Rocky Mountain Chocolate Factory, Inc. — Q3 FY2017 Form 10-Q
Reporting period: Quarter and nine months ended November 30, 2016. The interim financial statements are unaudited. The company is a confectionery manufacturer, franchisor and retailer; it also operates and franchises frozen-yogurt cafés through U-Swirl.
Business context and financial performance
At November 30, the company reported 544 open stores and cafés across its brands, plus 11 sold but not yet open. The company’s consolidation changed after it foreclosed on U-Swirl’s stock on February 29, 2016, bringing U-Swirl into the company while ending its financial control of SWRL.
| Metric | Three months ended Nov. 30 | Nine months ended Nov. 30 |
|---|---|---|
| Revenue | $9.96 million, up 1.5% year over year | $27.93 million, down 5.1% |
| Operating income | $1.62 million, up 29.0% | $4.35 million, down 0.2% |
| Consolidated net income | $1.01 million, versus $0.77 million | $2.72 million, versus $2.95 million |
| Net income attributable to RMCF | $1.01 million, versus $0.44 million | $2.72 million, versus $1.98 million |
| Basic / diluted EPS | $0.17 / $0.17, versus $0.08 / $0.07 | $0.47 / $0.45, versus $0.34 / $0.32 |
For the quarter, higher factory sales were partly offset by lower royalties and marketing fees and lower retail sales. Operating income benefited from lower operating costs. The increase in RMCF-attributable earnings also reflects the absence of earnings attributable to non-controlling interests, which reduced prior-year attributable income. For the nine-month period, lower revenue was largely offset by lower expenses; the higher effective tax rate partly weighed on net income.
Margins, cash flow, debt and liquidity
- Margins: Q3 total gross margin was 32.8%, down from 33.9%; nine-month gross margin was 33.4%, down from 34.4%. Nine-month adjusted gross margin, a non-GAAP measure, was 34.9% versus 35.7%. Management cited lower margins in factory and retail operations.
- Cash flow: Nine-month operating cash flow was $3.00 million, versus $4.61 million a year earlier. Investing used $1.17 million, including $1.05 million of property and equipment purchases; financing used $3.42 million. Cash decreased $1.60 million to $4.60 million.
- Liquidity: Working capital was $7.2 million, down from $7.4 million at February 29, 2016; the current ratio was 1.9 to 1. Cash and cash equivalents were $4.60 million.
- Debt and credit: Debt was $4.15 million, including $1.29 million current and $2.86 million long-term, compared with $5.09 million at fiscal year-end. The company had no borrowings on its $5.0 million line of credit, which was available and covenant-compliant; renewal was due September 30, 2017. The promissory note bears fixed interest of 3.75% and matures January 15, 2020.
- Capital returns: The company paid $2.10 million in dividends during the nine months, declared a further $0.12-per-share dividend payable December 9, 2016, and repurchased 35,108 shares for an average $10.01 each. Approximately $638,000 remained authorized for repurchases.
Changes, outlook and risks
For the nine months, factory sales declined 2.4%, retail sales 11.6%, franchise fees 45.7%, and royalty and marketing fees 6.5%. Management attributed lower franchise-related revenue primarily to fewer units in operation, with closures—especially U-Swirl locations—exceeding openings. Company-owned same-store sales rose 2.1% for the nine months, while same-store sales at franchise stores and cafés rose 0.5%. Factory sales were also affected by lower shipments to outside customers and lower same-store pounds purchased by franchise and license locations.
Management stated that operating cash flows and available financing should fund operations for at least the next 12 months. No specific earnings or revenue guidance was provided. Results are seasonal: confectionery sales historically peak from the Christmas holiday through Mother’s Day, while frozen-yogurt sales are expected to be strongest in summer. Management cautioned that quarterly results are not necessarily indicative of full-year performance. Key exposures include changes in consumer demand, franchisee recruitment and performance, raw-material and labor costs, competition, international expansion, and regulation. A 10% change in contracted ingredient prices was estimated to produce about a $200,000 favorable or unfavorable impact.
The company is involved in litigation related to the CherryBerry acquisition and a disputed stock-price shortfall payment. The claims include allegations that RMCF is liable for SWRL obligations and that a loan should be treated as equity; RMCF intends to defend its position. SWRL has not recorded a contingent liability because it considers payment less than probable. The filing notes a potential shortfall of approximately $1.8 million based on the stated February 2016 scenario, and prior requests for about $205,000. Management believes other ordinary-course legal matters will not materially adversely affect the company. The company recorded $60,000 in lease-settlement costs for closing an ALY location. Management reported effective disclosure controls and no material change in internal control during the quarter.
Important facts for investors to verify
- Whether store closures and reduced franchise counts continue to pressure royalties, fees and factory shipments.
- Whether lower gross margins, working-capital outflows and reduced operating cash flow persist.
- The outcome and potential exposure from the CherryBerry litigation and disputed shortfall-payment provisions.
- U-Swirl’s operating performance and the effects of its consolidation and prior change in control, including possible limits on tax-loss carryforwards.
- Availability and renewal of the unused credit line, debt amortization, and the company’s ability to sustain dividends and share repurchases.