Rocky Mountain Chocolate Factory, Inc. — Q2 FY2020 Form 10-Q
Business context and reporting period. The unaudited quarter and six-month periods ended August 31, 2019, compared with the periods ended August 31, 2018. The company manufactures confectionery, operates company stores, and franchises and licenses chocolate and frozen-yogurt locations. At quarter-end, 435 locations were open across its brands, with 10 additional locations sold but not yet open.
Financial performance and position
| Metric | Three months | Six months |
|---|---|---|
| Revenue | $7.39 million, down 5.3% | $15.81 million, down 2.2% |
| Operating income | $1.25 million, versus $1.04 million | $2.19 million, versus $1.82 million |
| Net income | $918,088, versus $750,815 | $1.63 million, versus $1.33 million |
| Basic / diluted EPS | $0.15 / $0.15, versus $0.13 / $0.13 | $0.27 / $0.26, versus $0.22 / $0.22 |
| Operating cash flow | $2.90 million for six months, versus $1.39 million |
- Factory sales fell 6.3% in the quarter and 2.4% year to date; retail sales fell 5.5% and 11.2%. Six-month royalty and marketing fees increased 3.6%, while franchise fees declined 6.2%.
- Quarterly factory gross margin declined to 23.4% from 25.2%; six-month factory gross margin declined to 23.1% from 24.1%. Management attributed factory margin pressure to excess capacity as production fell 14.8% in the quarter and 10.6% year to date. Six-month retail gross margin improved to 66.3% from 64.4%.
- Cash and cash equivalents were $5.75 million at August 31, up from $5.38 million at February 28. Working capital was approximately $9.5 million; the current ratio was 2.9 versus 3.0.
- Six-month investing cash outflow was $406,376, including $480,984 of property and equipment purchases. Financing cash outflow was $2.13 million, including $696,043 of debt payments and $1.43 million of dividends.
- Promissory-note debt was $480,445, classified as current and due January 15, 2020; no borrowing was outstanding on the $5 million credit line. Separately, operating lease liabilities totaled $3.07 million.
Material changes and management commentary
- Higher operating income and net income reflected lower operating expenses, despite lower revenue and weaker factory margins. Lower franchise, sales and marketing, and retail operating costs contributed; no company-store closure costs were recorded, compared with $118,793 in the quarter and $176,981 year to date in 2018.
- General and administrative expense increased 14.3% year to date. It included approximately $347,000 of costs for the company’s previously announced review of strategic alternatives ($92,000 in the quarter).
- Domestic franchise locations in operation declined as closures exceeded openings. Same-store sales increased 0.1% for franchise stores in the quarter and 0.5% year to date; company-owned same-store sales decreased 1.7% in the quarter and increased 0.2% year to date.
- The company adopted the new lease accounting standard on March 1, 2019, recording a $3.3 million right-of-use asset and lease liability at adoption. Management said adoption did not affect cash flows or operating results.
Outlook, risks and contingencies
- No specific earnings or revenue guidance was provided. Management said operating cash flows and available financing should be sufficient for at least the next 12 months.
- On September 30, 2019, the company renewed its $5 million Wells Fargo revolving credit line and extended maturity to September 30, 2021. At August 31, it had no balance outstanding and was in compliance with covenants.
- FTD Companies, the company’s largest customer, filed for Chapter 11 in June 2019. FTD accounted for approximately $1.5 million, or 9.3%, of six-month revenue. At August 31, related receivables and inventory totaled $532,576; the company said full recovery was uncertain and any potential loss was not probable and/or could not be estimated. A bankruptcy-court-approved rejection of the supplier agreement was received September 23.
- Other risks highlighted include seasonality, commodity and labor cost inflation, competition, consumer demand, franchise-store trends, and uncertainty around the strategic-alternatives process. The company reported approximately $714,000 in purchase obligations, primarily for manufacturing commodities; a 10% change in contracted ingredient prices was estimated to affect costs or benefits by about $71,000.
Key facts for investors to verify
- FTD-related recovery, future sales, and any resulting impairment or inventory loss.
- Whether factory production and margins recover from lower volumes and excess capacity.
- Progress and costs of the strategic-alternatives review; no outcome or transaction was assured.
- Repayment of the $480,445 promissory note due January 2020 and continued compliance with credit-line covenants.
- Effects of franchise-store closures and the 270,000 restricted stock units granted in the six-month period on future earnings and dilution.