Rocky Mountain Chocolate Factory, Inc. quarterly report, Q1 FY2017

Rocky Mountain Chocolate Factory, Inc. — Form 10-Q Summary

Reporting period: Three months ended May 31, 2016, the first quarter of fiscal 2017. The company is a confectionery manufacturer, franchisor and retailer, with frozen-yogurt operations through U-Swirl International. Results are unaudited.

Financial performance

Metric	Q1 2017	Prior-year quarter	Change
Total revenue	$9.38 million	$10.36 million	Down 9.5%
Operating income	$1.18 million	$1.41 million	Down 16.2%
Net income attributable to RMCF	$732,000	$763,000	Down 4.1%
Basic / diluted EPS	$0.13 / $0.12	$0.13 / $0.12	Unchanged
Operating cash flow	$1.90 million	$3.37 million	Down $1.47 million

• Factory sales fell 8.9% to $5.76 million; retail sales fell 10.5% to $1.26 million; franchise fees fell 61.0% to $106,000; royalty and marketing fees fell 4.7% to $2.25 million.
• Adjusted gross margin, a non-GAAP measure, was 33.1% versus 33.2%; factory adjusted gross margin was 25.7% versus 25.6%. Factory GAAP gross margin was 23.9% in both periods.
• Income tax provision was $415,000, with a 36.2% effective tax rate versus 31.7%. Management attributed the higher rate primarily to the change in U-Swirl control and foreclosure of U-Swirl International stock.
• Cash and equivalents were $6.10 million at May 31, down from $6.19 million at February 29. Working capital was $6.7 million, down from $7.4 million; the current ratio was 1.8 versus 1.9.
• Investing activities used $833,000, including $634,000 of property and equipment purchases and $273,000 for intangible assets. Financing activities used $1.16 million, including debt payments, dividends and stock repurchases.
• Total debt was $4.78 million, of which $1.27 million was current; the balance was a fixed-rate 3.75% promissory note. The $5 million revolving credit line was unused and available subject to borrowing-base limits. The company reported compliance with applicable covenants.

Material changes and operating context

• Revenue and operating income declined mainly on lower factory shipments, fewer franchise units, lower franchise fees and reduced company-owned retail sales. Domestic RMCF franchise-store average count fell 3.5%; average total franchise-store count fell from 444 to 393. Same-store sales increased 1.5% at company-owned stores and cafés and 0.3% across franchise stores and cafés, while same-store pounds purchased by the RMCF franchise and license network fell 5.8%.
• Factory adjusted gross margin percentage edged up, but factory and retail gross-margin dollars declined with sales. Retail operating expenses fell as company-owned locations were sold or closed.
• Operating cash flow was lower year over year; the prior period benefited from a $1.11 million inventory reduction. Cash declined modestly after investment spending, dividends and repurchases.
• Following SWRL’s default and inability to repay the company’s loan, RMCF foreclosed on U-Swirl International stock on February 29, 2016, taking that operating subsidiary into wholly owned status and ending RMCF’s financial control of SWRL. The company reported 580 stores and cafés across its brands at May 31, including 572 open and 8 sold but not yet open.

Outlook, risks and unusual items

• No specific revenue or earnings guidance is provided. Management believes operating cash flows and available financing will be sufficient for at least the next 12 months. Results are seasonal and quarterly results may not indicate full-year performance.
• The quarter included $60,000 of lease-settlement restructuring and acquisition-related charges for closing an Aspen Leaf Yogurt company-owned location.
• A CherryBerry-related dispute remains pending. Selling parties sought about $205,000 in shortfall payments on shares and allege RMCF is liable as SWRL’s alter ego and that the SWRL loan should be treated as equity. RMCF was added as a defendant in the Oklahoma action in May 2016. A potential shortfall payment was estimated at approximately $1.8 million at February 29 if payable; SWRL considered the liability less than probable and had not accrued it. RMCF says it will defend the claims.
• Commodity purchase contracts expose the company to ingredient-price movements; management estimated a 10% price change in contracted ingredients could produce a $257,000 favorable or unfavorable impact. Other cited risks include consumer demand, competition, raw-material and labor costs, franchise performance, international expansion and regulation.
• Management reported disclosure controls effective as of May 31, 2016, and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

• Whether franchise closures and declining network shipments continue, and whether same-store sales gains persist.
• The status and potential financial exposure of the CherryBerry litigation and any related contingent obligation.
• U-Swirl International’s post-foreclosure operating performance, debt repayment and tax treatment, including limitations on net operating loss carryforwards.
• Cash needs for capital expenditures, dividends and repurchases, and continued compliance with debt and credit-line covenants.
• The effect of seasonality, commodity costs and the major manufacturing customer, which represented about $1.4 million of quarterly external revenue versus $2.0 million a year earlier.
• Prior-year consolidated net income included $170,400 attributable to a non-controlling interest; the filing reports 2016 net income attributable to RMCF of $731,834. Investors should account for this difference when comparing reported net income.