Papa Murphy’s balances success, controversy

Take-and-bake pizza chain sees fortunes improve, but some franchisees update lawsuit

By Aaron Corvin, Columbian Port & Economy Reporter

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"We feel it's important to have a set of company stores in different places across the country in order to be able to execute the very same strategy that we're presenting to our franchisees,"said Ken Calwell, president and CEO of Papa Murphy's.

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As Papa Murphy’s prepares to mark a successful first anniversary as a publicly traded corporation, current and former franchisees have updated their lawsuit against the Vancouver-based company. The new claims beef up an initial complaint filed last April, around the same time Papa Murphy’s conducted its initial public offering of stock, that the company misled them about the challenges of getting into the take-and-bake pizza business.

The franchise owners at that time accused Papa Murphy’s of failing to disclose accurate information about the financial performance of stores in the South and Southeastern United States, including Texas, Alabama and Florida.

The company “systematically defrauded” plaintiffs, according to the updated complaint filed by the Bundy Law Firm of Kirkland. Had the company divulged certain information, including that new stores in the South and Southeast would experience much lower sales, the plaintiffs “would not have purchased their stores.”

The company denies the complaint’s expanded claims. The franchise disclosures made by the company “were accurate and truthful and were fully disclosed and explained,” according to the company’s attorneys, based in Vancouver and Washington, D.C., in a response filed on April 1 in Clark County Superior Court.

The lawsuit is complex, involving approximately 19 or 20 plaintiffs representing more than 40 stores in multiple states.

In a statement issued to The Columbian, Papa Murphy’s said it believes “the lawsuit has no merit whatsoever and we will defend these claims vigorously.” The company went on, “We have actively been in mediation with the 28 plaintiff groups, and of those, eight plaintiffs, which represent a significant portion of the stores involved in the litigation, have dismissed their claims. We are continuing to mediate with the remaining plaintiffs and are working hard to come to an amicable resolution.”

The company also said that helping franchise owners “grow sales and profitability is an ongoing priority for us.” Papa Murphy’s added that it has a history of “good franchise relations and very little franchise litigation.”

Caroline Fichter, the Kirkland attorney representing the franchisees, said her clients’ complaint is based on the fact that Papa Murphy’s “omitted key facts when it sold franchises to them.” She said the company “now tries to focus the media on the fact that some of the original plaintiffs have dismissed their claims. However, consistent with their pattern of behavior, they fail to mention that those dismissals were the result of confidential settlement agreements. Papa Murphy’s would apparently have the world believe that every one of those settling franchisees unconditionally surrendered.”

In sworn statements, Fichter said, plaintiffs have “explained how Papa Murphy’s and its employees encouraged them to purchase franchises by using misleadingly high sales numbers and low break-even points of as little as $5,300 in average weekly sales. Papa Murphy’s continues to promote its franchises using the same methods.”

The legal battle unfolds as Papa Murphy’s, founded in 1981 with 1,461 stores as of Dec. 20, 2014, enjoys good news about its brand and its financial health.

Earlier this year, for example, the company received a consumers’ choice award from Technomic for the quick-serve concept most likely to be recommended by consumers. And the company’s stock, which trades as FRSH on the Nasdaq exchange, has climbed 62 percent from $11.05 per share on May 2, 2014, when the company went public, to $17.97 per share on Friday.

In March, the company reported revenue of $97.39 million for all of 2014, up 21 percent from revenue of $80.49 million in 2013. Papa Murphy’s’ profit for all of last year: $1.2 million. That compares with a net loss of $2.6 million in 2013. The company also saw an increase of 8.4 percent in domestic comparable store sales. It was the company’s 16th consecutive quarter of comparable store sales growth.

Papa Murphy’s is taking steps that would help it freshen up its public face at its retail outlets. During the company’s earnings conference call in March, Ken Calwell, president and CEO of Papa Murphy’s, said part of the company’s long-term strategy is to acquire existing stores from franchisees so that it eventually “owns around 10 percent of our store base.” The company will then carry out its key growth initiatives, including product and customer-service improvements and an online sales system, at its company-owned stores.

In this way, Papa Murphy’s’ company-owned stores will “lead by example,” Calwell said. “We feel it’s important to have a set of company stores in different places across the country in order to be able to execute the very same strategy that we’re presenting to our franchisees.”

But while the company reports strong financial returns and girds to carry out its long-term growth plans, disgruntled current and former franchise owners in the South and Southeastern U.S. tell a different story. The updated suit, filed on Jan. 30 in Clark County Superior Court, describes them as individuals, married couples, families and high school friends who wanted to become small-business owners. Some allege they were misled into a situation in which they’ve had to sink their savings into a failing business.

Before deciding to buy two Papa Murphy’s stores in Texas in 2005 and 2008, Douglas and Lesia Billings were told by a company sales representative that they “could expect to make $100,000 per store and that they could pay off each store ‘easily’ within five years,” the lawsuit asserts. “As a direct result of their investment in a Papa Murphy’s franchise, the Billings have lost at least $416,000 primarily from their retirement savings.”

The suit goes on, “While the Billings have lost almost a half-million dollars and eight years of work in their investment,” Papa Murphy’s “has profited by collecting $40,000 in franchise fees and more than $217,000 in royalties from the Billings’ failing stores.”

In court documents, the company acknowledges a sales representative met with the Billings and that the company gave them a franchise disclosure document but denies allegations of wrongdoing.

‘Without comment’

The Billings are among approximately 19 or 20 plaintiffs who filed the updated lawsuit against Papa Murphy’s. The suit alleges Papa Murphy’s engaged in fraud and negligent misrepresentation, and violated the Washington state Franchise Investment Protection Act. It names numerous defendants, including the corporation and several affiliates, Lee Equity Partners — a New York private equity firm and major holder of stock in Papa Murphy’s — and several company officers, including Calwell.

The complaint seeks at least $20 million in damages.

In its response, the company rejects the suit’s claims on multiple grounds including that the damages sought by plaintiffs “are speculative and remote,” that plaintiffs lack legal standing to make their claims and that plaintiffs failed to “engage in contractually required negotiation and mediation.” The company also says that it reserves “the right to supplement these defenses as information is learned through discovery.”

The company asks the court to dismiss the suit “with prejudice” and to award it attorneys fees and other costs linked to the litigation.

One part of the suit against Papa Murphy’s focuses on the franchise-approval process. It says the company asked the plaintiffs to develop business plans based on templates provided by the company. The plaintiffs did so, estimating average sales, expenses, break-even points and profits. The company either approved the plans “without comment,” the suit alleges, “or told plaintiffs that their estimates were too conservative and that they could expect to do much better than they had.”

However, what Papa Murphy’s “knew but did not tell the plaintiffs,” the complaint contends, “was that, given the average sales and expenses for new stores in their region, their business plans were wildly over-optimistic.”

In its response, the company admits it asked some of the plaintiffs to develop business plans but denies the allegations related to the franchise-approval process.

Another part of the expanded suit says Papa Murphy’s required many of the plaintiffs to provide information about their net worth and liquid assets to decide if they were qualified franchisees. What the company “knew but did not tell the plaintiffs was that given the low sales, high marketing costs and long operating period to reach ‘average sales’ typical of new stores in their region,” the complaint asserts, “the plaintiffs lacked the financial resources to operate their franchise.”

Because the plaintiffs “were undercapitalized from day one,” the lawsuit says, they’ve been “forced to drain their personal savings and retirement accounts to feed failing businesses that they were trapped in.”

They wouldn’t have invested in a franchise, the complaint argues, if Papa Murphy’s had “accurately informed them that based on their qualification report they were not financially qualified to operate” a franchise.

The company denies those allegations. In its response, the company also says it’s the leading take-and-bake chain the U.S., “with 30 years of experience and a history of strong positive relationships with its franchise owners.”

Note: Papa Murphy’s has been in mediation with 28 plaintiff groups. There are now 19 or 20 representing more than 40 stores in multiple states. Accordingly, this story has been revised to reflect the company’s request to correct information it supplied in its earlier statement to The Columbian.