Rocky Mountain Chocolate Factory, Inc. — Q3 FY2020 Form 10-Q
Reporting period: Quarter and nine months ended November 30, 2019; comparisons are with the corresponding 2018 periods. The company is a confectionery manufacturer, franchisor and retail operator, including U-Swirl frozen-yogurt brands. At quarter-end, it reported 433 open locations and 8 sold-but-not-open locations across its brands.
Financial performance
| Metric | Three months ended Nov. 30, 2019 | Nine months ended Nov. 30, 2019 |
|---|---|---|
| Revenue | $7.91 million, down 11.6% | $23.72 million, down 5.5% |
| Operating income (loss) | $(98,000), versus $678,000 income | $2.09 million, down 16.3% |
| Net income (loss) | $(72,000), versus $525,000 income | $1.56 million, down 15.9% |
| Basic EPS | $(0.01), versus $0.09 | $0.26, versus $0.31 |
| Gross margin | 23.6%, versus 24.8% | 27.4%, versus 28.4% |
| Operating cash flow | Not separately reported for the quarter | $4.03 million, versus $1.70 million |
- Revenue mix: Quarterly factory sales fell 15.7% to $5.79 million; retail sales fell 2.4% to $704,000. Franchise and royalty fees rose 3.3% combined. For the nine months, factory sales fell 7.7% and retail sales fell 8.8%, while franchise and royalty fees increased.
- Margins: Factory gross margin was 18.9% for the quarter, down from 21.0%; management cited lower production and excess capacity, FTD-related inventory loss, and partial offsets from product rationalization. Nine-month factory gross margin declined to 21.6% from 22.9%.
- Cash, liquidity and debt: Cash was $5.46 million at Nov. 30, versus $5.38 million at Feb. 28, 2019. Working capital was $9.0 million and the current ratio was 2.6, compared with 3.0 at fiscal year-end. The company had $127,576 outstanding on a fixed-rate note due Jan. 15, 2020, which it expected to repay at maturity. A $5.0 million credit line was fully available, with no balance outstanding; the company reported covenant compliance.
- Cash uses: Nine-month investing activities used $754,000, including $864,000 of property and equipment purchases. Financing activities used $3.20 million, primarily for debt payments and dividends. The company paid $0.12 per share quarterly dividends and declared another $0.12 dividend payable in December.
Material changes, outlook and risks
- Quarterly general and administrative expense rose 77.6% to $1.53 million. It included approximately $771,000 of costs for the strategic-alternatives review and a contested proxy solicitation; nine-month costs for these matters were approximately $1.12 million. The review concluded with the subsequent Edible Arrangements alliance, and the proxy contest was terminated in December.
- FTD Companies, the company’s largest customer, filed for bankruptcy in June 2019. FTD purchases were about $1.5 million, or 6.3% of nine-month revenue, versus $1.8 million, or 7.1%, a year earlier; there were no FTD sales in the current quarter. The company recorded a $230,384 estimated inventory loss and disclosed $301,474 of remaining potential exposure, including receivables and inventory. Recovery and future revenue remain uncertain.
- After quarter-end, the company agreed to become an exclusive supplier of certain confectionery products to Edible Arrangements. The agreements include a planned sale of 126,839 common shares to Farids at $7.884 per share and a warrant for up to 960,677 shares at $8.76, vesting only if specified revenue thresholds are achieved. The share sale was subject to customary closing conditions.
- Management gave no specific financial guidance. It said operating cash flow and available financing should fund operations for at least the next 12 months. Results are seasonal, and the filing cautions that interim results are not necessarily indicative of full-year results.
- Other risks include declining domestic franchise units and same-store activity, dependence on customer demand and franchise purchases, input and labor cost inflation, commodity-price exposure, and execution of the Edible Arrangements relationship. The company reported no material changes to the risk factors in its prior Form 10-K. It also recorded a $290,000 liability related to a cooperation agreement with AB Value Management.
Important facts for investors to verify
- Whether FTD bankruptcy proceedings yield recovery on outstanding receivables and inventory, and whether sales from this customer are replaced.
- Closing and performance of the Edible Arrangements agreements, including supplier sales, revenue-threshold achievement, and potential warrant dilution.
- Whether factory production, factory margins, franchise unit counts, and same-store purchasing stabilize after recent declines.
- How much of elevated general and administrative expense was nonrecurring and whether operating profitability recovers.
- Repayment of the January 2020 promissory note, continued credit-line availability and covenant compliance, and the sustainability of the dividend.