Leadership by Necessity: Be Careful, You Might Get What You Wish For

Harry Loyle bought his first MotoPhoto store in 1985. Today he owns the company--well, three quarters of it anyway. But as president and CEO, he is, at last, in control. How he got there is a story of passion, persistence, disappointment, frustration, the achievement of a long-held dream, and a complex acquisition deal completed in February 2003.

"While the deal was exciting, that was only the ante for the poker game. That just got us the opportunity to have influence over the system. It was the beginning, not the end," says Loyle.

"Not only did we have a franchise system that was unstable, lacked trust and confidence, and the franchisor hadn't delivered on their promises for years because they were under-resourced, but we're being violently attacked in the industry marketplace," says Loyle. "Our 1-hour concept didn't work any more. It wasn't relevant."

To understand what happened, it's necessary to wind the clock back about 25 years, perhaps more. MotoPhoto was founded in the early 1980s in Oklahoma City "by two gentlemen who were more in the startup business game than the photo finish game," Loyle says. After about a dozen stores, they took the company public. In 1983, Progressive Industries, from Dayton, Ohio, bought controlling interest. Soon afterward, the company was moved to Ohio.

Moto was traded on the NASDAQ for almost 20 years and had pretty nice unit growth through 2000, says Loyle. The system expanded to more than 300 locations, had a master franchisee in Canada, and an unusual arrangement with the government of Norway--but it wasn't making much money. Then, in about 2000, says Loyle, "We ended up with almost a perfect storm." That storm had three main ingredients:

• Technology. With the transition from film to digital, the photographic industry was undergoing a radical revolution, "probably the first major change in our industry in 100 years," says Loyle.
• The economy. The recession following the dot.com crash in 2000 worsened after September 11, 2001, which severely curtailed travel (and photography).
• Internal problems. Moto had been public for 19 years, but made money in only 5 of them, says Loyle. "Whether it was excessive SG&A, debt structure, or a convoluted equity structure, they were never able to break out of that financial performance rut." He chalks it up to "an accumulation of lack of stellar management on the financial perspective of the franchisor."

Whatever the reasons, the confluence of these three factors, he says, "brought us to the opportunity, if you will, that something else had to be done."

Franchising beckons

To understand what that "something" would eventually be, it's time to roll back the clock again, this time to 1985, when Loyle and his wife ran a small chain of camera stores in southern New Jersey. "I was always a small business, entrepreneur kind of guy, and we were looking for where to go from here," he says. "We had three of our own locations, we were looking for growth, and saw the advantage in franchising." They bought their first Moto franchise that year and quickly acquired area development rights for southern New Jersey

Soon after, they added a financial interest in the brand. "We loved what was happening in the company and the industry," says Loyle. When the company floated a stock offering, they became the largest preferred shareholder. Over the next 15 years, they added development rights for New Jersey, Pennsylvania, and portions of New York and Connecticut. By the time they were done, they had opened 58 MotoPhoto stores. "We were pretty heavily engaged in the system," says Loyle.

Moto was opening new stores, but continued to have financial challenges. In the early '90s, when the company defaulted on preferred stock dividends for six consecutive quarters, Loyle, as the largest preferred shareholder, joined the board. One of the first things he did was negotiate the conversion of preferred stock into common stock. Instead of the largest preferred shareholder, Loyle was now the largest outside common shareholder (there was one larger, but he was inside management).

Then, for the better part of a decade, he sat on the board, holding a substantial investment in the company--only to oversee disappointing corporate financial performance. "Even with my board seat, I was not able to influence the direction of the company. I had one vote out of seven or eight," he says.

"It's a very interesting business lesson for me. If you're in a small company, you have to be in enough of a control position where if things go wrong you can have some influence," says Loyle. "I was not able to leverage my board seat to effectively influence the operation of the company. To be a ten percent minority shareholder in a public company doesn't do you any good. I don't do those investments any more."

Time to reevaluate

Starting around late 1999, Loyle began asking himself hard questions about his future with the company. "There was a lot of soul searching," he says. "Where do I want to go? Do I just quit and walk away, pack up my marbles and go play another game someplace else?" Three factors kept driving him back.

The first was he liked the industry. "That's probably a dangerous position to be in if you like to make money. But I clearly was very passionate for photo. I did my high school yearbook. I made money in college taking pictures. I've never had a real job. I came out right from college owning my own camera store. So this industry really was in my blood."

Second, says Loyle, "I also felt a pretty good responsibility for the system. Moto had a little over 300 stores. I personally sold 20 or 25 percent of them to people that I had sold, convinced, or coerced, basically telling them this was a pretty good opportunity. So there's clearly a sense of ethical and moral responsibility there."

The third reason was simpler. "I thought there was a financial opportunity. I didn't want to walk away from my prior investment, or the upside."

Time for action

His soul-searching led Loyle to look for ways he could have more influence on the company. This would play out in four major actions during his years with the brand:

1. Join the board. Work from the inside. "I was a franchisee, an area developer, and a board member. That wasn't very successful."
2. Become CEO. Loyle approached the board with an offer to take over as CEO and work for a dollar a year. "I already had enough stock ownership that if you turn the stock price around, I'm going to be amply rewarded." That didn't work either.
   
   "I don't know whether it was boardroom politics that I didn't know how to play well enough. Certainly the existing CEO wasn't very much in favor of that idea," says Loyle, "When he announced his retirement, he wanted to go outside and didn't support me even as a candidate. I basically had to scrap that idea." (Yet, says Loyle, although he and the CEO disagreed on direction, they were friends and remain so.)
3. Support the new CEO (PIPE dreams). Moto went outside to hire a new CEO. "My first inclination was, Well, the best thing I can do is give this new guy as much support as I possibly can. I did that as an area developer."
   
   Loyle assembled a PIPE (private investment in a public entity) investment group willing to put in about $1.7 million to buy 72 percent of the company. That would, they reasoned, 1) give the group influence and control, and 2) give the new CEO an opportunity to approach his secured creditors and preferred shareholders with some spending cash, providing some flexibility to try something different--which Loyle thought was badly needed.
   
   The group placed two contingencies on their investment: 1) Moto could meet current payables, so they didn't invest and watch the company go bankrupt; and 2) Moto was able to reach an agreement with its other preferred shareholder, Fuji--and quash Fuji's right to convert from preferred to common stock, a move that would have wrested control from the PIPE group.
   
   "I think the new CEO did a great job of trying to pitch the proposal, but basically they were not able to accomplish either contingency," says Loyle. It was then, in late 2002, that Loyle decided to resign from the board. "The strategy there was I could no longer be influential from the inside; I had to do something from the outside."
4. Buy the company. Loyle assembled another team and initiative, this time to buy control of the company and take it in the direction he'd been wanting to go for a long time. This time he'd succeed.

When he and his new team of investors and advisors looked at Moto, they identified 14 distinct constituent groups that would be affected: vendors, the board, senior management, company associates, area developers, franchisees, retail consumers, banks, etc. "We did the best job we could of determining how each would be affected by a potential transaction. Then we said, 'Okay, what are the potential transactions we can do?'"

Options included merging with another company; buying Fuji's preferred stock and taking their position; issuing new stock; and doing an asset liquidation. "We had six or seven different scenarios," says Loyle. "The one we ended up with was acquiring the company through a 363 bankruptcy filing."

(A Sec. 363 filing is a section of the bankruptcy code that allows a company in bankruptcy to sell off major pieces of its assets. Over the last decade, attorneys have pushed the law to allow sale of the entire company. "The way this differs from a normal Chapter 11 reorganization is that you go into the filing with a plan for reorganization, and that plan is selling off all the assets," Loyle explains.)

The acquisition attorney for this was Lane Fisher, of Fisher Zucker in Philadelphia. Zucker orchestrated the legal side of the complex, multi-part transaction, which required both scrupulous adherence to disclosure regulations as well as filing in several venues simultaneously. On November 25, 2002, the group signed the asset-purchase agreement, did the required SEC disclosure, filed for bankruptcy under Sec. 363, and on the next day notified the FTC of the transaction. (For further details on the transaction, see www.motophoto.com/upload_objects/pr080103.pdf)

After months of meticulous preparation, the team moved the entire process through the courts quickly. On February 10, 2003, they took possession of MotoPhoto. "It [short time] really was a testament to the entire team of people we had working on it, because all the prep work was done up front," says Loyle.

Now that you have what you wished for...

The acquisition took Moto from a public to a private company--and Harry Loyle from a frustrated area developer and former board member to majority shareholder and president and CEO of the newly minted Moto Franchise Corp. Loyle now owned 75 percent of the stock; five other shareholders, also area developers, owned the rest. The ADs were brought into the deal because of their relationships with franchisees across the country, says Loyle. "They went a long way in helping to keep calm in the franchise system as we went through this somewhat {turbulent? tremulous? tumultuous?} transaction."

The new owners approached their new company as if it had two problems: rebuilding trust and confidence (the emotional side), and delivering programs, services, and products to a changing marketplace (the logical, or business side; see sidebar, "Steering through change"). "We had to simultaneously attack both of these issues," says Loyle. The new Moto quickly laid out its four-year goals to its franchisees:

Year 1 (2003): Get control of the financials and generate as much cash as possible. "You want to build a resiliency in your balance sheet that allows you to withstand and to implement changes," says Loyle. "Almost arbitrarily, I wanted net operating income of 10 percent of sales. The management team made a Herculean effort and delivered 12.7."

Year 2 (2004): Invest in the system. "Now that we have some cash, some resiliency, let's invest in program development, in changing our business model, in coming out with new franchise policies--basically putting some of our money where our mouth is and making investments in MotoPhoto."

Year 3 (2005): Move the top-line revenue. The key challenge now became finding ways to make those programs and business model components resonate with the retail consumer.

Year 4 (2006): Do all three--run a financially sound business, invest in the future, and move the top line.

Get professional help

"We did a great job hitting our numbers and goals in '03 and '04, but in '05 I was not happy. We were not getting the top-line revenue growth," says Loyle.

At this point, relations with franchisees had been patched up, trust and confidence strengthened, and things were going well internally. Moto had put $2 million of investment back into the system and into the franchisees' hands. But as 2005 moved from summer into autumn, top-line revenue continued to lag.

"It just didn't feel right," he says. "We were not happy with our unit counts and comp store sales numbers. We had to do something different." He brought in an outside consultant to guide the company through a strategic planning process. Loyle found him right up the road, at the University of Dayton: Joe Schenk, dean of the MBA program. "I didn't expect him to come in with any answers, and he didn't, but he came in with a great process," says Loyle.

"When we started on this quest, it was pretty adversarial between franchisee and franchisor. I think we're through all that. But one of the disadvantages of getting everybody on the same side is that sometimes you lack the challenge and the discourse and the debate that forces you to face reality." Schenck quickly took care of that, says Loyle. "He got our attention and said, 'Okay, what are you going to do differently?'"

Plenty, as it turned out. "We took a pretty aggressive approach to our franchise business model. It was a pretty dramatic shakeup," says Loyle.

Strategy 1: Focus on services that have the most value to franchisees. For Moto that meant two areas:
a) Cost containment--Use the advantage of a system to deliver the best possible cost to franchisees (product, vendors, etc.); and
b) Boost retail sales--Work hardest on programs and support services that drive revenue at the store level.

Strategy 2: Align franchisees' activities with their capabilities. This was almost a sacrilegious position to take, says Loyle, especially after working so hard to rebuild the system. The new owners had worked hard to have 100 percent of its programs in all of its stores, but it soon became apparent many franchisees didn't agree. With this strategic shift, the franchisor would not only allow, but facilitate and encourage variation within the system.

"We're not completely disbanding franchise consistency. We have core programs that everybody does," he says. But beyond that, individual franchisees now can offer additional specialties. For example, one franchisee might offer wedding photography, while the Moto in the next town specializes in sporting events. "It gives us a little bigger challenge communicating to the retail marketplace, but now a franchisee can do a program they have interest in, the capabilities for, and that they think will have an impact on their marketplace."

Strategy 3: Give the franchisees money. "We went to our franchise system and said, 'Look, if you alter some of your processes at the store level, and by doing that we can cut our costs, we're going to give those costs back to you.'" That money could then be used to implement new programs and increase top-line revenue. Moto was able to cut royalties by more than half. Here's how:

• Using the web. Moto required all orders to be placed over the Internet. No more faxes or phone calls, allowing for reductions in customer service staff.
• Eliminating open account terms. "Rather than handling the credit collection ourselves, we said, 'Everybody has a business credit card nowadays. Let's go to credit card as our normal terms.'"
• Reducing the royalty bands. "Instead of asking a franchisee to report exactly what their sales were, we would set a band at the beginning of the year (which we've already done) and say, 'Okay, you're paying $750 a month, you're paying $1,000 a month, you're paying $500.'" Having a fixed number for the entire year allowed ACH (automatic clearing house) payment. "It eliminated the royalty calculations, submission of reports, checks, and us having to call when they didn't send a check," says Loyle.

Taken together, these steps reduced overhead enough to lower royalties more than 50 percent. For example, under the old system, royalties for an average store ($400,000 annual sales) at 6.5 percent were $26,000. Under the new system, that owner now pays $12,000 a year. "It was a very substantial reduction for our average franchisee. Obviously, they loved it," says Loyle. But, he says, strategy four is the critical one, because all these great ideas don't work unless sales and unit growth numbers rise.

Strategy 4.1: Boost store retail sales. By focusing on programs that deliver value to the franchisee; encouraging and empowering each franchisee to do things they are more comfortable and capable of doing; and by giving them money to do it, Loyle sees a good chance for boosting Moto's retail sales. "It's a little early to tell, since we only implemented this at the end of January, but that's the direction," he says.

Strategy 4.2: Add unit growth. Moto is planning to offer new franchise sales for the first time since the acquisition in early 2003. Since then, the number of units has fallen from 279 to 154. "Where we are now is now is writing the new UFOC, which allows us to get registered and do new franchise sales," he says.

Loyle says he chose not to sell new franchises while Moto was undergoing such dramatic change over the last three years. First, the company was unable to present a clear picture to candidates, but there was more. "I wasn't morally comfortable saying 'Put down your life savings, a quarter of a million dollars, and open up a brand new store from ground zero.'"

In fact, that won't be necessary for his target candidates: the upcoming effort to add units will focus on conversions of the thousand or so remaining independent one-hour photo shops. This way, says Loyle, the prospects are already in the business, know the pros and cons, and can come in for a significantly lower cost. "We have a good pool of a thousand," says Loyle. "We think the first 30, 40, or 50 sales will be pretty easy. If we could get to 100, we would consider that a very successful campaign."

Some of those candidates may come from the deal Moto signed in late February, aligning itself with the 400-plus-member Independent Photo Imagers buying group as part of a national co-branding initiative. The deal not only gives Moto franchisees purchasing advantages, but gives the IPI's camera store members a good look into Moto. "We're not selling yet because we're not registered, but we've had a couple dozen of their members already call us expressing high levels of interest when we're ready to go," says Loyle.

Riding out the storm

"We're still really struggling," says Loyle. "We're doing better than the other specialty retailers, but that's not good enough. We have to stop the decline and start increasing."

On the plus side, Loyle notes, Moto has been profitable all three years of its new existence. "We're not losing money; our balance sheet is in an excellent position. When you take these steps proactively, you don't wait until you get into a losing year or a strained balance sheet where you can't take any action. The reason we could drop our royalties 50 percent was because we could afford to," he says.

"We laugh now that in our existence we've been more profitable in our 3 years than the previous company was in 19 years," says Loyle. So far, so good, but he's not about to fly off to Disneyworld to celebrate. "You have to realize there's going to be another challenge right around the corner."

Loyle cites Moore's Law, which predicted the number of transistors on a computer chip would double every two years. "That's the speed at which all business is changing. There aren't too many businesses out there now that are utilizing the same business model that they did a decade ago. It just doesn't work."

That's the strategy. How it turns out is another story. "Wait a year and I'll tell you," says Harry Loyle, president and CEO of Moto Franchise Corp. At last.