Rocky Mountain Chocolate Factory, Inc.
Q3 2018 Earnings Call Transcript

Published: 12 Jan 2018

[Operator:]

Hello everyone and welcome to Rocky Mountain Chocolate Factory Reports First Nine Months of Fiscal Year 2018 Operating Results Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note today’s event is being recorded. The statements made on this conference call which are not historical facts are forward-looking statements based upon the Company’s current plan and strategies, and reflect the Company’s current assessment of the risks and uncertainties related to its business, including such things as product demand and market acceptance, the economic and business environment, and the impact of government pressures, currency risks, capacity, efficiency, and supply constraints, and other risks detailed in the Company’s press releases, shareholder communication, and Securities and Exchange Commission filings. For additional information, the Company urges you to consider reviewing its 10-Q and 10-K SEC filings. I will now turn the call over to Frank Crail, CEO. You may begin your conference.

[Frank Crail:]

Thank you, Operator. Good afternoon everyone and welcome to Rocky Mountain Chocolate Factory’s third quarter of fiscal 2018 conference call. I’m Frank Crail, President of Rocky Mountain Chocolate Factory and with me here today is Mr. Bryan Merryman, the Company’s Chief Operating Officer. We’re going to start the call today with Bryan giving you a summary of both our third quarter and first nine months of fiscal 2018 operating results. And at the conclusion of this presentation, we will be happy to answer any questions that you may have. So, at this time, I’d like to turn the call over to Bryan.

[Bryan Merryman:]

Thanks, Frank. I would like to also thank everyone for attending today’s call. I’m going to start with the nine months operating results. And note that the nine-month trends are more indicative of business conditions than the trends in the third quarter. Total revenues decreased 1.3%, factory revenues increased 2.3%. This was driven by 18.8% increase in shipments to customers outside our network of franchised stores, partially offset by a 3.4% decrease in shipments to franchisees and licensees, and a decline of 2.1% in the average number of domestic Rocky Mountain Chocolate Factory franchise stores in operation. Retail sales decreased 11.3%; this is the result of the sale of certain Company owned locations and the closure of an underperforming Company owned location, partially offset by the acquisition of a franchise location. Same store sales at all Company owned stores and cafés decreased 3.9%. Royalty and marketing fees decreased 11.6%; 15.3% decrease in domestic franchised units was the primary driver of that. We also had same store sales at domestic Rocky Mountain Chocolate Factory franchise store decrease 2.7% while same store sales at domestic U-Swirl franchise cafés declined 4.2%. Total same store domestic franchise sales across all brands decreased 3.2%. Franchise fees increased 133%. We had international license fees that we realized in the current year with no international license fee reported in the prior year. Factory margins dropped 170 basis points; margins were 25.6% versus 27.3%. This is due to increased production costs and product mix shift. Our year over year margin comparisons should improve in the fourth quarter, so that full year cash margins are comparable to last year. Adjusted EBITDA was 5,432,000 this year versus 5,822,000 last year. Net income was 2,000,493 this year compared to 2,718,000 last year. Diluted earnings per share came in at 42% in the current year -- or $0.42 in the current year versus $0.45 in the prior year. During the nine months we opened up 14 stores, five Cold Stone co-branded RMCF stores, five domestic RMCF franchise openings, three international RMCF locations opened, and one domestic U-Swirl location opened. We finished the quarter with approximately $4 million in cash and a current ratio of 1.9 to 1. On December 8, 2017, the Company paid its 58th consecutive quarterly cash dividend to shareholders in the amount of $0.12 per share. We executed international license agreements covering the countries of Vietnam and Panama and the State of Qatar. For the third quarter, total revenues were unchanged at $10 million. Factory revenues increased 1.2%; this was driven by a 15.5% increase in shipments to customers outside our network of franchise stores and partially offset by 8.7% decrease in same store pounds purchased by licensees and franchisees. We also had a decrease of 2.6% in the average number of domestic Rocky Mountain Chocolate Factory franchise stores in operations. Retail sales increased 1.7%, the result of the sale and closure of certain Company owned store and cafés, and same store sales at all Company locations increased -- or decreased 0.8%. Royalty and marketing fees decreased 9.8%; this was due to a 14.5% decrease in domestic franchise units in operation. Same store sales at domestic Rocky Mountain Chocolate Factory franchise stores decreased 4.6%. Same store sales at domestic U-Swirl franchise cafés decreased 3.5%, and total same store domestic franchise sales across all brands decreased 4.3%. In the quarter, franchise fees increased 74.7%; this was due to an increase in domestic franchise openings. Factory margins decreased 560 basis points to 24.1% versus 29.7%; this is a result of increase in production costs and product mix shift. Excluding retail operating expenses, all other operating expenses decreased 5.2%. Adjusted EBITDA for the quarter was $1,669,000 versus $2,068,000 last year. Net income came in at $751,000 compared to $1,012,000 last year. Diluted earnings per share were $.13 in the current quarter versus $0.17 in the prior year quarter. We opened nine stores during the three months, two Cold Stone RMCF co-branded stores, four domestic RMCF franchise openings, two international RMCF locations, and one U-Swirl domestic franchise location. Again, we finished the quarter with approximately $4 million in cash and 1.9 to 1 current ratio, and on December 2017 we paid our 58th consecutive quarterly cash dividend. And with that I’ll turn it back over to Frank.

[Frank Crail:]

Thanks, Brian. Operator, at this time, we would be happy to answer any questions anyone might have.

[Operator:]

[Operator Instructions] And our first question is from Tim Call with Capital Management Corporation.

[Tim Call:]

Hello. Could you review your litigation costs in the quarter and what you expect going forward? And then, if also, you could talk about industry consolidation with [indiscernible] bought by Ferrero and Nestle on the block. Is there a trend here that you might know more about than us?

[Bryan Merryman:]

I’m sorry. Can you, Tim, ask me the first part of that question again, please?

[Tim Call:]

Litigation costs in the quarter and what they would be going forward?

[Bryan Merryman:]

In the current comparison, litigation costs are not that much different year-over-year. But going forward, for the nine-month period, we do have less litigation costs related to the CherryBerry litigation, and we won’t see that going forward. We have had a bump in compliance-related legal costs. So, exactly where we end-up next year in legal costs in terms of year-over-year comparisons, I don’t have a clear picture of that quite yet. I’ll know a lot more when we report our year-end numbers. So, I don’t have really good clarity on that right now. So, we have seen some increase in compliance-related legal costs. In terms of industry consolidation, I think the confection business is super competitive. I think pricing is an issue being able to pass on price increases to customers. And I do see some further consolidation in the industry. I know the smaller confection companies are under a lot of pressure competitively. And I just think it’s a tough space and I would expect further consolidation.

[Operator:]

The next question is from Jason Cassidy, private investor.

[Unidentified Analyst:]

I was wondering if you could give a little bit of detail on the cost of sales. It seems like the gross margin is under pressure here. You just mentioned competitive pricing pressures. Is this a trend you think will continue or do you think that margin might recover in future?

[Bryan Merryman:]

Well, I think that the pressure is going to continue for sure. And I think if you look at our product mix, we’ve had a significant increase in sales of packaged product, which carries lower margins than bulk product. And that increase that we’ve had is across a lot of SKUs. And a lot of those SKUs have lower volumes, which creates efficiency issues. And going forward, what we can do to improve margins is work with our customers to improve volumes in the SKUs that we are creating for our customers or consolidate SKUs. I think that that’s definitely something we can work on; it’s not a quick fix to margins. I think cash margins this year versus last year going to be comparable for the full-year. And so, I think that that’s a continuing issue but we can work on it. If we can’t get volumes up in SKUs, then we can consolidate SKUs but we are we’re going have to work over a period of time with our customers to do that. We expect to see growth, continued growth in packaging and slight backups in bulk product, unless we can expand our franchise system at a more rapid rate than we are. So, I think going forward, we can address that issue; it will take some time. But, it’s also if we could see some balance and growth between sales outside our system and the number of units that we have in our system, margins could definitely improve.

[Operator:]

And the next question is from Tim Call with Capital Management Corporation.

[Tim Call:]

Could you talk about the new tax law and whether there would be any charges or benefits going forward?

[Bryan Merryman:]

Well, we are in the process of evaluating what the Tax Cuts and Jobs Act is going to do to the Company. Obviously with our effective tax rate at around 36.5%, the cut in corporate rate is going to benefit the Company materially. We also have the fiscal year that ends in February. So, we have some time to look at what we could actually do the balance of the year to benefit the Company as it relates to taxes going forward. And we -- the capital expenditures are treated where you can expense them 100%. That’s going to help us. We also have deferred tax assets and those may or may not have to be written down; we are evaluating that right now. But net-net, of course, it’s going to be a very material benefit to the Company.

[Tim Call:]

And with the factory operations being upgraded and streamlined, you put a lot of capital expenditures into that over the last year or two. How much more do you need to invest in operations and when will we start seeing the benefits of those investments?

[Bryan Merryman:]

We are behind this year in our capital expenditure investment. We’ve been from an operation standpoint very busy and getting a lot of packaged product out. And we should see a pickup in the fourth quarter in investment in the factory. And then, as far as what we need to invest in, in the future and the benefits of our investments, I think I’ll be in a much better position to talk about that after we’re through the fourth quarter and we have our business plans for next year and the next five years put together. So, quantifying and going forward, I’m not in a position to really answer that right now. But, I think when we do report our year-end numbers I’ll be in a position to give you a more detailed answer to that question.

[Operator:]

The next question is from Jim Amber, [ph] private investor.

[Unidentified Analyst:]

I was wondering about 2018 strategy to improve the EBITDA and the revenues? Is there a succinct strategy going forward that you have developed based on 2017?

[Bryan Merryman:]

Because our year ends in February, we talk about 2018 and 2019. In 2018, the current fiscal year, we definitely are having some challenges; they’re not unexpected. The number one issue is the decrease of almost 12% in our royalty and marketing fees; that decrease comes right off of pretax income. We’ve been able to make up for that with increases in our specialty market sales, sales outside of our system of stores, and also with franchise fees. And we’ll hopefully continue to see fees collected from international deals going forward. We will expect to continue to increase our sales outside of our system. And we really have to figure out a way to grow our systems -- our domestic system Rocky Mountain Chocolate Factory stores. And so, in fiscal 2019, we’re going to be considering some things that we have not done in the past and that includes acquisition of key market stores from franchisees if that opportunity presents itself. For instance we have a key market with a key store where the Company is likely to obtain that store back from the franchisee. That will free us up to hopefully either find the sophisticated operator to expand in that market or have the Company actually finance an expansion for an existing operator or do the expansion itself. We’re in a position to consider actually possibly doing Company owned stores, or financing franchisees to encourage the build out of additional stores. So, next fiscal year, there’s going to be resources allocated to doing some things we haven’t done in the past, and hopefully that will help us grow our base of stores.

[Operator:]

And the next question is from Brian Lundin [ph], Private investor.

[Unidentified Analyst:]

I was just wondering if you could give any additional color on the outside the systems sales this quarter?

[Bryan Merryman:]

I think that the sales outside the system this quarter and for the nine-month period, the increase in revenue was significant and right -- really right on our plan, we expect to be on our plan this year. We’re growing mostly with our existing customers and we’re happy with where the numbers have come in, in terms of sales with those customers and we expect it to continue to expand.

[Operator:]

And there are no further questions at this time. I will turn the call back over to Frank Crail for closing comments.

[Frank Crail:]

Thank you, Operator. Thanks again everybody for attending our third quarter of fiscal 2018 conference call. And we look forward to talking with you again in a few months, at year-end. So, have a great day and we’ll be talking to you soon. Bye, bye.

[Operator:]

This concludes today’s conference call. You may now disconnect.