rmcfd20190831

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended August 31, 2019

☐	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)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading symbol	Name of each exchange on which registered
Common Stock, $0.001 par value per share	RMCF	Nasdaq Global Market
Preferred Stock Purchase Rights	RMCF	Nasdaq Global Market

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 every Interactive Data File required to be submitted 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 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	☒

		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, 2019, the registrant had outstanding 5,994,997 shares of its common stock, $0.001 par value.

	Three Months Ended August 31,						Six Months Ended August 31,
	2019			2018			2019			2018
Revenues
Sales	$	5,384,040		$	5,736,319		$	11,844,651		$	12,318,368
Franchise and royalty fees		2,001,230			2,063,769			3,966,618			3,847,805
Total Revenue		7,385,270			7,800,088			15,811,269			16,166,173

Costs and Expenses
Cost of sales		3,738,435			3,883,884			8,353,179			8,549,126
Franchise costs		441,638			582,798			924,651			1,076,048
Sales and marketing		434,782			565,212			991,433			1,153,462
General and administrative		830,451			813,388			1,975,182			1,727,835
Retail operating		469,304			498,856			918,206			1,061,328
Depreciation and amortization, exclusive of depreciation and amortization expense of $147,415, $138,212, $293,114 and $274,717, respectively, included in cost of sales		225,417			296,737			457,372			597,737
Costs associated with Company-owned store closures		-			118,793			-			176,981
Total costs and expenses		6,140,027			6,759,668			13,620,023			14,342,517

Income from Operations		1,245,243			1,040,420			2,191,246			1,823,656

Other Income (Expense)
Interest Expense		(3,487	)		(19,418	)		(15,885	)		(42,057	)
Interest Income		6,007			4,627			16,186			9,204
Other income (expense), net		2,520			(14,791	)		301			(32,853	)

Income Before Income Taxes		1,247,763			1,025,629			2,191,547			1,790,803

Income Tax Provision		329,675			274,814			561,850			463,044

Consolidated Net Income	$	918,088		$	750,815		$	1,629,697		$	1,327,759

Basic Earnings per Common Share	$	0.15		$	0.13		$	0.27		$	0.22
Diluted Earnings per Common Share	$	0.15		$	0.13		$	0.26		$	0.22

Weighted Average Common Shares Outstanding - Basic		5,977,746			5,923,351			5,970,012			5,914,383
Dilutive Effect of Employee Stock Awards		279,584			59,479			275,935			68,536
Weighted Average Common Shares Outstanding - Diluted		6,257,330			5,982,830			6,245,947			5,982,919

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

	August 31,		February 28,
	2019		2019
	(unaudited)
Assets
Current Assets
Cash and cash equivalents	$	5,753,209	$	5,384,027
Accounts receivable, less allowance for doubtful accounts of $585,306 and $489,502, respectively		4,017,572		3,993,262
Notes receivable, current portion		134,926		110,162
Refundable income taxes		44,726		190,201
Inventories, less reserve for slow moving inventory of $178,658 and $371,147, respectively		4,195,198		4,270,357
Other		465,876		318,126
Total current assets		14,611,507		14,266,135

Property and Equipment, Net		5,857,664		5,786,139

Other Assets
Notes receivable, less current portion		317,507		281,669
Goodwill, net		1,046,944		1,046,944
Franchise rights, net		3,363,304		3,678,920
Intangible assets, net		460,865		498,337
Deferred income taxes		505,462		607,421
Lease right of use asset		3,066,826		-
Other		56,264		56,576
Total other assets		8,817,172		6,169,867

Total Assets	$	29,286,343	$	26,222,141

Liabilities and Stockholders' Equity
Current Liabilities
Current maturities of long term debt	$	480,445	$	1,176,488
Accounts payable		1,295,732		897,074
Accrued salaries and wages		597,856		655,853
Gift card liabilities		648,142		742,289
Other accrued expenses		291,353		293,094
Dividend payable		719,359		714,939
Contract liabilities		239,278		256,094
Lease liability		808,989		-
Total current liabilities		5,081,154		4,735,831

Lease Liability, Less Current Portion		2,257,837		-
Contract Liabilities, Less Current Portion		976,651		1,096,478

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, 5,991,162 shares and 5,957,827 shares issued and outstanding, respectively		5,991		5,958
Additional paid-in capital		7,037,501		6,650,864
Retained earnings		13,927,209		13,733,010

Total stockholders' equity		20,970,701		20,389,832

Total Liabilities and Stockholders' Equity	$	29,286,343	$	26,222,141

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

	Six Months Ended
	August 31,
	2019			2018
Cash Flows From Operating Activities
Net Income	$	1,629,697		$	1,327,759
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		750,486			872,454
Provision for obsolete inventory		47,945			57,614
Provision for loss on accounts and notes receivable		108,283			40,800
Asset impairment and store closure losses		-			67,822
Loss on sale or disposal of property and equipment		5,796			26,020
Expense recorded for stock compensation		386,670			280,728
Deferred income taxes		101,959			38,814
Changes in operating assets and liabilities:
Accounts receivable		(267,491	)		421,162
Refundable income taxes		145,475			257,685
Inventories		212,138			(1,579,686	)
Other current assets		(147,750	)		(154,537	)
Accounts payable		213,734			58,005
Accrued liabilities		(153,885	)		(254,540	)
Contract liabilities		(130,378	)		(71,671	)
Net cash provided by operating activities		2,902,679			1,388,429

Cash Flows from Investing Activities
Proceeds received on notes receivable		74,296			55,612
Purchases of property and equipment		(480,984	)		(242,432	)
(Increase) decrease in other assets		312			(13,717	)
Net cash used in investing activities		(406,376	)		(200,537	)

Cash Flows from Financing Activities
Payments on long-term debt		(696,043	)		(670,336	)
Dividends paid		(1,431,078	)		(1,417,305	)
Net cash used in financing activities		(2,127,121	)		(2,087,641	)

Net Increase (Decrease) in Cash and Cash Equivalents		369,182			(899,749	)

Cash and Cash Equivalents, Beginning of Period		5,384,027			6,072,984

Cash and Cash Equivalents, End of Period	$	5,753,209		$	5,173,235

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

					Additional
	Common Stock				Paid-in			Retained
	Shares		Amount		Capital			Earnings			Total
Balance as of May 31, 2018		5,905,436	$	5,905	$	6,286,952		$	14,213,773		$	20,506,630
Net income									750,815			750,815
Issuance of common stock, vesting of restricted stock units and other		43,224		43		(43	)					-
Share-based compensation						124,921						124,921
Common stock dividends									(713,839	)		(713,839	)
Balance as of August 31, 2018		5,948,660	$	5,948	$	6,411,830		$	14,250,749		$	20,668,527

Balance as of February 28, 2018		5,903,436	$	5,903	$	6,131,147		$	13,419,553		$	19,556,603
Net income									1,327,759			1,327,759
Issuance of common stock, vesting of restricted stock units and other		45,224		45		(45	)					-
Share-based compensation						280,728						280,728
Common stock dividends									(1,422,492	)		(1,422,492	)
Adoption of ASC 606									925,929			925,929
Balance as of August 31, 2018		5,948,660	$	5,948	$	6,411,830		$	14,250,749		$	20,668,527

Balance as of May 31, 2019		5,962,327	$	5,962	$	6,882,114		$	13,728,480		$	20,616,556
Net income									918,088			918,088
Issuance of common stock, vesting of restricted stock units and other		28,835		29		(29	)					-
Share-based compensation						155,416						155,416
Common stock dividends									(719,359	)		(719,359	)
Balance as of August 31, 2019		5,991,162	$	5,991	$	7,037,501		$	13,927,209		$	20,970,701

Balance as of February 28, 2019		5,957,827		5,958	$	6,650,864		$	13,733,010		$	20,389,832
Net income									1,629,697			1,629,697
Issuance of common stock, vesting of restricted stock units and other		33,335		33		(33	)					-
Share-based compensation						386,670						386,670
Common stock dividends									(1,435,498	)		(1,435,498	)
Balance as of August 31, 2019		5,991,162	$	5,991	$	7,037,501		$	13,927,209		$	20,970,701

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.

The Company’s revenues are currently derived from three principal sources, which are similar for its wholly owned subsidiaries RMCF and U-Swirl: (i) sales to franchisees and others of chocolates and other confectionery products manufactured by the Company; (ii) sales at Company-owned stores of chocolates, frozen yogurt, and other confectionery products (including products manufactured by the Company); (iii) the collection of initial franchise fees and royalties from franchisees’ sales of both confectionary products and frozen yogurt.

The following table summarizes the number of stores operating under the Rocky Mountain Chocolate Factory brand and frozen yogurt cafés as of August 31, 2019:

	Sold, Not Yet Open		Open		Total
Rocky Mountain Chocolate Factory
Company-owned stores		-		2		2
Franchise stores - Domestic stores and kiosks		1		179		180
International license stores		1		63		64
Cold Stone Creamery - co-branded		7		95		102
U-Swirl (Including all associated brands)
Company-owned stores		-		1		1
Company-owned stores - co-branded		-		3		3
Franchise stores - Domestic stores		-		82		82
Franchise stores - Domestic - co-branded		1		8		9
International license stores		-		2		2
Total		10		435		445

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 (the “SEC”) 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. In the opinion of management, the consolidated financial statements reflect all adjustments (of a normal and recurring nature) which are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The results of operations for the three and six months ended August 31, 2019 are not necessarily indicative of the results to be expected for the entire fiscal year, or any other future period.

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, 2019.

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ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

Subsequent Events

On September 30, 2019 the Company executed a Revolving Line of Credit Note with Wells Fargo Bank. This document was executed to renew the existing $5 million line of credit and extend the maturity date from September 30, 2019 to September 30, 2021.

Recent Accounting Pronouncements

In August 2018, the SEC adopted amendments to certain disclosure requirements in Securities Act Release No. 33-10532, Disclosure Update and Simplification. These amendments eliminate, modify, or integrate into other SEC requirements certain disclosure rules. Among the amendments is the requirement to present an analysis of changes in stockholders’ equity in the interim financial statements included in Quarterly Reports on Form 10-Q. The analysis, which can be presented as a footnote or separate statement, is required for the current and comparative quarter and year-to-date interim periods. The amendments are effective for all filings made on or after November 5, 2018. The Company adopted these amendments in its Quarterly Report on Form 10-Q for the quarter ended May 31, 2019.

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. The Company adopted ASU 2016-02 as of March 1, 2019, 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. The Company recorded a Right of Use Asset and Lease Liability on the Consolidated Balance Sheet of $3.3 million upon adoption. The impact of the new standard did not affect the Company’s cash flows or results of operations. The lease liability reflects the present value of the Company’s estimated future minimum lease payments over the lease term, which includes options that are likely to be exercised, discounted using an incremental borrowing rate or implicit rate. See Note 11 - Leasing Arrangements for additional information.

NOTE 5 – STOCKHOLDERS’ EQUITY

Cash Dividend

The Company paid a quarterly cash dividend of $0.12 per common share on March 15, 2019 to stockholders of record on March 5, 2019. The Company paid a quarterly cash dividend of $0.12 per share of common stock on June 14, 2019 to stockholders of record on June 4, 2019. The Company declared a quarterly cash dividend of $0.12 per share of common stock on August 16, 2019, which was paid on September 13, 2019 to stockholders of record on September 4, 2019.

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.

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, 2019. As of August 31, 2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.

Stock-Based Compensation

The Company’s 2007 Equity Incentive Plan (as amended and restated on August 8, 2013) authorizes the granting of stock awards to employees, non-employee directors, consultants and other participants, including stock options, restricted stock and restricted stock units.

The Company recognized $155,416 and $386,670 of stock-based compensation expense during the three- and six-month periods ended August 31, 2019, respectively, compared to $124,921 and $280,728 during the three- and six-month periods ended August 31, 2018, respectively. Compensation costs related to stock-based compensation are generally amortized over the vesting period of the stock awards.

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ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

The following table summarizes restricted stock unit activity during the six months ended August 31, 2019 and 2018:

	Six Months Ended
	August 31,
	2019			2018
Outstanding non-vested restricted stock units as of February 28:		25,002			77,594
Granted		270,000			-
Vested		(28,502	)		(43,224	)
Cancelled/forfeited		-			(200	)
Outstanding non-vested restricted stock units as of August 31:		266,500			34,170

Weighted average grant date fair value	$	9.40		$	12.05
Weighted average remaining vesting period (in years)		5.14			0.88

The Company issued an aggregate of 4,833 fully vested, unrestricted shares of common stock to non-employee directors during the six months ended August 31, 2019 compared to an aggregate of 2,000 shares issued during the six months ended August 31, 2018. In connection with these non-employee director stock issuances, the Company recognized $45,652 and $24,480 of stock-based compensation expense during the six months ended August 31, 2019 and 2018, respectively.

During the three- and six-month periods ended August 31, 2019, the Company recognized $152,289 and $341,018, respectively, of stock-based compensation expense related to restricted stock unit grants. The restricted stock unit grants generally vest in equal annual or quarterly installments over a period of five to six years. During the six-month periods ended August 31, 2019 and 2018, 28,502 and 43,224 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, 2019 was $2,309,265, which is expected to be recognized over the weighted-average period of 5.14 years.

The Company has no outstanding stock options as of August 31, 2019.

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, 2019. 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, 2019	Franchising			Manufacturing			Retail		U-Swirl		Other			Total
Total revenues	$	1,515,805		$	4,714,682		$	265,662	$	1,122,751	$	-		$	7,618,900
Intersegment revenues		(1,321	)		(232,309	)		-		-		-			(233,630	)
Revenue from external customers		1,514,484			4,482,373			265,662		1,122,751		-			7,385,270
Segment profit (loss)		828,978			955,360			7,979		296,880		(841,434	)		1,247,763
Total assets		1,445,041			11,838,237			1,005,356		5,620,012		9,377,697			29,286,343
Capital expenditures		(2,040	)		162,127			23,106		1,673		12,570			197,436
Total depreciation & amortization	$	10,353		$	151,848		$	2,533	$	185,208	$	22,891		$	372,833

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		6			61,152			1,734			9,966		39,502			112,360
Total depreciation & amortization	$	11,631		$	142,697		$	11,179		$	241,033	$	28,409		$	434,949

Six Months Ended August 31, 2019	Franchising			Manufacturing			Retail			U-Swirl		Other			Total
Total revenues	$	2,944,846		$	10,581,154		$	498,081		$	2,282,556	$	-		$	16,306,637
Intersegment revenues		(2,607	)		(492,761	)		-			-		-			(495,368	)
Revenue from external customers		2,942,239			10,088,393			498,081			2,282,556		-			15,811,269
Segment profit (loss)		1,446,888			2,124,047			(7,033	)		576,043		(1,948,398	)		2,191,547
Total assets		1,445,041			11,838,237			1,005,356			5,620,012		9,377,697			29,286,343
Capital expenditures		8,500			385,679			32,624			1,673		52,508			480,984
Total depreciation & amortization	$	21,183		$	301,980		$	5,143		$	375,977	$	46,203		$	750,486

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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		48,871			242,432
Total depreciation & amortization	$	23,556		$	283,724		$	23,854		$	485,084	$	56,236		$	872,454

Revenue from one customer of the Company’s Manufacturing segment represented approximately $1.5 million, or 9.3 percent, of the Company’s revenues from external customers during the six months ended August 31, 2019, compared to $1.4 million, or 8.8 percent, of the Company’s revenues from external customers during the six months ended August 31, 2018.

NOTE 8 – GOODWILL AND INTANGIBLE ASSETS

Intangible assets consist of the following:

				August 31, 2019				February 28, 2019
	Amortization Period (Years)			Gross Carrying Value		Accumulated Amortization		Gross Carrying Value		Accumulated Amortization
Intangible assets subject to amortization
Store design		10		$	220,778	$	214,903	$	220,778	$	214,152
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		715,339		260,349		715,339		223,628
Franchise rights		20			5,979,637		2,616,333		5,979,637		2,300,717
Total				$	7,467,557	$	3,643,388	$	7,467,557	$	3,290,300
Intangible assets not subject to amortization
Franchising segment-
Company stores goodwill				$	832,308			$	832,308
Franchising goodwill					97,318				97,318
Manufacturing segment-goodwill					97,318				97,318
Trademark					20,000				20,000
Total goodwill					1,046,944				1,046,944

Total Intangible Assets				$	8,514,501	$	3,643,388	$	8,514,501	$	3,290,300

Amortization expense related to intangible assets totaled $353,088 and $422,573 during the six months ended August 31, 2019 and 2018, respectively.

At August 31, 2019, annual amortization of intangible assets, based upon the Company’s existing intangible assets and current useful lives, is estimated to be the following:

2020		353,088
2021		594,229
2022		490,060
2023		411,607
2024		345,642
Thereafter		1,629,543
Total	$	3,824,169

NOTE 11 – LEASING ARRANGEMENTS

The Company conducts its retail operations in facilities leased under non-cancelable operating leases of up to ten years. Certain leases contain renewal options for between five and ten additional years at increased monthly rentals. Some of the leases provide for contingent rentals based on sales in excess of predetermined base levels.

The Company acts as primary lessee of some franchised store premises, which the Company then subleases to franchisees, but the majority of existing locations are leased by the franchisee directly.

In some instances, the Company has leased space for its Company-owned locations that are now occupied by franchisees. When the Company-owned location was sold or transferred, the store was subleased to the franchisee who is responsible for the monthly rent and other obligations under the lease.

The Company also leases trucking equipment and warehouse space in support of its manufacturing operations. Expense associated with trucking and warehouse leases is included in cost of sales on the consolidated statements of income.

ASU 2016-02 allows, as a practical expedient, the retention of the classification of existing leases as operating or financing. All of the Company’s leases are classified as operating leases and that classification has been retained upon adoption. The Company does not believe the utilization of this practical expedient has a material impact on lease classifications.

The Company accounts for payments related to lease liabilities on a straight-line basis over the lease term. Lease expense recognized for the six months ended August 31, 2019 and 2018 in the Consolidated Statements of Income was $478,707 and $522,181, respectively.

The amount of the ‘Right of Use Asset’ and ‘Lease Liability’ recorded in the Consolidated Balance Sheets upon the adoption of ASU 2016-02 was $3.3 million. The lease liability reflects the present value of the Company’s estimated future minimum lease payments over the life of its leases. This includes known escalations and renewal option periods reasonably assured of being exercised. Typically, renewal options are considered reasonably assured of being exercised if the sales performance of the location remains strong. Therefore, the ‘Right of Use Asset’ and ‘Lease Liability’ include an assumption on renewal options that have not yet been exercised by the Company, and are not currently a future obligation. The Company has separated non-lease components from lease components in the recognition of the ‘Right of Use Asset’ and ‘Lease Liability’ except in instances where such costs were not practical to separate. To the extent that occupancy costs, such as site maintenance, are included in the ‘Right of Use Asset’ and ‘Lease Liability,’ the impact is immaterial. For franchised locations, the related occupancy costs including property taxes, insurance and site maintenance are generally required to be paid by the franchisees as part of the franchise arrangement. In addition, the Company is the lessee under non-store related leases such as storage facilities and trucking equipment. For leases where the implicit rate is not readily determinable, the Company uses an incremental borrowing rate to calculate the lease liability that represents an estimate of the interest rate the Company would incur to borrow on a collateralized basis over the term of a lease. The weighted average discount rate used for operating leases was 3.4% as of August 31, 2019. The total estimated future minimum lease payments is $3.4 million.

Table of Contents

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

As of August 31, 2019, maturities of lease liabilities for the Company’s operating leases were as follows:

FY 20	$	416,147
FY 21		819,004
FY 22		694,755
FY 23		437,446
FY 24		315,963
Thereafter		717,039
Total	$	3,400,354

Less: imputed interest		(333,528	)
Present value of lease liabilities:	$	3,066,826

Weighted average lease term (years)		7.0

During the three months ended August 31, 2019 the Company entered into a lease amendment to extend the term of a lease for a Company-owned location. This lease amendment resulted in the Company recognizing a present value of future lease liability of $476,611 based upon a total lease liability of $532,811.

NOTE 12 –REVENUE FROM CONTRACTS WITH CUSTOMERS

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 the Company’s franchisees and others, or in its 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.

At August 31, 2019, 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:

FY 20	$	117,608
FY 21		188,664
FY 22		175,465
FY 23		162,496
FY 24		131,911
Thereafter		439,785
Total	$	1,215,929

Gift Cards

The Company’s franchisees sell gift cards, which do not have 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.

NOTE 13 – DISAGGREGATION OF REVENUE

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

Three Months Ended August 31, 2019

Revenues recognized over time under ASC 606:

	Franchising		Manufacturing		Retail		U-Swirl		Total

Franchise fees	$	65,327	$	-	$	-	$	16,602	$	81,929

Revenues recognized at a point in time:

	Franchising		Manufacturing		Retail		U-Swirl		Total
Factory sales		-		4,482,373		-		-		4,482,373
Retail sales		-		-		265,662		636,005		901,667
Royalty and marketing fees		1,449,157		-		-		470,144		1,919,301
Total	$	1,514,484	$	4,482,373	$	265,662	$	1,122,751	$	7,385,270

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		-		-		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

Table of Contents

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended August 31, 2019

Revenues recognized over time under ASC 606:
	Franchising		Manufacturing		Retail		U-Swirl		Total

Franchise fees	$	145,346	$	-	$	-	$	42,863	$	188,209

Revenues recognized at a point in time:
	Franchising		Manufacturing		Retail		U-Swirl		Total
Factory sales		-		10,088,393		-		-		10,088,393
Retail sales		-		-		498,081		1,258,177		1,756,258
Royalty and marketing fees		2,796,893		-		-		981,516		3,778,409
Total	$	2,942,239	$	10,088,393	$	498,081	$	2,282,556	$	15,811,269

Six Months Ended August 31, 2018

Revenues recognized over time under ASC 606:

	Franchising		Manufacturing		Retail		U-Swirl		Total

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		-		-		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

NOTE 14 – LOSS CONTINGENCY

The Company has historically conducted business with FTD under a Gourmet Foods Supplier Agreement (the “Supplier Agreement”), that among other provisions, provided assurance that custom inventory purchased by the Company and developed specifically for FTD would be purchased by FTD upon termination of the Supplier Agreement. On September 23, 2019, the Company received notice that the bankruptcy court had approved FTD to reject and not enforce the Supplier Agreement as part of the proceedings.

As a result of FTD’s bankruptcy, the sale of certain assets, and the court’s approval to reject and not enforce the terms of the Supplier Agreement, the Company is uncertain if accounts receivable and inventory balances associated with FTD at August 31, 2019 will be realized at their full value, or if any revenue will be received from FTD in the future. A potential loss associated with these balances is not probable and/or is not able to be estimated as of the date of these consolidated financial statements.

As of August 31, 2019, balances associated with FTD consist of the following:

	August 31, 2019
Ingredients and supplies	$	382,656
Finished candy		76,688
Accounts receivable		73,232

Total potential loss, contingent upon the bankruptcy proceedings	$	532,576

FTD represented approximately $1.5 million, or 9.3%, of the Company’s revenues during the six months ended August 31, 2019, compared to $1.4 million, or 8.8%, of the Company’s revenues during the six months ended August 31, 2018. FTD represented approximately $3.1 million or 9% of our total revenues during the year ended February 28, 2019 compared to revenue of approximately $5.1 million or 13% of our total revenues during the year ended February 28, 2018. Our future results may be adversely impacted by decreases in the purchases of this customer or the loss of this customer entirely.

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, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), 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: the outcome of our ongoing evaluation of strategic alternatives, including, but not limited to, the time table for identifying potential transactions or transaction candidates and whether any transaction will be completed, relationships and changes in our customers, 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, 2019. 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, 2019, there were two Company-owned, 95 licensee-owned and 242 franchised Rocky Mountain Chocolate Factory stores operating in 37 states, Canada, South Korea, Panama, and the Philippines. As of August 31, 2019, U-Swirl operated four Company-owned cafés and 92 franchised cafés located in 24 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 June 2019, the Company’s largest customer, FTD Companies, Inc. and its domestic subsidiaries (“FTD”), filed for Chapter 11 bankruptcy proceedings. As a part of such bankruptcy proceedings, divisions of FTD’s business and certain related assets, including the divisions that the Company has historically sold product to, were sold through the auction to multiple buyers. The Company is uncertain if accounts receivable and inventory balances associated with FTD at August 31, 2019 will be realized at their full value, or if any revenue will be received from FTD in the future.

Three Months Ended August 31, 2019 Compared to the Three Months Ended August 31, 2018

Basic earnings per share increased 15.4% from $0.13 in the three months ended August 31, 2018 to $0.15 in the three months ended August 31, 2019. Revenues decreased (5.3)% from $7.8 million in the three months ended August 31, 2018 to $7.4 million in the three months ended August 31, 2019. Operating income increased 19.7% from $1.0 million in the three months ended August 31, 2018 to $1.2 million in the three months ended August 31, 2019. Net income increased 22.3% from $751,000 in the three months ended August 31, 2018 to $918,000 in the three months ended August 31, 2019. The increase in operating income was due primarily to lower operating expenses in the three months ended August 31, 2019 compared to the three months ended August 31, 2018.

The decrease in factory sales for the three months ended August 31, 2019 versus the three months ended August 31, 2018 was primarily due to a 32.4% decrease in shipments of product to customers outside our network of franchise and licensed retail locations and a 2.7% decrease in purchases by our network of franchised and licensed stores. The decrease in shipments of product to customers outside our network of franchise and licensed retail stores was primarily the result of product rationalization and a decline in revenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, FTD, decreased during the three months ended August 31, 2019, with revenue from such customer decreasing to approximately $103,000, or 1.4%, of the Company’s revenues during the three months ended August 31, 2019, compared to $144,000, or 1.8% of the Company’s revenues during the three months ended August 31, 2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company will realize any revenue from FTD in the future, and if so, whether such revenues will return to historic levels.

Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 5.0% in the three months ended August 31, 2019, compared with the three months ended August 31, 2018.

The decrease in retail sales for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 was primarily due to fewer Company-owned units in operation because of the closure of certain underperforming Company-owned locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 1.7% in the three months ended August 31, 2019 compared to the three months ended August 31, 2018.

The decrease in royalties and marketing fees from the three months ended August 31, 2018 to the three months ended August 31, 2019 was primarily due to a 6.5% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 291 in the three months ended August 31, 2018 to 272 during the three months ended August 31, 2019. 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, 2019 compared to the three months ended August 31, 2018.

The decrease in franchise fee revenue for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 was the result of a decrease in revenue resulting from fewer franchise stores in operation and the associated recognition of revenue over the term of the franchise agreement.

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 190 basis points in the three months ended August 31, 2019 compared to the three months ended August 31, 2018 because of a charge associated with costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production for the three months ended August 31, 2019 compared to the three months ended August 31, 2018. The decrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 2019 compared to the prior year.

The decrease in franchise costs in the three months ended August 31, 2019 versus the three months ended August 31, 2018 is due primarily to a decrease in legal and professional expense in the three months ended August 31, 2019 compared to the three months ended August 31, 2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018.

The decrease in sales and marketing costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to planned cost reductions as a result of fewer domestic franchise units in operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.

The increase in general and administrative costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to higher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses increased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018.

The decrease in retail operating expenses for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 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 52.3% in the three months ended August 31, 2018 to 52.0% in the three months ended August 31, 2019. 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation. See Note 8 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7% from $138,000 in the three months ended August 31, 2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.

There was $119,000 in costs associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no costs associated with company-owned store closures incurred during the three months ended August 31, 2019. The costs incurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.

Net interest income was $3,000 in the three months ended August 31, 2019 compared to net interest expense of $15,000 incurred in the three months ended August 31, 2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.

Our effective income tax rate for the three months ended August 31, 2019 was 26.4%, compared to 26.8% for the three months ended August 31, 2018.

Six Months Ended August 31, 2019 Compared to the Six Months Ended August 31, 2018

Basic earnings per share increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018. Revenues decreased (2.2)% to $15.8 million for the six months ended August 31, 2019 compared to $16.2 million in the six months ended August 31, 2018. Operating income increased 20.2% from $1.8 million in the six months ended August 31, 2018 to $2.2 million in the six months ended August 31, 2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018 to $1.6 million in the six months ended August 31, 2019. The increase in operating income and net income was due primarily to lower operating expenses in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.

The decrease in factory sales for the six months ended August 31, 2019 versus the six months ended August 31, 2018 was primarily due to a 10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. The decrease in shipments of product to customers outside our network of franchise and licensed retail stores was primarily the result of product rationalization and a decline in revenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, FTD, were approximately $1.5 million, or 9.3%, of the Company’s revenues during the six months ended August 31, 2019, compared to $1.4 million, or 8.8% of the Company’s revenues during the six months ended August 31, 2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company will realize any revenue from FTD in the future, and if so, whether such revenues will return to historic levels.

Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 5.3% in the six months ended August 31, 2019, compared with the six months ended August 31, 2018.

The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to fewer Company-owned units in operation because of the closure of certain underperforming Company-owned locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés increased 0.2% in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.

The increase in royalties and marketing fees from the six months ended August 31, 2018 to the six months ended August 31, 2019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 6.5% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 293 in the six months ended August 31, 2018 to 274 during the six months ended August 31, 2019. 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 0.5% during the six months ended August 31, 2019 compared to the six months ended August 31, 2018.

The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was the result of a decrease in revenue resulting from fewer franchise stores in operation and the associated recognition of revenue over the term of the franchise agreement.

Factory margins decreased 110 basis points in the six months ended August 31, 2019 compared to the six months ended August 31, 2018 because of a charge associated with costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production for the six months ended August 31, 2019 compared to the six months ended August 31, 2018. The increase in retail gross margins was primarily the result of the closure of underperforming Company-owned locations during the prior fiscal year.

The decrease in franchise costs in the six months ended August 31, 2019 versus the six months ended August 31, 2018 is due primarily to a decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018. This decrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise costs.

The decrease in sales and marketing costs for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 is primarily due to planned cost reductions as a result of fewer domestic franchise units in operation.

The increase in general and administrative costs for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 is primarily due to higher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses increased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018.

The decrease in retail operating expenses for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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 53.7% in the six months ended August 31, 2018 to 52.3% in the six months ended August 31, 2019. 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation. See Note 8 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7% from $275,000 in the six months ended August 31, 2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.

There was $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2019. The costs incurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.

Interest income was approximately equal to interest expense in the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2019.

Our effective income tax rate for the six months ended August 31, 2019 was 25.6%, compared to 25.9% for the six months ended August 31, 2018.

Cash and cash equivalent balances increased approximately $400,000 to $5.8 million as of August 31, 2019 compared to $5.4 million as of February 28, 2019, primarily as a result of cash flow generated by operating activities exceeding cash flow used by financing activities, including repayment of debt and payment of dividends. Our current ratio was 2.9 to 1 at August 31, 2019 compared to 3.0 to 1 at February 28, 2019. 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, 2019, we had net income of $1,629,697. Operating activities provided cash of $2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $750,486 and the expense recorded for stock compensation of $386,670. During the comparable 2018 period, we had net income of $1,327,759, and operating activities provided cash of $1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $872,454 and the increase in inventory of $1,579,686.

During the six months ended August 31, 2019, investing activities used cash of $406,376, primarily due to the purchases of property, equipment of $480,984. In comparison, investing activities used cash of $200,537 during the six months ended August 31, 2018 primarily due to the purchase of property and equipment of $242,432.

Financing activities used cash of $2,127,121 for the six months ended August 31, 2019 and used cash of $2,087,641 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, 2019) 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, 2019, we were in compliance with all such covenants. The line of credit was renewed in September 2019 and is subject to renewal again in September 2021. As of August 31, 2019, 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, 2019 of $480,000). 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%. The promissory note matures on January 15, 2020. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of August 31, 2019, 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, 2019. As of August 31, 2019, 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.

As of August 31, 2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.

Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. These purchase obligations primarily consist of contractual obligations for future purchases of commodities for use in our manufacturing.

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, 2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $71,000 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, 2019, 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, 2019, $480,445 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 and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2019.

There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 2019 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, 2019. 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, 2019.

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.

CONSOLIDATED STATEMENTS OF INCOME		3
CONSOLIDATED BALANCE SHEETS		4
CONSOLIDATED STATEMENTS OF CASH FLOWS		5
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
Item 4.	Controls and Procedures	26

Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	27
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.	Defaults Upon Senior Securities	27
Item 4.	Mine Safety Disclosures	27
Item 5.	Other Information	27
Item 6.	Exhibits	28

Signatures		29

	August 31, 2019			February 28, 2019
Ingredients and supplies	$	2,347,557		$	2,612,954
Finished candy		1,971,270			1,983,854
U-Swirl food and packaging		55,029			44,696
Reserve for slow moving inventory		(178,658	)		(371,147	)
Total inventories	$	4,195,198		$	4,270,357

	August 31, 2019			February 28, 2019
Land	$	513,618		$	513,618
Building		5,031,395			5,031,395
Machinery and equipment		10,205,508			10,233,119
Furniture and fixtures		850,934			864,944
Leasehold improvements		1,151,346			1,131,659
Transportation equipment		435,306			422,458
		18,188,107			18,197,193

Less accumulated depreciation		(12,330,443	)		(12,411,054	)
Property and equipment, net	$	5,857,664		$	5,786,139

	Six Months Ended
	August 31,
	2019		2018
Cash paid for:
Interest, net	$	808	$	33,006
Income taxes		314,417		166,545
Non-cash Operating Activities
Accrued Inventory		237,842		96,454
Non-cash Financing Activities
Dividend payable	$	719,359	$	713,839

	August 31, 2019			February 28, 2019
Promissory note	$	480,445		$	1,176,488
Less: current maturities		(480,445	)		(1,176,488	)
Long-term obligations	$	-		$	-

	Three Months Ended
	August 31,				$			%
($'s in thousands)	2019		2018		Change			Change
Factory sales	$	4,482.4	$	4,782.1	$	(299.7	)		(6.3	)%
Retail sales		901.7		954.3		(52.6	)		(5.5	)%
Franchise fees		81.9		107.5		(25.6	)		(23.8	)%
Royalty and marketing fees		1,919.3		1,956.2		(36.9	)		(1.9	)%
Total	$	7,385.3	$	7,800.1	$	(414.8	)		(5.3	)%

PART II.	OTHER INFORMATION		27