Rocky Mountain Chocolate Factory, Inc. — Q2 FY2023 Form 10-Q
Reporting period: Three and six months ended August 31, 2022; interim financial statements are unaudited. Comparisons are to the periods ended August 31, 2021. The company manufactures confectionery, franchises and licenses stores, and operates retail and frozen-yogurt locations. At period-end it reported 338 locations, including company-owned, franchised and licensed stores.
Financial performance
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Revenue | $7.53 million | $7.93 million | $15.35 million | $15.52 million |
| Operating income (loss) | $(2.23) million | $0.26 million | $(2.37) million | $0.90 million |
| Net income (loss) | $(3.64) million | $0.20 million | $(3.76) million | $0.78 million |
| Basic EPS | $(0.59) | $0.03 | $(0.60) | $0.13 |
- Q2 revenue fell 5.1%; six-month revenue fell 1.1%. Factory sales declined 6.8% in Q2 and 2.3% for six months. Quarterly domestic franchise and licensee same-store pounds purchased fell 15.4%.
- Q2 total gross margin declined to 27.2% from 31.5%; factory margin was 21.3% versus 26.1%, and retail margin was 62.7% versus 67.1%. For six months, total gross margin was 23.8% versus 26.8%.
- General and administrative expense rose to $4.07 million in Q2, principally reflecting $1.8 million in contested proxy-solicitation costs and an $859,000 accrued severance liability. Six-month proxy costs were approximately $2.1 million.
- The company recorded a full valuation allowance against deferred tax assets after recent losses; income-tax expense was $1.42 million in Q2 and $1.39 million for the six-month period, despite pretax losses.
Cash, liquidity and obligations
- Cash and equivalents were $5.40 million at August 31, down from $7.59 million at February 28, 2022. Working capital was $7.3 million, down from $9.7 million; the current ratio fell to 2.0 from 2.8.
- Six-month operating cash flow was a use of $1.58 million, compared with $1.43 million provided in the prior-year period. Inventory increased $2.07 million. Investing activities used $599,000, including $587,000 of property and equipment purchases; there were no financing cash flows.
- No borrowings were outstanding on the $5.0 million revolving credit line at August 31; approximately $4.6 million was available. The company was not in compliance with all line covenants at quarter-end. A September 30 renewal eliminated the covenant it had breached and replaced it with one the company said it met at renewal.
- Lease liabilities totaled $2.78 million. New trucking-equipment leases during the six months added $1.4 million of future lease liability. Raw-material purchase obligations were approximately $53,000.
Outlook, risks and unusual items
- Management said operating cash flow should be sufficient for FY2023 capital expenditures and working-capital needs, with the credit line available if needed. No revenue or earnings guidance was provided. Results are seasonal and interim performance may not indicate full-year results.
- Management reported inflation and supply-chain disruption affecting ingredients, labor and freight, with possible lost sales from product availability constraints. The filing says these pressures are expected to continue and notes that passing cost increases to customers is not assured.
- The company expects potentially material additional proxy-contest and related legal costs. On September 28, 2022, it sued the AB Value/Radoff Group and Mary Bradley, alleging they fraudulently induced an August cooperation agreement. The company seeks to rescind the agreement, including a disputed potential $600,000 payment, and seeks damages; the outcome is uncertain.
- Negotiations with Canadian operator Immaculate Confections continued after a settlement negotiation period expired in March 2022. The agreement could require approximately 49 Canadian locations to de-identify if no solution is reached. The company reported about $30,000 of factory revenue from those locations for the six months.
- After quarter-end, former executive Edward Dudley’s September 30 separation agreement provided for contractual separation benefits, an additional $70,000 severance payment, $56,250 for consulting through year-end if requested, and accelerated vesting of 12,499 restricted stock units.
Investor items to verify
- Whether proxy-related expenses and the Dudley severance liability produce further material costs, and the outcome of the contested-solicitation litigation.
- Whether factory sales, franchisee purchasing and gross margins stabilize amid inflation, labor and supply-chain constraints.
- Cash use, inventory levels, working capital and covenant compliance under the renewed credit line.
- The realization of deferred tax assets and any subsequent changes to the valuation allowance.
- Progress and potential financial consequences of negotiations with Immaculate Confections in Canada.