Annual Report (10-k)

Date : 05/29/2019 @ 6:35PM
Source : Edgar (US Regulatory)
Stock : Rocky Mountain Chocolate Factory Inc (RMCF)
Quote : 8.49  -0.01 (-0.12%) @ 6:54PM

Annual Report (10-k)

 

 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

 (Mark One)

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

 

For the fiscal year ended February 28, 2019

OR

☐ 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  

       

Securities Registered Pursuant To Section 12(g) Of The Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.      Yes ☐     No ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes ☐       No ☒

 

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, 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 provided 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 Act).     Yes ☐    No ☒

 

The aggregate market value of the registrant’s common stock (based on the closing price as quoted on the Nasdaq Global Market on August 31, 2018, the last trading day of the registrant’s most recently completed second fiscal quarter) held by non-affiliates was $38,815,702. For purposes of this calculation, shares of common stock held by each executive officer and director and by holders of more than 5% of the registrant’s outstanding common stock have been excluded since those persons may under certain circumstances be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

 

As of May 10, 2019, there were 5,962,327 shares of the registrant’s common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement in connection with the 2019 Annual Meeting of Stockholders (the “Proxy Statement”) are incorporated by reference in Part III of this Annual Report on Form 10-K. The Proxy Statement will be filed with the Securities and Exchange Commission within 120 days of the registrant’s fiscal year ended February 28, 2019.

 

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.

FORM 10-K

 

 

TABLE OF CONTENTS

 

PART I.

3

   

ITEM 1. BUSINESS

3

ITEM 1A. RISK FACTORS

14

ITEM 1B. UNRESOLVED STAFF COMMENTS

21

ITEM 2. PROPERTIES

21

ITEM 3. LEGAL PROCEEDINGS

21

ITEM 4. MINE SAFETY DISCLOSURES

21

   

PART II.

22

   

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

22

ITEM 6. SELECTED FINANCIAL DATA

23

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

24

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

31

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

32

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

56

ITEM 9A.  CONTROLS AND PROCEDURES

56

ITEM 9B. OTHER INFORMATION

56

   

PART III.

57

   

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

57

ITEM 11. EXECUTIVE COMPENSATION

57

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

57

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

57

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

57

   

PART IV.

58

   

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

58

ITEM 16. FORM 10-K SUMMARY

60

 

 

Cautionary Note Regarding Forward - Looking Statements

 

This Annual R eport on Form 10-K (“Annual 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 A ct 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 Annual R eport are forward-looking statements. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as "will," "intend," "believe," "expect," "anticipate," "should ," "plan," "estimate , " "potential," or similar expressions. Factors which could cause results to differ include, but are not limited to: changes in the confectionery business environment, seasonality, consumer interest in our products, general economic conditions, the success of our frozen yogurt business , receptiveness of our products internationally, consumer and retail trends, costs and availability of raw materials, competition, the success of our co-branding strategy , the success of international expansion efforts and the effect of government regulations. Government regulations which we and our franchisees and licensees 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, licensing, 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 section entitled “Risk Factors” contained in this Annual R eport in Item 1A. These forward-looking statements apply only as of the date of this Annual R eport. 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 Annual R eport or those that might reflect the occurrence of unanticipated events.

 

 

 

PART I.

 

ITEM 1. BUSINESS

 

General

 

Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, and its subsidiaries (collectively, the “Company,” “we,” “us,” or “our”), including its operating subsidiary with the same name, Rocky Mountain Chocolate Factory, Inc., a Colorado corporation (“RMCF”), 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 wholly-owned 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 confectionary 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 March 31, 2019, there were two Company-owned, 90 licensee-owned and 245 franchised Rocky Mountain Chocolate Factory stores operating in 37 states, Canada, South Korea, Panama, and the Philippines. As of March 31, 2019, U-Swirl operated four Company-owned cafés, 68 franchised cafés and 30 licensed locations located in 26 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”. The Company was incorporated in Delaware in 2014 in connection with its 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. (“SWRL”), in exchange for a 60% controlling equity interest in SWRL (46% equity interest as of February 28, 2019). Upon completion of these transactions, we ceased to directly operate any Company-owned ALY locations or sell and support frozen yogurt franchise locations, which were being supported by SWRL. The SWRL Board of Directors is composed solely of board members also serving on our Board of Directors.

 

In fiscal year (“FY”) 2014, SWRL acquired the franchise rights and certain other assets of self-serve frozen yogurt concepts under the names “CherryBerry,” “Yogli Mogli Frozen Yogurt” and “Fuzzy Peach Frozen Yogurt.” In connection with these acquisitions, we entered into a credit facility with Wells Fargo Bank, N.A. used to finance the acquisitions by SWRL, and in turn, we entered into a loan and security agreement with SWRL to cover the purchase price and other costs associated with the acquisitions (the “SWRL Loan Agreement”). Borrowings under the SWRL Loan Agreement were secured by all of the assets of SWRL, including all of the outstanding stock of its wholly-owned subsidiary, U-Swirl. As a result of certain defaults under the SWRL Loan Agreement, we issued a demand for payment of all obligations under the SWRL Loan Agreement. SWRL was unable to repay the obligations under the SWRL Loan Agreement, and as a result, we foreclosed on all of the outstanding stock of U-Swirl on February 29, 2016 in full satisfaction of the amounts owed under the SWRL Loan Agreement. This resulted in U-Swirl becoming our wholly-owned subsidiary as of February 29, 2016, and concurrently we ceased to have financial control of SWRL as of February 29, 2016. As of February 28, 2019, SWRL had no operating assets.

 

In FY 2019, approximately 52% of the products sold at Rocky Mountain Chocolate Factory stores were prepared on the premises. We believe that in-store preparation of products creates a special store ambiance, and the aroma and sight of products being made attracts foot traffic and assures customers that products are fresh.

 

Our principal competitive strengths lie in our brand name recognition, our reputation for the quality, variety and taste of our products, the special ambiance of our stores, our knowledge and experience in applying criteria for selection of new store locations, our expertise in the manufacture of chocolate candy products and the merchandising and marketing of confectionary products, and the control and training infrastructures we have implemented to assure consistent customer service and execution of successful practices and techniques at our stores.

 

We believe our manufacturing expertise and reputation for quality has facilitated the sale of selected products through specialty markets. We are currently selling our products in a select number of specialty markets, including wholesale, fundraising, corporate sales, mail order, private label and internet sales.

 

U-Swirl cafés and associated brands are designed to be attractive to customers by offering the following:

 

inside café-style seating for 50 people and outside patio seating, where feasible and appropriate;

 

spacious surroundings of approximately 1,800 to 3,000 square feet;

 

8 to 16 flavors of frozen yogurt;

 

up to 70 toppings; and

 

self-serve format allowing guests to create their own favorite snack.

 

We believe that these characteristics provide U-Swirl with the ability to compete successfully in the retail frozen yogurt industry. While U-Swirl continues to pursue locations with the characteristics described above, we recognize that its acquisition strategy may lead U-Swirl to purchase competitors with diverse layouts.

 

 

The trade dress of the Aspen Leaf Yogurt, CherryBerry, Yogli Mogli, Fuzzy Peach, Let’s Yo! and Yogurtini locations are similar to that of U-Swirl, although their locations use different color schemes and are typically smaller than the U-Swirl cafés.

 

Our consolidated revenues are primarily derived from three principal sources: (i) sales to franchisees and other third parties of chocolates and other confectionery products manufactured by us (70%-68%-66%); (ii) sales at Company-owned stores of chocolates, other confectionery products and frozen yogurt (including products manufactured by us) (10%-11%-12%) and (iii) the collection of initial franchise fees and royalties from franchisees (20%-21%-22%). For FY 2019, approximately 98% of our revenues were derived from domestic sources, with 2% derived from international sources. The figures in parentheses above show the percentage of total revenues attributable to each source for the FY 2019, 2018 and 2017, respectively.

 

According to industry data, the total U.S. candy market generated approximately $35.8 billion of retail sales in 2015 with chocolate sales growing 2.2% from sales of approximately $22.8 billion during 2017 to $23.3 billion during 2018 and candy sales per capita of $111.16 during 2015.

 

According to Ice Cream and Frozen Desserts in the U.S. 9th Edition, published in January 2017 by Packaged Facts, in 2016 the U.S. market for ice cream and related frozen desserts, including frozen yogurt and frozen novelties, grew to $28 billion.

 

Business Strategy

 

Our objective is to build on our position as a leading international franchisor and manufacturer of high-quality chocolate, other confectionery products and frozen yogurt. We continually seek opportunities to profitably expand our business. To accomplish this objective, we employ a business strategy that includes the elements set forth below.

 

Product Quality and Variety  

 

We maintain the gourmet taste and quality of our chocolate candies by using only the finest chocolate and other wholesome ingredients. We use our own proprietary recipes, primarily developed by our master candy makers. A typical Rocky Mountain Chocolate Factory store offers up to 100 of our chocolate candies throughout the year and as many as 200, including many packaged candies, during the holiday seasons. Individual stores also offer numerous varieties of premium fudge and gourmet caramel apples, as well as other products prepared in the store from Company recipes.

 

Store Atmosphere and Ambiance

 

We seek to establish a fun, enjoyable and inviting atmosphere in each of our store locations. Unlike most other confectionery stores, each Rocky Mountain Chocolate Factory store prepares numerous products, including fudge, barks and caramel apples, in the store. In-store preparation is designed to be both fun and entertaining for customers and we believe the in-store preparation and aroma of our products enhance the ambiance at Rocky Mountain Chocolate Factory stores, are fun and entertaining for our customers and convey an image of freshness and homemade quality. To ensure that all stores conform to the Rocky Mountain Chocolate Factory image, our design staff has developed easily replicable designs and specifications and approves the construction plans for each new store. We also control the signage and building materials that may be used in the stores.

 

Site Selection

 

Careful selection of a site is critical to the success of our stores. We consider many factors in identifying suitable sites, including tenant mix, visibility, attractiveness, accessibility, level of foot traffic and occupancy costs. Final site selection occurs only after our senior management has approved the site. We believe that the experience of our management team in evaluating a potential site is one of our competitive strengths.

 

Customer Service Commitment

 

We emphasize excellence in customer service in our stores and cafés and seek to employ and to sell franchises to motivated and energetic people. We also foster enthusiasm for our customer service philosophy and our concepts through our regional meetings and other frequent contacts with our franchisees. Rocky Mountain Chocolate Factory holds a biennial convention for franchisees.

 

 

Increase Same Store Retail Sales at Existing Rocky Mountain Chocolate Factory and U-Swirl Locations

 

We seek to increase profitability of our store system through increasing sales at existing store locations. Changes in system wide domestic same store retail sales at Rocky Mountain Chocolate Factory locations are as follows:

 

2015

3.1%

2016

1.6%

2017

0.9%

2018

 (2.9)%

2019

1.0%

 

Changes in system wide domestic same store retail sales at frozen yogurt franchise locations are as follows:

 

2015

*

2016

 (1.4)%

2017

 (3.0)%

2018

 (4.3)%

2019

 (0.5)%

 

*Same store sales for acquired brands are reported after 24 months of operation as a part of our network of domestic franchise stores. Because the majority of our frozen yogurt franchise brands were acquired in January 2014, the earliest period same store sales are reported is for FY 2016.

 

We have designed a contemporary and coordinated line of packaged products that we believe capture and convey the freshness, fun and excitement of the Rocky Mountain Chocolate Factory retail store experience. We also believe that the successful launch of new packaging has had a positive impact on same store sales.

 

Same Store Pounds Purchased by Existing Franchised and Licensed Locations

 

In FY 2019, same store pounds purchased by franchisees and licensees decreased 0.5% compared to the prior fiscal year. We continue to add new products and focus our existing product lines in an effort to increase same store pounds purchased by existing locations. We believe historical decreases in same store pounds purchased, including for FY 2019, were due, in part, to a product mix shift from factory-made products to products made in the store, such as caramel apples.

 

Enhanced Operating Efficiencies

 

We seek to improve our profitability by controlling costs and increasing the efficiency of our operations. Efforts in the last several years include: the purchase of additional automated factory equipment, implementation of a comprehensive advanced planning and scheduling system for production scheduling, implementation of alternative manufacturing strategies, installation of enhanced point-of-sale systems in all of our Company-owned stores and the majority of our franchised stores, and implementation of a serial/lot tracking and warehouse management system. These measures have significantly improved our ability to deliver our products to our stores safely, quickly and cost-effectively and positively impact store operations.

 

Expansion Strategy

 

We are continually exploring opportunities to grow our brand and expand our business. Key elements of our expansion strategy are set forth below.

 

Unit Growth

 

We continue to pursue unit growth opportunities, despite the difficult financing environment for our concepts, in locations where we have traditionally been successful, to pursue new and developing real estate environments for franchisees which appear promising based on early sales results, and to improve and expand our retail store concepts, such that previously untapped and unfeasible environments generate sufficient revenue to support a successful Rocky Mountain Chocolate Factory or U-Swirl location.

 

 

High Traffic Environments

 

We currently establish franchised stores in the following environments: regional centers, outlet centers, tourist areas, street fronts, airports, other entertainment-oriented environments and strip centers. We have established a business relationship with most of the major developers in the United States and believe that these relationships provide us with the opportunity to take advantage of attractive sites in new and existing real estate environments.

 

Rocky Mountain Chocolate Factory Name Recognition and New Market Penetration

 

We believe the visibility of our stores and the high foot traffic at many of our locations has generated strong name recognition of Rocky Mountain Chocolate Factory and demand for our franchises. The Rocky Mountain Chocolate Factory system has historically been concentrated in the western and Rocky Mountain region of the United States, but growth has generated a gradual easterly momentum as new stores have been opened in the eastern half of the country. We believe this growth has further increased our name recognition and demand for our franchises. We believe that distribution of Rocky Mountain Chocolate Factory products through specialty markets also increases name recognition and brand awareness in areas of the country in which we have not previously had a significant presence and we believe it will also improve and benefit our entire store system.

 

We seek to establish a fun, enjoyable and inviting atmosphere in each of our store locations. Unlike most other confectionery stores, each Rocky Mountain Chocolate Factory store prepares numerous products, including fudge, barks and caramel apples, in the store. Customers can observe store personnel making fudge from start to finish, including the mixing of ingredients in old-fashioned copper kettles and the cooling of the fudge on large granite or marble tables, and are often invited to sample the store's products. In FY 2019, an average of approximately 52% of the revenues of franchised stores are generated by sales of products prepared on the premises. In-store preparation is designed to be both fun and entertaining for customers and we believe the in-store preparation and aroma of our products enhance the ambiance at Rocky Mountain Chocolate Factory stores, are fun and entertaining for our customers and convey an image of freshness and homemade quality.

 

To ensure that all stores conform to the Rocky Mountain Chocolate Factory image, our design staff has developed easily replicable designs and specifications and approves the construction plans for each new store. We also control the signage and building materials that may be used in the stores.

 

The average store size is approximately 1,000 square feet, approximately 650 square feet of which is selling space. Most stores are open seven days a week. Typical hours are 10 a.m. to 9 p.m., Monday through Saturday, and 12 noon to 6 p.m. on Sundays. Store hours in tourist areas may vary depending upon the tourist season.

 

In January 2007, we began testing co-branded locations, such as the co-branded stores with Cold Stone Creamery. Co-branding a location is a vehicle to exploit retail environments that would not typically support a stand-alone Rocky Mountain Chocolate Factory store. Co-branding can also be used to more efficiently manage rent structure, payroll and other operating costs in environments that have not historically supported stand-alone Rocky Mountain Chocolate Factory stores. As of February 28, 2019, Cold Stone Creamery franchisees operated 91 co-branded locations, our U-Swirl franchisees operated 12 co-branded locations and three Company-owned co-branded units were in operation.

 

We have previously entered into franchise developments and licensing agreements for the expansion of our franchise stores in Canada, the United Arab Emirates, the Republic of Panama, South Korea, the Republic of the Philippines, Vietnam, Qatar and Japan. We believe that international opportunities may create a favorable expansion strategy and reduce dependence on domestic franchise openings to achieve growth.

 

International units in operation were as follows at March 31, 2019:

 

Rocky Mountain Chocolate Factory

       

Canada

    58  

The Republic of Panama

    1  

The Republic of the Philippines

    4  

South Korea

    1  

U-Swirl Cafés (including all associated brands)

       

Qatar

    2  

Total

    66  

 

 

Products and Packaging

 

We produce approximately 700 chocolate candies and other confectionery products using proprietary recipes developed primarily by our master candy makers. These products include many varieties of clusters, caramels, creams, toffees, mints and truffles. These products are offered for sale and also configured into approximately 400 varieties of packaged assortments. We continue to engage in a major effort to expand our product line by developing additional exciting and attractive new products. During the Christmas, Easter and Valentine's Day holiday seasons, we may make as many as 100 items, including many candies offered in packages, that are specially designed for such holidays. A typical Rocky Mountain Chocolate Factory store offers up to 100 of these approximately 700 chocolate candies and other confectionery products throughout the year and up to an additional 100 during holiday seasons. Individual stores also offer more than 15 varieties of caramel apples and other products prepared in the store. In FY 2019, approximately 45% of the revenues of Rocky Mountain Chocolate Factory stores are generated by products manufactured at our factory, 52% by products made in individual stores using our recipes and ingredients purchased from us or approved suppliers and the remaining 3% by products such as ice cream, coffee and other sundries purchased from approved suppliers.

 

In FY 2019, approximately 28% of our product sales resulted from the sale of products outside of our system of franchised and licensed locations, which we refer to as specialty markets. The majority of sales to specialty markets are to a single customer. For FY 2019, this customer represented approximately 46% of total shipments to specialty markets and approximately 9% of our total revenues. These products are produced using the same quality ingredients and manufacturing processes as the products sold in our network of retail stores. See Item 1A “Risk Factors—Our Sales to Specialty Market Customers, Customers Outside Our System of Franchised Stores, Are Concentrated Among a Small Number of Customers.”

 

We use only the finest chocolates, nutmeats and other wholesome ingredients in our candies and continually strive to offer new confectionery items in order to maintain the excitement and appeal of our products. We develop special packaging for the Christmas, Valentine's Day and Easter holidays, and customers can have their purchases packaged in decorative boxes and fancy tins throughout the year.

 

Chocolate candies that we manufacture are sold at prices ranging from $19.75 to $29.95 per pound, with an average price of $23.32 per pound. Franchisees set their own retail prices, though we do recommend prices for all of our products.

 

Our frozen yogurt cafés feature a high-quality yogurt that we believe is superior to products offered by many of our competitors. Our product is nationally distributed and consistent among our cafés. Most cafés feature 8 to 16 flavor varieties, including custom and seasonal specialty flavors. Our toppings bars feature up to 70 toppings allowing for a customizable frozen dessert experience. Cafés typically sell frozen yogurt by the ounce, with prices generally ranging between $0.46 and $0.61 per ounce.

 

Operating Environment

 

Rocky Mountain Chocolate Factory

 

We currently establish Rocky Mountain Chocolate Factory stores in six primary environments: regional centers, outlet centers, tourist areas, street fronts, airports and other entertainment-oriented shopping centers. Each of these environments has a number of attractive features, including high levels of foot traffic. Rocky Mountain Chocolate Factory domestic franchise locations in operation as of February 28, 2019 include:

 

Regional Centers

    23.5 %

Outlet Centers

    21.3 %

Festival/Community Centers

    19.1 %

Tourist Areas

    15.8 %

Street Fronts

    7.7 %

Airports

    6.0 %

Other

    6.6 %

 

Regional Centers

 

As of February 28, 2019, there were Rocky Mountain Chocolate Factory stores in approximately 43 regional centers, including a location in the Mall of America in Bloomington, Minnesota. Although they often provide favorable levels of foot traffic, regional centers typically involve more expensive rent structures and competing food and beverage concepts.

 

Outlet Centers

 

As of February 28, 2019, there were approximately 39 Rocky Mountain Chocolate Factory stores in outlet centers. We have established business relationships with most of the major outlet center developers in the United States. Although not all factory outlet centers provide desirable locations for our stores, we believe our relationships with these developers will provide us with the opportunity to take advantage of attractive sites in new and existing outlet centers.

 

 

Tourist Areas , Street Fronts , Airports and Other Entertainment - Oriented Shopping Centers

 

As of February 28, 2019, there were approximately 29 Rocky Mountain Chocolate Factory stores in locations considered to be tourist areas, including Fisherman's Wharf in San Francisco, California and the River Walk in San Antonio, Texas. Tourist areas are very attractive locations because they offer high levels of foot traffic and favorable customer spending characteristics, and greatly increase our visibility and name recognition. We believe there are a number of other environments that have the characteristics necessary for the successful operation of Rocky Mountain Chocolate Factory stores such as airports and sports arenas. As of February 28, 2019, there were 11 franchised Rocky Mountain Chocolate Factory stores at airport locations.

 

Strip/Convenience Centers

 

Our self-serve frozen yogurt locations are primarily located in strip and convenience center locations. Such centers generally have convenient parking and feature many retail entities without enclosed connecting walkways. Such centers generally offer favorable rents and the ability to operate during hours when other operating environments are closed, such as late at night.

 

Franchising Program

 

General

 

Our franchising philosophy is one of service and commitment to our franchise system and we continuously seek to improve our franchise support services. Our concept has been rated as an outstanding franchise opportunity by publications and organizations rating such opportunities. In January 2011, Rocky Mountain Chocolate Factory was rated the number one franchise opportunity in the candy category by Entrepreneur Magazine (the last publication of this category ranking) and since then has been ranked in the Top 500 Franchises every year by Entrepreneur Magazine. As of March 31, 2019, there were 245 franchised stores in the Rocky Mountain Chocolate Factory system and 68 franchised stores under the U-Swirl frozen yogurt brands. We strive to bring this philosophy of service and commitment to all of our franchised brands and believe this strategy gives us a competitive advantage in the support of frozen yogurt franchises.

 

Franchisee Sourcing and Selection

 

The majority of new franchises are awarded to persons referred to us by existing franchisees, to interested consumers who have visited one of our domestic franchise locations and to existing franchisees. We also advertise for new franchisees in national and regional newspapers as suitable potential store locations come to our attention. Franchisees are approved by us on the basis of the applicant's net worth and liquidity, together with an assessment of work ethic and personality compatibility with our operating philosophy.

 

International Franchising and Licensing

 

In FY 1992, we entered into a franchise development agreement covering Canada with Immaculate Confections, Ltd. of Vancouver, British Columbia (“Immaculate Confections”). Pursuant to this agreement, Immaculate Confections purchased the exclusive right to franchise and operate Rocky Mountain Chocolate Factory stores in Canada. As of March 31, 2019, Immaculate Confections operated 58 stores under this agreement.

 

Our business was significantly affected by the global recession during 2008-2009. During this period there was a decrease in leads and qualified franchisees for domestic franchise growth. Amidst this environment we initiated a program to focus on international expansion. International growth is generally achieved through entry into a Master License Agreement covering specific countries, with a licensee that meets minimum qualifications to develop Rocky Mountain Chocolate Factory, or a brand of U-Swirl in that country. License agreements are generally entered into for a period of 3-10 years and allow the licensee exclusive development rights in a country. Generally, we require an initial license fee and commitment to a development schedule. International license agreements in place include the following:

 

 

In March 2013, we entered into a Licensing Agreement in the country of South Korea. As of March 31, 2019, one unit was operating under this agreement.

 

 

In October 2014, we entered into a Licensing Agreement in the Republic of the Philippines. As of March 31, 2019, four units were operating under the agreement.

 

 

In May 2017, we entered into a Licensing Agreement in the Republic of the Panama. As of March 31, 2019, one unit was operating under the agreement.

 

 

 

In May 2017, we entered into a Licensing Agreement in the Socialist Republic of Vietnam. As of March 31, 2019, there were no units operating under the agreement.

 

 

Through our U-Swirl subsidiary, we have additional international development agreements covering Canada and the State of Qatar. As of March 31, 2019, no units were operating in Canada and two units were operating in Qatar.

 

Co- B randing

 

In August 2009, we entered into a Master License Agreement with Kahala Franchise Corp. Under the terms of the agreement, select current and future Cold Stone Creamery franchise stores are co-branded with both the Rocky Mountain Chocolate Factory and the Cold Stone Creamery brands. Locations developed or modified under the agreement are subject to the approval of both parties. Locations developed or modified under the agreement will remain franchisees of Cold Stone Creamery and will be licensed to offer the Rocky Mountain Chocolate Factory brand. As of March 31, 2019, Cold Stone Creamery franchisees operated 90 stores under this agreement.

 

Additionally, we allow U-Swirl brands to offer Rocky Mountain Chocolate Factory products under terms similar to other co-branding agreements. As of March 31, 2019, there were 12 franchise and Company-owned U-Swirl cafés offering Rocky Mountain Chocolate Factory products.

 

Training and Support

 

Each domestic franchisee owner/operator and each store manager for a domestic franchisee is required to complete a comprehensive training program in store operations and management. We have established a training center at our Durango headquarters in the form of a full-sized replica of a properly configured and merchandised Rocky Mountain Chocolate Factory store. U-Swirl franchisees are required to complete a similar training program. Topics covered in the training course include our philosophy of store operation and management, customer service, merchandising, pricing, cooking, inventory and cost control, quality standards, record keeping, labor scheduling and personnel management. Training is based on standard operating policies and procedures contained in an operations manual provided to all franchisees, which the franchisee is required to follow by terms of the franchise agreement. Additionally, and importantly, trainees are provided with a complete orientation to our operations by working in key factory operational areas and by meeting with members of our senior management.

 

Our operating objectives include providing knowledge and expertise in merchandising, marketing and customer service to all front-line store level employees to maximize their skills and ensure that they are fully versed in our proven techniques.

 

We provide ongoing support to franchisees through our field consultants, who maintain regular and frequent communication with the stores by phone and by site visits. The field consultants also review and discuss store operating results with the franchisee and provide advice and guidance in improving store profitability and in developing and executing store marketing and merchandising programs.

 

Quality Standards and Control

 

The franchise agreements for Rocky Mountain Chocolate Factory and U-Swirl brands franchisees require compliance with our procedures of operation and food quality specifications and permits audits and inspections by us.

 

Operating standards for Rocky Mountain Chocolate Factory and U-Swirl brands stores are set forth in operating manuals. These manuals cover general operations, factory ordering, merchandising, advertising and accounting procedures. Through their regular visits to franchised stores, our field consultants audit performance and adherence to our standards. We have the right to terminate any franchise agreement for non-compliance with our operating standards. Products sold at the stores and ingredients used in the preparation of products approved for on-site preparation must be purchased from us or from approved suppliers.

 

The Franchise Agreement: Terms and Conditions  

 

The domestic offer and sales of our franchise concepts are made pursuant to the respective Franchise Disclosure Document prepared in accordance with federal and state laws and regulations. States that regulate the sale and operation of franchises require a franchisor to register or file certain notices with the state authorities prior to offering and selling franchises in those states.

 

Under the current form of our domestic franchise agreements, franchisees pay us (i) an initial franchise fee for each store, (ii) royalties based on monthly gross sales, and (iii) a marketing fee based on monthly gross sales. Franchisees are generally granted exclusive territory with respect to the operation of their stores only in the immediate vicinity of their stores. Chocolate and yogurt products not made on the premises by franchisees must be purchased from us or approved suppliers. The franchise agreements require franchisees to comply with our procedures of operation and food quality specifications, to permit inspections and audits by us and to remodel stores to conform with standards then in effect. We may terminate the franchise agreement upon the failure of the franchisee to comply with the conditions of the agreement and upon the occurrence of certain events, such as insolvency or bankruptcy of the franchisee or the commission by the franchisee of any unlawful or deceptive practice, which in our judgment are likely to adversely affect the system. Our ability to terminate franchise agreements pursuant to such provisions is subject to applicable bankruptcy and state laws and regulations. See "Regulation" Below for additional information.

 

 

The agreements prohibit the transfer or assignment of any interest in a franchise without our prior written consent. The agreements also give us a right of first refusal to purchase any interest in a franchise if a proposed transfer would result in a change of control of that franchise. The refusal right, if exercised, would allow us to purchase the interest proposed to be transferred under the same terms and conditions and for the same price as offered by the proposed transferee.

 

The term of each franchise agreement is ten years, and franchisees have the right to renew for one additional ten-year term.

 

Franchise Financing

 

We do not typically provide prospective franchisees with financing for their stores for new or existing franchises, but we have developed relationships with several sources of franchisee financing to whom we will refer franchisees. Typically, franchisees have obtained their own sources of such financing and have not required our assistance. In the normal course of business, we extend credit to customers, primarily franchisees that satisfy pre-defined credit criteria, for inventory and other operational costs.

 

During FY 2014, we began an initiative to finance entrepreneurial graduates of the Missouri Western State University (“MWSU”) entrepreneurial program. Beginning in FY 2010, recent graduates were awarded the opportunity to own a Rocky Mountain Chocolate Factory franchise under favorable financing terms. Prior to FY 2014, the financing was provided by an independent benefactor of the MWSU School of Business. Beginning in FY 2014, we began to finance the graduates directly, under similar terms as the previous financing facility. This program has generally included financing for the purchase of formerly Company-owned locations or for the purchase of underperforming franchise locations. As of February 28, 2019, approximately $219,000 was included in notes receivable as a result of this program. As of March 31, 2019, there were 15 units in operation by graduates of the MWSU entrepreneurial program.

 

Licensee Financing

 

During FY 2011, we began a program to finance the remodel costs of a select number of co-branded licensed Cold Stone Creamery locations. The financing was provided to existing Cold Stone Creamery franchisees that were required to meet a number of financial qualifications prior to approval. At February 28, 2019, approximately $3,000 was included in notes receivable as a result of this program. We initially financed this program in order to encourage early adoption of the co-branding program. Now that the program is mature, we do not intend to continue direct financing unless circumstances change.

 

Company Store Program

 

As of March 31, 2019, there were two Company-owned Rocky Mountain Chocolate Factory stores and four Company-owned U-Swirl cafés. Company-owned stores provide a training ground for Company-owned store personnel and district managers and a controllable testing ground for new products and promotions, operating and training methods and merchandising techniques, which may then be incorporated into the franchise store operations.

 

Managers of Company-owned stores are required to comply with all Company operating standards and undergo training and receive support from us similar to the training and support provided to franchisees. See "—Franchising Program—Training and Support" and "—Franchising Program—Quality Standards and Control."

 

Manufacturing Operations

 

General

 

We manufacture our chocolate candies at our factory in Durango, Colorado. All products are produced consistent with our philosophy of using only the finest high-quality ingredients to achieve our marketing motto of " T he Peak of Perfection in Handmade Chocolates ®."

 

We have always believed that we should control the manufacturing of our own chocolate products. By controlling manufacturing, we can better maintain our high product quality standards, offer unique, proprietary products, manage costs, control production and shipment schedules and potentially pursue new or under-utilized distribution channels.

 

Manufacturing Processes

 

The manufacturing process primarily involves cooking or preparing candy centers, including nuts, caramel, peanut butter, creams and jellies, and then coating them with chocolate or other toppings. All of these processes are conducted in carefully controlled temperature ranges, and we employ strict quality control procedures at every stage of the manufacturing process. We use a combination of manual and automated processes at our factory. Although we believe that it is currently preferable to perform certain manufacturing processes, such as dipping of some large pieces by hand, automation increases the speed and efficiency of the manufacturing process. We have from time to time automated certain processes formerly performed by hand where it has become cost-effective for us to do so without compromising product quality or appearance.

 

 

We also seek to ensure the freshness of products sold in Rocky Mountain Chocolate Factory stores with frequent shipments. Most Rocky Mountain Chocolate Factory stores do not have significant space for the storage of inventory, and we encourage franchisees and store managers to order only the quantities that they can reasonably expect to sell within approximately two to four weeks. For these reasons, we generally do not have a significant backlog of orders.

 

Ingredients

 

The principal ingredients used in our products are chocolate, nuts, sugar, corn syrup, cream and butter. The factory receives shipments of ingredients daily. To ensure the consistency of our products, we buy ingredients from a limited number of reliable suppliers. In order to assure a continuous supply of chocolate and certain nuts, we frequently enter into purchase contracts of between six to eighteen months for these products. 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. We have one or more alternative sources for most essential ingredients and therefore believe that the loss of any supplier would not have a material adverse effect on our business or results of operations. We currently purchase small amounts of finished candy from third parties on a private label basis for sale in Rocky Mountain Chocolate Factory stores.

 

Trucking Operations

 

We operate nine trucks and ship a substantial portion of our products from the factory on our own fleet. Our trucking operations enable us to deliver our products to the stores quickly and cost-effectively. In addition, we back-haul our own ingredients and supplies, as well as products from third parties, on return trips, which helps achieve even greater efficiencies and cost savings.

 

Marketing

 

General

 

We rely primarily on in-store promotion and point-of-purchase materials to promote the sale of our products. The monthly marketing fees collected from franchisees are used by us to develop new packaging and in-store promotion and point-of-purchase materials, and to create and update our local store marketing handbooks.

 

We focus on local store marketing efforts by providing customizable marketing materials, including advertisements, coupons, flyers and mail order catalogs generated by our in-house Creative Services department. The department works directly with franchisees to implement local store marketing programs.

 

We have not historically, and do not intend to, engage in national traditional media advertising in the near future. Consistent with our commitment to community support, we aggressively seek opportunities to participate in local and regional events, sponsorships and charitable causes. This support leverages low cost, high return publicity opportunities for mutual gain partnerships. Through programs such as Fudge for Troops, and collaborations with Care and Share Food Bank and other national/local organizations focused on youth/leadership development and underserved populations in our community, we have developed relationships that define our principal platforms, and contribute to charitable causes that provide exposure at a national level.

 

Internet and Social Medi a

 

Beginning in 2010, we initiated a program to leverage the marketing benefits of various social media outlets. These low-cost marketing opportunities seek to leverage the positive feedback of our customers to expand brand awareness through a customer’s network of contacts. Complementary to local store marketing efforts, these networks also provide a medium for us to communicate regularly and authentically with customers. When possible, we work to facilitate direct relationships between our franchisees and their customers. We use social media as a powerful tool to build brand recognition, increase repeat exposure and enhance dialogue with consumers about their preferences and needs. To date, the majority of stores have location specific websites and location specific Facebook® pages dedicated to help customers interact directly with their local store. Proceeds from the monthly marketing fees collected from franchisees are used by us to facilitate and assist stores in managing their online presence consistent with our brand and marketing efforts.

 

Licensing

 

We have developed relationships and utilized licensing partners to leverage the equity of the Rocky Mountain Chocolate Factory brand. These licensed products place our brands and story in front of consumers in environments where they regularly shop but may not be seeing our brands at present. We regularly review product opportunities and selectively pursue those we believe will have the greatest impact. The most recent example is the announcement of our Rocky Mountain Chocolate Factory Chocolatey Almond breakfast cereal, which was manufactured, marketed, and distributed by Kellogg’s Company. Some of our specialty markets customers have worked with us to offer licensed products alongside products we produce to further enhance brand placement and awareness.

 

 

Competition

 

The retailing of confectionery and frozen dessert products is highly competitive. We and our franchisees compete with numerous businesses that offer products similar to those offered by our stores. Many of these competitors have greater name recognition and financial, marketing and other resources than us. In addition, there is intense competition among retailers for real estate sites, store personnel and qualified franchisees.

 

We believe that our principal competitive strengths lie in our name recognition and our reputation for the quality, value, variety and taste of our products and the special ambiance of our stores; our knowledge and experience in applying criteria for selection of new store locations; our expertise in merchandising and marketing of chocolate, other candy products and frozen yogurt; and the control and training infrastructures we have implemented to assure execution of successful practices and techniques at our store locations. In addition, by controlling the manufacturing of our own chocolate products, we can better maintain our high product quality standards for those products, offer proprietary products, manage costs, control production and shipment schedules and pursue new or under-utilized distribution channels.

 

Trade Name and Trademarks

 

The trade name " Rocky Mountain Chocolate Factory ® ," the phrases, " The Peak of Perfection in Handmade Chocolates ® ", " America's Chocolatier ® ”, “The World’s Chocolatier ® as well as all other trademarks, service marks, symbols, slogans, emblems, logos and designs used in the Rocky Mountain Chocolate Factory system, are our proprietary rights. We believe that all of the foregoing are of material importance to our business. The trademark “Rocky Mountain Chocolate Factory” is registered in the United States and Canada. Applications to register the Rocky Mountain Chocolate Factory trademark have been filed and/or obtained in certain foreign countries.

 

In connection with U-Swirl’s frozen yogurt café operations, the following marks are owned by U-Swirl and have been registered with the U.S. Patent and Trademark Office: “U-Swirl Frozen Yogurt And Design”; “U-Swirl Frozen Yogurt”; “U-Swirl”; “U and Design”; “Worth The Weight”; “Frequent Swirler”; “Yogurtini”; “CherryBerry Self-Serve Yogurt Bar”; “Yogli Mogli”; “Best on the Planet”; “Fuzzy Peach”; “U-Swirl-N-Go”; and “Serve Yo Self”. The “U-Swirl Frozen Yogurt and Design” (a logo) is also registered in Mexico and U-Swirl has a registration for “U-Swirl” in Canada.

 

We have not attempted to obtain patent protection for the proprietary recipes developed by our master candy-maker and instead rely upon our ability to maintain the confidentiality of those recipes.

 

Employees

 

At February 28, 2019, we employed approximately 231 people. Most employees, with the exception of store management, factory management and corporate management, are paid on an hourly basis. We also employ some individuals on a temporary basis during peak periods of store and factory operations. We seek to assure that participatory management processes, mutual respect and professionalism and high-performance expectations for the employee exist throughout the organization. We believe that we provide working conditions, wages and benefits that compare favorably with those of our competitors. Our employees are not covered by a collective bargaining agreement. We consider our employee relations to be good.

 

Seasonal Factors

 

Our sales and earnings are seasonal, with significantly higher sales and earnings occurring during key holidays, such as Christmas, Easter and Valentine's Day, and the U.S. summer vacation season than at other times of the year, which may cause fluctuations in our quarterly results of operations. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings, the sale of franchises and the timing of purchases by customers outside our network of franchised locations. Because of the seasonality of our business, results for any quarter are not necessarily indicative of the results that may be achieved in other quarters or for a full fiscal year.

 

Regulation

 

Company-owned Rocky Mountain Chocolate Factory stores and Company-owned U-Swirl cafés are subject to licensing and regulation by the health, sanitation, safety, building and fire agencies in the state or municipality where located. Difficulties or failures in obtaining the required licensing or approvals could delay or prevent the opening of new stores. New stores must also comply with landlord and developer criteria.

 

Many states have laws regulating franchise operations, including registration and disclosure requirements in the offer and sale of franchises. We are also subject to the Federal Trade Commission regulations relating to disclosure requirements in the sale of franchises and ongoing disclosure obligations.

 

 

Additionally, certain states have enacted and others may enact laws and regulations governing the termination or non-renewal of franchises and other aspects of the franchise relationship that are intended to protect franchisees. Although these laws and regulations, and related court decisions, may limit our ability to terminate franchises and alter franchise agreements, we do not believe that such laws or decisions will have a material adverse effect on our franchise operations. However, the laws applicable to franchise operations and relationships continue to develop, and we are unable to predict the effect on our intended operations of additional requirements or restrictions that may be enacted or of court decisions that may be adverse to franchisors.

 

Federal and state environmental regulations have not had a material impact on our operations but more stringent and varied requirements of local governmental bodies with respect to zoning, land use and environmental factors could delay construction of new stores, increase our capital expenditures and thereby decrease our earnings and negatively impact competitive position.

 

Companies engaged in the manufacturing, packaging and distribution of food products are subject to extensive regulation by various governmental agencies. A finding of a failure to comply with one or more regulations could result in the imposition of sanctions, including the closing of all or a portion of our facilities for an indeterminate period of time. Our product labeling is subject to and complies with the Nutrition Labeling and Education Act of 1990 and the Food Allergen Labeling and Consumer Protection Act of 2004.

 

We provide a limited amount of trucking services to third parties, to fill available space on our trucks. Our trucking operations are subject to various federal and state regulations, including regulations of the Federal Highway Administration and other federal and state agencies applicable to motor carriers, safety requirements of the Department of Transportation relating to interstate transportation and federal, state and Canadian provincial regulations governing matters such as vehicle weight and dimensions.

 

We believe that we are operating in substantial compliance with all applicable laws and regulations.

 

Available Information

 

The Internet address of our website is www.rmcf.com . Additional websites specific to our franchise opportunities are www.sweetfranchise.com and www.u-swirl.com .

 

We file or furnish annual, quarterly and current reports, proxy statements and other information with the United States Securities and Exchange Commission (“SEC”). We make available free of charge, through our Internet website, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we file such material with, or furnish it to, the SEC. The SEC also maintains a website that contains these reports, proxy and information statements and other information that can be accessed, free of charge, at www.sec.gov. The contents of our websites are not incorporated into, and should not be considered a part of, this Annual Report.

 

 

ITEM 1A. RISK FACTORS

 

General Economic Conditions Could Have a Material Adverse Effect on our Business, Results of Operations and Liquidity or our Franchisees, with Adverse Consequences to Us .

 

Consumer purchases of discretionary items, including our products, generally decline during weak economic periods and other periods where disposable income is adversely affected. Our performance is subject to factors that affect worldwide economic conditions, including employment, consumer debt, reductions in net worth based on severe market declines, residential real estate and mortgage markets, taxation, fuel and energy prices, interest rates, consumer confidence, value of the U.S. dollar versus foreign currencies and other macroeconomic factors. These factors may cause consumers to purchase products from lower priced competitors or to defer purchases of discretionary products altogether.

 

Economic weakness could have a material effect on our results of operations, liquidity and capital resources. It could also impact our ability to fund growth and/or result in us becoming more reliant on external financing, the availability and terms of which may be uncertain. In addition, a weak economic environment may exacerbate the other risks noted below.

 

We rely in part on our franchisees and the manner in which they operate their stores to develop and promote our business. It is possible that some franchisees could file for bankruptcy or become delinquent in their payments to us, which could have a significant adverse impact on our business due to loss or delay in payments of royalties, contributions to our marketing fund and other fees.

 

Although we have developed criteria to evaluate and screen prospective developers and franchisees, we cannot be certain that the developers and franchisees we select will have the business acumen or financial resources necessary to open and operate successful franchises in their franchise areas, and state franchise laws may limit our ability to terminate or modify these franchise arrangements. Moreover, franchisees may not successfully operate stores in a manner consistent with our standards and requirements, or may not hire and train qualified managers and other store personnel. The failure of developers and franchisees to open and operate franchises successfully could have a material adverse effect on us, our reputation, our brand and our ability to attract prospective franchisees and could materially adversely affect our business, financial condition, results of operations and cash flows.

 

Our Sales to Specialty Market Customers, Customers Outside Our System of Franchised Stores, Are Concentrated Among a Small Number of Customers .

 

Revenue from one customer of our manufacturing segment 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 further decreases in the purchases of this customer or the loss of this customer entirely.

 

Our Growth is Dependent Upon Attracting and Retaining Qualified Franchisees and Their Ability to Operate Their Franchised Stores Successfully .

 

Our continued growth and success is dependent in part upon our ability to attract, retain and contract with qualified franchisees. Our growth is dependent upon the ability of franchisees to operate their stores successfully, promote and develop our store concepts, and maintain our reputation for an enjoyable in-store experience and high-quality products. Although we have established criteria to evaluate prospective franchisees and have been successful in attracting franchisees, there can be no assurance that franchisees will be able to operate successfully in their franchise areas in a manner consistent with our concepts and standards.

 

The Financial Performance of Our Franchisees Can Negatively Impact Our Business .

 

Our financial results are dependent in part upon the operational and financial success of our franchisees. We receive royalties, franchise fees, contributions to our marketing fund, and other fees from our franchisees. We have established operational standards and guidelines for our franchisees; however, we have limited control over how our franchisees’ businesses are run. While we are responsible for ensuring the success of our entire system of stores and for taking a longer-term view with respect to system improvements, our franchisees have individual business strategies and objectives, which might conflict with our interests. Our franchisees may not be able to secure adequate financing to open or continue operating their Rocky Mountain Chocolate Factory stores or U-Swirl cafés. If they incur too much debt or if economic or sales trends deteriorate such that they are unable to repay existing debt, our franchisees could experience financial distress or even bankruptcy. If a significant number of franchisees become financially distressed, it could harm our operating results through reduced royalty revenues and the impact on our profitability could be greater than the percentage decrease in the royalty revenues. Closure of franchised stores, which during FY 2019, and potentially in subsequent years, could exceed levels experienced in recent years, would reduce our royalty revenues and could negatively impact margins, since we may not be able to reduce fixed costs which we continue to incur.

 

 

We Have Limited Control w ith Respect to the Operations of Our Franchisees, Which Could Have a Negative Impact on Our Business .

 

Franchisees are independent business operators and are not our employees, and we do not exercise control over the day-to-day operations of their stores. We provide training and support to franchisees, and set and monitor operational standards, but the quality of franchised stores may be diminished by any number of factors beyond our control. Consequently, franchisees may not successfully operate stores in a manner consistent with our standards and requirements, or may not hire and train qualified managers and other store personnel. If franchisees do not operate to our expectations, our image and reputation, and the image and reputation of other franchisees, may suffer materially and system-wide sales could decline significantly, which would reduce our royalty revenues, and the impact on profitability could be greater than the percentage decrease in royalties and fees.

 

Our Expansion Plans Are Dependent on the Availability of Suitable Sites for Franchised Stores at Reasonable Occupancy Costs .

 

Our expansion plans are critically dependent on our ability to obtain suitable sites for franchised stores at reasonable occupancy costs for our franchised stores in high foot traffic retail environments. There is no assurance that we will be able to obtain suitable locations for our franchised stores in this environment at a cost that will allow such stores to be economically viable.

 

A Significant Shift by Franchisees from Company-Manufactured Products to Products Produced b y Third Parties Could Adversely Affect Our Operations .

 

In FY 2019, approximately 45% of franchised stores' revenues are generated by sales of products manufactured by and purchased from us, 52% by sales of products made in the stores with ingredients purchased from us or approved suppliers and 3% by sales of products purchased from approved suppliers for resale in the stores. Franchisees' sales of products manufactured by us generate higher revenues to us than sales of store-made or other products. We have seen a significant increase in system-wide sales of store-made and other products, which has led to a decrease in purchases from us and had an adverse effect on our revenues. If this trend continues, it could further adversely affect our total revenues and results of operations. Such a decrease could result from franchisees' decisions to sell more store-made products or products purchased from approved third party suppliers.

 

Same Store Sales Have Fluctuated and Will Continue to Fluctuate on a Regular Basis .

 

Our same store sales, defined as year-over-year sales for a store that has been open at least one year, have fluctuated significantly in the past on an annual and quarterly basis and are expected to continue to fluctuate in the future. During the past five fiscal years, same store sales results at Rocky Mountain Chocolate Factory franchise stores have fluctuated as follows: (a) from (2.9%) to 3.1% for annual results; and (b) from (4.6%) to 7.5% for quarterly results. During the past four fiscal years, same store sales results at U-Swirl franchise stores have fluctuated as follows: (a) from (4.3%) to (0.5%) for annual results; and (b) from (8.6%) to 2.8% for quarterly results. Sustained declines in same store sales or significant same store sales declines in any single period could have a material adverse effect on our results of operations.

 

Increases in Costs Could Adversely Affect Our Operations .

 

Inflationary factors such as increases in the costs of ingredients, energy 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 reflect potentially escalating costs of real estate and construction. There is no assurance that we will be able to pass on our increased costs to our customers.

 

Price I ncreases M ay N ot B e S ufficient T o O ffset C ost I ncreases A nd M aintain P rofitability O r M ay R esult I n S ales V olume D eclines A ssociated W ith P ricing E lasticity.

 

We may be able to pass some or all raw materials, energy and other input cost increases to customers by increasing the selling prices of our products, however, higher product prices may also result in a reduction in sales volume and/or consumption. If we are not able to increase our selling prices sufficiently, or in a timely manner, to offset increased raw material, energy or other input costs, including packaging, direct labor, overhead and employee benefits, or if our sales volume decreases significantly, there could be a negative impact on our financial condition and results of operations.

 

 

The Availability and Price of Principal Ingredients Used in Our Products Are Subject to Factors Beyond Our Control .

 

Several of the principal ingredients used in our products, including chocolate and nuts, are subject to significant price fluctuations. Although cocoa beans, the primary raw material used in the production of chocolate, are grown commercially in Africa, Brazil and several other countries around the world, cocoa beans are traded in the commodities market, and their supply and price are subject to volatility. We believe our principal chocolate supplier purchases most of its beans at negotiated prices from African growers, often at a premium to commodity prices. The supply and price of cocoa beans, and in turn of chocolate, are affected by many factors, including monetary fluctuations and economic, political and weather conditions in countries in which cocoa beans are grown. We purchase most of our nut meats from domestic suppliers who procure their products from growers around the world. The price and supply of nuts are also affected by many factors, including weather conditions in the various regions in which the nuts we use are grown. Although we often enter into purchase contracts for these products, significant or prolonged increases in the prices of chocolate or of one or more types of nuts, or the unavailability of adequate supplies of chocolate or nuts of the quality sought by us, could have a material adverse effect on us and our results of operations.

 

We Own 100% of the Operations of U-Swirl, Which Has a History of Losses and May Continue t o Report Losses in the Future .

 

In January 2013, we obtained a controlling ownership interest in SWRL. This interest was the result of a transaction designed to create a self-serve frozen yogurt company through the combination of three formerly separate self-serve frozen yogurt retailers (U-Swirl, Yogurtini and Aspen Leaf Yogurt). SWRL has historically reported net losses. In February 2016, we foreclosed on the all of the outstanding common stock of U-Swirl (the operating subsidiary of SWRL) in full satisfaction of the obligations under the SWRL Loan Agreement, pursuant to which U-Swirl became a wholly-owned subsidiary of the Company. If U-Swirl continues to not be profitable, those operating losses could have a material adverse effect on our overall results of operations.

 

We And Our Subsidiaries May Be Unable To Successfully   Integrate   The Operations Of Acquired Businesses And May Not Achieve The Co st Savings And Increased Revenues Anticipated As A Result Of These Acquisitions.

 

U-Swirl has acquired a number of other yogurt franchising businesses. Achieving the anticipated benefits of acquisitions will depend in part upon our and our subsidiaries’ ability to integrate these businesses in an efficient and effective manner. The integration of companies that have previously operated independently may result in significant challenges, and we and our subsidiaries may be unable to accomplish the integration smoothly or successfully. The integration of acquired businesses may also require the dedication of significant management resources, which may temporarily distract management’s attention from the day-to-day operations of the Company. In addition, the process of integrating operations may cause an interruption of, or loss of momentum in, the activities of one or more of our or our subsidiaries’ businesses and the loss of key personnel from us or the acquired businesses. Our and our subsidiaries’ strategy is, in part, predicated on the ability to realize cost savings and to increase revenues through the acquisition of businesses that add to the breadth and depth of our products and services. Achieving these cost savings and revenue increases is dependent upon a number of factors, many of which are beyond our control.

 

The Seasonality of Our Sales and New Store Openings Can Have a Significant Impact on Our Financial Results from Quarter to Quarter .

 

Our sales and earnings are seasonal, with significantly higher sales and earnings occurring during key holidays and summer vacation season than at other times of the year, which causes fluctuations in our quarterly results of operations. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and the sale 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 the results that may be achieved in other quarters or for a full fiscal year.

 

The Retailing of Confectionery and Frozen Dessert Products is Highly Competitive and Many of Our Competitors Have Competitive Advantages Over Us.

 

The retailing of confectionery and frozen dessert products is highly competitive. We and our franchisees compete with numerous businesses that offer similar products. Many of these competitors have greater name recognition and financial, marketing and other resources than we do. In addition, there is intense competition among retailers for real estate sites, store personnel and qualified franchisees. Competitive market conditions could have a material adverse effect on us and our results of operations and our ability to expand successfully.

 

Changes in Consumer Tastes and Trends Could Have a Material Adverse Effect on Our Operations .

 

The sale of our products is affected by changes in consumer tastes and eating habits, including views regarding consumption of chocolate and frozen yogurt. Numerous other factors that we cannot control, such as economic conditions, demographic trends, traffic patterns and weather conditions, influence the sale of our products. Changes in any of these factors could have a material adverse effect on us and our results of operations.

 

 

We Are Subject to Federal, State and Local Regulation .

 

We are subject to regulation by the Federal Trade Commission and must comply with certain state laws governing the offer, sale and termination of franchises and the refusal to renew franchises. Many state laws also regulate substantive aspects of the franchisor-franchisee relationship by, for example, requiring the franchisor to deal with its franchisees in good faith, prohibiting interference with the right of free association among franchisees and regulating discrimination among franchisees in charges, royalties or fees. Franchise laws continue to develop and change, and changes in such laws could impose additional costs and burdens on franchisors. Our failure to obtain approvals to sell franchises and the adoption of new franchise laws, or changes in existing laws, could have a material adverse effect on us and our results of operations.

 

Each of our Company-owned and franchised stores is subject to licensing and regulation by the health, sanitation, safety, building and fire agencies in the state or municipality where located. Difficulties or failures in obtaining required licenses or approvals from such agencies could delay or prevent the opening of a new store. We and our franchisees are also subject to laws governing our relationships with employees, including minimum wage requirements, overtime, working and safety conditions and citizenship requirements. Because a significant number of our employees are paid at rates related to the federal minimum wage, increases in the minimum wage would increase our labor costs. The failure to obtain required licenses or approvals, or an increase in the minimum wage rate, employee benefits costs (including costs associated with mandated health insurance coverage) or other costs associated with employees, could have a material adverse effect on us and our results of operations.

 

Companies engaged in the manufacturing, packaging and distribution of food products are subject to extensive regulation by various governmental agencies. A finding of a failure to comply with one or more regulations could result in the imposition of sanctions, including the closing of all or a portion of our facilities for an indeterminate period of time, and could have a material adverse effect on us and our results of operations.

 

Information Technology System Failures, Breaches of our Network Security or Inability to Upgrade or Expand our Technological Capabilities Could Interrupt our Operations and Adversely Affect our Business.

 

We and our franchisees rely on our computer systems and network infrastructure across our operations, including point-of-sale processing at our stores. Our and our franchisees’ operations depend upon our and our franchisees’ ability to protect our computer equipment and systems against damage from physical theft, fire, power loss, telecommunications failure or other catastrophic events, as well as from internal and external cybersecurity breaches, viruses and other disruptive problems. Any damage or failure of our computer systems or network infrastructure that causes an interruption in our operations could have a material adverse effect on our business and subject us or our franchisees to litigation or to actions by regulatory authorities.

 

A party who is able to compromise the security measures on our networks or the security of our infrastructure could, among other things, misappropriate our proprietary information and the personal information of our customers and employees, cause interruptions or malfunctions in our or our franchisee’s operations, cause delays or interruptions to our ability to operate, cause us to breach our legal, regulatory or contractual obligations, create an inability to access or rely upon critical business records or cause other disruptions in our operations. These breaches may result from human errors, equipment failure, or fraud or malice on the part of employees or third parties.

 

We expend financial resources to protect against such threats and may be required to further expend financial resources to alleviate problems caused by physical, electronic, and cyber security breaches. As techniques used to breach security are growing in frequency and sophistication and are generally not recognized until launched against a target, regardless of our expenditures and protection efforts, we may not be able to implement security measures in a timely manner or, if and when implemented, these measures could be circumvented. Any breaches that may occur could expose us to increased risk of lawsuits, loss of existing or potential future customers, harm to our reputation and increases in our security costs, which could have a material adverse effect on our financial performance and operating results.

 

In the event of a breach resulting in loss of data, such as personally identifiable information or other such data protected by data privacy or other laws, we may be liable for damages, fines and penalties for such losses under applicable regulatory frameworks despite not handling the data. Further, the regulatory framework around data custody, data privacy and breaches varies by jurisdiction and is an evolving area of law. We may not be able to limit our liability or damages in the event of such a loss.

 

We are also continuing to expand, upgrade and develop our information technology capabilities, including our point-of-sale systems, as well as the adoption of cloud services for e-mail, intranet, and file storage. If we are unable to successfully upgrade or expand our technological capabilities, we may not be able to take advantage of market opportunities, manage our costs and transactional data effectively, satisfy customer requirements, execute our business plan or respond to competitive pressures. Additionally, unforeseen problems with our point-of-sale system may affect our operational abilities and internal controls and we may incur additional costs in connection with such upgrades and expansion.

 

 

If W e , our Business Partners, or our Franchisees Are U nable to P rotect our C ustomers’ D ata, We Could Be Exposed to Data Loss, Litigation, Liability and Reputational Damage .

 

In connection with credit and debit card sales, we and our franchisees transmit confidential credit and debit card information by way of secure private retail networks. A number of retailers have experienced actual or potential security breaches in which credit and debit card information may have been stolen. Although we and our franchisees use private networks, third parties may have the technology or know-how to breach the security of the customer information transmitted in connection with credit and debit card sales, and our and our franchisees’ security measures and those of our and our franchisees’ technology vendors may not effectively prohibit others from obtaining improper access to this information. If a person were able to circumvent these security measures, he or she could destroy or steal valuable information or disrupt our and our franchisees’ operations. Any security breach could expose us and our franchisees to risks of data loss and liability and could seriously disrupt our and our franchisees’ operations and any resulting negative publicity could significantly harm our reputation. We may also be subject to lawsuits or other proceedings in the future relating to these types of incidents. Proceedings related to theft of credit and debit card information may be brought by payment card providers, banks, and credit unions that issue cards, cardholders (either individually or as part of a class action lawsuit), and federal and state regulators. Any such proceedings could harm our reputation, distract our management team members from running our business and cause us to incur significant unplanned liabilities, losses and expenses.

 

We also sell and accept for payment gift cards, and our customer loyalty program provides rewards that can be redeemed for purchases. Like credit and debit cards, gift cards, and rewards earned by our customers are vulnerable to theft, whether physical or electronic. We believe that, due to their electronic nature, rewards earned through our customer loyalty program are primarily vulnerable to hacking. Customers affected by any loss of data or funds could litigate against us, and security breaches or even unsuccessful attempts at hacking could harm our reputation, and guarding against or responding to hacks could require significant time and resources.

 

We also receive and maintain certain personal information about our customers, including information received through our marketing programs, franchisees and business partners. The use of this information by us is regulated at the federal and state levels. If our security and information systems are compromised or our employees fail to comply with these laws and regulations and this information is obtained by unauthorized persons or used inappropriately, it could adversely affect our reputation, as well as the results of operations, and could result in litigation against us or the imposition of penalties. In addition, our ability to accept credit and debit cards as payment in our stores and online depends on us maintaining our compliance status with standards set by the PCI Security Standards Council. These standards, set by a consortium of the major credit card companies, require certain levels of system security and procedures to protect our customers’ credit and debit card information as well as other personal information. Privacy and information security laws and regulations change over time, and compliance with those changes may result in cost increases due to necessary system and process changes.

 

We A re S ubject to P eriodic L itigation , W hich C ould R esult in U nexpected E xpense of T ime and R esources .

 

From time to time, we are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome in any current or future legal proceedings could have an adverse impact on our business, and financial results. In addition, any significant litigation in the future, regardless of its merits, could divert management's attention from our operations and result in substantial legal fees. Any litigation could result in substantial costs and a diversion of management's attention and resources that are needed to successfully run our business.

 

Changes in Health Benefit Claims and Healthcare Reform Legislation Could Have a Material Adverse Effect on Our Operations .

 

We accrue for costs to provide self-insured benefits for our employee health benefits program. We accrue for self-insured health benefits based on historical claims experience and we maintain insurance coverage to prevent financial losses from catastrophic health benefit claims. We monitor pending and enacted legislation in an effort to evaluate the effects of such legislation upon our business. Our financial position or results of operations could be materially adversely impacted should we experience a material increase in claims costs or a change in healthcare legislation that impacts our business. Our accrued liability for self-insured employee health benefits at February 28, 2019 and February 28, 2018 was $140,000 and $158,000, respectively.

 

Our Expansion Into New Markets May Present Increased Risks Due To Our Unfamiliarity With Those Areas And Our Target Customers’ Unfamiliarity With Our Brands.

 

Consumers in any new markets we enter will not be familiar with our brands, and we will need to build brand awareness in those markets through significant investments in advertising and promotional activity.  We may find it more difficult in our markets to secure desirable locations and to hire, motivate and keep qualified employees.

 

 

Issues Or Concerns Related To The Quality And Safety Of Our Products, Ingredients Or Packaging Could Cause A Product Recall And/Or Result In Harm To The Company’s Reputation, Negatively Impacting O ur Results of Operations .

 

In order to sell our products, we need to maintain a good reputation with our customers and consumers. Issues related to the quality and safety of our products, ingredients or packaging could jeopardize our Company’s image and reputation. Negative publicity related to these types of concerns, or related to product contamination or product tampering, whether valid or not, could decrease demand for our products or cause production and delivery disruptions. We may need to recall products if any of our products become unfit for consumption. In addition, we could potentially be subject to litigation or government actions, which could result in payments of fines or damages. Costs associated with these potential actions could negatively affect our results of operations.

 

Disruption To Our Manufacturing Operations Or Supply Chain Could Impair Our Ability To Produce Or Deliver Finished Products, Resulting In A Negative Impact On Our Results of Operations.

 

All of our manufacturing operations are located in Durango, Colorado. Disruption to our manufacturing operations or our supply chain could result from a number of factors, including: natural disaster, pandemic outbreak of disease, weather, fire or explosion, terrorism or other acts of violence, labor strikes or other labor activities, unavailability of raw or packaging materials, and operational and/or financial instability of key suppliers and other vendors or service providers. We believe that we take adequate precautions to mitigate the impact of possible disruptions. We have strategies and plans in place to manage disruptive events if they were to occur. However, if we are unable, or find that it is not financially feasible, to effectively plan for or mitigate the potential impacts of such disruptive events on our manufacturing operations or supply chain, our financial condition and results of operations could be negatively impacted.

 

If We Face Labor Shortages or Increased Labor Costs, our Results of Operations and our Growth Could Be Adversely Affected.

 

Labor is a primary component of operating our business. If we experience labor shortages or increased labor costs because of increased competition for employees, higher employee turnover rates, or increases in the federally-mandated or state-mandated minimum wage, change in exempt and non-exempt status, or other employee benefits costs (including costs associated with health insurance coverage or workers’ compensation insurance), operating expenses could increase and our growth could be adversely affected.

 

We have a substantial number of hourly employees who are paid wage rates at or based on the applicable federal or state minimum wage and increases in the minimum wage will increase our labor costs. The federal minimum wage has been $7.25 per hour since July 24, 2009. Federally-mandated, state-mandated or locally-mandated minimum wages may be raised in the future. As of the date hereof, many states and the District of Columbia have set a minimum wage level higher than the federal minimum wage, including Colorado, where we employ the majority of our employees and minimum wage as of the date hereof is $11.10. We may be unable to increase our prices in order to pass future increased labor costs on to our customers, in which case our margins would be negatively affected.

 

Our F inancial R esults M ay B e A dversely I mpacted B y T he F ailure T o S uccessfully E xecute O r I ntegrate A cquisitions, D ivestitures A nd J oint V entures.

 

From time to time, we may evaluate potential acquisitions, divestitures or joint ventures that align with our strategic objectives. The success of such activity depends, in part, upon our ability to identify suitable buyers, sellers or business partners; perform effective assessments prior to contract execution; negotiate contract terms; and, if applicable, obtain government approval. These activities may present certain financial, managerial, staffing and talent, and operational risks, including diversion of management’s attention from existing core businesses; difficulties integrating or separating businesses from existing operations; and challenges presented by acquisitions or joint ventures which may not achieve sales levels and profitability that justify the investments made. If the acquisitions, divestitures or joint ventures are not successfully implemented or completed, there could be a negative impact on our results of operations.

 

Anti- T akeover P rovisions I O ur C ertificate O f I ncorporation A nd B ylaws M ay D elay O r P revent A T hird P arty A cquisition O T he Company, W hich C ould D ecrease T he V alue O O ur C ommon S tock.

 

Effective March 1, 2015, we reorganized to create a holding company structure and the new holding company is organized in the State of Delaware. Our new certificate of incorporation and bylaws contain provisions that could make it more difficult for a third party to acquire us without the consent of our Board of Directors. These provisions will:

 

 

limit the business at special meetings to the purpose stated in the notice of the meeting;

 

 

authorize the issuance of “blank check” preferred stock, which is preferred stock with voting or other rights or preferences that could impede a takeover attempt and that the Board of Directors can create and issue without prior stockholder approval;

 

 

establish advance notice requirements for submitting nominations for election to the Board of Directors and for proposing matters that can be acted upon by stockholders at a meeting;

 

 

require the affirmative vote of the “disinterested” holders of a majority of our common stock to approve certain business combinations involving an “interested stockholder” or its affiliates, unless either minimum price criteria and procedural requirements are met, or the transaction is approved by a majority of our “continuing directors” (known as “fair price provisions”).

 

 

Although we believe all of these provisions will make a higher third-party bid more likely by requiring potential acquirers to negotiate with the Board of Directors, these provisions will apply even if an initial offer may be considered beneficial by some stockholders and therefore could delay and/or prevent a deemed beneficial offer from being considered. These provisions could also discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline.

 

Our Common Stock Price May Be Vo latile or M ay D ecline R egardless of our O perating P erformance.

 

Volatility in the market price of our common stock may prevent you from being able to sell your shares at or above the price you paid for such shares. Many factors, which are outside our control, may cause the market price of our common stock to fluctuate significantly, including those described elsewhere in this “Risk Factors” section and this Annual Report, as well as the following:

 

 

our operating and financial performance and prospects;

 

 

our quarterly or annual earnings or those of other companies in our industry compared to market expectations;

 

 

conditions that impact demand at our stores and for our products;

 

 

future announcements concerning our business or our competitors’ businesses;

 

 

the public’s reaction to our press releases, other public announcements and filings with the SEC;

 

 

the size of our public float, and the trading volume of our common stock;

 

 

coverage by or changes in financial estimates by securities analysts or failure to meet their expectations;

 

 

market and industry perception of our success, or lack thereof, in pursuing our growth strategy;

 

 

strategic actions by us or our competitors, such as acquisitions or restructurings;

 

 

changes in laws or regulations which adversely affect our industry or us;

 

 

changes in accounting standards, policies, guidance, interpretations or principles;

 

 

changes in senior management or key personnel;

 

 

issuances, exchanges or sales, or expected issuances, exchanges or sales of our capital stock;

 

 

changes in our dividend policy;

 

 

adverse resolution of new or pending litigation against us; and

 

 

changes in general market, economic and political conditions in the United States and global economies or financial markets, including those resulting from natural disasters, terrorist attacks, acts of war and responses to such events.

 

As a result, volatility in the market price of our common stock may prevent investors from being able to sell their common stock at or above the price they paid for such shares. These broad market and industry factors may materially reduce the market price of our common stock, regardless of our operating performance. In addition, price volatility may be greater if the public float and trading volume of our common stock is low. As a result, you may suffer a loss on your investment.

 

Our Ability to Pay Dividends on our Common Stock is Subject to the Discretion of our Board of Directors.

 

We have in the past made a regular quarterly cash dividend to our common stockholders. However, the payment of future dividends on our common stock will be subject to the discretion of our Board of Directors and will depend on, among other things, our results of operations, financial condition, capital requirements, and on such other factors as our Board of Directors may in its discretion consider relevant and in the best long-term interest of stockholders. Additionally, any change in the level of our dividends or the suspension of the payment thereof could adversely affect the market price of our common stock. For additional information on our payments of dividends, see "Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities—Dividends" under Part II of this Annual Report.

 

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES

 

Our manufacturing operations and corporate headquarters are located at a 53,000 square foot manufacturing facility, which we own, in Durango, Colorado. During FY 2019, our factory produced approximately 2.19 million pounds of chocolate candies, which was a decrease of approximately 13.9% from the approximately 2.55 million pounds produced in FY 2018. During FY 2008, we conducted a study of factory capacity. As a result of this study, we believe the factory has the capacity to produce approximately 5.3 million pounds per year, subject to certain assumptions about product mix. In January 1998, we acquired a two-acre parcel adjacent to our factory to ensure the availability of adequate space to expand the factory as volume demands.

 

U-Swirl’s principal offices are the same as the Company’s and located at 265 Turner Drive, Durango, Colorado 81303.

 

As of February 28, 2019, the Company had obligations for three non-cancelable leases of five to ten years for Rocky Mountain Chocolate Factory Company-owned stores having varying expiration dates from July 2019 to January 2026, some of which contain optional five or ten-year renewal rights. We do not deem any individual store lease to be significant in relation to our overall operations.

 

The leases for our U-Swirl Company-owned cafés range from approximately 1,600 to 3,000 square feet and have varying expiration dates from August 2019 to September 2024, some of which contain optional five or 10-year renewal rights. We currently have five café leases in place, which range between $3,500 and $8,100 per month, exclusive of common area maintenance charges and taxes.

 

For information as to the amount of our rental obligations under leases on both Company-owned and franchised stores, see Note 5 “Commitments and Contingencies” to our consolidated financial statements included in Item 8 of this Annual Report.

 

ITEM 3. LEGAL PROCEEDINGS

 

The Company is party to various other 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.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not Applicable.

 

 

PART II.

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information  

 

Our common stock trades on the Nasdaq Global Market under the trading symbol “RMCF.”

 

Holders

 

On May 10, 2019, there were approximately 300 record holders of our common stock. We believe that there are more than 800 beneficial owners of our common stock.

 

Dividends

 

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. Future declarations of dividends will depend on, among other things, our results of operations, financial condition, cash flows and capital requirements, and on such other factors as the Board of Directors may in its discretion consider relevant and in the best long-term interest of stockholders. We are subject to various financial covenants related to our line of credit and other long-term debt, however, those covenants do not restrict the Board of Director’s discretion of the future declaration of cash dividends.

 

Stock Repurchase Program

 

On July 15, 2014, the Company publicly announced a plan to purchase 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 common stock under the repurchase plan during FY 2019. As of February 28, 2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.

 

 

ITEM 6. SELECTED FINANCIAL DATA

 

The selected financial data presented below for the fiscal years ended February 28 or 29, 2015 through 2019, are derived from the consolidated financial statements of the Company, which have been audited by Plante & Moran, PLLC, our independent registered public accounting firm during the fiscal year ended February 28, 2019 or EKS&H LLLP, our independent registered public accounting firm for the fiscal years ended February 28 or 29, 2015 through 2018. The selected financial data should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this Annual Report and in Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operations” below.

 

All material inter-Company balances have been eliminated upon consolidation.

 

(Amounts in thousands, except per share data)

 

   

Fiscal Years Ended February 28 or 29,

 

Selected Statement of Operations Data

 

2019

   

2018

   

2017

   

2016

   

2015

 

Total revenues

  $ 34,545     $ 38,075     $ 38,296     $ 40,457     $ 41,508  

Operating income

    3,006       5,221       5,524       3,713       5,965  

Net income

  $ 2,239     $ 2,964     $ 3,450     $ 4,426     $ 3,938  
                                         

Basic Earnings per Common Share

  $ 0.38     $ 0.50     $ 0.59     $ 0.75     $ 0.64  

Diluted Earnings per Common Share

  $ 0.37     $ 0.50     $ 0.58     $ 0.73     $ 0.61  

Weighted average common shares outstanding

    5,931       5,884       5,843       5,894       6,144  

Weighted average common shares outstanding, assuming dilution

    5,983       5,980       5,994       6,095       6,413  

Selected Balance Sheet Data

                                       

Working capital

  $ 9,530     $ 7,364     $ 7,091     $ 7,433     $ 9,371  

Total Assets

    26,222       28,941       29,418       30,316       34,138  

Long-term debt

    -       1,176       2,529       3,831       5,083  

Stockholders' equity

    20,390       19,557       18,829       18,479       19,738  
                                         

Cash Dividend Declared per Common Share

  $ 0.48     $ 0.48     $ 0.48     $ 0.48     $ 0.45  

 

 

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes thereto, included elsewhere in this Annual Report on Form 10-K. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results may differ materially from those contained in or implied by any forward-looking statements. See “ Cautionary Note Regarding Forward-Looking Statements.” Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Item 1A. “Risk Factors.”

 

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 (“RMCF”) (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 wholly-owned subsidiary, U-Swirl International, Inc. (“U-Swirl”), franchises and operates self-serve frozen yogurt stores. 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 in selected locations outside of our system of retail stores and license the use of our brand with certain consumer products. As of March 31, 2019, there were two Company-owned, 90 licensee-owned and 245 franchised Rocky Mountain Chocolate Factory stores operating in 37 states, Canada, South Korea, Panama, and the Philippines. As of March 31, 2019, U-Swirl operated four Company-owned stores and 68 franchised and 30 licensed stores located in 26 states and Qatar. U-Swirl operates self-serve frozen yogurt cafes under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!” and “Aspen Leaf Yogurt”.

 

Current Trends and Outlook

 

Our business was significantly affected by the global recession during 2008-2009. We continued to experience this difficult environment throughout FY 2010 and FY 2011. The environment somewhat improved from FY 2012 to FY 2019, though we do not believe that the challenges have fully reversed. The economic recovery has had a less positive impact upon retail as consumers shift shopping to online. Locations that have historically been favorable locations for our franchisees, such as regional malls and outlet centers, have continued to struggle in the current environment. As a result, we intend to continue to focus on managing the business in a seasoned, disciplined and controlled manner.

 

The financing that our franchisees have historically relied upon was substantially affected by the changes in banking and lending requirements in the years after the global recession. Limited financing alternatives for domestic franchise growth led us to pursue a strategy of expansion through co-branding with complimentary concepts such as ice cream and frozen yogurt, international development, sale of our products to specialty markets, licensing the Rocky Mountain Chocolate Factory brand for use with other appropriate consumer products, and selected entry of Rocky Mountain Chocolate Factory branded products into other wholesale channels, along with business acquisitions as primary drivers of growth. This is a trend that continued in FY 2019 and we expect to continue into the foreseeable future.

 

Going forward in FY 2020, we are taking a conservative view of market conditions in the United States. We intend to continue to focus on our long-term objectives while seeking to maintain flexibility to respond to market conditions, including the pursuit of international growth opportunities to reduce our dependence on the domestic economy.

 

We are subject to seasonal fluctuations in sales because of key holidays and the location of our franchisees, which have traditionally been located in resort or tourist locations, and the nature of the products we sell, which are highly seasonal. As we expanded our geographical diversity to include regional centers and our franchise offerings to include frozen desserts, we have seen some moderation to our seasonal sales mix. Seasonal fluctuation in sales causes fluctuations in quarterly results of operations. Historically, the strongest sales of our products have occurred during key holidays and summer vacation seasons. Additionally, 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.

 

The most important factors in continued growth in our earnings are ongoing unit growth, increased same store sales and increased same store pounds purchased from the factory.

 

Our ability to successfully achieve expansion of our franchise systems depends on many factors not within our control including the availability of suitable sites for new store establishment and the availability of qualified franchisees to support such expansion.

 

Efforts to reverse the decline in same store pounds purchased from the factory by franchised stores and to increase total factory sales depend on many factors, including new store openings, competition, the receptivity of our franchise system to our product introductions and promotional programs. In FY 2019, same store pounds purchased from the factory by franchised and co-branded licensed stores declined approximately 1.2% in the first quarter, declined approximately 2.2% in the second quarter, declined approximately 1.9% in the third quarter, increased approximately 1.7% in the fourth quarter, and declined 0.5% overall in FY 2019 as compared to the same periods in FY 2018.

 

 

In May 2009, we announced the expansion of the co-branding test relationship with Cold Stone Creamery. We and Cold Stone Creamery, Inc. have agreed to expand the co-branding relationship to more than a hundred potential locations, based upon the performance of several test locations, operating under the test agreement announced in October 2008. We have additionally agreed to develop co-branded locations through U-Swirl and their associated brands. We believe that if this co-branding strategy continues to prove financially viable it could represent a significant future growth opportunity. As of February 28, 2019, Cold Stone licensees operated 91 co-branded locations, our U-Swirl franchisees operated 9 co-branded locations and we have co-branded 3 of our Company-owned cafés.

 

In April 2012, we announced our intent to pursue growth through international licensing. Since 2012, we have continued to develop internationally through the execution of license agreements in the countries of South Korea, the Republic of Panama, Vietnam, and the Republic of the Philippines. Through our U-Swirl subsidiary we have additional international development agreements covering Canada and Qatar.

 

Results of Operations

 

Fiscal 201 9 Compared To Fiscal 201 8

 

Results Summary

 

Basic earnings per share decreased 24.0% from $0.50 per share in FY 2018 to $0.38 per share in FY 2019. Revenues decreased 9.3% from $38.1 million for FY 2018 to $34.5 million for FY 2019. Operating income decreased 42.4% from $5.2 million in FY 2018 to $3.0 million in FY 2019. Net income decreased 24.5% from $3.0 million in FY 2018 to $2.2 million in FY 2019. The decrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.

 

Revenues

 

   

For the Year Ended

                 

($'s in thousands)

 

February 28,

         

%

 
   

2019

   

2018

   

Change

   

Change

 

Factory sales

  $ 24,179.5     $ 26,056.6     $ (1,877.1 )     (7.2 )%

Retail sales

    3,384.3       4,111.2       (726.9 )     (17.7 )%

Franchise fees

    335.0       681.6       (346.6 )     (50.9 )%

Royalty and marketing fees

    6,646.6       7,225.3       (578.7 )     (8.0 )%

Total

  $ 34,545.4     $ 38,074.7     $ (3,529.3 )     (9.3 )%

 

Factory Sales

 

The decrease in factory sales for FY 2019 compared to FY 2018 was primarily due to a 23.1% decrease in shipments of product to customers outside our network of franchised retail stores, partially offset by a 1.0% increase in shipments to our network of franchised and licensed stores. The decrease in shipments of product to customers outside our network of franchised and licensed stores was primarily the result of a decrease in purchases by the Company’s largest customer during FY 2019, with revenue from such customer decreasing to approximately $3.1 million, or 9.1%, of the Company’s revenues during FY 2019, compared to $5.1 million, or 13.4% of the Company’s revenues during FY 2018 for this same customer. Same-store pounds purchased by franchise and co-branded license locations decreased 0.5% during FY 2019 compared with FY 2018.

 

Retail Sales

 

The decrease in retail sales was primarily due to changes in retail units in operation resulting from the closure of certain underperforming Company-owned locations. Same store sales at all Company-owned stores and cafés increased 1.4% during FY 2019 compared with FY 2018.

 

Royalties, Marketing Fees and Franchise Fees

 

The decrease in royalties and marketing fees for FY 2019 compared to FY 2018 resulted primarily from a 9.1% decrease in franchise units in operation. The average number of total franchise stores in operation decreased from 317 during FY 2018 to 288 during FY 2019. This decrease is the result of domestic store closures exceeding domestic store openings. Same store sales at all franchise stores and cafés in operation increased 0.6% during FY 2019 compared to FY 2018. Franchise fee revenues decreased in FY 2019 compared to FY 2018 primarily as a result of $359,000 in international license fees being recognized during FY 2018 with no comparable fees recognized during FY 2019.

 

 

COSTS AND EXPENSES

 

Cost of Sales

 

   

For the Year Ended

                 
   

February 28,

       $    

%

 

($'s in thousands)

 

2019

   

2018

   

Change

   

Change

 
                                 

Cost of sales - factory

  $ 19,360.5     $ 19,703.6     $ (343.1 )     (1.7 )%

Cost of sales - retail

    1,239.0       1,473.1       (234.1 )     (15.9 )%

Franchise costs

    1,980.8       2,097.6       (116.8 )     (5.6 )%

Sales and marketing

    2,210.8       2,489.5       (278.7 )     (11.2 )%

General and administrative

    3,432.6       3,904.6       (472.0 )     (12.1 )%

Retail operating

    1,934.9       2,389.3       (454.4 )     (19.0 )%

Total

  $ 30,158.6     $ 32,057.7     $ (1,899.1 )     (5.9 )%

 

Gross Margin

 

For the Year Ended

                 
   

February 28,

       $    

%

 

($'s in thousands)

 

2019

   

2018

   

Change

   

Change

 
                                 

Factory gross margin

  $ 4,819.0     $ 6,353.0     $ (1,534.0 )     (24.1 )%

Retail gross margin

    2,145.3       2,638.1       (492.8 )     (18.7 )%

Total

  $ 6,964.3     $ 8,991.1     $ (2,026.8 )     (22.5 )%

 

Gross Margin

 

For the Year Ended

                 
   

February 28,

   

%

   

%

 
(Percent)  

2019

   

2018

   

Change

   

Change

 

 

                               

Factory gross margin

    19.9 %     24.4 %     (4.5 )%     (18.4 )%

Retail gross margin

    63.4 %     64.2 %     (0.8 )%     (1.2 )%

Total

    25.3 %     29.8 %     (4.5 )%     (15.1 )%

 

Adjusted Gross Margin

 

For the Year Ended

                 
   

February 28,

         

%

 

($'s in thousands)

 

2019

   

2018

   

Change

   

Change

 
                                 

Factory gross margin

  $ 4,819.0     $ 6,353.0     $ (1,534.0 )     (24.1 )%

Plus: depreciation and amortization

    555.9       523.0       32.9       6.3 %

Factory adjusted gross margin

    5,374.9       6,876.0       (1,501.1 )     (21.8 )%

Retail gross margin

    2,145.3       2,638.1       (492.8 )     (18.7 )%

Total Adjusted Gross Margin

  $ 7,520.2     $ 9,514.1     $ (1,993.9 )     (21.0 )%
                                 

Factory adjusted gross margin

    22.2 %     26.4 %     (4.2 )%     (15.9 )%

Retail gross margin

    63.4 %     64.2 %     (0.8 )%     (1.2 )%

Total Adjusted Gross Margin

    27.3 %     31.5 %     (4.2 )%     (13.3 )%

 

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.

 

 

Cost of Sales and Gross Margin

 

Factory gross margin decreased 450 basis points during FY 2019 compared to FY 2018 due primarily to lower efficiencies associated with a 13.9% decrease in production volume and higher costs associated with inventory obsolescence. Costs associated with inventory obsolescence were generally the result of the initiation of product rationalization resulting from lower volume and underperforming products. The decrease in Company-owned store margin is due primarily to a decrease in Company-owned café revenue from the sale of yogurt and the associated higher margins.

 

Franchise Costs

 

The decrease in franchise costs for FY 2019 compared to FY 2018 is due primarily to a decrease in professional fees and lower costs associated with lower international development in FY 2019 compared to FY 2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increased to 28.4% during FY 2019 from 26.5% during FY 2018. This increase as a percentage of royalty, marketing and franchise fees is primarily a result of an 11.7% decrease in total royalty and marketing fees and franchise fee revenue during FY 2019 compared to FY 2018.

 

Sales and Marketing

 

The decrease in sales and marketing costs during FY 2019 compared to FY 2018 is primarily due to lower marketing-related compensation and 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 during FY 2019 compared to FY 2018 is due primarily to lower professional fees, the result of resolving legal proceedings, and lower compensation costs. During FY 2019, approximately $103,000 of U-Swirl general and administrative costs were consolidated within our results, compared with approximately $307,000 during FY 2018. As a percentage of total revenues, general and administrative expenses decreased to 9.9% in FY 2019 compared to 10.3% in FY 2018.

 

Retail Operating Expenses

 

Retail operating expenses decreased during FY 2019 compared to FY 2018 due primarily to changes in units in operation, resulting from the sale of certain Company-owned units and the closure of a certain underperforming Company-owned location, offset by the acquisition of a franchised location. Retail operating expenses, as a percentage of retail sales, decreased to 57.2% during FY 2019 from 58.1% during FY 2018. This is primarily the result of a change in units in operation.

 

Depreciation and Amortization

 

Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $1,154,000 during FY 2019, an increase of 45.0% from $796,000 incurred during FY 2018. This increase was the result of a change in management’s estimates related to the future value of U-Swirl intangibles and the associated acceleration of amortization expense. During the year ended February 28, 2019 the Company reviewed its estimates of the future economic life of certain intangible assets. As a result of this review, the Company accelerated the rate of amortization of certain intangible assets to better reflect their expected future value. Depreciation and amortization included in cost of sales increased 6.3% from $523,000 during FY 2018 to $556,000 during FY 2019. This increase was the result of an increase in production assets in service.

 

Other Income (Expense)

 

Net interest expense was $50,300 in FY 2019 compared to net interest expense of $96,700 in FY 2018. This change was the result of lower average outstanding debt from a promissory note entered into in January 2014 to fund business acquisitions by U-Swirl.

 

 

Income Tax Expense

 

We realized an income tax expense of $717,000 in FY 2019 compared to an income tax expense of $2,160,000 during FY 2018. As described further in Note 6 to the consolidated financial statements, the decrease in the effective tax rate is primarily due to the revaluation of deferred tax assets and liabilities to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act recognized during FY 2018, with no comparable revaluation recognized during FY 2019. Additionally, the decrease in the effective tax rate during FY 2019 compared to 2018 was due to the lower enacted U.S. corporate tax rate of 21% under the Tax Cuts and Jobs Act being effective for all of FY 2019 and only two months of FY 2018.

 

Fiscal 201 8 Compared To Fiscal 201 7

 

A discussion of our results of operations for FY 2018 in comparison to FY 2017 can be found in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the Fiscal Year Ended February 28, 2018 .

 

Liquidity and Capital Resources

 

As of February 28, 2019, working capital was $9.5 million compared with $7.4 million as of February 28, 2018. The increase in working capital was due primarily to the impact of the adoption of ASU 2014-09, “REVENUE FROM CONTRACTS WITH CUSTOMERS” (“ASC 606”) during FY 2019 and our operating results less the payment of $2.8 million in cash dividends, $1.4 million in debt repayments and the purchase of $614,000 of property and equipment. We have historically generated excess operating cash flow. We review our working capital needs and projections and when we believe that we have greater working capital than necessary we have historically utilized that excess working capital to repurchase common stock and pay dividends to our stockholders.

 

Cash and cash equivalent balances decreased from $6.1 million as of February 28, 2018 to $5.4 million as of February 28, 2019 as a result of cash flows generated by operating activities being less than cash flows used in financing and investing activities. Our current ratio was 3.0 to 1.0 at February 28, 2019 compared to 1.9 to 1.0 at February 28, 2018. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.

 

During FY 2019, we had net income of $2.2 million. Operating activities provided cash of $4.0 million, with the principal adjustment to reconcile net income to net cash provided by operating activities being depreciation and amortization of $1.7 million and stock compensation expense of $520,000. During FY 2018, we had net income of $3.0 million. Operating activities provided cash of $4.8 million, with the principal adjustment to reconcile net income to net cash provided by operating activities being depreciation and amortization of $1.3 million and stock compensation expense of $0.6 million.

 

During FY 2019, investing activities used cash of $506,000, primarily due to the purchases of property and equipment of $614,000 the result of investment in factory infrastructure improvements, partially offset by proceeds received on notes receivable of $102,000. In comparison, investing activities used cash of $340,000 during FY 2018 primarily due to the purchases of property and equipment of $545,000 the result of investment in factory infrastructure improvements, partially offset by proceeds received on notes receivable of $231,000.

 

Financing activities used cash of $4.2 million during FY 2019 and used cash of $4.1 million during the prior year. The increase in cash used in financing activities was primarily due to an increase in the amount of debt service being applied to principal, the result of lower interest expense.

 

The Company has a $5.0 million credit line for general corporate and working capital purposes, of which $5.0 million was available for borrowing (subject to certain borrowing base limitations) as of February 28, 2019. The credit line is secured by substantially all of the Company’s assets, except retail store assets. Interest on borrowings is at LIBOR plus 2.25% (4.7% at February 28, 2019). Additionally, the line of credit is subject to various financial ratio and leverage covenants. At February 28, 2019, the Company was in compliance with all such covenants. The credit line is subject to renewal in September 2019 and the Company believes it is likely to be renewed on terms similar to the current terms.

 

The Company’s long-term debt is comprised of a promissory note used to finance prior business acquisitions by SWRL (unpaid balance as of February 28, 2019, $1.2 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%. This promissory note matures in January 2020. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of February 28, 2019, we were in compliance with all such covenants.

 

 

The table below presents significant contractual obligations of the Company at February 28, 2019.

(Amounts in thousands)

Contractual Obligations  

Total

   

Less than 1

year

   

2-3 Years

   

4-5 years

   

More Than 5

years

 

Notes payable

  $ 1,176     $ 1,176     $ -     $ -     $ -  

Operating leases

    2,949       758       1,333       683       175  

Purchase contracts

    880       880       -       -       -  

Other long-term obligations

    231       135       96       -       -  

Total

  $ 5,236     $ 2,949     $ 1,429     $ 683     $ 175  

 

For FY 2020, the Company anticipates making capital expenditures of approximately $900,000, which will be used to maintain and improve existing factory and administrative infrastructure. The Company believes that cash flow from operations will be sufficient to fund capital expenditures and working capital requirements for FY 2020. If necessary, the Company has an available bank line of credit to help meet these requirements.

 

Off-Balance Sheet Arrangements

 

Operating leases: Our Company-owned stores are occupied pursuant to non-cancelable leases of five to ten years having varying expiration dates, some of which contain optional renewal rights. We also lease warehouse facilities to support our manufacturing operations and we lease most of our transportation equipment. We do not deem any individual lease to be significant in relation to our overall operations.

 

Purchase obligations: As of February 28, 2019, we had purchase obligations of approximately $880,000. These purchase obligations primarily consist of contractual obligations for future purchases of commodities for use in our manufacturing.

 

Impact of Inflation

 

Inflationary factors such as increases in the costs of ingredients and labor directly affect the Company's operations. Most of the Company's leases provide for cost-of-living adjustments and require it to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally, the Company’s future lease cost for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that the Company will be able to pass on increased costs to its customers.

 

Depreciation expense is based on the historical cost to the Company of its 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.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosures. Estimates and assumptions include, but are not limited to, the carrying value of accounts and notes receivable from franchisees, inventories, the useful lives of fixed assets, goodwill, and other intangible assets, income taxes, contingencies and litigation. We base our estimates on analyses, of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

 

We believe that the following represent our more critical estimates and assumptions used in the preparation of our consolidated financial statements, although not all inclusive.

 

Accounts and Notes Receivable - In the normal course of business, we extend credit to customers, primarily franchisees, that satisfy pre-defined credit criteria. We believe that we have a limited concentration of credit risk primarily because our receivables are secured by the assets of the franchisees to which we ordinarily extend credit, including, but not limited to, their franchise rights and inventories. An allowance for doubtful accounts is determined through analysis of the aging of accounts receivable, assessments of collectability based on historical trends, and an evaluation of the impact of current and projected economic conditions. The process by which we perform our analysis is conducted on a customer by customer, or franchisee by franchisee, basis and takes into account, among other relevant factors, sales history, outstanding receivables, customer financial strength, as well as customer specific and geographic market factors relevant to projected performance. The Company monitors the collectability of its accounts receivable on an ongoing basis by assessing the credit worthiness of its customers and evaluating the impact of reasonably likely changes in economic conditions that may impact credit risks. Estimates with regard to the collectability of accounts receivable are reasonably likely to change in the future.

 

 

We recorded an average expense of approximately $149,000 per year for potential uncollectible accounts over the three-year period ended February 28, 2019. Write-offs of uncollectible accounts net of recoveries averaged approximately $209,500 over the same period. The provision for uncollectible accounts is recognized as general and administrative expense in the Statements of Income. Over the past three years, the allowances for doubtful notes and accounts have ranged from 10.0% to 10.7% of gross receivables.

 

Revenue Recognition - We recognize revenue on sales of products to franchisees and other customers at the time of delivery. Beginning in FY 2019, upon adoption of ASC 606, the Company began recognizing franchise fees and license fees over the term of the associated agreement, which is generally a period of 10-15 years. Prior to FY 2019, franchise fee revenue was recognized upon opening of the franchise store, or upon execution of an international license agreement. We recognize a marketing and promotion fee of one percent (1%) of the Rocky Mountain Chocolate Factory and U-Swirl franchised stores’ gross retail sales and a royalty fee based on gross retail sales. The Company recognizes no royalty on franchised stores’ retail sales of products purchased from the Company and recognizes a ten percent (10%) royalty on all other sales of product sold at franchise locations. Royalty fees for U-Swirl cafés are based on the rate defined in the acquired contracts for the franchise rights and range from 2.5% to 6% of gross retail sales. Rebates received from purveyors that supply products to our franchisees are included in franchise royalties and fees. Product rebates are recognized in the period in which they are earned. Rebates related to Company-owned locations are offset against operating costs.

 

Inventories - Our inventories are stated at the lower of cost or net realizable value and are reduced by an allowance for slow-moving, excess, discontinued and shelf-life expired inventories. Our estimate for such allowance is based on our review of inventories on hand compared to estimated future usage and demand for our products. Such review encompasses not only potentially perishable inventories but also specialty packaging, much of it specific to certain holiday seasons. If actual future usage and demand for our products are less favorable than those projected by our review, inventory reserve adjustments may be required. We closely monitor our inventory, both perishable and non-perishable, and related shelf and product lives. Historically we have experienced low levels of obsolete inventory or returns of products that have exceeded their shelf life. Over the three-year period ended February 28, 2019, the Company recorded expense averaging $228,900 per year for potential inventory losses, or approximately 1.1% of total cost of sales for that period.

 

Consolidation – The consolidated financial statements in this Annual Report include the accounts of the Company and its subsidiaries. On January 14, 2013 we acquired a controlling interest in U-Swirl. Prior to January 14, 2013, our consolidated financial statements exclude the financial information of U-Swirl. Beginning on January 14, 2013 and continuing through February 28, 2019, the results of operations, assets and liabilities of U-Swirl have been included in our consolidated financial statements. All material inter-Company balances have been eliminated upon consolidation.

 

Goodwill – Goodwill consists of the excess of purchase price over the fair market value of acquired assets and liabilities. Effective March 1, 2002, under ASC Topic 350, all goodwill with indefinite lives is no longer subject to amortization. ASC Topic 350 requires that an impairment test be conducted annually or in the event of an impairment indicator. We previously entered into a loan and security agreement with SWRL to cover the purchase price and other costs associated with acquisitions of SWRL (the “SWRL Loan Agreement”). Borrowings under the SWRL Loan Agreement were secured by all of the assets of SWRL, including all of the outstanding stock of its wholly-owned subsidiary, U-Swirl. As a result of certain defaults under the SWRL Loan Agreement, we issued a demand for payment of all obligations under the SWRL Loan Agreement. On February 29, 2016, RMCF repossessed all stock in U-Swirl pledged as collateral on the SWRL Loan Agreement. As of February 29, 2016 U-Swirl had $1,930,529 of Goodwill recorded as a result of past business acquisitions. We performed a test of impairment as a result of the change in ownership and the result of our test indicated a full impairment of the U-Swirl goodwill. Our testing and impairment is described in Note 13 to the financial statements.

 

Franchise Rights – Franchise rights consists of the purchase price paid in consideration of certain rights associated with franchise agreements. These franchise agreements provide for future payments to the franchisor of royalty and marketing fees. We consider franchise rights to have a 20 year life.

 

Other accounting estimates inherent in the preparation of our consolidated financial statements include estimates associated with its evaluation of the recoverability of deferred tax assets, as well as those used in the determination of liabilities related to litigation and taxation. Various assumptions and other factors underlie the determination of these significant estimates. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, current and expected economic conditions, and product mix. The Company constantly re-evaluates these significant factors and makes adjustments where facts and circumstances dictate. Historically, actual results have not significantly deviated from those determined using the estimates described above.

 

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company does not engage in commodity futures trading or hedging activities and does not enter into derivative financial instruments for trading or other speculative purposes. The Company also does not engage in transactions in foreign currencies or in interest rate swap transactions that could expose the Company to market risk. However, the Company is exposed to some commodity price and interest rate risks.

 

The Company frequently enters into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit the Company 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, the Company may benefit if prices rise during the terms of these contracts, but it may be required to pay above-market prices if prices fall and it is unable to renegotiate the terms of the contract. As of February 28, 2019, based on future contractual obligations for chocolate products, we estimate that a 10% increase or decrease in the prices of contracted ingredients would result in an $88,000 favorable or unfavorable price benefit or cost resulting from our commodity purchase contracts.

 

The Company has a $5 million bank line of credit that bears interest at a variable rate. As of February 28, 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.

 

The Company also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually to finance the previous acquisitions by SWRL. As of February 28, 2019, $1.2 million was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.

 

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

INDEX TO FINANCIAL STATEMENTS

 

 

 

Page

   

Reports of Independent Registered Public Accounting Firms

33-34

   

Consolidated Statements of Income

35

   

Consolidated Balance Sheets

36

   

Consolidated Statements of Changes in Stockholders’ Equity

37

   

Consolidated Statements of Cash Flows

38

   

Notes to Consolidated Financial Statements

39

 

 

Report of Independent Registered Public Accounting Firm

 

To the Stockholders and Board of Directors of Rocky Mountain Chocolate Factory, Inc.

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheet of Rocky Mountain Chocolate Factory, Inc. (the “Company”) as of February 28, 2019, the related consolidated statement of income, stockholders' equity, and cash flows for the year ended February 28, 2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of February 28, 2019 and the results of its operations and its cash flows for the year ended February 28, 2019, in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in Note 1 to the financial statements, the Company adopted Accounting Standards Codification (ASC) Topic 606, “Revenue from Contracts with Customers,” using the modified retrospective adoption method on March 1, 2018.

 

Basis for Opinion

 

The Company's management is responsible for these financial statements. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.

 

Change in Accounting Principle

 

As discussed in Note 1 and 17 to the financial statements, the Company adopted Accounting Standards Codification (ASC) Topic 606, “Revenue from Contracts with Customers,” using the modified retrospective adoption method on March 1, 2018.

 

We have audited the impact to the 2018 financial statements as disclosed under the modified retrospective method as a result of the adoption of ASC Topic 606, “Revenue from Contracts with Customers”, as described in Note 1 and 17 to the financial statements. In our opinion, the impacts are appropriate and have been properly disclosed. We were not engaged to audit, review, or apply any procedures to the 2018 financial statements of the Company other than with respect to the impacts disclosed and, accordingly, we do not express an opinion or any other form of assurance on the 2018 financial statements taken as a whole.

 

 

 

/s/ Plante & Moran, PLLC

 

 

Denver, Colorado

 

 

May 8, 2019          

 

 

Report of Independent Registered Public Accounting Firm

 

To the Stockholders and Board of Directors of Rocky Mountain Chocolate Factory, Inc.

 

Opinion on the Financial Statements

 

We have audited the accompanying balance sheet of Rocky Mountain Chocolate Factory, Inc. (the “Company”) as of February 28, 2018, the related statements of income, stockholders' equity, and cash flows for each of the years in the two-year period ended February 28, 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of February 28, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the two-year period ended February 28, 2018, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

The Company's management is responsible for these financial statements. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

 

/s/ EKS&H LLLP

 

 

 

Denver, Colorado

 

 

May 15, 2018          

 

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

 

    

FOR THE YEARS ENDED FEBRUARY 28,

 
    

2019

   

2018

   

2017

 

Revenues

                       

Sales

  $ 27,563,794     $ 30,167,760     $ 29,876,507  

Franchise and royalty fees

    6,981,653       7,906,935       8,419,870  

Total Revenue

    34,545,447       38,074,695       38,296,377  
                          

Costs and Expenses

                       

Cost of sales

    20,599,551       21,176,711       20,735,739  

Franchise costs

    1,980,781       2,097,555       2,067,530  

Sales and marketing

    2,210,800       2,489,483       2,658,421  

General and administrative

    3,432,618       3,904,560       4,005,142  

Retail operating

    1,934,891       2,389,296       2,404,003  

Depreciation and amortization, exclusive of depreciation and amortization expense of $555,926, $523,034, and $447,651, respectively, included in cost of sales

    1,153,873       796,221       841,058  

Costs associated with Company-owned store closures

    226,981       -       60,000  

Total costs and expenses

    31,539,495       32,853,826       32,771,893  
                         

Income from Operations

    3,005,952       5,220,869       5,524,484  
                         

Other Income (Expense)

                       

Interest expense

    (70,787 )     (121,244 )     (170,351 )

Interest income

    20,496       24,578       41,572  

Other expense, net

    (50,291 )     (96,666 )     (128,779 )
                         

Income Before Income Taxes

    2,955,661       5,124,203       5,395,705  
                         

Income Tax Provision

    716,862       2,160,295       1,945,589  
                         

Consolidated Net Income

  $ 2,238,799     $ 2,963,908     $ 3,450,116  
                         

Basic Earnings per Common Share

  $ 0.38     $ 0.50     $ 0.59  

Diluted Earnings per Common Share

  $ 0.37     $ 0.50     $ 0.58  
                         

Weighted Average Common Shares

                       

Outstanding - Basic

    5,931,431       5,884,337       5,843,245  

Dilutive Effect of Employee

                       

Stock Awards

    51,207       96,099       150,447  

Weighted Average Common Shares

                       

Outstanding - Diluted

    5,982,638       5,980,436       5,993,692  

 

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

 

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

    

AS OF FEBRUARY 28,

 
    

2019

   

2018

 

Assets

               

Current Assets

               

Cash and cash equivalents

  $ 5,384,027     $ 6,072,984  
Accounts receivable, less allowance for doubtful accounts of $489,502 and $479,472, respectively     3,993,262       3,897,334  

Notes receivable, current portion, less current portion of the valuation allowance of $0 and $9,000, respectively

    110,162       105,540  

Refundable income taxes

    190,201       342,863  

Inventories, less reserve for slow moving inventory of $371,147 and $357,706, respectively

    4,270,357       4,842,474  

Other

    318,126       310,173  

Total current assets

    14,266,135       15,571,368  
                 

Property and Equipment, Net

    5,786,139       6,166,240  

Other Assets

               

Notes receivable, less current portion and valuation allowance of $0 and $17,500, respectively

    281,669       235,983  

Goodwill, net

    1,046,944       1,046,944  

Franchise rights, net

    3,678,920       4,433,927  

Intangible assets, net

    498,337       587,377  

Deferred income taxes

    607,421       835,463  

Other

    56,576       63,333  

Total other assets

    6,169,867       7,203,027  

Total Assets

  $ 26,222,141     $ 28,940,635  

Liabilities and Stockholders' Equity

               

Current Liabilities

               

Current maturities of long term debt

  $ 1,176,488     $ 1,352,893  

Accounts payable

    897,074       1,647,991  

Accrued salaries and wages

    655,853       644,005  

Gift card liabilities

    742,289       3,057,131  

Other accrued expenses

    293,094       325,034  

Dividend payable

    714,939       708,652  

Contract liabilities

    256,094       471,910  

Total current liabilities

    4,735,831       8,207,616  

Long-Term Debt, Less Current Maturities

    -       1,176,416  

Contract Liabilities, Less Current Portion

    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; 50,000 authorized; -0- shares issued and outstanding

    -       -  

Undesignated series; 200,000 shares authorized; -0- shares issued and outstanding

    -       -  

Common stock, $.001 par value, 46,000,000 shares authorized, 5,957,827 shares and 5,903,436 shares issued and outstanding, respectively

    5,958       5,903  

Additional paid-in capital

    6,650,864       6,131,147  

Retained earnings

    13,733,010       13,419,553  

Total stockholders' equity

    20,389,832       19,556,603  

Total Liabilities and Stockholders' Equity

  $ 26,222,141     $ 28,940,635  

 

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

 

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

 

   

FOR THE YEARS ENDED FEBRUARY 28,

 
   

2019

   

2018

   

2017

 

Common Stock

                       

Balance at beginning of year

  $ 5,903     $ 5,854     $ 5,839  

Repurchase and retirement of common stock

    -       -       (35 )

Issuance of common stock

    6       5       2  

Exercise of stock options, vesting of restricted stock units and other

    49       44       48  

Balance at end of year

    5,958       5,903       5,854  
                         

Additional Paid-In Capital

                       

Balance at beginning of year

    6,131,147       5,539,357       5,340,190  

Repurchase and retirement of common stock

    -       -       (351,548 )

Issuance of common stock

    55,971       59,095       20,418  

Exercise of stock options, vesting of restricted stock units and other

    463,746       532,695       564,425  

Tax (expense) benefit from employee stock transactions

    -       -       (34,128 )

Balance at end of year

    6,650,864       6,131,147       5,539,357  
                         

Retained Earnings

                       

Balance at beginning of year

    13,419,553       13,283,646       13,132,879  

Net income attributable to RMCF stockholders

    2,238,799       2,963,908       3,450,116  

Cash dividends declared

    (2,851,271 )     (2,828,001 )     (2,806,583 )

Correction of immaterial error 1

    -       -       (492,766 )

Adoption of ASC 606 2

    925,929       -       -  

Balance at end of year

    13,733,010       13,419,553       13,283,646  

Total Stockholders' Equity

    20,389,832       19,556,603       18,828,857  
                         

Common Shares

                       

Balance at beginning of year

    5,903,436       5,854,372       5,839,396  

Repurchase and retirement of common stock

    -       -       (35,108 )

Issuance of common stock

    5,333       5,000       2,000  

Exercise of stock options, vesting of restricted stock units and other

    49,058       44,064       48,084  

Balance at end of year

    5,957,827       5,903,436       5,854,372  

 

1 As revised. Refer to Note 16 for information on immaterial correction of errors in prior period.

2 Refer to Note 17 for information on the adoption of ASC 606.

 

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

 

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   

FOR THE YEARS ENDED FEBRUARY 28,

 
   

2019

   

2018

   

2017

 

Cash Flows From Operating Activities

                       

Net Income

  $ 2,238,799     $ 2,963,908     $ 3,450,116  

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

                 

Depreciation and amortization

    1,709,799       1,319,255       1,288,709  

Provision for obsolete inventory

    325,478       166,868       138,125  

Provision for loss on accounts and notes receivable

    155,600       225,858       100,049  

Asset impairment and store closure losses

    67,822       -       -  

Loss on sale or disposal of property and equipment

    36,024       38,496       37,112  

Expense recorded for stock compensation

    519,772       591,839       584,893  

Deferred income taxes

    (78,934 )     23,411       262,248  

Changes in operating assets and liabilities:

                       

Accounts receivable

    (390,663 )     (229,948 )     (128,404 )

Refundable income taxes

    157,544       (295,000 )     (47,863 )

Inventories

    41,310       (365,323 )     (2,735 )

Other current assets

    (8,225 )     (54,091 )     29,442  

Accounts payable

    (545,588 )     96,491       (87,657 )

Accrued liabilities

    (84,191 )     242,578       (293,402 )

Contract Liabilities

    (129,527 )     33,270       (9,619 )

Net cash provided by operating activities

    4,015,020       4,757,612       5,321,014  
                         

Cash Flows from Investing Activities

                       

Addition to notes receivable

    -       (14,293 )     (133,202 )

Proceeds received on notes receivable

    102,256       230,637       318,219  

Purchase of intangible assets

    -       (8,508 )     (312,947 )

Proceeds from (cost of) sale or distribution of assets

    13,498       (7,926 )     39,045  

Purchases of property and equipment

    (613,786 )     (544,956 )     (1,238,472 )

(Increase) decrease in other assets

    (8,140 )     5,529       34,479  

Net cash used in investing activities

    (506,172 )     (339,517 )     (1,292,878 )
                         

Cash Flows from Financing Activities

                       

Payments on long-term debt

    (1,352,821 )     (1,302,432 )     (1,253,392 )

Repurchase of common stock

    -       -       (351,583 )

Tax expense of stock option exercise

    -       -       (34,128 )

Dividends paid

    (2,844,984 )     (2,821,874 )     (2,804,786 )

Net cash used in financing activities

    (4,197,805 )     (4,124,306 )     (4,443,889 )
                         

Net Decrease in Cash and Cash Equivalents

    (688,957 )     293,789       (415,753 )
                         

Cash and Cash Equivalents, Beginning of Period

    6,072,984       5,779,195       6,194,948  
                         

Cash and Cash Equivalents, End of Period

  $ 5,384,027     $ 6,072,984     $ 5,779,195  

 

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

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

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), Aspen Leaf Yogurt, LLC (“ALY”), and U-Swirl International, Inc. (“U-Swirl”), and its 46%-owned subsidiary, U-Swirl, Inc. (“SWRL”) (collectively, the “Company”).

 

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 self-serve frozen yogurt cafés. The Company also sells its candy in selected locations outside of its system of retail stores and licenses the use of its brand with certain consumer products.

 

U-Swirl operates self-serve frozen yogurt cafés under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!” and “Aspen Leaf Yogurt”.

 

The Company’s revenues are currently derived from three principal sources: sales to franchisees and others of chocolates and other confectionery products manufactured by the Company; the collection of initial franchise fees and royalties from franchisees’ sales; and sales at Company-owned stores of chocolates, frozen yogurt, and other confectionery products.

 

The following table summarizes the number of stores operating under the Rocky Mountain Chocolate Factory brand and its subsidiaries at February 28, 2019:

 

   

Sold, Not Yet

Open

   

Open

   

Total

 

Rocky Mountain Chocolate Factory

                       

Company-owned stores

    -       2       2  

Franchise stores - Domestic stores and kiosks

    4       183       187  

International license stores

    1       64       65  

Cold Stone Creamery - co-branded

    11       91       102  

U-Swirl (Including all associated brands)

                       

Company-owned stores

    -       1       1  

Company-owned stores - co-branded

    -       3       3  

Franchise stores - Domestic stores

    -       87       87  

Franchise stores - Domestic - co-branded

    -       9       9  

International license stores

    -       2       2  

Total

    16       442       458  

 

Consolidation

 

Management accounts for the activities of the Company and its subsidiaries, and the accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. As described above, on January 14, 2013, the Company acquired a controlling interest in SWRL. Prior to January 14, 2013, the Company’s consolidated financial statements excluded the financial information of SWRL. Beginning on January 14, 2013, the results of operations, assets and liabilities of SWRL have been included in these consolidated financial statements. The Company foreclosed on all of the outstanding stock of U-Swirl International, Inc. as of February 29, 2016 in full satisfaction of the amounts owed under a loan and security agreement with SWRL to cover the purchase price and other costs associated with the acquisitions (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 U-Swirl, Inc. as of February 29, 2016. As of February 29, 2016, U-Swirl, Inc. had no assets. All intercompany balances and transactions have been eliminated in consolidation.

 

Cash Equivalents

 

The Company considers all highly liquid instruments purchased with an original maturity of six months or less to be cash equivalents. The Company continually monitors its positions with, and the credit quality of, the financial institutions with which it invests. As of the balance sheet date, and periodically throughout the year, the Company has maintained balances in various operating accounts in excess of federally insured limits. This amount was approximately $4.9 million at February 28, 2019.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Accounts and Notes Receivable

 

In the normal course of business, the Company extends credit to customers, primarily franchisees that satisfy pre-defined credit criteria. The Company believes that it has limited concentration of credit risk primarily because its receivables are secured by the assets of the franchisees to which the Company ordinarily extends credit, including, but not limited to, their franchise rights and inventories. An allowance for doubtful accounts is determined through analysis of the aging of accounts receivable, assessments of collectability based on historical trends, and an evaluation of the impact of current and projected economic conditions. The process by which the Company performs its analysis is conducted on a customer by customer, or franchisee by franchisee, basis and takes into account, among other relevant factors, sales history, outstanding receivables, customer financial strength, as well as customer specific and geographic market factors relevant to projected performance. The Company monitors the collectability of its accounts receivable on an ongoing basis by assessing the credit worthiness of its customers and evaluating the impact of reasonably likely changes in economic conditions that may impact credit risks. Estimates with regard to the collectability of accounts receivable are reasonably likely to change in the future. At February 28, 2019, the Company had $391,831 of notes receivable outstanding and an allowance for doubtful accounts of $0 associated with these notes. The notes require monthly payments and bear interest rates ranging from 4.5% to 6%. The notes mature through November 2023 and approximately $375,000 of notes receivable are secured by the assets financed.

 

Inventories

 

Inventories are stated at the lower of cost or net realizable value. An inventory reserve is established to reduce the cost of obsolete, damaged and excess inventories to the lower of cost or net realizable value based on actual differences. This inventory reserve is determined through analysis of items held in inventory, and, if the recorded value is higher than the market value, the Company records an expense to reduce inventory to its actual market value. The process by which the Company performs its analysis is conducted on an item by item basis and takes into account, among other relevant factors, market value, sales history and future sales potential. Cost is determined using the first-in, first-out method.

 

Property and Equipment and Other Assets

 

Property and equipment are recorded at cost. Depreciation and amortization are computed using the straight-line method based upon the estimated useful life of the asset, which range from five to thirty-nine years. Leasehold improvements are amortized on the straight-line method over the lives of the respective leases or the service lives of the improvements, whichever is shorter.

 

The Company reviews its long-lived assets through analysis of estimated fair value, including identifiable intangible assets, whenever events or changes indicate the carrying amount of such assets may not be recoverable. The Company’s policy is to review the recoverability of all assets, at a minimum, on an annual basis.

 

Income Taxes

 

The Company provides for income taxes pursuant to the liability method. The liability method requires recognition of deferred income taxes based on temporary differences between financial reporting and income tax bases of assets and liabilities, using current enacted income tax rates and regulations. These differences will result in taxable income or deductions in future years when the reported amount of the asset or liability is recovered or settled, respectively. Considerable judgment is required in determining when these events may occur and whether recovery of an asset, including the utilization of a net operating loss or other carryforward prior to its expiration, is more likely than not. Due to historical U-Swirl losses, prior to FY 2016 the Company established a full valuation allowance on the Company’s deferred tax assets. During FY 2016 the Company took possession of the outstanding equity in U-Swirl. As a result of the Company’s ownership increasing to 100%, the Company began filing consolidated income tax returns in FY 2017. Because of this change, the Company has recognized the full value of deferred tax assets that had full valuation allowances prior to FY 2016. During the fourth quarter of FY 2017 the Company further evaluated the value of deferred tax assets and determined that the assets are restricted due to a limitation on the deductibility of future losses in accordance with Section 382 of the Internal Revenue Code as a result of the foreclosure transaction. The correction of this immaterial error to the Company’s balance sheet is further described in Note 16. The Company's temporary differences are listed in Note 6.

 

Gift C ard B reakage

 

The Company and its franchisees sell gift cards that are redeemable for product in stores. The Company manages the gift card program, and therefore collects all funds from the activation of gift cards and reimburses franchisees for the redemption of gift cards in their stores. A liability for unredeemed gift cards is included in accounts payable and accrued liabilities in the balance sheets.

 

There are no expiration dates on the Company’s gift cards, and the Company does not charge any service fees. While the Company’s franchisees continue to honor all gift cards presented for payment, the Company may determine the likelihood of redemption to be remote for certain cards due to long periods of inactivity. The Company has historically accumulated gift card liabilities and has not recognized breakage associated with the gift card liability. The adoption of ASU 2014-09, “REVENUE FROM CONTRACTS WITH CUSTOMERS” (“ASC 606”) during FY 2019 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. Accrued gift card liability was $742,289 and $3,057,131 at February 28, 2019 and 2018, respectively. The Company recognized breakage of $139,188 and $0 during FY 2019 and FY 2018, respectively. See Note 17 to the financial statements for a complete description of the adjustments recorded upon the adoption of ASC 606.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Goodwill

 

Goodwill arose from three transaction types. The first type was the result of the incorporation of the Company after its inception as a partnership. The goodwill recorded was the excess of the purchase price of the Company over the fair value of its assets. The Company has allocated this goodwill equally between its Franchising and Manufacturing operations. The second type was the purchase of various retail stores, either individually or as a group, for which the purchase price was in excess of the fair value of the assets acquired. Finally, goodwill arose from business acquisitions, where the fair value of the consideration given for acquisition exceeded the fair value of the identified assets net of liabilities.

 

The Company performs a goodwill impairment test on an annual basis or more frequently when events or circumstances indicate that the carrying value of a reporting unit more likely than not exceeds its fair value. Recoverability of goodwill is evaluated through comparison of the fair value of each of the Company’s reporting units with its carrying value. To the extent that a reporting unit’s carrying value exceeds the implied fair value of its goodwill, an impairment loss is recognized. On February 29, 2016 RMCF repossessed all stock in U-Swirl International, Inc. pledged as collateral on the SWRL Loan Agreement. This was the result of SWRL’s inability to repay the SWRL Loan Agreement and inability to cure defaults of financial covenants. As of February 29, 2016, U-Swirl had $1,930,529 of goodwill recorded as a result of past business acquisitions. In the fourth quarter of FY 2016, RMCF performed a test of impairment as a result of the change in ownership and the result of the Company’s test indicated a full impairment of the U-Swirl goodwill. The Company’s testing and impairment is described in Note 13 to the financial statements.

 

Franchise Rights

 

Franchise rights arose from the entry into agreements to acquire substantially all of the franchise rights of Yogurtini, CherryBerry, Fuzzy Peach, Let’s Yo! and Yogli Mogli. Franchise rights are amortized over a period of 20 years.

 

Insurance and Self-Insurance Reserves

 

The Company uses a combination of insurance and self-insurance plans to provide for the potential liabilities for workers’ compensation, general liability, property insurance, director and officers’ liability insurance, vehicle liability and employee health care benefits. Liabilities associated with the risks that are retained by the Company are estimated, in part, by considering historical claims experience, demographic factors, severity factors and other assumptions. While the Company believes that its assumptions are appropriate, the estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends.

 

Sales

 

Sales of products to franchisees and other customers are recognized at the time of delivery. Sales of products to franchisees and other customers are made at standard prices, without any bargain sales of equipment or supplies. Sales of products at retail stores are recognized at the time of sale.

 

Rebates

 

Rebates received from purveyors that supply products to the Company’s franchisees are included in franchise royalties and fees. Product rebates are recognized in the period in which they are earned. Rebates related to Company-owned locations are offset against operating costs.

 

Shipping Fees

 

Shipping fees charged to customers by the Company’s trucking department are reported as sales. Shipping costs incurred by the Company for inventory are reported as cost of sales or inventory.

 

Franchise and Royalty Fees

 

Beginning in FY 2019, upon adoption of adoption of ASC 606, the Company began recognizing franchise fees over the term of the associated franchise agreement, which is generally a period of 10 to 15 years. Prior to FY 2019, franchise fee revenue was recognized upon opening of the franchise store. In addition to the initial franchise fee, the Company also recognizes a marketing and promotion fee of one percent (1%) of franchised stores’ gross retail sales and a royalty fee based on gross retail sales. The Company recognizes no royalty on franchised stores’ retail sales of products purchased from the Company and recognizes a ten percent (10%) royalty on all other sales of product sold at franchise locations. Royalty fees for U-Swirl cafés are based on the rate defined in the acquired contracts for the franchise rights and range from 2.5% to 6% of gross retail sales.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

In certain instances, the Company is required to pay a portion of franchise fee revenue, or royalty fees to parties the Company has contracted with to assist in developing and growing a brand. The agreements generally include Development Agents, or commissioned brokers who are paid a portion of the initial franchise fee, a portion of the ongoing royalty fees, or both. When such agreements exist, the Company reports franchise fee and royalty fee revenues net of the amount paid, or due, to the agent/broker.

 

Use of Estimates

 

In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, the disclosure of contingent assets and liabilities, at the date of the consolidated financial statements, and revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Vulnerability Due to Certain Concentrations

 

Revenue from one customer of our manufacturing segment 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 further decreases in the purchases of this customer or the loss of this customer entirely.

 

Stock-Based Compensation

 

At February 28, 2019, the Company had one stock-based compensation plan, the Company’s 2007 Equity Incentive Plan, for employees and non-employee directors which authorized the granting of stock awards.

 

The Company recognized $519,772, $591,839, and $584,893 related to equity-based compensation expense during the years ended February 28, 2019, 2018 and 2017, respectively. Compensation costs related to share-based compensation are generally recognized over the vesting period.

 

Beginning March 1, 2017, the Company adopted ASU No. 2019-09, which requires recognition of excess tax benefits and tax deficiencies in the income statement. Prior to March 1, 2017 tax benefits or expense resulting from the difference in the compensation cost recognized for stock options are reported as financing cash flows in the accompanying Statements of Cash Flows. The excess tax expense included in net cash provided by financing activities for the years ended February 28, 2017 was $34,128.

 

During FY 2019 and 2018, the Company granted no restricted stock units. There were no stock options granted to employees during FY 2019 or FY 2018. The restricted stock unit grants generally vest 17 to 20% annually over a period of five to six years. The Company recognized $463,795 of consolidated stock-based compensation expense related to grants made in prior years during FY 2019 compared with $532,739 in FY 2018 and $564,473 in FY 2017. Total unrecognized stock-based compensation expense of non-vested, non-forfeited shares granted, as of February 28, 2019 was $114,183, which is expected to be recognized over the weighted average period of 0.4 years.

 

The Company issued 2,000 fully vested, unrestricted shares of stock to non-employee directors during the year ended February 28, 2019 compared to no shares issued during the year ended February 28, 2018 and 2,000 issued during the year ended February 28, 2017. In connection with these non-employee director stock issuances, the Company recognized $24,480, $0 and $20,420 of stock-based compensation expense during year ended February 28, 2019, 2018 and 2017, respectively.

 

During the year ended February 28, 2018, the Company issued 5,000 shares of common stock under the Company’s equity incentive plan to an independent contractor providing information technology consulting services to the Company. These shares were issued as a part of the compensation for services rendered to the Company by the contractor. Associated with this unrestricted stock award, the Company recognized $59,100 in stock-based compensation expense during the year ended February 28, 2018. During the year ended February 28, 2019, the Company issued 3,333 shares of common stock under the Company’s equity incentive plan to the former Vice President of Creative Services. These shares were issued in consideration of services rendered prior to retirement and based on the number of unvested restricted stock units that were forfeited upon retirement. Associated with this unrestricted stock award, the Company recognized $31,497 in stock-based compensation expense during the year ended February 28, 2019.

 

Earnings P er Share

 

Basic earnings per share is computed as net earnings divided by the weighted average number of common shares outstanding during each year. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through stock options and restricted stock units. Following the expiration of all outstanding options, during FY 2017, no stock options were excluded from diluted shares.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Advertising and Promotional Expenses

 

The Company expenses advertising costs as incurred. Total advertising expense for RMCF amounted to $275,441, $355,678, and $279,698 for the fiscal years ended February 28, 2019, 2018 and 2017, respectively. Total advertising expense for U-Swirl and its brands amounted to $168,000, $222,093, and $335,771 for the fiscal years ended February 28, 2019, 2018 and 2017, respectively.

 

Fair Value of Financial Instruments

 

The Company’s financial instruments consist of cash and cash equivalents, trade receivables, payables, notes payable and notes receivable. The fair value of all instruments approximates the carrying value, because of the relatively short maturity of these instruments.

 

Recent Accounting Pronouncements

 

In August 2018, the Securities and Exchange Commission (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. In light of the anticipated timing of effectiveness of the amendments and expected proximity of effectiveness to the filing date for most filers’ quarterly reports, the SEC’s Division of Corporate Finance issued a Compliance and Disclosure Interpretation related to Exchange Act Forms, (“CDI – Question 105.09”), that provides transition guidance related to this disclosure requirement. CDI – Question 105.09 states that the SEC would not object if the filer’s first presentation of the changes in shareholders’ equity is included in its Quarterly Report on Form 10-Q for the quarter that begins after the effective date of the amendments. As such, the Company adopted these SEC amendments on November 30, 2018 and will present the analysis of changes in stockholders’ equity in its interim financial statements in its May 31, 2019 Quarterly Report on Form 10-Q. The Company does not anticipate that the adoption of these SEC amendments will have a material effect on the Company’s financial position, results of operations, cash flows or stockholders’ equity.

 

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

  

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires the recognition of lease assets and lease liabilities on the balance sheet by lessees for those leases currently classified as operating leases under ASC 840 “Leases.” These amendments also require qualitative disclosures along with specific quantitative disclosures. These amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company will adopt this guidance effective with the three month period ending May 31, 2019 (the first quarter of Fiscal Year 2020). The Company can elect to record a cumulative-effect adjustment as of the beginning of the year of adoption or apply a modified retrospective transition approach. The Company expects that substantially all of its operating lease commitments will be subject to the new guidance and will be recognized as operating lease liabilities and right-of-use assets upon adoption. The Company anticipates ASU 2016-02 will have a material impact on the consolidated balance sheet. The impact of ASU 2016-02 is non-cash in nature, as such, it will not affect the Company’s cash flows. The cumulative adjustment to be recorded as right-of-use assets and operating lease liabilities, upon adoption, is expected to be in the range of $3,500,000 to $3,900,000.

 

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

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Company adopted ASC 606 as of March 1, 2018, using the modified retrospective method. This method allows the new standard to be applied retrospectively through a cumulative catch-up adjustment recognized upon adoption. As a result, comparative information in the Company’s financial statements has not been restated and continues to be reported under the accounting standards in effect for those periods. See Note 17 to these financial statements for additional details regarding the adjustments recorded upon adoption of this standard.

 

 

NOTE 2 - INVENTORIES

 

Inventories consist of the following at February 28:

 

   

2019

   

2018

 

Ingredients and supplies

  $ 2,612,954     $ 2,764,727  

Finished candy

    1,983,854       2,371,610  

U-Swirl food and packaging

    44,696       63,843  

Reserve for slow moving inventory

    (371,147 )     (357,706 )

Total inventories

  $ 4,270,357     $ 4,842,474  

 

 

NOTE 3 - PROPERTY AND EQUIPMENT, NET

 

Property and equipment consists of the following at February 28:

 

   

2019

   

2018

 

Land

  $ 513,618     $ 513,618  

Building

    5,031,395       4,905,103  

Machinery and equipment

    10,263,119       10,686,631  

Furniture and fixtures

    864,944       1,067,788  

Leasehold improvements

    1,131,659       1,568,260  

Transportation equipment

    422,458       434,091  

Asset impairment

    (30,000 )     (62,891 )
      18,197,193       19,112,600  
                 

Less accumulated depreciation

    (12,411,054 )     (12,946,360 )

Property and equipment, net

  $ 5,786,139     $ 6,166,240  

 

 

NOTE 4 - LINE OF CREDIT AND LONG-TERM DEBT

 

Line of Credit

 

At February 28, 2019, the Company had a $5.0 million working capital line of credit from Wells Fargo Bank, N.A., collateralized by substantially all of the Company’s assets with the exception of the Company’s retail store assets. Draws may be made under the line at 50% of eligible accounts receivable plus 50% of eligible inventories. Interest on borrowings is at LIBOR plus 2.25% (4.7% at February 28, 2019). At February 28, 2019, $5.0 million was available for borrowings under the line of credit, subject to borrowing base limitations. Additionally, the line of credit is subject to various financial ratio and leverage covenants. At February 28, 2019, the Company was in compliance with all such covenants. The credit line is subject to renewal in September 2019 and the Company believes it is likely to be renewed on terms similar to current terms. At February 28, 2019 and 2018 there was no amount outstanding under this line of credit.

 

Effective January 16, 2014, the Company entered into a business loan agreement with Wells Fargo Bank, N.A. (the “Wells Fargo Loan Agreement”) for a $7.0 million long-term line of credit to be used to loan money to SWRL to fund the purchase price of business acquisitions by SWRL (the “Wells Fargo Loan”). The Company made its first draw of approximately $6.4 million on the Wells Fargo Loan on January 16, 2014 and the first draw was the amount outstanding at February 28, 2014. Interest on the Wells Fargo Loan is at a fixed rate of 3.75% and the maturity date is January 15, 2020. The Wells Fargo Loan may be prepaid without penalty at any time by the Company. The Wells Fargo Loan is collateralized by substantially all of the Company’s assets. Additionally, the Wells Fargo Loan is subject to various financial ratio and leverage covenants. As of February 28, 2019, the Company was in compliance with all such covenants. The Wells Fargo Loan Agreement also contains customary representations and warranties, covenants and acceleration provisions in the event of a default by the Company.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Long-term debt consists of the following at February 28:

 

    

2019

   

2018

 

Note payable in monthly installments of principal and interest at 3.75% per annum through December 2019 collateralized by sustantially all business assets

  $ 1,176,488     $ 2,529,309  

Less current maturities

    1,176,488       1,352,893  

Long-term obligations

  $ -     $ 1,176,416  

 

 

NOTE 5 – COMMITMENTS AND CONTINGENCIES

 

Operating Leases

 

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 following is a schedule by year of future minimum rental payments required under such leases for the years ending February 28 or 29:

 

2020

  $ 318,000  

2021

    259,000  

2022

    249,000  

2023

    243,000  

2024

    249,000  

Thereafter

    175,000  

Total

  $ 1,493,000  

 

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. The Company’s current policy is not to act as primary lessee on any further franchised locations, except in rare instances. At February 28, 2019, the Company was the primary lessee at four of the Company’s 313 domestic franchised stores.

 

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's liability as primary lessee on sublet franchise outlets, all of which is fully offset by sublease rentals, is as follows for the years ending February 28 or 29:

 

2020

  $ 92,000  

2021

    75,000  

2022

    21,000  

Total

  $ 188,000  

 

The following is a schedule of lease expense for all retail operating leases for the three years ended February 28:

 

   

2019

   

2018

   

2017

 

Minimum rentals

  $ 1,030,536     $ 1,270,240     $ 944,938  

Less sublease rentals

    (572,000 )     (603,000 )     (318,000 )

Contingent rentals

    22,800       26,100       25,200  
    $ 481,336     $ 693,340     $ 652,138  

 

In FY 2019, the Company renewed an operating lease for warehouse space in the immediate vicinity of its manufacturing operation. The following is a schedule, by year, of future minimum rental payments required under such lease for the years ending February 28 or 29:

 

2020

  $ 116,000  

2021

    121,000  

2022

    125,000  

2023

    129,000  

2024

    33,000  

Total

  $ 524,000  

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Company also leases trucking equipment under operating leases. The following is a schedule by year of future minimum rental payments required under such leases for the years ending February 28 or 29:

 

2020

  $ 323,000  

2021

    323,000  

2022

    257,000  

2023

    29,000  

Total

  $ 932,000  

 

The following is a schedule of lease expense for trucking equipment operating leases for the three years ended February 28:

 

2019

   

2018

   

2017

 
325,229       225,992       220,791  

 

Purchase contracts

 

The Company frequently enters into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit the Company 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, the Company may benefit if prices rise during the terms of these contracts, but it may be required to pay above-market prices if prices fall and it is unable to renegotiate the terms of the contract. As of February 28, 2019, the Company was contracted for approximately $880,000 of raw materials under such agreements.

 

 

NOTE 6 - INCOME TAXES

 

Income tax expense (benefit) is comprised of the following for the years ended February 28:

 

   

2019

   

2018

   

2017

 

Current

                       

Federal

  $ 653,226     $ 1,916,720     $ 1,411,127  

State

    142,570       220,164       272,214  

Total Current

    795,796       2,136,884       1,683,341  
                         

Deferred

                       

Federal

    (67,410 )     55,658       240,233  

State

    (11,524 )     (32,247 )     22,015  

Total Deferred

    (78,934 )     23,411       262,248  

Total

  $ 716,862     $ 2,160,295     $ 1,945,589  

 

A reconciliation of the statutory federal income tax rate and the effective rate as a percentage of pretax income is as follows for the years ended February 28 or 29:

 

   

2019

   

2018

   

2017

 

Statutory rate

    21.0 %     31.9 %     34.0 %

State income taxes, net of federal benefit

    3.4 %     2.4 %     3.6 %

Domestic production deduction

    0.0 %     (0.9 )%     (1.1 )%

Work opportunity tax credits

    (0.7 )%     (0.2 )%     (0.4 )%

Other

    0.5 %     0.8 %     0.0 %

Impact of tax reform

    0.0 %     8.2 %     0.0 %

Effective rate - provision (benefit)

    24.2 %     42.2 %     36.1 %

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The components of deferred income taxes at February 28 are as follows:

 

   

2019

   

2018

 

Deferred Tax Assets

               

Allowance for doubtful accounts and notes

  $ 120,368     $ 124,469  

Inventories

    91,265       86,938  

Accrued compensation

    87,930       130,049  

Loss provisions and deferred income

    492,468       817,945  

Self-insurance accrual

    34,426       38,868  

Amortization

    217,481       520,379  

Restructuring charges

    98,693       98,728  

U-Swirl accumulated net loss

    325,253       258,173  

Valuation allowance

    (98,693 )     (98,728 )

Net deferred tax assets

  $ 1,369,191     $ 1,976,821  
                 

Deferred Tax Liabilities

               

Depreciation and amortization

    (682,542 )     (1,066,113 )

Prepaid expenses

    (79,228 )     (75,245 )

Deferred Tax Liabilities

    (761,770 )     (1,141,358 )
                 

Net deferred tax assets

  $ 607,421     $ 835,463  

 

The following table summarizes deferred income tax valuation allowances as of February 28:

 

   

2019

   

2018

 

Valuation allowance at beginning of period

  $ 98,728     $ 148,494  

Tax expense (benefits) realized by valuation allowance

    (35 )     -  

Tax benefits released from valuation allowance

    -       -  

Impact of tax reform

    -