NROM.OB - Noble Romans

[SmallCap]

Noble Romans is a nanocap pure franchised non traditional food service company

 

This is a company that I have been following for a while now and believe that it is a solid situation with a decent margin of safety and still has significant growth prospects.

 

The current market cap is currently 19M, the shares are thinly traded, insiders own 22.7% of the company and 4 outside investors own 40% of the company the largest of the outside investors is Robert Stiller the founder and president of Green Mountain Coffee.

 

The company has a long history with lots of ups and downs, they were a company owned chained of pizza restaurants that most people in Indiana can still remember. That business is gone and now the majority of their business is in non-traditional locations like convenience stores, entertainment facilities, military bases, hospitals and most recently a huge growth area has been grocery store chains.

 

Around 2005 they started a significant push into the highly competitive market of QSR’s and while they sold around 150 franchises and it looked like they were going to have rather explosive growth things rapidly started to fall apart and many of them never even opened.  Many of the ones that did open, closed leaving around 20-30 QSR’s in operation and while they seem to be doing ok. But the effect of this failed growth effort is a couple of things:

· They developed a bad reputation in the franchise industry

· Their multi year growth push came to nothing

· A group of former franchisees filed a suit against them (more on that later)

 

In addition to those few QSR locations they also have a longstanding group around 740 non traditional locations that send back roughly 6% of their revenues to Noble Romans.

 

Stability of the business,

Because this is a pure franchise play where the company only owns 2 locations for testing and training purposes their overhead needs are incredibly small, they have less then 30 employees and Paul Mobely has done a great job of keeping a tight rein on the expenses. Their revenue depends on around 1300 different franchised or licensed locations where Noble Romans gets a portion of their revenue. This puts them into the utility business type of situation where their entire overhead is covered by a certain number of locations and any locations after that are pure profit. For them to open up additional franchises doesn’t require any additional staff because of the simple model that they have put together.

 

For the last 4 years they have been aggressively paying down their debt and are on an amortization schedule of being completely debt free by Oct 2013. It seems likely it will be before that date. They do not appear to have any future needs to tap the capital markets for any funds. Their internally generated funds are more then sufficient to fund future needs and their model doesn’t require capital outlays. Paying off the debt frees up 1.8M per year of cash flow.

 

All of that in my mind makes this company a solid investment with very little downside but not a very exciting investment unless there is future growth areas.

 

Future Growth areas

With the stability of their existing and diverse non traditional locations and the failure of their growth attempts in the QSR area the thing that looks to be propelling their growth in the next few years is the integration of their grab and go system into Grocery store chains. They developed a grab and go concept for their convenience store franchises where they have already prepared but not cooked pizzas ready to be taken home and popped into the oven. They are fresh made and not frozen.  They then take this concept and put it into grocery stores with delis where the pizzas are freshly made using their ingredients and to their specifications. The results have been excellent.

 

They started rolling this out in Sept of 2009 and as of now they have 540 stores signed up and 450 of them installed and running. Once a store is up and running Noble Romans has nothing more to do with them except collect the checks from the suppliers. Paul estimates that the average store could sell 100 Pizzas per week but I believe that is optimistic. He reports that early sales results have them already at the 75 range but I will use 60 per week in my calculations.

 

They started going a showing this concept to different chains and a number of them signed up a portion of their stores and would likely signup the rest of their stores after those are proven. But something else happened along the way and that is some grocery store suppliers came to them and wanted to roll this out to their client base and become the supplier for this product to those stores. This setup is a no brainer, win win for NROM. They now have a more efficient distribution method and a new group out there selling their concept and their margins are completely unaffected. Their first distributor was a distributor to 800 stores and they have been bringing NROM’s lots of new agreements. They now have 3 additional distributors who are taking this concept and running with it.

 

For Noble Romans to have gone from 0 to around 500 grocery stores in the first 15 months of the concept and to now have tested it in a portion of a number of store chains and 4 and possibly more distributors pushing the concept should provide a significant growth factor for a number of years.

 

If you look at the 740 existing non traditional locations, this area is growing slowly at this point. But those locations provide sufficient cash flow to cover overhead and pay down debt. There is still significant opportunities to grow this area but it has been slow lately.  But if you take these areas and you add on this grocery store area this company has great potential.

 

The numbers for the grocery store area:

For each pizza sold in the store Noble Romans gets $1.12.

Assuming that each store location sells 60 per week that is $31,20 per year per store

Multiply that by $1.12 and you get $3494.4 per store with no COGS

If you assume just 500 stores open this year you get an additional $1,747,200 flowing down to the bottom line.

 

I believe it is reasonable to expect them to open at least another 500 this year.

 

In addition to all this they have just this last month rolled out an additional 5 items to go along with Pizzas to sell through this channel. These items are complementary to pizzas but not dependent on pizzas for sales. Paul Mobley expects that these additional items will result in more revenue to the company then the Pizzas in the stores. He also expects that these items will roll out broader and faster then the take and bake pizza concept. I have absolutely no validating data for these last two statements but I am just restating what he has said.

 

Problem areas:

 

The Lawsuit

In 2007 a group of former franchisees sued the company. I have watched Paul go through a couple of lawsuits and realized that he is one tough guy in a lawsuit situation and he doesn’t give an inch. Anyway this lawsuit has gone on since then and has been a significant drag on the companies cash flow and profits. They have taken two significant charges relating to this lawsuit. At the end of last year the judge through out the plaintiffs case as having no merit. There is still another small case regarding Indiana’s franchise rules but there isn’t nearly as much at stake with that one. There is now a countersuit by Noble Romans for 5.7M against the plaintiffs for damages and legal costs. Now there is no way that they will collect all of that but it seems that they might be able to collect 1/3 of it. This lawsuit was hanging over the company for a couple of years and it now appears to be gone.

 

Corporate governance

The president and chairman Paul Mobley who owns 15.5% of the company also has his son Scott who owns 5.7% of the company. They take reasonable salaries and have been very careful watching expenses. But in 2010 they repriced a small number of significantly out of the money options and in 2011 they gave out a number of 10 year warrants to officers to make up for some 10 year warrants that were about to expire worthless. The net effect to shareholders of these two actions isn’t that significant but I still didn’t like it. Amid all the mistakes that have been made and the failed QSR push Paul has been a very candid and open point of contact for investors. He doesn’t hide behind a IR group but is willing to talk candidly with shareholders.

 

Summary:

I have left out a lot of the numbers that you can find in the filings. Their BS and P&L are extremely easy to understand and their entire write-up is very simple and straightforward. I don’t think this one will end up in anyone’s too hard pile.

 

I started buying this one back in 2003 and didn’t sell nearly enough with the significant run up in 2006 but have bought more starting in 2008.

 

Interested in anyone’s thoughts on this one and can anyone poke any holes in it? If you have any more questions feel free to post them.

 

SmallCap

[Baoxiaodao]

SmallCap, I like the way you wrote up this story. Thanks for the idea. Well reasoned.

 

My rule of thumb for any investment is people first. From what you wrote, I just feel kind of uncomfortable with the management.

[SmallCap]

Baoxiaodao,

 

It is a very good point and one that has given me pause a few times on this company. For myself, I have had enough time spent reading his reports and enough time talking with him that I feel comfortable with where he is taking the company.

 

I don't think that he has been unreasonable at all with the number and prices of the warrants that have been given out but I really didn't like the way that it was handled and have told him that.

 

If you feel like it call him up and have a conversation with him about the company and tell me what you think, he is relativity easy to get in touch with.

 

SmallCap

[moustachio]

This company has a new stand alone take and bake pizza restaurant they have been rolling out lately. It is basically the same concept as a Papa Murphys. Because they are operated as franchises they can potentially provide some very high margin revenue from royalties and fees. Despite the possibility of this growth the business isn't trading at a very expensive valuation. There is a seeking alpha article that explains the bull case quite well: http://seekingalpha.com/article/1903531-noble-romans-the-power-of-operating-leverage

 

Disclosure: I'm long NROM.

[Okta]

At the current price of $0.43 per share, the company is really cheap. This is no deep value, because the company is still profitable.

[Pelagic]

At the current price of $0.43 per share, the company is really cheap. This is no deep value, because the company is still profitable.

 

Interesting, this does seem quite cheap.

 

Any ideas on what has caused its share price to halve in the last two months?

 

It seems two hedge funds took stakes possibly with the hopes of encouraging a sale while management has a strategic vision in place to revamp their offerings and focus on a stand alone restaurant model.

 

I see one of the funds sold a portion of its stake, perhaps that's the root of the decline, although it looks like they still hold around 5% of the company.

 

 

[johnny]

In December 2015, the Company borrowed $175,000 from two officers of the Company, which are evidenced by promissory notes which mature in January 2017. Interest on the notes are payable at the rate of 10% per annum quarterly in arrears and the loans are unsecured.

 

In January, 2016, the Company entered into a Third Amendment to its Credit Agreement (the “Third Amendment”). Pursuant to the Third Amendment, the Company consolidated its three term loans with the Bank into a new term loan of $1,967,000 repayable in monthly payments of principal in the amount of $54,654 plus interest on the unpaid balance of LIBOR plus 6% per annum. The new term loan matures March 31, 2017

 

Not crazy about that. Doesn't kill the thesis at all, but it certainly does seem like that insider-loan had no reason to happen.

 

edit:

 

Maybe they actually did need that loan to happen. They ended 2015 with $194,021 in cash on the balance sheet. Since $175,000 of that was a high-interest, possibly hastily-made loan by insiders, I'm not sure this explanation would be too reassuring.

[Poor Charlie]

Took a quick look at this today.  Here are some questions/comments I have:

 

-Why don’t they generate any cash?  This is an asset-light franchise business that has tax assets.  They should be generating a ton of cash relative to pre-tax income.  But that doesn’t seem to be the case.  Consider that over the last 11 years they’ve earned close to $30m in pre-tax income from continuing operations but generated only around $7m in actual cash (b/s cash hasn’t changed much, they’ve paid off around $7m in debt, and they haven’t paid dividends or bought back stock). 

 

-What’s up with the AR?  Franchisors normally collect pretty quickly (almost always less than 30 days).  DSO for NROM in 2015 was almost 100.  And that’s excluding the huge (almost 3x current AR) long-term AR balances they carry.  Collections seem to be a pretty big issue too.

 

 

[Poor Charlie]

Guess I figured out the AR issue:

 

"Noble Roman’s franchise has distinguished itself by its high franchisee failure rates, and its insistence on suing franchise owners once they fail.  Noble Roman’s, with a reported SBA Franchise Loan Default rate of 38%, once again has been named to our list of The Worst Franchises by SBA Loan Default Rate.  One writer has described Noble Roman’s as “franchising’s version of The Walking Dead…”

 

          -http://www.unhappyfranchisee.com/category/franchisor/noble-romans/

 

"Noble Roman's Inc. is still waiting to collect about $1.5 million more than a year after scoring an apparent victory in a lengthy court battle with some of its former franchisees."

 

          -http://www.ibj.com/articles/46831-noble-roman-s-awarded-1-5m-in-battle-with-franchisees

[wachtwoord]

I'm interested but have more reading to do. There doesn't seem to be any bid and ask though. Is that correct? (no use to research something I can't buy)

[SmallCap]

I have a question for you all

 

I have been a very long time follower and investor in this company, at one time it grew into my largest holding, I sold nearly all my shares in 2015 in the 1.20-2.00 range and watched it trend down when it hit the 0.30's I decided that was cheap enough to give it another try so I picked up 30K shares at .35 on Dec 14th, now less then a month later it is at .68 nearly double. (Yay for me) The issue for me is that it has nearly doubled with absolutely no news.

 

My question is should I just go ahead and sell it at this point based not on the underlying value but based on the very quick run up on no news?

[debtvulture]

They did a convert deal recently, that is some news.  They are also opening up a pizza restaurant concept that, if successful, they hope to franchise.

[KJP]

They did a convert deal recently, that is some news.  They are also opening up a pizza restaurant concept that, if successful, they hope to franchise.

 

Not news, but there is a recent SeekingAlpha article.  That often drives activity in stocks like this. 

[Homestead31]

2 schools of thought.

 

1) sell if you think it is fairly valued, regardless of recent performance.  So just bc it has run up it could still be very cheap.

 

2) you never go broke taking a profit.  Michael burry had a rule to sell half of anything if it went up more than 50% in six months. 

 

Only you know which school of thought is right for you.  I would look into professor Sanjay bakshi's writings on this.  He has a presentation or blog post that details all of the stocks he bought and sold after a quick run up.  Several of them went on to be multi-naggers that he missed bc he was eager to take quick profits

 

https://dl.dropboxusercontent.com/u/28494399/Blog%20Links/October_Quest_2013.pdf

[awindenberger]

Take some profits, but let the position run if you believe its still undervalued.

 

I find that I always make the wrong decision, so by selling some shares it "forces" the stock to go higher. ;-)

 

Its clear that the Seeking Alpha article caused the recent move up, as it was quite compelling. I imagine the stock will trade lower again, at least temporarily, once the buying wave is complete.

[wachtwoord]

What is your alternative investment if you decide to sell? An important factor in this decision.