly valued. We will be using eight different methods to value Cracker Barrel. These methods include Trailing Price/Earnings, Forecasted Price/Earnings, Price/Book, Dividends/Price, Price Earnings Growth, Price/Earnings Before Interest Depreciation and Amortization (EBITDA), Price/Free Cash Flows, and Enterprise Value/EBITDA. 50 51

Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008. Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.

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Trailing Price/Earnings (P/E) Trailing price to earnings ratio is calculated by taking the price per share of common stock and dividing it by the prior year‟s earnings per share. This method is based on actual earnings because to find the trailing earnings per share you take net income and divide it by the number of shares outstanding. We gathered the information for this method from Yahoo Finance on November 2, 2009. Trailing P/E PPS

EPS

P/E Trailing

Industry Avg.

Computed PPS

CBRL

32.74

2.89

11.32

12.59

36.42

CBRL Restated

32.74

2.47

12.59

31.03

Denny's

2.16

0.21

10.33

DineEquity

20.76

-4.63

-

Darden

30.41

2.75

11.06

Bob Evan's

26.12

-0.09

-

Brinker

12.60

0.77

16.36

Once the information has been gathered it enables you to calculate the industry average for the trailing price to earnings (P/E) ratio, which does not include Cracker Barrel. To get this average you add up all of the P/E ratios, after removing any outliers, and divide it by the number of companies you are averaging. It is also important to note that any negative P/E ratios are not relevant. In our model, DineEquity and Bob Evans have negative P/E ratios so are not used, and there are no outliers. Once you have computed the industry average you are able to compute the price per share by multiplying the industry average times the trailing earnings per share that was calculated. We found Cracker Barrel‟s as stated computed price per share to be $36.42 and the restated price per share to be $31.03. According to this method, Cracker Barrel is undervalued given their as stated earnings per share, and fairly valued when their earnings per share are restated. 175

Forecasted P/E This method is similar to the trailing price to earnings method except the forecasted price to earnings ratio is calculated by taking the price per share of common stock and dividing it by the forecasted earnings per share. This method is based on forecasted earnings because in order to calculate the forecasted earnings per share you take the forecasted net income for the next year and divide it by the number of shares outstanding. We gathered the information for this method from Yahoo Finance on November 2, 2009.

Forecasted P/E PPS

EPS 1yr Out

P/E Forecasted

Industry Avg.

Computed PPS

CBRL

32.74

3.16

9.91

31.32

CBRL Restated

32.74

2.63

9.91

26.06

Denny's

2.16

8.61

DineEquity

20.76

10.54

Darden

30.41

10.44

Bob Evan's

26.12

10.46

Brinker

12.60

9.50

Once the information has been gathered it enables you to calculate the industry average for the forecasted price to earnings (P/E) ratio, which does not include Cracker Barrel. To get this average you add up all of the P/E ratios, after removing any outliers, and divide it by the number of companies you are averaging. As in the previous method it is important to note that any negative P/E ratios are not relevant. In our model there are no outliers. 176

Once you have computed the industry average you are able to compute the price per share by multiplying the industry average times the forecasted earnings per share that was calculated. We found Cracker Barrel‟s computed price per share to be $31.32 and the restated price per share to be $26.06. According to this method Cracker Barrel is fairly valued as stated, but when Cracker Barrel is restated it is overvalued. Price/Book (P/B) This method of comparables evaluates a firm‟s market value of equity to its book value of equity. This is a reliable method in valuating stocks because unlike price/earnings, the P/B ratio will always be positive.52 The following is the P/B ratio for Cracker Barrel and its competitors. Price To Book PPS

BPS

P/B

Industry Average

Computed PPS

CBRL

32.74

5.97

5.49

2.66

15.90

CBRL Restated

32.74

5.53

5.92

2.66

14.74

Denny's

2.16

-1.52

-

DineEquity

20.76

4.34

4.79

Darden

30.41

12.01

2.53

Bob Evan's

26.12

19.36

1.35

Brinker

12.60

6.34

1.99

The price to book ratio can be found by dividing a firms‟ price per share by its book value of equity per share. In calculating the price to book ratio we began by observing the current market price per share for Cracker Barrel and its competitors. The price per share and book value per share were found on Yahoo Finance on November 2, 2009. Cracker Barrel‟s restated book value of equity per share was calculated by 52

Accounting Glossary. http://www.accountingglossary.net/definition/375-Price/Book_Ratio_P/B. December 7, 2009

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taking the restated book value of equity and dividing it by the number of shares outstanding. Next we divided price per share by book value of equity per share, and took an average of the competitors P/B ratio. Denny‟s was left out of the industry average because it had a negative P/B ratio. We then multiplied the industry average by Cracker Barrel‟s BPS in order to calculate their price per share. A share price of $15.90 is lower than the stated market price of $32.74, meaning that the company is overvalued according to this method. The restated computed price was $14.74, which means the company is still overvalued. Dividends/Price (D/P) The dividend yield is the return on investment for a stock.53 This method of comparables takes into account the cash flow that investors receive from investment. However, not every company pays dividends so there is a possibility some firms could be left out of this method. The following is the dividend/price ratio for Cracker Barrel and its competitors. Dividends/Price PPS

DPS

D/P

Industry Avg.

Computed PPS

CBRL

32.74

0.80

0.02

0.03

26.67

CBRL Restated

32.74

0.80

0.02

0.03

26.67

Denny's

2.16

-

DineEquity

20.76

-

Darden

30.41

1.00

0.03

Bob Evan's

26.12

0.64

0.02

Brinker

12.60

0.44

0.03

53

Investopedia. http://www.investopedia.com/terms/p/pegratio.asp. December 7, 2009.

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The dividend to price ratio can be found by dividing a company‟s dividends per share by their price per share. The price per share and dividends per share for Cracker Barrel and its competitors were found on Yahoo Finance. Next we divided dividend per share by the price per share to come up with the D/P ratio. A D/P average for Cracker Barrel‟s competitors was then calculated to be .03. Denny‟s and Dine Equity were left out because they did not have any dividends paid out to shareholders. To compute Cracker Barrel‟s share price using this approach we took their dividends per share and divided it by the industry average. Cracker Barrel‟s as stated and restated computed price per share was $26.67. Compared to the market share price of $32.74, the computed PPS using this method suggest that the company is overvalued. Price Earnings Growth The price earnings growth (PEG) method is “used to determine a stock's value while taking into account earnings growth.”54 This method uses the information we gathered from Yahoo Finance for the trailing P/E ratio. Since we already know the trailing P/E ratio and the five years growth for the company we are able to calculate the PEG ratio. The PEG ratio calculation is P/E divided by the five years growth.

54

Investopedia. http://www.investopedia.com/terms/p/pegratio.asp. December 7,2009.

179

Price Earnings Growth P/E

Growth-5

PEG

EPS

Industry Avg.

years CBRL

11.33

CBRL Restated Denny's DineEquity Darden Bob Evan's Brinker

Computed PPS

9.89

2.89

1.08

30.90

5.00

2.47

1.08

13.31

10.81

19.00

0.44

-

10.00

0.93

11.61

12.40

0.89

-

8.67

1.39

16.89

8.64

1.11

Once you have the PEG ratio for the other firms in the industry you can calculate the industry average PEG. If there are any outliers they must be removed; in this model Denny‟s is an outlier and was removed from the average. Once you have the PEG industry average you can calculate the computed price per share. This is done by multiplying the five year growth times the EPS times the PEG industry average. We found the computed price per share to be $30.90 and the restated price per share to be $13.31. This method tells analysts that the as stated computed price per share is fairly valued and the restated price per share is overvalued. Price/EBITDA This method is found by finding the price/earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio. In order to find the market cap we found the number of shares outstanding for each company and the stock price on November 2, 2009 and multiplied them together. We then collected the EBITDA numbers from Yahoo Finance for the other firms in the industry. Cracker Barrel‟s EBITDA was found on our stated and restated income statements by taking net income and adding back interests, taxes, depreciation, and amortization.

180

Price/EBITDA Market

EBITDA

P/EBITDA

Cap

Industry

EBITDA/Shares Computed

Avg.

PPS

CBRL

743.94

208.97

3.56

3.59

9.20

33.02

CBRL

743.94

172.50

4.31

3.59

7.59

27.25

Denny's

208.67

91.27

2.29

DineEquity

364.97

392.57

0.93

Darden

4245.74

922.90

4.60

Bob Evan's

810.20

194.10

4.17

Brinker

1291.22

389.74

3.31

Restated

Once the market cap and EBITDA are known it allows for the computation of the Price/EBITDA ratio, which is market cap divided by EBITDA. This allowed us to find the industry average, after removing the outlier (DineEquity), for the Price/EBITDA ratio, which was 3.59. After finding the industry average, the EBITDA/Shares ratio must be computed. This is EBITDA divided by the total number of shares outstanding. Finally, you multiply the industry average times the EBITDA/Shares ratio to calculate the computed price per share. We found the as stated computed price per share to be $33.02 and the restated computed price per share to be $27.25. According to this method Cracker Barrel is fairly valued as stated, and they are overvalued when their financial statements were restated. Price/Free Cash Flow This ratio measures a company‟s market price to its free cash flows. Free cash flows (FCF) represent the cash that a company is able to generate after laying out the

181

money required to maintain or expand its asset base.55 In order to compute a price for Cracker Barrel using this method, we will need to take an industry average to come up with an estimate price for the company. Price/Free Cash Flow Market

FCF

P/FCF

Industry Avg.

Cap

Computed PPS

CBRL

743.94

155.08

4.80

Denny's

208.67

30.14

6.92

DineEquity

364.97

146.03

2.50

Darden

4245.74

221.10

19.20

Bob Evan's

810.20

55.09

14.71

Brinker

1291.22

263.83

4.89

4.77

32.57

The companies‟ market capitalization was taken off of Yahoo Finance on November 2, 2009. Free cash flow is computed by taking a firm‟s cash flow from operations and adding or subtracting out its cash flows from investing. The cash flows used were taken off of each of the companies‟ most recent 10-K. We then took each company‟s market capitalization and divided it by their free cash flow to come up with their P/FCF ratio. Next, we took an average of Cracker Barrel‟s competitors and came up with an industry average of 4.77. Darden and Bob Evans were outliers so they were not included in the industry average. To compute a share price using this method we multiplied the industry average by Cracker Barrel‟s market capitalization, and then divided it by the number of shares outstanding. The numbers of shares outstanding are 22,722,685. Our computed price of $32.57 a share is very close to the market price per share of $32.74, meaning that the company is fairly valued according to the method.

55

Investopedia. http://www.investopedia.com/terms/p/pegratio.asp. December 7, 2009

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Enterprise Value/EBITDA (EV/EBITDA) This method of comparables gives a measure of the value of a firm compared to earnings before interest, taxes, depreciation, and amortization. The reasons why analysts use this method is because it does not take a company‟s capital structure into account, and because it ignores the effects of non-cash items such as amortization and depreciation.56 The following are the results of Cracker Barrel‟s price per share using this method. EV/EBITDA EV

EBITDA

EV/EBITDA

Industry Avg.

Computed PPS

CBRL

1492.46

208.97

5.70

4.13

CBRL

2268.52

172.50

5.70

-23.80

Denny's

494.41

91.27

5.42

DineEquity

2470.05

392.57

6.29

Darden

5971.16

922.90

6.47

Bob Evan's

1091.04

194.10

5.62

Brinker

1837.23

389.74

4.71

Restated

The enterprise value and earnings before interest, tax, depreciation, and amortization (EBITDA) for each company were found on Yahoo Finance. Cracker Barrel‟s restated EBITDA was calculated by taking the net income on our restated income statement and adding back restated interest, tax, depreciation, and amortization. We divided the enterprise value by EBITDA for each of the competitors in the industry, and calculated an industry average of 5.7.

56

Money Terms. http://moneyterms.co.uk/ev_ebitda/. December 7,2009.

183

We then multiplied the industry average by Cracker Barrel‟s EBITDA to calculate their new enterprise value. Next, we added back cash of $11,609,000, subtracted out book value of liabilities of $1,109,559,000, and divided by the number of shares outstanding to compute Cracker Barrel‟s price per share. These numbers were found in the financial statements of Cracker Barrel‟s 10-K for 2009. The same process was used to calculate the restated price. The as stated and restated computed prices per share for Cracker Barrel were $4.13 and -$23.80 respectively. According to this method Cracker Barrel is overstated. Conclusion The method of comparables is a quick, simple approach in valuing a firm. The value of a firm using the method of comparables is derived by computing industry averages. Due to this, there are no theories or analyst opinions that add value to this valuation process. According to the method of comparables, we concluded that Cracker Barrel‟s current price per share is overvalued. We will not be emphasizing the results of the method of comparables because it is not the best approach in valuing a firm. Instead, we will be focusing on intrinsic valuation models. Intrinsic Valuation Models Intrinsic valuation models have the ability to give a much more accurate description of a firm‟s value than the method of comparables shown in the previous section. These models‟ descriptive power can be attributed to the use of forecasted financials in order to find a time consistent model price. After this is performed, a sensitivity analysis is applied to the financial data. This analysis implements varying growth rates and cost of equity or WACC estimates in order to see how slight changes affect the model prices. Included in this section are the discounted dividends, discounted free cash flows, residual income, long run residual income, and abnormal growth valuations. These intrinsic valuations give anywhere from 5% up to 95%

184

explanatory power of the firm‟s value and therefore hold heavy weight when analyzing a company. Discounted Dividends Valuation The discounted dividends valuation “expresses the value of the firm‟s equity as the present value of forecasted future dividends”57. Out of all the models we use to value Cracker Barrel, the discounted dividends model explains the least about the company‟s value. The reason for this is that the model derives value strictly from the firm‟s dividend payments, hardly touching any core financial data reported by the firm. The basis for understanding the price given in this model is that it is the per share forecasted price of investing in the company based solely on dividends. This price only yields about 5% explanatory power of the firm‟s value. There are two main inputs for the discounted dividends model: the cost of equity, 𝐾𝑒 , and forecasted dividends. Both of these inputs play a vital role in the accuracy of this model. Due to the small amount of inputs this model is very unstable. The slightest changes in either growth rates or cost of equity can drastically change the model price, which discredits the effectiveness of the model. In theory this model works, but in actuality it lacks feasibility. In reality, dividends almost never grow at a constant rate and sometimes companies refrain from paying dividends at all. In order to value Cracker Barrel using the discounted dividends model, we had to find the forecasted dividends per share. To do this we took the dividends per share in 2009 and grew them at a rate of eight cents per year. We then needed to get the present value factor for each year so that the values of each year‟s dividends will be time consistent. After that we multiplied the forecasted dividends per share by the present value factor for each year. We then estimated the dividends per share in perpetuity for 2020 to be $2.00 based on the trend of dividends per share in prior years. This number was then divided by the initial cost of equity minus the perpetuity

57

Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.

185

growth rate to find the present value of the perpetuity. The present value of the perpetuity then needed to be discounted back to year zero by multiplying it by the present value factor in year 2019. In order to find the model price as of 7/31/2009, the date in which the Cracker Barrel 10-K‟s financials are base on, the time consistent forecasted dividends per share and the time consistent terminal value of the perpetuity were added together. From there, the model price needed to be grown by three months so that the model price is time consistent with our observed price date of 11/2/09. To 3

do this we multiplied the model price as of 7/31/09 by(1 + 𝐾𝑒 )(12 ). After all of these calculations we found the time consistent model price to be $29.34 per share. This indicated that Cracker Barrel‟s the observed price on 11/2/09 of $32.74 per share is overvalued. Discounted Dividends Model

Cost of Equity

Growth rates 0.05 0.07 0.09 0.1127

0 34.3 23.31 17.35 13.27

0.017 47.11 28.05 19.59 14.38

0.033 82.55 36.49 22.91 15.86

0.05

0.067

0.084

0.101

60.24 29.34 18.26

353.22 32.74 22.45

151.63 31.6

67.35

0.13 0.15 0.17

11.17 9.39 8.07

11.87 16.43 11.8

12.76 9.83 8.35

14.09 10.36 8.68

16.14 11.1 9.13

19.7 12.15 9.73

27.44 13.74 10.56

Undervalued Model Price > 36.01

Fair Valued 36.01 > Model Price > 29.47

Overvalued 29.47 > Model Price

The table above is a sensitivity analysis. Its purpose is to show how sensitive the model price is to small variances in growth rates and the cost of equity. When finding the time consistent model price mentioned earlier we used a growth rate of 5% and a cost of equity of 9%. From the table above it can be observed that the discounted dividends valuation is highly sensitive to any variances. That being said, this model may not be giving an accurate assessment of value for Cracker Barrel.

186

Discounted Free Cash Flows Model The discounted free cash flow model arrives at the value of a firm‟s equity by combining two different values: the present value of the free cash flow perpetuity and the present value of the forecasted free cash flows. After combining the two present values, the book value of debt and preferred stock is subtracted to find the firm‟s market value of equity. The market value of equity is then divided by the amount of shares to find the price per share. We grew this share price by 3/12 multiplied by the annual WACC(BT) to make it time consistent with the observed share price on November 2nd. This model has a higher explanatory power (10-20%) than the discounted dividends model, but still maintains a high level of variance. This is due to the fact that the free cash flow perpetuity is many years into the future, which can cause cash flow projections to be grossly misstated. The forecasted cash flows to be discounted can be found by subtracting the cash flow from investing activities (CFFI) from the cash flows from operations (CFFO). This can be done for a small number of years, usually 5-10, into the future. For our analysis we forecasted cash flows for the next 10 years. The cash flows are then multiplied by the present value factor, which incorporates the firm‟s before tax WACC. The actual present value factor is found by the formula 1/(1 + WACCbt)^n), where WACCbt is the firm‟s forecasted before tax weighted average cost of capital, and n is the number of years the cash flow will be discounted. The perpetuity present value is found by first determining a “seed value” for the perpetuity. This value is a cash flow forecast that follows the trend of the last few years of the 10 year free cash flow forecasts. This seed value is then divided by the perpetuity growth rate (WACCbt – g). This yields the present value of the perpetuity at a point 10 years in the future, which must then be discounted back to time zero. Multiplying the present value of the perpetuity by the present value factor of year ten will give the value of the future cash flow perpetuity at time zero.

187

The sensitivity analysis of the discounted free cash flows model uses inputs of the growth rate and the weighted average cost of capital. The growth rate is required to be greater than one and less than the cost of capital. These rates are increased or decreased to produce different outcomes that are compared to the time consistent price. Comparing the prices allows an analyst to determine whether a firm‟s share price is overvalued or undervalued according to the model. The model works under an assumption that a firm‟s free cash flows will continue to grow forever, which is almost certainly not attainable. Discounted Free Cash Flows Model Perpetuity Growth

WACC

0

0.017

0.033

0.05

0.067

0.084

0.101

0.04

200.1

334.99

1060.39

0.06

111.6

151.34

234.49

614.36

0.08

67.91

84.79

111.83

172.17

390.3

0.103

39.11

46.89

57.67

76.24

112.4

213.1

2026.64

0.12

25.16

29.94

36.15

45.87

61.81

92.8

179.26

0.14

13.26

16.14

19.68

24.83

32.37

44.49

67.18

0.16

4.49

6.31

8.47

11.45

15.52

21.41

30.69

Undervalued

Fair Valued

Model Price > 36.01

36.01 > Model Price > 29.47

Overvalued 29.47 > Model Price

Using a 10 percent analyst‟s view, a model price between $29.47 and $36.01 is deemed fairly valued. According to the model, Cracker Barrel‟s stock price is undervalued. The cells that are blacked out represent negative values. The substantial volatility of the discounted free cash flow model is clearly depicted in our results. When using lower WACCbt values, prices skyrocket as the perpetuity growth rate increases. The inherent volatility of results and relatively low explanatory power of this model will be considered when we apply the results to our overall valuation.

188

Residual Income The residual income valuation model presents a very accurate estimate of a firm‟s current value. It boasts an explanatory power from 70% to 90%, much higher than the other intrinsic models. This is a result of the model focusing more on the book value of equity of the firm, as opposed to the terminal value of the perpetuity. This results in a more short term view of the value of the company. Putting a larger weight on the firm‟s current financial standing makes the model less susceptible to forecast errors, which are likely to be large in future years. The residual income model is also much less sensitive to changes in the growth rate of the perpetuity. However, the model is not accurate in forecasting and tends to consistently state firm‟s stock prices as overvalued. To set up this model, an analyst must first forecast net income and dividends figures 10 years into the future. In our model, we grew net income by 3% in the first year, followed by 4% the next year. The remaining years were held at a constant 5% growth rate. Dividends were forecasted to grow by 8 cents per share each year, based on analysis of previous dividend trends. The firm‟s book value of equity can then be forecasted through the same amount of years. To accomplish this, the difference between year 1‟s forecasted net income and forecasted dividends is added to the firm‟s latest reported book value of equity (year zero book value of equity). This process is repeated to forecast the book value of equity to 10 years. The firm‟s annual residual income is then computed for each of the forecasted years by subtracting the forecasted “benchmark” income from the forecasted net income. The benchmark income is derived by multiplying the previous year‟s book value of equity by the firm‟s initial cost of equity. We found this initial cost of equity to be 11.27%. A positive annual residual income signals that the firm created value in that year, while a negative annual residual income indicates the firm destroyed value in that year.

189

Each year‟s residual income forecast must then be calculated in present value terms by multiplying the residual income by a present value factor. The present value factor for each year is found by dividing 1 by 1 plus the initial cost of equity raised to the year the present value factor is found. In formula form, (1/(1+initial ke)^n). Adding together each year‟s present value yields the total present value of the year-by-year residual income, which will be used to calculate the market value of equity for the firm. Next, the terminal value of the perpetuity, another component of the market value of equity, must be found. Like in the discounted free cash flows model, a seed value for the perpetuity must be created. Because our forecasted annual residual income numbers were decreasing, we continued that trend into year 2020 to determine the seed value. We multiplied year 2019‟s annual RI by 1 minus the present value factor of the same year to give us 2020‟s seed value for the perpetuity of $22.16. This seed value was then divided by the initial cost of equity minus the perpetuity growth rate to find the present value of the perpetuity. The present value at year 2019 must then be discounted back to time zero by multiplying the present value by the year 2019 present value factor. Now the firm‟s market value of equity can be calculated. The time zero published book value of equity added to the total present value of the year-by-year residual income figures plus the terminal value of the perpetuity will yield the market value of equity at year end. Divide the market value of equity by the total number of shares to find the residual income model price at fiscal year end. For our analysis, we again multiplied this share price by 1 plus the initial cost of equity raised to the (3/12) power to find a time consistent price. Cracker Barrel‟s fiscal year end was 3 months prior to the date we used to observe the share price.

190

Residual Income Model - As Stated Perpetuity Growth

Cost of Equity

-0.1

-0.2

-0.3

-0.4

-0.5

-0.6

-0.7

0.05

38.52

34.91

33.36

32.5

31.96

31.58

31.3

0.07

30.68

28.66

27.73

27.2

26.85

26.61

26.43

0.09

24.9

23.79

23.25

22.93

22.72

22.57

22.46

0.1127

20.01

19.49

19.23

19.07

18.96

18.88

18.82

0.13

17.15

16.89

16.75

16.67

16.61

16.56

16.53

0.15

14.5

14.43

14.39

14.36

14.34

14.33

14.32

0.17

12.41

12.43

12.45

12.46

12.47

12.47

12.48

Undervalued Model Price > 36.01

Fair Valued 36.01 > Model Price > 29.47

Overvalued 29.47 > Model Price

Residual Income Model - Restated Perpetuity Growth

Cost of Equity

-0.1

-0.2

-0.3

-0.4

-0.5

-0.6

-0.7

0.05

32.91

29.83

28.51

27.78

27.31

26.99

26.75

0.07

26.39

24.64

23.83

23.37

23.07

22.86

22.71

0.09

21.56

20.58

20.1

19.82

19.63

19.5

19.4

0.1127

17.46

16.98

16.74

16.59

16.48

16.41

16.36

0.13

15.05

14.8

14.66

14.57

14.52

14.47

14.44

0.15

12.82

12.72

12.67

12.63

12.61

12.59

12.58

0.17

11.04

11.04

11.03

11.03

11.03

11.03

11.03

Undervalued Model Price > 36.01

Fair Valued 36.01 > Model Price > 29.47

Overvalued 29.47 > Model Price

The above charts represent the sensitivity analyses of the residual income model using Cracker Barrel‟s reported numbers as well as with our restated figures. We once again used a 10% analyst‟s position in valuing the firm based on the residual income model. This means that a model price above $36.01 indicates the firm is undervalued, while a model price under $29.47 indicates the firm is overvalued. Anything in between the range shows the firm is fairly valued.

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Both the as-stated and restated models indicate that Cracker Barrel‟s stock is overvalued except for extremely low costs of equity. Using restated figures shows the stock to be slightly more overvalued than with as-stated numbers. The low sensitivity to growth rates of the residual income model is clearly shown in our results. For each cost of equity, prices remain stable across each growth rate of the perpetuity. At the initial cost of equity we derived for Cracker Barrel of 11.27%, the model yields a stock price just above half of the observed share price. These results are a definite cause for concern as the residual income model holds such a high explanatory power. The results of this model will have a significant impact on our overall valuation of the firm. Abnormal Earnings Growth (AEG) Valuation “Under this approach, the value of a firm‟s equity is expressed as the sum of its current book value and the present value of forecasted abnormal earnings.”58 Abnormal earnings are the difference between a firm‟s market value and book value. The three inputs in the model are dividends reinvested (DRIP), cumulative dividend earnings, and normal earnings. In theory, the abnormal earnings growth model should give similar results to the residual income model. This is true because abnormal earnings growth in a given year is equal to its change in residual income. Because the AEG model is considered to be the “ugly cousin” to the residual income model, it is implied that the AEG model also has an explanatory power of about 70%. We will discuss in this section the steps taken in calculating a model price for Cracker Barrel using the AEG valuation. The first step in the model is to calculate dividends reinvested. The DRIP implements an assumption that an investor will reinvest their dividends based on the cost of equity return. Total dividends reinvested can be found by multiplying the cost of equity (Ke) by the total amount of dividends paid out from the previous year. The DRIP was calculated for the next nine years by using our forecasted dividend payments, and a cost of equity of 11.27%. 58

Palepu

192

After the DRIP was found, the next step in the model was to calculate the cumulative earnings. There is a direct and indirect component to cumulative wealth. The direct component is net income, which is the shareholder‟s claim to earnings. The indirect component is the dividend reinvestment from shareholders. We calculated each year‟s forecasted cumulative dividend earnings for the next nine years by taking that year‟s net income and adding to it the DRIP, which is the previous year‟s total dividends multiplied by the cost of equity. The third step in the AEG model was to find Cracker Barrel‟s “benchmark” normal earnings for the next nine years. The “benchmark” normal earnings used is an assumption that net income would grow by the cost of equity. To calculate normal earnings we took the net income from the previous year and multiplied it by one plus the cost of equity. This was repeated for the next nine years. After cumulative dividend earnings and normal earnings have been computed, we can calculate AEG. The AEG for the next nine years was calculated by taking cumulative dividend earnings and subtracting normal earnings for each year. Since AEG is equal to the change in residual income, we compared our calculated AEG to the change in residual income to ensure that our calculations were correct. Both numbers were the same, so we concluded that our AEG was correct. Next, we had to get the present value of each year‟s AEG. To get the present value we discounted back AEG by multiplying it by the formula 1/(1 + 𝐾𝑒)𝑡 . Once each year‟s AEG was discounted back to the year 2009, the total present value of AEG was computed by adding up the present value of each year‟s AEG. The next step was to find the terminal value of the perpetuity. In order to do so we had to come up with a seed value for AEG in year ten. Looking at the most recent years‟ AEG, we came up with a seed value of 3.33 stated and 1.93 restated. We then found the present value of the perpetuity by dividing the seed value by (Ke – growth rate). Then we had to discount back the perpetuity by the present value factor for the year 2019. 193

The last step was to calculate the time consistent implied price per share. To do so we took our forecasted net income in 2010 and subtracted out the present values of the total AEG and the terminal value. This gave us the total average net income of the perpetuity. Next, we divided the average net income of the perpetuity by the number of shares outstanding to calculate the average earnings per share of the perpetuity. The average EPS of the perpetuity was then multiplied by the cost of equity to compute an intrinsic value of $20.88 stated and $18.87 restated. We then had to grow our intrinsic values three months forward to get a time consistent price, because our fiscal year end was at the end of July and our observed share price was at the beginning of November. In order to do so we multiplied the intrinsic value price per share by one plus the cost of equity raised to 3/12 power. The following graphs show the sensitivity analysis for the as stated and restated AEG models. AEG

Sensitivity to change in Cost of Equity

As Stated 0.05 0.07 0.09 0.1127

-0.1 78.41 46.24 30.81 21.44

-0.2 75.14 45.91 31.31 22.13

Perpetuity Growth -0.3 -0.4 -0.5 73.73 72.95 72.46 45.76 45.68 45.62 31.55 31.7 31.8 22.49 22.71 22.85

-0.6 72.12 45.58 31.86 22.96

-0.7 71.86 45.55 31.91 23.04

0.13 0.15 0.17

17.14 13.81 11.54

17.8 14.38 12.01

18.15 14.7 12.28

18.63 15.14 12.68

18.71 15.22 12.75

Undervalued Model Price > 36.01

18.37 14.9 12.46

18.52 15.04 12.58

Fair Valued 36.01 > Model Price > 29.47

Overvalued 29.47 > Model Price

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AEG

Restated

Sensitivity to change in Cost of Equity

0.05 0.07 0.09 0.1127

-0.1 68.05 40.74 27.5 19.38

-0.2 64.77 40.09 27.66 19.78

Perpetuity Growth -0.3 -0.4 63.37 62.59 39.8 39.63 27.74 27.79 19.99 20.11

-0.5 62.1 39.52 27.82 20.2

-0.6 61.75 39.44 27.84 20.26

-0.7 61.5 39.38 27.86 20.31

0.13 0.15 0.17

15.6 12.65 10.62

16.02 13.03 10.94

16.25 13.24 11.13

16.48 13.47 11.33

16.55 13.54 11.39

16.6 13.59 11.44

16.38 13.38 11.25

Undervalued

Fair Valued

Model Price > 36.01

36.01 > Model Price > 29.47

Overvalued 29.47 > Model Price

We used negative growth rates in the AEG model in order to restore earnings back to equilibrium. The sensitivity analysis for the as stated AEG shows that with a 9% cost of equity Cracker Barrel‟s stock is fairly valued. A lower cost of equity will result in the company‟s stock being undervalued, and any cost of equity above 9% results in the company being overvalued. As for the restated AEG, when the cost of equity is 7% or lower, the firm is undervalued. Any cost of equity of 9% or above results in the company‟s share price being overvalued. Since our estimated cost of equity is 11.27%, according to the AEG model, Cracker Barrel is overvalued as stated and restated. Long Run Return On Equity Residual Income Model The long run return on equity (ROE) residual income model is like the residual income model except that it takes into account a firms dividends when calculating the market value of equity. In order to calculate this new model a different formula must be created, which is: 𝑀𝑉𝐸0 = 𝐵𝑉𝐸0 +

𝐵𝑉𝐸0 𝑅𝑂𝐸 − (𝐵𝑉𝐸0 ∗ 𝐾𝑒) 𝐾𝑒 − 𝑔

As seen from the equation, this model is sensitive to changes in ROE, Cost of Capital (Ke), and growth. For this reason, this model is helpful in determining if a firm is fairly valued. 195

To use the equation the company‟s seed value for the ROE must be found. We found the forecasted ROE to be:

ROE As Stated ROE Restated

1

2

3

4

5

6

7

8

9

10

11

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

52.9%

39.4%

32.1%

27.6%

24.4%

21.9%

20.1%

18.6%

17.4%

16.3%

15.53%

47.55%

37.20%

31.20%

27.37%

24.56%

22.41%

20.71%

19.33%

18.19%

17.23%

16.37%

In this graph the seed value ROE is the perpetuity starting in year 2020, which is 15.53%. After finding the forecasted ROE you find the percentage change in ROE to find the growth. We found our growth percentage to be -5.57%. Once these numbers have been calculated you can test the sensitivity to changes in the model. In our model we used 2% intervals for ROE and growth to see the price sensitivity. For the cost of equity we did 3% intervals to see the price sensitivity in the model. In order to see price sensitivity we changed two variables and held one constant. In the first set of tables we held the growth rate constant; for the as stated it was 5.57% and for the restated it was -5.03%. Then we changed the ROE and Ke to see the price sensitivity.

As Stated

Cost of Equity

0.1 0.05 8.25 0.07 6.97 0.09 6.04 0.1127 5.25 0.13 4.78 0.15 4.34 0.17 3.97

0.12 9.31 7.86 6.82 5.93 5.4 4.89 4.48

Undervalued Model Price > 36.01

0.14 10.37 8.76 7.59 6.60 6.01 5.45 4.99

Change In ROE 0.1553 0.18 11.18 12.49 9.45 10.55 8.19 9.14 7.12 7.95 6.48 7.24 5.88 6.56 5.38 6.01

Fair Valued 36.01 > Model Price > 29.47

0.2 13.55 11.45 9.92 8.63 7.85 7.12 6.52

0.22 14.61 12.34 10.7 9.3 8.47 7.68 7.03

Overvalued 29.47 > Model Price 196

Restated

Cost of Equity

0.05 0.07 0.09 0.1127 0.13 0.15 0.17

0.1 8.39 7.03 6.06 5.25 4.75 4.3 3.93

0.12 9.51 7.97 6.86 5.94 5.39 4.87 4.45

Undervalued Model Price > 36.01

Change In ROE 0.14 16.4 0.18 10.63 11.97 12.86 8.9 10.02 10.77 7.67 8.63 9.28 6.63 7.47 8.03 6.02 6.78 7.29 5.44 6.13 6.59 4.97 5.6 6.02

0.2 13.98 11.71 10.09 8.73 7.92 7.16 6.54

Fair Valued 36.01 > Model Price > 29.47

Overvalued 29.47 > Model Price

0.22 15.09 12.64 10.89 9.42 8.55 7.73 7.06

In the second set of tables we held the return on equity constant; the as stated was 15.53% and the restated was 16.4%. Then we changed the variables for growth and Ke to see the price sensitivity. As Stated

Cost of Equity

Change In Growth 0.01 -0.01 -0.03 -0.0557 -0.07 0.05 21.95 16.65 13.99 12.06 11.34 0.07 14.7 12.54 11.25 10.19 9.77 0.09 11.08 10.08 9.42 8.83 8.59 0.1127 8.67 8.26 7.96 7.68 7.56 0.13 7.45 7.27 7.13 6.99 6.93 0.15 6.41 6.39 6.36 6.34 6.33 0.17 5.64 5.7 5.75 5.8 5.83 Undervalued Model Price > 36.01

Fair Valued 36.01 > Model Price > 29.47

-0.09 10.59 9.31 8.31 7.42 6.86 6.32 5.86

-0.11 10.02 8.95 8.09 7.3 6.8 6.31 5.88

Overvalued 29.47 > Model Price

197

Restated

Cost of Equity

0.05 0.07 0.09 0.1127 0.13 0.15 0.17

Change In Growth 0.01 -0.01 -0.03 -0.0503 -0.07 21.56 16.24 13.58 11.97 10.92 14.44 12.24 10.92 10.02 9.4 10.88 9.84 9.14 8.63 8.27 8.52 8.06 7.72 7.47 7.28 7.32 7.03 6.92 6.78 6.67 6.3 6.23 6.17 6.13 6.09 5.54 5.56 5.58 5.6 5.61

Undervalued

-0.09 10.16 8.93 7.98 7.12 6.59 6.06 5.62

Fair Valued 36.01 > Model Price > 29.47

Model Price > 36.01

-0.11 9.59 8.57 7.74 6.99 6.51 6.04 5.63

Overvalued 29.47 > Model Price

For the final set of tables we held the cost of capital constant; for both the as stated and restated it was 11.27%. Then we changed the ROE and growth to see the price sensitivity of the model. As Stated

Change In Growth

0.01 -0.01 -0.03 0.0557 -0.07 -0.09 -0.11

0.09 4.78 5 5.15

0.11 5.97 6 6.01

0.13 7.16 6.99 6.87

5.3 5.37 5.44 5.51

6.03 6.04 6.05 6.06

6.76 6.71 6.65 6.61

Undervalued Model Price > 36.01

Change In ROE 0.1553 0.17 8.67 9.55 8.26 8.99 7.96 8.59 7.68 7.56 7.42 7.3

8.22 8.05 7.86 7.71

Fair Valued 36.01 > Model Price > 29.47

0.19 10.74 9.99 9.45

0.21 11.94 10.99 10.31

8.94 8.72 8.47 8.26

9.67 9.39 9.07 8.81

Overvalued 29.47 > Model Price

198

Restated

Change In Growth

0.01 -0.01 -0.03 -0.0503 -0.07 -0.09 -0.11

0.1 4.98 5.09 5.18 5.24 5.29 5.33 5.36

0.12 6.09 6.02 5.97 5.94 5.91 5.89 5.87

Undervalued Model Price > 36.01

Change In ROE 0.14 16.4 0.18 7.19 8.52 9.41 6.95 8.06 8.8 6.77 7.72 8.36 6.63 7.47 8.03 6.53 7.28 7.78 6.45 7.12 7.57 6.38 6.99 7.4

0.2 10.51 9.72 9.16 8.73 8.4 8.13 7.91

Fair Valued 36.01 > Model Price > 29.47

Overvalued 29.47 > Model Price

0.22 11.62 10.65 9.95 9.42 9.02 8.69 8.42

According to the model, the price is not overly sensitive to the change in cost of equity and change in ROE or the change in growth and change in ROE. However, the price is sensitive to change in growth and change in cost of equity; this can be seen in the second set of tables. According to this model, Cracker Barrel is extremely overvalued. Analyst Recommendation Through an in-depth examination of Cracker Barrel we have determined that its stock price is overvalued. This is based upon an observed price per share of $32.74 on November 2nd, 2009 and a 10% analyst‟s perspective. We reached this conclusion after a thorough examination of the firm and its competitors in the restaurant industry. The industry analysis allowed us to identify components of a successful firm in the restaurant industry, as well as what threats a company might face. We were then able to identify the key success factors that contributed to Cracker Barrel‟s value. Performing an accounting analysis allowed us to determine the validity of Cracker Barrel‟s financial statements. A thorough ratio analysis permitted us to compare Cracker Barrel‟s performance to its competitors in the industry. From there we were able to forecast

199

Cracker Barrel‟s financial statements ten years into the future. This allowed us to gain a models based valuation on the current stock price. In our accounting analysis we found no indication of goodwill, and very little amounts of research and development. These costs did not need to be restated. However, the present value of Cracker Barrel‟s operating leases consisted of more than 10% of their long term debt. Because of this, we restated the financial statements to include a capitalization the leases. The restated financial statements showed increased liabilities and assets, while net income decreased. It is our opinion that these restated financials showed a more clear depiction of Cracker Barrel‟s financial position. Our financial analysis showed that Cracker Barrel was in a fairly strong financial position compared to the industry. Although the firm mostly had below average liquidity due to its retail sector, it was near industry average when we only examined restaurant operations. We believe this is a safe estimate given that retail operations consist of only around 20% of revenues and are a key component of Cracker Barrel‟s customer experience. However, the most heavily weighted factor of our analysis was the examination of the intrinsic model valuations. All models except for the discounted free cash flows model showed Cracker Barrel‟s stock price to be overvalued. We placed small significance on this model due to its relatively low explanatory power and sensitivity to perpetuity growth rates. The residual income model, one of the more accurate valuation models, indicated overwhelmingly that Cracker Barrel‟s stock price was overvalued. In addition, the AEG, long run return on equity residual income, and discounted dividends models also clearly indicated an overvalued stock price. Although the firm is not near any financial trouble and performed above average in our ratio analysis, we placed more emphasis on the results of the intrinsic valuation models. In nearly all models, the model price was clearly below the observed stock price, using a 10% margin of safety. We believe that Cracker Barrel cannot sustain its

200

stock price in the long term. For this reason, we recommend that investors do not buy stock in Cracker Barrel.

201

Appendices Liquidity Ratios Current Ratio Cracker Barrel Bob Evans Denny's Darden Dine Equity Brinker International Industry

2004 0.84 0.33 0.32 0.51 1.82 1.06 0.81

2005 0.64 0.3 0.42 0.39 1.14 0.73 0.6

2006 1.98 0.52 0.46 0.37 1.22 0.49 0.61

2007 0.73 0.51 0.44 0.51 1.14 1.21 0.76

2008 Five Year Average 0.83 1 0.22 0.37 0.5 0.43 0.41 0.44 1.06 1.28 0.87 0.87 0.61 0.68

Quick Asset Ratio 2004 0.25 0.19 0.26 0.22 1.81 0.96 0.69

2005 0.16 0.17 0.36 0.16 1.13 0.61 0.49

2006 1.59 0.34 0.4 0.17 1.22 0.41 0.51

2007 0.2 0.37 0.39 0.31 1.1 1.15 0.66

2008 Five Year Average 0.24 0.49 0.12 0.24 0.45 0.37 0.22 0.22 1.02 1.26 0.8 0.79 0.52 0.57

Working Capital Turnover 2004 Cracker Barrel -60.74 Bob Evans -12.18 Dennys -10.36 Darden -14.84 Dine Equity 7.49 Brinker International 170.4 Industry 28.1

2005 -20.89 -11.11 -11.28 -8.28 39.93 -32.05 -4.56

2006 6.87 -20.56 -13.62 -7.72 24.47 -16.28 -6.74

2007 -31.61 -16.76 -12.76 -10.52 9.26 39.18 1.68

2008 Five Year Average -54.1 -27.5 -6.8 -14.45 -14.17 -10.78 -9.92 -11.23 92.66 17.22 -59.82 27.68 0.39 1.69

2006 194.11 98.25 68.25 134.82 7.67 79.01 77.6

2007 199.98 80.65 69.15 122.62 4.2 87.8 72.88

2008 Five Year Average 176.84 194.66 87.06 90.91 50.2 64.67 95.35 132.54 13.68 8.32 80.97 86.31 65.45 76.55

Cracker Barrel Bob Evans Dennys Darden Dine Equity Brinker International Industry

Accounts Receivable Turnover 2004 Cracker Barrel 242.88 Bob Evans 89.32 Dennys 77.58 Darden 165.36 Dine Equity 8.09 Brinker International 97.74 Industry 87.61

2005 159.5 99.29 58.16 144.57 7.97 86.01 79.2

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Days Sales’ Outstanding Days Sales’ Outstanding Cracker Barrel Bob Evans Dennys Darden Dine Equity Brinker International Industry

2004 1.5 4.1 4.7 2.2 45.1 3.7 12

2005 2.3 3.7 6.3 2.5 45.8 4.2 12.5

2006 1.9 3.7 5.3 2.7 47.6 4.6 12.8

2007 1.8 4.5 5.3 3 86.9 4.2 20.8

2008 Five Year Average 2.1 1.9 4.2 4 7.3 5.8 3.8 2.8 26.7 50.4 4.5 4.3 9.3 13.5

Inventory Turnover Cracker Barrel Without Retail Cracker Barrel With Retail Bob Evans Dennys Darden Dine Equity Brinker International Industry

2004 16.69 5.54 17.52 91.09 19.63 1541.68 26.89 339.36

2005 13.93 5.02 18.15 94.97 17.4 395.88 21.79 109.64

2006 18.52 5.5 16.74 95.35 22.28 526.43 28.79 137.92

2007 17.25 5.15 16.81 120.55 20.32 22.98 41.87 44.51

2008 Five Year Average 19.72 17.22 4.96 5.24 16.51 17.15 104.51 101.29 23.71 20.67 98.88 517.17 33.94 30.65 55.51 137.39

Days’ Supply of Inventory Cracker Barrel Bob Evans Dennys Darden Dine Equity Brinker International Industry

2004 65.9 20.8 4 18.6 0.2 13.6 11.4

2005 72.7 20.1 3.8 21 0.9 16.8 12.5

2006 66.3 21.8 3.8 16.4 0.7 12.7 11.1

2007 70.8 21.7 3 18 15.9 8.7 13.5

2008 Five Year Average 73.6 69.9 22.1 21.3 3.5 3.6 15.4 17.9 3.7 4.3 10.8 12.5 11.1 11.9

Cash to Cash Cycle Cracker Barrel Bob Evans Dennys Darden Dine Equity Brinker International Industry

2004 67.4 24.9 8.7 20.8 45.4 17.3 23.4

2005 75 23.8 10.1 23.5 46.7 21 25

2006 68.2 25.5 9.2 19.1 48.3 17.3 23.9

2007 72.6 26.2 8.3 20.9 102.8 12.9 34.2

2008 Five Year Average 75.6 71.8 26.3 25.4 10.8 9.4 19.2 20.7 30.4 54.7 15.3 16.7 20.4 25.4

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Profitability Ratios Gross Profit Margin

Cracker Barrel Bob Evans Dennys Darden Dine Equity Brinker International Industry

2004 67.0% 71.5% 21.3% 22.0% 36.4% 72.4% 44.7%

2005 67.3% 69.6% 20.4% 22.4% 38.9% 71.7% 44.6%

2006 68.2% 70.4% 21.4% 11.5% 40.4% 72.0% 43.1%

2007 68.3% 70.9% 16.8% 23.5% 37.0% 72.1% 44.0%

2004 7.7%

2005 7.7% 6.7% 4.6% 5.0% 8.0% 20.4% 5.8% 8.8%

2006 7.3% 4.0% 5.4% 11.1% 9.6% 20.8% 64.2% 22.2%

2007 7.2% 3.4% 5.9% 8.5% 6.8% -0.6% 7.9% 5.7%

2005 5.78% 2.47% 2.53% -0.75% 5.51% 12.62% 4.27% 4.84%

2006 5.24% 0.72% 3.46% 3.05% 6.76% 12.75% 5.12% 6.23%

2007 6.89% 2.07% 3.66% 3.34% 3.62% -0.10% 1.18% 2.34%

Five Year 2008 Average 67.6% 70.2% 25.0% 22.5% 32.8% 71.6% 44.4%

67.7% 70.5% 21.0% 20.4% 37.1% 72.0% 44.2%

Operating Profit Margin

Cracker Barrel CBRL Restated Bob Evans Dennys Darden Dine Equity Brinker International Industry

9.5% 5.6% 6.7% 15.1% 6.6% 8.7%

Five Year 2008 Average 6.3% 7.2% 3.5% 4.4% 6.2% 6.3% 8.0% 7.6% 5.6% 7.3% -11.7% 8.8% 2.3% 17.4% 2.1% 9.5%

Net Profit Margin

Cracker Barrel CBRL Restated Bob Evans Dennys Darden Dine Equity Brinker International Industry

2004 4.70% 6.01% -3.92% 4.54% 9.31% 4.07% 4.00%

Five Year 2008 Average 2.75% -0.88% 3.73% 1.93% 5.69% -9.57% 1.22% 0.60%

5.07% 1.10% 3.88% 0.73% 5.22% 5.00% 3.17% 3.60%

204

Asset Turnover

Cracker Barrel CBRL Restated Bob Evans Dennys Darden Dine Equity Brinker International Industry

2004 1.79 1.53 1.89 1.88 0.43 1.91 1.53

2005 1.53 1.31 1.68 1.96 1.90 0.42 1.66 1.52

2006 1.45 1.13 1.34 1.94 1.70 0.45 1.93 1.47

2007 1.40 1.08 1.40 2.12 1.85 0.63 1.97 1.59

Five Year 2008 Average 1.88 1.47 1.45 2.01 1.73 0.56 1.83 1.52

1.61 1.25 1.48 1.99 1.81 0.50 1.86 1.53

2005 8.8% 3.2% 4.3% -1.5% 10.5% 5.3% 7.1% 5.1%

2006 7.6% 0.8% 4.6% 5.9% 11.5% 5.8% 9.9% 7.5%

2007 9.6% 2.2% 5.1% 7.1% 6.7% -0.1% 2.3% 4.2%

Five Year 2008 Average 5.2% -1.3% 5.4% 3.9% 9.8% -5.4% 2.2% 3.2%

7.9% 1.2% 5.7% 1.6% 9.4% 1.9% 5.9% 4.9%

2005 14.5% 6.2% 5.9% 2.8% 24.7% 12.9% 15.9% 12.4%

2006 13.4% 1.8% 8.4% -11.4% 26.6% 15.2% 19.3% 11.6%

2007 53.6% 17.1% 8.6% -14.0% 16.4% -0.2% 4.8% 3.1%

Five Year 2008 Average 63.0% -23.7% 9.2% -8.0% 18.4% 20.8% 6.4% 9.4%

31.7% 0.4% 9.0% -3.7% 21.0% 11.5% 11.9% 9.9%

Return on Assets

Cracker Barrel CBRL Restated Bob Evans Dennys Darden Dine Equity Brinker International Industry

2004 8.4% 9.2% -7.4% 8.5% 4.0% 7.8% 4.4%

Return on Equity

Cracker Barrel CBRL Restated Bob Evans Dennys Darden Dine Equity Brinker International Industry

2004 14.1% 12.8% 12.2% 19.0% 8.7% 13.2% 13.2%

205

Capital Structure Ratios Debt/Equity Cracker Barrel Cracker Barrel Restated Bob Evans Denny's Darden Dine Equity Brinker International Industry

2004 0.64 0.92 0.38 -2.89 1.37 1.42 1.23 0.30

2005 0.76 1.26 0.81 -2.92 1.31 1.62 0.96 0.36

2006 4.56 6.64 0.68 -2.98 1.45 1.66 1.06 0.37

2007 11.15 17.26 0.70 -3.07 0.87 -4.89 1.88 -0.90

2008 Five Year Average 13.16 6.06 18.52 8.92 0.97 0.71 -2.99 -2.97 2.36 1.47 77.59 15.48 2.69 1.56 16.12 3.25

2004 0.64 0.92 0.38 -2.89 1.37 1.42 1.23 0.30

2005 0.76 1.26 0.81 -2.92 1.31 1.62 0.96 0.36

2006 4.56 6.64 0.68 -2.98 1.45 1.66 1.06 0.37

2007 11.15 17.26 0.70 -3.07 0.87 -4.89 1.88 -0.90

2008 Five Year Average 13.16 6.06 18.52 8.92 0.97 0.71 -2.99 -2.97 2.36 1.47 77.59 15.48 2.69 1.56 16.12 3.25

2004 2003.65 34.14 0.54

2005 1218.84 32.51 10.67 40.22 9.47 23.50 23.28

2006 831.88 37.06 4.96

2007 11.94 37.88 4.02 12.95 24.57 220.75 60.03

2008 Five Year Average 15.21 816.30 4.66 29.25 3.34 4.71 3.63 18.93 12.26 205.30 147.58 54.23 42.55

Times Interest Earned Cracker Barrel Cracker Barrel Restated Bob Evans Denny's Darden Dine Equity Brinker International Industry Debt Service Margin Cracker Barrel Bob Evans Denny’s Darden Dine Equity Brinker International Industry

11.69 27.68 18.51

3.32 260.65 76.50

Altman's Z-Score Cracker Barrel Cracker Barrel Restated Bob Evans Denny's Darden Dine Equity Brinker International Industry

2005 4.09 2.83 2.92 0.21 3.19 2.23 4.23 2.56

2006 2.66 1.93 3.79 0.90 3.06 2.32 5.05 3.02

2007 2.74 1.95 3.51 0.79 2.52 0.50 3.95 2.25

2008 2.65 1.98 3.00 0.00 2.28 0.60 3.28 1.83

2009 Five Year Average 2.80 2.99 1.96 2.13 3.22 3.29 0.48 2.35 2.68 1.41 3.50 4.00 3.02 2.37

206

Growth Rates

Internal Growth Rate 2004

2005

2006

2007

2008

2009

Cracker Barrel

6.8%

7.2%

6.1%

8.8%

3.9%

3.6%

Bob Evans

7.0%

2.3%

3.2%

3.4%

3.9%

-1.6%

Dennys

-7.4%

-1.5%

5.9%

7.1%

3.9%

Darden

8.0%

10.0%

9.5%

4.5%

7.2%

Dine Equity

1.5%

3.0%

3.4%

-2.5%

-6.6%

Brinker International

7.8%

7.1%

8.7%

0.5%

0.4%

1.6%

Industry Avg.

3.4%

4.2%

6.1%

2.6%

1.7%

1.8%

5.5%

Sustainable Growth Rate 2004

2005

2006

2007

2008

2009

11.2%

12.7%

34.0%

106.3%

54.9%

33.4%

9.7%

4.2%

5.3%

5.8%

7.7%

-3.1%

Dennys

14.0%

2.8%

-11.8%

-14.6%

-7.8%

Darden

19.0%

23.1%

23.2%

8.4%

24.2%

3.7%

7.8%

9.1%

9.9%

-520.6%

Brinker International

17.3%

13.9%

17.9%

1.3%

1.3%

4.7%

Industry Avg.

12.7%

10.4%

8.8%

2.2%

-99.0%

6.3%

Cracker Barrel Bob Evans

Dine Equity

17.3%

207

Operating Leases Restated Financial Statements Balance Sheet ASSETS 2004 2005 2006 2007 2008 2009 Adjusted Adjusted Adjusted Adjusted Adjusted Adjusted Current Assets: Total current assets

Property and Equipment: Buildings under capital leases Leasehold improvements Assets Under Capitalized Lease Rights (Net) Total Less: Accumulated depreciation and amortization of capital leases Property and equipment - net Other Assets Total

203040

190483

653830

200281

220639

198325

3289 3289 3289 3289 3289 3289 193859 228859 149061 165472 183729 200704 241168 432774 489788 353459 325535 416718 1743482 2096822 1905162 1853688 1897351 1989156 383741

445750

432870

481247

526576

570662

1359741 1651072 1472292 1372441 1370775 1418494 20367

30767

44963

45767

47824

45080

1676872 1966046 2171085 1618489 1639238 1661899

LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Total current liabilities

242235

295345

330533

274669

264719

264962

Long-term Debt Capital lease obligations (net) Interest rate swap liability Other Long-term Obligations Deferred Income Taxes

185138 241168 0 36225 98770

212218 432682 0 48411 107310

911464 508074 0 55128 81890

756306 368952 0 67499 62433

779061 334382 39618 83147 54330

638040 426690 61232 89610 55655

Total Long Term Liabilities

561301 800621 1556556 1255190 1290538 1271227 803536 1095966 1887089 1529859 1555257 1536189

Commitments and Contingencies (Note 10) Shareholders' Equity: 48,769,368 shares issued and outstanding Additional paid-in capital Accumulated other comprehensive (loss) Retained earnings

488 13982 0 858866

466 0 0 869614

309 4257 -4529 283959

237 0 -8988 97381

223 731 -27653 110680

227 12972 -44822 157333

Total shareholders' equity

873336

870080

283996

88630

83981

125710

Total

1676872 1966046 2171085 1618489 1639238 1661899

208

Income Statement Restated Income Statement

Total revenue Cost of goods sold Gross profit Labor & other related expenses Impairment and store closing charges Other store operating expenses Op. Lease Expense Depreciation Expense, Operating Leases Store operating income General and administrative Operating income Interest expense Interest income Income before income taxes Provision for income taxes Income from continuing operations Income from discontinued operations net of tax Net income

2004 2005 2006 2007 2008 2009 Adjusted Adjusted Adjusted Adjusted Adjusted Adjusted 2380947 2567548 2219475 2351576 2384521 2367285 785703 847045 706095 744275 773757 764909 1595244 1720503 1513380 1607301 1610764 1602376 880617 939849 832943 892839 909546 916256 0 0 5369 0 877 2088 405139 447506 384442 410131 422293 421594 -30156 -30174 -35634 -29044 -30294 12231 21634 26629 19695 18443 309488 351073 299166 313336 287397 274289 126501 130986 128830 136186 127273 120199 182987 220087 170336 177150 160124 154090 8444 26526 49031 83936 75564 73940 5 96 764 7774 185 0 174548 193657 122069 100988 84745 80150 62663 66925 44854 40498 28212 24105 111885 126732 77215 60490 56533 56045 0 0 20790 86082 250 -31 111885

126732

98005

146572

56783

56014

209

3 Month Regression 3 Month Treasury Bill Beta

Adjusted R2

B ub

B lb

Ke

Ke low

Ke Up

72

0.90092

0.14006

1.40785

0.39399

0.10607

0.06552

0.14663

60

0.98494

0.17458

1.52196

0.44793

0.11280

0.06983

0.15576

48

0.95320

0.15996

1.56147

0.34493

0.11026

0.06159

0.15892

36

0.86592

0.15189

1.51866

0.21317

0.10327

0.05105

0.15549

24

0.86571

0.13517

1.70329

0.02814

0.10326

0.03625

0.17026

24 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.415655 R Square 0.172769 Adjusted R Square 0.135168 Standard Error 0.129327 Observations 24 ANOVA df Regression Residual Total

Intercept X Variable 1

1 22 23

SS 0.076849 0.367959 0.444808

Coefficients 0.016509 0.865714

Standard Error 0.026997 0.403871

MS 0.076849 0.016725

F 4.594758

Significance F 0.04338

t Stat 0.6115 2.143539

P-value 0.547136 0.04338

Lower 95% -0.03948 0.028136

Upper 95% 0.072497 1.703292

Lower 95.0% -0.03948 0.028136

210

Upper 95.0% 0.072497 1.703292

36 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.419665 R Square 0.176118 Adjusted R Square 0.151886 Standard Error 0.107773 Observations 36 ANOVA df 1 34 35

SS MS F 0.084418 0.084418 7.268061 0.394908 0.011615 0.479326

Coefficients 0.009959 0.865919

Standard Error t Stat P-value 0.018097 0.550317 0.5857 0.321194 2.695934 0.010835

Regression Residual Total

Intercept X Variable 1

Significance F 0.010835

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.02682 0.046736 -0.02682 0.046736 0.213173 1.518665 0.213173 1.518665

48 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.421707 R Square 0.177836 Adjusted R Square 0.159963 Standard Error 0.103546 Observations 48 ANOVA df Regression Residual Total

Intercept X Variable 1

1 46 47

Coefficients 0.012404 0.953201

Significance SS MS F F 0.106682 0.106682 9.949934 0.002833 0.493206 0.010722 0.599888 Standard Error t Stat P-value 0.015002 0.826794 0.412622 0.302186 3.154352 0.002833

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.01779 0.042602 -0.01779 0.042602 0.344932 1.561469 0.344932 1.561469 211

60 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.434248 R Square 0.188572 Adjusted R Square 0.174581 Standard Error 0.094674 Observations 60 ANOVA df 1 58 59

SS 0.120814 0.519865 0.640679

Coefficients 0.008201 0.984942

Standard Error 0.012237 0.268277

Regression Residual Total

Intercept X Variable 1

MS 0.120814 0.008963

F 13.47889

t Stat 0.670225 3.671361

P-value 0.505375 0.000527

MS 0.10798 0.008595

F 12.5635

Significance F 0.000527

Lower 95% -0.01629 0.447927

Upper 95% 0.032696 1.521957

Lower 95.0% -0.01629 0.447927

Upper 95.0% 0.032696 1.521957

72 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.390087 R Square 0.152168 Adjusted R Square 0.140056 Standard Error 0.092708 Observations 72 ANOVA df Regression Residual Total

Intercept X Variable 1

1 70 71

SS 0.10798 0.601633 0.709613

Coefficients 0.006211 0.90092

Standard Error 0.010926 0.254174

t Stat 0.568486 3.544503

P-value 0.571525 0.000706

Significance F 0.000706

Lower 95% -0.01558 0.393986

Upper 95% 0.028003 1.407854

Lower 95.0% -0.01558 0.393986

Upper 95.0% 0.028003 1.407854 212

One Year Regression 1 Year Treasury Bill Beta

Adjusted R2

B ub

B lb

Ke

Ke low

Ke Up

72

0.90092

0.14033

1.40731

0.39452

0.10607

0.06556

0.14659

60

0.98422

0.17469

1.52065

0.44779

0.11274

0.06982

0.15565

48

0.95220

0.16001

1.55974

0.34467

0.11018

0.06157

0.15878

36

0.86480

0.15183

1.51682

0.21277

0.10318

0.05102

0.15535

24

0.86536

0.13529

1.70225

0.02846

0.10323

0.03628

0.17018

24 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.415794 R Square 0.172884 Adjusted R Square 0.135288 Standard Error 0.129318 Observations 24 ANOVA df Regression Residual Total

Intercept X Variable 1

1 22 23

SS MS F 0.0769 0.0769 4.598457 0.367908 0.016723 0.444808

Coefficients 0.016761 0.865356

Standard Error t Stat P-value 0.02702 0.620333 0.541412 0.403542 2.144401 0.043303

Significance F 0.043303

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.03927 0.072797 -0.03927 0.072797 0.028461 1.70225 0.028461 1.70225

213

36 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.4196 R Square 0.176064 Adjusted R Square 0.15183 Standard Error 0.107776 Observations 36 ANOVA df Regression Residual Total

Intercept X Variable 1

1 34 35

Coefficients 0.010123 0.864797

Significance SS MS F F 0.084392 0.084392 7.265337 0.010848 0.394934 0.011616 0.479326 Standard Error t Stat P-value 0.018105 0.559152 0.579723 0.320838 2.695429 0.010848

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.02667 0.046917 -0.02667 0.046917 0.212775 1.516819 0.212775 1.516819

48 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.421763 R Square 0.177884 Adjusted R Square 0.160012 Standard Error 0.103544 Observations 48 ANOVA df Regression Residual Total

SS 1 0.10671 46 0.493178 47 0.599888

Coefficients Intercept X Variable 1

Standard Error

0.012579 0.015007 0.952204 0.301821

MS 0.10671 0.010721

F 9.953159

Significance F 0.002829

t Stat

P-value

Lower 95%

0.838234 3.154863

0.406234 0.002829

-0.01763 0.34467

Upper 95%

Lower 95.0%

0.042786 0.01763 1.559738 0.34467 214

Upper 95.0% 0.042786 1.559738

60 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.434374 R Square 0.18868 Adjusted R Square 0.174692 Standard Error 0.094668 Observations 60 ANOVA df Regression Residual Total

1 58 59 Coefficients

Intercept X Variable 1

0.008417 0.984221

SS MS F 0.120884 0.120884 13.48848 0.519795 0.008962 0.640679 Standard Error

t Stat

P-value

0.012239 0.687711 0.494376 0.267985 3.672666 0.000525

Significance F 0.000525

Lower 95%

Upper 95%

-0.01608 0.032916 0.44779 1.520652

Lower 95.0%

Upper 95.0%

0.01608 0.032916 0.44779 1.520652

72 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.390437 R Square 0.152441 Adjusted R Square 0.140333 Standard Error 0.092693 Observations 72 ANOVA df Regression Residual Total

Intercept X Variable 1

1 70 71

SS 0.108174 0.601439 0.709613

Coefficients 0.006437 0.900918

Standard Error 0.010925 0.253904

MS 0.108174 0.008592

F 12.59014

Significance F 0.000697

t Stat 0.589154 3.548259

P-value 0.557655 0.000697

Lower 95% -0.01535 0.394522

Upper 95% 0.028226 1.407314

Lower 95.0% -0.01535 0.394522 215

Upper 95.0% 0.028226 1.407314

Two Year Regression 2 Year Treasury Bill Beta

Adjusted R2

B ub

B lb

Ke

Ke low

Ke Up

72

0.90227

0.14061

1.40890

0.39564

0.10618

0.06565

0.14671

60

0.98466

0.17474

1.52125

0.44807

0.11277

0.06985

0.15570

48

0.95237

0.16000

1.56003

0.34471

0.11019

0.06158

0.15880

36

0.86480

0.15171

1.51710

0.21251

0.10318

0.05100

0.15537

24

0.86651

0.13538

1.70426

0.02877

0.10332

0.03630

0.17034

24 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.415903 R Square 0.172975 Adjusted R Square 0.135383 Standard Error 0.129311 Observations 24 ANOVA df Regression Residual Total

Intercept X Variable 1

1 22 23

SS MS F 0.076941 0.076941 4.601383 0.367867 0.016721 0.444808

Coefficients 0.016959 0.866513

Standard Error t Stat P-value 0.027038 0.62722 0.536971 0.403953 2.145084 0.043242

Significance F 0.043242

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.03911 0.073031 -0.03911 0.073031 0.028766 1.704261 0.028766 1.704261

216

36 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.419457 R Square 0.175944 Adjusted R Square 0.151707 Standard Error 0.107784 Observations 36 ANOVA df 1 34 35

SS MS F 0.084335 0.084335 7.259349 0.394992 0.011617 0.479326

Coefficients 0.010198 0.864801

Standard Error t Stat P-value 0.01811 0.563115 0.577052 0.320972 2.694318 0.010878

Regression Residual Total

Intercept X Variable 1

Significance F 0.010878

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.02661 0.047002 -0.02661 0.047002 0.212507 1.517095 0.212507 1.517095

48 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.421753 R Square 0.177876 Adjusted R Square 0.160003 Standard Error 0.103544 Observations 48 ANOVA df Regression Residual Total

Intercept X Variable 1

1 46 47

SS MS F 0.106706 0.106706 9.952605 0.493183 0.010721 0.599888

Coefficients 0.012634 0.952373

Standard Error t Stat P-value 0.015008 0.841816 0.404246 0.301883 3.154775 0.00283

Significance F 0.00283

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.01758 0.042845 -0.01758 0.042845 0.344714 1.560033 0.344714 1.560033 217

60 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.434424 R Square 0.188724 Adjusted R Square 0.174736 Standard Error 0.094665 Observations 60 ANOVA df Regression Residual Total

Intercept X Variable 1

1 58 59

Coefficients 0.008512 0.984659

Significance SS MS F F 0.120911 0.120911 13.49231 0.000524 0.519767 0.008962 0.640679 Standard Error t Stat P-value 0.01224 0.695436 0.489559 0.268067 3.673188 0.000524

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.01599 0.033014 -0.01599 0.033014 0.448066 1.521253 0.448066 1.521253

72 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.390783 R Square 0.152711 Adjusted R Square 0.140607 Standard Error 0.092678 Observations 72 ANOVA

Regression Residual Total

Intercept X Variable 1

Significance df SS MS F F 1 0.108366 0.108366 12.61646 0.000689 70 0.601247 0.008589 71 0.709613 Standard Coefficients Error t Stat P-value 0.006578 0.010924 0.602158 0.549014 0.902272 0.25402 3.551965 0.000689

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.01521 0.028365 -0.01521 0.028365 0.395644 1.4089 0.395644 1.4089 218

Seven Year Regression 7 Year Treasury Bill Beta

Adjusted R2

B ub

B lb

Ke

Ke low

Ke Up

72

0.90094

0.14009

1.40782

0.39406

0.10608

0.06553

0.14663

60

0.98101

0.17359

1.51759

0.44443

0.11248

0.06955

0.15541

48

0.94947

0.15919

1.55692

0.34201

0.10996

0.06136

0.15855

36

0.86193

0.15057

1.51454

0.20932

0.10295

0.05075

0.15516

24

0.86677

0.13486

1.70623

0.02731

0.10334

0.03618

0.17050

24 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.415302 R Square 0.172475 Adjusted R Square 0.134861 Standard Error 0.12935 Observations 24 ANOVA df Regression Residual Total

Intercept X Variable 1

1 22 23

SS MS F 0.076718 0.076718 4.585313 0.36809 0.016731 0.444808

Coefficients 0.017906 0.866769

Standard Error t Stat P-value 0.027147 0.659594 0.51636 0.40478 2.141335 0.043577

Significance F 0.043577

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.03839 0.074206 -0.03839 0.074206 0.027307 1.706232 0.027307 1.706232

219

36 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.418143 R Square 0.174844 Adjusted R Square 0.150574 Standard Error 0.107856 Observations 36 ANOVA df Regression Residual Total

Intercept X Variable 1

1 34 35

Coefficients 0.0108 0.861931

Significance SS MS F F 0.083807 0.083807 7.204316 0.011156 0.395519 0.011633 0.479326 Standard Error t Stat P-value 0.018153 0.594958 0.555811 0.321126 2.684086 0.011156

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.02609 0.047691 -0.02609 0.047691 0.209323 1.514538 0.209323 1.514538

48 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.420809 R Square 0.17708 Adjusted R Square 0.15919 Standard Error 0.103594 Observations 48 ANOVA df Regression Residual Total

Intercept X Variable 1

1 46 47

Coefficients 0.013133 0.949466

Significance SS MS F F 0.106228 0.106228 9.898504 0.002899 0.49366 0.010732 0.599888 Standard Error t Stat P-value 0.015031 0.873722 0.386808 0.301783 3.146189 0.002899

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.01712 0.04339 -0.01712 0.04339 0.342008 1.556923 0.342008 1.556923 220

60 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.433127 R Square 0.187599 Adjusted R Square 0.173592 Standard Error 0.094731 Observations 60 ANOVA df Regression Residual Total

Intercept X Variable 1

1 58 59

Coefficients 0.009016 0.981013

SS MS 0.120191 0.120191 0.520488 0.008974 0.640679

Significance F F 13.3933 0.000547

Standard Error t Stat P-value 0.012257 0.735532 0.46498 0.268059 3.659686 0.000547

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.01552 0.033551 -0.01552 0.033551 0.444434 1.517592 0.444434 1.517592

72 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.390131 R Square 0.152202 Adjusted R Square 0.140091 Standard Error 0.092706 Observations 72 ANOVA df Regression Residual Total

Intercept X Variable 1

1 70 71

SS 0.108005 0.601608 0.709613

Coefficients 0.007183 0.900943

Standard Error 0.010932 0.254146

MS 0.108005 0.008594

t Stat 0.657072 3.544978

F 12.56687

Significance F 0.000705

P-value 0.513289 0.000705

Upper Lower 95% 95% -0.01462 0.028986 0.394064 1.407822

Lower 95.0% -0.01462 0.394064

Upper 95.0% 0.028986 1.407822

221

Ten Year Regression 10 Year Treasury Bill Beta

Adjusted R2

B ub

B lb

Ke

Ke low

Ke Up

72

0.89918

0.13974

1.40573

0.39262

0.10593

0.06541

0.14646

60

0.97869

0.17310

1.51486

0.44252

0.11230

0.06940

0.15519

48

0.94734

0.15879

1.55424

0.34043

0.10979

0.06123

0.15834

36

0.85999

0.15012

1.51213

0.20784

0.10280

0.05063

0.15497

24

0.86563

0.13458

1.70478

0.02648

0.10325

0.03612

0.17038

24 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.414976 R Square 0.172205 Adjusted R Square 0.134578 Standard Error 0.129371 Observations 24 ANOVA df Regression Residual Total

Intercept X Variable 1

1 22 23

SS MS F 0.076598 0.076598 4.576641 0.36821 0.016737 0.444808

Coefficients 0.018212 0.86563

Standard Error t Stat P-value 0.027186 0.669907 0.509888 0.404631 2.139309 0.043758

Significance F 0.043758

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.03817 0.074594 -0.03817 0.074594 0.026477 1.704783 0.026477 1.704783

222

36 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.41761 R Square 0.174398 Adjusted R Square 0.150116 Standard Error 0.107885 Observations 36 ANOVA df 1 34 35

SS MS F 0.083594 0.083594 7.182084 0.395733 0.011639 0.479326

Coefficients 0.011014 0.859986

Standard Error t Stat P-value 0.018169 0.606192 0.548413 0.320898 2.679941 0.01127

Regression Residual Total

Intercept X Variable 1

Significance F 0.01127

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.02591 0.047939 -0.02591 0.047939 0.207844 1.512129 0.207844 1.512129

48 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.420348 R Square 0.176692 Adjusted R Square 0.158794 Standard Error 0.103619 Observations 48 ANOVA df Regression Residual Total

Intercept X Variable 1

1 46 47 Coefficients 0.013321 0.947339

SS MS 0.105996 0.105996 0.493893 0.010737 0.599888

Significance F F 9.87218 0.002933

Standard Error t Stat P-value 0.015041 0.885632 0.380422 0.301508 3.142003 0.002933

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.01696 0.043598 -0.01696 0.043598 0.340435 1.554243 0.340435 1.554243

223

60 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.432563 R Square 0.187111 Adjusted R Square 0.173096 Standard Error 0.094759 Observations 60 ANOVA df 1 58 59

SS MS F 0.119878 0.119878 13.35045 0.520801 0.008979 0.640679

Coefficients 0.009206 0.978692

Standard Error t Stat P-value 0.012265 0.750582 0.455939 0.267854 3.653827 0.000557

Regression Residual Total

Intercept X Variable 1

Significance F 0.000557

Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.01534 0.033756 -0.01534 0.033756 0.442524 1.51486 0.442524 1.51486

72 Slice SUMMARY OUTPUT Regression Statistics Multiple R 0.389693 R Square 0.151861 Adjusted R Square 0.139744 Standard Error 0.092725 Observations 72 ANOVA df Regression Residual Total

Intercept X Variable 1

1 70 71

SS 0.107762 0.60185 0.709613

Coefficients 0.007388 0.899177

Standard Error 0.010936 0.253985

MS 0.107762 0.008598

F 12.53361

Significance F 0.000715

t Stat 0.67553 3.540284

P-value 0.501564 0.000715

Lower 95% -0.01442 0.392621

Upper 95% 0.029199 1.405734

Lower 95.0% -0.01442 0.392621

224

Upper 95.0% 0.029199 1.405734

Method of Comparables

CBRL CBRL Restated Denny's DineEquity Darden Bob Evan's Brinker

CBRL CBRL Restated Denny's DineEquity Darden Bob Evan's Brinker

CBRL CBRL Restated Denny's DineEquity Darden Bob Evan's Brinker

CBRL CBRL Restated Denny's DineEquity Darden Bob Evan's Brinker

PPS 32.74 32.74 2.16 20.76 30.41 26.12 12.60

EPS 2.89 2.47 0.21 -4.63 2.75 -0.09 0.77

Trailing P/E P/E Trailing 11.32

Industry Avg. 12.59 12.59

10.33 11.06 16.36

Forecasted P/E EPS 1yr Out P/E Forecasted 3.16 2.63 8.61 10.54 10.44 10.46 9.50

PPS 32.74 32.74 2.16 20.76 30.41 26.12 12.60

PPS 32.74 32.74 2.16 20.76 30.41 26.12 12.60

PPS 32.74 32.74 2.16 20.76 30.41 26.12 12.60

CBRL PPS 36.42287 31.03578

Price To Book BPS P/B 5.97 5.49 5.53 5.92 -1.52 4.34 4.79 12.01 2.53 19.36 1.35 6.34 1.99

Dividends/Price DPS D/P 0.80 0.02 0.80 0.02 1.00 0.03 0.64 0.02 0.44 0.03

Industry Avg. 9.91 9.91

Industry Average 2.66 2.66

Industry Avg. 0.03 0.03

CBRL PPS 31.32 26.06

CBRL PPS 15.90 14.74

CBRL PPS 26.67 26.67

225

CBRL CBRL Restated Denny's DineEquity Darden Bob Evan's Brinker

CBRL CBRL Restated Denny's DineEquity Darden Bob Evan's Brinker

CBRL Denny's DineEquity Darden Bob Evan's Brinker

CBRL CBRL Restated Denny's DineEquity Darden Bob Evan's Brinker

P/E 11.33 10.81 11.61 16.89

Market Cap 743.94 743.94 208.67 364.97 4245.74 810.20 1291.22

Mkt Cap 743.94 208.67 364.97 4245.74 810.20 1291.22

EV 1492.46 2268.52 494.41 2470.05 5971.16 1091.04 1837.23

Price Earnings Growth Growth-5 PEG EPS 9.89 2.89 5.00 2.47 19.00 0.44 10.00 0.93 12.40 0.89 8.67 1.39 8.64 1.11

EBITDA 208.97 172.50 91.27 392.57 922.90 194.10 389.74

Industry Avg. 1.08 1.08

Price/EBITDA P/EBITDA Industry Avg 3.56 3.59 4.31 3.59 2.29 0.93 4.60 4.17 3.31

Price/Free Cash Flow FCF P/FCF 155.08 4.80 30.14 6.92 146.03 2.50 221.10 19.20 55.09 14.71 263.83 4.89

EV/EBITDA EBITDA EV/EBITDA 208.97 172.50 91.27 5.42 392.57 6.29 922.90 6.47 194.10 5.62 389.74 4.71

EBITDA/Shares 9.20 7.59

Industry Avg. 4.77

Industry Avg. 5.70 5.70

CBRL PPS 30.90 13.31

CBRL PPS 33.02 27.25

CBRL PPS 32.57

CBRL PPS 4.13 -23.80

226

Intrinsic Valuation Models Discounted Dividends Discounted Dividends Approach

WACC(AT)

0.11

0.05

Kd

0.1127

Ke

Perp Relevant Valuation Item

0 2009

1 2010

2 2011

3 2012

4 2013

5 2014

6 2015

7 2016

8 2017

9 2018

10 2019

11 2020

DPS (Dividends Per Share)

0.88

0.96

1.04

1.12

1.20

1.28

1.36

1.44

1.52

1.6

2.00

PV Factor PV YBY (Year by Year) Div Payments

0.917 0.807

0.708 0.793

0.650 0.780

0.596 0.763

0.547 0.744

0.502 0.723

0.460 0.700

0.422 0.676

0.033 82.55 36.49 22.91 15.86

0.05

0.067

0.084

0.101

60.24 29.34 18.26

353.22 32.74 22.45

151.63 31.6

67.35

12.76 9.83 8.35

14.09 10.36 8.68

16.14 11.1 9.13

19.7 12.15 9.73

27.44 13.74 10.56

0.842 0.772 0.808 0.803 Perp Growth Total PV of YBY divs 7.60 Sensitivity to change 0 0.017 in K(e) TPV TV Perp (Present Value of Terminal 21.12Value Perpatuity 0.05 34.3 47.11 Model Price 7/31/09 28.72 0.07 23.31 28.05 Time Consisent Price 29.34 0.09 17.35 19.59 0.1127 13.27 14.38 Observed Share Price (11/2/09) Initial Cost of Equity (You Derive) Perpetuity Growth Rate (g)

32.74 0.09 0.05

0.13 0.15 0.17

11.17 9.39 8.07

11.87 16.43 11.8

Undervalued Model Price > 36.01

50.00

Fair Valued Overvalued 36.01 > Model Price > 29.4729.47 > Model Price

Hi Fairly valued 36.014 Low Fairly valued 29.466 227

Discounted Free Cash Flow

Discounted Free Cash Flow

WACC(BT) 0.105 0

1

2009

2

Kd

0.0542

Ke

0.11

3

4

5

6

7

8

9

10

2010

2011 2012

2013

2014

2015

2016

2017

2018

2019 2020

Cash Flow From Operations (Millions) Cash Flow From Investing Activities

179 -62

185 192 -20 -26

202 -27

212 -29

222 233 245 -30 -32 -33

257 -35

270 -36

FCF Firm's Assets PV Factor (WACC(BT)) PV YBY Free Cash Flows

117 0.91 106

165 166 0.82 0.75 135 124

174 0.68 118

183 0.61 112

192 202 212 0.56 0.50 0.46 107 102 97

223 234 246 0.41 0.38 92 88

0.033

0.05 0.067 0.084

Perp Growth

Total PV YBY FCF FCF Perp Market Value of Assets (7/31/09) Book Value Debt & Preferred Stock Market Value of Equity divide by Shares to Get PPS at 12/31 Time consistent Price (11/2/09) Oberved Share Price (11/2/09) WACC(BT) Perp Growth Rate

1080.74 1737.97 2818.71 $1,110 $1,709.16 $75.22 76.24 32.74 0.103 0.05

Sensitivity to change 0 in 0.017 WACC(BT)

0.101

0.04 200.1

334.99

1060.39

4632

0.06 111.6

151.34

234.49

614.36

0.08 67.91

84.79

111.83

172.17 390.3

0.103 39.11

46.89

57.67

76.24 112.4 213.1

0.12 25.16

29.94

36.15

45.87 61.81

92.8

179.26

0.14 13.26

16.14

19.68

24.83 32.37 44.49

67.18

0.16 4.49

6.31

8.47

11.45 15.52 21.41

30.69

2026.64

Undervalued

Fair Valued

Overvalued

Model Price > 36.01

36.01 > Model Price > 29.47

29.47 > Model Price

228

11

Residual Income As Stated 0.105

WACC(AT)

0.0542

Kd

0.113

Ke

All Items in Millions of Dollars

Net Income (Millions) Total Dividends (Millions) Book Value Equity (Millions)

0

1

2

3

4

5

6

7

8

9

10

11

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

72

74

77

81

85

89

93

98

103

108

136

20 187

22 239

24 293

25 348

27 405

29 465

31 528

33 593

35 661

36 733

Annual Normal Income (Benchmark) Annual Residual Income PV Factor YBY PV RI change in Residual Income ROE Percent Change in ROE Book Value Equity (Millions) Total PV of YBY RI Terminal Value Perpetuity MVE 12/31/09 Divide By Shares Model Price on 12/31/09 Time consistent Price (11/2/09) Oberved Share Price (11/2/09) Initial Cost of Equity (You Derive) Perpetuity Growth Rate (g)

15.28 56.44 0.899 50.73

136 271.32 35.81 442.75 22.723 19.48 20.01 32.74 0.1127 -0.1

21.11 26.98 32.98 39.20 52.77 49.85 47.70 45.51 0.808 0.726 0.652 0.586 42.62 36.19 31.12 26.68 -3.68 -2.91 -2.15 -2.19 52.9% 39.4% 32.1% 27.6% 24.4% -25.4% -18.6% -14.1% -11.7% %value 31% 61% Perp Growth 8% Sensitivity to change -0.1 in Cost -0.2 of Equity -0.3 100% 0.05 38.52 34.91 33.36

66.83 74.54 36.14 33.57 22.16 0.382 0.344 13.82 11.54 -2.46 -2.56 17.4% 16.3% 15.53% -6.6% -5.9% -5.57% 0.6553

-0.4

-0.5

-0.6

-0.7

32.5

31.96

31.58

31.3

0.07

30.68

28.66

27.73

27.2

26.85

26.61

26.43

0.09

24.9

23.79

23.25

22.93

22.72

22.57

22.46

0.1127

20.01

19.49

19.23

19.07

18.96

18.88

18.82

0.13

17.15

16.89

16.75

16.67

16.61

16.56

16.53

0.15

14.5

14.43

14.39

14.36

14.34

14.33

14.32

0.17

12.41

12.43

12.45

12.46

12.47

12.47

12.48

Undervalued

Fair Valued

Model Price > 36.01

change in Residual Income

45.68 52.42 59.47 43.27 40.97 38.60 0.527 0.474 0.426 22.80 19.40 16.43 -2.24 -2.30 -2.37 21.9% 20.1% 18.6% -9.9% -8.5% -7.4%

-3.68

-2.91

-2.15

104.18

Overvalued

36.01 > Model Price > 29.47 29.47 > Model Price

-2.19

-2.24

-2.30

-2.37

-2.46

-2.56

229

Residual Income Restated WACC(AT)

0.105

0.0542

Kd

0.1127

Ke

All Items in Millions of Dollars

Net Income (Millions) Total Dividends (Millions) Book Value Equity (Millions)

0

1

2

3

4

5

6

7

8

9

10

11

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

60

62

64

67

71

74

78

82

86

90

20 165

22 205

24 246

25 287

27 331

29 376

31 423

33 472

35 523

36 577

37.28 42.35 36.85 35.48 0.527 0.474 19.42 16.80 -1.35 -1.37 22.4% 20.7% -8.8% -7.6%

47.64 34.08 0.426 14.50 -1.40 19.3% -6.7%

126

Annual Normal Income (Benchmark) Annual Residual Income PV Factor YBY PV RI change in Residual Income ROE Percent Change in ROE

14.17 45.61 0.899 40.99

Book Value Equity (Millions) Total PV of YBY RI Terminal Value Perpetuity MVE 12/31/09 Divide By Shares Model Price on 12/31/09 Time consistent Price (11/2/09)

126 227.45 33.23 386.39 22.723 17.00 17.46

Oberved Share Price (11/2/09) Initial Cost of Equity (You Derive) Perpetuity Growth Rate (g)

32.74 0.1127 -0.1

18.65 23.13 27.68 32.39 42.92 40.90 39.55 38.20 0.808 0.726 0.652 0.586 34.66 29.69 25.80 22.40 -2.69 -2.02 -1.35 -1.35 47.5% 37.2% 31.2% 27.4% 24.6% -21.8% -16.1% -12.3% -10.3% %value 33% 59% Perp Growth 9% Sensitivity to change -0.1 in Cost -0.2of Equity -0.3 100% 0.05 32.91 29.83 28.51

53.16 58.94 32.64 31.16 20.56 0.382 0.344 12.49 10.71 -1.44 -1.49 18.2% 17.2% 16.37% -5.9% -5.3% -5.03% 0.6553

-0.4

-0.5

-0.6

-0.7

27.78

27.31

26.99

26.75

0.07

26.39

24.64

23.83

23.37

23.07

22.86

22.71

0.09

21.56

20.58

20.1

19.82

19.63

19.5

19.4

0.1127

17.46

16.98

16.74

16.59

16.48

16.41

16.36

0.13

15.05

14.8

14.66

14.57

14.52

14.47

14.44

0.15

12.82

12.72

12.67

12.63

12.61

12.59

12.58

0.17

11.04

11.04

11.03

11.03

11.03

11.03

11.03

Undervalued Model Price > 36.01

Fair Valued

96.678

Overvalued

36.01 > Model Price > 29.47 29.47 > Model Price

230

Long Run ROE Residual Income As Stated Booke Value of Equity Return on Equity Percent change in ROE Cost of Equity Market value of Equity Divide by shares

Model Price on 12/31/09 Time consistent Price Observed Share Price

125.71 16.4% -5.03% 11.27% 165.0169 22.72269

As Stated

Sensitivity to change in Cost of Equity

7.26 7.46 $32.74

0.1

0.12

Change In ROE 0.14 0.1553 0.18

0.2

0.22

0.05 0.07 0.09 0.1127

8.25 6.97 6.04 5.25

9.31 7.86 6.82 5.93

10.37 8.76 7.59 6.60

11.18 9.45 8.19 7.12

12.49 10.55 9.14 7.95

13.55 11.45 9.92 8.63

14.61 12.34 10.7 9.3

0.13 0.15 0.17

4.78 4.34 3.97

5.4 4.89 4.48

6.01 5.45 4.99

6.48 5.88 5.38

7.24 6.56 6.01

7.85 7.12 6.52

8.47 7.68 7.03

Undervalued Model Price > 36.01

Fair Valued Overvalued 36.01 > Model Price > 29.47 29.47 > Model Price

As Stated

Sensitivity to change in Cost of Equity

0.05 0.07 0.09 0.1127 0.13

0.01 21.95 14.7 11.08 8.67 7.45

-0.01 16.65 12.54 10.08 8.26 7.27

0.15 0.17

6.41 5.64

6.39 5.7

Undervalued Model Price > 36.01

Change In Growth

0.01 -0.01 -0.03 -0.0557 -0.07 -0.09 -0.11

Undervalued Model Price > 36.01

6.36 5.75

6.34 5.8

6.33 5.83

-0.09 10.59 9.31 8.31 7.42 6.86

-0.11 10.02 8.95 8.09 7.3 6.8

6.32 5.86

6.31 5.88

Fair Valued Overvalued 36.01 > Model Price > 29.47 29.47 > Model Price

As Stated 0.09 4.78 5 5.15 5.3 5.37 5.44 5.51

Change In Growth -0.03 -0.0557 -0.07 13.99 12.06 11.34 11.25 10.19 9.77 9.42 8.83 8.59 7.96 7.68 7.56 7.13 6.99 6.93

0.11 5.97 6 6.01 6.03 6.04 6.05 6.06

Change In ROE 0.13 0.1553 0.17 7.16 8.67 9.55 6.99 8.26 8.99 6.87 7.96 8.59 6.76 7.68 8.22 6.71 7.56 8.05 6.65 7.42 7.86 6.61 7.3 7.71

0.19 10.74 9.99 9.45 8.94 8.72 8.47 8.26

0.21 11.94 10.99 10.31 9.67 9.39 9.07 8.81

Fair Valued Overvalued 36.01 > Model Price > 29.47 29.47 > Model Price

231

Long Run ROE Residual Income Restated Booke Value of Equity Return on Equity Percent change in ROE Cost of Equity Market value of Equity Divide by shares

Model Price on 12/31/09 Time consistent Price Observed Share Price

125.71 16.4% -5.03% 11.27% 165.0169 22.72269

Restated

Sensitivity to change in Cost of Equity

7.26 7.46 $32.74

0.1

0.12

Change In ROE 0.14 16.4 0.18

0.2

0.22

0.05 0.07 0.09 0.1127

8.39 7.03 6.06 5.25

9.51 7.97 6.86 5.94

10.63 8.9 7.67 6.63

11.97 10.02 8.63 7.47

12.86 10.77 9.28 8.03

13.98 11.71 10.09 8.73

15.09 12.64 10.89 9.42

0.13 0.15 0.17

4.75 4.3 3.93

5.39 4.87 4.45

6.02 5.44 4.97

6.78 6.13 5.6

7.29 6.59 6.02

7.92 7.16 6.54

8.55 7.73 7.06

Undervalued Model Price > 36.01

Fair Valued Overvalued 36.01 > Model Price > 29.47 29.47 > Model Price

Restated

Sensitivity to change in Cost of Equity

0.05 0.07 0.09 0.1127 0.13

0.01 21.56 14.44 10.88 8.52 7.32

-0.01 16.24 12.24 9.84 8.06 7.03

0.15 0.17

6.3 5.54

6.23 5.56

Undervalued Model Price > 36.01

Change In Growth

0.01 -0.01 -0.03 -0.0503 -0.07 -0.09 -0.11

Undervalued Model Price > 36.01

6.17 5.58

6.13 5.6

6.09 5.61

-0.09 10.16 8.93 7.98 7.12 6.59

-0.11 9.59 8.57 7.74 6.99 6.51

6.06 5.62

6.04 5.63

Fair Valued Overvalued 36.01 > Model Price > 29.47 29.47 > Model Price

Restated 0.1 4.98 5.09 5.18 5.24 5.29 5.33 5.36

Change In Growth -0.03 -0.0503 -0.07 13.58 11.97 10.92 10.92 10.02 9.4 9.14 8.63 8.27 7.72 7.47 7.28 6.92 6.78 6.67

0.12 6.09 6.02 5.97 5.94 5.91 5.89 5.87

Change In ROE 0.14 16.4 0.18 7.19 8.52 9.41 6.95 8.06 8.8 6.77 7.72 8.36 6.63 7.47 8.03 6.53 7.28 7.78 6.45 7.12 7.57 6.38 6.99 7.4

0.2 10.51 9.72 9.16 8.73 8.4 8.13 7.91

0.22 11.62 10.65 9.95 9.42 9.02 8.69 8.42

Fair Valued Overvalued 36.01 > Model Price > 29.47 29.47 > Model Price

232

Abnormal Earnings Growth As Stated

WACC(AT)

2009

Net Income (Millions) Total Dividends (Millions)

0.0542

Kd

1 2011

2 2012

3 2013

4 2014

5 2015

6 2016

7 2017

8 2018

9 2019

72

74

77

81

85

89

93

98

103

108

20

22

24

25

27

29

31

33

35

36

$2.25 $76.13 $79.81

$2.46 $79.29 $82.21

$2.66 $83.34 $85.50

$2.87 $87.58 $89.77

$3.07 $92.02 $94.26

Cum-Dividend Earnings Normal Earnings

($3.68) ($2.91) ($2.15) ($2.19) 0.80768836 0.72588151 0.6523605 0.586286 ($2.97) ($2.11) ($1.41) ($1.28) -3.68 -2.91 -2.15 -2.19 -26.3621842 71.73 Perp Growth ($12.88) Sensitivity to change -0.1 in Cost of Equity -0.2 -0.3 0.05 78.41 75.14 73.73 ($5.39) 0.07 46.24 45.91 45.76 0.09 30.81 31.31 31.55 $53.47 0.1127 21.44 22.13 22.49

Core Net Income Total PV of AEG Continuing (Terminal) Value PV of Terminal Value Total PV of AEG Total Average Net Income Perp (t+1)

22.72269

Dividends Divide by shares to Get Average EPS Perp

2.35

Capitalization Rate (perpetuity)

0.1127

Ke

0 2010

Dividends Reinvested at 11.27% (Drip)

Abnormal Earning Growth (AEG) PV Factor PV of AEG Residual Income Check Figure

0.105

0.13 0.15 0.17

17.14 13.81 11.54

17.8 14.38 12.01

18.15 14.7 12.28

10 2020

$3.28 $3.48 $3.69 $3.89 $96.67 $101.55 $106.65 $112.01 $98.97 $103.92 $109.12 $114.57

($2.24) ($2.30) ($2.37) ($2.46) ($2.56) 0.526904 0.4735364 0.4255742 0.3824699 0.3437313 ($1.18) ($1.09) ($1.01) ($0.94) ($0.88) -2.24 -2.30 -2.37 -2.46 -2.56

-0.4 72.95 45.68 31.7 22.71

-0.5 72.46 45.62 31.8 22.85

-0.6 72.12 45.58 31.86 22.96

-0.7 71.86 45.55 31.91 23.04

18.37 14.9 12.46

18.52 15.04 12.58

18.63 15.14 12.68

18.71 15.22 12.75

($3.33)

($15.67)

$0.11

Intrinsic Value Per Share (12/31/2009) time consistent implied price 11/2/2009

$20.88 21.44

Nov 2, 2009 Observed Price Ke g

32.74

Undervalued Model Price > 36.01

Fair Valued 36.01 > Model Price > 29.47

Overvalued 29.47 > Model Price

0.1127 -0.1

233

11

Abnormal Earnings Growth Restated WACC(AT)

2009

Net Income (Millions) Total Dividends (Millions)

0.105

0.0542

Kd

0 2010

1 2011

2 2012

3 2013

4 2014

5 2015

6 2016

7 2017

8 2018

9 2019

60

62

64

67

71

74

78

82

86

90

20

22

24

25

27

29

31

33

35

36

$2.25 $63.82 $66.51

$2.46 $66.49 $68.51

$2.66 $69.89 $71.25

$2.87 $73.46 $74.81

$3.07 $77.20 $78.55

$3.28 $81.11 $82.48

$3.48 $85.20 $86.60

$3.69 $89.49 $90.93

$3.89 $93.99 $95.48

Dividends Reinvested at 11.27% (Drip) Cum-Dividend Earnings Normal Earnings Abnormal Earning Growth (AEG) PV Factor PV of AEG Residual Income Check Figure

($2.69) ($2.02) 0.80768836 0.72588151 ($2.17) ($1.46)

($1.35) ($1.35) ($1.35) ($1.37) ($1.40) 0.65236 0.586286 0.526904 0.473536 0.425574 ($0.88) ($0.79) ($0.71) ($0.65) ($0.59)

-19.2767358 59.77 Perp Growth ($8.33) Sensitivity to change -0.1 in Cost of -0.2 Equity -0.3 0.05 68.05 64.77 63.37 ($3.13) 0.07 40.74 40.09 39.8 0.09 27.5 27.66 27.74 $48.32 0.1127 19.38 19.78 19.99

Core Net Income Total PV of AEG Continuing (Terminal) Value PV of Terminal Value Total PV of AEG Total Average Net Income Perp (t+1)

22.72269

Dividends Divide by shares to Get Average EPS Perp

2.13

Capitalization Rate (perpetuity)

0.1127

Ke

0.13 0.15 0.17

15.6 12.65 10.62

16.02 13.03 10.94

16.25 13.24 11.13

($1.44) ($1.49) 0.38247 0.343731 ($0.55) ($0.51)

-0.4 62.59 39.63 27.79 20.11

-0.5 62.1 39.52 27.82 20.2

-0.6 61.75 39.44 27.84 20.26

-0.7 61.5 39.38 27.86 20.31

16.38 13.38 11.25

16.48 13.47 11.33

16.55 13.54 11.39

16.6 13.59 11.44

10 2020

11

($1.93)

($9.09)

$0.11

Intrinsic Value Per Share (12/31/2009) time consistent implied price 11/2/2009

$18.87 19.38

Nov 2, 2009 Observed Price Ke g

32.74

Undervalued Model Price > 36.01

Fair Valued Overvalued 36.01 > Model Price > 29.47 29.47 > Model Price

0.1127 -0.1

234

Works Cited 1. Cracker Barrel Fact Book 2008. May 27, 2009. 2. Answer.com. Cracker Barrel Old Country Store. http://www.answers.com/topic/cbrl-group-inc 3. Richard Gibson. “A New Recipe.” Wall Street Journal. July 13, 2009. 4. Julie Jargon. “Restaurants Look Beyond Chicken Fingers.” Wall Street Journal. September 1, 2009. 5. Lorri Mealey. “Restauranting FAQs.” About.com. http://restaurants.about.com/od/openingarestaurant/a/Restaurant_FAQs.htm 6. Brett Arends. “Will The Recovery Boost Restaurant Stocks?” Wall Street Journal. August 13, 2009. 7. Yahoo Finance. Cracker Barrel Old Country Store. (CBRL) http://finance.yahoo.com/q/co?s=CBRL 8. AHN Staff. “U.S. Restaurants Adjust Menu Price, Size to Reflect Higher Cost of Food Ingredients.” October 29, 2008. All Headline News. http://www.allheadlinenews.com/articles/7012830379#ixzz0RHTmJRL8 9. Jim Woods. “Consumers Show Little Appetite for Restaurants.” Seeking Alpha. January 14, 2009. http://seekingalpha.com/article/114572-consumers-show-little-appetite-forrestaurants 10. Katy McLaughlin. “Macaroni Grill‟s Order: Cut Calories, Keep Customers.” Wall Street Journal. September 16, 2009. 11. Cracker Barrel Annual Report. 2008. 12. Cracker Barrel 10 – K. 2008. 13. Diana Ransom. “Can They Really Make Money Off the Dollar Menu?” Wall Street Journal. May 21, 2009. 14. Julie Jargon. “Denny‟s Tries Night-Owl Vibe.” Wall Street Journal. June 30, 2009. 15. Connor Dougherty. “Restaurant Traffic Declines Worldwide.” Wall Street Journal. August 25, 2009. 16. The Darden Menu. Fast Company. July 1, 2009. 17. Cracker Barrel FAQ. http://investor.crackerbarrel.com/faq.cfm?expand=true 18. Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008. 19. Cracker Barrel 10 – K. 2004-2009. 20. Jones, Charles. Investments: Analysis and Management. 9th Ed. 2003 21. Ibbotson and Associates, Stocks, Bonds, Bills, and Inflation (2006).

235

22. Economic Research Federal Reserve Bank of St. Louis http://research.stlouisfed.org/fred2/series/GS10?cid=115 23. Machon, Michael. “Banking on Financial Ratios” http://www.bdo.ca/library/publications/agriculture/articles/Accounting_Financial_ Ratios.cfm 24. DineEquity 10-K, 2008 25. Ward, Peter. Cash-to-Cash is What Counts. Via http://www.vitalentusa.com/learn/cash_to_cash.php 26. Money Terms. http://moneyterms.co.uk/ev_ebitda/. December 7, 2009 27. Investopedia. http://www.investopedia.com/terms/p/pegratio.asp . December 7, 2009. 28. Accounting Glossary. http://www.accountingglossary.net/definition/375-Price/Book_Ratio_P/B. December 7, 2009

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Equity Analysis & Valuation - Mark E. Moore

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