Rocky Mountain Chocolate Factory, Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended February 29, 2016. The filing is an annual report, not a standalone fourth-quarter filing; quarterly figures are unaudited.
Business context
The company manufactures premium confectionery, franchises and licenses Rocky Mountain Chocolate Factory stores, and operates through U-Swirl’s frozen-yogurt brands. Revenue comes mainly from factory product sales, company-operated retail, and franchise and royalty fees. At March 31, 2016, the company reported 3 company-owned, 96 licensee-owned, and 272 franchised Rocky Mountain Chocolate Factory stores; U-Swirl had 8 company-owned and 210 franchised cafes.
Financial performance and liquidity
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Revenue | $40.46 million | $41.51 million |
| Operating income | $3.71 million | $5.96 million |
| Net income attributable to RMCF | $4.43 million | $3.94 million |
| Diluted earnings per share | $0.73 | $0.61 |
| Cash from operating activities | $6.79 million | $5.87 million |
| Cash and cash equivalents | $6.19 million | $7.16 million |
| Working capital | $7.43 million | $9.37 million |
| Total long-term debt, including current maturities | $5.09 million | $6.29 million |
Revenue declined 2.5%; operating income fell about 37.7%. The company reported consolidated net income of $3.81 million before attributing a $619,000 loss to non-controlling interests. FY 2016 income tax benefit was $261,000, versus tax expense of $2.04 million in FY 2015; the benefit primarily reflected recognition of U-Swirl deferred tax assets after the foreclosure.
Adjusted gross margin, a non-GAAP measure, was 34.8%, down from 37.0%; factory adjusted gross margin was 28.9%, down from 30.3%, while retail margin improved to 65.7% from 64.9%. The company generated $6.79 million in operating cash flow, used $694,000 in investing activities and $7.06 million in financing activities, including $3.03 million for share repurchases and $2.84 million in dividends. Its current ratio was 1.9. A $5 million revolving credit line was undrawn and available subject to borrowing-base limits; the company reported compliance with covenants. The separate acquisition note had a $5.09 million balance, fixed interest of 3.75%, and a January 2020 maturity.
Fourth quarter: Revenue was $11.01 million versus $11.17 million a year earlier. Net income attributable to RMCF was $2.44 million versus $1.39 million; diluted EPS was $0.41 versus $0.22. The filing does not provide a clear standalone fourth-quarter operating-income figure.
Material changes versus the prior year
- Factory sales rose 1.8% to $26.36 million, supported by higher shipments to customers outside the franchise network. Same-store factory pounds purchased by franchisees and licensees declined 1.5%.
- Retail sales fell 19.4% to $5.01 million, principally following sales of company-owned stores and closures of underperforming cafes. Same-store sales at company-owned locations declined 0.8%.
- Royalty and marketing fees decreased 3.1%; average total franchise units declined from 476 to 423, with closures exceeding openings. Same-store sales across franchise stores and cafes increased 0.7%.
- U-Swirl revenue fell 15.7% to $6.54 million as its average domestic franchise cafe count declined. Its franchise system had fallen from a peak of 287 cafes in August 2014 to 210 at February 2016.
- The company foreclosed on U-Swirl International’s stock on February 29, 2016, after SWRL breached financial covenants and failed to repay its matured loan. U-Swirl International became wholly owned; RMCF ceased to control SWRL, which had no operating assets at year-end.
- The company recorded $2.33 million of impairment expense, including a full $1.93 million impairment of U-Swirl goodwill. Despite lower operating income, higher attributable net income reflected the tax benefit and the non-controlling-interest attribution.
Outlook, risks and unusual items
- Management said it would take a conservative view of U.S. market conditions in FY 2017, maintain flexibility, and pursue international expansion, co-branding, licensing, specialty-market sales and selected acquisitions. It expected approximately $1.6 million of FY 2017 capital expenditures and believed operating cash flow would fund capex and working-capital needs.
- Key risks include seasonality, competition, store closures and franchisee financing and performance, ingredient and labor costs, and concentration in specialty-market customers. One manufacturing customer accounted for approximately $5.2 million, or 13%, of FY 2016 revenue; one customer represented 63% of specialty-market shipments.
- A CherryBerry-related dispute includes claims for approximately $205,000 in requested shortfall payments and allegations that RMCF is liable for SWRL obligations and that the loan should be treated as equity. A potential contractual shortfall payment could approximate $1.8 million; management said the liability was less than probable and did not record it. The Oklahoma action remained pending, and RMCF said it intended to defend itself.
- Commodity purchase contracts covered approximately $945,000 of raw materials at year-end. A 10% price change in contracted ingredients was estimated to produce about a $95,000 favorable or unfavorable effect.
- The company declared dividends of $0.12 per share quarterly during FY 2016 and repurchased 233,302 shares at an average $12.99. Approximately $990,000 remained under the repurchase authorization.
Most important facts for investors to verify
- Whether U-Swirl can stabilize its franchise base and operating performance now that its operating subsidiary is wholly owned, and whether further impairments or losses arise.
- The sustainability of earnings excluding the FY 2016 tax benefit and the effects of the U-Swirl impairment and non-controlling-interest accounting.
- Progress in franchise openings, closures, same-store sales and factory pounds purchased, alongside the declining unit count.
- Exposure to the major specialty-market customer and the status, potential financial effect and accounting treatment of the CherryBerry litigation and shortfall claims.
- Cash use for dividends and buybacks relative to debt service, the available credit facility, and planned FY 2017 capital expenditures.
The independent auditor issued an unqualified opinion on the consolidated financial statements. Management concluded disclosure controls and internal control over financial reporting were effective as of February 29, 2016; the auditor did not express an opinion on internal-control effectiveness.