Rocky Mountain Chocolate Factory, Inc. — Q1 FY2016 Form 10-Q
Reporting period: Three months ended May 31, 2015; interim financial statements are unaudited. Effective March 1, 2015, the company reorganized under a new Delaware holding company; shares were exchanged one-for-one and trading continued under RMCF.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total revenue | $10.364 million | $10.322 million | +0.4% |
| Income from operations | $1.411 million | $1.347 million | +4.8% |
| Consolidated net income | $933,359 | $937,272 | Slight decrease |
| Net income attributable to RMCF | $762,959 | $711,334 | +7.3% |
| Basic / diluted EPS | $0.13 / $0.12 | $0.12 / $0.11 | Higher |
| Operating cash flow | $3.365 million | $3.678 million | Lower |
| Cash and equivalents at period end | $8.368 million | $9.795 million | Lower year over year |
Factory sales rose 7.7% to $6.325 million, while retail sales fell 28.7% to $1.412 million. Franchise and royalty fees totaled $2.628 million; within these, franchise fees increased substantially, while royalty and marketing fees declined 2.3%. Adjusted gross margin, a non-GAAP measure, fell to 33.2% from 38.4%; factory adjusted gross margin declined to 25.6% from 28.8%. Management attributed factory margin pressure to higher material costs and changes in customer and product mix.
At May 31, working capital was $8.8 million, versus $9.4 million at February 28, and the current ratio was 2.1. Current assets were $17.083 million and current liabilities $8.265 million. Total reported debt was approximately $5.993 million, including $1.219 million of current maturities; a separate $5.0 million revolving credit line was undrawn and available. The company stated it complied with its own line-of-credit and promissory-note covenants. Management believes operating cash flows and available financing will fund operations for at least 12 months.
Operating activities generated $3.365 million; investing activities used $109,344, and financing activities used $2.045 million, including $1.034 million for share repurchases and $721,536 in dividends paid. Cash increased $1.211 million from February 28.
Changes versus the prior-year quarter
- Revenue was nearly flat, as higher factory sales and franchise fees largely offset lower retail sales and royalty and marketing fees.
- Operating income improved, but the comparison benefited from no restructuring and acquisition charges in 2015; the prior-year quarter included $124,551 of such charges.
- RMCF-attributable income and EPS increased, while consolidated net income was slightly lower and operating cash flow declined.
- Factory adjusted gross margin and total adjusted gross margin contracted. Same-store sales decreased 3.4% at company-owned stores and cafés, 4.2% at U-Swirl cafés, and 1.1% across total franchise stores and cafés.
Outlook, risks, and unusual items
- No specific earnings or revenue guidance was provided. Management highlighted unit growth, same-store sales, and franchisee purchases from the factory as key drivers; results are seasonal and quarterly results may not indicate full-year performance.
- U-Swirl failed its loan covenant: required trailing 12-month adjusted EBITDA was $1.804 million, versus reported $1.532 million. RMCF could impose 15% default interest, accelerate repayment, or foreclose on its security interest. U-Swirl owed RMCF $6.8 million under the secured loan agreement; RMCF also reported a right to convert debt into U-Swirl equity.
- A potential CherryBerry share-sale shortfall payment was estimated at approximately $480,000. Management judged payment less than probable and recorded no liability.
- Factory ingredient contracts expose the company to commodity-price movements; management estimated a 10% change in contracted ingredient prices would create an approximately $87,000 favorable or unfavorable effect. Other stated risks include competition, store closures, raw-material and labor costs, franchise expansion, consumer demand, and U-Swirl performance.
- The company repurchased 75,968 shares at an average $13.62 during the quarter; approximately $2.986 million remained authorized. It paid a $0.12-per-share quarterly dividend in March and paid another $0.12 dividend in June.
- Management reported disclosure controls were effective and no material changes to internal control occurred during the quarter. No material legal proceedings or off-balance-sheet arrangements were reported.
Important facts for investors to verify
- U-Swirl’s covenant breach, cure or enforcement status, and the recoverability and conversion terms of the $6.8 million receivable.
- Whether lower franchise unit counts and same-store sales stabilize, and whether factory sales growth can offset weaker retail and royalty revenue.
- Drivers of factory margin compression, including ingredient costs and customer/product mix, and subsequent margin trends.
- Cash generation and capital allocation after dividends and buybacks, along with the July 31, 2015 renewal of the revolving credit line.
- Potential CherryBerry shortfall exposure and any changes in management’s probability assessment or recorded liability.