A Fair Deal for All

March 25, 2002

Good things, it appears, come to those who wait and debate.

Following 18 months of mediated negotiations, Detroit-based Little Caesars Enterprises (LCE) has settled a class-action lawsuit filed by its franchisees. In the process, the parties created what they call the best franchise agreement in the pizza business.

The agreement, reached on Sept. 1, in Bexar County Court (San Antonio), and approved by Judge Janet Littlejohn, includes:

· forgiveness of more than half the $23 million debt owed to LCE by its franchisees

· immediate stoppage of payments made to Little Caesars National Advertising Program (LCNAP)

· the formation of joint corporate-franchisee committees to weigh in on all advertising and operational issues

· a split of pre-tax profits between LCE and franchisees on all revenues accumulated by Blue Line Distribution, LCE's supply arm

· potential franchisee rights to source suppliers other than Blue Line

· payment of $2.25 million by LCE for franchisees' legal fees

Lee Hotchkiss, one of seven Little Caesars franchisees who represented the class during the negotiations, said the conflicts with LCE started about five years ago, when multiple franchisees accused LCE of breaking its franchise agreement. They claimed Blue Line Distribution was selling them substandard products at prices higher than those on the open market. Franchisees also claimed they weren't getting their money's worth from LCNAP's mandated advertising program, which required payments of 4 percent of every franchisee's gross sales.

In 1998, 250 franchisees formed the Independent Organization of Little Caesar's Franchisees. The group filed the lawsuit against LCE in January 2000.

Since September, however, both parties say that those issues and many others have been settled favorably.

"The settlement has created a better relationship with our franchisees," said Mike Scruggs, senior vice president of global operations for Little Caesars. "It's a win-win for everyone."

Bob Rooyakker, a 12-year Little Caesars franchisee of eight northern Michigan stores, agreed.

"Any time any litigation of this nature is settled and neither side is completely victorious, that's the sign of a good settlement," said Rooyakker, a former lawyer who, along with Hotchkiss represented the franchisees in the settlement. "We've been able to solve our differences and come to a mutual agreement."

Benefits of the Settlement

Estimated Benefits (as projected by franchisees' attorney):
* Reduction of 4 percent advertising fee to 1 percent (until debt is eliminated in 2003): estimated savings of $136 million
* Blue Line profit sharing: estimated payout of $27 million
* Blue Line competitive pricing: estimated savings of $102-$170 million
Total estimated benefits: $266-$333 million

Real Benefits 
LCE debt forgiveness of $14.2 million
* LCE payment of franchisees' legal fees: $2.25 million
* Investment earn-out credit, capped at $5 million
Total real benefits: $21.5 million

But don't break out the champagne just yet, said Susan Kezios, president of the American Franchisee Association (AFA), which represents owners of 30,000 franchise outlets. She believes that only time will tell whether LCE will hold up its end of the bargain.

"It's not surprising that the deal, on the surface, seems pretty sweet, but let's talk again a year from now," said Kezios. "(The franchisees) had some bitterly contested issues. We're talking big money being sucked out of them and into that corporation."

That "big money," Kezios said, included rebates franchisees said Blue Line received from its suppliers but didn't pass along to them.

"That's why I'm not surprised about the (Blue Line) profit-sharing part of the settlement, because it was a big concern of the franchisees that the corporation was getting kickbacks," she added. "Franchisees only get fair deals when three things happen: when they threaten to or actually form an independent association; when they threaten to file a lawsuit or actually do it; and when they threaten to or actively support franchise legislation. Only when franchisors are over a barrel do they move."

The Details

In an addendum to the settlement, Michael Caddell, a Houston attorney who represented the franchisees, set the value of the settlement at $350 million. Caddell's estimates were based on projected savings gained over 10 years through the elimination of advertising mandates, reduced pricing, plus Blue Line profit sharing.

Additionally, LCE paid $2.25 million in legal fees for services rendered to the franchisees by Caddell & Chapman Attorneys at Law, committed $5 million in credits for franchisees who build new stores or relocate or refurbish current ones, and forgave $14.2 million of the group's advertising expense debt. Franchisees will pay off the remaining $9 million in installments based on 1 percent of gross sales. Rooyakker estimates the debt will be paid off in 18 months.

Dave Scrivano, vice president of administration for Little Caesars, said Caddell's estimate "makes no sense," and was "never mentioned in the negotiations." Anything beyond the debt forgiveness and incentive credits, Scrivano added, is purely speculative. Rooyakker and Hotchkiss also agreed that they didn't understand exactly how Caddell arrived at that figure, and Caddell didn't return calls to explain the estimate.

Now that franchisee advertising co-op contributions are eliminated, a panel made up of an equal number of franchisees and LCE representatives will meet regularly to make marketing decisions. This won't rule out national TV campaigns permanently, Scruggs said, but the company's marketing focus currently is on store-level and community efforts. Franchisees like Rooyakker are pleased with that local focus, but he did point out that national ad campaigns like the well-known "Pizza, Pizza" commercials were highly effective in establishing "the Little Caesar man" as a pizza icon.

"The advertising arena has changed so much from where it was 10 years ago," Rooyakker said. "Now you have to go down to the local levels to reach those consumers who are coming in to the stores."

Like the Marketing Committee, an Operations Committee made up of an equal number of franchisees and LCE representatives will be formed. This committee will allow franchisees a say in store-level operations, product specs and distribution.

The committee will enforce a competitive pricing mandate that ensures Blue Line's prices are competitive with food and supply prices charged to franchisees of Pizza Hut, Domino's Pizza and Papa John's, and with prices at Denver-based Multifoods Distribution. An independent third-party marketing/consulting firm will conduct quarterly evaluations of Blue Line's prices using a "market basket" of about 25 key items.

Should a franchisee challenge Blue Line practices, he may file a grievance with the committee for review. If an agreement can't be reached between both parties, the franchisee then can source vendors other than Blue Line. Currently, Multifoods is the only approved third-party vendor.

The Future Brightens

For Little Caesars, the agreement represents a positive step for a company that has struggled in recent years. It has long claimed to have 4,000 stores, which, based on unit numbers, would make it the third-largest pizza company in the world.

But the closure of several hundred domestic stores since 1999 makes that number questionable, and foodservice industry watchers, Nations Restaurant News, and Chicago-based Technomic, place the number closer to 3,300.

As a privately held company, Little Caesars doesn't report sales numbers, though NRN, and Technomic, estimate its 2000 gross sales at $1.1 and $1.3 billion respectively. The two also estimate the company's per-store gross sales average for 2000 to be between $326,000 and $394,000 respectively.

The Settlement In Detail

1. Forgiveness of $14.2 million of $23 million debt owed to LCE.
2. Mandatory advertising co-op contributions stopped.
3. Formation of a marketing committee to give franchisees equal input in advertising promotions.
4. Formation of an operations committee to give franchisees equal say on product quality and specifications, distribution and changes in franchise agreements.
5. Formation of a national advisory board of franchisees. This will review the operation of Blue Line Distribution.
6. Competitive pricing mandate: Blue Line's prices will be compared to those at three major pizza chains and one distributor.
7. Blue Line profit-sharing program. LCE will share 50 percent of all pre-tax profits on all Blue Line revenues. Payments will be made directly to franchisees each month.
8. Investment earn-out credit. Beginning Jan. 1, 2002, LCE will pay this amount equal to .5 percent of gross revenues on new, refurbished or relocated stores.

What the company will say about its current situation is that business is strong.

"We've had a very good year, and a particularly good (third) quarter, when were up about 9.5 percent," said Scrivano, who credited much of the sales boost to product improvements and focused marketing. "In the past four weeks (October) we've been up 13 percent on comparable same-stores sales systemwide."

Both Hotchkiss and Rooyakker echoed Scrivano's claims, saying that business has been particularly strong. Add in the positive changes from the agreement, added Rooyakker, and the company is better positioned to reclaim some of its former dominance.

"I think with this agreement, we're going to have a true partnership," he said. "So the competition damn well better watch out."

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