Business context and reporting period
Rocky Mountain Chocolate Factory, Inc. is a franchisor, confectionery manufacturer and retail operator, including its U-Swirl frozen-yogurt business. This unaudited Form 10-Q covers the three months ended May 31, 2020, compared with the three months ended May 31, 2019. COVID-19 closures and restrictions materially disrupted company-owned, franchised and licensed locations.
Key financial results
| Metric | Quarter ended May 31, 2020 | Prior-year quarter |
|---|---|---|
| Revenue | $2.70 million | $8.43 million |
| Operating income (loss) | $(4.83) million | $946,000 |
| Net income (loss) | $(3.67) million | $712,000 |
| Basic and diluted EPS | $(0.61) | $0.12 basic; $0.11 diluted |
| Operating cash flow | $(1.60) million | $1.83 million |
| Cash and cash equivalents | $7.44 million at May 31, 2020 | $4.82 million at February 29, 2020 |
| Working capital / current ratio | $5.1 million / 1.5 | $8.0 million / 2.4 at February 29, 2020 |
Revenue fell 67.9% year over year. Factory sales declined 61.9%, retail sales 78.0%, franchise fees 48.3%, and royalty and marketing fees 82.5%. Factory gross margin was negative 30.7%, versus positive 22.8%; factory adjusted gross margin, a non-GAAP measure, was negative 23.4%, versus positive 25.4%. Retail gross margin fell to 50.6% from 66.3%.
General and administrative expense rose 177.8% to $3.18 million, primarily from higher bad-debt expense, impairment and professional fees. The company recorded $544,801 of impairment and store-closure losses, including $317,243 of company-store goodwill impairment. The income tax benefit was $1.18 million.
Financing activities provided $4.26 million, principally from $3.45 million of credit-line borrowings and $1.54 million of Paycheck Protection Program (PPP) loans; dividends paid were $722,000. Total debt was $4.99 million at quarter-end, comprising $3.45 million on the line of credit and $1.54 million of PPP loans. Lease liabilities totaled $2.52 million, including current and long-term portions.
Material changes and unusual items
- COVID-19-related closures and restricted operations reduced store traffic, franchisee orders, production and sales. Most locations began reopening in May, generally with restrictions; management said timing of a return to pre-pandemic operations was uncertain.
- Lower production volume left fixed factory costs and idle labor in excess of revenue; approximately $280,000 of paid production labor during stay-at-home orders was included in cost of sales.
- Allowances for potentially uncollectible accounts and notes receivable rose to $2.11 million from $557,916 at February 29, 2020.
- The company drew the maximum available amount under its $5.0 million credit facility, subject to its borrowing base. It failed the facility’s trailing-twelve-month adjusted EBITDA covenant at May 31. On June 26, Wells Fargo issued a reservation-of-rights letter, including the right to demand immediate repayment and restrictions on further draws. The company intended to seek covenant amendments; lender agreement was not assured.
- The $1.54 million PPP loans bear 1% interest and mature in April 2022. Forgiveness is conditional, and the company gave no assurance that any portion would be forgiven.
- The Board suspended the first-quarter cash dividend and future quarterly dividends pending improvement in public-health and economic uncertainty.
- FTD, previously the company’s largest customer, filed for bankruptcy in 2019. The company reported $198,271 of potential loss exposure related to FTD balances and said further recovery was uncertain.
Outlook, risks and management commentary
Management described cost reductions, lower production, reduced discretionary spending and capital expenditures, extended vendor payment terms, and liquidity preservation measures. It believed cash on hand and operating cash flows would meet liquidity needs and capital expenditures for at least the next 12 months, while noting that additional financing might be needed and might not be available on acceptable terms. Management also highlighted online sales and the Edible Arrangements alliance as areas of focus. The alliance makes the company an exclusive supplier of certain branded chocolate products to Edible and includes an e-commerce licensing arrangement. Potential benefits are uncertain; warrants for up to 960,677 shares at $8.76 are contingent on revenue thresholds.
Other risks include continuing pandemic effects, franchisee and licensee financial health, the credit-facility covenant breach and lender rights, uncertain PPP forgiveness, FTD recovery, commodity and labor costs, and seasonality. The filing states results for this quarter are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether the company and Wells Fargo reached a covenant amendment or other resolution, and whether repayment or additional borrowing restrictions were imposed.
- Subsequent liquidity, cash burn and operating cash flow, especially if reopening or sales recovery was slower than expected.
- Whether franchisee and licensee operations recovered and whether receivable allowances or asset impairments increased.
- The amount of PPP loan forgiveness, if any, and the company’s repayment obligations.
- Recoveries, if any, from FTD and performance of the Edible alliance and related contingent warrants.
- Whether and when dividends resume; the filing provides no resumption date.