NOBLE ROMAN’S (NROM) – UPDATED WRITE-UP

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Lipton Financial Services

CONCLUSION

We need not make precise projections in terms of cash flow and earnings, other than presenting the rough parameters below. Our statistical template provided above assumes only a continuation of the four company operated stores that are in place, maintenance of the other two operating segments, and no surprises, positive or negative. Substantial progress has been made over the last two years, both operationally and in terms of balance sheet restructuring. With $3.4M of EBITDA in the last twelve months, and the possibility of substantial growth from here, the stock is obviously cheap statistically. There would normally be a great deal of private equity interest at this kind of a valuation, but this is a very small deal in today’s environment and management has no desire to change ownership at anywhere near the current valuation. Time will obviously tell as to what extent this management team capitalizes on the current opportunity, but it seems like the necessary pieces are in place to take this reincarnated brand a great deal further.

THE COMPANY

Noble Roman’s, Inc. (NROM) is over forty years old as an Indiana Corporation, having operated, franchised and licensed versions of the “Noble Roman’s Pizza” brand. Founder and Chairman, Paul Mobley, formed NROM in 1972, still leads the company from a strategic standpoint, plays an active CFO and shareholder relations role, and his son, Scott, is President and CEO. Locations selling NROM Pizza today include 50 states and Canada. While the company has operated and franchised stores with varying degrees of success over the years, the underlying reputation for serving a high quality product has been generally maintained. This is evidenced by the most recent commentary in social media (Yelp and Facebook) relative to the openings of Noble Roman’s Craft Pizza and Pub locations (NRCPP), the most recent incarnation of the brand.

Though customers of Noble Roman’s mostly remember the brand with the nostalgia of their youth, the long operating history has included a number of starts and stops. In particular, the six years ending in ‘17 were burdened by losses related to the unsuccessful effort to build a “Take ‘N Bake” version of Noble Roman’s, and the Company paid a predictable price for the failure. We describe below, when discussing the improved balance sheet, some of those costs.

THREE OPERATING SEGMENTS

Noble Roman’s today has three primary areas of focus, in order of current emphasis: (1) Expansion of a new generation of NRCPPs, which, following the successful openings of four company operated locations, has recently begun to award franchise rights. (2) Franchises-Licenses for “non-traditional” locations, primarily in convenience stores (often affiliated with gas stations) and entertainment facilities. (3) Licenses to sell Noble Roman’s products within grocery stores.

“NOBLE ROMAN’S CRAFT PIZZA AND PUB” (NRCPP)

This is by far the most attractive expansion opportunity for the Company. The fast casual restaurant features two styles of crust, both thin and Deep Dish Sicilian, with their famous breadsticks served with spicy cheese sauce, specialty salads, four pasta dishes, all “designed to be fast, easy to prepare and delicious to eat.” New pizza oven technology provides bake times of only 2.5 minutes for the regular crust, 5.75 minutes for Sicilian, with the dough preparation room visible to customers.

The concept as we would describe it is: similar to Blaze, MOD, and so many other participants in the fast casual pizza segment, but “evolved” and “differentiated” in major ways. NRCPP serves personal size pies as well as family sized, serves traditional crust as well as Sicilian (for the same price), serves a limited number of salads, sandwiches, chicken wings, and desserts. Wine & Beer (including Craft Beers) is served at a modest but comfortable bar, where you can also dine. Half a dozen TV sets create a low key sports bar “vibe”.  Anecdotally, we have personally been to all four locations, several times to the first of them, and have been impressed with the quality of operations that has been taking place.  Social media commentary, including Yelp and Facebook, confirms our reaction, and the public’s view of The Brand seems to be a combination of nostalgia combined with admiration of the current updated approach. The hospitality quotient provided so far should presumably be replicable in the foreseeable future because the company operated stores, as well as initial franchised locations, will continue to be in NROM’s “back yard”. The first location (Westfield) opened  1/31/17. A second location (Whitestown) opened 11/17/17. The third location (Fishers) opened 1/18/18 and the fourth (Carmel) opened 5/29/18.  The Company has shown an ability to open these four stores, at budgeted cost, in only 3-4 months after lease signing. Naturally, the speed of future openings is dependent on lease negotiations, real estate variance requirements, and the configuration of the proposed site.

UNIT LEVEL ECONOMICS OF NOBLE ROMAN’S CRAFT PIZZA & PUB

The locations are about 4,000 square feet, cost about $630,000 (including about $50,000 of pre-opening expenses). The targeted average annual volume is $1.35M  with a first year store level EBITDA above 20%. Cost of Goods combined with Labor (including fringe benefits) is expected to average no more than 50% of sales. These parameters provide an immediate 43% cash on cash return, allowing for just over a 2 year cash payback. The first four locations are collectively meeting, and sometimes (Westfield) individually exceeding all these targeted parameters (ex the extreme weather in Q4) on an annualized basis, though only the first (Westfield) has been open for more than one year. It is important to note that many successful restaurant franchisors project targeted cash on cash returns in year three much lower than shown above (and don’t include pre-opening expenses in their calculation), obviously far less attractive than the indicated fully loaded immediate returns of NRCPP. Since the company, as well as the first of the franchised locations, will be located near Indianapolis, pre-opening costs and initial opening inefficiencies should continue to be minimized. 

 FRANCHISING OF NOBLE ROMAN’S CRAFT PIZZA AND PUB

While four locations in Indiana (only one of which is two years old) does not imply worldwide expansion opportunities, NROM management has many years of multi-unit operating, and franchising, experience and there are very few concepts in the restaurant industry that have generated the returns as described above. Average Unit Volumes (AUVs) could build further as the Indiana market is penetrated, or perhaps be cannibalized, but delivery (in conjunction with DoorDash) and a new curbside Pizza Valet pickup service has both just started in January, a mobile app is starting its beta test, and many other operating and marketing initiatives are in the works. Greater Indianapolis alone could support at least 20 units, the State of Indiana many more, so an obviously unlimited growth runway is in place. The Company, operationally led by President and CEO, Scott Mobley, has done an admirable job of getting NRCPP off and running, profitable from the very beginning. Noble Roman’s brand is known, to varying degrees, in all 50 states, and could no doubt succeed in well run, properly situated locations almost anywhere, but Indiana and the immediately surrounding geography represent the most obvious expansion opportunities. It is noteworthy that well located non-traditional locations in C stores and hospitals do impressive enough volumes to indicate that NROM pizzas can attract customers far from Indianapolis but stores close to the home base are naturally the current priority.

The franchising strategy for NRCPPs is to sign single unit, experienced, operators close to home. Further away, only very well capitalized operators, fully committed (operationally, financially, psychologically) to building out markets, will be enrolled. Since an operating organization is in place at NROM that can support local franchisees in their startup phase, and multi-unit franchisees will pay non-refundable up front franchise fees that should more than offset support services, the franchising effort should contribute immediate incremental profits and cash flow to NROM. The initial franchisee fee is $30,000 for a single unit, $25,000 for the second, $20,000 thereafter. Ongoing royalties are 5%, plus a 2% contribution to a creative fund.

The first franchisee is under construction and should open around 5/1/19, a highly regarded Indiana based Dairy Queen franchisee, Holly and Patrick O’Neil, who currently operate nineteen DQ locations. Since they have been expanding their number of DQ locations in recent years, they seem to have the financial and operating resources to open additional NRCPP locations if the first location is successful. The excellent reputation of Holly and Patrick (who has been head of the DQ franchise association) will no doubt be encouraging to other potential franchisees. They could also provide operating expertise to the NRCPP system. Nobody has all the answers and every successful franchisor has learned a great deal from their experienced franchise partners. Their first location will be in Lafayette, Indiana, a previously successful jurisdiction for Noble Roman’s.

NON-TRADITIONAL FRANCHISING

The company has franchised about 750 units, including convenience stores, travel plazas, entertainment venues, hospitals, most several Wal-Mart and Circle K locations.  A prototype counter top unit was introduced in early ’16 and expansion within this division is picking up momentum in recent months. There is obviously a time lag from when a new license is signed to when a location opens for business. This steady source of revenues amounted to $4.5M in ’17, up from $4.4M in ’16. Revenues from this segment were flat at $4.5M in calendar ’18, but up about $100,000 (9%) in Q4, presumably a harbinger of more growth to come. 38 non-traditional franchised locations joined the system in calendar ’18, and 19 left. Since signings, reflected by “Upfront Fees” increased from $286k in ’17 to $379k (which included $30k from the first NRCPP) in ’18 (up 22% net of the NRCPP fee), an increase in non-traditional royalty revenues can be expected in the future. This momentum is continuing in Q1’19, as the company announced that, through 3/26/19, 14 new locations have been signed up versus 6 in ’18. It should be noted that non-traditional locations closed are typically older low volume units, and are being replaced by higher volume new units. It should also be understood that while a few units have opened within Circle Ks and WalMarts, those retail systems are difficult to quickly penetrate for a number of reasons and we expect independent operators to be the more predictable source of growth. Overall, the pace of signings within this segment, with tens of thousands of potential outlets throughout the country, has clearly picked up over the last eighteen months, and could be capable of, at least offsetting the current slippage in the grocery channel described below. The initial franchise fee is $7,500, except for $10,000 at hospitals. The ongoing royalty is 7% of sales, with no advertising contribution since customers in these locations are mostly on the premises for other reasons.

GROCERY STORE LICENSING

Noble Roman’s has licensed, by way of a supply agreement, sales of its products to 2,106 grocery stores. The licensed grocery store must purchase proprietary ingredients through a Noble Roman’s approved distributor. The deli department of the grocery store then assembles the products and displays them using Noble Roman’s point of sale marketing materials. The distributors collect for Noble Roman’s a fee in lieu of royalty as they sell ingredients to the grocery stores and remit this amount within ten days of each month end. While the number of grocery stores under license expanded steadily for several years, especially until the end of 2016, the labor requirement within the grocery deli departments has limited further growth, and the improving economy has reduced the number of budget driven pizza consumers, so license revenues from this segment has contracted in the last two years. It is unknown how many of the 2106 grocery locations are currently offering product, especially since stores sometimes are removed and then later return. NROM management has explored the possibility of assembling the pies at the distribution level, reducing the labor requirement at the individual grocery store, but a solution has not yet been developed. Royalties and fees from grocery store distribution was $1.4M in calendar 2018, down from $1.8M in ’17. While this division’s revenue has slipped in the last two years, the economy seems to be slowing once again, which would make deli-workers more available and consumers more interested in a take and bake product. This division can therefore be considered “counter cyclical”. With two other far larger and more promising divisions, NROM management is concentrating efforts elsewhere and a change in results from this division shouldn’t affect overall performance by much.

THE BALANCE SHEET – SUBSTANTIALLY IMPROVED

During ’15, ’16 and early ’17, as the Take ‘n Bake version was winding down, and the NRCPP version was incubating, the Company was carrying short term debt with an interest rate over 20%, especially burdensome when the company was still reporting operating losses from termination of the Take ‘N Bake adventure. $2.4M was raised in late 2016 and early 2017 in the form of 10% debentures, maturing in December 2019 and January 2020, convertible at $0.50/share, with 2.4M warrants @ $1.00 attached. It is worth noting that both Paul Mobley, Chairman, and Marcel Herbst, Director, participated in this private placement. While the terms of the convertible debt were not pretty, it was a lot better than what had been in place. More importantly, in September ’17 the Company put in place $4.5M of conventional bank debt, maturing in September 2022, at an interest rate of LIBOR plus 4.25%. Additionally, a $1.6M Development Line of credit facility was established to fund three new company operated locations.  Each tranche of the Development Line is repaid starting four months after being drawn, on a seven year amortization schedule. As described earlier, the rapid cash on cash returns from the new locations are easily capable of servicing the Development Line and generating excess cash as well. Overall, the new financing arrangements have provided NROM with adequate financial flexibility, allowing steady further development of NRCPP locations, building a franchise operation, also further developing the two other segments. Calendar 2018 results benefited from over $500k of cash interest savings YTY. It is also important to note that NROM has a Deferred Tax Asset on their balance sheet of $5.6M, sheltering about $15M of pretax earnings.

In the Q3’18 report, the Company indicated its plan to extend the maturity date of the 10% convertible (at $0.50) notes, (with warrants at $1.00/share attached), by three years, $650k of which has been accepted to date. According to the 10-K, “The Company is prohibited by its loan agreement with its senior debt lender from repaying the Notes as long as its senior debt is outstanding. In order to meet the maturity schedules in late 2019 and 2020, the Notes must either be converted to common stock, extended beyond the maturity of the senior debt or replaced with other like securities. The Company may not be able to accomplish any of those alternatives. The Company intends to extend or refinance with external capital the Notes maturing in 2019 and 2020. However, the Company may not be able to refinance its debt or sell additional debt or equity securities on favorable terms, or at all.”

The above paragraph in the 10-K is appropriately conservative in its description. We believe that the Company can “remarket” the 10% Convertible (at $.50, with warrants attached) Notes, since the balance sheet and cash generation of the Company is much improved since those securities were originally placed in late 2016.

It is noteworthy that Current Accounts Receivable, at 12/31/18, were down 12.4% to $1.574M from a year earlier, and the Company stated in their year end report that all existing franchisees are current in their payments. Non-cash writedowns of the Carrying Value of Receivables over the last several years, including the largest, $4.1M in calendar 2018, do not relate to current franchisees. While there will be an ongoing collection effort, legal expenses in this area are expected to be lower than in the past.

RECENT DEVELOPMENTS – Q4 AND FULL YEAR ’18 RESULTS

2018 as a whole demonstrated significant corporate progress. Adjusted Net Income was $2.5M, up 70% from 2017. Adjusted EBITDA was $3.4M, up 6.6% from 2017.

The largest addback adjustments to the GAAP net loss of $3.1M were $4.1M non-cash adjustment of receivables from 2014 and 2015, and $930k adjustment of the value of deferred tax credits. Adjusted EBITDA was affected by the same items, with Depreciation and Interest comparisons added. We supply the full tables of Adjustments to Net Income and EBITDA as an Appendix to this article.

The dominant portion of fourth quarter results was the operation of four NRCPP units versus two a year earlier, which obviously affected revenues and related costs. Weather, especially in December, affected sales, so store level EBITDA margin was 10.5% from 18.4% in Q4’17. Store level EBITDA for the year was 18.9% (vs.23.7%), still impressive considering the inefficiencies of operating three units less than a year old and the Q4 weather. Most importantly, the Company stated in their latest  release that March sales were running 23% over the December level and “the margin is expected to move back above 20% in the coming months”. While Q4 average annualized sales were about $1.15M, the full year annualized average volume was $1.36M by our calculation of operating store-weeks. The demonstrated recovery in March, combined with the customer (and staff) enthusiasm over the Pizza Valet service, delivery through DoorDash, and other operating and marketing initiatives, should continue to support the targeted average annual run rate of $1.35M per unit.

Up front fees, reflecting franchise signups were up 13.6% for the quarter and 32.5% for the year. Non-traditional franchise fees (ongoing royalties) were flat for the year but up 9.1% in Q4. As the signups convert to operating units, and with new signups in ’19 (14 vs 6 as of 3/26), both of these categories should build further.

Grocery store license fees were down 28.2% in Q4 and 22.2% for the year. As discussed earlier, this division can be considered counter cyclical and could at least stabilize in a slowing economy. Moreover, with only $1.4M of revenues for all of ’18, $323k in Q4, this division is far less important going forward than non-traditional locations generating $4.5M annually and now growing and, of course,  the expansion of the NRCPP division.

The conference call discussion briefly discussed the results, talked about the recovery of sales and margins in March, estimated that the first franchised location in Lafayette, IN, will open around May 1st. Most importantly, CEO, Scott Mobley, discussed the success of the Pizza Valet curbside pickup and the implementation of delivery through DoorDash. He described at length a large number of recent and planned initiatives, including: a bar enhancement program, expansion of an already successful catering effort, introduction of daily food specials, pending introduction of online ordering,  expansion of their award winning social media effort, and others. Paul Mobley, Executive Chairman, indicated that two new company operated locations could open later this year. He disclosed, as we have already  referenced,  the signup rate of non-traditional locations and the recovery in NRCPP sales in March.

THE CURRENT BALANCE SHEET AND ENTERPRISE VALUE

There is currently about $6.8M of total debt, and about 21.6M shares currently outstanding. The debt consists of $4.8M bank debt, including the current portion, and $2.0M of convertible debt (at $0.50/share). There are 2.4M warrants, that were attached to the original convertible debentures, at $1.00 per share, which would obviously bring in $2.4M of equity if exercised. There are about 1M additional shares due to various options and warrants, which would bring in roughly $500k if exercised. In total therefore, about 27M shares would be outstanding, fully diluted, but that would have brought in over $5M of equity, reducing the current $6.8M of current debt very substantially. We can therefore consider that the total enterprise value of NROM is something like ($0.47/share x 27M shares=$12.7M) plus $1.8M of remaining debt after cash generated from exercise of all options and warrants, or a total enterprise value of about $14.5M. Dividing by the $3.4M of trailing twelve month EBITDA, the Enterprise Value is 4.3x TTM EBITDA.  When questioned on the conference call about the possibility of broadening the Board of Directors (currently four members, two of which are independent, plus Paul and Scott Mobley), Paul Mobley indicated that this is under active consideration.

CONCLUSION – Provided at the beginning of this article

 

 

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