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Among 3 New Fast-Casual Pizza Chains, Transparency Pays

Do franchise buyers want to know how much a franchise can make? And even if buyers want it, does it pay for franchisors to disclose it?

For Wall Street, there is market evidence to show that investors are willing to pay and are more confident with firms that are upfront, according to Robert Eccles, author of the 2001 book, The Value Reporting Revolution. But that is for stock investors, who seem to always value more and better financial information. What about franchise buyers who put their life savings into their franchise? Do they also value financial transparency disclosed by the franchisor, particularly with franchise-level profits?

Franchise researcher Robert Bond says the answer is yes. He wrote about the number one question that all franchise buyers must first grapple with, namely, what is a reasonable return on their capital that a buyer can expect in investing into a franchise. "The single most important factor in buying any business is calculating a realistic and verifiable projection of sales, expenses and profits," writes Bond, author of How Much Can I Make?

Entrepreneur professor Scott Shane of Case Western Reserve University in Cleveland, Ohio also thinks so. Citing the results of a 1993 British survey of franchise buyers, Shane says making money is the name of the game. "People buy franchises to get access to a proven system and to make money," writes Shane in his book From Ice Cream to the Internet, Using Franchising to Drive the Growth and Profits of Your Company.

When it comes to franchise-level profits and operating results, franchise sellers often like to send buyers on chases to gather the information individually from existing franchisees. But the best source of information on franchise earnings is to obtain the information from the franchisor. "The only source in a position to supply accurate information about a franchise opportunity is the franchisor itself," researcher Bond writes, explaining that franchisors have to keep track of revenue of all franchises to calculate royalties and of earnings to understand franchise success.

Buyers may want franchise-level revenues and profits from franchisors, but is there evidence that the market responds well to franchisors that provide such financial transparency? Providing an answer is not simple. There are many lurking variables, that is to say hidden or unconsidered factors that inadvertently affect the outcome. But consider three current examples – Blaze Pizza, Pieology and Pie Five.

Three very similar fast-casual pizza chains, but different levels of earnings disclosure

Pie Five, Pieology and Blaze Pizza were all founded in 2011. And all have been in a race to sell franchises of their 3-minute fast-baking pizza concept since 2013. When compared, these three seem to show that transparency pays when it comes to closing the deal with more franchise buyers.

Fast casual pizza franchisors ranked by franchise-level earnings transparencyWhere there is the most franchise earnings transparency in franchise disclosure documents, that brand has the most buyers.

Blaze Pizza has the strongest transparency, followed by Pieology, and then Pie Five in financial performance disclosures to its franchise buyers. Simultaneously, Blaze, Pieology and Pie Five follow the same exact ranking when it comes to the most buyers opening the most franchises.

In these concepts, franchise buyers are more plentiful where franchise earnings are best disclosed by the franchisor.

Is this a coincidence? Or does a franchisor providing franchise-level earnings give buyers more confidence when they research a franchise to buy?

Complicating the issue is that Pie Five's parent firm, Rave Restaurant Group, is a publicly traded company (NASDAQ: RAVE). Publicly traded firms are required to provide substantial information on a quarterly and annual reporting basis to shareholders. Those SEC reports are considerably more detailed, numerous and audited than the annual report the Federal Trade Commission requires of franchisors. Those non-audited reports are required but they aren't filed with the federal government. A few states will keep a file of them.

Despite the volumes of information that Rave must provide to Wall Street, Pie Five is the worst at providing franchise-level earnings or even revenue to prospective franchise buyers in its Franchise Disclosure Document, although its competitors do.

Pie Five backs away from disclosing earnings

Pie Five's disclosure document wimps out, simply stating: "We do not make any representations about a franchisee's future financial performance or the past financial performance of company-operated or franchised outlets."

This is a strange statement considering that the information is already essentially revealed in Rave's annual 10-K SEC filing to its shareholders. Easily deduced from Rave's SEC filing, the average gross sales for all Pie Five franchises in the United States during its fiscal year 2015 was $590,895. An average Pizza Inn domestic franchise had average gross sales of $545,366.

Again, none of that store-level gross sales information that is filed with its Security & Exchange Commission reports for shareholders is in the FTC's Franchise Disclosure Document for buyers, who want it the most.

Pie Five's revenues went up as it rose by 88 percent in average units opened in the quarter. For the year, system-wide retail sales increased 110 percent for Pie Five over the previous fiscal year. The franchisor's boom in system-wide revenue was driven by a 138 percent increase of its restaurant units in 2016 compared to 2015.

While it might be launching new franchises, unfortunately existing Pie Five stores are seeing plummeting sales. Pie Five restaurants experienced a 5.1 percent decline in same-store sales for its fiscal year ended June 26, 2016. The drop was worse in the company's fourth quarter, when same-restaurant sales were down 12 percent.

"In the current first fiscal quarter, the Pie Five system has continued to experience difficult sales trends," said CEO Coleman in a press release. "Many of the newer restaurants that enter the comparable store base continue to experience a decline in sales from their initial year, particularly in the case of those stores that opened with very high sales volumes." Regarding his other brand, Coleman continued, "The Pizza Inn system's sales trends have been flat in the current quarter." But he added that he was pleased with its renewed potential in growth.

Of the three chains, this is the only one with published negative same-restaurant sales figures.

Here is the conundrum. Transparency pays in selling franchises if the franchisor's numbers are better than their competitors. For Pie Five, transparency in revealing its dismal same-restaurant sales is working against the chain. But because it is a publicly traded company, the stock market expects this store-level disclosure. For privately held firms, there is no such impetus to disclose bad news. Providing those numbers is voluntary under consumer regulation of franchise buyers. If a franchisor withholds important numbers, chances are it is because those numbers are not flattering.

Logically a potential buyer will refrain from investing in a chain where the franchisor is transparent with unflattering numbers.

This journal is hearing franchise developers complain that nowadays buyers are asking for franchise earnings and same-restaurant sales – or else. As a consequence the majority of franchisors nowadays are disclosing franchise-level earnings.

Pieology in the middle

Pieology may not be a publicly held company, but it does disclose average store sales in Item 19 of its Franchise Disclosure Document. Pieology's franchises that had been in business for at least two years had average gross sales of $1,352,932 in 2015.

jar of coinsBefore it opened its first franchise, Pieology was already more transparent than Pie Five. In its first year of selling franchises, California-based Pieology disclosed to franchise buyers gross sales, cost of goods sold and even EBITDA (a non-GAAP profit measure) for its company-owned Fullerton store.

Such financial breakouts are very rare for franchisors.

Pieology provides an audited financial statement to buyers to clarify how healthy the franchisor is. Buyers want to know what the likelihood is of a franchisor going belly-up. According to its audited income statement, Pieology had $3 million in net income in 2015.

That is good news.

However, when it comes to store-level sales, Pieology has not posted same-restaurant sales growth like competitor Pie Five or Blaze has. A buyer will not know if store sales in this chain are shrinking or growing.

When asked for same-restaurant sales figures, a spokesperson for the company stated to this journal: "As a private company, we do not release any sales information to the public."

Nor do they release same-restaurant sales to franchise buyers.

Uh-oh.

Why is that troublesome news? Because franchisors voluntarily provide franchise-level earnings information. As a general rule, if franchises are growing in sales, franchisors flaunt that information to attract buyers. If earnings are poor, sellers naturally do not want to disclose such information. Rather than do so, they instead send buyers to collect their own information from the few franchisees who are willing to provide strangers with financial glimpses of their own franchised business.

But buyers want to know, and they want to know it from the franchisor.

Blaze Fast-Fire'd gives the most info and grows fastest

And then there is Blaze Fast-Fire'd Pizza.

Rumor last year was that it wanted an initial public offering. Now it does not. It remains privately held.

Blaze had two company stores in 2012. Just like its competitors Pieology and Pie Five, Blaze franchisees began to open their first stores in 2013. Of the three, Blaze provides the most details for average franchised restaurant revenue compared to its competitors. Blaze declared average gross sales of $1,335,162 for its 47 franchised stores in 2015 that had been open at least a year. For those franchises open for at least two years, nine in all, average gross sales were $1,533,768.

In a press release early this year, Blaze self-reported that its same-restaurant sales were up for 2015 by 7 percent. It may not have the strict disclosure requirement of a publicly traded firm, but Blaze does report franchise performance measurements that it wants to highlight to potential franchise buyers.

More franchisor transparency, more buyer confidence, and more franchises sold

What is the end result of providing store-level performance information to potential buyers?

Buyers look like they are figuring out which franchises have higher revenues. It also appears that buyers are paying more attention to gross sales disclosed in documents for buyers rather than in reports to shareholders.

In three very similar concepts that were founded at the same time and began franchising in the same year, competitor Blaze, which provides the most franchise-level financial detail in its Franchise Disclosure Document, a report that is mandated to be given to store investors before they buy, has the most franchises. The Blaze system had 5 company-owned restaurants and 100 franchised at the end of 2015. Pieology, second in transparency in revealing franchise-level earnings, was second in the number of franchised units opened. At the end of the line is Pie Five, which provides no earnings disclosure for its franchises.

That is surprising since of the three, Pie Five is publicly traded. Compared to its privately traded competitors, Pie Five must provide reams of information to the Securities and Exchange Commission on its performance for stockholders. Publicly traded companies are required to provide an audited annual report of their financial statements, senior management statements on what worked well for it and what did not, quarterly earnings reports, and board seats that are up for election. In between those reports, the SEC requires another filing for any material change in the business.

That is a lot of required reporting.

However, when it comes to the performance of franchises, very little is disclosed – usually same-restaurant sales. It is not just publicly-traded firms that release comparable sales figures. Private firms will sometimes release same-store sales figures in what they hope will help them sell their franchises. That number is often aggregated with company-owned stores, or sometimes it is only company-owned same-restaurant sales.

Despite Pie Five not releasing any store-level EBITDA profit figures or even at least top-line store revenue information in its disclosure documents, franchise buyers are still snatching up franchise stores. But it is not as sizzling as its competitors Blaze or Pieology.

franchise units opened by Blaze, Pieology and Pie FiveWhen one looks at the increase in franchise owners for these new fast-casual franchisors who coincidentally began franchising in the same year, buyers seem to prefer restaurants from franchisors who disclose franchise-level financial performance. Franchise owners have been opening more Blaze Pizza and Pieology restaurants than Pie Five stores (see chart).

And yet despite such lack of essential information, buyers of Pie Five are still lining up to open new stores, although not as much as Blaze or Pieology. Pie Five wants them to jump on the bus at an even faster rate. On Wednesday, Rave Restaurant Group announced it had hired Brett Heinen as its new director of franchise development. He worked as the director of franchise sales at troubled Dickey's Barbecue Pit. He says that he helped sell more than 250 Dickey's throughout the country.

Of course, what is missing the most is the essential information—franchise-level earnings, not revenue per franchise but actual profits per average franchise. In business, earnings refer to bottom-line profits, not top-line revenue. If a franchisee invests in a new store in a new concept, one of the first things she'll want to know is store profits, right?

Domino's leads in franchise transparency

Competitor Domino's Pizza (NYSE: DPZ) stands out as a franchisor that is brave enough to declare bottom-line restaurant profit. It is $120,000 per store in 2015. Those profits per store have almost doubled over the past five years. And with that, the net asset value and the resale value of the franchised stores have grown nicely.

Blaze, Pieology and Pie Five dare not follow. None of these tiny fast-casual competitors of giant Domino's disclose franchise-level profits.

What are the results?

Domino's, an old established legacy chain of 5,200 U.S. pizzerias, incrementally grew itself by a net 133 franchises in the United States in 2015. With 13,000 quick service restaurants across the globe, Domino's also grew over 1,000 restaurants worldwide in 2015.

The word is now out within its network and even published that Domino's stores are profitable. In Domino's system of incremental growth, new buyers nowadays do not have much opportunity to buy new stores. Becoming a franchisee is a reward for employees. That is to say, old stores that belong to franchisees are being sold off almost exclusively to successful employees of either franchisees or the franchisor. It is almost exclusively existing Domino's franchisees that are developing new stores and expanding the franchise system.

Domino's is seeing stellar same-restaurant sales growth compared to competitors at 12 percent growth in same-restaurant sales in 2015. It just announced for its quarter that ended in September that it had 13 percent same-restaurant sales growth.

"We are clearly taking share within the [pizza] category," declares Domino's CEO Patrick Doyle in an earnings conference with stock analysts about both new fast-casual pizza and older quick service restaurant competitors.

Easier to sell more franchises when franchise earnings are disclosed

What should franchisor Pie Five, the bottom of these three "hot" concepts do to better attract franchise buyers? First, Pie Five could begin to match its competitors by at least taking what is essentially in its annual shareholder's report and publish average gross sales for its franchises in its Franchise Disclosure Document. That is the document that it is typically required of a franchisor to give to franchise buyers to help with their due diligence in researching the concept.

Pie Five should also point out that competitor Pieology does not disclose same-restaurant sales, while it bravely does.

That is an easy fix.

Here is the tough fix: Pie Five needs to bring its same-restaurant sales into positive growth. There is no getting around that. Being able to disclose growing same-restaurant sales and profitable franchises will make it easier for its new franchise development leader to sell franchises at the level of its competition.

Once it figures out how to run profitable pizza stores that are gaining in sales, Pie Five will want to break out franchises by one and two year comparable sales to at least match its competitors' disclosures. It will eventually want to rise above its competitors by following Domino's example and disclose average franchised restaurant profits.

After all, if a chain has profitable franchise stores, it wants to flaunt that fact. Such financial disclosure is sweet music to a franchise buyer's ear.

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About Don Sniegowski

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Don Sniegowski is editor of Blue MauMau, the daily news journal for franchise & small business owners. Call him at +1 (270) 321-1268, tweet @bluemaumau or email don@bluemaumau.org.