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 November 30, 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      X     

(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 December 31, 2015, the registrant had outstanding 5,839,396 shares of its common stock, $.001 par value per share.

 

 
1

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARY

FORM 10-Q

TABLE OF CONTENTS

 

PART I.       FINANCIAL INFORMATION

3

     

ITEM 1.

Financial Statements

3

CONSOLIDATED STATEMENTS OF INCOME

3

CONSOLIDATED BALANCE SHEETS

4

CONSOLIDATED STATEMENTS OF CASH FLOWS

5

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

6

ITEM 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk

24

ITEM 4.

Controls and Procedures

25

     

PART II.      OTHER INFORMATION

25

     

ITEM 1.

Legal Proceedings

25

ITEM 1A.

Risk Factors

26

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

26

ITEM 3.

Defaults Upon Senior Securities

26

ITEM 4.

Mine Safety Disclosures

26

ITEM 5.

Other Information

26

ITEM 6.

Exhibits

27

     

Signatures

 28

 

 
2

 

 

PART I.   FINANCIAL INFORMATION

 

Item 1.     Financial Statements

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

 

   

Three Months Ended November 30,

   

Nine Months Ended November 30,

 
   

2015

   

2014

   

2015

   

2014

 

Revenues

                               

Sales

  $ 8,024,803     $ 8,583,981     $ 22,480,092     $ 23,108,761  

Franchise and royalty fees

    1,782,510       1,977,581       6,965,797       7,232,455  

Total revenues

    9,807,313       10,561,562       29,445,889       30,341,216  

 

                               

Costs and Expenses

                               

Cost of sales, exclusive of depreciation and amortization expense of $98,009, $102,179, $300,731 and $292,632, respectively

    5,202,953       5,527,876       14,448,327       14,229,018  

Franchise costs

    657,660       558,560       1,871,113       1,623,505  

Sales and marketing

    593,793       608,536       1,832,828       1,838,395  

General and administrative

    1,087,633       1,230,495       3,550,781       3,816,996  

Retail operating

    669,961       724,608       2,318,404       2,697,163  

Depreciation and amortization

    343,548       357,865       1,064,211       1,097,404  

Restructuring and acquisition related charges

    -       -       -       709,212  

 

                               

Total costs and expenses

    8,555,548       9,007,940       25,085,664       26,011,693  

 

                               

Income from Operations

    1,251,765       1,553,622       4,360,225       4,329,523  

 

                               

Other Income (Expense)

                               

Interest expense

    (52,553 )     (60,666 )     (167,424 )     (183,333 )

Interest income

    13,779       16,208       40,814       43,274  

Other Income (Expense), net

    (38,774 )     (44,458 )     (126,610 )     (140,059 )

 

                               

Income Before Income Taxes

    1,212,991       1,509,164       4,233,615       4,189,464  

 

                               

Income Tax Provision

    439,355       554,500       1,286,400       1,368,165  

 

                               

Consolidated Net Income

  $ 773,636     $ 954,664     $ 2,947,215     $ 2,821,299  

Less: Net income (loss) attributable to non-controlling interest

    332,835       (7,714 )     963,659       270,231  

Net Income attributable to RMCF

  $ 440,801     $ 962,378     $ 1,983,556     $ 2,551,068  

 

                               

Basic Earnings per Common Share

  $ .08     $ .16     $ .34     $ .41  

Diluted Earnings per Common Share

  $ .07     $ .15     $ .32     $ .40  
                                 

Weighted Average Common Shares Outstanding - Basic

    5,840,407       6,162,829       5,911,561       6,171,327  

Dilutive Effect of Stock Options and Restricted Stock Units

    181,742       218,027       209,173       265,153  

Weighted Average Common Shares Outstanding - Diluted

    6,022,149       6,380,856       6,120,734       6,436,480  

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
3

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

   

November 30,

   

February 28,

 
   

2015

   

2015

 
   

(unaudited)

         
Assets                

Current Assets

               

Cash and cash equivalents

  $ 5,153,920     $ 7,157,371  

Accounts receivable, less allowance for doubtful accounts of $825,118 and $696,798, respectively

    4,107,459       4,291,470  

Notes receivable, current portion, less current portion of the valuation allowance of $2,262 and $3,762, respectively

    336,093       359,493  

Refundable income taxes

    4,436       172,945  

Inventories, less reserve for slow moving inventory of $205,967 and $197,658, respectively

    5,071,320       4,785,376  

Deferred income taxes

    515,303       572,957  

Other

    320,872       318,275  

Total current assets

    15,509,403       17,657,887  
                 

Property and Equipment, Net

    6,564,819       6,797,536  
                 

Other Assets

               

Notes receivable, less current portion and valuation allowance of $30,000 and $28,500, respectively

    669,075       668,302  

Goodwill, net

    2,977,473       2,977,473  

Franchise Rights, net

    5,238,513       5,439,460  

Intangible assets, net

    424,599       440,428  

Other

    149,890       157,127  

Total other assets

    9,459,550       9,682,790  

 

               

Total Assets

  $ 31,533,772     $ 34,138,213  
                 

Liabilities and Stockholders’ Equity

               

Current Liabilities

               

Current maturities of long term debt

  $ 1,242,066     $ 1,208,888  

Accounts payable

    1,851,747       1,675,746  

Accrued salaries and wages

    734,954       819,184  

Other accrued expenses

    3,006,376       2,910,777  

Dividend payable

    700,728       721,536  

Deferred income

    604,238       951,241  

 

               

Total current liabilities

    8,140,109       8,287,372  

 

               

Long-Term Debt, Less Current Maturities

    4,148,741       5,083,479  

Deferred Income Taxes

    1,071,961       1,029,507  
                 

Commitments and Contingencies

               
                 

Stockholders’ Equity

               

Preferred stock, $.001 par value per share; 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 per share, 100,000,000 shares authorized, 0 and 6,012,799 issued and outstanding, respectively

    -       180,384  

Common stock, $.001 par value per share, 46,000,000 shares authorized, 6,018,198 and 0 issued, and 5,839,396 and 0 outstanding, respectively

    6,018       -  

Additional paid-in capital

    7,225,711       7,163,092  

Retained earnings

    11,391,255       11,524,708  

Non-controlling interest in equity of subsidiary

    1,894,025       869,671  

Treasury stock, 178,802 shares and 0 shares, at cost

    (2,344,048 )     -  

Total stockholders’ equity

    18,172,961       19,737,855  
                 

Total liabilities and stockholders’ equity

  $ 31,533,772     $ 34,138,213  

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
4

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

   

Nine Months Ended

 
   

November 30,

 
   

2015

   

2014

 

Cash Flows From Operating activities

               

Net income

  $ 2,947,215     $ 2,821,299  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation and amortization

    1,064,211       1,097,404  

Provision for slow moving inventory

    68,175       33,251  

Asset impairment and store closure losses

    -       178,000  

Provision for loss on accounts and notes receivable

    129,000       192,137  

Loss (gain) on sale or disposal of property and equipment

    90,149       (6,524 )

Expense recorded for stock compensation

    615,740       700,526  

Deferred income

    (430,043 )     (491,115 )

Deferred income taxes

    100,108       (250,075 )

Changes in operating assets and liabilities:

               

Accounts receivable

    50,028       307,530  

Inventories

    121,220       (208,403 )

Other current assets

    (9,182 )     23,649  

Accounts payable

    (321,489 )     (190,245 )

Accrued liabilities

    179,878       278,639  

Net cash provided by operating activities

    4,605,010       4,486,073  
                 

Cash Flows From Investing Activities

               

Addition to notes receivable

    (46,489 )     (163,396 )

Proceeds received on notes receivable

    259,619       383,208  

Purchase of intangible assets

    (54,479 )     -  

Proceeds from sale of assets

    23,692       531,345  

Purchases of property and equipment

    (625,180 )     (446,166 )

Decrease (increase) in other assets

    (115,407 )     (8,786 )

Net cash used in investing activities

    (558,244 )     296,205  
                 

Cash Flows From Financing Activities

               

Payments on long-term debt

    (901,560 )     -  

Repurchase of common stock

    (3,030,708 )     (1,904,829 )

Issuance of common stock

    -       69,599  

Proceeds from issuance of common stock in subsidiary

    -       892,895  

Tax benefit of stock awards

    19,868       200,544  

Dividends paid

    (2,137,817 )     (2,039,911 )

Net cash used in financing activities

    (6,050,217 )     (2,781,702 )
                 

Net Increase (Decrease) in Cash and Cash Equivalents

    (2,003,451 )     2,000,576  
                 

Cash and Cash Equivalents, Beginning of Period

    7,157,371       5,859,729  
                 

Cash and Cash Equivalents, End of Period

  $ 5,153,920     $ 7,860,305  

 

  

The accompanying notes are an integral part of these consolidated financial statements.

 

 
5

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

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 (“RMCF”), Aspen Leaf Yogurt, LLC (“ALY”), and its 39%-owned subsidiary, U-Swirl, Inc. (“U-Swirl”), of which RMCF 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, 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 per share, 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 November 30, 2015, the Company held approximately 39% of U-Swirl’s outstanding common stock. Additionally, the Company has the right to acquire approximately 29,290,700 shares of U-Swirl’s common stock as of November 30, 2015 through the conversion of outstanding debt owed by U-Swirl to the Company (see discussion of the U-Swirl Loan Agreement below). If the Company exercised this conversion right, the Company would hold approximately 74% of U-Swirl’s common stock. The U-Swirl Board of Directors is composed solely of Board members also serving on the Company’s Board of Directors.

 

In fiscal year 2014, the Company entered into a promissory note with a third-party lender, and in turn, the Company 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. Borrowings under the U-Swirl Loan Agreement are payable in cash or conversion of the obligations into capital stock of U-Swirl, or a combination thereof, at the discretion of the Company. The U-Swirl Loan Agreement is secured by all of the assets of U-Swirl and its subsidiaries. U-Swirl is subject to various financial and leverage covenants under the U-Swirl Loan Agreement. U-Swirl was not compliant with the covenants at November 30, 2015. The loan covenants require U-Swirl to maintain consolidated adjusted EBITDA of $1,804,000 for the twelve months ended November 30, 2015. At November 30, 2015, U-Swirl reported $1,318,000 of adjusted EBITDA. Pursuant to the U-Swirl Loan Agreement, upon the occurrence and continuance of an event of default, among other remedies, the Company may charge interest on all amounts due under the loan at the default rate of 15% per annum, accelerate payment of all amounts due under the loan, foreclose on its security interest, and/or convert any amounts due under the loan to capital stock of U-Swirl at a premium. At November 30, 2015 we believe that the conversion of the loan into preferred stock as settlement of the obligation would result in 63% more preferred shares issued when compared to the amount issuable if U-Swirl was compliant with the loan covenants.

 

In fiscal year 2014, U-Swirl acquired the franchise rights of frozen yogurt stores branded as “CherryBerry”, “Yogli Mogli Frozen Yogurt” and “Fuzzy Peach Frozen Yogurt”, and U-Swirl currently operates and franchises self-serve frozen yogurt cafés 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.

  

 
6

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

The following table summarizes the number of stores operated by the Company, its franchisees and licensees at November 30, 2015:

 

   

Sold, Not Yet

Open

   

Open

   

Total

 

Rocky Mountain Chocolate Factory

                       

Company-owned stores

    -       3       3  

Franchise stores – Domestic stores

    3       191       194  

Franchise stores – Domestic kiosks

    -       5       5  

International License Stores

    1       76       77  

Cold Stone Creamery – co-branded

    8       72       80  

U-Swirl (Including all associated brands)

                       

Company-owned stores

    -       6       6  

Company-owned stores – co-branded

    -       3       3  

Franchise stores – Domestic stores

    *       194       194  

Franchise stores – Domestic – co-branded

    *       15       15  

International License Stores

    1       8       9  

Total

    13       573       586  

 

*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 nine months ended November 30, 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.

 

Subsequent Events

 

On January 5, 2015 U-Swirl, Inc filed Form 15, Certification and Notice of Termination of Registration Under Section 12(g) of the Securities Exchange Act of 1934 or Suspension of Duty to File Reports Under Sections 13 and 15(d) of the Securities Act of 1934.

 

New Accounting Pronouncements

 

In January 2016, Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) No. 2016-01, Financial Instruments - Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities, which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 will be effective for us in the first quarter of our fiscal year 2019, and early adoption is not permitted. The Company is currently evaluating the impact that the standard will have on its consolidated financial statements.

 

In November 2015, FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes, which eliminates the current requirement to present deferred tax liabilities and assets as current and noncurrent in a classified balance sheet. Instead, entities will be required to classify all deferred tax assets and liabilities as noncurrent. This ASU will be effective for the Company beginning in its first quarter of fiscal year 2018 and early adoption is permitted. The Company is evaluating the timing of its adoption of this ASU. The Company does not expect this adoption to have a material impact on its financial statements.

 

 
7

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

In September 2015, FASB issued ASU 2015-16, Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustments, which requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The standard will be effective for us in the first quarter of our fiscal year 2017, although early adoption is permitted. The Company does not expect that the adoption of this ASU will have a significant impact on its consolidated financial statements.

 

In July 2015, FASB issued ASU 2015-11, Inventory (Topic 330), Simplifying the Measurement of Inventory, which changes the measurement principle for inventory from the lower of cost or market to the lower of cost and net realizable value. ASU 2015-11 defines net realizable value as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The new guidance must be applied on a prospective basis and will be effective for us in the first quarter of our fiscal year 2017 with early adoption permitted. The Company does not believe the implementation of this standard will have a material impact on its consolidated financial statements.

 

In April 2015, FASB issued ASU No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30), Simplifying the Presentation of Debt Issuance Costs. 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 amendment. ASU 2015-03 will be effective for us in the first quarter of our fiscal year 2017, with early adoption permitted. When adopted, ASU 2015-03 is not expected to have a material impact on the Company’s consolidated financial statements.

 

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 amends the guidance for revenue recognition to replace numerous, industry-specific requirements and converges areas under this topic with those of the International Financial Reporting Standards. The ASU implements a five-step process for customer contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. The amendment also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. Other major provisions include the capitalization and amortization of certain contract costs, ensuring the time value of money is considered in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. The amendments in this ASU are effective for reporting periods beginning after December 15, 2016; however, in August 2015, the FASB delayed the effective date by one year. For us the delayed effective date is for the first quarter of our fiscal year 2019. The deferral permits early adoption, but does not allow adoption any earlier than the original effective date of the standard. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The Company is currently assessing the impact the adoption of ASU 2014-09, including possible transition alternatives, will have on its consolidated financial statements.

 

NOTE 2 - EARNINGS PER SHARE

 

Basic earnings per share is calculated using the weighted-average number of shares of common stock outstanding. Diluted earnings per share reflects the potential dilution that could occur from common stock issuable through stock options and restricted stock units. For the three months ended November 30, 2015, there were 12,936 stock options excluded from the computation of earnings per share, compared with 12,936 stock options excluded from the computation of earnings per share for the three months ended November 30, 2014 because their effect would have been anti-dilutive. For the nine months ended November 30, 2015 and 2014, 12,936 and 12,936 stock options, respectively, were excluded 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

 

Inventories consist of the following:

 

   

November 30, 2015

   

February 28, 2015

 

Ingredients and supplies

  $ 2,625,848     $ 2,755,232  

Finished candy

    2,549,952       2,130,133  

U-Swirl, Inc. food and packaging

    101,487       97,669  

Reserve for slow moving inventory

    (205,967 )     (197,658 )

Total inventories

  $ 5,071,320     $ 4,785,376  

  

 
8

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 4 - PROPERTY AND EQUIPMENT, NET

 

Property and equipment consists of the following:

 

   

November 30, 2015

   

February 28, 2015

 

Land

  $ 513,618     $ 513,618  

Building

    4,773,563       4,774,825  

Machinery and equipment

    9,920,470       10,120,865  

Furniture and fixtures

    1,194,855       1,224,433  

Leasehold improvements

    1,921,524       2,056,244  

Transportation equipment

    438,601       427,727  

Asset Impairment

    (260,163 )     (290,640 )
      18,502,468       18,827,072  
                 

Less accumulated depreciation

    (11,937,649 )     (12,029,536 )

Property and equipment, net

  $ 6,564,819     $ 6,797,536  

 

NOTE 5 - STOCKHOLDERS’ EQUITY

 

Cash Dividend

 

The Company paid a quarterly cash dividend of $0.12 per share of common stock 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. The Company paid a quarterly cash dividend of $0.12 per share of common stock on September 11, 2015 to stockholders of record on September 1, 2015. The Company declared a quarterly cash dividend of $0.12 per share of common stock on November 17, 2015 payable on December 11, 2015 to stockholders of record on November 27, 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. During the three months ended August 31, 2015, the Company repurchased 145,329 shares under the repurchase plan at an average price of $12.75 per share. During the three months ended November 30, 2015, the Company repurchased 12,005 shares under the repurchase plan at an average price of $12.00 per share. As of November 30, 2015, approximately $989,704 remains available under the repurchase plan for further stock repurchases.

 

Stock-Based Compensation

 

At November 30, 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 $147,354 and $615,740 of stock-based compensation expense during the three and nine month periods ended November 30, 2015, respectively, compared to $166,843 and $700,526 during the three and nine month periods ended November 30, 2014, respectively. Compensation costs related to stock-based compensation are generally amortized over the vesting period of the stock awards.

 

The following table summarizes stock option activity during the nine months ended November 30, 2015 and 2014:

 

   

Nine Months Ended

November 30,

 
   

2015

   

2014

 

Outstanding stock options as of February 28:

    12,936       155,880  

Granted

    -       -  

Exercised

    -       (142,944 )

Cancelled/forfeited

    -       -  

Outstanding stock options as of November 30:

    12,936       12,936  
                 

Weighted average exercise price

  $ 14.70     $ 14.70  

Weighted average remaining contractual term (in years)

    0.29       1.29  

  

 
9

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

The following table summarizes restricted stock unit activity during the nine months ended November 30, 2015 and 2014:

 

   

Nine Months Ended

November 30,

 
   

2015

   

2014

 

Outstanding non-vested restricted stock units as of February 28:

    237,641       295,040  

Granted

    -       -  

Vested

    (55,899 )     (56,199 )

Cancelled/forfeited

    -       -  

Outstanding non-vested restricted stock units as of November 30:

    181,742       238,841  
                 

Weighted average grant date fair value

  $ 12.22     $ 12.14  

Weighted average remaining vesting period (in years)

    3.47       4.33  

 

During the nine months ended November 30, 2015, the Company granted 4,000 fully vested, unrestricted shares of common stock to non-employee directors compared with the grant of 4,000 fully vested, unrestricted shares of common stock to non-employee directors in the nine months ended November 30, 2014. There were no unrestricted shares of common stock granted during the three month periods ended November 30, 2015 or 2014. In connection with these non-employee director stock grants, the Company recognized $61,040 and $47,480 of stock-based compensation expense during the nine-month periods ended November 30, 2015 and 2014, respectively.

 

During the three and nine month periods ended November 30, 2015, the Company recognized $147,353 and $307,846, respectively, of stock-based compensation expense related to non-vested, non-forfeited restricted stock unit grants. The restricted stock unit grants generally vest between 17% and 20% annually over a period of five to six years. During the nine month periods ended November 30, 2015 and 2014, 55,899 and 56,199 restricted stock units vested and were issued as common stock, respectively. Total unrecognized compensation expense of non-vested, non-forfeited restricted stock units granted as of November 30, 2015 was $2,011,819, which is expected to be recognized over the weighted-average period of 3.5 years.

 

The Company recognized $0 and $99,250 of U-Swirl stock-based compensation expense during the three and nine months ended November 30, 2015, respectively, compared with $0 and $152,518 recognized during the three and nine months ended November 30, 2014, respectively.

  

 
10

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6 – SUPPLEMENTAL CASH FLOW INFORMATION

 

   

Nine Months Ended

November 30,

 
   

2015

   

2014

 
Cash paid for:            
Interest   $ 128,881     $ 143,806  

Income taxes

    997,914       1,112,040  

Non-Cash Operating Activities

               
Accrued Inventory     497,190       477,176  

Non-Cash Financing Activities

               
Dividend Payable   $ 700,728     $ 671,901  

Sale of assets and inventory to buyers for notes receivable:

               
Long-lived assets     127,500       446,353  
Inventory     -       17,301  
Accounts receivable     5,000       17,043  
Other assets     75,000       10,858  

 

NOTE 7 - OPERATING SEGMENTS

 

The Company classifies its business interests into five reportable segments: Franchising, Manufacturing, Retail Stores, U-Swirl, Inc. 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 these consolidated financial statements and Note 1 to the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal 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:

 

Three Months Ended

November 30, 2015

 

 

Franchising

   

Manufacturing

   

Retail

   

U-Swirl, Inc.

   

Other

   

Total

 

Total revenues

  $ 1,159,250     $ 7,499,619     $ 248,164     $ 1,293,843     $ -     $ 10,200,876  

Intersegment revenues

    (1,238 )     (392,325 )     -       -       -       (393,563 )

Revenue from external customers

    1,158,012       7,107,294       248,164       1,293,843       -       9,807,313  

Segment profit (loss)

    277,663       2,029,847       (61,439 )     (158,478 )     (874,602 )     1,212,991  

Total assets

    1,162,582       12,540,706       1,087,849       12,721,643       4,020,992       31,533,772  

Capital expenditures

    -       120,302       1,716       12,847       167,943       302,808  

Total depreciation & amortization

    8,717       98,286       3,810       197,717       35,018       343,548  

 

Three Months Ended

November 30, 2014

 

 

Franchising

   

Manufacturing

   

Retail

   

U-Swirl, Inc.

   

Other

   

Total

 

Total revenues

  $ 1,244,732     $ 7,994,116     $ 350,261     $ 1,430,397     $ -     $ 11,019,506  

Intersegment revenues

    (1,407 )     (456,537 )     -       -       -       (457,944 )

Revenue from external customers

    1,243,325       7,537,579       350,261       1,430,397       -       10,561,562  

Segment profit (loss)

    438,160       2,189,548       (94,387 )     (100,978 )     (923,179 )     1,509,164  

Total assets

    1,115,716       12,878,192       1,166,851       15,284,436       7,425,254       37,870,449  

Capital expenditures

    22,050       28,414       658       (7,505 )     4,526       48,143  

Total depreciation & amortization

    10,661       102,699       6,083       199,787       38,635       357,865  

  

 
11

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

Nine Months Ended

November 30, 2015

 

 

Franchising

   

Manufacturing

   

Retail

   

U-Swirl, Inc.

   

Other

   

Total

 

Total revenues

  $ 4,291,383     $ 19,662,432     $ 1,082,279     $ 5,476,052     $ -     $ 30,512,146  

Intersegment revenues

    (3,953 )     (1,062,304 )     -       -       -       (1,066,257 )

Revenue from external customers

    4,287,430       18,600,128       1,082,279       5,476,052       -       29,445,889  

Segment profit (loss)

    1,787,646       4,815,854       (89,578 )     528,166       (2,808,473 )     4,233,615  

Total assets

    1,162,582       12,540,706       1,087,849       12,721,643       4,020,992       31,533,772  

Capital expenditures

    22,709       341,126       2,676       51,319       207,350       625,180  

Total depreciation & amortization

    28,288       302,145       14,406       599,267       120,105       1,064,211  

 

 

Nine Months Ended

November 30, 2014

 

 

Franchising

   

Manufacturing

   

Retail

   

U-Swirl, Inc.

   

Other

   

Total

 

Total revenues

  $ 4,290,060     $ 19,331,459     $ 1,445,444     $ 6,424,909     $ -     $ 31,491,872  

Intersegment revenues

    (2,917 )     (1,147,739 )     -       -       -       (1,150,656 )

Revenue from external customers

    4,287,143       18,183,720       1,445,444       6,424,909       -       30,341,216  

Segment profit (loss)

    1,922,482       5,045,608       (129,726 )     131,461       (2,780,361 )     4,189,464  

Total assets

    1,115,716       12,878,192       1,166,851       15,284,436       7,425,254       37,870,449  

Capital expenditures

    28,753       295,188       34,511       55,847       31,867       446,166  

Total depreciation & amortization

    31,393       294,204       23,224       632,622       115,961       1,097,404  

 

Revenue from one customer of the Company’s Manufacturing segment represented approximately $3.1 million, or 10.5 percent, of the Company’s revenues from external customers during the nine months ended November 30, 2015, compared to $2.9 million, or 9.6 percent of the Company’s revenues from external customers during the nine months ended November 30, 2014.

 

NOTE 8 – GOODWILL AND INTANGIBLE ASSETS

 

Intangible assets consist of the following:

               

November 30, 2015

   

February 28, 2015

 
   

Amortization Period (Years)

   

Gross Carrying Value

   

Accumulated Amortization

   

Gross Carrying Value

   

Accumulated Amortization

 

Intangible assets subject to amortization

                                           

Store design

      10       $ 220,778     $ 209,277     $ 220,778     $ 208,152  

Packaging licenses

    3 - 5       120,830       120,830       120,830       120,830  

Packaging design

      10         430,973       430,973       430,973       430,973  

Trademark/Non-competition agreements

    5 - 20       459,340       46,242       459,340       31,538  

Franchise Rights

      20         5,904,771       666,258       5,850,290       410,830  

Total

                7,136,692       1,473,580       7,082,211       1,202,323  

Intangible assets not subject to amortization

                                           

Franchising segment-

                                           

Company stores goodwill

                1,122,328       267,020       1,122,328       267,020  

Franchising goodwill

                2,202,529       197,682       2,202,529       197,682  

Manufacturing segment-Goodwill

                295,000       197,682       295,000       197,682  

Trademark

                20,000       -       20,000       -  

Total Goodwill

                3,639,857       662,384       3,639,857       662,384  
                                             

Total Intangible Assets

              $ 10,776,549     $ 2,135,964     $ 10,722,068     $ 1,864,707  

 

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.

 

 
12

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

Amortization expense related to intangible assets totaled $277,839 and $275,790 during the nine months ended November 30, 2015 and 2014, respectively.

 

At November 30, 2015, annual amortization of intangible assets, based upon our existing intangible assets and current useful lives, is estimated to be the following:

 

2016

  $ 100,077  

2017

    404,596  

2018

    420,696  

2019

    427,126  

2020

    413,969  

Thereafter

    3,896,648  

Total

  $ 5,663,112  

 

NOTE 9 – OTHER ACCRUED LIABILITIES

 

Other accrued expenses consisted of the following as of November 30, 2015 and February 28, 2015:

 

   

November 30, 2015

   

February 28, 2015

 

Gift card liabilities

    2,645,255       2,571,525  

Other accrued expenses

    361,121       339,252  

Total other accrued expenses

  $ 3,006,376     $ 2,910,777  

 

NOTE 10 – 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 nine months ended November 30, 2015, the Company paid $68,130 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.

 

In July 2015, we entered into stock purchase agreements with each of (i) Franklin Crail, the Company’s Chief Executive Officer, President and Chairman of the Board, (ii) Bryan Merryman, the Company’s Chief Operating Officer, Chief Financial Officer, Treasurer and a director, and (iii) Edward Dudley, the Company’s Senior Vice President - Sales and Marketing, pursuant to which the Company purchased an aggregate of 54,500 shares of the Company’s common stock from Messrs. Crail, Merryman and Dudley (the “Stock Purchase Agreements”) at an average price of $12.60 per share. The price the Company paid for the shares was at a 3% discount to the closing price of the Company’s common stock on the transaction date.

 

NOTE 11 – RESTRUCTURING AND ACQUISITION RELATED CHARGES

 

In connection with the acquisitions of the assets of CherryBerry, Yogli Mogli and Fuzzy Peach in fiscal year 2014, the Company recorded net restructuring charges of $124,551 during the nine months ended November 30, 2014 associated with these acquisitions. These charges were primarily the result of professional fees for due diligence, valuation, audit and other activities in connection with these acquisitions.

 

On September 4, 2014, Ulderico Conte, Henry E. Cartwright and Terry A. Cartwright resigned as directors and officers of U-Swirl. Also on September 4, 2014, the U-Swirl Board of Directors appointed Bryan J. Merryman as the Chairman of the Board, replacing Franklin E. Crail. Mr. Merryman currently serves as the Chief Operating Officer and Chief Financial Officer of the Company.

 

In connection with these management changes, U-Swirl announced an operational restructuring designed to enhance U-Swirl’s operating efficiencies, improve its franchise support capabilities, and rationalize its cost structure. This restructuring resulted in expense associated with termination of certain employment agreements, severance payments for other employees and expense associated with the impairment of certain long-lived leasehold improvement, property and equipment. The Company recorded restructuring charges of $584,661 during the nine months ended November 30, 2014 associated with this operational restructuring.

 

 
13

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

Total restructuring and acquisition charges incurred were comprised of the following for the nine months ended November 30, 2014:

 

Professional fees

  $ 186,011  

Severance/transitional compensation

    212,027  

Leasehold improvements, property and equipment impairment of long-lived assets

    243,000  

Acceleration of restricted stock unit vesting

    65,049  

Other

    3,125  
         

Total

  $ 709,212  

 

The Company did not incur any restructuring charges during the nine months ended November 30, 2015.

 

NOTE 12 – SALE OR DISTRIBUTION OF ASSETS

 

During the nine months ended November 30, 2015, the Company sold one Company-owned Rocky Mountain Chocolate Factory location and financed the upgrade and reopening of a former franchised Rocky Mountain Chocolate Factory location. During the nine months ended November 30, 2014, the Company sold one Company-owned Rocky Mountain Chocolate Factory location and four U-Swirl Company–owned cafés. These locations were sold for a combination of cash and notes receivable. Associated with these asset disposal activities, the Company recorded the following in the nine months ended November 30, 2015 and 2014:

 

   

2015

   

2014

 

Cash received on asset sales

  $ -     $ 525,000  

Notes receivable

    264,433       431,244  

 

NOTE 13 – NOTE PAYABLE

 

The Company’s long-term debt is comprised of a promissory note, the proceeds of which were loaned to U-Swirl and used to finance U-Swirl’s business acquisitions (unpaid balance as of November 30, 2015, $5.4 million). As more fully described in Note 1, the Company and U-Swirl entered into the U-Swirl Loan Agreement pursuant to which U-Swirl could borrow up to $7.75 million from the Company to fund acquisitions. Pursuant to applicable accounting rules, the U-Swirl Loan Agreement is an intercompany balance and transaction that is eliminated in consolidation.

 

As of November 30, 2015 and February 28, 2015, notes payable consisted of the following:

 

   

November 30, 2015

   

February 28, 2015

 
                 

Promissory note

  $ 5,390,807     $ 6,292,367  

Less: current maturities

    (1,242,066 )     (1,208,888 )

Long-term obligations

  $ 4,148,741     $ 5,083,479  

 

The following table summarizes annual maturities of our notes payable as of November 30, 2015:

 

   

Amount

 

2016

  $ 305,684  

2017

    1,254,007  

2018

    1,302,526  

2019

    1,352,921  

Thereafter

    1,175,669  

Total minimum payments

    5,390,807  

Less: current maturities

    (1,242,066 )
         

Long-term obligations

  $ 4,148,741  

  

 
14

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 14 - CONTINGENCIES

 

In January 2014, U-Swirl entered into an Asset Purchase Agreement (the “CherryBerry Purchase Agreement”) with CherryBerry Enterprises LLC, CherryBerry Corporate LLC, CherryBerry LLC, and their respective owners (collectively, the CherryBerry Selling Parties”), pursuant to which U-Swirl acquired the franchise rights of frozen yogurt stores branded as “CherryBerry” (the “CherryBerry Acquisition”). As a part of the consideration for the CherryBerry Acquisition, U-Swirl agreed to issue an aggregate of 4,000,000 shares of U-Swirl common stock (the “CB Shares”) to the CherryBerry Selling Parties, which were subject to a one-year lock-up agreement. The CB Shares were issued to the CherryBerry Selling Parties in February 2015. Pursuant to the terms of the CherryBerry Purchase Agreement, following expiration of the lock-up period, if any of the CherryBerry Selling Parties desired to sell their CB Shares, they must first offer such shares to U-Swirl and RMCF prior to any sale of the CB Shares on the open market. 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 CherryBerry Purchase Agreement, U-Swirl agreed to pay a shortfall payment equal to the difference of the sale price of the CB Shares and $0.50 per share, multiplied by the number of shares sold by the CherryBerry Selling Parties. If U-Swirl was required to pay the shortfall payment at November 30, 2015, the shortfall payment would approximate $1,760,000. U-Swirl determined the likelihood of incurring the liability to be less than probable and has not recorded a contingent liability at November 30, 2015. In July and August 2015, the CherryBerry Selling Parties submitted to U-Swirl several requests for payment of approximately $205,000 of shortfall payments based on the sale of a portion of the CB Shares.

 

On August 25, 2015, U-Swirl filed a lawsuit against the CherryBerry Selling Parties, a former officer and director of U-Swirl and unknown other parties, in the District Court for La Plata County, Colorado, alleging wrongful actions on their part to cause the price of U-Swirl’s common stock to decline and thereafter making an improper demand for the shortfall payment described above, and certain other actions in violation of various provisions of the CherryBerry Purchase Agreement. U-Swirl seeks unspecified damages, attorneys’ fees, other costs, and a determination that the shortfall payment arrangement is void. On September 30, 2015, the CherryBerry Selling Parties filed an answer and counterclaim to the lawsuit in the U.S. District Court for the District of Colorado, and moved the lawsuit to federal court in the U.S. District Court for the District of Colorado. The counterclaim added RMCF to the lawsuit, and alleges that U-Swirl materially breached the CherryBerry Purchase Agreement by not paying the shortfall payment, that U-Swirl is the alter ego of RMCF and RMCF is liable for any obligations of U-Swirl, and that the U-Swirl Loan Agreement should be recharacterized as equity. The CherryBerry Selling Parties seek payment in full of the shortfall payment under the CherryBerry Purchase Agreement, declaratory judgements that U-Swirl is the alter ego of RMCF and the U-Swirl Loan Agreement should be recharacterized as equity, and interest, attorneys’ fees, costs and other equitable relief. The lawsuit is currently in the early stages of litigation. U-Swirl and RMCF intend to defend the counterclaim vigorously. It is not possible at this time to predict the outcome of this matter or reasonably estimate any potential loss.

 

 
15

 

 

Item 2.

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 Quarterly Report 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 ability to attract and retain qualified franchisees, the success of our franchised stores, 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 39%-owned 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 November 30, 2015, there were 3 Company-owned, 72 Cold Stone Creamery co-branded 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 November 30, 2015, U-Swirl operated 9 Company-owned cafés and 217 franchised cafés located in 38 states, Canada, Turkey, and the United Arab Emirates . In fiscal year 2014, U-Swirl acquired the franchise rights of frozen yogurt stores branded as “Cherryberry”, “Yogli Mogli Frozen Yogurt” and “Fuzzy Peach Frozen Yogurt”, and U-Swirl currently operates and franchises self-serve frozen yogurt cafés 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 November 30, 2015, we held a 39% interest in U-Swirl. Additionally, we have the right to acquire approximately 29,290,700 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 would hold approximately 74% of U-Swirl’s common stock as of November 30, 2015.

 

 
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The most important factors in continued growth in our earnings are ongoing unit growth, increased same-store sales, increased same-store pounds purchased from the factory and sales of product to customers outside our systems of franchised and licensed stores.

 

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. During fiscal year 2008 we had a peak number of domestic franchise units in operation. Since 2008 we have experienced an environment where more domestic franchise units have closed than have opened. We have relied on license opportunities with co-branding partners, the acquisition of franchise systems through our subsidiary, and international expansion to offset the trend in domestic franchise units.

 

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 November 30, 2015 Compared to the Three Months Ended November 30, 2014

 

Basic earnings per share decreased 50.0% from $.16 in the three months ended November 30, 2014 to $.08 in the three months ended November 30, 2015. Revenues decreased 7.1% from $10.6 million in the three months ended November 30, 2014 to $9.8 million in the three months ended November 30, 2015. Operating income decreased 19.4% from $1.6 million in the three months ended November 30, 2014 to $1.3 million in the three months ended November 30, 2015. Net income decreased 54.2% from $962,000 in the three months ended November 30, 2014 to $441,000 in the three months ended November 30, 2015. The decrease in revenues was primarily the result of lower factory sales and lower franchise-related revenues. The decrease in operating income was primarily the result of lower revenues, partially offset by lower operating costs. The decrease in net income and earnings per share is the result of a decline in operating income and an increase in the earnings attributable to the non-controlling interest in U-Swirl. The difference between the 19.4% decline in operating income and the 54.2% decrease in net income attributable to RMCF shareholders was due primarily to a derivative fair value charge of $710,000 in the three months ended November 30, 2015, versus a derivative fair value charge of $92,000 in the prior-year period (a derivative fair value charge benefits the non-controlling interest in our subsidiary).

 

Revenues

 

Three Months Ended

                 
   

November 30,

    $    

%

 

($’s in thousands)

 

2015

   

2014

   

Change

   

Change

 

Factory sales

  $ 7,107.3     $ 7,537.6     $ (430.3 )     (5.7 %)

Retail sales

    917.5       1,046.3       (128.8 )     (12.3 %)

Franchise fees

    60.2       275.1       (214.9 )     (78.1 %)

Royalty and Marketing fees

    1,722.3       1,702.6       19.7       1.2 %

Total

  $ 9,807.3     $ 10,561.6     $ (754.3 )     (7.1 %)

 

Factory Sales

 

The decrease in factory sales for the three months ended November 30, 2015 versus the three months ended November 30, 2014 was primarily due to a 14.6% decrease in shipments of product to customers outside our network of franchise retail locations and a 1.7% decrease in purchases by our network of franchised and licensed stores. The decrease in shipments of products to customers outside our network of franchise retail location was the result of timing differences resulting in an increase in such shipments during the three months ended August 31, 2015 and a decrease during the three months ended November 30, 2015 when compared with the prior year periods. Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 3.8% in the three months ended November 30, 2015, compared with the three months ended November 30, 2014.

 

Retail Sales

 

The decrease in retail sales was primarily due to changes in retail units in operation resulting from the sale of four Company-owned locations and the closure of a certain underperforming Company-owned location during the last fiscal year. Same store sales at all Company-owned stores and cafés decreased 3.5% in the three months ended November 30, 2015 compared to the three months ended November 30, 2014.

 

Royalties, Marketing Fees and Franchise Fees

 

The increase in royalties and marketing fees for the three months ended November 30, 2014 compared to the three months ended November 30, 2015 resulted from a 12.3% decrease in franchise units in operation more than offset by higher same store sales and an increase in the effective royalty rate for Rocky Mountain Chocolate Factory franchise locations, the result of a decrease in franchise purchases. The average number of total franchise stores in operation decreased from 478 in the three months ended November 30, 2014 to 419 during the three months ended November 30, 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 increased 1.1% during the three months ended November 30, 2015 compared to the three months ended November 30, 2014. Franchise fee revenues decreased primarily as a result of the recognition of international license fees during the three months ended November 30, 2014 with no comparable fees recognized during the three months ended November 30, 2015.

 

 
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Costs and Expenses  

Three Months Ended

November 30,

    $    

%

 

($’s in thousands)

 

2015

   

2014

   

Change

   

Change

 
                                 

Cost of sales – factory adjusted

  $ 4,859.4     $ 5,134.6     $ (275.2 )     (5.4 %)

Cost of sales - retail

    343.6       393.3       (49.7 )     (12.6 %)

Franchise costs

    657.6       558.6       99.0       17.7 %

Sales and marketing

    593.8       608.5       (14.7 )     (2.4 %)

General and administrative

    1,087.6       1,230.5       (142.9 )     (11.6 %)

Retail operating

    670.0       724.6       (54.6 )     (7.5 %)

Total

  $ 8,212.0     $ 8,650.1     $ (438.1 )     (5.1 %)

 

Adjusted Gross Margin  

Three Months Ended

November 30,

    $    

%

 

($’s in thousands)

 

2015

   

2014

   

Change

   

Change

 
                                 

Factory adjusted gross margin

  $ 2,247.9     $ 2,403.0     $ (155.1 )     (6.5 %)

Retail

    573.9       653.0       (79.1 )     (12.1 %)

Total

  $ 2,821.8     $ 3,056.0     $ (234.2 )     (7.7 %)

 

Adjusted Gross Margin  

Three Months Ended

November 30,

   

%

   

%

 
   

2015

   

2014

   

Change

   

Change

 

(Percent)

                               

Factory adjusted gross margin

    31.6 %     31.9 %     (0.3 %)     (0.9 %)

Retail

    62.6 %     62.4 %     0.2 %     0.3 %

Total

    35.2 %     35.6 %     (0.4 %)     (1.1 %)

 

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:

 

   

Three Months Ended

 
   

November 30,

 

($’s in thousands)

 

2015

   

2014

 

Factory adjusted gross margin

  $ 2,247.9     $ 2,403.0  

Less: Depreciation and Amortization

    98.0       102.2  

Factory GAAP gross margin

  $ 2,149.9     $ 2,300.8  

 

Cost of Sales

 

Factory margins decreased 30 basis points in the three months ended November 30, 2015 compared to the three months ended November 30, 2014 due primarily to increased costs of certain materials and a shift in product mix and customer mix in the three months ended November 30, 2015 compared to the three months ended November 30, 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 November 30, 2015, compared to the three months ended November 30, 2014. The increase in Company-owned store margin is due primarily to a larger portion of retail revenues being derived by U-Swirl Company-owned cafés and the associated higher margins, compared to Company-owned Rocky Mountain Chocolate Factory locations.

 

 
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Franchise Costs

 

The increase in franchise costs in the three months ended November 30, 2015 versus the three months ended November 30, 2014 is due primarily to increased franchise costs associated with supporting U-Swirl franchise units. In the six months ended February 28, 2014, 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 36.9% in the three months ended November 30, 2015 from 28.2% in the three months ended November 30, 2014.

 

Sales and Marketing

 

The decrease in sales and marketing costs for the three months ended November 30, 2015 compared to the three months ended November 30, 2014 is primarily due to higher marketing related costs for Rocky Mountain Chocolate Factory, more than offset by lower marketing-related costs associated with U-Swirl franchise locations. Marketing costs for U-Swirl franchise locations declined because of lower marketing fee revenues because of fewer franchise stores in operation.

 

General and Administrative

 

The decrease in general and administrative costs for the three months ended November 30, 2015 compared to the three months ended November 30, 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, partially offset by an increase in professional fees. For the three months ended November 30, 2015, approximately $287,000 of U-Swirl general and administrative costs were consolidated within our results, compared with $391,000 in the three months ended November 30, 2014. As a percentage of total revenues, general and administrative expenses decreased to 11.1% in the three months ended November 30, 2015 compared to 11.7% in the three months ended November 30, 2014.

 

Retail Operating Expenses

 

The decrease in retail operating expenses for the three months ended November 30, 2015 compared to the three months ended November 30, 2014 was due primarily to changes in units in operation, resulting from the sale of certain Company-owned units and the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increased from 69.3% in the three months ended November 30, 2014 to 73.0% in the three months ended November 30, 2015. This increase is primarily the result of the change in units in operation from the prior year.

 

Depreciation and Amortization

 

Depreciation and amortization of $344,000 in the three months ended November 30, 2015 decreased 4.0% from $358,000 incurred in the three months ended November 30, 2014. This decrease was the result of fewer Company-owned store assets in service.

 

Other Income

 

Net interest expense was $38,800 in the three months ended November 30, 2015 compared to net interest expense of $44,500 incurred in the three months ended November 30, 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 November 30, 2015 was 36.2%, compared to 36.7% for the three months ended November 30, 2014. The decrease of 0.5% was primarily the result of the change in U-Swirl net operating income. During the three months ended November 30, 2015 and November 30, 2014 there was no income tax expense recognized on U-Swirl income. 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.

 

Nine Months Ended November 30, 2015 Compared to the Nine Months Ended November 30, 2014

 

Basic earnings per share decreased 17.1% from $.41 in the nine months ended November 30, 2014 compared to $.34 in the nine months ended November 30, 2015. Revenues decreased 3.0% to $29.4 million for the nine months ended November 30, 2015 compared to $30.3 million in the nine months ended November 30, 2014. Operating income increased 0.7% from $4.3 million in the nine months ended November 30, 2014 to $4.4 million in the nine months ended November 30, 2015. Net income decreased 22.2% from $2.6 million in the nine months ended November 30, 2014 to $2.0 million in the nine months ended November 30, 2015. The increase in operating income was due primarily to an overall decrease in operating expenses. The increase in operating income was more than offset by an increase in net income attributable to non-controlling interest for the nine months ended November 30, 2015 compared to the nine months ended November 30, 2014. The difference between the 0.7% increase in operating income and the 22.2% decrease in net income attributable to RMCF shareholders was due primarily to a derivative fair value charge of $1.1 million in the nine months ended November 30, 2015, versus a derivative fair value charge of $333,000 in the prior-year period (a derivative fair value charge benefits the non-controlling interest in our subsidiary).

 

 
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Revenues

 

Nine Months Ended

                 
   

November 30,

    $    

%

 

($’s in thousands)

 

2015

   

2014

   

Change

   

Change

 

Factory sales

  $ 18,600.1     $ 18,183.6     $ 416.5       2.3 %

Retail sales

    3,880.0       4,925.0       (1,045.0 )     (21.2 %)

Franchise fees

    444.4       480.4       (36.0 )     (7.5 %)

Royalty and marketing fees

    6,521.4       6,752.2       (230.8 )     (3.4 %)

Total

  $ 29,445.9     $ 30,341.2     $ (895.3 )     (3.0 %)

 

Factory Sales

 

The increase in factory sales for the nine months ended November 30, 2015 versus the nine months ended November 30, 2014 was primarily due to an 11.4% increase in shipments of product to customers outside our network of franchised retail stores. This increase was primarily the result of the addition of new customers outside our network of licensed and 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 1.9% 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 five Company-owned locations and the closure of a certain underperforming Company-owned café. Same store sales at all Company-owned stores and cafés decreased 2.0% in the nine months ended November 30, 2015 compared to the nine months ended November 30, 2014. Same-store sales at U-Swirl cafés decreased 1.9% in the nine months ended November 30, 2015 compared to the nine months ended November 30, 2014.

 

Royalties, Marketing Fees and Franchise Fees

 

The decrease in royalties and marketing fees for the nine months ended November 30, 2014 compared to the nine months ended November 30, 2015 resulted from an 11.3% decrease in franchise units in operation and lower same store sales. The average number of total franchise stores in operation decreased from 485 in the nine months ended November 30, 2014 to 430 during the nine months ended November 30, 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 increased 0.2% during the nine months ended November 30, 2015 compared to the nine months ended November 30, 2014. Franchise fee revenues decreased as a result of fewer domestic franchise unit openings during the nine months ended November 30, 2015 compared to the nine months ended November 30, 2014.

 

Costs and Expenses

 

Nine Months Ended

                 
   

November 30,

    $    

%

 

($’s in thousands)

 

2015

   

2014

   

Change

   

Change

 
                                 

Cost of sales – factory adjusted

  $ 13,171.3     $ 12,530.5     $ 640.8       5.1 %

Cost of sales - retail

    1,277.0       1,698.5       (421.5 )     (24.8 %)

Franchise costs

    1,871.1       1,623.5       247.6       15.3 %

Sales and marketing

    1,832.8       1,838.4       (5.6 )     (0.3 %)

General and administrative

    3,550.8       3,817.0       (266.2 )     (7.0 %)

Retail operating

    2,318.4       2,697.2       (378.8 )     (14.0 %)

Total

  $ 24,021.4     $ 24,205.1     $ (183.7 )     (0.8 %)

 

Adjusted gross margin

 

Nine Months Ended

                 
   

November 30,

    $    

%

 

($’s in thousands)

 

2015

   

2014

   

Change

   

Change

 
                                 

Factory adjusted gross margin

  $ 5,428.8     $ 5,653.1     $ (224.3 )     (4.0 %)

Retail

    2,603.0       3,226.5       (623.5 )     (19.3 %)

Total

  $ 8,031.8     $ 8,879.6     $ (847.8 )     (9.5 %)

  

 
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Adjusted Gross Margin

 

Nine Months Ended

                 
   

November 30,

   

%

   

%

 
   

2015

   

2014

   

Change

   

Change

 

(Percent)

                               

Factory adjusted gross margin

    29.2 %     31.1 %     (1.9 %)     (6.1 %)

Retail

    67.1 %     65.5 %     1.6 %     2.4 %

Total

    35.7 %     38.4 %     (2.7 %)     (7.0 %)

 

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:

 

   

Nine Months Ended

 
   

November 30,

 

($’s in thousands)

 

2015

   

2014

 

Factory adjusted gross margin

  $ 5,428.8     $ 5,653.1  

Less: Depreciation and Amortization

    300.7       292.6  

Factory GAAP gross margin

  $ 5,128.1     $ 5,360.5  

 

Costs and Expenses

 

Cost of Sales

 

Factory margins decreased 190 basis points in the nine months ended November 30, 2015 compared to the nine months ended November 30, 2014 due primarily to increased costs of certain materials and a shift in product mix and customer mix in the nine months ended November 30, 2015 compared to the nine months ended November 30, 2014. Product and customer mix changed during the nine months ended November 30, 2015 primarily as a result of new customers outside of our system of franchise and licensed locations and additional product offerings to these customers. 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 nine months ended November 30, 2015, compared to the nine months ended November 30, 2014. The increase in Company-owned store margin is due primarily to a larger portion of retail revenues being derived by U-Swirl Company-owned cafés and the associated higher margins, compared to Company-owned Rocky Mountain Chocolate Factory locations.

 

Franchise Costs

 

The increase in franchise costs in the nine months ended November 30, 2015 versus the nine months ended November 30, 2014 is due primarily to franchise costs associated with supporting U-Swirl franchise units. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increased to 26.9% in the nine months ended November 30, 2015 from 22.4% in the nine months ended November 30, 2014. This increase as a percentage of royalty, marketing and franchise fees is primarily a result of higher franchise costs.

 

Sales and Marketing

 

Sales and marketing costs were approximately unchanged in the nine months ended November 30, 2015 compared to the nine months ended November 30, 2014.

 

General and Administrative

 

The decrease in general and administrative costs for the nine months ended November 30, 2015 compared to the nine months ended November 30, 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, partially offset by an increase in professional fees. For the nine months ended November 30, 2015, approximately $956,000 of U-Swirl general and administrative costs were consolidated within our results, compared with $1,378,700 in the nine months ended November 30, 2014. As a percentage of total revenues, general and administrative expenses decreased to 12.1% in the nine months ended November 30, 2015 compared to 12.6% in the nine months ended November 30, 2014.

 

 
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Retail Operating Expenses

 

The decrease in retail operating expenses for the nine months ended November 30, 2015 compared to the nine months ended November 30, 2014 was due primarily to changes in units in operation, resulting from the sale of certain Company-owned units and the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increased from 54.8% in the nine months ended November 30, 2014 to 59.8% in the nine months ended November 30, 2015. This increase is primarily the result of the change in units in operation from the prior year.

 

Depreciation and Amortization

 

Depreciation and amortization of $1,064,000 in the nine months ended November 30, 2015 decreased 3.0% from $1,097,000 incurred in the nine months ended November 30, 2014. This decrease was the result of fewer Company-owned store assets in service.

 

Restructuring and acquisition related charges

 

There were no restructuring and acquisition related charges during the nine months ended November 30, 2015, compared to $709,200 during the nine months ended November 30, 2014. The decline is primarily the result of U-Swirl management restructuring activities and costs associated with business acquisitions and the associated expenses incurred during the nine months ended November 30, 2014 with no comparable activity during the current year.

 

Other Income

 

Net interest expense was $126,600 in the nine months ended November 30, 2015, a decrease of 9.6% compared to net interest expense of $140,000 in the nine months ended November 30, 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 nine months ended November 30, 2015 was 30.4%, compared to 32.7% for the nine months ended November 30, 2014. The decrease of 2.3% was primarily the result of the change in U-Swirl net operating income and associated provision for income taxes. There was no income tax expense recognized on U-Swirl income before income taxes for the nine months ended November 30, 2014 while income tax expense at an effective rate of 4.0% was recognized during the nine months ended November 30, 2015 on U-Swirl income before income taxes. U-Swirl has significant net operating loss carryovers and no income tax expense was recognized in the nine months ended November 30, 2014. 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 its 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 November 30, 2015, working capital was $7.4 million, compared with $9.4 million as of February 28, 2015, a decrease of $2.0 million. The decrease in working capital was primarily due to the payment of dividends, payments on long term debt and repurchases of common stock partially offset by positive operating results.

 

Cash and cash equivalent balances decreased $2.0 million from $7.2 million as of February 28, 2015 to $5.2 million as of November 30, 2015 as a result of cash flow used by financing activities, including repayment of indebtedness, payment of dividends and stock repurchases. Our current ratio was 1.9 to 1 at November 30, 2015 compared to 2.1 to 1 at 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 nine months ended November 30, 2015, we had net income of $2,947,215. Operating activities provided cash of $4,605,010, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $1,064,211 and stock compensation expense of $615,740. During the comparable 2014 period, we had net income of $2,821,299, and operating activities provided cash of $4,486,073. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $1,097,404 and stock compensation expense of $700,526.

 

For the nine months ended November 30, 2015, investing activities used cash of $558,244, primarily due to the purchases of property and equipment of $625,180. In comparison, investing activities provided cash of $296,205 during the nine months ended November 30, 2014 primarily due to the sale of certain assets.

 

 
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Financing activities used cash of $6,050,217 for the nine months ended November 30, 2015 and used cash of $2,781,702 during the prior year period. This was primarily due to increased cash used to repurchase common stock during the nine months ended November 30, 2015.

 

We have a $5.0 million ($5.0 million available as of November 30, 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 November 30, 2015, we were in compliance with all such covenants. The line is subject to renewal on September 30, 2017. As of November 30, 2015, no amount was outstanding under this line of credit.

 

The Company’s long-term debt is comprised of a promissory note, the proceeds of which were loaned to U-Swirl and used to finance business acquisitions by U-Swirl (unpaid balance as of November 30, 2015, $5.4 million). The promissory note allowed 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 November 30, 2015, we were in compliance with all such covenants.

 

At the time the Company entered into the promissory note described above, the Company 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 November 30, 2015, $6.3 million was outstanding under the U-Swirl Loan Agreement. Borrowings under the U-Swirl Loan Agreement are payable in cash or conversion of the obligations into capital stock of U-Swirl, or a combination thereof, at the discretion of the Company. The U-Swirl Loan Agreement is secured by all of the assets of U-Swirl and its subsidiaries. In addition, U-Swirl is subject to various financial and leverage covenants under the U-Swirl Loan Agreement. U-Swirl was not compliant with the covenants at November 30, 2015. The loan covenants require U-Swirl to maintain consolidated adjusted EBITDA of $1,804,000 for the twelve months ended November 30, 2015. At November 30, 2015 U-Swirl reported $1,318,000 of adjusted EBITDA. Pursuant to the U-Swirl Loan Agreement, upon the occurrence and continuance of an event of default, among other remedies, we may charge interest on all amounts due under the loan at the default rate of 15% per annum, accelerate payment of all amounts due under the loan, foreclose on our security interest, and/or convert any amounts due under the loan to capital stock of U-Swirl at a premium.

 

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 nine months ended November 30, 2015, the Company repurchased 233,302 shares under the repurchase plan at an average price of $12.99 per share. As of November 30, 2015, approximately $989,700 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.

 

 
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Off-Balance Sheet Arrangements

 

As of November 30, 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 our 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.

 

Item 3.     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 November 30, 2015, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $103,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.

 

We have a $5.0 million bank line of credit that bears interest at a variable rate. As of November 30, 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 interest at a fixed rate of 3.75% annually. As of November 30, 2015, $5.4 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.    

 

 
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Item 4.     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 Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of November 30, 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 November 30, 2015 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II.     OTHER INFORMATION

 

Item 1.     Legal Proceedings

 

Except as set forth below, we are not currently involved in any material legal proceedings other than routine litigation incidental to our business.

 

In January 2014, U-Swirl entered into an Asset Purchase Agreement (the “CherryBerry Purchase Agreement”) with CherryBerry Enterprises LLC, CherryBerry Corporate LLC, CherryBerry LLC, and their respective owners (collectively, the CherryBerry Selling Parties”), pursuant to which U-Swirl acquired the franchise rights of frozen yogurt stores branded as “CherryBerry” (the “CherryBerry Acquisition”). As a part of the consideration for the CherryBerry Acquisition, U-Swirl agreed to issue an aggregate of 4,000,000 shares of U-Swirl common stock (the “CB Shares”) to the CherryBerry Selling Parties, which were subject to a one-year lock-up agreement. The CB Shares were issued to the CherryBerry Selling Parties in February 2015. Pursuant to the terms of the CherryBerry Purchase Agreement, following expiration of the lock-up period, if any of the CherryBerry Selling Parties desired to sell their CB Shares, they must first offer such shares to U-Swirl and RMCF prior to any sale of the CB Shares on the open market. 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 CherryBerry Purchase Agreement, U-Swirl agreed to pay a shortfall payment equal to the difference of the sale price of the CB Shares and $0.50 per share, multiplied by the number of shares sold by the CherryBerry Selling Parties. In July and August 2015, the CherryBerry Selling Parties submitted to U-Swirl several requests for payment of approximately $205,000 of shortfall payments based on the sale of a portion of the CB Shares.

 

On August 25, 2015, U-Swirl filed a lawsuit against the CherryBerry Selling Parties, a former officer and director of U-Swirl and unknown other parties, in the District Court for La Plata County, Colorado, alleging wrongful actions on their part to cause the price of U-Swirl’s common stock to decline and thereafter making an improper demand for the shortfall payment described above, and certain other actions in violation of various provisions of the CherryBerry Purchase Agreement. U-Swirl seeks unspecified damages, attorneys‘ fees, other costs, and a determination that the shortfall payment arrangement is void. On September 30, 2015, the CherryBerry Selling Parties filed an answer and counterclaim to the lawsuit in the U.S. District Court for the District of Colorado, and moved the lawsuit to federal court in the U.S. District Court for the District of Colorado. The counterclaim added RMCF to the lawsuit, and alleges that U-Swirl materially breached the CherryBerry Purchase Agreement by not paying the shortfall payment, that U-Swirl is the alter ego of RMCF and RMCF is liable for any obligations of U-Swirl, and that the U-Swirl Loan Agreement should be recharacterized as equity. The CherryBerry Selling Parties seek payment in full of the shortfall payment under the CherryBerry Purchase Agreement, declaratory judgements that U-Swirl is the alter ego of RMCF and the U-Swirl Loan Agreement should be recharacterized as equity, and interest, attorneys’ fees, costs and other equitable relief. The lawsuit is currently in the early stages of litigation. U-Swirl and RMCF intend to defend the counterclaim vigorously.

 

 
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Item 1A.     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.

 

Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds

 

Issuer Purchases of Equity Securities

 

Period

 

Total Number of

Shares (or Units)

Purchased (1)

 

Average Price

Paid per Share

(or Unit) (1)

 

Total Number of Shares

(or Units) Purchased as

Part of Publicly

Announced Plans or

Programs (1)

 

Maximum Number (or

Approximate Dollar Value) of

Shares (or Units) that May Yet Be

Purchased Under the Plans or

Programs (1)

September 1, 2015—September 30, 2015

 

12,005

 

$12.00

 

12,005

 

$989,704

October 1, 2015—October 31, 2015

 

-

 

-

 

-

 

$989,704

November 1, 2015—November 30, 2015

 

-

 

-

 

-

 

$989,704

Total 

 

12,005

 

$12.00

 

12,005

 

$989,704

 


(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.

 

Item 3.     Defaults Upon Senior Securities

 

None.

 

Item 4.     Mine Safety Disclosures

 

Not Applicable.

 

Item 5.     Other Information

 

None.

  

 
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Item 6.     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).

 

 

10.1*

Revolving Line of Credit , dated October 30, 2015 in the amount of $5,000,000, between Wells Fargo Bank and Rocky Mountain Chocolate Factory, Inc.

 

 

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

  

 
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Signatures

 

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.

 

 

  ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
    (Registrant)  
     

Date: January 14, 2016

 

/s/ Bryan J. Merryman

   

Bryan J. Merryman, Chief Operating Officer,

Chief Financial Officer, Treasurer and Director

 

 

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