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Rocky Mountain Chocolate Factory, Inc. (NASDAQ:RMCF)

F2Q 2014 Earnings Conference Call

October 15, 2013 04:15 PM ET

Executives

Franklin Crail - Chairman of the Board, President, Chief Executive Officer

Bryan Merryman - Chief Financial Officer, Chief Operating Officer, Treasurer, Director

Analysts

Tom Kerr – Singular Research

Robert Littlehale – JPMorgan

Jeff Geygan – Milwaukee Private Wealth Management

Bill Wolfenden – Cottonwood Investments

Operator

Hello and welcome to the Rocky Mountain Chocolate Factory second quarter earnings conference call. All participants will be in listen-only mode. (Operator Instructions). After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded.

Some of the statements made during this call may be considered forward-looking statements that involve a number of risks and uncertainties. There are several factors that could cause actual results of Rocky Mountain Chocolate Factory to differ materially from these forward-looking statements. These factors include, but are not limited to, the potential need for additional financing, the availability of suitable locations for new stores, and the availability of qualified franchisees to support new stores, customer acceptance of new products, dependence upon major customers, economic and consumer spending trends, and such other factors listed from time to time in public announcements and in Rocky Mountain Chocolate Factory’s SEC reports.

In addition, please be advised that the financial results for the fiscal periods presented in this call do not necessarily indicate the results that may be expected for any future quarters or the upcoming fiscal year. To Rocky Mountain Chocolate Factory’s knowledge, the information relayed in this conference call is correct as of the date of its transmission and the company does not undertake any obligation to update this information in the future.

I would now like to turn the conference over to Franklin Crail, CEO. Mr. Crail?

Franklin Crail

Thank you. Good afternoon, ladies and gentlemen, and welcome to Rocky Mountain Chocolate Factory second quarter fiscal 2014 conference call. I am Frank Crail, President of Rocky Mountain Chocolate Factory and with me here today is Mr. Bryan Merryman, the company’s Chief Operating Officer.

We are going to start the call this afternoon with Bryan giving you a summary of the company’s operating results for both the second quarter and the first six months of fiscal 2014. In conclusion of this presentation, we will be happy to answer any questions you may have at that point.

I’d like to turn the call over to Bryan right now.

Bryan Merryman

Thanks, Frank. I’d also like to welcome everyone to our call today. First, I will start out with some highlights on the first half of the year and then I will get into a little bit more detailed operating information.

In the first half, we have strong positive same-store sales and same-store pounds purchased from Rocky Mountain Chocolate Factory’s domestic franchise system. We also had further international progress with the execution of license agreements, covering the countries of South Korea and the Kingdom of Saudi Arabia and we opened our first South Korean store in May of this year and our fifth store in September of this year.

After exceeding the expectations in the initial test phase of Kellogg’s Rocky Mountain Chocolate Factory Chocolatey Almond Cereal, Kellogg’s informed us of an expanded rollout plan for early 2014. The consolidated entity had solid revenue growth, driven by increased royalty and marketing fees, retail sales and franchise fees. We secured approval to repurpose up to $2.5 million of our existing $5 million line of credit and a preliminary term sheet for up to $7 million of additional financing to continue to seek frozen yogurt acquisition opportunities.

Our frozen yogurt operation [swung] from a significant loss in the prior year to a significant profit in the current year validating expectations with the transactions consolidating our yogurt operations would create scale and a profitable company capable of becoming a consolidation force in the frozen yogurt industry. We finished the quarter debt-free and on September 13, we paid our 41st consecutive quarterly cash dividend.

For the first six months, total revenues increased 8.4%. This was driven by an increase in royalty and marketing fees of 25.1%. This increase was due to increased franchised units in operation resulting from acquisitions and consolidations of our frozen yogurt operations.

Franchise fees increased to 112.6%. This was due primarily to an increase in international license fees. We also opened 11 new store franchise locations and two Rocky Mountain Chocolate Factory domestic franchise locations. This was partially offset by decrease in domestic U.S. Rocky Mountain Chocolate Factory franchise openings from four in the prior year to two in the current year.

Retail sales increased 19.8%. This was due to an increase in the average company-owned units in operations and the increase in unit volume, resulting from the acquisition of our majority-owned subsidiary U-Swirl. We also had a 1.2% increase in company-owned same-store sales.

Franchise Rocky Mountain Chocolate Factory same-store sales were up 2.4% in the first half. Same-store pounds purchased were up 2.5% in the first half. Factory adjusted gross margin decreased 10 basis points. A small decrease in adjusted margin was due to a small decrease in production in the first six months of the year.

Net income increased to approximately $2,207,000 from $1,891,000 in the previous year. Fully diluted earnings per share were $0.35 versus $0.30. We continue to generate excess cash flow. On September 13th, the company paid its 41st consecutive quarterly cash dividend. The company finished the first six months of the year in excellent financial condition, 3.4 to 1 current ratio and remains free of long-term debt. We opened 22 locations in the first half including 11 U-Swirl locations, six locations co-branded with Cold Stone stores, three international stores and two domestic Buckingham Chocolate Factory standalone stores.

In the second quarter, total revenues increased 12.1%, our factory revenues increased 2.6%. We had a 2.2% increase in same-store pounds purchased by our domestic franchisees and 8.4% increase in shipments to customers outside of our system of franchise stores. Our retail sales in the second quarter increased 21.4%, again this was due to more company-owned units in operation and resulted from our acquisition of U-Swirl and our company-owned locations. This was partially offset by a decrease of 0.4% in same-stores sales at Rocky Mountain Chocolate Factory’s company-owned locations.

Our royalty and marketing fees increased 30.8%, an increase of, due to an increase of 18.6% in domestic franchise stores including our U-Swirl locations. Also we had a 1.7% increase in same-store sales at domestic Rocky Mountain Chocolate Factory locations.

Our franchise fees increased 75.6% in the second quarter. We opened 8 U-Swirl locations and 1 Rocky Mountain Chocolate Factory domestic location. Factory margins increased to 150 basis points in the second quarter to 38.5% from 34.3% this was due mainly to an increase in average selling price of the product.

Our net income increased to $1,028,000 versus $829,000 in the previous year. Basic earnings per share were $0.17 versus $0.14, fully diluted earnings per share were $0.16 versus $0.13. During the quarter we opened 15 stores, 8 U-Swirl stores, 4 co-branded with Cold Stone and one domestic store and we had two international openings both of which were in Korea. We continue to generate excess cash flow in the second quarter and finished the quarter with approximately $4.1 million in cash.

With that I’ll turn it back over to Frank.

Franklin Crail

Thanks Bryan. All right at this time, we would be happy to answer any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Tom Kerr with Singular Research.

Tom Kerr – Singular Research

Hi guys. Two questions, any further comment or insight into the strength in same-store sales, a positive number there or was that consumer spending difference or something to that extent? And second question any updates on Japan whether it’s new partners or new unit openings? Thanks.

Bryan Merryman

Tom on the first question I think that the economy continues to be better than it was in the previous year slightly. Also over the past several years, we've closed down a number of weaker stores that would generally report weaker comps. And so both same-store pounds purchased and comps are little stronger than the economy I think because our store base has gotten stronger with the elimination of some weaker stores over the recession in the past couple of years as well. On Japan we’re still five units in Japan and we still have business development activities going there and we still continue to seek another partner in Japan.

Tom Kerr – Singular Research

Okay, thanks.

Operator

Our next question comes from [David Lucy], he is a private shareholder.

Unidentified Analyst

Hi guys, good quarter. Just to continue on Japan, do you think the setback or stalling there is all about the partner or is that big decrease in the Yen have anything to do with that do you think?

Bryan Merryman

I think that’s a secondary cause of, we’re kind of getting on track in Japan, the Yen is a secondary cause that certainly didn’t help I think just operations is the primary cause. And I think that the real estate strategy is being fine-tuned there as well. And I think we’ll see a resumption of growth here in the next 6 to 12 months and it will not be in regional mall locations, it will be in different real estate, but maybe more savings for our concept in Japan.

Unidentified Analyst

Great. Thank you very much.

Operator

The next question is from Robert Littlehale with JPMorgan.

Robert Littlehale – JPMorgan

The acquisition of Josie’s which I guess was done by U-Swirl. Could you talk a little bit about the rationale behind that please?

Franklin Crail

The Josie’s acquisition was 11 units. It’s a very small system and the founder of the system didn’t want to support the system anymore, didn’t really have the resources. The CEO of U-Swirl negotiated that deal and brought Josie’s into the U-Swirl system for no upfront consideration. There is a somewhat small earn-out that could happen for the founders and owners of Josie's over the next couple of years, but the transaction is really not material.

Operator

(Operator Instructions) We do have another question from Jeff Geygan, he is with Milwaukee Private Wealth Management.

Jeff Geygan – Milwaukee Private Wealth Management

Bryan, did you mention the same-store sales for the yogurt business?

Bryan Merryman

We're not reporting same-store sales for the yogurt business because we didn’t own the units in the previous reporting period. We know the number, but it's not our number.

Jeff Geygan – Milwaukee Private Wealth Management

I see. The change, the repurposing of your line of credit plus the new term sheet that you referenced for $7 million, what does that imply about your future use of leverage as it relates to either Rocky Mountain or the yogurt business?

Bryan Merryman

Well, both of those actions were taken because we have opportunities to put that money to work. We wanted to get financing in place in advance of closing on some trip transaction. And so that’s just through -- hopefully that’s a small step in what we do in the next 12 to 24 months as it relates to the acquisition opportunities that we see out there.

Jeff Geygan – Milwaukee Private Wealth Management

Okay. And I assume that as you are talking about acquisition opportunities that's Yogurt?

Franklin Crail

Yes, that's Frozen Yogurt. It's not that we're not looking for acquisition opportunities for Rocky Mountain Chocolate Factory as well, they just come around a lot less often.

Jeff Geygan – Milwaukee Private Wealth Management

Understood. And should we as shareholders start thinking differently about Rocky Mountain Chocolate Factory as a yogurt centric business?

Franklin Crail

Well, I would say right now Rocky Mountain Chocolate Factory, the chocolate operation endorsed the yogurt operation, there is certainly the opportunity for the yogurt business in the near term to be at least as large as the chocolate business. Almost every company we have talked to and even companies we haven't talked to through our advisors and the people we know in the industry, it just appears that every single yogurt company out there is for sale.

And so I think there is just a tremendous consolidation opportunity. And so for successfully it, we could find ourselves with a business that’s as large as a Rocky Mountain Chocolate Factory or larger.

Jeff Geygan – Milwaukee Private Wealth Management

Interesting. And back to the store disclosure, if I look at more same-store sales, if I look at U-Swirl's release, will they break out same-store sales year over year?

Franklin Crail

They won't, because the number of locations that we didn't own in the prior period, don't have same-store sales in them. We don’t own them so we don’t report same store sales on those locations.

Jeff Geygan – Milwaukee Private Wealth Management

I see. And then at some will you breakout the Yogurtini, Aspen Leaf, U-Swirl, so we get a better sense of the evolution of those businesses?

Franklin Crail

Well, U-Swirl in their filings breaks out some information as it relates to those concepts. So if you go and look at their Q and their K, you will see for instance units are broken out by the three brands. Hopefully at some point in the future we’ll have enough units in whole brand, our entire system under one brand and we won’t be talking about separate brands. But for now there is some separate information that is available in their filings.

Jeff Geygan – Milwaukee Private Wealth Management

Great. Thank you.

Operator

Our next question comes from Bill Wolfenden with Cottonwood Investments.

Bill Wolfenden – Cottonwood Investments

Hi. Good afternoon. You made an interesting comment of ‘every yogurt store’s for sale’, I am just wondering if you could expand on that. Is that to tell you something about the nature of the business and is it not a good business or is it mostly mom and pop people, they’re trying to catch out? I am just trying to figure out that comment. And then secondly what are the ranges of multiples that you anticipate paying for these yogurt companies?

Franklin Crail

Well I think that it’s pretty clear in a lot of the country not everywhere. I mean there are still frozen yogurt stores that are opening in various parts of the country, but in other parts of the country we're seeing consolidation and a lot of closures. And in other parts of the country the most matured parts we’ve seen consolidation and now units opening again. And so I think we’ll continue to see that trend of consolidation units open and reconsolidation. It’s clear that in many, many markets if the concept was way overbuilt and the consolidation needed to happen. Same store sales, at nearly every target that we look at are down high single-digits to low double-digits. And so there is clearly pressure on the industry to consolidate stores.

However, we believe there are good stores in almost every target that we've looked at that will last for the long term. And consequently we’re paying and we are willing to pay very low multiples as it relates to acquisitions of groups of stores in the royalties to come with those stores.

So in anticipation, the reason we do that is that when you analyze a store base of almost everyone that we've looked at, there is quite a few stores in there, that we don’t expect to be around in the long term and their revenue streams to be around in the long term. So it’s a business that you have to make sure, you don’t pay too higher multiple for.

Bill Wolfenden – Cottonwood Investments

So when you say lower multiples, are we talking two to three times cash flow here?

Franklin Crail

We’re talking in that neighborhood and we are also talking about eliminating most of the overhead and most of the targets that we are looking at.

Bill Wolfenden – Cottonwood Investments

And is that because you’re consolidating stores or there is a benefit of scale with multiple stores or combination?

Franklin Crail

Well, we’re talking on systems. And we don’t really need the overhead from those systems to support those stores.

Bill Wolfenden – Cottonwood Investments

Corporate overhead, not store level, I understand, what you are saying.

Franklin Crail

Right. Corporate overhead, almost a 100% of it.

Bill Wolfenden – Cottonwood Investments

Understood. And then obviously you have done market research, the market’s still growing or holding but there is just too much saturation of stores. So in other words if there is five yogurt stores in my town and then they are doing $100 of sales total and then two of them closed, are the other three still doing $100 of sales or does that number decrease? Do you understand the question, the overall number?

Franklin Crail

Yes. I do understand the question. And according to the research sources that we have, the industry continues to grow. And the total growth in the industry still looks pretty good. However there is just way too many units out there.

Bill Wolfenden – Cottonwood Investments

No, that’s something that I can see that in the town, earlier there used to be five and now there is three.

And then last question, shifting gears if I may. A few of the retailers recently have been reporting negative numbers last week, but you just actually reported some tough numbers citing the macro environment. Are you guys seeing any slowdown since the end of the quarter in September and October from the consumer perspective?

Franklin Crail

Well, we don’t provide that information unfortunately, but I will say that over the last eight or nine quarters same-store sales have been positive every quarter. They have been choppy month to month sometimes, but overall the direction is positive, we don’t see any dramatic change in the run rate of our sales since the end of the quarter.

Bill Wolfenden – Cottonwood Investments

Great. Thanks for the time.

Operator

We show no further questions at this time. I would like to turn the conference back over to management for any closing remarks.

Franklin Crail

Okay. Thank you, operator. Again I would like to thanks everyone for attending our conference call this afternoon and we will be talking with you again in three months. Have a nice day. Thank you.

Operator

Thank you. To access the digital replay of this conference you may dial, 187-734-475-29 or 412-317-0088, beginning at 5:45 PM Eastern Time today. You will be prompted to enter a conference number, which will be 10034905. Please record your name and company when joining. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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