UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 31, 2015
___
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to________
Commission file number: 001-36865
Rocky Mountain Chocolate Factory, Inc.
(Exact name of registrant as specified in its charter)
Delaware
47-1535633
(State or other jurisdiction of
Incorporation or organization)
(I.R.S. Employer Identification No.)
265 Turner Drive, Durango, CO 81303
(Address of principal executive offices, including zip code)
(970) 259-0554
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes X No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ____ No X
On June 30, 2015, the registrant had outstanding 5,943,351 shares of its common stock, $.001 par value.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
TABLE OF CONTENTS
PART I.
FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4.
CONTROLS AND PROCEDURES
PART II.
OTHER INFORMATION
Item 1.
LEGAL PROCEEDINGS
Item 1A.
RISK FACTORS
Item 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Item 3.
DEFAULTS UPON SENIOR SECURITIES
Item 4.
MINE SAFETY DISCLOSURES
Item 5.
Item 6.
EXHIBITS
SIGNATURE
Financial Statements
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
(unaudited)
Three Months Ended May 31,
2015
2014
Revenues
Sales
Franchise and royalty fees
Total revenues
Costs and Expenses
Cost of sales, exclusive of depreciation and amortization expense of $101,890 and $89,628, respectively
Franchise costs
Sales and marketing
General and administrative
Retail operating
Depreciation and amortization
Restructuring and acquisition related charges
Total costs and expenses
Income from Operations
Other Income (Expense)
Interest expense
Interest income
Other Income (Expense), net
Income Before Income Taxes
Income Tax Provision
Consolidated Net Income
Less: Net income attributable to non-controlling interest
Net Income attributable to RMCF
Basic Earnings per Common Share
Diluted Earnings per Common Share
Weighted Average Common Shares Outstanding - Basic
Dilutive Effect of Stock Options and Restricted Stock Units
Weighted Average Common Shares Outstanding - Diluted
The accompanying notes are an integral part of these consolidated financial statements.
May 31,
February 28,
Current Assets
Cash and cash equivalents
Accounts receivable, less allowance for doubtful accounts of $733,028 and $696,798, respectively
Notes receivable, current portion, less current portion of the valuation allowance of $2,262 and $3,762, respectively
Refundable income taxes
Inventories, less reserve for obsolete inventory of $210,435 and $197,658, respectively
Deferred income taxes
Other
Total current assets
Property and Equipment, Net
Other Assets
Notes receivable, less current portion and valuation allowance of $30,000 and $28,500, respectively
Goodwill, net
Franchise rights, net
Intangible assets, net
Total other assets
Total Assets
Current maturities of long term debt
Accounts payable
Accrued salaries and wages
Other accrued expenses
Dividend payable
Deferred income
Total current liabilities
Long-Term Debt, Less Current Maturities
Deferred Income Taxes
Commitments and Contingencies
Stockholders’ Equity
Preferred stock, $.001 par value; 250,000 authorized; 0 shares issued and outstanding
Series A Junior Participating Preferred Stock, authorized 50,000 shares
Undesignated series, authorized 200,000 shares
Common stock, $.03 par value, 100,000,000 shares authorized, 0 and 6,012,799 issued and outstanding, respectively
Common stock, $.001 par value, 46,000,000 shares authorized, 6,024,619 and 0 issued, and 5,948,651 and 0 outstanding, respectively
Additional paid-in capital
Retained earnings
Non-controlling interest in equity of subsidiary
Treasury stock, 75,968 shares and 0 shares, at cost
Total stockholders’ equity
Total Liabilities and Stockholders’ Equity
Cash Flows From Operating Activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loss on accounts and notes receivable
Provision for obsolete inventory
Loss (gain) on sale of property and equipment
Expense recorded for stock based compensation
Changes in operating assets and liabilities:
Accounts receivable
Inventories
Other current assets
Accrued liabilities
Net cash provided by operating activities
Cash Flows From Investing Activities
Addition to notes receivable
Proceeds received on notes receivable
Purchase of intangible assets
Purchases of property and equipment
Net cash used in` investing activities
Cash Flows From Financing Activities
Payments on long-term debt
Repurchase of common stock
Tax benefit of stock awards
Dividends paid
Issuance of common stock, net
Proceeds from issuance of common stock in subsidiary
Net cash provided by (used in) financing activities
Net Increase in Cash and Cash Equivalents
Cash and Cash Equivalents, Beginning of Period
Cash and Cash Equivalents, End of Period
NOTE 1 – NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Nature of Operations
The accompanying consolidated financial statements include the accounts of Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, its wholly-owned subsidiaries, Rocky Mountain Chocolate Factory, Inc., a Colorado corporation, and Aspen Leaf Yogurt, LLC (“ALY”), and its 39%-owned subsidiary, U-Swirl, Inc. (“U-Swirl”) of which, Rocky Mountain Chocolate Factory, Inc. has financial and operational control (collectively, the “Company”). All intercompany balances and transactions have been eliminated in consolidation.
The Company is an international franchisor, confectionery manufacturer and retail operator in the United States, Canada, Japan, South Korea and the United Arab Emirates. Founded in 1981, the Company is headquartered in Durango, Colorado and manufactures an extensive line of premium chocolate candies and other confectionery products. U-Swirl franchises and operates soft-serve frozen yogurt stores. The Company also sells its candy in selected locations outside of its system of retail stores and licenses the use of its brand with certain consumer products.
Effective March 1, 2015, the Company was reorganized to create a holding company structure. The operating subsidiary with the same name, Rocky Mountain Chocolate Factory, Inc., a Colorado corporation (“RMCF”), which was previously the public company, became a wholly-owned subsidiary of a newly formed entity, Rocky Mountain Chocolate Factory, Inc., a Delaware corporation (“Newco”), and all of the outstanding shares of common stock of RMCF, par value $0.03 per share, were exchanged on a one-for-one basis for shares of common stock, par value $0.001, of Newco. The new holding company began trading on March 2, 2015 on the NASDAQ Global Market under the symbol “RMCF”, which was the same symbol used by RMCF prior to the holding company reorganization.
In January 2013, through the Company’s wholly-owned subsidiaries, including ALY, the Company entered into two agreements to sell all of the assets of its ALY frozen yogurt stores, along with its interest in the self-serve frozen yogurt franchises and retail units branded as “Yogurtini” which the Company also acquired in January 2013, to U-Swirl, a publicly traded company (OTCQB: SWRL), in exchange for a 60% controlling equity interest in U-Swirl. Upon completion of these transactions, RMCF ceased to directly operate any Company-owned ALY locations or sell and support frozen yogurt franchise locations, which is now being supported by U-Swirl. As of May 31, 2015, the Company held approximately 39% of U-Swirl’s outstanding common stock. Additionally, RMCF has the right to acquire approximately 27,146,000 shares of U-Swirl’s common stock through the conversion of outstanding debt owed by U-Swirl to RMCF. If RMCF exercised this conversion right, RMCF would hold approximately 72% of U-Swirl’s common stock. The Company entered into the promissory note used to finance the acquisitions of U-Swirl and entered into a loan and security agreement with U-Swirl. The loan and security agreement between the Company and U-Swirl is subject to various financial and leverage covenants. U-Swirl was not compliant with the covenants at May 31, 2015. The loan covenants required U-Swirl to maintain consolidated adjusted EBITDA of $1,804,000 for the twelve months ended May 31, 2015. At May 31, 2015 U-Swirl had reported $1,532,000 of adjusted EBITDA. In the event of default, we may charge interest on all amounts due under the loan agreement with U-Swirl at the default rate of 15% per annum, accelerate payment of all amounts due under the Loan Agreement, and foreclose on our security interest. At May 31, 2015 we believe that the conversion of the loan into preferred stock as settlement of the obligation would result in 68% more preferred shares issued when compared to the amount issuable if U-Swirl was compliant with the loan covenants. The U-Swirl Board of Directors is composed solely of Board members also serving the Rocky Mountain Chocolate Factory, Inc. Board of Directors.
Between fiscal year 2014 and 2016, U-Swirl acquired the franchise rights of frozen yogurt stores branded as “Cherryberry”, “Yogli Mogli” and “Fuzzy Peach”, and U-Swirl operates self-serve frozen yogurt cafes under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Josie’s Frozen Yogurt,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!,” and “Aspen Leaf Yogurt”.
The Company’s revenues are currently derived from three principal sources: sales to franchisees and others of chocolates and other confectionery products manufactured by the Company; the collection of initial franchise fees, royalty and marketing fees from franchisees’ sales; and sales at Company-owned stores of chocolates, frozen yogurt, and other confectionery products.
The following table summarizes the number of stores operating under the Rocky Mountain Chocolate Factory brand and its subsidiaries at May 31, 2015:
Sold, Not Yet
Open
Total
Rocky Mountain Chocolate Factory
Company-owned stores
Franchise stores – Domestic stores
Franchise stores – Domestic kiosks
International License Stores
Cold Stone Creamery – co-branded
U-Swirl Stores (Including all associated brands)
Company-owned stores – co-branded
Franchise stores – Domestic – co-branded
*U-Swirl cafés and the brands franchised by U-Swirl have historically utilized a development area sales model. The result is that many areas are under development and the rights to open cafés within the development areas have been established, but there is no assurance that any individual development area will result in a determinable number of café openings.
Basis of Presentation
The accompanying consolidated financial statements have been prepared by the Company, without audit, and reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial reporting and Securities and Exchange Commission regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Certain amounts previously presented for prior periods have been reclassified to conform to the current presentation. The reclassifications had no effect on net income, working capital or equity previously reported. In the opinion of management, the consolidated financial statements reflect all adjustments (of a normal and recurring nature) which are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The results of operations for the three months ended May 31, 2015 are not necessarily indicative of the results to be expected for the entire fiscal year.
These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended February 28, 2015.
New Accounting Pronouncements
In April 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2015-03, Simplifying the Presentation of Debt Issuance Costs ("ASU 2015-03"). ASU 2015-03 requires that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of debt liability, consistent with debt discounts or premiums. The recognition and measurement guidance for debt issuance costs would not be affected by the amendments in ASU 2015-03. ASU 2015-03 will be effective for fiscal years beginning after December 15, 2015. We are currently evaluating the impact that the adoption of ASU 2015-03 may have on our consolidated financial statements or disclosures.
In May 2014, FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers,” which supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605),” and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and is to be applied retrospectively. Early adoption is permitted for years beginning after December 15, 2016. The Company is currently evaluating the new standard.
NOTE 2 - EARNINGS PER SHARE
Basic earnings per share is calculated using the weighted-average number of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through stock options and restricted stock units. For the three months ended May 31, 2015 and 2014, 12,936 and 12,936 stock options were excluded, respectively, from the computation of earnings per share because their effect would have been anti-dilutive. Restricted stock units become dilutive within the period granted and remain dilutive until the units vest and are issued as common stock.
NOTE 3 – INVENTORIES
The Company held the following inventory at May 31, 2015 and February 28, 2015:
May 31, 2015
February 28, 2015
Ingredients and supplies
Finished candy
U-Swirl food and packaging
Reserve for slow moving inventory
Total inventories
NOTE 4 - PROPERTY AND EQUIPMENT, NET
Property and equipment at May 31, 2015 and February 28, 2015 consists of the following:
Land
Building
Machinery and equipment
Furniture and fixtures
Leasehold improvements
Transportation equipment
Asset impairment
Less accumulated depreciation
Property and equipment, net
NOTE 5 - STOCKHOLDERS’ EQUITY
Cash Dividend
The Company paid a quarterly cash dividend of $0.12 per common share on March 13, 2015 to stockholders of record on February 27, 2015. The Company paid a quarterly cash dividend of $0.12 per share of common stock on June 12, 2015 to stockholders of record on June 2, 2015.
Future declaration of dividends will depend on, among other things, the Company's results of operations, capital requirements, financial condition and on such other factors as the Company's Board of Directors may in its discretion consider relevant and in the best long term interest of the Company’s stockholders.
Stock Repurchases
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. During the three months ended May 31, 2015, the Company repurchased 75,968 shares under the repurchase plan at an average price of $13.62 per share. As of May 31, 2015, approximately $2,986,000 remains available under the repurchase plan for further stock repurchases.
Stock-Based Compensation
At May 31, 2015, the Company had stock-based compensation plans for employees and non-employee directors that authorized the granting of stock awards, including stock options and restricted stock units.
The Company recognized $321,033 of stock-based compensation expense during the three months ended May 31, 2015 compared with $296,772 during the three months ended May 31, 2014. Compensation costs related to stock-based compensation are generally amortized over the vesting period. The following table summarizes stock option transactions for common stock during the three months ended May 31, 2015 and 2014:
Three Months Ended
Outstanding stock options as of February 28:
Granted
Exercised
Cancelled/forfeited
Outstanding stock options as of May 31:
Weighted average exercise price
Weighted average remaining contractual term (in years)
The following table summarizes non-vested restricted stock unit transactions for common stock during the three months ended May 31, 2015 and 2014:
Outstanding non-vested restricted stock units as of February 28:
Vested
Outstanding non-vested restricted stock units as of May 31:
Weighted average grant date fair value
Weighted average remaining vesting period (in years)
The Company issued 4,000 fully vested, unrestricted shares of stock to non-employee directors during the three months ended May 31, 2015 and 2014. In connection with these non-employee director stock issuances, the Company recognized $61,040 and $47,480 of stock-based compensation expense during the three months ended May 31, 2015 and 2014, respectively.
During the three months ended May 31, 2015, the Company recognized $160,493 of stock-based compensation expense related to non-vested, non-forfeited restricted stock unit grants. The restricted stock units generally vest between 17% and 20% annually over a period of five to six years. Total unrecognized stock-based compensation expense of non-vested, non-forfeited restricted stock units, as of May 31, 2015, was $2,306,526, which is expected to be recognized over the weighted average period of 4.0 years.
The Company recognized $99,500 of stock-based compensation expense attributable to U-Swirl during the three months ended May 31, 2015 compared with $82,449 recognized during the three months ended May 31, 2014.
NOTE 6 – SUPPLEMENTAL CASH FLOW INFORMATION
Interest, net
Income taxes
Non-Cash Operating Activities
Non-Cash Financing Activities
NOTE 7 - OPERATING SEGMENTS
The Company classifies its business interests into five reportable segments: Franchising, Manufacturing, Retail Stores, U-Swirl, Inc. operations and Other. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1 to the Company’s financial statements included in the Company’s Annual Report on Form 10-K for the year ended February 28, 2015. The Company evaluates performance and allocates resources based on operating contribution, which excludes unallocated corporate general and administrative costs and income tax expense or benefit. The Company’s reportable segments are strategic businesses that utilize common merchandising, distribution, and marketing functions, as well as common information systems and corporate administration. All inter-segment sales prices are market based. Each segment is managed separately because of the differences in required infrastructure and the difference in products and services:
Franchising
Manufacturing
Retail
U-Swirl
Intersegment revenues
Revenue from external customers
Segment profit (loss)
Total assets
Capital expenditures
Total depreciation & amortization
May 31, 2014
Revenue from one customer of the Company’s Manufacturing segment represented approximately $2.0 million of the Company’s revenues from external customers during the three months ended May 31, 2015 compared to $1.6 million during the three months ended May 31, 2014.
NOTE 8 – GOODWILL AND INTANGIBLE ASSETS
Intangible assets at May 31, 2015 and February 28, 2015 consist of the following:
Gross CarryingValue
AccumulatedAmortization
Intangible assets subject to amortization
Store design
Packaging licenses
Packaging design
Trademark/Non-competition agreements
Franchise Rights
Intangible assets not subject to amortization
Company stores goodwill
Franchising goodwill
Manufacturing segment-Goodwill
Trademark
Total intangible assets
Effective March 1, 2002, under Accounting Standards Codification Topic 350, all goodwill with indefinite lives is no longer subject to amortization. Accumulated amortization related to intangible assets not subject to amortization is a result of amortization expense related to indefinite life goodwill incurred prior to March 1, 2002.
Amortization expense related to intangible assets totaled $93,150 and $91,930 during the three months ended May 31, 2015 and 2014, respectively.
At May 31, 2015, annual amortization of intangible assets, based upon our existing intangible assets and current useful lives, is estimated to be the following:
2016
2017
2018
2019
2020
Thereafter
NOTE 9 – RELATED PARTY TRANSACTIONS
Our President and Chief Executive Officer has members of his immediate family with ownership interests in retail marketing businesses. These businesses have, on occasion, provided services to the Company and may provide services in the future. For the three months ended May 31, 2015, the Company paid $7,581 and no amount was recorded to accounts payable that related to these businesses. Transactions with these businesses have been immaterial to our results of operations.
NOTE 10 – RESTRUCTURING AND ACQUISITION RELATED CHARGES
On January 17, 2014, U-Swirl entered into an Asset Purchase Agreement with CherryBerry, which was the franchisor of self-serve frozen yogurt retail stores branded as “CherryBerry.” Pursuant to the CherryBerry Purchase Agreement, U-Swirl purchased certain assets of CherryBerry used in its business of franchising frozen yogurt stores, including all of its franchise rights and one company-owned store. On January 17, 2014, U-Swirl also entered into an Asset Purchase Agreement with Yogli Mogli, which was the franchisor of self-serve frozen yogurt retail stores branded as “Yogli Mogli”. Pursuant to the Yogli Mogli Purchase Agreement, U-Swirl purchased certain assets of Yogli Mogli used in its business of franchising frozen yogurt stores, including all of its franchise rights and four company-owned stores. On February 20, 2014, U-Swirl entered into an Asset Purchase Agreement to acquire the business assets of Fuzzy Peach Franchising, LLC. The acquisition of all intellectual property and worldwide franchise and license rights includes the rights associated with 17 Fuzzy Peach Frozen Yogurt stores. Associated with these transactions, the Company recorded net restructuring charges of $124,551 during the three months ended May 31, 2014.
Restructuring and acquisition charges incurred were comprised of the following for the three months ended May 31:
Professional fees
Severance/transitional compensation
The company did not record any restructuring charges in the three months ended May 31, 2015.
NOTE 11- CONTINGENCIES
The CherryBerry selling parties entered into a one-year lock-up agreement with respect to the 4,000,000 shares of the U-Swirl common stock (the “CB Shares”) payable at the closing of the CherryBerry Acquisition. The CB Shares were issued to the selling parties in February 2015. Following expiration of the lock-up period, if any of the CherryBerry selling parties desire to sell their CB Shares, they must first offer such shares to the Company, at a price equal to the average of the market prices at the time of sale. If the proceeds from the sale of any of the CB Shares is less than $0.50 per share and the CherryBerry selling parties comply with other terms of the agreement, the Company has agreed to pay a shortfall payment. If the Company was required to pay the shortfall payment at May 31, 2015, the shortfall payment would approximate $480,000. The Company determined the likelihood of incurring the liability to be less than probable and has not recorded a contingent liability at May 31, 2015.
NOTE 12 – SUBSEQUENT EVENTS
Management evaluated all activity of the Company through the issue date of the financial statements and concluded that no subsequent events have occurred that would require recognition or disclosure in the financial statements.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q (“Quarterly Report”) includes statements of our expectations, intentions, plans and beliefs that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are intended to come within the safe harbor protection provided by those sections. These forward-looking statements involve various risks and uncertainties. The nature of our operations and the environment in which we operate subject us to changing economic, competitive, regulatory and technological conditions, risks and uncertainties. The statements, other than statements of historical fact, included in this Quarterly Report are forward-looking statements. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as "will," "intend," "believe," "expect," "anticipate," "should," "plan," "estimate," "potential," or similar expressions. Factors which could cause results to differ include, but are not limited to: changes in the confectionery business environment, seasonality, consumer interest in our products, general economic conditions, the success of U-Swirl, Inc., receptiveness of our products internationally, consumer and retail trends, costs and availability of raw materials, competition, the success of our co-branding strategy, the success of international expansion efforts and the effect of government regulations. Government regulations which we and our franchisees either are or may be subject to and which could cause results to differ from forward-looking statements include, but are not limited to: local, state and federal laws regarding health, sanitation, safety, building and fire codes, franchising, employment, manufacturing, packaging and distribution of food products and motor carriers. For a detailed discussion of the risks and uncertainties that may cause our actual results to differ from the forward-looking statements contained herein, please see the “Risk Factors” contained in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended February 28, 2015. These forward-looking statements apply only as of the date of this Quarterly Report. As such they should not be unduly relied upon for more current circumstances. Except as required by law, we undertake no obligation to release publicly any revisions to these forward-looking statements that might reflect events or circumstances occurring after the date of this Quarterly Report or those that might reflect the occurrence of unanticipated events.
Unless otherwise specified, the “Company,” “we,” “us” or “our” refers to Rocky Mountain Chocolate Factory, Inc, a Delaware corporation and its consolidated subsidiaries.
Overview
We are an international franchisor, confectionery manufacturer and retail operator. Founded in 1981, we are headquartered in Durango, Colorado and manufacture an extensive line of premium chocolate candies and other confectionery products. Our subsidiary, U-Swirl, Inc. (“U-Swirl”), franchises and operates soft-serve frozen yogurt stores. Our revenue and profitability are derived principally from our franchised/license system of retail stores that feature chocolate, frozen yogurt and other confectionery products. We also sell our candy in selected locations outside of our system of retail stores and license the use of our brand with certain consumer products. As of May 31, 2015, there were 4 Company-owned, 72 licensee-owned and 272 franchised Rocky Mountain Chocolate Factory stores operating in 41 states, Canada, Japan, South Korea, the Kingdom of Saudi Arabia and the United Arab Emirates. As of May 31, 2015, U-Swirl operated 9 Company-owned stores and 251 franchised stores located in 37 states, Canada, Turkey, the United Arab Emirates and Pakistan. In fiscal year 2014, U-Swirl acquired the franchise rights of frozen yogurt stores branded as “Cherryberry”, “Yogli Mogli” and “Fuzzy Peach”, and U-Swirl currently operates self-serve frozen yogurt cafes under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Josie’s Frozen Yogurt,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!,” and “Aspen Leaf Yogurt”.
Effective March 1, 2015, we reorganized to create a holding company structure. Our operating subsidiary with the same name, Rocky Mountain Chocolate Factory, Inc., a Colorado corporation (“RMCF”), which was previously the public company, became a wholly-owned subsidiary of a newly formed entity, Rocky Mountain Chocolate Factory, Inc., a Delaware corporation (“Newco”), and all of the outstanding shares of common stock of RMCF were exchanged on a one-for-one basis for shares of common stock of Newco. Our new holding company began trading on March 2, 2015 on the NASDAQ Global Market under the symbol “RMCF”, which was the same symbol used by RMCF prior to the holding company reorganization.
In January 2013, through our wholly-owned subsidiaries, including Aspen Leaf Yogurt, LLC (“ALY”), we entered into two agreements to sell all of the assets of our ALY frozen yogurt stores, along with our interest in the self-serve frozen yogurt franchises and retail units branded as “Yogurtini” which we also acquired in January 2013, to U-Swirl, a publicly traded company (OTCQB: SWRL), in exchange for a 60% controlling equity interest in U-Swirl. Upon completion of these transactions, RMCF ceased to directly operate any Company-owned Aspen Leaf Yogurt locations or sell and support frozen yogurt franchise locations, which are now being supported by U-Swirl. As of May 31, 2015, we held a 39% controlling interest in U-Swirl. Additionally, we have the right to acquire approximately 27,146,000 shares of common stock of U-Swirl through the conversion of convertible debt owed by U-Swirl to our company. If the Company exercised this conversion right, we believe we would hold approximately 72% of U-Swirl’s common stock.
The most important factors in continued growth in our earnings are ongoing unit growth, increased same-store sales and increased same-store pounds purchased from the factory.
Our ability to successfully achieve expansion of our franchise system depends on many factors not within our control, including the availability of suitable sites for new store establishment, the availability of adequate financing options and the availability of qualified franchisees to support such expansion.
Efforts to reverse the decline in same-store pounds purchased from the factory by franchised stores and to increase total factory sales depend on many factors, including new store openings, same-store sales, and the receptivity of our franchise system to our product introductions and promotional programs.
Results of Operations
Three Months Ended May 31, 2015 Compared to the Three Months Ended May 31, 2014
Basic earnings per share increased 8.3% from $.12 per share during the three months ended May 31, 2014 to $.13 per share during the three months ended May 31, 2015. Revenues increased by $41,800 in the three months ended May 31, 2015 compared to the three months ended May 31, 2014. This increase in revenues was due primarily to an increase in factory sales and franchise fees, mostly offset by a decline in retail sales. Operating income increased 4.8% from $1.36 million for the three months ended May 31, 2014 to $1.41 million for the three months ended May 31, 2015. Net income increased 7.3% from $711,000 in the three months ended May 31, 2014 to $763,000 in the three months ended May 31, 2015. The increase in operating income and net income was due primarily to restructuring and acquisition charges in the three months ended May 31, 2014 with no comparable expense in the three months ended May 31, 2015.
%
Change
Factory sales
Retail sales
Franchise fees
Royalty and marketing fees
Factory Sales
The increase in factory sales for the three months ended May 31, 2015 versus the three months ended May 31, 2014 was primarily due to a 32.5% increase in shipments of product to customers outside our network of franchised retail stores. This increase was partially offset by a 5.7% decrease in the average number of domestic Rocky Mountain Chocolate Factory franchised stores in operation and a 1.0% decrease in same-store pounds purchased by our network of franchise and license stores.
Retail Sales
The decrease in retail sales was primarily due to changes in retail units in operation resulting from the sale of certain Company-owned locations and the closure of a certain underperforming Company-owned location. Same store sales at all Company-owned stores and cafés decreased 3.4% in the three months ended May 31, 2015 compared to the three months ended May 31, 2014. Same-store sales at U-Swirl cafés decreased 4.2% in the three months ended May 31, 2015 compared to the three months ended May 31, 2014, which management believes reflects the impact of store overcapacity within the self-serve frozen yogurt market.
Royalties, Marketing Fees and Franchise Fees
The decrease in royalties and marketing fees from the three months ended May 31, 2014 to the three months ended May 31, 2015 resulted from a 9.0% decrease in franchise units in operation and lower same store sales. The average number of total franchise stores in operation decreased from 488 in the three months ended May 31, 2014 to 444 during the three months ended May 31, 2015. This decrease is the result of domestic store closures exceeding domestic store openings. Same store sales at total franchise stores and cafés in operation decreased 1.1% during the three months ended May 31, 2015 compared to the three months ended May 31, 2014. Franchise fee revenues increased as a result of the license fees associated with the license agreements for the development and franchising of CherryBerry stores in the Canadian province of Ontario being recognized in the three months ended May 31, 2015 and no international license fees being recognized in the three months ended May 31, 2014.
Cost of sales – factory adjusted
Cost of sales - retail
Factory adjusted gross margin
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin minus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin. The following table provides a reconciliation of factory adjusted gross margin to factory gross margin, the most comparable performance measure under GAAP:
Less: depreciation and amortization
Factory GAAP gross margin
Cost of Sales
Factory margins decreased 320 basis points in the three months ended May 31, 2015 compared to the three months ended May 31, 2014 due primarily to increased costs of certain materials and a shift in product mix and customer mix in the three months ended May 31, 2015 compared to the three months ended May 31, 2014. This change in customer and product mix resulted from a decrease in domestic franchise customers and an increase in sales of products to customers outside our franchise system during the three months ended May 31, 2015, compared to the three months ended May 31, 2014. Company-owned store margin during the three months ended May 31, 2015 was nearly unchanged from the three months ended May 31, 2014.
Franchise Costs
The increase in franchise costs in the three months ended May 31, 2015 versus the three months ended May 31, 2014 is due primarily to franchise costs associated with supporting U-Swirl franchise units. In the six months ended February 28, 2015 U-Swirl was reorganized resulting in additional resources being allocated to the support of U-Swirl franchisees. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increased to 23.0% in the three months ended May 31, 2015 from 22.1% in the three months ended May 31, 2014. This increase as a percentage of royalty, marketing and franchise fees is primarily a result of higher franchise costs partially offset by higher franchise and royalty revenues.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended May 31, 2015 compared to the three months ended May 31, 2014 is primarily due to lower marketing-related costs associated with U-Swirl franchise locations.
General and Administrative
The decrease in general and administrative costs for the three months ended May 31, 2015 compared to the three months ended May 31, 2014 is due primarily to the reorganization of U-Swirl in the prior year and the associated focus on reduction of duplicative general and administrative costs. For the three months ended May 31, 2015, approximately $403,000 of U-Swirl general and administrative costs were consolidated within our results, compared with $548,000 in the three months ended May 31, 2014. As a percentage of total revenues, general and administrative expenses decreased to 12.8% in the three months ended May 31, 2015 compared to 13.5% in the three months ended May 31, 2014.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended May 31, 2015 compared to the three months ended May 31, 2014 was due primarily to changes in units in operation, resulting from the sale of a certain Company-owned units and the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increased from 52.5% in the three months ended May 31, 2014 to 60.6% in the three months ended May 31, 2015.
Depreciation and Amortization
Depreciation and amortization of $365,000 in the three months ended May 31, 2015 decreased 2.4% from $374,000 incurred in the three months ended May 31, 2014. This decrease was the result of fewer Company-owned store assets in service mostly offset by an increase in depreciation associated with factory asset additions.
Other Income
Net interest expense was $45,300 in the three months ended May 31, 2015 compared to net interest expense of $48,800 realized in the three months ended May 31, 2014. This change was the result of less interest expense incurred on lower average outstanding promissory note balances.
Income Tax Expense
Our effective income tax rate for the three months ended May 31, 2015 was 31.7%, compared to 27.8% for the three months ended May 31, 2014. The increase of 3.9% was primarily the result of the consolidation of the U-Swirl net operating income. There was no income tax expense recognized on U-Swirl income before income taxes for the three months ended May 31, 2014 while income tax expense was recognized during the three months ended May 31, 2015 on U-Swirl income before income taxes. U-Swirl has significant net operating loss carryovers. In accordance with section 382 of the Internal Revenue Code, deductibility of U-Swirl’s U.S. net operating loss carryovers may be subject to annual limitation in the event of a change in control. We have performed a preliminary evaluation as to whether a change in control has taken place, and have concluded that there was a change of control with respect to the net operating losses of U-Swirl when the Company acquired a 60% ownership interest in January 2013. Our effective income tax rate may increase in future periods, or for the full year as a result of estimates related to the income tax liability arising from the income before income taxes of U-Swirl.
Liquidity and Capital Resources
As of May 31, 2015, working capital was $8.8 million, compared with $9.4 million as of February 28, 2015, a decrease of $600,000. The decrease in working capital was primarily due to positive operating results more than offset by the payment of dividends and repurchases of common stock.
Cash and cash equivalent balances increased $1.21 million from $7.16 million as of February 28, 2015 to $8.37 million as of May 31, 2015 as a result of cash flow generated by operating activities. Our current ratio was 2.1 to 1 at May 31, 2015 and February 28, 2015. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
For the three months ended May 31, 2015, we had net income of $933,359. Operating activities provided cash of $3,365,246, with the principal adjustment to reconcile the net income to net cash provided by operating activities being a change in inventories of $1,111,144 and the change in accounts receivable of $766,824. During the comparable 2014 period, we had net income of $937,272, and operating activities provided cash of $3,678,071. The principal adjustment to reconcile the net income to net cash provided by operating activities was the change in inventories of $355,877 and the change in accounts receivable of $1,337,281.
For the three months ended May 31, 2015, investing activities used cash of $109,344, primarily due to the purchases of property, equipment, goodwill and other intangible assets of $200,386. In comparison, investing activities used cash of $166,640 during the three months ended May 31, 2014 primarily due to the purchase of property and additions to notes receivable.
Financing activities used cash of $2,044,975 for the three months ended May 31, 2015 and provided cash of $423,813 during the prior year period. This was primarily due to increased cash used to repurchase common stock during the three months ended May 31, 2015 and less proceeds from the exercise of stock warrants in our subsidiary.
We have a $5.0 million ($5.0 million available as of May 31, 2015) working capital line of credit collateralized by substantially all of our assets with the exception of our retail store assets. Additionally, the line of credit is subject to various financial ratio and leverage covenants. As of May 31, 2015, we were in compliance with all such covenants. The line is subject to renewal on July 31, 2015. As of May 31, 2015, no amount was outstanding under this line of credit.
The Company’s long-term debt is comprised of a promissory note used to finance business acquisitions of U-Swirl (unpaid balance as of May 31, 2015, $6.0 million). The promissory note allows the Company to borrow up to a maximum of $7.0 million to finance business acquisitions and bears interest at a fixed annual rate of 3.75%. The promissory note matures on January 15, 2020, with amortized principal and accrued interest due monthly on the promissory note. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of May 31, 2015, we were in compliance with all such covenants.
At the time the Company entered into the promissory note used to finance the acquisitions of U-Swirl described above, the Company also entered into a loan and security agreement with U-Swirl (the “U-Swirl Loan Agreement”), pursuant to which U-Swirl could borrow up to $7.75 million from the Company to fund acquisitions. At May 31, 2015, $6.8 million was outstanding under the U-Swirl Loan Agreement. Any outstanding amounts under the U-Swirl Loan Agreement are convertible at any time at the Company’s option into shares of preferred stock of U-Swirl. Borrowings under the U-Swirl Loan Agreement are secured by all of the assets of U-Swirl. In addition, the U-Swirl Loan Agreement is subject to various financial and leverage covenants. U-Swirl was not compliant with the covenants at May 31, 2015. The loan covenants required U-Swirl to maintain consolidated adjusted EBITDA of $1,804,000 for the twelve months ended May 31, 2015. At May 31, 2015 U-Swirl had reported $1,532,000 of adjusted EBITDA. In an event of default, we may charge interest on all amounts due under the U-Swirl Loan Agreement at the default rate of 15% per annum, accelerate payment of all amounts due under the U-Swirl Loan Agreement, and foreclose on our security interest.
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. During the three months ended May 31, 2015 the Company repurchased 75,968 shares under the repurchase plan at an average price of $13.62 per share. As of May 31, 2015, approximately $2,986,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months.
Off-Balance Sheet Arrangements
As of May 31, 2015, we had no off-balance sheet arrangements or obligations.
Impact of Inflation
Inflationary factors such as increases in the costs of ingredients and labor directly affect our operations. Most of our leases provide for cost-of-living adjustments and require us to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally, our future lease costs for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that we will be able to pass on increased costs to our customers.
Depreciation expense is based on the historical cost to us of fixed assets, and is therefore potentially less than it would be if it were based on current replacement cost. While property and equipment acquired in prior years will ultimately have to be replaced at higher prices, it is expected that replacement will be a gradual process over many years.
Seasonality
We are subject to seasonal fluctuations in sales, which cause fluctuations in quarterly results of operations. Historically, the strongest sales of our confectionary products have occurred during the Christmas holiday through Mother’s Day. We believe the strongest sales of frozen yogurt products will occur during the summer months. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and sales of franchises. Because of the seasonality of our business and the impact of new store openings and sales of franchises, results for any quarter are not necessarily indicative of results that may be achieved in other quarters or for a full fiscal year.
Quantitative and Qualitative Disclosures about Market Risk
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of May 31, 2015, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in an $87,000 favorable or unfavorable price benefit resulting from our contracts.
We have a $5.0 million bank line of credit that bears interest at a variable rate. As of May 31, 2015, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this credit facility.
We have a $7.0 million promissory note with interest at a fixed rate of 3.75% annually. As of May 31, 2015, $6.0 million was outstanding under the note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our CEO and CFO, has evaluated the effectiveness, as of May 31, 2015, of our disclosure controls and procedures. Based on that evaluation, our CEO and CFO have concluded that our disclosure controls and procedures were effective as of May 31, 2015.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended May 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Legal Proceedings
We are not currently involved in any material legal proceedings other than routine litigation incidental to our business.
Risk Factors
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2015. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2015.
Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
Period
Total Number of
Shares (or Units)
Purchased
Average Price
Paid per Share
(or Unit)
Purchased as Part of
Publicly Announced
Plans or Programs
Maximum Number (or
Approximate Dollar Value)
of Shares (or Units) that May
Yet Be Purchased Under the
Plans or Programs (1)
March 1, 2015 to March 31, 2015
April 1, 2015 to April 30, 2015
May 1, 2015 to May 31, 2015
(1) On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities
None.
Mine Safety Disclosures
Not applicable.
Other Information
Exhibits
3.1
Amended and Restated Certificate of Incorporation of Rocky Mountain Chocolate Factory, Inc., a Delaware corporation (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K filed on March 2, 2015).
3.2
Certificate of Designations of Series A Junior Participating Preferred Stock, Par Value $0.001 Per Share, of Rocky Mountain Chocolate Factory, Inc., a Delaware corporation (incorporated by reference to Exhibit 3.2 to the Current Report on Form 8-K filed on March 2, 2015).
3.3
Amended and Restated Bylaws of Rocky Mountain Chocolate Factory, Inc., a Delaware corporation (incorporated by reference to Exhibit 3.3 to the Current Report on Form 8-K filed on March 2, 2015).
31.1*
Certification of Chief Executive Officer Filed Pursuant To Section 302 Of The Sarbanes-Oxley Act of 2002.
31.2*
Certification of Chief Financial Officer Filed Pursuant To Section 302 Of The Sarbanes-Oxley Act of 2002.
32.1**
Certification of Chief Executive Officer Furnished Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002.
32.2**
Certification of Chief Financial Officer Furnished Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002.
101.INS **XBRL Instance Document.
101.SCH **XBRL Taxonomy Extension Schema Document.
101.CAL **XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF **XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB **XBRL Taxonomy Extension Label Linkbase Document.
101.PRE **XBRL Taxonomy Extension Presentation Linkbase Document.
____________________________
* Filed herewith.
** Furnished herewith.
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date: July 15, 2015
/s/ Bryan J. Merryman
Bryan J. Merryman, Chief Operating Officer,
Chief Financial Officer, Treasurer and Director
21