Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q (“Quarterly Report”) includes statements of our expectations, intentions, plans and beliefs that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are intended to come within the safe harbor protection provided by those sections. These forward-looking statements involve various risks and uncertainties. The nature of our operations and the environment in which we operate subject us to changing economic, competitive, regulatory and technological conditions, risks and uncertainties. The statements, other than statements of historical fact, included in this Quarterly Report are forward-looking statements. Many of the forward-looking statements contained in this
Quarterly Report
may be identified by the use of forward-looking words such as "will," "intend," "believe," "expect," "anticipate," "should," "plan," "estimate," "potential," or similar expressions. Factors which could cause results to differ include, but are not limited to: changes in the confectionery business environment, seasonality, consumer interest in our products, general economic conditions, the
ability to attract and retain qualified franchisees, the success of our franchised stores,
the success of
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 2
9
, 201
6
. These forward-looking statements apply only as of the date of this Quarterly Report. As such they should not be unduly relied upon for more current circumstances. Except as required by law, we undertake no obligation to release publicly any revisions to these forward-looking statements that might reflect events or circumstances occurring after the date of this Quarterly Report or those that might reflect the occurrence of unanticipated events.
Unless otherwise specified, the “Company,” “we,” “us” or “our” refers to Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, and its consolidated subsidiaries.
Overview
Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, and its subsidiaries (including its operating subsidiary with the same name, Rocky Mountain Chocolate Factory, Inc., a Colorado corporation) (collectively, the “Company,” “we,” “us,” or “our”) is 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 self-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 confectionery products. We also sell our candy in selected locations outside of our system of retail stores and license the use of our brand with certain consumer products. As of November 30, 2016, there were 4 Company-owned, 82 Cold Stone Creamery co-branded and 285 franchised Rocky Mountain Chocolate Factory stores operating in 40 states, Canada, Japan, South Korea, the Philippines, the Kingdom of Saudi Arabia and the United Arab Emirates. As of November 30, 2016, U-Swirl operated 5 Company-owned cafés and 168 franchised cafés located in 35 states, Canada and the United Arab Emirates. U-Swirl operates and franchises self-serve frozen yogurt cafés under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Josie’s Frozen Yogurt,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!,” and “Aspen Leaf Yogurt”.
Effective March 1, 2015, we reorganized to create a holding company structure. Our operating subsidiary with the same name, Rocky Mountain Chocolate Factory, Inc., a Colorado corporation (“RMCF”), which was previously the public company, became a wholly-owned subsidiary of a newly formed entity, Rocky Mountain Chocolate Factory, Inc., a Delaware corporation (“Newco”), and all of the outstanding shares of common stock of RMCF were exchanged on a one-for-one basis for shares of common stock of Newco. Our new holding company began trading on March 2, 2015 on the NASDAQ Global Market under the symbol “RMCF”, which was the same symbol used by RMCF prior to the holding company reorganization.
In January 2013, through our wholly-owned subsidiaries, including Aspen Leaf Yogurt, LLC (“ALY”), we entered into two agreements to sell all of the assets of our ALY frozen yogurt stores, along with our interest in the self-serve frozen yogurt franchises and retail units branded as “Yogurtini” which we also acquired in January 2013, to U-Swirl, Inc., a publicly traded company (OTCQB: SWRL) (“SWRL”), in exchange for a 60% controlling equity interest in SWRL, which was subsequently diluted to 39% as of February 29, 2016 following various issuances of common stock of SWRL. At that time, U-Swirl was a wholly-owned subsidiary of SWRL, and was the operating subsidiary for all of SWRL’s operations. Upon completion of these transactions, we ceased to directly operate any Company-owned ALY locations or sell and support frozen yogurt franchise locations, which was being supported by SWRL.
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, the Company entered into a credit facility with Wells Fargo, N.A. used to finance the acquisitions of SWRL, and in turn, the Company 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. Under the SWRL Loan Agreement, SWRL was subject to various financial covenants. SWRL was not compliant with the financial covenants during the year ended February 29, 2016 and the loan matured on January 16, 2016 without payment in full by SWRL. Upon the occurrence and during the continuance of an event of default, we were entitled to charge interest on all amounts due under the SWRL Loan Agreement at the default rate of 15% per annum, accelerate payment of all amounts due under the SWRL Loan Agreement, and foreclose on all or any portion of the security interest. As a result of the defaults, 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 a wholly-owned subsidiary of the Company as of February 29, 2016 and concurrently the Company ceased to have financial control of SWRL as of February 29, 2016. As of February 29, 2016, SWRL had no operating assets.
Results of Operations
Three Months Ended
November 30,
201
6
Compared to the Three Months Ended
November 30,
201
5
Basic earnings per share increased 112.5% from $.08 in the three months ended November 30, 2015 to $.17 in the three months ended November 30, 2016. Revenues increased 1.5% from $9.8 million in the three months ended November 30, 2015 to $10.0 million in the three months ended November 30, 2016. Operating income increased 29.0% from $1.3 million in the three months ended November 30, 2015 to $1.6 million in the three months ended November 30, 2016. Net income increased 129.5% from $441,000 in the three months ended November 30, 2015 to $1.0 million in the three months ended November 30, 2016.
The increase in revenues was primarily the result of higher factory sales mostly offset by lower royalty and marketing fees and lower retail sales. The increase in operating income was primarily the result of lower operating costs. The increase in net income and earnings per share is the result of a decline in operating costs and a decrease in the earnings attributable to the non-controlling interest.
Revenues
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($’s in thousands)
|
|
2016
|
|
|
2015
|
|
|
Change
|
|
|
Change
|
|
Factory sales
|
|
$
|
7,424.4
|
|
|
$
|
7,107.3
|
|
|
$
|
317.1
|
|
|
|
4.5
|
%
|
Retail sales
|
|
|
826.2
|
|
|
|
917.5
|
|
|
|
( 91.3
|
)
|
|
|
(10.0%
|
)
|
Franchise fees
|
|
|
86.4
|
|
|
|
60.2
|
|
|
|
26.2
|
|
|
|
43.5
|
%
|
Royalty and Marketing fees
|
|
|
1,618.2
|
|
|
|
1,722.3
|
|
|
|
( 104.1
|
)
|
|
|
(6.0%
|
)
|
Total
|
|
$
|
9,955.2
|
|
|
$
|
9,807.3
|
|
|
$
|
147.9
|
|
|
|
1.5
|
%
|
Factory Sales
The increase in factory sales for the three months ended November 30, 2016 versus the three months ended November 30, 2015 was primarily due to a 15.8% increase in shipments of product to customers outside our network of franchise retail locations. The increase in shipments of products to customers outside our network of franchise retail locations was the result of an increase in purchases from new customers. Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 0.8% in the three months ended November 30, 2016, compared with the three months ended November 30, 2015.
Retail Sales
The decrease in retail sales was primarily due to changes in retail units in operation resulting from the sale of certain Company-owned locations and the closure of a certain underperforming Company-owned location. Same store sales at all Company-owned stores and cafés increased 3.6% in the three months ended November 30, 2016 compared to the three months ended November 30, 2015.
Royalties, Marketing Fees and Franchise Fees
The decrease in royalties and marketing fees from the three months ended November 30, 2015 to the three months ended November 30, 2016 resulted from a 12.9% decrease in domestic franchise units in operation partially offset by higher same store sales. The average number of total domestic franchise stores in operation decreased from 419 in the three months ended November 30, 2015 to 365 during the three months ended November 30, 2016.
This decrease is the result of domestic store closures exceeding domestic store openings, primarily the result of franchise and license closures of U-Swirl franchise locations. Same store sales at total franchise stores and cafés in operation increased 1.1% during the three months ended November 30, 2016 compared to the three months ended November 30 2015. Franchise fees increased primarily as a result of an increase in franchise transfers and the associated fees and an increase in the average franchise fee recognized on domestic franchise openings during the three months ended November 30, 2016 compared to the three months ended November 30, 2015.
Costs and Expenses
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($’s in thousands)
|
|
2016
|
|
|
2015
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales – factory
|
|
$
|
5,221.7
|
|
|
$
|
4,957.4
|
|
|
$
|
264.3
|
|
|
|
5.3
|
%
|
Cost of sales - retail
|
|
|
322.5
|
|
|
|
343.6
|
|
|
|
( 21.1
|
)
|
|
|
(6.1%
|
)
|
Franchise costs
|
|
|
520.6
|
|
|
|
657.6
|
|
|
|
( 137.0
|
)
|
|
|
(20.8%
|
)
|
Sales and marketing
|
|
|
642.0
|
|
|
|
593.8
|
|
|
|
48.2
|
|
|
|
8.1
|
%
|
General and administrative
|
|
|
880.5
|
|
|
|
1,087.6
|
|
|
|
( 207.1
|
)
|
|
|
(19.0%
|
)
|
Retail operating
|
|
|
551.2
|
|
|
|
670.0
|
|
|
|
( 118.8
|
)
|
|
|
(17.7%
|
)
|
Total
|
|
$
|
8,138.5
|
|
|
$
|
8,310.0
|
|
|
$
|
( 171.5
|
)
|
|
|
(2.1%
|
)
|
Gross Margin
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($’s in thousands)
|
|
2016
|
|
|
2015
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory gross margin
|
|
$
|
2,202.7
|
|
|
$
|
2,149.9
|
|
|
$
|
52.8
|
|
|
|
2.5
|
%
|
Retail
|
|
|
503.7
|
|
|
|
573.9
|
|
|
|
( 70.2
|
)
|
|
|
(12.2%
|
)
|
Total
|
|
$
|
2,706.4
|
|
|
$
|
2,723.8
|
|
|
$
|
( 17.4
|
)
|
|
|
(0.6%
|
)
|
Gross Margin
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
%
|
|
|
%
|
|
|
|
2016
|
|
|
2015
|
|
|
Change
|
|
|
Change
|
|
(Percent)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory gross margin
|
|
|
29.7
|
%
|
|
|
30.2
|
%
|
|
|
(0.5%
|
)
|
|
|
(1.7%
|
)
|
Retail
|
|
|
61.0
|
%
|
|
|
62.6
|
%
|
|
|
(1.6%
|
)
|
|
|
(2.6%
|
)
|
Total
|
|
|
32.8
|
%
|
|
|
33.9
|
%
|
|
|
(1.1%
|
)
|
|
|
(3.2%
|
)
|
Adjusted Gross Margin
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($’s in thousands)
|
|
2016
|
|
|
2015
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory gross margin
|
|
$
|
2,202.7
|
|
|
$
|
2,149.9
|
|
|
$
|
52.8
|
|
|
|
2.5
|
%
|
Plus: depreciation and amortization
|
|
|
118.2
|
|
|
|
98.0
|
|
|
|
20.2
|
|
|
|
20.6
|
%
|
Factory adjusted gross margin
|
|
|
2,320.9
|
|
|
|
2,247.9
|
|
|
|
73.0
|
|
|
|
3.2
|
%
|
Retail
|
|
|
503.7
|
|
|
|
573.9
|
|
|
|
( 70.2
|
)
|
|
|
(12.2%
|
)
|
Total Adjusted Gross Margin
|
|
$
|
2,824.6
|
|
|
$
|
2,821.8
|
|
|
$
|
2.8
|
|
|
|
0.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory adjusted gross margin
|
|
|
31.3
|
%
|
|
|
31.6
|
%
|
|
|
(0.3%
|
)
|
|
|
(0.9%
|
)
|
Retail
|
|
|
61.0
|
%
|
|
|
62.6
|
%
|
|
|
(1.6%
|
)
|
|
|
(2.6%
|
)
|
Total Adjusted Gross Margin
|
|
|
34.2
|
%
|
|
|
35.2
|
%
|
|
|
(1.0%
|
)
|
|
|
(2.8%
|
)
|
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin minus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales
Factory margins decreased
50 basis points in the three months ended November 30, 2016 compared to the three months ended November 30, 2015 due primarily to lower costs of certain materials more than offset by increased costs of labor and overhead in the three months ended November 30, 2016 compared to the three months ended November 30, 2015. The decrease in Company-owned store margin is due primarily to a decrease in Company-owned café revenue resulting from the sale of yogurt and the associated higher margins. This change is the result of a decrease in units in operation during the three months ended November 30, 2016 compared to the prior year.
Franchise Costs
The decrease in franchise costs in the three months ended November 30, 2016 versus the three months ended November 30, 2015 is due primarily to lower franchise costs associated with supporting U-Swirl franchise units as a result of the foreclosure of U-Swirl in the prior year and the associated focus on reduction of duplicative franchise costs. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 30.5% in the three months ended November 30, 2016 from 36.9% in the three months ended November 30, 2015.
Sales and Marketing
The increase in sales and marketing costs for the three months ended November 30, 2016 compared to the three months ended November 30, 2015 is primarily due to higher marketing related compensation associated with additional sales staff partially offset by lower marketing-related costs associated with U-Swirl franchise locations. Marketing costs for U-Swirl franchise locations declined because of lower marketing fee revenues, the result of fewer franchise stores in operation.
General and Administrative
The decrease in general and administrative costs for the three months ended November 30, 2016 compared to the three months ended November 30, 2015 is due primarily to the foreclosure of U-Swirl in the prior year and the associated focus on reduction of duplicative general and administrative costs. For the three months ended November 30, 2016, approximately $86,000 of U-Swirl general and administrative costs were consolidated within our results, compared with $287,000 in the three months ended November 30, 2015. As a percentage of total revenues, general and administrative expenses decreased to 8.8% in the three months ended November 30, 2016 compared to 11.1% in the three months ended November 30, 2015.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended November 30, 2016 compared to the three months ended November 30, 2015 was due primarily to changes in units in operation, resulting from the sale of certain Company-owned units and the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 73.0% in the three months ended November 30, 2015 to 66.7% in the three months ended November 30, 2016. This decrease is primarily the result of the decrease in units in operation from the prior year.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $202,000 in the three months ended November 30, 2016, a decrease of 17.9% from $246,000 incurred in the three months ended November 30, 2015. This decrease was the result of fewer Company-owned store assets in service. Depreciation and amortization included in cost of sales increased 20.6% from $98,000 in the three months ended November 30, 2015 to $118,000 in the three months ended November 30, 2016. This increase was the result of an increase in production assets in service.
Other Income
Net interest expense was $31,300 in the three months ended November 30, 2016 compared to net interest expense of $38,800 incurred in the three months ended November 30, 2015. This change was the result of less interest expense incurred on lower average outstanding promissory note balances.
Income Tax Expense
Our effective income tax rate for the three months ended November 30, 2016 was 36.1%, compared to 36.2% for the three months ended November 30, 2015. For the three months ended November 30, 2015, the financial statements presented represent the consolidated statements of two separate consolidated groups for income tax purposes. The Company has filed income tax returns consolidating the results of the Company and its wholly-owned subsidiary, ALY. SWRL has filed a separate consolidated income tax return for the results of SWRL and its wholly owned subsidiary, U-Swirl. RMCF and SWRL have filed separate income tax returns because RMCF owned only 39% of SWRL. Beginning on March 1, 2016, the results of U-Swirl will be included in RMCF’s consolidated income tax return, and on the same date, will be removed from SWRL’s consolidated tax return. This is a result of the foreclosure of RMCF on the outstanding stock of U-Swirl in satisfaction of debt between RMCF and SWRL. The consolidated tax return for RMCF for future periods will include all operating results of U-Swirl. SWRL will file separate income tax returns in future periods, however, there are no remaining operating assets held by SWRL.
U-Swirl has significant net operating loss carryovers. In accordance with Section 382 of the Internal Revenue Code, deductibility of U-Swirl’s U.S. net operating loss carryovers may be subject to annual limitation in the event of a change in control. We have performed a preliminary evaluation as to whether a change in control has taken place, and have concluded that there was a change of control with respect to the net operating losses of U-Swirl when the Company acquired a 60% ownership interest in January 2013.
Nine Months
Ended
November 30,
201
6
Compared to the
Nine Months
Ended
November 30,
201
5
Basic earnings per share increased 38.2% from $.34 in the nine months ended November 30, 2015 compared to $.47 in the nine months ended November 30, 2016. Revenues decreased 5.1% to $27.9 million for the nine months ended November 30, 2016 compared to $29.4 million in the nine months ended November 30, 2015. Operating income decreased 0.2% from $4.36 million in the nine months ended November 30, 2015 to $4.35 million in the nine months ended November 30, 2016. Net income increased 37.0% from $2.0 million in the nine months ended November 30, 2015 to $2.7 million in the nine months ended November 30, 2016.
The decrease in operating income was due primarily to a decrease in revenue mostly offset by a decrease in operating expenses. This decrease was more than offset by no amount of net income being attributable to non-controlling interest.
Revenues
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($’s in thousands)
|
|
2016
|
|
|
2015
|
|
|
Change
|
|
|
Change
|
|
Factory sales
|
|
$
|
18,159.8
|
|
|
$
|
18,600.1
|
|
|
$
|
( 440.3
|
)
|
|
|
(2.4%
|
)
|
Retail sales
|
|
|
3,431.6
|
|
|
|
3,880.0
|
|
|
|
( 448.4
|
)
|
|
|
(11.6%
|
)
|
Franchise fees
|
|
|
241.5
|
|
|
|
444.4
|
|
|
|
( 202.9
|
)
|
|
|
(45.7%
|
)
|
Royalty and marketing fees
|
|
|
6,100.5
|
|
|
|
6,521.4
|
|
|
|
( 420.9
|
)
|
|
|
(6.5%
|
)
|
Total
|
|
$
|
27,933.4
|
|
|
$
|
29,445.9
|
|
|
$
|
(1,512.5
|
)
|
|
|
(5.1%
|
)
|
Factory Sales
The decrease in factory sales for the nine months ended November 30, 2016 versus the nine months ended November 30, 2015 was primarily due to a 10.4% decrease in shipments of product to customers outside our network of franchised retail stores, a 3.5% decrease in the average number of domestic Rocky Mountain Chocolate Factory franchised stores in operation, and a 2.7% decrease in same-store pounds purchased by our network of franchise and license stores. Revenue from one customer of the Company’s Manufacturing segment represented approximately $2.1 million, or 11.6% of factory sales, during the nine months ended November 30, 2016 compared to revenue of $3.1 million, or 16.7% of factory sales, from the same customer in the nine months ended November 30, 2015.
Retail Sales
The decrease in retail sales was primarily due to changes in retail units in operation resulting from the sale of certain Company-owned locations and the closure of a certain underperforming Company-owned location. Same store sales at all Company-owned stores and cafés increased 2.1% in the nine months ended November 30, 2016 compared to the nine months ended November 30, 2015.
Royalties, Marketing Fees and Franchise Fees
The decrease in royalties and marketing fees for the nine months ended November 30, 2016 compared to the nine months ended November 30, 2015 resulted from an 11.6% decrease in franchise units in operation partially offset by higher same store sales. The average number of total franchise stores in operation decreased from 430 in the nine months ended November 30, 2015 to 380 during the nine months ended November 30, 2016.
This decrease is the result of domestic store closures exceeding domestic store openings, primarily the result of franchise and license closures of U-Swirl franchise locations. Same store sales at total franchise stores and cafés in operation increased 0.5% during the nine months ended November 30, 2016 compared to the nine months ended November 30, 2015. Franchise fee revenues decreased as a result of no international license fees being recognized in the nine months ended November 30, 2016 and license fees associated with the license agreements for the development and franchising of CherryBerry stores in the Canadian province of Ontario being recognized in the nine months ended November 30, 2015.
Costs and Expenses
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($’s in thousands)
|
|
2016
|
|
|
2015
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales – factory
|
|
$
|
13,196.9
|
|
|
$
|
13,472.1
|
|
|
$
|
( 275.2
|
)
|
|
|
(2.0%
|
)
|
Cost of sales - retail
|
|
|
1,176.6
|
|
|
|
1,277.0
|
|
|
|
( 100.4
|
)
|
|
|
(7.9%
|
)
|
Franchise costs
|
|
|
1,571.6
|
|
|
|
1,871.1
|
|
|
|
( 299.5
|
)
|
|
|
(16.0%
|
)
|
Sales and marketing
|
|
|
1,959.1
|
|
|
|
1,832.8
|
|
|
|
126.3
|
|
|
|
6.9
|
%
|
General and administrative
|
|
|
3,101.7
|
|
|
|
3,550.8
|
|
|
|
( 449.1
|
)
|
|
|
(12.6%
|
)
|
Retail operating
|
|
|
1,876.8
|
|
|
|
2,318.4
|
|
|
|
( 441.6
|
)
|
|
|
(19.0%
|
)
|
Total
|
|
$
|
22,882.7
|
|
|
$
|
24,322.2
|
|
|
$
|
(1,439.5
|
)
|
|
|
(5.9%
|
)
|
Gross margin
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($’s in thousands)
|
|
2016
|
|
|
2015
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory gross margin
|
|
$
|
4,962.9
|
|
|
$
|
5,128.0
|
|
|
$
|
( 165.1
|
)
|
|
|
(3.2%
|
)
|
Retail
|
|
|
2,255.0
|
|
|
|
2,603.0
|
|
|
|
( 348.0
|
)
|
|
|
(13.4%
|
)
|
Total
|
|
$
|
7,217.9
|
|
|
$
|
7,731.0
|
|
|
$
|
( 513.1
|
)
|
|
|
(6.6%
|
)
|
Gross Margin
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
%
|
|
|
%
|
|
|
|
2016
|
|
|
2015
|
|
|
Change
|
|
|
Change
|
|
(Percent)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory gross margin
|
|
|
27.3
|
%
|
|
|
27.6
|
%
|
|
|
(0.3%
|
)
|
|
|
(1.1%
|
)
|
Retail
|
|
|
65.7
|
%
|
|
|
67.1
|
%
|
|
|
(1.4%
|
)
|
|
|
(2.1%
|
)
|
Total
|
|
|
33.4
|
%
|
|
|
34.4
|
%
|
|
|
(1.0%
|
)
|
|
|
(2.9%
|
)
|
Adjusted Gross Margin
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($’s in thousands)
|
|
2016
|
|
|
2015
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory gross margin
|
|
$
|
4,962.9
|
|
|
$
|
5,128.0
|
|
|
$
|
( 165.1
|
)
|
|
|
(3.2%
|
)
|
Plus: depreciation and amortization
|
|
|
324.4
|
|
|
|
300.7
|
|
|
$
|
23.7
|
|
|
|
7.9
|
%
|
Factory adjusted gross margin
|
|
|
5,287.3
|
|
|
|
5,428.7
|
|
|
|
( 141.4
|
)
|
|
|
(2.6%
|
)
|
Retail
|
|
|
2,255.0
|
|
|
|
2,603.0
|
|
|
|
( 348.0
|
)
|
|
|
(13.4%
|
)
|
Total Adjusted Gross Margin
|
|
$
|
7,542.3
|
|
|
$
|
8,031.7
|
|
|
$
|
( 489.4
|
)
|
|
|
(6.1%
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory adjusted gross margin
|
|
|
29.1
|
%
|
|
|
29.2
|
%
|
|
|
(0.1%
|
)
|
|
|
(0.3%
|
)
|
Retail
|
|
|
65.7
|
%
|
|
|
67.1
|
%
|
|
|
(1.4%
|
)
|
|
|
(2.1%
|
)
|
Total Adjusted Gross Margin
|
|
|
34.9
|
%
|
|
|
35.7
|
%
|
|
|
(0.8%
|
)
|
|
|
(2.2%
|
)
|
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin minus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Costs and Expenses
Cost of Sales
Factory margins decreased 30 basis points in the nine months ended November 30, 2016 compared to the nine months ended November 30, 2015 due primarily to lower costs of certain materials more than offset by increased costs of labor and overhead. The decrease in Company-owned store margin is due primarily to a decrease in Company-owned revenues from higher margin items. This change is the result of a
decrease in units in operation and lower revenues associated with Company-owned frozen yogurt cafés during the nine months ended November 30, 2016 compared to the prior year.
Franchise Costs
The decrease in franchise costs in the nine months ended November 30, 2016 versus the nine months ended November 30, 2015 is due primarily to lower franchise costs associated with supporting U-Swirl franchise units as a result of the foreclosure of U-Swirl in the prior year and the associated focus on reduction of duplicative franchise costs. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 24.8% in the nine months ended November 30, 2016 from 26.9% in the nine months ended November 30, 2015. This decrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise costs.
Sales and Marketing
The increase in sales and marketing costs for the nine months ended November 30, 2016 compared to the Nine months ended November 30, 2015 is primarily due to higher marketing related compensation associated with additional sales staff partially offset by lower marketing-related costs associated with U-Swirl franchise locations. Marketing costs for U-Swirl franchise locations declined because of lower marketing fee revenues resulting from fewer franchise stores in operation.
General and Administrative
The decrease in general and administrative costs for the nine months ended November 30, 2016 compared to the nine months ended November 30, 2015 is due primarily to the foreclosure of U-Swirl in the prior year and the associated focus on reduction of duplicative general and administrative costs. For the nine months ended November 30, 2016, approximately $347,000 of U-Swirl general and administrative costs were consolidated within our results, compared with $956,000 in the nine months ended November 30, 2015. As a percentage of total revenues, general and administrative expenses decreased to 11.1% in the nine months ended November 30, 2016 compared to 12.1% in the nine months ended November 30, 2015.
Retail Operating Expenses
The decrease in retail operating expenses for the nine months ended November 30, 2016 compared to the nine months ended November 30, 2015 was due primarily to changes in units in operation, resulting from the sale of certain Company-owned units and the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 59.8% in the nine months ended November 30, 2015 to 54.7% in the nine months ended November 30, 2016. This decrease is primarily the result of a decrease in units in operation from the prior year.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $638,000 in the nine months ended November 30, 2016, a decrease of 16.4% from $763,000 incurred in the nine months ended November 30, 2015. This decrease was the result of fewer Company-owned store assets in service. Depreciation and amortization included in cost of sales increased 7.9% from $301,000 in the nine months ended November 30, 2015 to $324,000 in the nine months ended November 30, 2016. This increase was the result of an increase in production assets in service.
Restructuring and acquisition related charges
Restructuring and acquisition related charges of $60,000 during the nine months ended November 30, 2016 increased from $0 during the nine months ended November 30, 2015. The increase is primarily the result of lease settlement costs related to the closure of an ALY Company-owned location.
Other Income
Net interest expense was $100,300 in the nine months ended November 30, 2016, a decrease of 20.7% compared to net interest expense of $126,600 in the nine months ended November 30, 2015. This change was the result of less interest expense incurred on lower average outstanding promissory note balances.
Income Tax Expense
Our effective income tax rate for the nine months ended November 30, 2016 was 36.1%, compared to 30.4% for the nine months ended November 30, 2015. The increase of 5.7% is primarily due to the tax consequences of a change in the controlling interest in SWRL and foreclosure upon the stock of U-Swirl. For the nine months ended November 30, 2015, the financial statements presented represent the consolidated statements of two separate consolidated groups for income tax purposes. The Company has filed income tax returns consolidating the results of the Company and its wholly-owned subsidiary, ALY. SWRL has filed a separate consolidated income tax return for the results of SWRL and its wholly owned subsidiary, U-Swirl. RMCF and SWRL have filed separate income tax returns because RMCF owned only 39% of SWRL. Beginning on March 1, 2016, the results of U-Swirl will be included in RMCF’s consolidated income tax return, and on the same date, will be removed from SWRL’s consolidated tax return. This is a result of the foreclosure of RMCF on the outstanding stock of U-Swirl in satisfaction of debt between RMCF and SWRL. The consolidated tax return for RMCF for future periods will include all operating results of U-Swirl. SWRL will file separate income tax returns in future periods, however, there are no remaining operating assets held by SWRL.
U-Swirl has significant net operating loss carryovers. In accordance with Section 382 of the Internal Revenue Code, deductibility of U-Swirl’s U.S. net operating loss carryovers may be subject to annual limitation in the event of a change in control. We have performed a preliminary evaluation as to whether a change in control has taken place, and have concluded that there was a change of control with respect to the net operating losses of U-Swirl when the Company acquired a 60% ownership interest in January 2013.
Liquidity and Capital Resources
As of November 30, 2016, working capital was $7.2 million, compared with $7.4 million as of February 29, 2016, a decrease of $200,000. The decrease in working capital was primarily due to the payment of dividends, payments on long term debt and repurchases of common stock partially offset by positive operating results.
Cash and cash equivalent balances decreased $1.6 million from $6.2 million as of February 29, 2016 to $4.6 million as of November 30, 2016 as a result of cash flow used by financing activities, including repayment of indebtedness, payment of dividends and stock repurchases. Our current ratio was 1.9 to 1 at November 30, 2016 and February 29, 2016. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
For the nine months ended November 30, 2016, we had net income of $2,718,446. Operating activities provided cash of $2,997,051, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $962,632, stock compensation expense of $447,581 and an increase in accounts payable of $156,150 mostly offset by an increase to inventory of $771,281 and an increase in accounts receivable of $650,708. During the comparable 2015 period, we had net income of $2,947,215, and operating activities provided cash of $4,605,010. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $1,064,211 and stock compensation expense of $615,740.
For the nine months ended November 30, 2016, investing activities used cash of $1,171,779, primarily due to the purchases of property and equipment of $1,048,667. In comparison, investing activities used cash of $558,244 during the nine months ended November 30, 2015 primarily due to the purchases of property and equipment of $625,180.
Financing activities used cash of $3,423,767 for the nine months ended November 30, 2016 and used cash of $6,050,217 during the prior year period. This was primarily due to a decrease in cash used to repurchase common stock during the nine months ended November 30, 2016 compared to the nine months ended November 30, 2015.
We have a $5.0 million ($5.0 million available as of November 30, 2016) working capital line of credit collateralized by substantially all of our assets with the exception of our retail store assets. Additionally, the line of credit is subject to various financial ratio and leverage covenants. As of November 30, 2016, we were in compliance with all such covenants.
The line is subject to renewal on September 30, 2017. As of November 30, 2016, no amount was outstanding under this line of credit.
The Company’s long-term debt is comprised of a promissory note, the proceeds of which were loaned to SWRL and used to finance business acquisitions by SWRL (unpaid balance as of November 30, 2016, $4.1 million). The promissory note allowed the Company to borrow up to a maximum of $7.0 million to finance business acquisitions and bears interest at a fixed annual rate of 3.75%. The promissory note matures on January 15, 2020, with amortized principal and accrued interest due monthly on the promissory note. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of November 30, 2016, we were in compliance with all such covenants.
As discussed above, in 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, the Company entered into a credit facility with Wells Fargo Bank, N.A. used to finance the acquisitions by SWRL, and in turn, the Company entered into the SWRL Loan Agreement with SWRL. 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. Under the SWRL Loan Agreement, SWRL was subject to various financial covenants. SWRL was not compliant with the financial covenants during the year ended February 29, 2016 and the loan matured on January 16, 2016 without payment in full by SWRL. Upon the occurrence and during the continuance of an event of default, we were entitled to charge interest on all amounts due under the SWRL Loan Agreement at the default rate of 15% per annum, accelerate payment of all amounts due under the SWRL Loan Agreement, and foreclose on all or any portion of the security interest. As a result of the defaults, 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 as of February 29, 2016 in full satisfaction of the amounts owed under the SWRL Loan Agreement. This resulted in U-Swirl becoming a wholly-owned subsidiary of the Company as of February 29, 2016, and concurrently the Company ceased to have financial control of SWRL as of February 29, 2016. As of February 29, 2016, SWRL had no operating assets.
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. During the nine months ended November 30, 2016, the Company repurchased 35,108 shares under the repurchase plan at an average price of $10.01 per share. As of November 30, 2016, approximately $638,121 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.
Off-Balance Sheet Arrangements
As of November 30, 2016, we had no off-balance sheet arrangements or obligations.
Impact of Inflation
Inflationary factors such as increases in the costs of ingredients and labor directly affect our operations. Most of our leases provide for cost-of-living adjustments and require us to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally, our future lease costs for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that we will be able to pass on increased costs to our customers.
Depreciation expense is based on the historical cost to us of our fixed assets, and is therefore potentially less than it would be if it were based on current replacement cost. While property and equipment acquired in prior years will ultimately have to be replaced at higher prices, it is expected that replacement will be a gradual process over many years.
Seasonality
We are subject to seasonal fluctuations in sales, which cause fluctuations in quarterly results of operations. Historically, the strongest sales of our confectionary products have occurred during the Christmas holiday through Mother’s Day. We believe the strongest sales of frozen yogurt products will occur during the summer months. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and sales of franchises. Because of the seasonality of our business and the impact of new store openings and sales of franchises, results for any quarter are not necessarily indicative of results that may be achieved in other quarters or for a full fiscal year.