Rocky Mountain Chocolate Factory, Inc. — Q1 FY2024 Form 10-Q
Reporting period: Three months ended May 31, 2023, compared with the three months ended May 31, 2022. The interim financial statements are unaudited. The company produces confectionery products, operates retail stores, and earns franchise and royalty fees.
Financial performance
| Metric | Q1 FY2024 | Prior-year quarter |
|---|---|---|
| Revenue | $6.44 million | $6.90 million |
| Operating loss | $1.54 million | $0.32 million |
| Loss from continuing operations | $1.53 million; $0.24 per share | $0.29 million; $0.05 per share |
| Consolidated net loss | $0.82 million; $0.13 per share | $0.11 million; $0.02 per share |
| Cash from operating activities | $(0.42) million | $0.01 million |
| Cash and cash equivalents | $5.15 million at May 31, 2023 | $4.72 million at February 28, 2023 |
Revenue declined 6.8%. Durango Product sales fell 6.5% to $4.82 million, royalty and marketing fees fell 4.5% to $1.37 million, and retail sales fell 23.3% to $0.19 million. The retail decline reflected a Company-owned store sale in the prior year; sales at the remaining Company-owned store increased 15.7%.
Durango Product GAAP gross margin fell to 3.0% from 14.2%; total adjusted gross margin, a non-GAAP measure, was 8.5% versus 19.3%. Management attributed the product-margin decline mainly to 37.2% lower production volume, 25.4% higher overhead costs, and wage and material inflation, partly offset by higher prices. Domestic franchise and licensed same-store pounds purchased decreased 10.8%, and domestic franchise same-store sales decreased 2.7%.
Liquidity, capital and balance sheet
- Working capital was $5.7 million, down from $6.2 million at February 28, 2023; the current ratio was 2.2 to 1.
- The company reported a $5.0 million revolving credit line, fully available subject to borrowing limitations. The facility is secured by substantially all assets except retail store assets, bears interest at SOFR plus 2.37% (7.45% at quarter-end), and is due for renewal in September 2023. The company reported covenant compliance and expected renewal on similar terms.
- Operating lease liabilities totaled $2.24 million, including $0.75 million current. No material borrowing balance under the credit line is stated clearly in the filing text.
- Capital expenditures were $0.55 million. Cash used in continuing operating activities was $0.38 million; inventory reduction provided a $0.68 million cash-flow benefit, partly offset by lower accounts payable.
Material changes, unusual items and outlook
- U-Swirl operations are reported as discontinued operations. The company sold U-Swirl franchise rights and related intangible assets on May 1 for total consideration of $2.76 million, comprising approximately $1.75 million cash and a $1.0 million secured three-year note. The sale generated a reported $0.63 million gain. Discontinued operations contributed $0.70 million of earnings, so the continuing-operations loss was partly offset in consolidated results.
- General and administrative expense rose 20.3% to $1.93 million; management cited higher compensation, partly offset by lower prior-year proxy-contest and CEO-hiring costs. Franchise costs increased 62.1% to $0.68 million, including higher professional fees, stock compensation and travel.
- The company recorded no income tax benefit on its continuing-operations loss because it maintained a full valuation allowance against deferred tax assets, including an approximately $2.0 million reserve established in fiscal 2023.
- Management cited ongoing inflation and supply-chain disruption affecting raw-material, labor and freight costs, and cautioned that it may not be able to pass higher costs on to customers. Sales are seasonal, and quarterly results may not indicate full-year performance. The filing provides no specific financial guidance.
- The company accrued $345,124 for a retiring executive’s agreement. It had approximately $548,000 in raw-material purchase commitments. Management reported no legal proceedings expected to have a material adverse effect.
Controls and investor verification
Management concluded disclosure controls and internal control over financial reporting were ineffective at May 31, 2023, due to a material weakness: insufficient technical accounting expertise to process complex, non-routine transactions. The company plans to retain an accounting expert; remediation was not yet complete.
- Verify renewal and terms of the revolving credit facility due in September 2023.
- Monitor collection and repayment terms for the $1.0 million secured U-Swirl sale note, and confirm the final financial impact of the divestiture.
- Track production volume, cost inflation, product gross margins, franchisee purchasing and same-store sales.
- Assess progress in remediating the material weakness and the continued realizability of deferred tax assets.
- Review the continuing costs and cash requirements associated with the executive retirement agreement, leases and commodity purchase commitments.