Rocky Mountain Chocolate Factory ($RMCF) Summary of Call with CFO Allen Arroyo.

A Couple of New Insights

We had the opportunity to talk with Allen Arroyo, the current CFO of RMCF 0.00%↑ this week. We were impressed with his background, industry knowledge, candor and focus on what needs to be done at the company. RMCF 0.00%↑ continues to be an intriguing long-term turnaround opportunity, but as we noted in our original post, we feel that the time to achieve the turnaround is probably going to take longer than many shareholders believe.

Bio of Allen Arroyo CFO:

Mr. Arroyo joined the Company in August 2022. He has extensive experience in corporate finance, strategy and operations within the food industry, including banking practices and financial transactions. Mr. Arroyo began his career with IHOP (now Dine Brands Global, Inc. (NYSE:DIN)), where he spent 17 years leading a team directing SEC and financial reporting, risk management and internal controls. Subsequently, he served as CFO for several privately held and private equity-backed dining and restaurant firms, most notably Blaze Pizza which expanded from ten to 225 stores in less than four years, Mastro's Restaurants, Inc., and Due North Holdings. He comes to RMCF from Nevoa, Inc., where he was instrumental in raising capital and implementing new technology and systems. He holds an MBA from Pepperdine University and a BA in accounting from California State University, Northridge.

We believe Mr. Arroyo’s background and experience at IHOP (including being there for their first securitization) along with the hiring of Kara Conklin as its new Vice President of Franchise Development, are very positive for the company. Her background is with companies we view as similar to RMCF 0.00%↑ in terms of franchise ownership and location development.

Ms. Conklin’ Bio:

Ms. Conklin has nearly two decades of franchise development and operating experience, beginning her career with the Subway® network, Quiznos®, Coffee Bean & Tea Leaf®, and Jamba®, among others. Most recently, she served as Director of Franchise Sales for the West Coast for Focus Brands®, representing such brands as Auntie Anne’s®, Cinnabon®, McAlister’s Deli®, Moe’s Southwest Grill®, and Schlotzksy’s®.

Q&A Note: Answers are my summary of our conversation and not direct quotes.

• What is the difference between a Licensee (110 stores) and a Franchisee (150 stores)?

  • A licensee is a co-branded Cold Stone Creamry store. A general rule of thumb is that 10 Cold Stone Creamry stores generate about the same revenue to the company as one franchisee store.

• We believe your significant single unit operator ownership (70-75% of stores are owned by single unit operators) is a systemic weakness, what are your thoughts on this?

  • Only 2 or 3 franchisees own 3 stores.

  • Once the bottom 10-15 stores are closed, the median AUV should approach $600K. (We view this as relatively low in the restaurant franchise space, making attracting new multi-unit operators a challenge).

  • This is being addressed in their long-term plan and recent hires.

• In your presentation you talk about a goal of 250 stores with AUVs of $800K, that seems aggressive.

  • That goal would be more of an aspiration than solid goal.

  • This was new information to us:

    • Airports do $2M in AUV.

    • A couple of RMCF 0.00%↑ in Native American casinos in CA generate over $1M in AUV. (Note: The new focus on multi-unit operators is a huge positive and the biggest reason for a possible step change in revenue grow in the future. If the company can recruit multi-unit operators that already operate in locations such as these, that would be a positive in our opinion.).

• What’s the pitch to multi-unit operators of a $600K AUV concept?

  • Low labor costs

    • A store only needs 2 or 3 full-time employees. A few more during peak season.

    • Lower occupancy costs because a store does not require a full kitchen.

      • The stores will run 800-1000 square feet.

      • No need for an endcap space or extra parking.

      • $1M store AUV gets an operator to 20% operating margins.

    • Lower relative Cost of Goods.

• With renewed emphasis on omni-channel and Costco opportunities, how do franchisees feel about the channel conflict?

  • Mr. Arroyo acknowledged there will always be some friction, but what they sell in Costco are items you cannot buy in a store, like gift packs or specialty flavors.

• What are your thoughts on your potential of adding a high-end concept?

  • Aspirational and long-way off. Management understands what needs to be done with the current business and they do realize they have a lot to do before they do that.

    • Might focus on Colorado and Rocky Mountains (Sangre de Cristo Mountains near Durango remind visitors of the Swiss Alps).

• The new arrangement with the packer in Utah seems like it would significantly impact gross margin potential, can you quantify this relative to your recent presentation slide of 25-30% long-term gross margin potential?

  • He believes that the added transportation costs and margin that they must give the packer will negatively impact gross margins by 400-500bps.

    • That would imply that the new range of future gross margin would be 20-25%.

      • We do believe a portion of that can be recaptured by the ability of the company to increase volume at the factory to leverage fixed costs (due to the removal of the labor induced choke point demonstrated in the last quarter).

  • We are waiting for a response as to the scope of the $6-$6.5M of cap ex being spent on the factory. It seems like a substantial portion is really just deferred maintenance expenditures versus high ROI projects, but we do know know for sure.

Summary:

We believe that the new management team and recent hires are fully aware of what needs to be done to grow the business. There is no way to get to their 250 units and $800K AUV without recruiting several multi-unit operators that can commit to opening multiple stores over several years. The biggest weakness of the business model in the past was relying on one unit operators (no ability to grow store base without recruiting lots of individuals with significant resources, which is very hard to do). Since same-store sales never really grow more than 1-3%, unit growth seems to be the most likely path to revenue growth. The partnership with new design firm, Design Well Spent Co., is a positive and could help the company rebrand and attract the multi-unit operators that they need. The turnaround potential reminds us a bit of Potbelly’s (attracting multi-unit operators) and we will continue to follow the company’s progress and write on it when we feel there is something important to discuss.

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