Rocky Mountain Chocolate Factory, Inc. — Form 10-K
Reporting period: Fiscal year ended February 28, 2017 (FY2017), with quarterly data including the fourth quarter. The company is a chocolate manufacturer and franchisor and operates frozen-yogurt brands through U-Swirl. The audited financial statements received an unqualified opinion; the auditor did not express an opinion on internal control over financial reporting.
Financial performance and position
| Metric | FY2017 | FY2016 |
|---|---|---|
| Revenue | $38.30 million | $40.46 million |
| Operating income | $5.52 million | $3.71 million |
| Net income attributable to RMCF stockholders | $3.45 million | $4.43 million |
| Diluted EPS | $0.58 | $0.73 |
| Operating cash flow | $5.32 million | $6.79 million |
| Cash and cash equivalents at year-end | $5.78 million | $6.19 million |
| Working capital | $7.09 million | $7.43 million |
| Total debt | $3.83 million | $5.09 million |
- Revenue fell 5.3%. Factory sales declined 3.5%, retail sales 11.0%, royalties and marketing fees 5.3%, and franchise fees 40.8%.
- Operating income rose 48.8%, primarily because FY2017 had no comparable charge for the prior year’s impairment of long-lived assets and goodwill ($2.33 million in FY2016). Net income fell 22.0%, mainly reflecting FY2017 income tax expense of $1.95 million versus an FY2016 tax benefit of $261,400.
- Product gross margin was 30.6%, down from 33.5% (calculated on product sales); factory gross margin was 24.6%, down from 27.3%. Higher factory labor and overhead, maintenance and equipment issues, and product mix contributed to the decline.
- Cash from operations was $5.32 million; investing activities used $1.29 million, including $1.24 million for property and equipment; financing activities used $4.44 million, including $2.80 million in dividends and $1.25 million in debt repayments.
- The company had a $5 million revolving credit line with no amount drawn at year-end, subject to borrowing-base limits and covenants. The line was due for renewal in September 2017. The $3.83 million acquisition-related note bears fixed interest of 3.75% and matures in January 2020; the company reported covenant compliance.
- Quarter four revenue was $10.36 million versus $11.01 million in the prior-year quarter; gross margin was $1.92 million versus $2.76 million, and net income was $732,000 versus $2.44 million.
Changes, outlook and material considerations
- Domestic RMCF same-store retail sales increased 0.9% for FY2017, while frozen-yogurt franchise same-store sales declined 3.0%. Same-store pounds purchased from the factory declined 4.7% overall; franchise and co-branded locations averaged 371 units versus 423 in FY2016. Closures exceeded openings.
- U-Swirl revenue declined 20.2% to $5.22 million, primarily as the average number of domestic franchise cafés fell 20.4%. U-Swirl had a history of losses; RMCF took ownership of its operating subsidiary through foreclosure in February 2016 after defaults under the intercompany loan.
- Management described a conservative view of U.S. market conditions for FY2018, citing online-shopping shifts and continued difficulties at malls and outlet centers. It expects to emphasize controlled operations and pursue growth through international licensing, co-branding, specialty-market sales, consumer-product licensing and selected acquisitions. Planned FY2018 capital expenditures were approximately $1.0 million; management expected operating cash flow to fund these and working-capital needs.
- The company declared dividends of $0.12 per share each quarter in FY2017 ($0.48 for the year). Future dividends remain subject to board discretion and financial conditions.
- A single manufacturing customer generated approximately $4.1 million, or 11% of FY2017 revenue; specialty-market shipments were also concentrated, with one customer representing 52% of such shipments.
- In the CherryBerry dispute, selling parties seek shortfall payments tied to SWRL shares and have asserted claims involving RMCF. The company estimated a potential shortfall of approximately $1.8 million as of February 28, 2017, judged payment less than probable and recorded no liability. Discovery was ongoing, with trial scheduled to begin September 18, 2017.
- FY2017 included an immaterial correction of previously reported tax-related amounts: beginning retained earnings was reduced by $492,766, with related adjustments to accrued liabilities and deferred tax assets. No amendment of prior filings was considered necessary.
- Other key risks include seasonal sales, commodity and labor cost changes, dependence on franchisee performance and suitable sites, continued store closures, competition, product-safety or supply-chain disruptions, and the ability to sustain U-Swirl operations. The company also expected new revenue-recognition guidance to change the timing of initial franchise, master-license and renewal fee revenue.
Important facts for investors to verify
- Whether franchise closures and declining factory pounds purchased stabilize, and whether FY2018 same-store sales and unit trends improve.
- The profitability and cash requirements of U-Swirl following its consolidation, and any further impairment or restructuring needs.
- The status and potential financial exposure from the CherryBerry litigation and related shortfall-payment claims.
- The credit-line renewal terms, borrowing-base availability, covenant compliance and scheduled debt repayments.
- The customer concentration in manufacturing and specialty-market sales, and the effect of any change in that customer’s orders.
- The implications of the tax correction and the timing and magnitude of revenue-recognition changes for franchise and licensing fees.