Noble Romans, Inc. - Dirt Cheap - Can Management Deliver?

| About: Noble Roman's, (NROM)
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Summary

Noble Romans, Inc. is down 50% over the last six months, can opportunity be realized?

The company is consistently profitable, even after excessive management compensation and unproductive expenses.

The brand is valuable, enterprise value is four times free cash flow, so what's the problem?

THE COMPANY, MANAGEMENT, DIRECTORS & OWNERSHIP

Noble Roman's Inc. (OTCQB:NROM) is a forty-four-year-old (from 1972) Indiana corporation that sells and services franchises and licenses for non-traditional food service operations and stand-alone take 'n bake locations under the "Noble Roman's" and "Tuscano's" brand names. It is the Noble Roman's pizza brand that has been the primary emphasis through the years and still offers the major opportunity for the Company.

The Company has been run for virtually all those years (since 1974) by Paul W. Mobley, from 1974-1978 as Chief Operating Officer, working his way by 1991 to Chief Financial Officer and Chief Executive Officer. Mr. Mobley (75 years of age) today functions as Executive Chairman of the Board and Chief Financial Officer. He is a Director and the highest paid employee (more on that later), owning 1.956 million shares (8.9% of shares outstanding) plus options on an additional 1.213 million shares (5.5%).

Mr. Paul Mobley's son, A. Scott Mobley (52 years of age), is the President and CEO, since 11/2014. He started with the Company in 1987 (at the age of 23) as Director of Marketing, working his way to President and COO by 1997. He is a Director, second highest paid employee, owns .973 million shares outright (4.6%) plus options on an additional .538 million shares (2.5%).

A third Director (out of 4 current Directors) is Mr. Schuster Tanger (30 years of age) whose money management firm owns 1.426 million shares (6.9%) of which 35,000 are by way of options. Mr. Tanger was appointed to the board in accordance with an Agreement between his firm and Noble Roman's. According to the 8K filed on 4/8/15, Mr. Tanger's firm agreed to (1) a Standstill Period until 8/31/2017 as well as (2) to "vote all shares in favor of the Company's proposals."

The fourth Director, since 1999, has been Douglas H.Coape Arnold (70 years of age). He has been Managing General Partner of Geovest Capital Partners, L.P. since 1997. He is a Chartered Financial Analyst. He owns 55,000 shares outright and has 375,000 options.

According to the current Proxy material, relating to the customary need for independent Directors, "For the purpose of determining director independence, the Company has adopted the New York Stock Exchange definition of independence. The board of directors has determined that Mr. Coape-Arnold and Mr. Tanger are independent directors under that definition."

Before I move on to discuss the fundamental developments at Noble Roman's, I have to question the board's conclusion as to "independent" directors, based on Mr. Tanger's Agreement to "vote all shares in favor of the Company's proposals." In fact, based on the above, and the fundamentals as follows, as a shareholder, I am voting AGAINST management's proposals (1) to elect A. Scott Mobley as a Director and (2) to approve compensation as disclosed (4) to transact other business, voting IN FAVOR ONLY of proposal (3) to engage Somerset CPAs, PC as independent auditors. I am voting this way because, based on the facts as described below, I do not have confidence in management (and the Board of Directors) acting appropriately in the interest of all the shareholders as a group.

THE FUNDAMENTALS AND PROMISE

Fundamentally, Noble Roman's has been a promising situation for many years, but over four decades the potential for growth in sales and earnings invariably seems to elude management and especially the shareholders.

Since 1997, the Company has concentrated on franchising and licensing of non-traditional locations. They have awarded franchises and licenses in 50 states plus D.C., Puerto Rico, the Bahamas, the Dominican Republic and Canada. The non-traditional locations (over 700 units) are primarily in convenience stores, gas stations, and entertainment facilities. There are a small number of company locations and about ten franchises for Take-N-Bake retail outlets (though this approach is currently being revamped). The most promising near term opportunity is for expansion of the number of grocery stores that are licensed to sell Take-N-Bake pies that are freshly assembled and sold through their fresh delicatessen departments.

There were over 1500 grocery stores selling Noble Roman's pies at the end of calendar 2015, and this number appears to be growing steadily at the current time. This approach requires third party distributors in between raw material manufacturers (to NROM specs) and delivery to individual super markets. During 2015 that number grew from eleven to twenty-nine, opening up potential distribution to thousands of new grocery outlets. In conjunction with a new sales effort, an upgraded broker network has been put in place to properly monitor individual store locations. Deli counters have to be stocked in a timely fashion with appropriate product selection, so this distribution, profitable and expandable, is far from automatic and must be properly supported.

In terms of other current "initiatives", management is "retooling" their fast casual Take-N-Bake unit, since the initial versions rolled out several years ago have not generated sufficient sales. Time will tell whether the latest version will be more successful

The Company's non-traditional "kiosk" system has also been recently redesigned and presented at a franchising trade show in February. The response was described as positive but sales results have not been disclosed yet.

First quarter 2016 showed "flat" pretax earnings, year to year, at $584,000. The Company has a $21 million tax loss carryforward. In terms of progress with the grocery network: in 2015, 478 additional licenses were signed, of which 404 locations were opened (152 in Q4). During Q1 of 2016, there were 239 licenses signed, and 93 were opened. Progress is being made, but it is painfully slow. The balance sheet appears strong with under $3 million of bank debt against $15 million of equity, and pretax (untaxed) operating earnings close to $3 million in recent years, but as of a shareholder letter dated 3/14/2016 the Company was working to restructure the debt. It is worth noting that, among the debts, shareholders were owed $160,000 (with a 10% interest rate). The circumstances behind that loan are unclear. We could go back for many years, but this promising situation, comfortably profitable in recent years, has yet to benefit its public shareholder base. Management invariably "overpromises" and "under-delivers", pretax operating earnings remain around $3 million, and the optimistic future never seems to materialize.

Steps were taken in March of 2016 to reduce corporate overhead by $500,000 but my question is "why now?", and not before. The Company has been spending $540,000 per year to present at trade shows, but the results have not been apparent. Paul Mobley has a seven-year employment contract, at $650,000 per year and Scott Mobley's rate is $445,000 annually. They both reduced their salaries voluntarily last year, but no doubt they will be paid fully if results start to improve. Even if the Company starts to earn $5 million (or more) pretax, $1.1 million (plus travel and benefits) is far too much of a burden for a Company of this size.

RECENT STOCK PERFORMANCE & VALUATION

The stock has declined, over a six-month period, by about 50%, from $1.00 to $0.50. (Creating an equity value just over $10 million and an enterprise value of about $13 million. No doubt contributing to the decline was the selling of approximately 2 million shares (10%) by the Privet Fund, which had owned about 15% of the Company (They are at 4.5% according to the most recent filing). They became increasingly disillusioned, as evidenced by publicly disclosed correspondence to management as well as commentary on conference calls. It is worth noting that management dispensed with the quarterly earnings call most recently, for undisclosed reasons.

There appears to be substantial potential here, but shareholders are hurting. This stock is substantially undervalued but management is either uncaring or incapable or a bit of both. We have a more than viable (potentially hugely profitable) mid-western Brand, with a "free cash flowing" licensing business that today generates $3 million (untaxed for a long time to come). An interesting licensing analogy is Nathan's Famous hot dogs. NROM could, and should, be debt free within a year, so dividends, company buyback or re-structuring should be possible. A current enterprise value approximating four times free cash flow is "dirt cheap", but I doubt that this management team can "bring home the bacon".

LIQUIDITY OF SHARES

NROM can appropriately be called a "micro-cap" with a total enterprise value approximating $13 million at the current time. The stock normally trades under 100,000 shares per day, only about $50,000 in market value. It is noteworthy that NROM stock traded over 1 million shares last week, but that level of activity is unusual and may be connected to liquidation of the last shares that the Privet Fund owned. A potential purchaser could view this possibility as a positive, since Privet's selling has likely been part of the recent decline. Should Privet selling be "done", currently or some time soon, it would not take much buying power for the stock to move higher, but purchasers should be appropriately cautious in their bidding.

CONCLUSION AND RECCOMENDATION

An early investing mistake I made was bottom fishing stocks with the assumption that management acts responsibility to protect their investors interests. I was taught to invest in companies that practice sound management principles including fair compensation based on the execution of strategic initiatives that produce results. Ray Kroc always put the franchisee's success first. This has been a key to McDonald's (NYSE:MCD) growth and success.

I intend to hold my shares, and recommend purchase to others. The value here is compelling, and management is experienced enough with a substantial enough stake, to at least hold the Company together, if not realize its potential. As described above, I am very disturbed with the management compensation arrangements, as well as the apparent lack of independence by Directors. I am voting my shares accordingly (as described above) and I suggest other shareholders do the same. There are no "independent" Directors here, no matter what the Proxy material says, so we have to protect our own interest.

Disclosure: I am/we are long NROM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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