Struggling Noble Roman's takes over franchisee's 6 units

March 24, 2008

Noble Roman's Inc. has taken over the operation of six franchised restaurants in Indianapolis in a bid to prove its concept can be executed profitably.

The move--which comes amid a chorus of discontent from franchisees and as the company explores the possibility of selling itself--could help the 1,000-restaurant chain avoid the embarrassment of store failures in its own back yard.

In the last few years, Noble Roman's management has blamed franchisees for most of the company's problems, including several stand-alone stores that closed shortly after opening. The company last year stepped up its enforcement of franchise standards, lengthened training requirements and strengthened the franchisee-selection process. Father-son duo Paul and Scott Mobley, who run the company, say those efforts are paying off.

But now, the Mobleys are taking a more drastic step, one that will test their own operational mettle: They have assumed control of six dual-brand Noble Roman's and Tuscano's Italian Style Subs restaurants in Carmel, Fishers, Westfield and Noblesville after the locations struggled with what the company calls "management and supervision difficulties." The locations had been operated by a single franchisee, local businessman Steve Patton. He did not return IBJ phone messages.

The move is a departure for a 36-year-old company that now focuses almost entirely on franchising; Noble Roman's owns only two locations, primarily for training purposes.

The company hopes to whip the restaurants into shape and resell them, using part of the proceeds to buy out the former franchisee, said Paul Mobley, the company's chairman.

Mobley said the chain's intervention on Feb. 2 has resulted in a weekly sales improvement of 33.3 percent for the six locations, although he would not provide actual sales figures.

On the block

The company's franchising problems have rattled investors, spurring a recent plunge in the company's stock price. Shares now fetch $1.28, off 84 percent since July.

The chain this month said it has hired Newport Beach, Calif.-based Roth Capital Partners, a specialist in small-cap companies, to evaluate "various strategies to enhance shareholder value."

The move raises the possibility that the company could be sold, although observers say tight credit markets and a sputtering economy likely will make a sale difficult, if not impossible.

So far, the problems at Noble Roman's haven't eroded earnings, and company officials say they remain upbeat. Noble Roman's in 2007 reported profit of $2.5 million, up from $1.9 million a year earlier. Royalty and fee income totaled $10.4 million, up from $8.1 million.

Noble Roman's has reinvented itself several times over the years since launching in the 1970s as a chain of dine-in restaurants. In 1997, after intense competition and rising costs made stand-alone pizza joints difficult to operate profitably, Noble Roman's turned to franchising nontraditional outlets like bowling alleys and gas stations--a strategy that has paid off handsomely.

The chain has sold hundreds of franchise owners on features such as a fastlunch system and a proprietary partially baked crust that ensures Noble Roman's pizza always tastes the same and can be cooked quickly.

"I think we're positioned very well," Paul Mobley said. "Ninety percent of our business is on the nontraditional side, and our sales have been quite strong in that environment."

Pie in the face

The company's latest incarnation--franchising dual-brand stand-alone restaurants featuring Noble Roman's and Tuscano's Italian Style Subs--has struggled since its launch in 2005. Several franchisees across the country were forced to close and declare bankruptcy after sales were meager. At least four area developers quit the concept, jettisoning plans to open more than 230 restaurants.

The chain still has commitments from 20 area developers to open 631 units, but some also are looking for a way out. Mike Ellis is trying to sell a 25-store development territory in Missouri for below his cost. So is Bob Hopkins, who paid $100,000 for the right to sell 70 franchise locations in the Atlanta area.

"They give you absolutely no help," said Hopkins, a former stockbroker. "They sucker you in with what I think are almost false claims about what you can do and the type of business you get out of your store. They send a so-called real estate expert down to try and find your locations. And I end up with a store on a one-way street tucked in a corner with competition all around."

Even when Hopkins sent out coupons, he couldn't get enough business to repay Advo, the coupon distributor. His store closed after five months, having never once covered expenses with sales. Hopkins filed for bankruptcy.

"I don't think they understand their own business," Hopkins said of the Mobleys. "I'm sorry I got involved. The whole model stinks."

The Mobleys say the system works if franchisees follow it. Paul Mobley said Hopkins refused to follow the system.

"It's not an instant money machine," Mobley said. "It's about people. You gotta work at it."

Bad taste

Several franchisees said Noble Roman's misled them about how much they would make and failed to provide the promised support. When sales numbers came in low, they say, the chain was more likely to antagonize than to help.

Mike Brunswick closed his store in New Tampa, an affluent suburb of Tampa, after just four months in business. He talked about the experience in message boards--how the company just "tells you whatever you want to hear."

Noble Roman's sued Brunswick for defamation and breach of contract late last year. The company says Brunswick bad-mouthed the Noble Roman's/Tuscano's concept to customers who were considering buying a franchise.

The lawsuit has landed in the inboxes of some other angry franchisees.

"You have a duty not to tortiously interfere with our contracts, and you should be very careful about making any disparaging remarks regarding Noble Roman's," wrote Mitchell Grunat, the company's vice president of franchise sales, in an e-mail to a franchisee. "As you can see from the file-stamped copy attached, we take those matters very seriously and will not hesitate to act on violations."

Most of the controversy involves the company's stand-alone locations, but there are some signs of problems at nontraditional outlets.

The CEO of Vermont-based Bowl New England, J. Richard Corley, expressed his frustration with the concept in an April 2006 memo to the company.

"We have been very disappointed in the meager sales volume," he wrote. "This coupled with a number of other problems such as delivery times; invoice pricing and quality problems forced us not to renew these agreements."

Noble Roman's sent an employee to one of the company's bowling alleys and found they were selling another type of pizza, and allegedly still using the Noble Roman's name. Noble Roman's filed a lawsuit alleging the bowling alleys were in violation of their trademark rights, along with a two-year noncompete agreement. The lawsuit was settled last year.

A tough business

Times are tough for just about every restaurant company, and pizza has been hit especially hard, said George Farra, a principal with Indianapolis investment firm Woodley Farra Manion Portfolio Management.

Prices for wheat and cheese are rising, and competition is fierce. Noble Roman's also is facing debt in excess of $5.5 million, and in February borrowed another $3 million from Wells Fargo. A rough year could make debt service more difficult, Farra said.

Another challenge for the company, he said, is managing such a far-flung franchise network, which extends across 45 states.

When the best operators are struggling, less-effective companies such as Noble Roman's can really feel the burn, said Mark Foster, chief investment officer at Columbus-based Kirr Marbach & Co.

"The track record here just isn't very good," Foster said. "They started this franchise operation and were signing a lot of people up, and come to find out they're not executing as well as they should."

The chain built a strong brand locally, but competition has grown and Noble Roman's isn't a known quantity in many of the markets where it's trying to compete.

Whether the company can successfully operate the restaurants it took over will say a lot, Foster said. After all, it's hard to sell franchises if the core operation is broken.

"You've got tons of competition," Foster said. "If you don't have a nice place to go to with something new and unique on the menu, it gets a little stale after a while."

Insiders bail out

The turmoil at Noble Roman's has sunk the company's share price.

Shares had jumped to $7 after the company announced a flurry of new franchise development agreements last year. But they sunk to $1.28 in recent trading, near the company's 52-week low.

Starting in late 2006, insiders began dumping shares.

New York-based Geovest Capital Partners LP, a company controlled by board member Douglas H. Coape-Arnold, sold more than 950,000 shares in dozens of transactions between November 2006 and June 2007, at prices ranging from roughly $3 to $7 per share.

Coape-Arnold, reached at his office in New York, refused to talk about Noble Roman's.

But Paul Mobley said Geovest Capital's managing partner had no input on the firm's decision to sell Noble Roman's stock, which is thinly traded on NASDAQ's OTC Bulletin Board.

Mobley, for his part, sold about 169,000 shares for $1.2 million in June 2007.

Even after the sales, insiders own about 40 percent of the shares in Noble Roman's. Mobley alone owns about 20 percent.

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