Rocky Mountain Chocolate Factory, Inc. (NASDAQ:RMCF) Q3 2024 Earnings Call Transcript

Rocky Mountain Chocolate Factory, Inc. (NASDAQ:RMCF) Q3 2024 Earnings Call Transcript January 11, 2024

Rocky Mountain Chocolate Factory, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, ladies and gentlemen. Thank you for standing by. Welcome to today’s conference call to discuss Rocky Mountain Chocolate’s Financial Results for the Fiscal Third Quarter 2024. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded. Joining us on the call today are the company’s CEO, Rob Sarlls, and CFO, Allen Arroyo. Please be advised that this conference call will contain forward-looking statements that are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to certain known and unknown risks and uncertainties as well as assumptions that could cause actual results to differ materially from those reflected in these forward-looking statements.

These forward-looking statements are also subject to other risks and uncertainties that are described from time to time in the company’s filings with the SEC. Do not place undue reliance on any forward-looking statements, which are being made only as of the date of this call. Except as required by law, the company undertakes no obligation to publicly update or revise any forward-looking statements. The company’s presentation also includes certain non-GAAP financial measures, including adjusted EBITDA, as supplemental measures of performance of the business. All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with the SEC rules. You will find reconciliation tables and other important information in the earnings press release and Form 8-K furnished to the SEC earlier today, which are currently available on the company’s EDGAR page on the SEC’s website and will be available on the company’s Investor Relations section of its website within approximately 24 hours after this call has ended.

And now, I will turn the call over to the company’s CEO, Rob Sarlls. Rob, please go ahead.

Rob Sarlls: Thank you, and good morning, everyone. We accomplished a major pivot in our business in the fiscal third quarter, with the permanent relocation of our consumer packaging functions to a third-party world-class co-packer in Utah. This co-packer will now handle all of the final assembly of our boxed and toted chocolates, fulfilling a critical need within our simplify and focus strategic objective. Labor availability has been a challenge in Durango for a while, particularly for our labor intensive packaging operation. It has historically taken anywhere between 15 and 50 people to hand pack assorted chocolate boxes and other toted items with manpower needs typically peaking during the holiday season. We had a particularly tough year with labor in 2023 such that we were frequently deploying chocolate manufacturing talent to fill and complete boxed chocolate needs.

This not only reduced our availability to fully meet seasonal holiday production requirements, but also impacted our ability to capitalize on new business opportunities, including e-commerce. This difficult but critically needed transition, the third-party co-packing, came with additional one-time relocation costs, including additional transportation and expedited production costs to prioritize the delivery of inventory to our franchisee network and omni-channel partners. Although this had a temporary impact on margins, it was an essential step to ensure a positive outcome for our partners and to strengthen our long-term positioning. The combined effects of these factors prevented us from fully capturing anticipated holiday volumes, and we estimate the resulting impact would have been approximately in excess of $1 million in unrealized product sales.

Despite the short-term impact, we are pleased with the net result of the packaging move to Utah, and I’m proud of the hard work by our operations and supply chain team to facilitate this relocation effort in the midst of our busiest season. As a consequence, we’ve eliminated the long-standing production ceiling we faced in Durango, and this move has created substantial additional capacity to meet future demand. As evidenced, in December alone, we produced in Durango nearly 50% more pounds of premium chocolate products than we did in the entirety of the fiscal fourth quarter of the prior year. This is a direct result of labor relief in Durango as our production team can now focus on what they do best, making even more high quality premium chocolate and confectionary products.

This improved configuration empowers us to meet the higher demand volumes we anticipate from new and existing specialty retail omni-channel partners as well as planned expansion in e-commerce and our franchise network, which we plan to expand in the years ahead. Quickly turning to several other milestones that reflect the ongoing execution of our strategic transformation plan. To do more with less, we once again made meaningful reductions in G&A, marking our third consecutive quarter of double-digit sequential improvement. We also made continued progress in growing our product gross margins, which reached to double digits on an adjusted basis for the first time in a year. To amplify and elevate the Rocky Mountain Chocolate brand, we engaged an award-winning retail and hospitality design firm, Design Well Spent Co. to lead the aesthetic refresh of both company and franchisee owned storefronts.

Additionally, as we announced in November, we completed the build out of our senior leadership team with the addition of Kara Conklin as our VP of Franchise Development, who joins us from Focus Brands. Kara brings nearly 20 years of franchise and operating experience. She has a proven track record with multi-unit operators, an area in which we are focusing on much more in the future, and as importantly, a passion for the transformation and elevation of our brand in the franchise business world. Kara is already out in front of current and prospective franchisees, pushing forward our stated plans to expand our franchise store base over the next several years. Turning to the Board, in December, we added the appointment of Steve Craig, a seasoned business strategist and successful retail developer, to the Board of Directors.

For nearly four decades, Steve has developed, owned and operated commercial real estate primarily outdoor malls for retail shops and restaurants throughout the United States. He brings nearly 30 years of Executive and Board experience with both public and private companies. Steve is also committed to the development of aspiring entrepreneurial youth, having funded an endowment and founding the Steven L. Craig School of Business at Missouri Western State University. And in fact, the Craig School of Business Center for Franchise Development, which offers training to students interested in franchise ownership, has graduated 33 students who were awarded franchises, but this includes 15 alumni currently operating — actually 10 alumni operating 15 Rocky Mountain Chocolate stores, some of which are among our best operators.

Steve’s direct experience as a multi-unit operator and franchisee of Rocky Mountain Chocolate since 2011 made him an ideal addition to our Board. To summarize the quarter, our new management team is fully built and laser focused on executing on our strategic transformation plan. The lessons learned from the holiday season and our relocation of our consumer packaging to Utah have us well equipped to better capitalize on the upcoming Valentine’s Day demand cycle and other critical business opportunities going forward, including e-commerce and expanding business with existing and new specialty retail customers with much greater certainty. The hard work continues and we’re nearing an inflection point as we prepare to return to growth and profitability in fiscal 2025.

I will now hand it over to our CFO Allen to discuss our fiscal Q3 financial highlights before returning for closing remarks. Allen?

Allen Arroyo: Thank you, Rob. Please note that all financial results discussed today are for continuing operations, while all variance commentary is on a year-over-year basis, unless stated otherwise. Moving on to our results. Total revenue was $7.7 million compared to $8.8 million in the prior year. The decrease was attributable to higher factory overhead and production constraints related to personnel at our Durango facility, the latter of which impacted fulfillment and offset strong holiday seasonal demand. Taking a deeper look at our sales, total product sales were $6.1 million compared to $7.3 million. Royalty and marketing revenue was $1.2 million versus approximately flat over the prior year. Retail sales at our company-operated stores increased 21% to $364,000 compared to $302,000.

The increase was a result of opening of a second company-owned store in July 2023. Same-store sales for our company-owned store in Durango decreased 1.1% year-over-year, primarily due to the aforementioned production constraints. Same-store sales across all domestic Rocky Mountain Chocolate Factory locations decreased 2.1% during the quarter compared to the prior year. And franchise fee revenue was $41,000 compared to $49,000. Total product and retail gross profit was $0.7 million compared to $1.9 million, with a gross margin of 10.2% compared to 24.5%. The decrease was primarily attributed to the previously mentioned constraints, which led to lower product availability and overhead absorption. The decrease in gross margin was also due to one-time costs associated with the relocation of packaging operations to Salt Lake City, Utah.

Total operating expenses decreased 7% to $8.5 million compared to $9 million. The improvement was due primarily to a decrease in professional fees related to the costs associated with the contested solicitation of proxies in fiscal 2023. Net loss from continuing operations was $0.8 million or $0.12 per share compared to a net loss from continuing operations of $0.2 million or $0.03 per share. Adjusted EBITDA loss was $3 million compared to adjusted EBITDA of $1.2 million. The decrease was primarily due to lower sales and gross margin, partially offset by lower sales and marketing expenses and franchise costs. Turning to our balance sheet, we ended the third quarter with a cash balance of $2.1 million compared to $4.7 million at the end of fiscal year 2023.

The net decrease in cash was primarily due to cash used in operations and the purchase of property and equipment, partially offset by the sale of [indiscernible] assets. For the nine months through the end of the third quarter, we spent $2.5 million in capital expenditures, the highest level for such time period in over a decade. In the near future, we’ll be exploring the use of equipment-based financing as part of our capital structure. We ended the third quarter with total inventories of $3.7 million, roughly flat compared to the year-end fiscal 2023. As of November 30, 2023, we utilized $1.0 million from our line of credit. However, our balance sheet remains free of any long-term debt. With that, I’d like to turn the call back over to Rob for closing remarks.

Rob Sarlls: Thanks, Allen. Looking to the close of fiscal 2024 and beyond, the actions we’ve taken over the past year have laid the groundwork for the future of the business. We’re in a much stronger position going into the 2025 fiscal year to support and sustain our current business and take better advantage of new business opportunities than we were entering fiscal 2024. Our efforts and execution of the transformation plan are beginning to bear fruit, and we have the right team in place to accelerate the execution next year. That concludes our prepared remarks. We’ll be glad to answer any questions now. Operator, back to you.

Operator: Thank you. [Operator Instructions] Our first question comes from [Jim McIlree] (ph) with Dawson James. Your line is open.

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Q&A Session

Unidentified Analyst: Yeah, thank you, and good morning.

Rob Sarlls: Good morning, Jim.

Unidentified Analyst: I’m trying to understand the inventory levels and the issues that you had with the co-packaging. It seems like if you’re having trouble with the co-packaging that you would have just shipped out as much inventory as you had and that inventory level should go down. I’m just — if you can help me understand what’s going on there?

Rob Sarlls: Yeah, sure. So, typically, our inventory builds going into, let’s call it, the September-October timeframe, and we had challenges in labor throughout the fiscal year. Back in June, we had to institute a pretty meaningful hourly wage increase to attract new talent to work in the production facility. And then, we typically in past years needed to add on, again, as I said in my prepared remarks, anywhere from 15 to 50 folks to package final box products. So, we deliberately managed our inventory’s lean going into the end of last fiscal year and it was the ramp up for the current fiscal year that was made difficult by the labor challenges. So, we would have probably had — well, no, we definitely would have had higher inventory levels had we been able to recruit faster than we had anticipated.

And the move to get the outsource of the final packaging, which had always been in our strategic plan, was accelerated to make sure that we met as much of the current holiday for ’23 as we possibly could.

Unidentified Analyst: Okay. And then, I’m also trying to understand the packaging move. So, I know that it’s been part of the plan, but was it delayed this quarter? Or did you have specific issues with the move this quarter?

Rob Sarlls: No. There was no scheduled move at the beginning of the current fiscal year. As the labor situation unfold at Durango, it became imperative that we find an immediate solution, because we could not get enough labor to do the very manual hand packing of individual chocolates into assorted boxes or dropping them into what we call these stand up totes. So, getting the co-packing into Utah the second week of October really ensured that we can meet the super majority of the demand, but not all of the demand that we possibly could. So, it was a very necessary, very immediately needed move. It happens to fit with the strategic plan, and it completely sets us up for the future where there’s unlimited labor to access in Utah as we ramp up our business going forward.

Unidentified Analyst: And is that transition complete now?

Rob Sarlls: Yes.

Unidentified Analyst: Or is there — are there any remaining issues that you need to address in order to finish up that transition?

Rob Sarlls: No. That transition was essentially completed while the bus was running at 100 miles an hour. The good news is some of the extra costs that we incurred in the quarter, we had a different charge from the co-packer was done with hourly rates of people, that is moving to per piece pricing as of 11 days ago. So, we’re going to have much greater visibility and also accountability of our new co-packing partners be as efficient as they can be. And that will give us the benefit going forward.

Unidentified Analyst: Okay. And just two more if I might.

Rob Sarlls: Sure.

Unidentified Analyst: You mentioned the capital spending. In the quarter, can you indicate what your capital spending needs are for this fiscal year and next if you have — if you can?

Rob Sarlls: Yeah. Let me start and then I’ll have Allen finish. So, the number we cited at $2.5 million, that was through November, so that’s a nine-month number. And Allen, why don’t you take it from there?

Allen Arroyo: Yeah. No, we’ve essentially spent most of the CapEx for the fiscal year. We have some payments remaining, but essentially we’re complete with that. We’re currently planning our capital allocation strategy for fiscal ’25, which, again, we had a strategic plan that we signaled earlier in the year that said, over the two years, it would be about $6 million to $6.5 million. So, we’re currently evaluating that. Again our priority is to get into operating cash flow positive quickly, but we are monitoring that. But as far as this fiscal year, most of the spend has occurred.

Unidentified Analyst: And when you said that over the two years the $6 million to $6.5 million, were you referring to fiscal ’24 and ’25 or ’24 and ’25?

Allen Arroyo: No, ’24 and ’25 when we announced that earlier in the year.

Unidentified Analyst: Okay. And I’m sorry, just one more.

Rob Sarlls: Sure.

Unidentified Analyst: The gross margin with the packaging now moved to Utah, is — does that just get you back to what prior gross margins are, or should that result in, let’s call it, nothing is permanent, but let’s call it a permanent improvement in gross margins?

Rob Sarlls: That’s a hard one to answer. Let me do the best I can and have Allen chime in. Clearly, we’re looking to improve margins and doing everything we can to get there. This was really more of a function of ceilings and prevention to do what you can do in terms of meeting needs or expanding the opportunity of the business. So, there’s always an “added cost” when you go outside versus inside. But the fact of the matter is that when you are either paying time and a half or double time to existing employees to shift away from manufacturing product to packing product and/or dealing with having to hire expensive temporary talent in Durango, the added cost becomes less of an issue rather than just actual availability to complete what you can complete.

So, volume solves a lot, and margins get better with volume. We’ve been needing to ramp up volume for a couple of years, even preceding all of us that have joined in the last year-and-a-half or so. So, enabling to open up that volume capture without any limitation, that’s going to provide more of this solve with respect to operating margins. And I think anything else — Allen, anything to add?

Allen Arroyo: No, I think that covers it. I think the outsourcing of the packaging itself doesn’t improve it, but as Rob mentioned being able to increase throughput is what’s going to bring the margin improvement overall.

Unidentified Analyst: Okay. Very good. Thank you. And I’ll talk to you later. Thank you.

Rob Sarlls: Appreciate the questions, Jim. Thank you.

Operator: Thank you. [Operator Instructions] Our next question comes from Roger Lipton with LFSI. Your line is open.

Roger Lipton: Yes, good morning, Rob and Allen.

Rob Sarlls: Good morning.

Roger Lipton: It sounds like you’re set up, I could say, finally. It hasn’t been so long, it just seems that way if you own the stock. But you talked about being set up now to deliver against the new demand, omni-channel demand and so forth. In particular, what are the omni-channels that you expect to see this increased demand from?

Rob Sarlls: Great question. And just for everybody’s benefit, realize that we have two primary businesses. One and the most important in our hearts is taking care of our franchisees and that is a super majority of our business as everybody knows. But we’ve had a long-standing multi-decade business of working with specialty retailers and also have a e-commerce opportunity that we’ve yet to fully hit the gas pedal on. And so, speaking backwards, e-commerce can be much better met and fulfilled when you have no ceiling on how much boxed chocolate you can make from a labor standpoint. So that will open up e-commerce at some point in the very near end future. With the specialty retailer, again, we’ve had multi-decade relationships.

We’ve had a particularly excellent fulfillment with a couple of them despite the challenges we had that would like to see us do more volume. And then, Andrew Ford and his team have been actively courting other retail opportunities where we are now a more attractive option than some heritage brands that are in the marketplace. And we continue to pursue those and look forward to having further updates in future quarters.

Roger Lipton: Okay. And you mentioned Steve Ells. Steve Ells, as I recall, was — built Chipotle. Is there a relationship there?

Rob Sarlls: No, it’s Steve Craig.

Roger Lipton: Oh, Steve Craig. Okay. I’ll use as Steve Craig. I could have sworn you said Steve Ells, but I could be wrong.

Rob Sarlls: No problem.

Roger Lipton: Okay. Thank you, gentlemen. I still would love to come to Durango one of these days and — or maybe Utah now to see the new package…

Allen Arroyo: Yeah, come to Durango.

Rob Sarlls: Come to Durango.

Roger Lipton: Well, that’s okay, that’s fine. It’s easier to get to Salt Lake City than Durango, but whichever. Thank you very much. Talk to you soon.

Rob Sarlls: Great, Roger. Thanks for the questions.

Operator: Thank you. There are no further questions. Thank you, ladies and gentlemen. This concludes today’s conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.

Allen Arroyo: Thank you.

Rob Sarlls: Thanks, everyone, and thanks, Michelle.

Operator: You’re welcome.