Rocky Mountain Chocolate Factory, Inc. — FY2020 Form 10-K
Reporting period: Fiscal year ended February 29, 2020; comparisons are primarily with FY2019. The filing was signed May 29, 2020. This is an annual report, not a standalone quarterly filing; it includes unaudited fourth-quarter data.
Business context
The company manufactures confectionery products, operates a small number of company-owned retail locations, and earns revenue through manufacturing sales and its franchise and license system. It also operates self-serve frozen-yogurt brands. As of March 31, 2020, its Rocky Mountain Chocolate Factory system included 2 company-owned, 98 licensee-owned, and 237 franchised stores; U-Swirl had 3 company-owned, 59 franchised, and 25 licensed locations.
In FY2020, the company entered a long-term strategic alliance with Edible Arrangements, becoming the exclusive supplier of certain branded chocolate products. A related e-commerce agreement places Edible in charge of online sales and marketing through the company’s website and broader e-commerce channel.
Financial results and changes
| Metric | FY2020 | FY2019 | Change |
|---|---|---|---|
| Revenue | $31.85 million | $34.55 million | Down 7.8% |
| Operating income | $1.39 million | $3.01 million | Down 53.7% |
| Net income | $1.03 million | $2.24 million | Down 53.8% |
| Diluted EPS | $0.17 | $0.37 | Down |
| Operating cash flow | $4.40 million | $4.02 million | Up |
- Factory sales fell 11.0% to $21.52 million, primarily reflecting lower specialty-market shipments and lower purchases by FTD, the company’s largest customer. Retail sales declined 5.4% to $3.20 million. Royalty and marketing fees rose 2.4% to $6.81 million, partly due to the purchase-based royalty structure.
- Factory and retail gross margin dollars together were $6.50 million, down 6.6%; the reported combined margin rate on those sales increased to 26.3% from 25.3%. Operating margin was approximately 4.4% of revenue versus 8.7% in FY2019; net margin was approximately 3.2% versus 6.5%.
- General and administrative expense rose 67.1% to $5.74 million. It included approximately $2.27 million of one-time costs tied to the strategic-alternatives review and a contested proxy solicitation. The review concluded with the Edible alliance; the solicitation ended in December 2019.
- Net income was positive for the full year, but the third and fourth quarters reported net losses of $72,000 and $524,000, respectively. Fourth-quarter revenue was $8.13 million, compared with $9.43 million in the prior-year quarter.
Cash, debt and liquidity
- At February 29, 2020, cash and cash equivalents were $4.82 million, working capital was $8.00 million, and the current ratio was 2.4, down from 3.0 a year earlier.
- Operating activities provided $4.40 million; investing activities used $0.91 million, including $0.98 million of property and equipment purchases; financing activities used $4.05 million, including $2.87 million of dividends and $1.18 million of debt repayment.
- There was no long-term debt outstanding at year-end. The company had a $5.0 million revolving line, subject to borrowing-base limits, with no balance at year-end. On March 16, 2020, it drew $3.4 million, the full amount available under the borrowing base.
- In April 2020, the company received $1.5 million in PPP loans at 1% interest, due in 2022. Forgiveness is conditional, and the filing gives no assurance that any amount will be forgiven. Management said it believed available liquidity was sufficient for at least the next twelve months, while warning that further financing might be needed.
Outlook, risks and unusual items
- COVID-19: Store closures, reduced hours and lower customer traffic had disrupted operations and reduced franchisee and licensee orders. Management expected a significant negative effect on FY2021 sales and earnings but said it could not reasonably estimate the amount. It cut expenses and production, halted nearly all discretionary capital spending, drew the available revolver amount, and suspended future quarterly dividends.
- FTD bankruptcy: FTD filed for Chapter 11 in June 2019, and the bankruptcy court approved rejection of the supplier agreement. FTD revenue fell to approximately $1.5 million, or 5% of company revenue, from $3.1 million, or 9%. The company recorded an estimated $230,384 inventory loss; recovery of remaining related receivables and inventory was uncertain.
- Edible alliance and dilution: The company issued Edible a warrant to purchase up to 960,677 shares at $8.76 per share, vesting only if specified revenue thresholds are met. The alliance’s future contribution depends on customer demand, franchisee participation, logistics and technology integration.
- Other principal risks include franchisee financial distress and store closures, continued declines in factory pounds purchased by existing locations (down 4.6% in FY2020), dependence on a limited number of specialty-market customers, seasonal sales, ingredient and labor costs, and potential credit-covenant pressure. The company reported it was in compliance with line-of-credit covenants at year-end.
- The company reported no legal proceedings expected to have a material adverse effect. Management concluded disclosure controls and internal control over financial reporting were effective as of February 29, 2020; the auditor issued an unqualified opinion on the financial statements and highlighted COVID-19’s impact on results and liquidity.
Important facts for investors to verify
- Subsequent-period sales, operating status of stores, franchisee health, cash burn and liquidity after the March revolver draw and April PPP proceeds.
- Actual FY2021 impact of COVID-19, including whether the company can maintain covenant compliance and obtain additional financing if needed.
- Collections and inventory recovery related to FTD, including the remaining potential loss and any later bankruptcy distributions.
- Edible alliance sales performance, contract execution and whether warrant revenue thresholds are met, including potential share dilution.
- Whether and when the board resumes dividends, and the effect of lower factory purchases, store closures and one-time FY2020 costs on normalized earnings.