Rocky Mountain Chocolate Factory, Inc. — Q3 FY2016 Form 10-Q
Business context and period: Unaudited results for the three and nine months ended November 30, 2015, compared with the same periods in 2014. The company manufactures and sells confectionery products, franchises and operates retail stores, and consolidates U-Swirl, in which it held approximately 39% but had financial and operational control. At quarter-end, the filing listed 573 open locations and 13 sold-not-yet-open locations across its businesses.
Financial performance
| Metric | Three months ended Nov. 30 | Nine months ended Nov. 30 |
|---|---|---|
| Total revenue | $9.81 million, down 7.1% from $10.56 million | $29.45 million, down 3.0% from $30.34 million |
| Operating income | $1.25 million, down 19.4% from $1.55 million | $4.36 million, up 0.7% from $4.33 million |
| Consolidated net income | $774,000, down from $955,000 | $2.95 million, up from $2.82 million |
| Net income attributable to RMCF | $441,000, down from $962,000 | $1.98 million, down from $2.55 million |
| Basic / diluted EPS | $0.08 / $0.07, versus $0.16 / $0.15 | $0.34 / $0.32, versus $0.41 / $0.40 |
| Operating cash flow | Not separately presented for the quarter | $4.61 million, versus $4.49 million |
- Quarterly revenue declines reflected lower factory sales and franchise-related revenue. Factory sales fell 5.7%; retail sales fell 12.3%; franchise fees fell 78.1%. Royalty and marketing fees rose 1.2% for the quarter.
- For the nine-month period, factory sales rose 2.3%, helped by increased sales to customers outside the franchise system. Retail sales fell 21.2%, and royalty and marketing fees fell 3.4%.
- Management attributed the sharp drop in RMCF-attributable income to lower operating income and a larger share of earnings attributable to non-controlling interest in U-Swirl. It also cited derivative fair-value charges of $710,000 for the quarter and $1.1 million for nine months, versus $92,000 and $333,000, respectively, in the prior-year periods.
- Adjusted gross margin, a non-GAAP measure excluding depreciation and amortization from factory gross margin, was 35.2% for the quarter versus 35.6%, and 35.7% for nine months versus 38.4%. Nine-month factory adjusted gross margin declined to 29.2% from 31.1%; management cited higher material costs and product/customer mix.
Liquidity, debt and capital allocation
- At November 30, 2015, cash was $5.15 million, down from $7.16 million at February 28, 2015. Working capital was approximately $7.37 million and the current ratio was 1.9, versus 2.1 at fiscal year-end.
- Nine-month operating activities provided $4.61 million; investing activities used $558,000, principally for $625,000 of property and equipment purchases; financing activities used $6.05 million, including $902,000 of debt payments, $3.03 million of stock repurchases and $2.14 million of dividends.
- Debt outstanding was $5.39 million, including $1.24 million due within one year. The promissory note carries a fixed 3.75% rate. The company had a $5.0 million working-capital credit line, fully available and undrawn; RMCF reported compliance with its own debt and credit-line covenants.
- The company repurchased 233,302 shares during the nine months at an average $12.99 per share; approximately $990,000 remained authorized. Quarterly dividends of $0.12 per share were paid or declared.
- Management said operating cash flows and available financing should fund operations for at least the next 12 months. No quantitative earnings or revenue guidance was provided.
Management commentary, risks and contingencies
- Domestic franchise closures continued to exceed openings. Average franchise units in operation declined year over year; same-store pounds purchased by domestic RMCF franchise and license locations fell 3.8% in the quarter and 1.9% for nine months. Company-owned same-store sales also declined.
- U-Swirl failed its loan covenant requiring trailing-12-month adjusted EBITDA of $1.804 million; it reported $1.318 million. The U-Swirl loan balance was $6.3 million. Remedies may include 15% default interest, acceleration, foreclosure or conversion of debt into U-Swirl equity. RMCF also held a right to convert the debt, which could increase its ownership.
- A dispute with CherryBerry sellers concerns a stock-price shortfall payment. Sellers requested approximately $205,000; the potential payment was estimated at approximately $1.76 million if triggered at quarter-end. U-Swirl assessed the liability as less than probable and recorded no contingency. Sellers’ counterclaim names RMCF and seeks, among other relief, payment and a ruling that U-Swirl is RMCF’s alter ego. The company said the case was at an early stage and that potential loss could not be reasonably estimated.
- Management cited seasonality, consumer demand, franchisee recruitment and store performance, competition, raw-material costs and availability, and regulatory requirements as risks. The company reported no material change in the risk factors from its latest 10-K and no off-balance-sheet arrangements.
- Disclosure controls were concluded effective as of November 30, 2015; no material change in internal control over financial reporting was reported for the quarter.
Most important facts for investors to verify
- U-Swirl’s covenant default, available remedies, repayment prospects and potential effect on RMCF’s ownership or financial exposure.
- Status and potential outcome of the CherryBerry litigation and any shortfall-payment obligation.
- Drivers of falling franchise-unit counts, same-store sales and factory margins, and whether sales growth outside the franchise system can offset those declines.
- Why RMCF-attributable earnings fell materially despite higher nine-month consolidated net income and slightly higher operating income.
- Cash use from repurchases and dividends relative to working-capital needs, debt maturities and planned capital expenditures.