Rocky Mountain Chocolate Factory, Inc. — Form 10-K Summary
Reporting period: Fiscal year ended February 28, 2019. The filing is an annual report, not a standalone 2018 Q4 filing; it includes unaudited fourth-quarter results for FY2019.
Business context
The company manufactures premium confectionery, franchises and licenses chocolate stores, and operates and franchises self-serve frozen-yogurt concepts through U-Swirl. Revenue comes mainly from factory product sales, company-operated retail, and franchise and royalty fees. At March 31, 2019, the filing reports 245 franchised and 90 licensee-owned Rocky Mountain Chocolate Factory stores, plus 2 company-owned stores; U-Swirl had 68 franchised, 30 licensed, and 4 company-owned locations.
Financial performance and liquidity
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Revenue | $34.5 million | $38.1 million | Down 9.3% |
| Operating income | $3.0 million | $5.2 million | Down 42.4% |
| Net income | $2.24 million | $2.96 million | Down 24.5% |
| Basic / diluted EPS | $0.38 / $0.37 | $0.50 / $0.50 | Basic EPS down 24.0% |
| Gross margin | $7.0 million; 25.3% | $9.0 million; 29.8% | Down 4.5 percentage points |
| Cash from operations | $4.02 million | $4.76 million | Down $0.74 million |
Factory gross margin fell to 19.9% from 24.4%; management cited reduced production efficiency amid a 13.9% decline in factory output and higher inventory-obsolescence costs. Cash and equivalents were $5.38 million, working capital $9.53 million, and the current ratio 3.0 at year-end. The company had $1.18 million of debt, all classified as current and due by January 2020, and no borrowings on its $5.0 million revolving credit line. It paid $2.845 million in dividends during FY2019; the declared annual rate was $0.48 per share.
FY2019 investing activities used $0.51 million, including $0.61 million of capital expenditures. Financing activities used $4.20 million, principally for $1.35 million of debt repayment and $2.84 million of dividends. Management expected FY2020 capital expenditures of approximately $0.9 million and believed operating cash flow and available credit would cover capital and working-capital needs.
FY2019 fourth quarter: Revenue was $9.43 million, gross margin $1.31 million, net income $0.386 million, and basic and diluted EPS $0.06. The comparable FY2018 quarter reported revenue of $10.50 million and net income of $0.471 million.
Material changes and unusual items
- Factory sales declined 7.2%, with a 23.1% drop in shipments to customers outside the franchise network. The largest specialty-market customer generated approximately $3.1 million, or 9.1% of revenue, versus $5.1 million, or 13.4%, in FY2018.
- Royalty and marketing fees fell 8.0%; average franchise locations in operation declined 9.1%, as domestic closures exceeded openings. Franchise and license fees fell 50.9%, partly because FY2018 included $359,000 of international license fees.
- Same-store sales increased 1.0% at Rocky Mountain Chocolate Factory domestic franchise locations and declined 0.5% at frozen-yogurt franchise locations. Same-store pounds purchased from the factory declined 0.5% overall.
- Adoption of ASC 606 changed recognition of initial franchise and license fees from generally at store opening to over agreement terms, typically 10–15 years, and introduced gift-card breakage recognition. The modified-retrospective adoption increased opening retained earnings by $925,929; FY2018 comparative figures were not restated.
- Management accelerated amortization of certain U-Swirl intangible assets after reassessing their expected economic lives. Depreciation and amortization outside cost of sales rose 45.0% to $1.15 million. Company-owned store closure costs were $227,000.
- The effective income tax rate was 24.2%, versus 42.2% in FY2018, when tax reform caused a one-time deferred-tax revaluation expense. FY2019 net income therefore benefited from a lower comparative tax burden.
Outlook, risks, and contingencies
Management took a conservative view of U.S. market conditions for FY2020 and planned disciplined operations, with continued pursuit of international growth, co-branding, licensing, and specialty-market sales. It provided no specific revenue or earnings guidance. Management identified unit growth, higher same-store sales, and increased factory purchases by existing stores as key drivers of earnings.
Key risks include continued franchise closures and declining factory purchases, dependence on a concentrated specialty-market customer, U-Swirl’s history of losses, seasonal demand, competition for customers and locations, ingredient and labor cost inflation, and disruption at the company’s single Durango manufacturing site. The $5.0 million credit line was due for renewal in September 2019; management believed renewal on similar terms was likely. The company reported compliance with debt covenants. Ordinary-course legal proceedings were not expected by management to have a material effect. Fixed-price commodity purchase contracts totaled approximately $880,000; a 10% price change in contracted ingredients was estimated to affect costs or benefits by about $88,000.
Important facts for investors to verify
- Whether revenue, factory output, margins, franchise counts, and factory purchases stabilize after FY2019 declines.
- The specialty-market customer’s subsequent order levels and the effect of any further reduction or loss of that customer.
- U-Swirl’s operating performance and the impact of accelerated amortization and store closures.
- FY2020 renewal and terms of the credit line, repayment of the $1.18 million note, and cash available after dividends and capital spending.
- The effects of ASC 606 on recurring reported revenue and the company’s estimates for gift-card breakage and franchise-fee recognition.
- The filing gives inconsistent U-Swirl company-owned location counts in different sections and dates; confirm the current store count and basis of each figure.