Business context and reporting period
Rocky Mountain Chocolate Factory, Inc. is a confectionery manufacturer, franchisor and retail operator; its U-Swirl subsidiary franchises and operates frozen-yogurt cafés. This unaudited Form 10-Q covers the three months ended May 31, 2017, compared with the three months ended May 31, 2016. At May 31, 2017, the company reported 530 operating stores and cafés across its chocolate and frozen-yogurt brands, including licensed and co-branded locations.
Financial performance and liquidity
| Metric | Three months ended May 31, 2017 | Prior-year period |
|---|---|---|
| Total revenue | $9.35 million | $9.38 million |
| Operating income | $1.29 million | $1.18 million |
| Net income | $814,000 | $732,000 |
| Diluted EPS | $0.14 | $0.12 |
| Operating cash flow | $2.91 million | $1.90 million |
- Gross margin was 30.4%, down from 31.6%; factory gross margin improved to 24.7% from 23.9%, while retail gross margin declined to 65.2% from 66.8%. Adjusted gross margin, a non-GAAP measure, was 32.2% versus 33.1%.
- Cash and cash equivalents were $7.64 million at May 31, up from $5.78 million at February 28, 2017. Working capital was $7.2 million and the current ratio was 1.8:1.
- Long-term debt totaled $3.51 million, including $1.31 million current and $2.20 million long-term. The promissory note bears fixed interest of 3.75%. No balance was outstanding on the $5 million revolving credit line; availability is subject to borrowing-base limitations.
- Investing activities used $23,000 and financing activities used $1.02 million, including $702,524 in dividends and $321,831 in debt payments. Cash increased $1.86 million during the quarter.
Material changes versus the prior comparable period
- Revenue declined 0.3%. Factory sales increased 7.3% and franchise-fee revenue rose 136.1%, including $200,000 of international master-license fees for Panama and Vietnam. Retail sales fell 19.0%, while royalty and marketing fees declined 15.8%.
- Management attributed lower royalty and marketing fees primarily to fewer franchise locations, particularly frozen-yogurt franchise closures. Average total franchise stores in operation fell from 393 to 331; same-store sales across franchise stores and cafés declined 3.9%.
- Operating income increased 9.4% and net income increased 11.2%, helped by higher factory sales and franchise fees and lower operating expenses. General and administrative expense fell 9.0%; no restructuring charges were recorded, compared with $60,000 in the prior-year quarter.
- Operating cash flow increased from $1.90 million to $2.91 million. The company reported a $1.09 million decrease in accounts receivable as a key contributor.
Outlook, risks, contingencies and unusual items
- No numerical revenue or earnings guidance was provided. Management said operating cash flows and available financing should be sufficient to fund operations for at least the next 12 months. The credit line is due for renewal in September 2017; the company reported compliance with its credit-line and promissory-note covenants at quarter-end.
- Results are seasonal, with historically stronger sales during key holidays and the summer vacation season; quarterly results may not indicate full-year performance. Risks cited include consumer demand, competition, franchise and international expansion, raw-material and labor costs, and regulation.
- A lawsuit involving CherryBerry selling parties remains in discovery, with trial set to begin September 18, 2017. The claims include an asserted stock-sale shortfall payment and allegations concerning RMCF’s relationship to SWRL. The potential shortfall was estimated at approximately $1.8 million if payable as of February 28, 2017; the company says the likelihood of liability is less than probable and has not recorded a contingent liability.
- One manufacturing customer represented approximately 20.3% of external revenue, versus 14.9% in the prior-year quarter. Adoption of the new revenue-recognition standard is expected to change the timing of initial franchise, master-license, territory and renewal fee revenue and may materially affect those revenues.
- The company reported no material changes in risk factors from its latest Form 10-K, no off-balance-sheet arrangements, and no material subsequent events requiring disclosure.
Most important facts for investors to verify
- Whether franchise closures and weaker royalty and marketing fees continue, particularly in the U-Swirl system.
- The sustainability of improved factory sales and operating cash flow, given the quarter’s significant receivables-related cash contribution and customer concentration.
- The outcome and potential financial exposure of the CherryBerry litigation.
- Renewal and borrowing terms for the credit line in September 2017, and the effect of the upcoming revenue-recognition standard on franchise-fee timing.
- Whether margins, especially retail gross margin, recover amid cost pressures and lower retail sales.