rmcfd20180831

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 August 31, 2018

___	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 ☒ 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 ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer	☐	Accelerated filer	☐

Non-accelerated filer	☐	Smaller reporting company	☒
(Do not check if a smaller reporting company)
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

On October 1, 2018, the registrant had outstanding 5,948,660 shares of its common stock, $.001 par value.

Table of Contents

Three Months Ended August 31,

Six Months Ended August 31,

2018

2017

2018

2017

Revenues

Sales

5,736,319

6,063,381

12,318,368

13,270,320

Franchise and royalty fees

2,063,769

2,203,310

3,847,805

4,342,818

Total Revenue

7,800,088

8,266,691

16,166,173

17,613,138

Costs and Expenses

Cost of sales

3,883,884

3,852,471

8,549,126

8,867,436

Franchise costs

582,798

558,407

1,076,048

1,073,199

Sales and marketing

565,212

566,031

1,153,462

1,192,383

General and administrative

813,388

976,647

1,727,835

2,105,353

Retail operating

498,856

616,927

1,061,328

1,189,751

Depreciation and amortization, exclusive of depreciation and amortization expense of $138,212, $127,882, $274,717 and $253,497, respectively, included in cost of sales

296,737

194,990

597,737

389,924

Restructuring and acquisition related charges

118,793

176,981

Total costs and expenses

6,759,668

6,765,473

14,342,517

14,818,046

Income from Operations

1,040,420

1,501,218

1,823,656

2,795,092

Other Income (Expense)

Interest Expense

(19,418

)

(32,088

)

(42,057

)

(67,277

)

Interest Income

4,627

6,213

9,204

13,431

Other income (expense), net

(14,791

)

(25,875

)

(32,853

)

(53,846

)

Income Before Income Taxes

1,025,629

1,475,343

1,790,803

2,741,246

Income Tax Provision

274,814

547,059

463,044

999,290

Consolidated Net Income

750,815

928,284

1,327,759

1,741,956

Basic Earnings per Common Share

.13

0.16

.22

0.30

Diluted Earnings per Common Share

.13

0.16

.22

0.29

Weighted Average Common Shares Outstanding - Basic

5,923,351

5,876,727

5,914,383

5,865,549

Dilutive Effect of Employee Stock Awards

59,479

104,776

68,536

114,071

Weighted Average Common Shares Outstanding - Diluted

5,982,830

5,981,503

5,982,919

5,979,620

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

	August 31,		February 28,
	2018		2018
	(unaudited)
Assets
Current Assets
Cash and cash equivalents	$	5,173,235	$	6,072,984
Accounts receivable, less allowance for doubtful accounts of $520,262 and $479,472, respectively		3,458,476		3,897,334
Notes receivable, current portion, less current portion of the valuation allowance of $12,500 and $9,000, respectively		73,025		105,540
Refundable income taxes		85,178		342,863
Inventories, less reserve for slow moving inventory of $364,248 and $357,706, respectively		6,009,845		4,842,474
Other		464,477		310,173
Total current assets		15,264,236		15,571,368

Property and Equipment, Net		5,855,990		6,166,240

Other Assets
Notes receivable, less current portion and valuation allowance of $14,000 and $17,500, respectively		199,642		235,983
Goodwill, net		1,046,944		1,046,944
Franchise rights, net		4,056,424		4,433,927
Intangible assets, net		542,307		587,377
Deferred income taxes		494,555		835,463
Other		70,116		63,333
Total other assets		6,409,988		7,203,027

Total Assets	$	27,530,214	$	28,940,635

Liabilities and Stockholders' Equity
Current Liabilities
Current maturities of long term debt	$	1,378,601	$	1,352,893
Accounts payable		1,351,295		1,647,991
Accrued salaries and wages		648,005		644,005
Gift card liabilities		688,572		3,057,131
Other accrued expenses		184,310		325,034
Dividend payable		713,839		708,652
Deferred revenue		291,676		471,910
Total current liabilities		5,256,298		8,207,616

Long-Term Debt, Less Current Maturities		480,372		1,176,416
Deferred Revenue, Less Current Portion		1,125,017		-

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, $.001 par value, 46,000,000 shares authorized, 5,948,660 shares and 5,903,436 shares issued and outstanding, respectively		5,949		5,903
Additional paid-in capital		6,411,829		6,131,147
Retained earnings		14,250,749		13,419,553
Total stockholders' equity		20,668,527		19,556,603

Total Liabilities and Stockholders' Equity	$	27,530,214	$	28,940,635

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

	Six Months Ended
	August 31,
	2018			2017
Cash Flows From Operating Activities
Net Income	$	1,327,759		$	1,741,956
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		872,454			643,421
Provision for obsolete inventory		57,614			43,660
Provision for loss on accounts and notes receivable		40,800			58,800
Asset impairment and store closure losses		67,822			-
Loss on sale or disposal of property and equipment		26,020			17,912
Expense recorded for stock compensation		280,728			324,480
Deferred income taxes		38,814			61,987
Changes in operating assets and liabilities:
Accounts receivable		421,162			756,766
Refundable income taxes		257,685			(125,447	)
Inventories		(1,579,686	)		(1,421,625	)
Other current assets		(154,537	)		(131,457	)
Accounts payable		58,005			56,151
Accrued liabilities		(254,540	)		76,776
Deferred income		(71,671	)		85,270
Net cash provided by operating activities		1,388,429			2,188,650

Cash Flows from Investing Activities
Addition to notes receivable		-			(14,292	)
Proceeds received on notes receivable		55,612			135,733
Purchase of intangible assets		-			(8,508	)
Proceeds from (cost of) sale or distribution of assets		4,023			(9,576	)
Purchases of property and equipment		(246,455	)		(283,988	)
(Increase) decrease in other assets		(13,717	)		7,697
Net cash used in investing activities		(200,537	)		(172,934	)

Cash Flows from Financing Activities
Payments on long-term debt		(670,336	)		(645,564	)
Dividends paid		(1,417,305	)		(1,405,050	)
Net cash used in financing activities		(2,087,641	)		(2,050,614	)

Net Decrease in Cash and Cash Equivalents		(899,749	)		(34,898	)

Cash and Cash Equivalents, Beginning of Period		6,072,984			5,779,195

Cash and Cash Equivalents, End of Period	$	5,173,235		$	5,744,297

The accompanying notes are an integral part of these 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, a Colorado limited liability company (“ALY”), U-Swirl International, Inc., a Nevada corporation (“U-Swirl”), and its 46%-owned subsidiary, U-Swirl, Inc., a Nevada corporation (“SWRL”) of which, RMCF had financial control until February 29, 2016 (collectively, the “Company”). All intercompany balances and transactions have been eliminated in consolidation.

The Company is an international franchisor, confectionery manufacturer and retail operator. 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 cafés. The Company also sells its candy outside of its system of retail stores and licenses the use of its brand with certain consumer products.

In January 2013, through its 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 SWRL, in exchange for a 60% controlling equity interest in SWRL, which has been subsequently diluted down to 46% as of August 31, 2018 following various issuances of common stock of SWRL. Until February 29, 2016, U-Swirl was a wholly-owned subsidiary of SWRL, and was the operating subsidiary for all of SWRL’s operations. The SWRL Board of Directors is composed solely of Board members also serving on the Company’s Board of Directors.

In fiscal year (“FY”) 2014, SWRL acquired the franchise rights and certain other assets of self-serve frozen yogurt concepts under the names “CherryBerry,” “Yogli Mogli Frozen Yogurt” and “Fuzzy Peach Frozen Yogurt.” In connection with these acquisitions, we entered into a credit facility with Wells Fargo Bank, N.A. used to finance the acquisitions by SWRL, and in turn, we entered into a loan and security agreement with SWRL to cover the purchase price and other costs associated with the acquisitions (the “SWRL Loan Agreement”). Borrowings under the SWRL Loan Agreement were secured by all of the assets of SWRL, including all of the outstanding stock of its wholly-owned subsidiary, U-Swirl. As a result of certain defaults under the SWRL Loan Agreement, we issued a demand for payment of all obligations under the SWRL Loan Agreement. SWRL was unable to repay the obligations under the SWRL Loan Agreement, and as a result, we foreclosed on all of the outstanding stock of U-Swirl on February 29, 2016 in full satisfaction of the amounts owed under the SWRL Loan Agreement. This resulted in U-Swirl becoming our wholly-owned subsidiary as of February 29, 2016, and concurrently we ceased to have financial control of SWRL as of February 29, 2016. As of August 31, 2018, SWRL had no operating assets.

U-Swirl operates self-serve frozen yogurt cafés under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “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 and royalties from franchisees’ sales of both confectionary products and frozen yogurt; and sales at Company-owned stores of chocolates, frozen yogurt, and other confectionery products.

Table of Contents

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

The following table summarizes the number of stores operating under the Rocky Mountain Chocolate Factory brand and frozen yogurt cafés as of August 31, 2018:

	Sold, Not Yet Open		Open		Total
Rocky Mountain Chocolate Factory
Company-owned stores		-		3		3
Franchise stores - Domestic stores and kiosks		7		182		189
International license stores		1		67		68
Cold Stone Creamery - co-branded		9		89		98
U-Swirl (Including all associated brands)						-
Company-owned stores		-		1		1
Company-owned stores - co-branded		-		3		3
Franchise stores - Domestic stores*		*		95		95
Franchise stores - Domestic - co-branded*		*		11		11
International license stores		-		1		1
Total		17		452		469

*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. 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 six months ended August 31, 2018 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, 2018.

Subsequent Events

Management evaluated all activity of the Company through the issue date of the financial statements and concluded that no subsequent events have occurred that would require recognition or disclosure in the financial statements.

Recent Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 significantly changes the impairment model for most financial assets and certain other instruments. ASU 2016-13 will require immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets, which will generally result in earlier recognition of allowances for credit losses on loans and other financial instruments. ASU 2016-13 is effective for the Company's fiscal year beginning March 1, 2020 and subsequent interim periods. The Company is currently evaluating the impact the adoption of ASU 2016-13 will have on the Company's consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires the recognition of lease assets and lease liabilities on the balance sheet by lessees for those leases currently classified as operating leases under ASC 840 “Leases.” These amendments also require qualitative disclosures along with specific quantitative disclosures. These amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. The Company can elect to record a cumulative-effect adjustment as of the beginning of the year of adoption or apply a modified retrospective transition approach. The Company expects that substantially all of its operating lease commitments will be subject to the new guidance and will be recognized as operating lease liabilities and right-of-use assets upon adoption. The Company anticipates ASU 2016-02 will have a material impact on the consolidated balance sheet. The impact of ASU 2016-02 is non-cash in nature, as such, it will not affect the Company’s cash flows. The Company is currently evaluating the impact of ASU 2016-02 on the consolidated statements of income.

Table of Contents

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASC 606”). This guidance, as amended by subsequent ASUs on the topic, supersedes current guidance on revenue recognition in Topic 605, Revenue Recognition. ASC 606 provides that revenues are to be recognized when control of promised goods or services is transferred to a customer in an amount that reflects the consideration expected to be received for those goods or services. This new standard does not impact the Company's recognition of revenue from sales of confectionary items to our franchisees and others, or in Company-owned stores as those sales are recognized at the time of the underlying sale and are presented net of sales taxes and discounts. The standard also did not change the recognition of royalties and marketing fees from franchised or licensed locations, which are based on a percent of sales and recognized at the time the sales occur. The standard changed the timing in which the Company recognizes initial fees from franchisees and licensees for new franchise locations and renewals that impact the term of the franchise agreement. The Company's policy for recognizing initial franchise and renewal fees through February 28, 2018, was to recognize initial franchise fees upon new store opening and renewals that impact the term of the franchise agreement upon renewal. In accordance with the new guidance, the initial franchise services are not distinct from the continuing rights or services offered during the term of the franchise agreement, and will be treated as a single performance obligation. Beginning March 1, 2018, initial franchise fees are being recognized as the Company satisfies the performance obligation over the term of the franchise agreement, which is generally 10-15 years.

The Company adopted ASC 606 as of March 1, 2018, using the modified retrospective method. This method allows the new standard to be applied retrospectively through a cumulative catch up adjustment recognized upon adoption. As a result, comparative information in the Company’s financial statements has not been restated and continues to be reported under the accounting standards in effect for those periods. See Note 12 to these financial statements for additional details regarding the adjustments recorded upon adoption of this standard.

NOTE 5 – STOCKHOLDERS’ EQUITY

Cash Dividend

The Company paid a quarterly cash dividend of $0.12 per common share on March 16, 2018 to stockholders of record on March 6, 2018. The Company paid a quarterly cash dividend of $0.12 per share of common stock on June 15, 2018 to stockholders of record on June 5, 2018. The Company declared a quarterly cash dividend of $0.12 per share of common stock on August 16, 2018, which was paid on September 14, 2018 to stockholders of record on September 4, 2018.

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 Board of Directors may in its discretion consider relevant and in the best long-term interest of the Company’s stockholders. The Company is subject to various financial covenants related to its line of credit and other long-term debt, however, those covenants do not restrict the Board of Director’s discretion on the future declaration of cash dividends.

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. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.

Stock-Based Compensation

At August 31, 2018, the Company has stock-based compensation plans for employees and non-employee directors that authorize the granting of stock awards, including stock options, restricted stock and restricted stock units.

The Company recognized $124,921 and $280,728 of stock-based compensation expense during the three- and six-month periods ended August 31, 2018, respectively, compared to $190,065 and $324,480 during the three- and six-month periods ended August 31, 2017, respectively. Compensation costs related to stock-based compensation are generally amortized over the vesting period of the stock awards.

The following table summarizes restricted stock unit activity during the six months ended August 31, 2018 and 2017:

	Six Months Ended
	August 31,
	2018			2017
Outstanding non-vested restricted stock units as of February 28:		77,594			123,658
Granted		-			-
Vested		(43,224	)		(44,064	)
Cancelled/forfeited		(200	)		(1,360	)
Outstanding non-vested restricted stock units as of August 31:		34,170			78,234

Weighted average grant date fair value	$	12.05		$	12.17
Weighted average remaining vesting period (in years)		0.88			1.76

The Company issued 2,000 fully vested, unrestricted shares of common stock to non-employee directors during the six months ended August 31, 2018 compared to no shares issued during the six months ended August 31, 2017. In connection with these non-employee director stock issuances, the Company recognized $24,480 and $0 of stock-based compensation expense during the six months ended August 31, 2018 and 2017, respectively.

During the three months ended August 31, 2017, the Company issued 5,000 shares of unrestricted common stock under the Company’s equity incentive plan to an independent contractor providing information technology consulting services to the Company. These shares were issued as a part of the compensation for services rendered to the Company by the contractor. In connection with this stock award, the Company recognized $59,100 in expense during the three months ended August 31, 2017. No comparable shares were issued and no comparable expense was recorded in the three months ended August 31, 2018.

During the three- and six-month periods ended August 31, 2018, the Company recognized $124,921 and $256,248, respectively, of stock-based compensation expense related to 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 six-month periods ended August 31, 2018 and 2017, 43,224 and 44,064 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 August 31, 2018 was $361,905, which is expected to be recognized over the weighted-average period of 0.9 years.

Table of Contents

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

The Company has no outstanding stock options as of August 31, 2018.

NOTE 7 – OPERATING SEGMENTS

The Company classifies its business interests into five reportable segments: Franchising, Manufacturing, Retail Stores, U-Swirl operations and Other. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1 to 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, 2018. 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 August 31, 2018

Franchising

Manufacturing

Retail

U-Swirl

Other

Total

Total revenues

1,470,486

5,032,787

298,359

1,250,905

8,052,537

Intersegment revenues

(1,732

)

(250,717

)

(252,449

)

Revenue from external customers

1,468,754

4,782,070

298,359

1,250,905

7,800,088

Segment profit (loss)

693,383

1,070,613

(120,262

)

229,818

(847,923

)

1,025,629

Total assets

1,199,536

13,332,652

1,011,649

5,920,971

6,065,406

27,530,214

Capital expenditures

61,152

1,734

9,966

43,025

115,883

Total depreciation & amortization

11,631

142,697

11,179

241,033

28,409

434,949

Three Months Ended August 31, 2017

Franchising

Manufacturing

Retail

U-Swirl

Other

Total

Total revenues

1,492,673

5,211,974

484,963

1,408,678

8,598,288

Intersegment revenues

(1,109

)

(330,488

)

(331,597

)

Revenue from external customers

1,491,564

4,881,486

484,963

1,408,678

8,266,691

Segment profit (loss)

667,702

1,309,468

32,498

413,642

(947,967

)

1,475,343

Total assets

1,236,795

13,014,273

1,166,435

9,055,699

4,981,613

29,454,815

Capital expenditures

5,636

169,538

12,736

3,208

16,144

207,262

Total depreciation & amortization

11,554

132,144

3,832

143,188

32,154

322,872

Table of Contents

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended August 31, 2018

Franchising

Manufacturing

Retail

U-Swirl

Other

Total

Total revenues

2,783,691

10,903,302

659,794

2,384,159

16,730,946

Intersegment revenues

(2,767

)

(562,006

)

(564,773

)

Revenue from external customers

2,780,924

10,341,296

659,794

2,384,159

16,166,173

Segment profit (loss)

1,182,654

2,239,948

(198,756

)

364,973

(1,798,016

)

1,790,803

Total assets

1,199,536

13,332,652

1,011,649

5,920,971

6,065,406

27,530,214

Capital expenditures

3,535

172,917

3,805

13,304

52,894

246,455

Total depreciation & amortization

23,556

283,724

23,854

485,084

56,236

872,454

Six Months Ended August 31, 2017

Franchising

Manufacturing

Retail

U-Swirl

Other

Total

Total revenues

3,099,159

11,710,184

846,990

2,603,987

18,260,320

Intersegment revenues

(2,415

)

(644,767

)

(647,182

)

Revenue from external customers

3,096,744

11,065,417

846,990

2,603,987

17,613,138

Segment profit (loss)

1,430,391

2,696,507

(3,933

)

653,838

(2,035,557

)

2,741,246

Total assets

1,236,795

13,014,273

1,166,435

9,055,699

4,981,613

29,454,815

Capital expenditures

5,636

218,598

16,336

5,824

37,594

283,988

Total depreciation & amortization

22,946

262,006

7,658

286,278

64,533

643,421

Revenue from one customer of the Company’s Manufacturing segment represented approximately $1.4 million, or 8.8 percent, of the Company’s revenues from external customers during the six months ended August 31, 2018, compared to $2.2 million, or 12.3 percent, of the Company’s revenues from external customers during the six months ended August 31, 2017.

NOTE 8 – GOODWILL AND INTANGIBLE ASSETS

Intangible assets consist of the following:

August 31, 2018

February 28, 2018

Amortization

Period (in years)

Gross Carrying

Value

Accumulated

Amortization

Gross Carrying

Value

Accumulated

Amortization

Intangible assets subject to amortization

Store design

220,778

213,403

220,778

212,653

Packaging licenses

120,830

Packaging design

430,973

Trademark/Non-competition agreements

715,339

180,407

715,339

136,087

Franchise rights

5,979,637

1,923,213

5,979,637

1,545,710

Total

7,467,557

2,868,826

7,467,557

2,446,253

Intangible assets not subject to amortization

Franchising segment-

Company stores goodwill

1,099,328

267,020

1,099,328

267,020

Franchising goodwill

295,000

197,682

295,000

197,682

Manufacturing segment-goodwill

295,000

197,682

295,000

197,682

Trademark

20,000

Total goodwill

1,709,328

662,384

1,709,328

662,384

Total Intangible Assets

9,176,885

3,531,210

9,176,885

3,108,637

Table of Contents

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

Effective March 1, 2002, under Accounting Standards Codification Topic 350, all goodwill with indefinite lives is no longer subject to amortization. Accumulated amortization related to intangible assets not subject to amortization is a result of amortization expense related to indefinite life goodwill incurred prior to March 1, 2002.

Amortization expense related to intangible assets totaled $422,573 and $221,381 during the six months ended August 31, 2018 and 2017, respectively.

At August 31, 2018, annual amortization of intangible assets, based upon our existing intangible assets and current useful lives, is estimated to be the following:

2019	$	421,474
2020		706,177
2021		594,229
2022		490,060
2023		411,607
Thereafter		1,975,184
Total	$	4,598,731

NOTE 12 – ADOPTION OF ASU 2014-09, “REVENUE FROM CONTRACTS WITH CUSTOMERS” (“ASC 606”)

As described in Note 1, effective March 1, 2018, the Company adopted ASC 606. ASC 606 provides that revenues are to be recognized when control of promised goods or services is transferred to a customer in an amount that reflects the consideration expected to be received for those goods or services. This new standard does not impact the Company's recognition of revenue from sales of confectionary items to our franchisees and others, or in our Company-owned stores as those sales are recognized at the time of the underlying sale and are presented net of sales taxes and discounts. The standard also does not change the recognition of royalties and marketing fees from franchised or licensed locations, which are based on a percent of sales and recognized at the time the sales occur. The standard does change the timing in which the Company recognizes initial fees from franchisees and licensees for new franchise locations and renewals that affect the term of the franchise agreement.

Initial Franchise Fees, License Fees, Transfer Fees and Renewal Fees

The Company's policy for recognizing initial franchise and renewal fees through February 28, 2018, was to recognize initial franchise fees upon new store openings and renewals that impact the term of the franchise agreement upon renewal. In accordance with the new guidance, the initial franchise services are not distinct from the continuing rights or services offered during the term of the franchise agreement, and will be treated as a single performance obligation. Beginning March 1, 2018, initial franchise fees are being recognized as the Company satisfies the performance obligation over the term of the franchise agreement, which is generally 10-15 years.

Gift Cards

The Company’s franchisees sell gift cards which do not have either expiration dates, or non-usage fees. The proceeds from the sale of gift cards by the franchisees are accumulated by the Company and paid out to the franchisees upon customer redemption. The Company has historically accumulated gift card liabilities and has not recognized breakage associated with the gift card liability. The adoption of ASC 606 requires the use of the “proportionate” method for recognizing breakage, which the Company has not historically utilized. Upon adoption of ASC 606 the Company began recognizing breakage from gift cards when the gift card is redeemed by the customer or the Company determines the likelihood of the gift card being redeemed by the customer is remote (“gift card breakage”). The determination of the gift card breakage rate is based upon Company-specific historical redemption patterns.

Impact to Prior Periods

The cumulative adjustment recorded upon adoption of ASC 606 consisted of net contract liabilities of approximately $1,022,720, a reduction in gift card liability of $2,250,743 and approximately $302,094 of associated adjustments to the deferred tax balances which are recorded in deferred income taxes. The Company did not record any contract assets. The following table outlines the adjustments to the consolidated financial statements made upon adoption of ASC 606 on March 1, 2018:

	Amount
Increase in deferred revenue	$	(1,022,720	)
Reduction in gift card liabilities		2,250,743
Adjustment to deferred income tax assets		(302,094	)

Cumulative increase to retained earnings	$	925,929

Table of Contents

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

The adoption of ASC 606 impacted the Company’s previously reported financial statements as follows:

CONSOLIDATED BALANCE SHEET

AS OF FEBRUARY 28, 2018

Previously

Reported

Adjustments

Restated

Assets

Current Assets

Cash and cash equivalents

6,072,984

Accounts receivable, net

3,897,334

Notes receivable, current portion, net

105,540

Refundable income taxes

342,863

Inventories, net

4,842,474

Other

310,173

Total current assets

15,571,368

Property and Equipment, Net

6,166,240

Other Assets

Notes receivable, less current portion, net

235,983

Goodwill, net

1,046,944

Franchise rights, net

4,433,927

Intangible assets, net

587,377

Deferred income taxes

835,463

(302,094

)

533,369

Other

63,333

Total other assets

7,203,027

(302,094

)

6,900,933

Total Assets

28,940,635

(302,094

)

28,638,541

Liabilities and Stockholders' Equity

Current Liabilities

Current maturities of long-term debt

1,352,893

Accounts payable

1,647,991

Accrued salaries and wages

644,005

Gift card liabilities

3,057,131

(2,250,743

)

806,388

Other accrued expenses

325,034

Dividend payable

708,652

Deferred revenue

471,910

(143,445

)

328,465

Total current liabilities

8,207,616

(2,394,188

)

5,813,428

Long-Term Debt, Less Current Maturities

1,176,416

Deferred Revenue, Less Current Portion

1,166,165

Commitments and Contingencies

Stockholders' Equity

Preferred stock

Common stock

5,903

Additional paid-in capital

6,131,147

Retained earnings

13,419,553

925,929

14,345,482

Total stockholders' equity

19,556,603

925,929

20,482,532

Total Liabilities and Stockholders' Equity

28,940,635

(302,094

)

28,638,541

Table of Contents

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

The following table contains a reconciliation of revenue reported for the current period and revenue had the Company reported under the prior method for revenue recognition:

	Three Months Ended August 31,					Six Months Ended August 31,
	2018			2017		2018			2017
Franchise Fees contained within the Statement of Income:	$	107,538		$	163,000	$	200,673		$	412,125
Adjustment required to conform revenue to prior period method:		(18,538	)		-		(10,173	)		-
Comparable franchise fees:	$	89,000		$	163,000	$	190,500		$	412,125

At August 31, 2018, annual revenue expected to be recognized in the future, related to performance obligations that are not yet fully satisfied, are estimated to be the following:

2019	$	127,919
2020		246,670
2021		196,548
2022		184,300
2023		170,171
Thereafter		491,084
Total	$	1,416,692

Table of Contents

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

NOTE 13 – DISAGGREGATION OF REVENUE

The following table presents disaggregated revenue by method of recognition and segment:

Three Months Ended August 31, 2018

Revenues recognized over time under ASC 606:

Franchising

Manufacturing

Retail

U-Swirl

Total

Franchise fees

36,005

71,533

107,538

Revenues recognized at a point in time:

Franchising

Manufacturing

Retail

U-Swirl

Total

Factory sales

4,782,070

Retail sales

298,359

655,890

954,249

Royalty and marketing fees

1,432,749

523,482

1,956,231

Total

1,468,754

4,782,070

298,359

1,250,905

7,800,088

Six Months Ended August 31, 2018

Revenues recognized over time under ASC 606:

Franchising

Manufacturing

Retail

U-Swirl

Total

Revenues recognized over time under ASC 606:

Franchise fees

110,521

90,152

200,673

Revenues recognized at a point in time:

Franchising

Manufacturing

Retail

U-Swirl

Total

Factory sales

10,341,296

Retail sales

659,794

1,317,278

1,977,072

Royalty and marketing fees

2,670,403

976,729

3,647,132

Total

2,780,924

10,341,296

659,794

2,384,159

16,166,173

This Quarterly Report on Form 10-Q (“Quarterly Report”) includes statements of our expectations, intentions, plans and beliefs that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are intended to come within the safe harbor protection provided by those sections. These forward-looking statements involve various risks and uncertainties. The nature of our operations and the environment in which we operate subject us to changing economic, competitive, regulatory and technological conditions, risks and uncertainties. The statements, other than statements of historical fact, included in this Quarterly Report are forward-looking statements. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as "will," "intend," "believe," "expect," "anticipate," "should," "plan," "estimate," "potential," or similar expressions. Factors which could cause results to differ include, but are not limited to: changes in the confectionery business environment, seasonality, consumer interest in our products, general economic conditions, the success of our frozen yogurt business, 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, 2018. 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.

We are an international franchisor, confectionery manufacturer and retail operator. Founded in 1981, we are headquartered in Durango, Colorado and manufacture an extensive line of premium chocolate candies and other confectionery products. Our subsidiary, U-Swirl International, Inc. (“U-Swirl”), franchises and operates soft-serve frozen yogurt cafés. Our revenues and profitability are derived principally from our franchised/license system of retail stores that feature chocolate, frozen yogurt and other confectionary products. We also sell our candy outside of our system of retail stores and license the use of our brand with certain consumer products. As of August 31, 2018, there were three Company-owned, 89 licensee-owned and 249 franchised Rocky Mountain Chocolate Factory stores operating in 38 states, Canada, South Korea, Panama, and the Philippines. As of August 31, 2018, U-Swirl operated four Company-owned cafés and 107 franchised cafés located in 27 states and Qatar. U-Swirl operates self-serve frozen yogurt cafés under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!” and “Aspen Leaf Yogurt”.

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, Inc., a publicly traded company (OTCQB: SWRL) (“SWRL”), in exchange for a 60% controlling equity interest in SWRL, which was subsequently diluted down to 46% as of August 31, 2018 following various issuances of common stock of SWRL. Until February 29, 2016, U-Swirl was a wholly-owned subsidiary of SWRL, and was the operating subsidiary for all of SWRL’s operations.

In fiscal year (“FY”) 2014, SWRL acquired the franchise rights and certain other assets of self-serve frozen yogurt concepts under the names “CherryBerry,” “Yogli Mogli Frozen Yogurt” and “Fuzzy Peach Frozen Yogurt.” In connection with these acquisitions, we entered into a credit facility with Wells Fargo Bank, N.A. used to finance the acquisitions by SWRL, and in turn, we entered into a loan and security agreement with SWRL to cover the purchase price and other costs associated with the acquisitions (the “SWRL Loan Agreement”). Borrowings under the SWRL Loan Agreement were secured by all of the assets of SWRL, including all of the outstanding stock of its wholly-owned subsidiary, U-Swirl. As a result of certain defaults under the SWRL Loan Agreement, we issued a demand for payment of all obligations under the SWRL Loan Agreement. SWRL was unable to repay the obligations under the SWRL Loan Agreement, and as a result, we foreclosed on all of the outstanding stock of U-Swirl on February 29, 2016 in full satisfaction of the amounts owed under the SWRL Loan Agreement. This resulted in U-Swirl becoming our wholly-owned subsidiary as of February 29, 2016, and concurrently we ceased to have financial control of SWRL as of February 29, 2016. As of August 31, 2018, SWRL had no operating assets.

Three Months Ended August 31, 2018 Compared to the Three Months Ended August 31, 2017

Basic earnings per share decreased 18.8% from $0.16 in the three months ended August 31, 2017 to $0.13 in the three months ended August 31, 2018. Revenues decreased 5.6% from $8.3 million in the three months ended August 31, 2017 to $7.8 million in the three months ended August 31, 2018. Operating income decreased 30.7% from $1.5 million in the three months ended August 31, 2017 to $1.0 million in the three months ended August 31, 2018. Net income decreased 19.1% from $928,000 in the three months ended August 31, 2017 to $751,000 in the three months ended August 31, 2018. The decrease in operating income was due primarily to lower revenue in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.

The decrease in factory sales for the three months ended August 31, 2018 versus the three months ended August 31, 2017 was primarily due to a 13.3% decrease in shipments of product to customers outside our network of franchise retail locations and a 0.3% decrease in purchases by our network of franchised and licensed stores. This change was primarily the result of a decrease in purchases by the Company’s largest customer during the three months ended August 31, 2018, with revenue from such customer decreasing to approximately $100,000, or 1.8%, of the Company’s revenues during the three months ended August 31, 2018, compared to $300,000, or 3.4% of the Company’s revenues during the three months ended August 31, 2017 for this same customer. The Company believes the decrease in orders is due to lower sales of its customer. If future purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales to such customer will return to historical levels.

Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 2.2% in the three months ended August 31, 2018, compared with the three months ended August 31, 2017.

The decrease in retail sales was primarily due to changes in retail units in operation resulting from the sale of certain Company-owned locations and the closure of certain underperforming Company-owned locations. Same store sales at all Company-owned stores and cafés decreased 0.1% in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.

The decrease in royalties and marketing fees from the three months ended August 31, 2017 to the three months ended August 31, 2018 was primarily due to a 10.2% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 324 in the three months ended August 31, 2017 to 291 during the three months ended August 31, 2018. 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 0.1% during the three months ended August 31, 2018 compared to the three months ended August 31, 2017. Franchise fee revenues decreased as a result of a decrease in international license fees recognized during the three months ended August 31, 2018 compared to the three months ended August 31, 2017. During the three months ended August 31, 2017, U-Swirl entered into a master license agreement for the State of Qatar.

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 plus 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.

Factory margins decreased 390 basis points in the three months ended August 31, 2018 compared to the three months ended August 31, 2017 due primarily to lower efficiencies associated with an 11.8% decrease in production volume and an increase in transportation fuel costs in the three months ended August 31, 2018 compared to the three months ended August 31, 2017. The increase in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 2018 compared to the prior year.

The increase in franchise costs in the three months ended August 31, 2018 versus the three months ended August 31, 2017 is due primarily to an increase in legal and professional expense in the three months ended August 31, 2018 compared to the three months ended August 31, 2017. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increased to 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.

The decrease in sales and marketing costs for the three months ended August 31, 2018 compared to the three months ended August 31, 2017 is primarily due to lower marketing-related costs associated with U-Swirl franchise locations as a result of fewer units in operation.

The decrease in general and administrative costs for the three months ended August 31, 2108 compared to the three months ended August 31, 2017 is primarily due to a decrease in legal and professional expense in the three months ended August 31, 2018 compared to the three months ended August 31, 2017. As a percentage of total revenues, general and administrative expenses decreased to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.

The decrease in retail operating expenses for the three months ended August 31, 2018 compared to the three months ended August 31, 2017 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018. This slight increase is primarily the result of the change in units in operation from the prior year.

Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017. This increase was the result of a change in management’s estimates related to the future value of U-Swirl intangibles and the associated acceleration of amortization expense. Depreciation and amortization included in cost of sales increased 8.1% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018. This increase was the result of an increase in production assets in service.

There was $119,000 in restructuring charges incurred during the three months ended August 31, 2018 and no restructuring charges incurred during the three months ended August 31, 2017. The increase in restructuring costs was the result of charges related to closing certain underperforming Company-owned locations.

Net interest expense was $15,000 in the three months ended August 31, 2018 compared to net interest expense of $26,000 incurred in the three months ended August 31, 2017. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2018.

Our effective income tax rate for the three months ended August 31, 2018 was 26.8%, compared to 37.1% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.

Six Months Ended August 31, 2018 Compared to the Six Months Ended August 31, 2017

Basic earnings per share decreased 26.7% to $0.22 for the six months ended August 31, 2018 compared to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2 million for the six months ended August 31, 2018 compared to $17.6 million in the six months ended August 31, 2017. Operating income decreased 34.8% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.7 million in the six months ended August 31, 2017 to $1.3 million in the six months ended August 31, 2018. The decrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.

The decrease in factory sales for the six months ended August 31, 2018 versus the six months ended August 31, 2017 was primarily due to a 26.0% decrease in shipments of product to customers outside our network of franchise retail locations. This change was primarily the result of a decrease in purchases by the Company’s largest customer during the six months ended August 31, 2018, with revenue from such customer decreasing to approximately $1.4 million, or 8.8%, of the Company’s revenues during the six months ended August 31, 2018, compared to $2.2 million, or 12.3% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The Company believes the decrease in orders is due to lower sales of its customer. If future purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales to such customer will return to historical levels

Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4% in the six months ended August 31, 2018, compared with the six months ended August 31, 2017.

The decrease in retail sales was primarily due to changes in retail units in operation as a result of the closure of certain underperforming Company-owned locations. Same store sales at all Company-owned stores and cafés decreased 0.1% in the six months ended August 31, 2018 compared to the six months ended August 31, 2017.

The decrease in royalties and marketing fees from the six months ended August 31, 2017 to the three months ended August 31, 2018 was primarily due to a 10.4% decrease in domestic franchise units in operation and lower same store sales. The average number of total domestic franchise stores in operation decreased from 327 in the six months ended August 31, 2017 to 293 during the six months ended August 31, 2018. This decrease is the result of domestic store closures exceeding domestic store openings. Same store sales at total franchise stores and cafés in operation decreased 0.6% during the six months ended August 31, 2018 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.

Factory margins decreased 250 basis points in the six months ended August 31, 2018 compared to the six months ended August 31, 2017 due primarily to lower efficiencies associated with an 11.3% decrease in production volume in the six months ended August 31, 2018 compared to the six months ended August 31, 2017. The decrease in retail gross margins was primarily the result of inventory discounts prior to closing certain underperforming Company-owned locations.

The increase in franchise costs in the six months ended August 31, 2018 versus the six months ended August 31, 2017 is due primarily to an increase in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increased to 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017. This increase as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.

The decrease in sales and marketing costs for the six months ended August 31, 2018 compared to the six months ended August 31, 2017 is primarily due to lower marketing-related costs associated with U-Swirl franchise locations.

The decrease in general and administrative costs for the six months ended August 31, 2018 compared to the six months ended August 31, 2017 is primarily due to a decrease in legal and professional expenses. As a percentage of total revenues, general and administrative expenses decreased to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.

The decrease in retail operating expenses for the six months ended August 31, 2018 compared to the six months ended August 31, 2017 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018. This decrease is primarily the result of the change in units in operation from the prior year.

Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017. This increase was the result of a change in management’s estimates related to the future value of U-Swirl intangibles and the associated acceleration of amortization expense. Depreciation and amortization included in cost of sales increased 8.4% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018. This increase was the result of an increase in production assets in service.

There were no restructuring and acquisition related charges during the six months ended August 31, 2017 compared to $177,000 during the six months ended August 31, 2018. The increase in restructuring costs was the result of charges related to closing certain underperforming Company-owned locations.

Net interest expense was $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.

Our effective income tax rate for the six months ended August 31, 2018 was 25.9%, compared to 36.5% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.

As of August 31, 2018, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.

Cash and cash equivalent balances declined approximately $900,000 to $5.2 million as of August 31, 2018 compared to $6.1 million as of February 28, 2018 as a result of cash flow used by financing activities, including repayment of debt and payment of dividends exceeding cash flow generated by operating activities. Our current ratio was 2.9 to 1 at August 31, 2018 compared to 1.9 to 1 at February 28, 2018. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.

During the six months ended August 31, 2018, we had net income of $1,327,759. Operating activities provided cash of $1,388,429, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454 and the increase in inventory of $1,579,686. During the comparable 2017 period, we had net income of $1,741,956, and operating activities provided cash of $2,188,650. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421 and the increase in inventory of $1,421,625.

During the six months ended August 31, 2018, investing activities used cash of $200,537, primarily due to the purchases of property, equipment of $246,455. In comparison, investing activities used cash of $172,934 during the six months ended August 31, 2017 primarily due to the purchase of property and equipment of $283,988.

Financing activities used cash of $2,087,641 for the six months ended August 31, 2018 and used cash of $2,050,614 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.

We have a $5.0 million ($5.0 million available as of August 31, 2018) 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 August 31, 2018, we were in compliance with all such covenants. The line of credit is subject to renewal in September 2019. As of August 31, 2018, no amount was outstanding under this line of credit.

Our outstanding long-term debt is comprised of a promissory note used to finance business acquisitions of SWRL (unpaid balance as of August 31, 2018 of $1.9 million). The promissory note allowed us 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%. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of August 31, 2018, we were in compliance with all such covenants.

On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.

We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.

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.

We are subject to seasonal fluctuations in sales, which cause fluctuations in quarterly results of operations. Historically, the strongest sales of our products have occurred during key holidays and the summer vacation season. 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.

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 August 31, 2018, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.

We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018, 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 line of credit.

We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under 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 Securities and Exchange Commission’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 concluded that our disclosure controls and procedures are effective as of August 31, 2018.

There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 2018 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

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, 2018. 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, 2018.

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 did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.

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.

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.

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	17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25
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

	August 31, 2018			February 28, 2018
Ingredients and supplies	$	2,828,131		$	2,764,727
Finished candy		3,487,938			2,371,610
U-Swirl, Inc. food and packaging		58,024			63,843
Reserve for slow moving inventory		(364,248	)		(357,706	)
Total inventories	$	6,009,845		$	4,842,474

	August 31, 2018			February 28, 2018
Land	$	513,618		$	513,618
Building		4,803,445			4,905,103
Machinery and equipment		10,180,006			10,686,631
Furniture and fixtures		890,766			1,067,788
Leasehold improvements		1,187,856			1,568,260
Transportation equipment		422,458			434,091
Asset impairment		(77,891	)		(62,891	)
		17,920,258			19,112,600

Less accumulated depreciation		(12,064,268	)		(12,946,360	)
Property and equipment, net	$	5,855,990		$	6,166,240

	Six Months Ended
	August 31,
	2018		2017
Cash paid for:
Interest, net	$	33,006	$	53,345
Income taxes		166,545		1,062,750
Non-cash Operating Activities
Accrued Inventory		96,454		325,922
Non-cash Financing Activities
Dividend payable	$	713,839	$	708,412

	August 31, 2018			February 28, 2018
Promissory note	$	1,858,973		$	2,529,309
Less: current maturities		(1,378,601	)		(1,352,893	)
Long-term obligations	$	480,372		$	1,176,416

	Amount
2019	$	682,533
2020		1,176,440

Total minimum payments		1,858,973
Less: current maturities		(1,378,601	)

Long-term obligations	$	480,372

	August 31,				$			%
($'s in thousands)	2018		2017		Change			Change
Factory sales	$	4,782.1	$	4,881.5	$	(99.4	)		(2.0	)%
Retail sales		954.3		1,181.9		(227.6	)		(19.3	)%
Franchise fees		107.5		163.0		(55.5	)		(34.0	)%
Royalty and marketing fees		1,956.2		2,040.3		(84.1	)		(4.1	)%
Total	$	7,800.1	$	8,266.7	$	(466.6	)		(5.6	)%

	Three Months Ended
	August 31,				$			%
($'s in thousands)	2018		2017		Change			Change

Cost of sales - factory	$	3,575.4	$	3,461.2	$	114.2			3.3	%
Cost of sales - retail		308.5		391.3		(82.8	)		(21.2	)%
Franchise costs		582.8		558.4		24.4			4.4	%
Sales and marketing		565.2		566.0		(0.8	)		(0.1	)%
General and administrative		813.4		976.6		(163.2	)		(16.7	)%
Retail operating		498.9		616.9		(118.0	)		(19.1	)%
Total	$	6,344.2	$	6,570.4	$	(226.2	)		(3.4	)%