Rocky Mountain Chocolate Factory, Inc. — Q3 FY2024 Form 10-Q
Reporting period: Three and nine months ended November 30, 2023; comparative periods ended November 30, 2022. The company is a confectionery producer, franchisor and retailer. At quarter-end, its network included 2 company-owned, 156 franchised and 113 licensed Rocky Mountain Chocolate stores.
Financial performance
| Metric | Three months 2023 | Three months 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Revenue | $7.70 million | $8.83 million | $20.69 million | $22.28 million |
| Operating loss | $0.78 million | $0.20 million | $3.33 million | $2.94 million |
| Loss from continuing operations | $0.76 million | $0.20 million | $3.28 million | $2.93 million |
| Consolidated net loss | $0.76 million | $0.21 million | $2.58 million | $3.97 million |
| Basic loss per share | $0.12 | $0.03 | $0.40 | $0.63 |
Revenue and margins: Quarterly revenue declined 12.8%; nine-month revenue declined 7.2%. Durango Product sales fell 16.8% in the quarter and 9.6% year to date, while royalty and marketing fees were up 3.8% quarterly and 1.0% year to date. Durango Product gross margin contracted to 7.1% from 22.9% for the quarter and to 4.8% from 19.9% for nine months. Management attributed the deterioration to lower production volume, higher overhead, and wage and raw-material inflation. Retail gross margin was 62.0% for the quarter and 63.5% year to date. The company also reports non-GAAP adjusted gross margin: 13.1% quarterly and 11.2% year to date.
Cash flow and liquidity: Cash was $2.08 million at November 30, down from $4.72 million at February 28, 2023. For the nine months, operating activities used $2.56 million, investing activities used $1.07 million, and financing activities provided $1.00 million from line-of-credit borrowing. Capital expenditures were $2.62 million. Working capital was approximately $3.0 million, versus $6.2 million at fiscal year-end. Current assets were $10.08 million and current liabilities $7.08 million.
Debt and obligations: The company had drawn $1.00 million on its $4.0 million Wells Fargo revolving line, with $3.0 million available subject to borrowing limits. The line is secured by substantially all assets other than retail-store assets and carried a 7.68% rate at November 30. Lease liabilities totaled $1.87 million. No other material borrowing balance is specified in the filing text.
Material changes versus the prior period
- Quarterly sales weakness was concentrated in manufactured product shipments; domestic franchise same-store sales rose 2.1% in the quarter but fell 1.3% over nine months.
- Production economics weakened sharply: nine-month Durango Product gross margin fell to 4.8%, with management citing a 15.2% decline in production volume and a 21.9% increase in overhead costs.
- General and administrative expense declined by $0.75 million for the quarter and $2.77 million year to date. The comparable 2022 periods included approximately $0.76 million and $2.9 million, respectively, of proxy-contest costs; year-to-date 2022 also included executive-related legal/search costs and $0.86 million of severance.
- The company opened a second company-owned store in July 2023. Company-owned retail sales increased 20.6% for the quarter and 6.0% year to date, partly reflecting the new store.
- U-Swirl was sold and presented as discontinued operations. The company recorded a $0.63 million disposal gain in the nine-month period; the sale consideration included $1.76 million cash and a $1.00 million secured three-year note.
Outlook, risks and unusual items
- No numerical earnings or revenue guidance is provided. Management says seasonality affects results, with historically stronger sales during holidays and summer, and cautions that interim results are not necessarily indicative of full-year performance.
- The company was below its credit agreement’s minimum current-asset/current-liability ratio of 1.5:1. The financial-statement note reports 1.42:1 and says a waiver had been requested but not approved. The lender may demand repayment of amounts drawn; management stated cash on hand then was sufficient to repay the $1.0 million draw, but future ability to repay could be inadequate. The company is exploring a waiver, credit-line amendments and supplemental financing.
- Management expects inflation and supply-chain pressures to continue affecting raw-material, labor and freight costs, and says it may not be able to pass all increased costs to customers. Fixed-price raw-material purchase commitments were approximately $229,000.
- The company maintained a full valuation allowance against deferred tax assets and recorded no income-tax benefit on its nine-month continuing-operations loss.
- Disclosure controls and procedures were concluded to be ineffective at November 30, 2023, due to a material weakness involving accounting for complex, non-routine transactions. The company had engaged accounting experts and expected remediation before fiscal year-end, subject to effective operation and testing of controls.
- The filing reports no legal proceedings expected to have a material adverse effect and no material changes to previously disclosed risk factors. It identifies inflation, seasonality, consumer trends, raw-material availability, competition, co-branding execution and regulation among relevant risks.
Important facts for investors to verify
- Whether Wells Fargo granted the requested covenant waiver and whether the company remains in compliance; reconcile the filing’s 1.42:1 covenant ratio with the MD&A reference to 1.5:1.
- Whether production margins recover as volume, overhead, labor and ingredient costs change, and whether recent capital spending improves production efficiency.
- Collection terms and credit quality of the $1.00 million secured note receivable from the U-Swirl asset sale.
- Progress and testing results for remediation of the material weakness in internal controls.
- Whether seasonal holiday sales and franchise-store performance offset the decline in manufactured product shipments and cash balances.