Rocky Mountain Chocolate Factory: Q3 Earnings Review (NASDAQ:RMCF)

Rocky Mountain Chocolate Factory, Inc. (NASDAQ:RMCF) is a micro-cap stock with a market cap that has dropped to $34.064 million. While the company has seen a downward trend in sales performance since 2015, activist investors started pushing for change around 2019. It has been a long and costly battle. However, this last quarter, we may be seeing a glimpse of the direction in which the essentially new board and management team want to head into, implementing R&D and getting rid of at least 20% of products that are not generating revenue. The stock has traded under the ten-dollar mark since 2018 and was severely hit by the COVID-19 pandemic.

RMCF has just released its latest Q3 2023 earnings report, in which sales increased by 11% YoY to $9.8 million and net losses were reduced to $212,000. The new management team are focused on growth, improving processes and increasing margins. However, the economic environment remains unfavourable. The proxy battle has been extremely costly and cutting into cash resources. Although sales are growing, the number of franchisees remains stagnant. Therefore I recommend a hold status until we see more of the management’s strategic plans unfold in future financial reports.

Company overview

RMCF is an international confectionery and ice cream franchisor, manufacturer, and retail operator founded in 1981 in a small town in Colorado. The company went public in 1985 and is present in approximately 328 store locations, mainly in the USA and Canada. It generates revenue from five segments: manufacturing is the largest segment, followed by franchising, U-Swirl, retail and others. The increase in sales YoY between 2021 and 2022 is heightened due to the COVID-19 impact on FY21.

The company’s flagship manufacturing business brings in much more revenue than its franchisee brands which have been largely stagnant and even decreasing in store numbers over the years. It has two franchisee offerings in its portfolio. Firstly, the Rocky Mountain chocolate factories are in the form of little cafes and chocolate stores. The second brand is U-Swirl, a frozen yoghurt offering, which accounts for only 71 stores.

The new management team are looking to improve the business value by adding a new R&D team, enhancing supplier relationships, increasing salaries to overcome labour issues, cutting out at least 20% of products that are not significantly contributing to revenue and aiming to increase profit margin and growth. We can see that the company has successfully changed the face of an outdated board and management team; however, the impact on business operations will still need to be proven in the upcoming financial reports.

Q3 Financial overview and valuation

This financial year we are looking at results from a major management transition. Although it is still early on, significant business changes and their impact on performance still need to be realised. The company has just released its Q3 2023 results, which showed an improvement in sales YoY, beating records that were last set in 2017, reaching $9.8 million.

Revenue is generated through various channels. However, the most significant growth was in total factory sales, which increased by 14% to $7.3 million due to increased shipping and higher sales. Royalty and marketing revenue is the second most significant at $1.5 million, but there was no real growth YoY. Franchise fee revenue were stagnant at a low of $60,000.

Gross profit increased by 17% YoY for the quarter to $2.1 million at a margin of 26.3%. This was due to inflated pricing due to inflation, which also impacted operational costs. Operational expenses decreased to $9.7 million primarily due to the slowdown in the proxy battle and increased operational efficiencies. With significant management onboarding and operational changes, such as a new R&D team, we can expect some losses, such as those in Q2 2023.

This last quarter the company reported a loss of $212,000, and its adjusted EBITDA increased 30% YoY to $1.3 million. The company’s TTM levered cash flow is positive but very low at $7,344.00. The company may need more funds with many strategic changes to be made in the coming months and plans to develop new products.

It has a balance sheet with no long-term debt and a minimum cash balance of $3.2 million. We can expect severe cash burn for a company going through significant changes. This decreased from last year due to an increase in inventory to be used in the holiday season, which typically has a high demand. It has good liquidity with a current ratio of 2.2, although its quick ratio is sufficient to meet short-term obligations at 1.12.

Risks

While I can appreciate that changes had to be made to the company, which has seen sales and the number of stores slow down and even decrease if we look at its U-Swirl brand. RMCF has spent much money over the last four years dealing with an expensive proxy battle. The result has been changes made to the board and the management team. However, there needs to be more cash made available to invest in the business changes the company wants to implement, such as producing new products with its unique R&D team. Cash from operations is at a negative $1.58 million TTM. Although sales have increased, this could essentially be to increased prices due to inflation. The company has grown little if we look at the stagnant revenue from franchisee fees and royalty and marketing fees this past quarter, and at the same time, it has been burning through its cash supply.

Final thoughts

RMCF has a new fresh-faced management team that is enthusiastic about improving the business. The CEO is making it a point to visit local shops, improve relations with suppliers, increase wages, cut out underperforming products and add new products to the business. However, with a business that has been decreasing in sales since 2015, the expense of the proxy battle and the costs involved in improving the business, there is still a long way to go before we can call it a thriving business. For this reason, I recommend a hold status.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.