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

F3Q 2014 (Qtr End 11/30/2013) Earnings Call

January 21, 2014, 4:15 PM ET

Executives

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

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

Analysts

James Fonda - Sidoti & Company

Tom Kerr - Singular Research

David Luebke - J.P. Turner & Company

Jeff Geygan - Milwaukee Private Wealth Management

Operator

Hello and welcome to the Rocky Mountain Chocolate Factory third quarter earnings conference call. (Operator Instructions)

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. 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, everyone, and welcome to Rocky Mountain Chocolate Factory's third 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're going to start the call this afternoon with Bryan giving you a summary of our third quarter and nine months operating results, and at the conclusion of this presentation, we'll be happy to answer any questions that you may have.

So at this time, I'll turn the call over to Bryan.

Bryan Merryman

Thanks, Frank. I would also like to welcome everyone to today's call. I'm going to start with a few highlights from the first nine months of the year and then get into some operating details on the nine months and the three months.

For fiscal 2014, we showed further international progress with the execution of license agreements covering the country's of South Korea and the Kingdom of Saudi Arabia, and opened the first South Korean store in May and our fifth store in September. We expect the first Saudi Arabian store to open in the first quarter of fiscal 2015.

After exceeding expectations in initial test phase of Kellogg's Rocky Mountain Chocolate Factory Chocolatey Almond Cereal, Kellogg's informed us of an expansion rollout plan for early 2014. We showed solid revenue growth driven by increased royalty and marketing fees, retail sales and franchise fees.

Our frozen yogurt operation swung from a significant loss in the prior year to a modest profit in the current year, validating expectations with the transactions consolidating our yogurt operations, created scale and a profitable company capable of becoming a consolidation force in the frozen yogurt industry.

Subsequent to the end of the third quarter, Rocky Mountain Chocolate Factory and Wells Fargo Bank finalized a $7 million bank credit facility agreement for the purposes of funding acquisition by the company's majority-owned subsidiary U-Swirl, Inc. Also subsequent to the end of the third quarter, on January 17, 2014, Rocky Mountain's majority-owned subsidiary, U-Swirl, Inc., completed the acquisition of two self-serve frozen yogurt chains.

On a combined basis, the acquisitions more than triple the number of frozen yogurt cafés operated by U-Swirl, its franchisees and licensees. The acquisitions by U-Swirl were funded through a $7.7 million convertible note with Rocky Mountain Chocolate Factory, Inc., and on December 13, we paid our 42 consecutive quarterly cash dividend.

With that, I'll get into more detail on the nine month. Total revenues increased 8.1%. Royalty and marketing fees increased 22.7%, which was increased franchise units in operation, resulting from acquisitions and consolidation of our frozen yogurt operations. Franchise fees increased 57.9%. This was due to an increase in international license fees.

Retail sales increased 19.2%. This was an increase in average company-owned units and unit volume, resulting from the acquisition of a majority position in U-Swirl, Inc., offset by a 1.4% decrease in all company-owned stores same-store retail sales.

Franchise Rocky Mountain Chocolate Factory same-store sales were up 1.8% for the nine months when compared with last year and the same-store pounds were flat down 10 basis points compared to the prior year. Factory adjusted gross margins decreased 20 basis points. This was due to an increase in average selling price more than offset by increase in the cost of certain materials.

Net income was approximately $2,906,000 compared to $1,382,000. Fully diluted earnings per share was $0.45 versus $0.22 last year. On December 13, the company paid its 42 consecutive quarterly cash dividend of $0.11 per share.

The company finished the nine months in excellent financial condition of 3.31 to 1 current ratio. During the nine months, we opened 27 new locations, including 12 U-Swirl locations, five Cold Stone co-branded locations, six international locations, and one company-owned store and three domestic RMCF standalone franchise openings.

For the third quarter, total revenues increased 7.5%, factory revenues increased 4.7%. This was due to a 31.8% increase in shipments to customers outside our system of franchise stores, partially offset by a 4.9% decrease in same-store pounds purchase by our domestic franchises. We believe the decrease in same-store pounds purchase is a result of a change in the number of shopping days after Thanksgiving and a corresponding change to franchise purchases.

Retail sales increased 17.4%. This was due to an increase in average company-owned units, resulting from the acquisition of a majority interest in U-Swirl and their company-owned store locations. This was partially offset by a 7.6% decrease in all same-store sales at company-owned locations.

Royalty and marketing fees increased 16.9%, an increase of 23.7% in domestic franchise stores, including U-Swirl franchise locations. We also had flat same-store sales at domestic RMCF franchise locations.

Franchise fees decreased 40.4% in the quarter. We had five openings in the three months ended November 30, 2012, compared to two in the three months ended November 30, 2013. Factory adjusted margins decreased 40 basis points from 31.2% to 30.8%. This again was an increase in average selling price more than offset by increases in cost of certain materials.

Net income for the quarter was $699,000 compared with a loss of $509,000 in the previous period. Basic and fully diluted earnings per share were $0.11 for the quarter versus an $0.08 loss per share in the prior year.

During the quarter we opened eight stores, including one U-Swirl store; two Cold Stone co-branded store; one domestic RMCF franchise opening; one company-owned store opening; and three international openings, two in Korea and one in Canada. We finished the quarter with approximately $3.4 million in cash and in excellent financial condition.

And with that, I'll turn it back over to Frank for any questions.

Franklin Crail

Thanks Bryan. Operator, at this time, we'll be glad to answer any questions.

Question-and-Answer Session

Operator

(Operator Instructions) And it looks like our first question comes from James Fonda of Sidoti & Company.

James Fonda - Sidoti & Company

Bryan, can you just talk a little bit I guess on the gross margin expansion. I mean I know revenue was pretty strong, but the gross margin didn't expand as much as it did in the previous quarter. So I was just curious on that.

Bryan Merryman

We actually saw our gross margins back up very slightly and this was due to increased raw material costs that have been offsetting our price increase.

Operator

The next question comes from Tom Kerr of Singular Research.

Tom Kerr - Singular Research

I just wanted to see if you guys had any update on Japan? Any new partners, new stores, turn around the existing units there, anything like that?

Bryan Merryman

No. They did pretty well in December. We've decided to give them a year to turn their operation around and begin expansion again before we really take on another partner, based on the magnitude of the investment that they've made. We made a trip to Japan. We talked extensively about the operation, and we're feeling good about our partner and wanting to give them a shot at turning around before we find somebody else.

Tom Kerr - Singular Research

Does that change the long-term original goals of store openings?

Bryan Merryman

No, it doesn't. I think it just puts the significant growth that we'd like to see in that country out at least another year, but it doesn't change our long-term goals.

Operator

Our next question comes from David Luebke of J.P. Turner & Company.

David Luebke - J.P. Turner & Company

Just for the record, I am a registered representative, not an analyst. Bryan, I'd like to ask you, did you make the previously scheduled presentation in Florida this morning?

Bryan Merryman

Yes. We made a presentation. I made a U-Swirl presentation and I also made a Rocky Mountain Chocolate Factory presentation this morning, both happened after the press release went out today and we also announced the acquisitions on Friday. So it felt appropriate to not cancel the presentations.

David Luebke - J.P. Turner & Company

So you think it was appropriate to make a presentation to a select on the acquisition, and [multiple speakers] of the news before this shareholder conference call?

Bryan Merryman

The presentations are 20 minutes long with five minutes of questions and answers. Almost everyone is new to the story. The presentations are very general. And in 20 minutes, you try to explain a business and its opportunity, it's very high level and I believe it was completely appropriate to not cancel those presentations today. Presentations are always given to a select group of people and there was nothing discussed in the presentations about the earnings press release. And we did talk about the acquisitions, but nothing that was in the press release that went out on Friday.

Operator

Our next question comes from [ph] Johan Dakins of RJP Capital.

Unidentified Analyst

A question regarding U-Swirl, are you planning on multi-brand approach there or will you ultimately have only one brand?

Bryan Merryman

Well, in the near-term we are planning a multi-brand approach. Right now, the company that we've acquired as well as I believe every company in the industry is seeing a negative same-store sales and averaging volumes are coming down as well. We don't think right now is an appropriate time to re-brand. But as we gain scale and the shakeout continues in the industry and same-store sales stabilize and AUV start to head north again, at that time we'll look at a national re-branding, because our goal is absolutely to create a national brand.

Unidentified Analyst

I have a further question about Rocky Mountain. Have you been approached by private equity or premium chocolate manufacturers lately?

Bryan Merryman

That's not the information we would disclose on the call. But the company is not in play and we continue to look forward to managing the company and building both companies.

Operator

Our next question comes from Jeff Geygan of Milwaukee Private Wealth Management.

Jeff Geygan - Milwaukee Private Wealth Management

I'm just a little curious about the division between the yogurt business and the chocolate business, and how you see that playing out going forward?

Bryan Merryman

Well, right now the yogurt business has its own management team. We're in the process of setting up a business infrastructure to support both companies. And so we intend to create a holding company infrastructure and ultimately create a holding company, so that there is not duplicative functions in both companies. And so that's how we plan to manage the business.

The management team at Rocky Mountain Chocolate Factory, other than myself is fully focused on Rocky Mountain Chocolate Factory. The management team at U-Swirl is fully focused on U-Swirl, and then I am splitting my time between the two companies.

Jeff Geygan - Milwaukee Private Wealth Management

And as a follow-up, I guess as a shareholder for a long-term, I beg the question, would you be willing to break this company in two, so that the legacy chocolate business can standalone and perform independently and this rapidly growing roll-up of yogurt businesses could perform independently? And the other half of that question is, who within your corporate structure has any kind of roll-up experience, given that that's where we're committing our capital to right now on the U-Swirl side?

Bryan Merryman

Well, I mean I spent my career at Deloitte & Touche and have plenty of M&A experience through my background there. We have an investment-backed banker. I also spent a couple of years working in investment banking. I worked for another company that hired [ph] Salomon Brothers and was sold. And so I have plenty of experience in M&A work. Our investment banker has a ton of experience in M&A work as well.

And really our strategy is very simple, is to acquire franchisors, to do what we do and that support franchise systems and collect royalties in very simple business model, stay away from company stores. And I think we're very well qualified to execute on a role given that it's franchising and it's what we know how to do.

And the first part of that question in terms of that that company is standing alone and being independent of Rocky Mountain Chocolate Factory, that's possible. We have very high hopes for the roll-up, we would like to buy all of the major players in the industry, if that's possible. And depending on how those negotiations would go, if they happen, we're open to any structure that's going to create shareholder value for both the U-Swirl shareholders and Rocky Mountain Chocolate Factory shareholders.

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

Thank you, operator. Again, I'd like to thank everybody for attending our conference call this afternoon and we look forward to talking to you at our yearend. So everyone have a good day and thank you very much.

Operator

To access the digital replay of this conference you may dial, 1-877-344-7529 or 1-412-317-0088, beginning at 6:00 PM Eastern Standard Time today. You will be prompted to enter the conference number, which is 10039052. Please record your name and company when joining. The conference now has concluded. Thank you for attending today's presentation. You may now disconnect.

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