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NOBLE ROMAN (NROM) REPORTS Q2 – FRANCHISING PROFIT MARGIN IMPROVEMENT IS HIGHLIGHT

NOBLE ROMAN (NROM) REPORTS Q2 – FRANCHISING PROFIT MARGIN IMPROVEMENT IS HIGHLIGHT

CONCLUSION:

Noble Roman’s is steadily earning at an annualized untaxed rate of about $.12/share, with about $15M of tax protected earnings. EBITDA is running at around $3.5M annually, the highest level over the last several years, though a variety of “clean-up” issues have eaten into that calculation.  With a total enterprise value not much more than $15M, this established mid-west brand holds growth potential both with new company operated Pub locations as well as from franchising the Pubs and non-traditional locations. Just as a bank financing several years ago “transformed” the prospects, and allowed the company to create the Pub concept and establish the present much improved situation, a larger financing currently being negotiated promises to take NROM to the next level. Absent that, slower but steady company operated growth, while servicing the current debt, should still be possible, and franchising would take the lead.

OVERALL OPERATING RESULTS

Noble Roman’s Q2 results was consistent with Q1 in terms of increased earnings and EBITDA. Progress in the franchising segment outweighed margin pressure within the Craft Pizza & Pub operation. Net Income, which is tax protected for about $15 million, was $580k, up 5.5% for the quarter and 1.21M, up 11.0% for six months. EBITDA was $877.1k for three months, up 9.2%, and $1.724 for six months, up 9.5%. Both numbers annualize to a $3.5M annual rate (almost exactly the same as calendar ’18), and could improve to a $4M rate with a strong seasonal period ahead. Franchising revenues was essentially flat for three month and six months, with growth elsewhere offsetting a continuing decline in the relatively small grocery store segment. The extreme weather in the winter and early spring affected sales and margins in the Craft Pizza & Pub company stores in the early part of the second quarter, though to a much lesser degree than in the first quarter.

SUMMARY BY SEGMENT

The Noble Roman’s Craft Pizza & Pub remains the most promising portion of the current operations. The four existing company stores, as disclosed in the recent 10Q, generated approximately $900k of store level EBITDA margin in 2018. Considering that these locations cost about $2.4M to establish, that represents a 37.5% cash on cash return. Especially since only one of the restaurants was open more than eighteen months in Q2’19, this represents one of the most attractive returns within the fast casual restaurant industry. In Q2’19, however, the store level margin came down from 22.6% to 15.7%, much of it beyond the company control, and part of which could be recoverable over time. The good news is that prime costs were better in Q2, cost of sales 140 bp better to an impressively  low 20.9%. Salaries and wages also improved by 160 bp to 28.6%. Paper and Packaging was up 10 bp to 2.7%.  Facility costs increased by 310 bp, mostly from an unexpected increase in common area charges based on (supposedly) actual expenses in 2018 and the company has requested an audit of these numbers. While the company cannot predict the outcome of their “negotiation”, we think there could be at least some partial positive adjustment going forward and higher sales would obviously reduce this impact in any event. Other Operating Expenses increased 590 bp to 16.4%. Per the 10Q, 140 bp was an increase in insurance cost (which the company is currently renegotiating), 190 bp was advertising and 150 bp was delivery expense. The advertising expense, not a lot of dollars ($25,000) relative to $1.3M of sales, can obviously be leveraged as more company and/or franchised  locations are built within the trade area. The delivery expense burden will more likely come down than go up, in our view. From a macro standpoint, we believe that the third party delivery agents have seen their best days in terms of margin, and restaurant operators in general will carry less of a burden. Also, Noble Roman’s is doing their best to encourage use of their curbside pickup Pizza Valet service, which is increasingly being embraced by customers. Overall, we view it likely that store level margins can be improved over time, and higher sales would obviously be a big help. In the meantime, the four current operated locations at the current average annualized sales level of $1.33M, are generated an attractive cash on cash return. Relative to the franchising of the Pizza Pub, the first franchised operator, after a highly successful opening in Lafayette, IN., is exploring sites for a second location, and a second franchised operator, in Evansville, IN is expected to open late this fall.

The franchising segment, excluding grocery stores (which has been de-emphasized), reported revenues up 4.5% and 9.8% for three months and six months, respectively. Most impressively, the margin contribution from this segment increased by 850 bp to 66.4% and 960 bp to 67.6%, for three and six months, respectively. In the most recent quarter, salaries and wages came down 520 bp to 10.8%, trade show expense was reduced 80 bp to 6.5%, insurance by 50bp to 4.0%, travel and auto expense by 170 bp to 1.7%.The company noted in their quarterly release that in the period from 1/1 through 8/14, 21 new non-traditional locations have opened versus 17 a year earlier. Also: “the first two weeks’ sales of all non-traditional franchise openings in 2019 have averaged 32.8% higher than openings from previous years.”

The least important segment, in terms of revenue contribution, is the royalties and fees from grocery stores, which came down by $84k to $285k, and by $199k to $590k, for three and six months, respectively. As has been discussed previously, with the labor market tight, grocery stores have been challenged in terms of staffing deli departments, so have been reluctant to take on new products. Noble Roman’s has therefore decided to employ capital and personnel in the two other highly productive and more promising areas.

THE BALANCE SHEET

Cash improved by about $150k between 12/31 and 6/30, while paying off about $400k of bank debt and reducing accounts payable and accrued expenses by about $415k. Current Accounts Receivable went up by about $210k over six months to $1.78M but this is a seasonal factor and the amount is down by about $80k since June 30, 2018. Total Current Assets of $3.6M is 2.7x Current Liabilities. The question of the Company’s ability to repay the $1.9M remaining amount of convertible subordinated notes outstanding, which mature between November ’19 and February ’20 was raised on the Q2 conference call. $675,000 of those notes were voluntarily extended for three years. As the 10Q filing puts it: “the remaining Notes, in the amount of $1.225 million must either be converted into common stock, extended beyond the maturity of the senior debt or replaced with other like securities.” The Company has said that a new financing is being negotiated that would, if finalized, allow for repayment of all existing debt, including the convertible Notes, as well as provide funds for five additional Pizza Pubs. Should that financing not materialize, we view it as likely than any Convertible Notes remaining can be re-marketed for essentially the same terms, with an extended maturity date. It seems obvious to us that a 10% coupon, convertible at $0.50/share, with warrants attached (at $1.00) is a far better piece of paper today than when originally issued in 2017, and the general interest rate environment is even lower today than it was then.

CONFERENCE CALL

CEO and President, Scott Mobley, presided over the Q2 conference call. After financial results were provide in summary form by Chairman and CFO, Paul Mobley, Scott provided an operating summary in which he summarized operating initiatives designed to improve both sales and margins at the company operated Pubs. New sub sandwiches, combo meals and side items are being introduced, using local area marketing tactics. Online ordering, essential these days, has just been rolled out. Though the Company is not advertising the delivery option, relying on their Pizza Valet curbside pickup offering, Grubhub is now joining DoorDash as a third party vendor. A new and improved website is being introduced. Split pricing on the various pizza crusts is being added. Since the Sicilian crust is viewed as a premium product, the price is being raised by a modest $0.25 on the personal size, $0.50 for medium, $1.00 for large. Relative to the non-traditional franchising opportunity, Scott talked about a record setting location on an Indian reservation in Arizona. While no promises are being made relative to building sales at the Pubs beyond the $1.33M annualized level (Per Q2), the company clearly thinks this is possible and is bending every effort to do so.

CONCLUSION: Provided at the beginning of this article

Roger Lipton

P.S. – For more information, consult our full writeup of NROM, accessible from the Home Page @ Corporate Description, Public and Private Companies

DELIVERY, THE BIG THING IN RESTAURANT LAND – THIS IS WHAT “THE LAST MILE” LOOKS LIKE !!

DELIVERY, THE BIG THING IN RESTAURANT LAND – THIS IS WHAT “THE LAST MILE” LOOKS LIKE !!

Restaurant companies are unanimous in their pursuit of delivery as one of the huge opportunities to increase the productivity of their physical plants. Too much square footage continues to be a burden on productivity, especially when it takes labor at $15.00 (ex the tip credit) per hour to service the space. It’s also clear by this time that control over the “last mile” is of major concern to restaurant operators. Not only is the reputation of The Brand at stake, but valuable information relative to the customers is in the hands of the third party agent, potentially not as useful to the food provider.

A reality of this new source of business is that margins for the restaurant company will be affected since 15-30% of the ticket is paid to the delivery agent. While some argue that a large portion of the delivery dollars is “incremental”, it stands to reason that a customer who receives product at home on Wednesday night is less likely to visit that restaurant on Thursday or Friday. On the hopeful side: delivery companies are already competing for market share, negotiating their fees lower, therefore improving the remaining margin for the restaurant. Overall, this is clearly a portion of dining dollars that is very much in a state of flux.

ON THE GROUND IN DELIVERY LAND

Two articles caught our eye in the last day or so, in the New York Times and the New York Post, describing the reality of “the last mile”, and it’s not pretty.

The Post described how a delivery worker (from DoorDash) punched a pizza store employee in the head because the order wasn’t ready for pickup. We are not trying to focus on DoorDash (DD) in particular, because this could happen with any third party agent, but another DD employee posted a negative review on Yelp because the food “trash” wasn’t ready on time. Another DD hire made a scene after getting a parking ticket while waiting for a delivery pickup. Since delivery agents, including DD, UberEats, Postmates and others,  get paid primarily for completed deliveries and little, if anything,  for waiting time, they are obviously very sensitive to availability of the order. At the same time, restaurant employees, including one cited at (well run) Cheescake Factory, are not necessarily treating the delivery person with great courtesy. Another potential problem, as pointed out by a group of restaurant operators in Los Angeles, is that delivery agents are not trained in food handling and temperature maintenance standards. One LA based operator said “If a customer gets hepatitis they are going to sue the restaurant.” Another stomach turning pitfall, as described, is the hungry delivery person that helps themself to part of the milkshake or a couple of the ribs. All of this can be considered “anecdotal”, but proper selection and training for third party agents is no doubt far from optimal at this early point in the evolution of the food delivery industry. Parenthetically, stock investors might well keep all of this in mind before they pay a huge valuation for DoorDash when it comes public.

The New York Times described the experience of a bicycle delivery person in Manhattan, obviously a unique market, but still indicative of urban issues. The bicycle person, working for UberEats as well as Postmates, had continuous decisions on the run to make, all while anticipating traffic patterns and potential delays. Should he pick up several orders at a Mexican restaurant five blocks away for UberEats, or divert to two orders for Postmates at Shake Shack that was a little closer. As he said “I had to decide: take on three orders at once and risk falling behind? Stick with UberEats, which was running a $10 bonus for doing six deliveries by 1:30, or try for a Postmates bonus? Information was limited. The UberEats app doesn’t tell you where the delivery is going until you pick it up. I could not know what the Postmates job would pay. The Postmates clock ticked down – you have seconds to accept or decline an order. I was threading my way around lurching honking trucks and oblivious texting pedestrians and watching for cops and looking down at the phone mounted on my handlebars and calculating delivery times.”

The article goes on to describe the intense competition among companies like Grubhub’s Seamless, UberEats, Caviar, DoorDash and Postmates, and delivery agents are often representing more than one company. The restaurants have been forced into the e-commerce business, outsourcing their product to the hands of a fleet of freelance personnel who may or may not appropriately represent the restaurant Brand. Especially as competition has increased, the net hourly pay for delivery agents has become closer to $10/hour than $20, sometimes even less than $10. We can only imagine the professional skills, or lack thereof, of a person that is going to subject themselves to this kind of pressure for that kind of wage. There are a myriad of other hurdles that delivery agents in urban areas will have to deal with, but that will vary by venue. We can say with assurance, however, just as above described in suburbia, there is huge work to be done to iron out the issues, reduce the risk, and improve the profitability for the restaurant operator.

CONCLUSION:

The challenge remains to make delivery incrementally profitable, without taking on a huge risk to The Brand in the process. To whatever extent possible, maximum control over the delivery process should be at The Brand level. In the meantime, takeout and curbside pickup may be convenient enough to maintain market share, without incurring the risks as described above. Perhaps orders, above a certain size at limited times of the day within a certain radius, can be delivered by properly trained store level employees. There is a large market to be served, but not necessarily at the risk of The Brand.

Roger Lipton

RESTAURANT SALES AND TRAFFIC TRENDS – QUICK HINT….NO SILVER BULLET !!

RESTAURANT SALES AND TRAFFIC TRENDS – QUICK HINT….NO SILVER BULLET !!

We will know more specifically, as companies start to report results,  in the next several weeks how the second calendar quarter developed relative to sales and traffic. Anecdotally (see Postscript below), however, we hear nothing particularly encouraging. The late spring early summer numbers that showed sales up low single digits and traffic down low single digits seems to be continuing (see Postscript below), which has basically been the case for the last two years. Quick service restaurants that provide a midday (food) fuel stop seem to be holding up a bit better than full service casual dining companies that are required to provide an experience to help  justify the much higher average ticket. While wage rates are moving higher, discretionary income is not. Five dollars is the favored price point at lunch, but when a family of four sits down for a full service meal at Applebee’s, it is going to run upwards of $50.00 with tax and tip and that is a noticeable after tax expenditure. The weather was unsettled in many parts of the country in the last couple of months and that can also affect traffic by a point or two which is the difference between “strong”, “mediocre”, or “weak” sales these days. A constant drumbeat from newscasters about tariffs is affecting not only the business world but dining customers who understand that budgets have to balance at some point. National economic discourse, where debt doesn’t matter to the existing administration and unlimited social programs are the mantra for the Democratic contenders, is no doubt further unsettling relative to consumer confidence. Without question, for any number of reasons, the economy is slowing. Sales and traffic trends are unlikely to buck this reality, and we will let you know when they do.

From an operator’s standpoint: they continue to be pleased by a more business friendly environment. However, you can’t pay the rent with an intangible such as “less regulation” and lower taxes was last year’s story. Wages move inexorably higher, and there is no material expense that is moving lower. The only thing that can help restaurant margins is higher sales, and one or two points of sales improvment is not enough to overcome higher costs. Our expectation, therefore, is for more of the same as Q2 reports are made public. The better operators will come close to maintaining margins, but most year to year comparisons will not look good. The lower tax rates last year allowed many companies to show strong year to year after tax earnings, though pretax operating earnings were down in many cases,  but that will not be repeated in 2019. Stock repurchases could help some companies, but fewer than last year as some companies have already leveraged their balance sheets.

We leave you with some good news. (There had to be something, right?) Though too many operators are sitting with real estate that is fully utilized only on Friday and Saturday nights, there remains a great deal of opportunity relative to food consumed “offsite”. Curbside pickup, takeout, and catering all offer opportunity, though they are different business to a degree and must be managed accordingly. At least you don’t need more square footage. Furthermore, margins on delivery service should start to improve as Doordash, Ubereats, Grubhub and the others compete for business. Delivery is a necessary evil these days, but restaurant companies can’t afford to cut 20-30 points out of their gross margin. Many operators have suggested that delivery business is largely incremental. We accept that delivery is incremental, in part, but it stands to reason that if a customer has food delivered tonight, they are far less likely to visit that same restaurant tomorrow night. Delivery will be become more profitable (at least less of a burden on margins), and delivery companies will experience margin contraction, which they may or may not be able to offset with operating efficiencies.

Roger Lipton

P.S.  No longer “anecdotal”. Just received the highly regarded Miller Pulse survey results through June. Headline is positive (“June Sales Cap Off a Solid Second Quarter”) but details show more of the same. Overall restaurant same store sales rose 2.0% in June, up 2.1% for Q2 as a whole. The QSR segment was up 2.3% and Casual Dining was up 0.4% in June. The 2.0% result in June was, as Miller Pulse put it “a model of consistency, remaining in the narrow 2.0-2.3% range since the dip in February”. Importantly, “traffic, as is the norm these days, was weak again at -1.7% for the month”. In summary, the numbers confirmed our anecdotal conclusions.