Rocky Mountain Chocolate Factory, Inc. — Q1 FY2020 Form 10-Q
Reporting period: Three months ended May 31, 2019; comparative period is the three months ended May 31, 2018. The unaudited filing covers the company and consolidated subsidiaries. The company manufactures confectionery products, franchises and licenses chocolate stores, and operates and franchises frozen-yogurt cafés.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $8.426 million | $8.366 million | Up 0.7% |
| Operating income | $946,003 | $783,236 | Up 20.8% |
| Net income | $711,609 | $576,944 | Up 23.3% |
| Basic / diluted EPS | $0.12 / $0.11 | $0.10 / $0.10 | Basic EPS up 20% |
| Operating cash flow | $1.828 million | $1.374 million | Up $454,000 |
| Capital expenditures | $283,548 | $130,572 | Up $152,976 |
- Revenue mix: Factory sales were $5.606 million, up 0.8%; retail sales were $854,591, down 16.4%; franchise fees were $106,280, up 14.1%; and royalty and marketing fees were $1.859 million, up 9.9%.
- Margins: Factory gross margin was 22.8%, down from 23.2%; retail gross margin was 66.3%, up from 61.4%; and combined gross margin was 28.6%, down from 29.1%. The filing reports adjusted gross margin of 30.8%, versus 31.2% (a non-GAAP measure).
- Cash and liquidity: Cash was $5.896 million at May 31, versus $5.384 million at February 28. Working capital was $8.9 million and the current ratio was 2.6:1, compared with 3.0:1 at February 28.
- Debt and leases: The $830,000 promissory note, bearing fixed interest at 3.75%, matures in January 2020 and was classified as current. No borrowings were outstanding on the $5 million credit line; availability was subject to borrowing-base limits, and the line was due for renewal in September 2019. The company recorded $3.3 million of lease right-of-use assets and liabilities upon adopting the lease standard.
- Cash uses: Financing activities used $1.062 million, including $346,547 of debt payments and $715,179 of dividends paid. A quarterly dividend of $0.12 per share was declared May 28 and paid June 14, 2019.
Material changes and management commentary
- Management attributed higher operating and net income mainly to higher revenue and lower operating expenses. General and administrative expense rose 17.7%, including approximately $255,000 of professional fees for the company’s process to explore strategic alternatives. Management provided no specific outcome or timetable for that process.
- Royalty and marketing fee growth reflected the purchase-based royalty structure and higher same-store sales, partly offset by a 5.0% decline in domestic franchise units in operation. Average total franchise stores in operation fell from 296 to 282; franchise same-store sales increased 0.7%.
- Company-owned retail sales declined following prior-period closures, although same-store sales at company-owned chocolate stores and U-Swirl cafés increased 2.4%. Retail operating costs also decreased with fewer company-owned units.
- The company generated $511,547 of net cash in the quarter. Operating cash flow improved, while investing outflows increased, primarily due to higher property and equipment purchases.
- The company adopted ASC 842 on March 1, 2019, recognizing lease assets and liabilities; management said adoption did not affect cash flows or results of operations. The filing states that expected operating cash flows and available financing should fund operations for at least the next 12 months.
Outlook, risks and contingencies
- No earnings or revenue guidance was provided. Management cautioned that quarterly results are seasonal and are not necessarily indicative of full-year results; holiday and summer periods are historically stronger.
- Risks discussed include changing consumer demand, competition, general economic conditions, the frozen-yogurt business, international and co-branding expansion, raw-material availability and costs, and regulation. The company reported no material changes to the risk factors in its FY2019 Form 10-K.
- One manufacturing customer represented approximately $1.4 million, or 16.3% of external revenue, versus $1.3 million, or 15.2%, a year earlier; management warned that a decline in purchases could reduce sales.
- Commodity purchase contracts exposed the company to an estimated $38,000 favorable or unfavorable effect from a 10% move in contracted ingredient prices. Purchase obligations were approximately $378,000.
- The company was in compliance with debt and credit-line covenants. It reported ordinary-course legal proceedings and said their resolution was not expected to have a material adverse effect. No material changes in internal control were reported, and disclosure controls were considered effective.
Investor verification points
- Track the strategic-alternatives review, its costs, and any disclosed outcome.
- Monitor renewal of the credit line in September 2019 and repayment or refinancing of the note due January 2020.
- Assess franchise-unit closures and openings, royalty growth, and the performance of the concentrated manufacturing customer.
- Review whether operating cash flow sustains capital spending and dividends, and how commodity costs affect factory margins.
- Consider the effects of 270,000 restricted stock units granted during the quarter, including potential dilution and future compensation expense.