Rocky Mountain Chocolate Factory, Inc. — Q2 FY2024 Form 10-Q
Reporting period: Three and six months ended August 31, 2023; interim financial statements are unaudited. The company is a confectionery producer and franchisor with company-operated retail stores. It reported 269 operating Rocky Mountain Chocolate locations at period-end, plus four sold but not yet open.
Financial performance and liquidity
| Metric | Three months ended Aug. 31, 2023 | Six months ended Aug. 31, 2023 |
|---|---|---|
| Revenue | $6.56 million; essentially flat year over year | $12.99 million; down 3.5% |
| Operating loss | $1.01 million, versus $2.43 million | $2.55 million, versus $2.74 million |
| Loss from continuing operations | $999,000, versus $3.15 million | $2.53 million, versus $3.44 million |
| Consolidated net loss | $999,000, versus $3.64 million | $1.82 million, versus $3.76 million |
| Basic loss per share | $0.16 | $0.29 |
- Quarterly revenue comprised $4.71 million of Durango product sales, $1.54 million of franchise and royalty fees, and $309,000 of retail sales. For the six months, product sales were $9.53 million, franchise and royalty fees $2.96 million, and retail sales $501,000.
- Durango product gross margin fell to 3.7% from 21.3% for the quarter, and to 3.3% from 17.6% for the six months. Management cited lower production volume, higher overhead, and wage and materials inflation. Retail gross margin improved to 68.1% from 59.0% for the quarter and to 64.5% from 59.8% for the six months.
- Cash and equivalents were $3.98 million at August 31, down from $4.72 million at fiscal year-end. Working capital was $4.5 million, versus $6.2 million; the current ratio was 1.8, versus 2.2.
- Operating activities used $967,000 of cash in the six months. Investing activities provided $234,000 overall, including proceeds from the U-Swirl disposal, while property and equipment purchases were $1.25 million. There were no financing cash flows.
- No credit-line borrowings were outstanding at August 31; the company reported $5 million available, subject to borrowing limitations. The secured facility bore interest at SOFR plus 2.37% (7.68% at period-end) and the company was covenant-compliant. On September 28, the facility was renewed with comparable terms but its maximum was reduced to $4 million.
- Total assets were $20.53 million and stockholders’ equity was $12.87 million at August 31. Lease liabilities totaled approximately $2.06 million; these are not presented as funded debt.
Material changes versus prior period
- Quarterly revenue was nearly unchanged, while six-month revenue declined 3.5%, principally reflecting lower product shipments. Domestic franchise same-store sales rose 2.3% in the quarter and were approximately unchanged for the six months.
- Quarterly losses narrowed substantially, in part because prior-year general and administrative expense included about $1.8 million of proxy-contest costs; six-month 2022 costs were about $2.1 million. The prior-year periods also included other CEO/CFO transition and severance-related expenses.
- Production profitability deteriorated sharply despite product price increases taking effect in May 2022. Six-month production volume declined 29.6%, according to management; overhead costs rose 22.6%.
- U-Swirl was classified as discontinued operations following sales of its company-owned locations and franchise rights. The May 2023 franchise-rights sale generated $1.76 million cash and a $1.00 million three-year secured note, with a reported $635,000 disposal gain. Six-month consolidated results include $704,000 of discontinued-operation income, including that gain.
- Capital expenditures increased to $1.25 million from $554,000 in the comparable six-month period, primarily for production equipment.
Outlook, risks and unusual items
- The filing provides no quantified earnings or revenue guidance. Management cautioned that results are seasonal and interim performance is not necessarily indicative of full-year results.
- Management expects continued pressure from inflation and supply-chain disruption affecting raw materials, labor and freight, and noted it may not be able to pass all cost increases to customers. Commodity purchase commitments were approximately $309,000.
- A full valuation allowance was recorded against deferred tax assets; accordingly, the company recognized no income tax benefit on its continuing-operations losses in the 2023 periods.
- Disclosure controls and procedures were deemed ineffective at August 31 because of a material weakness involving the finance department’s ability to account for complex, non-routine transactions under GAAP. The company retained accounting experts and expected remediation before fiscal year-end, subject to successful testing over time.
- The company reported no pending legal proceeding expected to have a material adverse effect and no material change to previously disclosed risk factors. Risks include inflation, raw-material availability and cost, competition, seasonality, consumer demand, and co-branding execution.
- The board approved a limited waiver permitting ABV-Radoff to sell up to 200,000 shares to Global Value Investment Corp.; the company’s chairman is GVIC’s CEO and a principal. The broader settlement standstill remained in effect.
- A retirement agreement with a former senior vice president resulted in $345,124 of accrued expense at August 31, including consulting fees, bonus, accelerated equity vesting and other benefits.
Most important facts for investors to verify
- Whether production volumes, overhead and input-cost inflation improve, and whether product pricing can restore Durango margins.
- Cash burn and working-capital trends, capital-spending needs, and the effect of the credit facility’s reduction from $5 million to $4 million.
- U-Swirl sale-note repayment terms and collectability, and the separation of discontinued-operation gains from recurring results.
- Progress and testing supporting remediation of the material weakness and restoration of effective disclosure controls.
- How the proxy-contest expense comparison and other prior-year unusual costs affect interpretation of year-over-year loss improvement.