Rocky Mountain Chocolate Factory, Inc.
Q3 2017 Earnings Call Transcript

Published: 13 Jan 2017

[Operator:]

Good day and welcome to Rocky Mountain Chocolate Factory's Third Quarter Fiscal 2017 Operating Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please also note that today's event is being recorded. Statements made on this conference call which are not historical fact 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 economy 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. At this time, I'd like to turn the conference call over to Mr. Franklin Crail, President. Sir, please go ahead.

[Franklin Crail:]

Thank you, Operator. Good afternoon everyone and welcome to Rocky Mountain Chocolate Factory's third quarter fiscal 2017 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 providing you a brief summary of our third quarter operating results and at the conclusion of his presentation, we will be happy to answer any questions you might have. At this time, I'd like to turn the call over to Bryan.

[Bryan Merryman:]

Thank you, Frank. I'd also like to welcome everyone to today's call. I'm going to start with an overview of the first nine months of fiscal 2017 and then get into a little more detail on the third quarter. For the nine months, total revenues increased 5.1%, Factory revenue -- excuse me, total revenues for the nine month decreased 5.1% revenue. Factory revenue decreased 2.4%. This is due primarily to a 10.4% decrease in shipment to customers outside our network to franchise store, and to a lesser extent, a 2.7% decrease in same-store pound purchased by franchisees and licensees, and a decline of 3.5% in the average number of domestic Rocky Mountain Chocolate Factory franchise stores and operation. Retail sales decreased 11.6%. This was due to the sale of certain company-owned locations and the closure of an underperforming company-owned location. Same-store sales at all company-owned stores and cafes increased 2.1%, royalty and marketing fees decreased 6.5%. This was due to an 11.6% decrease in domestic franchise units in operation. Same-store sales at domestic Rocky Mountain Chocolate Factory franchise stores increased 2.1%, while same-store sales at domestic U-Swirl franchise cafes declined 3.4%. Total same-store domestic franchise sales across all brands increased 0.5%. Franchise fees decreased 45.7% in the first nine months versus the prior year. This was due to international license fees recorded in the prior year with no international fees recorded in the current year. Factory margins decreased 30 basis points in the first nine months to 27.3% versus 27.6% last year. This was driven by a decrease in the cost of certain commodities, primarily chocolate and almonds, more than offset by increased costs of labor and overhead. Excluding retail, operating expenses decreased 8.6%. This was driven by lower G&A expense and franchise cost. Adjusted EBITDA for the first nine months was $5,822,000 versus $6,039,000 last year. Net income was $2,718,000 this year compared to $1,994,000 last year. Diluted earnings per share was $0.45 in the current year compared to $0.32 in the prior year. During the first nine months, 32 stores opened. This was six Cold Stone Creamery RMCF co-branded stores, two domestic RMCF franchise openings, 18 international RMCF locations opened, and five domestic U-Swirl locations opened as well as one international U-Swirl location. We finished the quarter with approximately $4.6 million in cash and a current ratio of 1.9 to 1. During the first nine months, we repurchased 35,000 shares of our common stock at an average purchase price of approximately $10 per share. On December 9th, 2016, the company paid its 54th consecutive quarterly cash dividend to shareholders in the amount of $0.12 per share. During the first quarter of this year, we acquired certain assets of two small confections companies, FernCreek Confections and Elaine's Toffee Company. These acquisitions allowed us to acquire an all-natural gluten-free line of products and a high-end toffee line, as well expanding our customer relationships. In the third quarter, total revenues increased 1.5%, which was driven by 4.5% increase in factory revenues, due primarily to a 15.8% increase in shipments to customers outside our network of franchise stores, partially offset by 0.8% decrease in same-store pounds purchased by franchisees and licensees. Retail sales decreased 10%. This was the result of the sale of certain company-owned locations and the closure of an underperforming company-owned location. Same-store sales at all company-owned stores and cafes increased 3.6%. Royalty and marketing fees decreased 6% in the quarter. This was due to a 12.9% decrease in domestic franchise units. Same-store sales at domestic Rocky Mountain Chocolate Factory franchise stores increased to 2.8%, while same-store sales at domestic U-Swirl franchise cafe declined 3.4%. Total same-store domestic franchise sales across all brands increased 1.1% in the quarter. Franchise fees increased 43.5% in the quarter. This was due to an increase in franchise transfers and associated fee that comes along with those transfers. Factory margins decreased 50 basis points in the third quarter to 29.7% versus 30.2% last year. This was due to a decrease in the cost of commodities, primarily chocolate and almonds, more than offset by increased cost of labor and overhead. Excluding retail, operating expenses decreased 12.7%, primarily lower G&A expense and franchise costs. Adjusted EBIDTA was $2,068,000 in the third quarter versus $1,741,000 last year. Net income was $1,012,000 compared to $441,000 last year. Diluted earnings per share came in at $0.17 in the current quarter versus $0.07 in the prior year. During the third quarter, we opened seven stores, one Cold Stone Creamery RMCF co-branded store, four international RMCF locations, one domestic RMCF franchise location, and one domestic U-Swirl location. We finished the quarter with approximately $4.6 million in cash, again, a current ratio of 1.9 to 1. And on December 9th, 2016, the company paid its 54th consecutive quarterly cash dividend to shareholders in the amount of $0.12 per share. And with that, I'll turn it back over to Frank for questions and answers.

[Franklin Crail:]

Thanks Bryan. Okay, at this time, we'd be glad to answer any questions that anyone has.

[Operator:]

Ladies and gentlemen, at this time we'll begin the question-and-answer session. [Operator Instructions] And our first question comes from Tim Call from The Capital Management Corp. Please go ahead with your question.

[Tim Call:]

Congratulation on a strong quarter. With free cash flow paying down so much debt rather fast, your interest expense fell 21% year-over-year, is there a point where you hit your ideal debt level and what would that be?

[Bryan Merryman:]

Well, our intention right now is to just continue to pay the loan that we took out to acquire the various yogurt brands that we own to continue to pay that down and also to continue to pay the dividends and buyback stock. And so we haven't really pinned [ph] an ideal debt level. We intend to be fairly conservative and like to pay the debt off completely. And hopefully between now and when we pay that debt off, we'll also consider a dividend increase and see another dividend increase in a not-too-distant future.

[Tim Call:]

Items like franchise transfer fees and factory sales can be lumpy, should we expect any long-term growth trend from either these franchise fees or factory sales?

[Bryan Merryman:]

Well, franchise fees are driven by franchise openings and by master license agreements and in the current year, we don't have a new international license agreement and so you see the fees dropping in that area. And so looking forward, it's really dependent on unit growth, which domestically has been somewhat slow. Hopefully, with the new administration, the rules around financing our kind of concept with the SBA will be loosened up and maybe even hopefully rolled back to the way they were having insight in that, it's just a -- it’s a hope we think that new administration might be more small business friendly and that could lead to unit growth in the future. We've heard some article stating that that new leadership is looking in area at maybe loosening up the SBA lending rules again. So, that could generate some significant cash flow in the future. If we saw the rules rolled back and made similar to what they used to be before the recession.

[Tim Call:]

Thank you. I'll get back in line.

[Operator:]

[Operator Instructions] Our next question comes from John Gay, the Quiet Investor. Please go ahead with your question.

[John Gay:]

Thank you. That was a nice quarter. It was good to see. My questions concern U-Swirl, has that assimilations been complete? Number one. And number two, I sell-side with its future significance to the company at all?

[Bryan Merryman:]

The assimilation has been complete for some time. There's basically from an administrative standpoint two employees. Of course we have -- we own company stores and there's employees in those stores, but from an administrative standpoint, that only has two employees that are 100% U-Swirl. The rest -- the administration that happens in that company happens between people that work on both U-Swirl and Rocky Mountain Chocolate Factory. So, it's been complete for some time. Yogurt is more than likely to have a diminishing role in the future of the company given current trends.

[John Gay:]

Okay. Thank you.

[Operator:]

[Operator Instructions] And at this time, I'm showing no additional questions. I'd like to turn the conference call back over to management for any closing remarks. And sir we actually have -- Mr. Call has rejoined the question queue for a follow-up.

[Tim Call:]

Thank you. With the Cold Stone Creamery JV signings growing so much in recent years, that represents 22% of your chocolate store base. Do you expect that positive trend to continue? And as you pay down your own loan debt, would you ever entertain lending those JV's money in order for them to accomplish their JV move?

[Bryan Merryman:]

Yes, we actually have lent money in the past to get the program started and we would consider it in the future. We haven’t lended -- lent franchisees any money on new locations. We've never done that. We have a policy against it actually. But existing locations that have a track record where we could analyze the credit worthiness of the franchisee, we do that periodically on the Rocky Mountain Chocolate Factory side. We've done it on the Cold Stone side and we'll continue to entertain doing it.

[Tim Call:]

And with international chocolate store signings, they have -- that's now become 25% of your chocolate store footprint. Do you see international expansion trends continuing? And do these stores have similar sales and profitability as domestic chocolate stores?

[Bryan Merryman:]

Well, in terms of our unit count, our international is primarily Canada and those stores are very strong stores and have similar economics as U.S. stores. The remaining international stores that we have outside of Canada, the largest concentration stores we have it in South Korea and we have 18. Of those 18 stores, 15 have opened in the current year, many of them recently, and it's really too early to call and we don't really know what the economics are going to be on those stores. In Japan, we only have five locations and three of those are co-branded locations and the economics are much smaller than they are domestically. So, we'll continue to attempt to expand internationally. What's happening in Korea I think we'll have a big impact on how we go forward. Also, there's some uncertainty right now around what the U.S. policies are going to be and how -- so some of the discussions we're in right now, potential partners are kind of sitting back and waiting to see what happens with the new administrations.

[Tim Call:]

Are there new products trends occurring in other channels like grocery stores?

[Bryan Merryman:]

Yes, I mean we continue to acquire new customers in a variety of retail environments out there, specialty, retail, grocery, foods [Indiscernible]. It's not a business that goes straight up or down. You have new customers and you're losing customers and sometimes customers grow with you and sometimes they back up. It's not as predictable as our franchise system, but I think we're doing well there and we have our biggest customer this year come in substantially lower than last year at beginning of the year, talked about that in the last couple of calls that we've had. They have been stronger in the back half of the year. Orders have firmed up with them and so very optimistic about that business going forward.

[Tim Call:]

There are some federal tax proposals being talked about with taxing imports, lowering your corporate tax rate, lowering repatriation tax. When you look at that, do you see a net benefit for Rocky Mountain or is there -- how do you look at it?

[Bryan Merryman:]

Well, I mean -- if our -- I mean it would be huge for Rocky Mountain if the corporate rate was cut in half. I mean our income tax rate is 37%, so it's pretty easy to do the math on the corporate rate went down to 15%; that would be huge for us. So, I mean keeping our fingers crossed, I don't know how quickly something like that can happen, but it would be a huge benefit to the shareholders of Rocky Mountain.

[Operator:]

And we --

[Bryan Merryman:]

We don't have any international tax issues or any international taxation, so that's not an issue.

[Operator:]

And we do have an additional question from Jason Cassidy who is a Private Investor.

[Jason Cassidy:]

Hi. Can you talk about the two brands that you acquired earlier this year? Are those growing brands? And how do you market and distribute those products?

[Bryan Merryman:]

Well, we -- two very small brands that we acquired FernCreek Confections and Elaine's Toffee Company. Really what we acquired was equipment inventory and a set of customers. We have not been through a full year with those two brands yet. We did have good sales with those this year and we'll have a better idea about how those brands look next year when we report our year-end. But we picked up some very good customer relationships and some kind of high-profile customers and we're optimistic, we can grow those relationships both with Elaine's FernCreek and hopefully also bring Rocky Mountain Chocolate Factory those customers as well. But it's early on with those brands and very small acquisitions.

[Jason Cassidy:]

Okay. It sounds like the view of the yogurt business is changing, if you're kind of signaling that that's going to be a diminishing part of the company, I wonder with the balance sheet being pretty strong, what your view of the acquisition is if that's the strategy that you'll prosecute from here or just be opportunistic or do you have any thoughts on the broader growth by acquisition category?

[Bryan Merryman:]

That's really not our focus right now. Our focus really is to try to grow our franchise system. Really try to grow what we call specialty markets and that's just sales outside of our franchise system as well as to grow internationally, that's our focus right now. We have looked at acquisitions in the past and identified a couple of the companies which fit well with Rocky Mountain, but there's no discussions going on right now. That could happen in the future depending on the relationship between Rocky Mountain Chocolate Factory and those companies. So, that could change, but that's not our focus right now. It could become our focus in the future again. We'll see how this strategy plays out.

[Jason Cassidy:]

Okay. Thank you.

[Operator:]

And we do have a follow-up question from John Gay from The Quiet Investor. Please go ahead with your follow-up.

[John Gay:]

Yes, thank you. I think you've already answered that when you talked about the international franchising efforts, which is what I was really concerned with. Thank you for attending to that.

[Operator:]

And gentlemen, once again at this time, I'm showing no additional questions.

[Franklin Crail:]

All right. Thank you very much Operator. And again thank you very much for participating in our third quarter conference call and we look forward talking with you again at year end. Have a nice day and we will be back with you later. Bye, bye.

[Operator:]

And ladies and gentlemen to access the digital replay of this conference, you may dial 1-877-344-7529 or 1-412-317-0088, beginning at 6