Rocky Mountain Chocolate Factory, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended August 31, 2015. The unaudited consolidated results include the company’s chocolate manufacturing, franchising and retail businesses, as well as U-Swirl, which the company consolidates despite owning approximately 39%. Effective March 1, 2015, the company reorganized under a Delaware holding company; shares were exchanged one-for-one.
Financial results and liquidity
| Metric | Three months ended August 31, 2015 | Prior-year quarter | Six months ended August 31, 2015 | Prior-year period |
|---|---|---|---|---|
| Total revenue | $9.27 million | $9.46 million | $19.64 million | $19.78 million |
| Operating income | $1.70 million | $1.43 million | $3.11 million | $2.78 million |
| Consolidated net income | $1.24 million | $0.93 million | $2.17 million | $1.87 million |
| Net income attributable to RMCF | $0.78 million | $0.88 million | $1.54 million | $1.59 million |
| Basic EPS | $0.13 | $0.14 | $0.26 | $0.26 |
| Operating cash flow | Not provided by quarter | $3.97 million | $3.71 million |
- Quarterly revenue fell 1.9%, while operating income rose 18.8%. RMCF-attributable income declined 11.1%, partly reflecting a larger share of consolidated earnings attributable to non-controlling interests.
- For the six months, revenue declined 0.7%, operating income rose 12.0%, and RMCF-attributable income declined 2.9%. The company reported no restructuring or acquisition-related charges in 2015, versus $709,000 in the prior-year period.
- Six-month adjusted gross margin, a company-defined non-GAAP measure, was 36.0%, down from 40.1%; factory adjusted gross margin was 27.7%, down from 30.5%. Management attributed lower factory margins to material costs and product/customer mix. Retail margin improved, but retail revenue and gross-margin dollars declined.
- At August 31, cash and cash equivalents were $5.91 million, working capital was $7.5 million, and the current ratio was 1.9, compared with $7.16 million, $9.4 million, and 2.1, respectively, at February 28, 2015. Operating cash flow was $3.97 million; investing activities used $314,000 and financing activities used $4.90 million. Financing outflows included $2.89 million of share repurchases, $1.44 million of dividends paid, and $599,000 of debt payments.
- Total debt was $5.69 million, including $1.23 million current maturities. The company had no balance outstanding on its $5.0 million working-capital credit line, which was due for renewal September 28, 2015; the company reported compliance with its covenants. Its separate fixed-rate 3.75% promissory note had a $5.69 million balance and matures January 2020.
Business trends and changes versus prior periods
- Quarterly factory sales rose 8.2%, mainly from a 52.9% increase in sales to customers outside the franchise network. Six-month factory sales rose 8.0%, including a 37.4% increase in outside-network shipments. Domestic franchise same-store pounds purchased fell 0.6% for the quarter and 0.7% for the six-month period.
- Quarterly royalty and marketing fees fell 7.4%; the average franchise-store count decreased 10.3% year over year and franchise same-store sales fell 4.1%. For six months, royalty and marketing fees fell 5.0%, the average franchise-store count declined 9.7%, and franchise same-store sales fell 2.9%. Domestic closures continued to exceed openings.
- Retail sales declined 18.3% for the quarter and 23.6% for six months, primarily due to company-owned store sales and closures. Company-owned store and café same-store sales rose 0.4% in the quarter but fell 1.5% for six months.
- Factory adjusted gross margin percentage fell as sales mix shifted toward outside-network customers and material costs increased. Lower retail operating costs reflected fewer company-owned units, but retail operating expenses rose as a percentage of retail sales.
Outlook, risks, contingencies and notable items
- The filing gives no specific revenue, earnings or margin guidance. Management said operating cash flow and available financing should be sufficient for operations for at least the next 12 months. It identified unit growth, same-store sales and franchisee factory purchases as key drivers, while noting domestic franchise-unit declines and dependence on suitable locations, financing and qualified franchisees.
- U-Swirl failed its loan covenant requiring $1.804 million of adjusted EBITDA for the 12 months ended August 31; it reported $1.423 million. The company may, subject to a continuing default, raise the rate to 15%, accelerate repayment, foreclose on collateral, or convert the debt to U-Swirl shares. RMCF said it could convert the loan and increase its ownership. The company itself reported compliance with its promissory-note and credit-line covenants.
- CherryBerry sellers sought approximately $205,000 in shortfall payments under an acquisition agreement. U-Swirl sued to challenge the claims; the sellers later counterclaimed, adding RMCF and seeking payment, alleging RMCF liability for U-Swirl obligations, and seeking to recharacterize the U-Swirl loan as equity. The filing says the matter is at an early stage and potential loss cannot be reasonably estimated. U-Swirl had not recorded a liability; it estimated a potential shortfall of approximately $1.64 million if payment were required on all relevant shares.
- Other disclosed exposures include seasonality, ingredient and labor inflation, competition, franchise-store performance, and commodity-price risk. The company estimated a 10% change in contracted ingredient prices could produce approximately $196,000 of favorable or unfavorable impact. It also warned that U-Swirl tax attributes may be limited and future effective tax rates may increase.
- Quarterly cash dividends were $0.12 per share; future dividends remain subject to board discretion. At August 31, $1.13 million remained under the share-repurchase authorization. Management reported disclosure controls were effective and no material changes in internal control during the quarter.
Important facts for investors to verify
- U-Swirl’s covenant breach, available remedies, loan-conversion terms, and performance against future covenant tests.
- Developments and potential financial exposure in the CherryBerry litigation, including the requested shortfall payments and claims against RMCF.
- Whether factory-sales growth outside the franchise network can offset declining franchise-store counts, royalties and same-store sales, and how the mix affects margins.
- Renewal status and terms of the $5.0 million working-capital credit line, and liquidity after debt service, dividends and share repurchases.
- Future dividend and repurchase decisions, and any resulting effects on cash, share count and per-share earnings.