Rocky Mountain Chocolate Factory, Inc. — Q2 FY2018 Form 10-Q
Reporting period: Quarter and six months ended August 31, 2017. The interim financial statements are unaudited. The company manufactures confectionery products, franchises and licenses chocolate and frozen-yogurt brands, and operates a small number of stores and cafés.
Financial performance
| Metric | Three months ended Aug. 31, 2017 | Year-over-year change | Six months ended Aug. 31, 2017 | Year-over-year change |
|---|---|---|---|---|
| Total revenue | $8.27 million | Down 3.9% | $17.61 million | Down 2.0% |
| Operating income | $1.50 million | Down 3.4% | $2.80 million | Up 2.1% |
| Net income | $928,284 | Down 4.8% | $1.74 million | Up 2.1% |
| Basic / diluted EPS | $0.16 / $0.16 | Basic EPS was $0.17 / diluted $0.16 in 2016 | $0.30 / $0.29 | Basic EPS was $0.29 / diluted $0.28 in 2016 |
| GAAP gross margin | 36.5% | Up from 36.2% | 33.2% | Down from 33.8% |
For the quarter, factory sales declined 1.9%, retail sales fell 11.9%, and royalty and marketing fees decreased 8.8%; franchise fees rose 229.3%, primarily due to international license fees. For the six-month period, factory sales increased 3.1%, while retail sales fell 15.4% and royalty and marketing fees declined 12.3%. International master license agreements were signed for Qatar, Vietnam and Panama during the six months.
Factory gross margin improved year over year, supported by lower costs for certain materials. Retail sales and margins weakened amid changes in company-owned locations and lower same-store sales. Same-store sales declined 4.1% at company-owned stores and cafés and 2.4% across franchise stores and cafés in the quarter; six-month declines were 5.0% and 3.2%, respectively.
Cash flow, liquidity and debt
- Six-month operating cash flow was $2.19 million, compared with $2.15 million in the prior-year period. Inventory growth used $1.42 million of cash.
- Investing activities used $173,000, mainly for $284,000 of property and equipment purchases. Financing activities used $2.05 million, including $1.41 million of dividends and $646,000 of debt payments. No shares were repurchased in the period.
- Cash was $5.74 million at August 31, 2017, versus $5.78 million at February 28, 2017. Working capital was $7.5 million and the current ratio was 1.9 to 1.
- Total promissory-note debt was $3.19 million, of which $1.33 million was current. The note carries a fixed 3.75% interest rate. The company also had a $5.0 million revolving credit line, undrawn at quarter-end; it reported compliance with applicable covenants.
- Management said operating cash flows and available financing should fund operations for at least the next twelve months. A quarterly dividend of $0.12 per share was declared in August, payable in September.
Changes, outlook and risks
- Management attributed lower quarterly operating income chiefly to reduced revenue. For the six-month period, higher factory sales and factory gross margin supported higher operating income and net income despite lower total revenue.
- Domestic franchise locations in operation decreased as closures exceeded openings. Management also cited lower company-owned retail sales following store sales and the closure of an underperforming location.
- No formal earnings or revenue guidance was provided. Management cautioned that results are seasonal and interim results are not necessarily indicative of full-year performance.
- One manufacturing customer represented approximately 12.3% of six-month external revenue, compared with 8.6% a year earlier. Ingredient purchase contracts expose the company to commodity-price changes; management estimated a 10% price movement on contracted ingredients could produce a $159,000 favorable or unfavorable impact.
- The company expects the new revenue-recognition standard to change the timing of initial franchise, master-license, territory and renewal fees, potentially materially; the impact was still being quantified. The forthcoming lease standard is expected to materially increase reported balance-sheet assets and liabilities, with no cash-flow impact expected.
- The filing reports favorable summary judgment for the company and SWRL in the CherryBerry litigation and says the company expects no further proceedings. Management stated there were no material changes to previously reported risk factors and no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether domestic franchise closures and negative same-store sales continue, and whether new international licenses translate into recurring revenue.
- Whether factory sales growth can offset weakness in retail and royalty revenue, including the effect of customer concentration.
- Inventory growth, cash conversion and the pace of scheduled debt repayments while dividends continue.
- The quantified revenue impact and timing effects when the new revenue-recognition standard is adopted, and the eventual lease liabilities recognized.
- Commodity-input costs and any changes to the undrawn credit facility, covenant compliance or liquidity outlook.