Rocky Mountain Chocolate Factory, Inc. — Q2 FY2017 10-Q
Reporting period: Three and six months ended August 31, 2016; balance sheet compared with February 29, 2016. The company is a confectionery manufacturer, franchisor and retail operator, including frozen-yogurt operations through U-Swirl.
Financial performance
| Metric | Three months ended Aug. 31, 2016 | Six months ended Aug. 31, 2016 | Comparable-period change |
|---|---|---|---|
| Total revenue | $8.60 million | $17.98 million | Down 7.3% and 8.5%, respectively |
| Operating income | $1.55 million | $2.74 million | Down 8.4% and 11.9% |
| Consolidated net income | $975,000 | $1.71 million | Down 21.4% and 21.5% |
| Net income attributable to RMCF | $975,000 | $1.71 million | Up 25.0% and 10.6% |
| Basic EPS | $0.17 | $0.29 | Up from $0.13 and $0.26 |
| Operating margin | 18.1% | 15.2% | Down from 18.3% and 15.8% |
The difference between consolidated net income and income attributable to RMCF in 2015 reflected non-controlling interests ($460,424 for the quarter and $630,824 for six months); no such deduction was reported in 2016. Revenue declines reflected lower factory and retail sales and lower franchise and royalty fees. Factory adjusted gross margin was 29.8% for the quarter and 27.6% for six months; total adjusted gross margin was 37.9% and 35.4%, respectively. These are non-GAAP measures; the filing cautions they exclude depreciation and amortization.
Cash flow, balance sheet and debt
- Six-month operating cash flow was $2.15 million, down from $3.97 million. Investing used $1.07 million, including $932,000 of property and equipment purchases; financing used $2.41 million, including $621,000 of debt payments, $1.40 million of dividends and $352,000 of share repurchases.
- Cash declined to $4.88 million from $6.19 million. Working capital was $6.8 million, down $0.6 million; the current ratio was 1.8, versus 1.9 at fiscal year-end.
- Total debt was $4.46 million, including $1.28 million current and $3.19 million long-term. The acquisition-related promissory note bears fixed interest of 3.75%. The $5 million asset-backed revolving line was undrawn, available in full and covenant-compliant; it is due for renewal in September 2017.
- Management said operating cash flows and available financing should fund operations for at least 12 months. No off-balance-sheet arrangements were reported.
Material changes and management commentary
- Domestic franchise-store closures exceeded openings: average domestic franchise units fell from 442 to 385 for the quarter and from 437 to 389 for the six-month period. Same-store sales at total franchise stores and cafés were down 0.1% and 0.2%, respectively.
- Factory sales fell 3.8% for the quarter and 6.6% for six months. Shipments outside the franchise network declined substantially; same-store pounds purchased by domestic RMCF franchise and license locations fell 2.1% for the quarter and 3.7% for six months.
- Company-owned store and café same-store sales rose 0.2% for the quarter and 0.9% for six months. Lower retail revenue overall reflected store sales and closures. Management attributed reduced G&A and retail operating expenses partly to fewer units and reduced duplicative U-Swirl costs.
- The company foreclosed on U-Swirl stock on February 29, 2016 after SWRL defaulted on its loan; U-Swirl became wholly owned and RMCF ceased controlling SWRL. Management cited this change as a reason for higher effective tax rates: 35.9% for the quarter and 36.0% for six months. U-Swirl tax-loss carryforwards may be limited under Section 382.
- Six-month results included $60,000 in lease-settlement costs for closing an ALY company-owned location. The company repurchased 35,108 shares during the six months; $638,121 remained authorized. Quarterly dividends were $0.12 per share.
Outlook, risks and contingencies
No specific earnings or revenue guidance was provided. The filing notes seasonality, with historically stronger sales around holidays and during summer, and cautions that interim results are not necessarily indicative of full-year results. Risks include franchise closures and franchisee performance, consumer demand, competition, commodity and labor costs, international expansion and regulation. Fixed-price ingredient contracts expose the company to above-market costs if prices fall; management estimated a 10% price change in contracted ingredients could create a $176,000 favorable or unfavorable impact.
A dispute connected to SWRL’s CherryBerry acquisition remains pending. Claims include alleged unpaid share-price shortfall payments and assertions that SWRL is RMCF’s alter ego and that a loan should be treated as equity. The potential shortfall was estimated at approximately $1.8 million as of February 29, 2016; SWRL had not accrued it because management assessed payment as less than probable. RMCF was added as a defendant in the Oklahoma action, and the company said it would vigorously defend its rights. Management believes other ordinary-course legal matters will not materially adversely affect the company.
Important facts for investors to verify
- Progress in resolving the CherryBerry litigation, including potential exposure to the shortfall claim and alter-ego or loan-recharacterization claims.
- Whether franchise closures continue to outpace openings and how that affects royalties, factory shipments and future revenue.
- Customer concentration: one manufacturing customer contributed about $1.5 million, or 8.6% of six-month revenue, versus $2.3 million, or 11.8%, a year earlier.
- Cash generation, inventory growth, capital spending and the company’s ability to sustain dividends and repurchases while reducing debt; also monitor renewal of the revolving credit line in September 2017.
- Tax consequences of the U-Swirl foreclosure and the availability or limitation of its tax-loss carryforwards.