Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q (“Quarterly Report”) includes statements of our expectations, intentions, plans and beliefs that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are intended to come within the safe harbor protection provided by those sections. These forward-looking statements involve various risks and uncertainties. The nature of our operations and the environment in which we operate subject us to changing economic, competitive, regulatory and technological conditions, risks and uncertainties. The statements, other than statements of historical fact, included in this Quarterly Report are forward-looking statements. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as "will," "intend," "believe," "expect," "anticipate," "should," "plan," "estimate," "potential," or similar expressions. Factors which could cause results to differ include, but are not limited to: changes in the confectionery business environment, seasonality, consumer interest in our products, general economic conditions, the success of
our frozen yogurt business
, receptiveness of our products internationally, consumer and retail trends, costs and availability of raw materials, competition, the success of our co-branding strategy, the success of international expansion efforts and the effect of government regulations. Government regulations which we and our franchisees either are or may be subject to and which could cause results to differ from forward-looking statements include, but are not limited to: local, state and federal laws regarding health, sanitation, safety, building and fire codes, franchising, employment, manufacturing, packaging and distribution of food products and motor carriers. For a detailed discussion of the risks and uncertainties that may cause our actual results to differ from the forward-looking statements contained herein, please see the “Risk Factors” contained in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended February 2
8
, 201
8
. These forward-looking statements apply only as of the date of this Quarterly Report. As such they should not be unduly relied upon for more current circumstances. Except as required by law, we undertake no obligation to release publicly any revisions to these forward-looking statements that might reflect events or circumstances occurring after the date of this Quarterly Report or those that might reflect the occurrence of unanticipated events.
Unless otherwise specified, the “Company,” “we,” “us” or “our” refers to Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, and its consolidated subsidiaries
.
Overview
We are an international franchisor, confectionery manufacturer and retail operator. Founded in 1981, we are headquartered in Durango, Colorado and manufacture an extensive line of premium chocolate candies and other confectionery products. Our 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 outside of our system of retail stores and license the use of our brand with certain consumer products. As of November 30, 2018, there were two Company-owned, 91 licensee-owned and 248 franchised Rocky Mountain Chocolate Factory stores operating in 38 states, Canada, South Korea, Panama, and the Philippines. As of November 30, 2018, U-Swirl operated four Company-owned cafés and 102 franchised cafés located in 27 states and Qatar. U-Swirl operates self-serve frozen yogurt cafés under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!” and “Aspen Leaf Yogurt”.
Results of Operations
Three Months Ended
November 30,
201
8
Compared to the Three Months Ended
November 30,
201
7
Results Summary
Basic earnings per share decreased 30.8% from $0.13 in the three months ended November 30, 2017 to $0.09 in the three months ended November 30, 2018. Revenues decreased 10.2% from $10.0 million in the three months ended November 30, 2017 to $8.9 million in the three months ended November 30, 2018. Operating income decreased 43.4% from $1.2 million in the three months ended November 30, 2017 to $0.7 million in the three months ended November 30, 2018. Net income decreased 30.1% from $751,000 in the three months ended November 30, 2017 to $525,000 in the three months ended November 30, 2018. The decrease in operating income was due primarily to lower revenue in the three months ended November 30, 2018 compared to the three months ended November 30, 2017.
Revenues
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
($'s in thousands)
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
Change
|
|
Factory sales
|
|
$
|
6,862.0
|
|
|
$
|
7,511.3
|
|
|
$
|
(649.3
|
)
|
|
|
(8.6
|
)%
|
Retail sales
|
|
|
721.3
|
|
|
|
840.2
|
|
|
|
(118.9
|
)
|
|
|
(14.2
|
)%
|
Franchise fees
|
|
|
61.7
|
|
|
|
150.9
|
|
|
|
(89.2
|
)
|
|
|
(59.1
|
)%
|
Royalty and marketing fees
|
|
|
1,304.8
|
|
|
|
1,459.1
|
|
|
|
(154.3
|
)
|
|
|
(10.6
|
)%
|
Total
|
|
$
|
8,949.8
|
|
|
$
|
9,961.5
|
|
|
$
|
(1,011.7
|
)
|
|
|
(10.2
|
)%
|
Factory Sales
The decrease in factory sales for the three months ended November 30, 2018 versus the three months ended November 30, 2017 was primarily due to an 18.8% decrease in shipments of product to customers outside our network of franchise retail locations and a 3.0% decrease in purchases by our network of franchised and licensed stores. This change was primarily the result of a decrease in purchases by the Company’s largest customer during the three months ended November 30, 2018, with revenue from such customer decreasing to approximately $374,000, or 4.2% of the Company’s revenues during the three months ended November 30, 2018, compared to $682,000, or 6.8% of the Company’s revenues during the three months ended November 30, 2017 for this same customer. The Company believes the decrease in orders is due to lower sales of its customer. If future purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales to such customer will return to historical levels.
Same-store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.9% in the three months ended November 30, 2018, compared with the three months ended November 30, 2017.
Retail Sales
The decrease in retail sales was primarily due to changes in retail units in operation resulting from the sale of certain Company-owned locations and the closure of certain underperforming Company-owned locations. Same-store sales at all Company-owned stores and cafés increased 8.6% in the three months ended November 30, 2018 compared to the three months ended November 30, 2017.
Royalties, Marketing Fees and Franchise Fees
The decrease in royalties and marketing fees from the three months ended November 30, 2017 to the three months ended November 30, 2018 was primarily due to an 8.7% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 312 in the three months ended November 30, 2017 to 285 during the three months ended November 30, 2018. This decrease is the result of domestic store closures exceeding domestic store openings. Same-store sales at total franchise stores and cafés in operation increased 0.7% during the three months ended November 30, 2018 compared to the three months ended November 30, 2017. Franchise fee revenues decreased as a result of a decrease in domestic store openings and the fees recognized during the three months ended November 30, 2018 compared to the three months ended November 30, 2017.
Costs and Expenses
Cost of Sales
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($'s in thousands)
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales - factory
|
|
$
|
5,419.8
|
|
|
$
|
5,703.4
|
|
|
$
|
(283.6
|
)
|
|
|
(5.0
|
)%
|
Cost of sales - retail
|
|
|
280.5
|
|
|
|
336.6
|
|
|
|
(56.1
|
)
|
|
|
(16.7
|
)%
|
Franchise costs
|
|
|
463.1
|
|
|
|
515.1
|
|
|
|
(52.0
|
)
|
|
|
(10.1
|
)%
|
Sales and marketing
|
|
|
519.2
|
|
|
|
593.0
|
|
|
|
(73.8
|
)
|
|
|
(12.4
|
)%
|
General and administrative
|
|
|
860.9
|
|
|
|
827.2
|
|
|
|
33.7
|
|
|
|
4.1
|
%
|
Retail operating
|
|
|
446.1
|
|
|
|
584.8
|
|
|
|
(138.7
|
)
|
|
|
(23.7
|
)%
|
Total
|
|
$
|
7,989.6
|
|
|
$
|
8,560.1
|
|
|
$
|
(570.5
|
)
|
|
|
(6.7
|
)%
|
Gross Margin
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($'s in thousands)
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory gross margin
|
|
$
|
1,442.2
|
|
|
$
|
1,807.9
|
|
|
$
|
(365.7
|
)
|
|
|
(20.2
|
)%
|
Retail gross margin
|
|
|
440.8
|
|
|
|
503.6
|
|
|
|
(62.8
|
)
|
|
|
(12.5
|
)%
|
Total
|
|
$
|
1,883.0
|
|
|
$
|
2,311.5
|
|
|
$
|
(428.5
|
)
|
|
|
(18.5
|
)%
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
%
|
|
|
%
|
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
Change
|
|
(Percent)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory gross margin
|
|
|
21.0
|
%
|
|
|
24.1
|
%
|
|
|
(3.1
|
)%
|
|
|
(12.7
|
)%
|
Retail gross margin
|
|
|
61.1
|
%
|
|
|
59.9
|
%
|
|
|
1.2
|
%
|
|
|
2.0
|
%
|
Total
|
|
|
24.8
|
%
|
|
|
27.7
|
%
|
|
|
(2.8
|
)%
|
|
|
(10.3
|
)%
|
Adjusted Gross Margin
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($'s in thousands)
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory gross margin
|
|
$
|
1,442.2
|
|
|
$
|
1,807.9
|
|
|
$
|
(365.7
|
)
|
|
|
(20.2
|
)%
|
Plus: depreciation and amortization
|
|
|
140.0
|
|
|
|
134.3
|
|
|
|
5.7
|
|
|
|
4.2
|
%
|
Factory adjusted gross margin
|
|
|
1,582.2
|
|
|
|
1,942.2
|
|
|
|
(360.0
|
)
|
|
|
(18.5
|
)%
|
Retail gross margin
|
|
|
440.8
|
|
|
|
503.6
|
|
|
|
(62.8
|
)
|
|
|
(12.5
|
)%
|
Total Adjusted Gross Margin
|
|
$
|
2,023.0
|
|
|
$
|
2,445.8
|
|
|
$
|
(422.8
|
)
|
|
|
(17.3
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory adjusted gross margin
|
|
|
23.1
|
%
|
|
|
25.9
|
%
|
|
|
(2.8
|
)%
|
|
|
(10.8
|
)%
|
Retail gross margin
|
|
|
61.1
|
%
|
|
|
59.9
|
%
|
|
|
1.2
|
%
|
|
|
2.0
|
%
|
Total Adjusted Gross Margin
|
|
|
26.7
|
%
|
|
|
29.3
|
%
|
|
|
(2.6
|
)%
|
|
|
(8.9
|
)%
|
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 margins decreased 310 basis points in the three months ended November 30, 2018 compared to the three months ended November 30, 2017 due primarily to lower efficiencies associated with a 17.0% decrease in production volume and an increase in transportation fuel and equipment costs in the three months ended November 30, 2018 compared to the three months ended November 30, 2017. The increase in Company-owned store margin is due primarily to a change in units in operation during the three months ended November 30, 2018 compared to the prior year.
Franchise Costs
The decrease in franchise costs in the three months ended November 30, 2018 versus the three months ended November 30, 2017 is due primarily to a decrease in legal and professional expense in the three months ended November 30, 2018 compared to the three months ended November 30, 2017. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increased to 33.9% in the three months ended November 30, 2018 from 32.0% in the three months ended November 30, 2017.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended November 30, 2018 compared to the three months ended November 30, 2017 is primarily due to lower marketing-related costs associated with U-Swirl franchise locations as a result of fewer units in operation.
General and Administrative
General and administrative costs increased 4.1% in the three months ended November 30, 2018 compared to the three months ended November 30, 2017. This increase was primarily the result of an increase in legal costs. As a percentage of total revenues, general and administrative expenses increased to 9.6% in the three months ended November 30, 2018 compared to 8.3% in the three months ended November 30, 2017.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended November 30, 2018 compared to the three months ended November 30, 2017 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 69.6% in the three months ended November 30, 2017 to 61.8% in the three months ended November 30, 2018. This decrease is primarily the result of the change in units in operation from the prior year.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $282,000 in the three months ended November 30, 2018, an increase of 39.6% from $202,000 in the three months ended November 30, 2017. This increase was the result of a change in management’s estimates related to the future value of U-Swirl intangibles and the associated acceleration of amortization expense. Depreciation and amortization included in cost of sales increased 4.2% from $134,000 in the three months ended November 30, 2017 to $140,000 in the three months ended November 30, 2018. This increase was the result of an increase in production assets in service.
Other
Income
(Expense)
Net interest expense was $11,000 in the three months ended November 30, 2018 compared to net interest expense of $22,000 incurred in the three months ended November 30, 2017. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended November 30, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended November 30, 2018 was 21.2%, compared to 36.2% for the three months ended November 30, 2017. The decrease of 14.7% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.
Nine
Months
Ended
November 30,
201
8
Compared to the
Nine Months
Ended
November 30,
201
7
Results Summary
Basic earnings per share decreased 26.2% to $0.31 for the nine months ended November 30, 2018 compared to $0.42 for the nine months ended November 30, 2017. Revenues decreased 8.9% to $25.1 million for the nine months ended November 30, 2018 compared to $27.6 million in the nine months ended November 30, 2017. Operating income decreased 36.0% from $4.0 million in the nine months ended November 30, 2017 to $2.5 million in the nine months ended November 30, 2018. Net income decreased 25.7% from $2.5 million in the nine months ended November 30, 2017 to $1.9 million in the nine months ended November 30, 2018. The decrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.
Revenues
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
($'s in thousands)
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
Change
|
|
Factory sales
|
|
$
|
17,203.3
|
|
|
$
|
18,576.8
|
|
|
$
|
(1,373.5
|
)
|
|
|
(7.4
|
)%
|
Retail sales
|
|
|
2,698.4
|
|
|
|
3,045.1
|
|
|
|
(346.7
|
)
|
|
|
(11.4
|
)%
|
Franchise fees
|
|
|
262.3
|
|
|
|
563.0
|
|
|
|
(300.7
|
)
|
|
|
(53.4
|
)%
|
Royalty and marketing fees
|
|
|
4,951.9
|
|
|
|
5,389.8
|
|
|
|
(437.9
|
)
|
|
|
(8.1
|
)%
|
Total
|
|
$
|
25,115.9
|
|
|
$
|
27,574.7
|
|
|
|
(2,458.8
|
)
|
|
|
(8.9
|
)%
|
Factory Sales
The decrease in factory sales for the nine months ended November 30, 2018 versus the nine months ended November 30, 2017 was primarily due to a 22.5% decrease in shipments of product to customers outside our network of franchise retail locations. This change was primarily the result of a decrease in purchases by the Company’s largest customer during the nine months ended November 30, 2018, with revenue from such customer decreasing to approximately $1.8 million, or 7.1%, of the Company’s revenues during the nine months ended November 30, 2018, compared to $2.9 million, or 10.3% of the Company’s revenues during the nine months ended November 30, 2017 for this same customer. The Company believes the decrease in orders is due to lower sales of its customer. If future purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales to such customer will return to historical levels
Same-store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.5% in the nine months ended November 30, 2018, compared with the nine months ended November 30, 2017.
Retail Sales
The decrease in retail sales was primarily due to changes in retail units in operation as a result of the closure of certain underperforming Company-owned locations. Same-store sales at all Company-owned stores and cafés increased 2.1% in the nine months ended November 30, 2018 compared to the nine months ended November 30, 2017.
Royalties, Marketing Fees and Franchise Fees
The decrease in royalties and marketing fees from the nine months ended November 30, 2017 to the nine months ended November 30, 2018 was primarily due to a 9.9% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 322 in the nine months ended November 30, 2017 to 290 during the nine months ended November 30, 2018. This decrease is the result of domestic store closures exceeding domestic store openings. Same-store sales at total franchise stores and cafés in operation were approximately unchanged during the nine months ended November 30, 2018 compared to the nine months ended November 30, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the nine months ended November 30, 2017 with no comparable international fees recognized during the nine months ended November 30, 2018. During the nine months ended November 30, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the nine months ended November 30, 2018.
Costs and Expenses
Cost of Sales
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($'s in thousands)
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales - factory
|
|
$
|
13,266.0
|
|
|
$
|
13,823.2
|
|
|
$
|
(557.2
|
)
|
|
|
(4.0
|
)%
|
Cost of sales - retail
|
|
|
983.5
|
|
|
|
1,084.2
|
|
|
|
(100.7
|
)
|
|
|
(9.3
|
)%
|
Franchise costs
|
|
|
1,539.1
|
|
|
|
1,588.3
|
|
|
|
(49.2
|
)
|
|
|
(3.1
|
)%
|
Sales and marketing
|
|
|
1,672.6
|
|
|
|
1,785.4
|
|
|
|
(112.8
|
)
|
|
|
(6.3
|
)%
|
General and administrative
|
|
|
2,588.8
|
|
|
|
2,932.6
|
|
|
|
(343.8
|
)
|
|
|
(11.7
|
)%
|
Retail operating
|
|
|
1,507.4
|
|
|
|
1,774.5
|
|
|
|
(267.1
|
)
|
|
|
(15.1
|
)%
|
Total
|
|
$
|
21,557.4
|
|
|
$
|
22,988.2
|
|
|
$
|
(1,430.8
|
)
|
|
|
(6.2
|
)%
|
Gross Margin
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($'s in thousands)
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory gross margin
|
|
$
|
3,937.3
|
|
|
$
|
4,753.6
|
|
|
$
|
(816.3
|
)
|
|
|
(17.2
|
)%
|
Retail gross margin
|
|
|
1,714.9
|
|
|
|
1,960.9
|
|
|
|
(246.0
|
)
|
|
|
(12.5
|
)%
|
Total
|
|
$
|
5,652.2
|
|
|
$
|
6,714.5
|
|
|
$
|
(1,062.3
|
)
|
|
|
(15.8
|
)%
|
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
%
|
|
|
%
|
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory gross margin
|
|
|
22.9
|
%
|
|
|
25.6
|
%
|
|
|
(2.7
|
)%
|
|
|
(10.6
|
)%
|
Retail gross margin
|
|
|
63.6
|
%
|
|
|
64.4
|
%
|
|
|
(0.8
|
)%
|
|
|
(1.3
|
)%
|
Total
|
|
|
28.4
|
%
|
|
|
31.1
|
%
|
|
|
(2.7
|
)%
|
|
|
(8.5
|
)%
|
Adjusted Gross Margin
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
$
|
|
|
%
|
|
($'s in thousands)
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory gross margin
|
|
$
|
3,937.3
|
|
|
$
|
4,753.6
|
|
|
$
|
(816.3
|
)
|
|
|
(17.2
|
)%
|
Plus: depreciation and amortization
|
|
|
414.7
|
|
|
|
387.8
|
|
|
|
26.9
|
|
|
|
6.9
|
%
|
Factory adjusted gross margin
|
|
|
4,352.0
|
|
|
|
5,141.4
|
|
|
|
(789.4
|
)
|
|
|
(15.4
|
)%
|
Retail gross margin
|
|
|
1,714.9
|
|
|
|
1,960.9
|
|
|
|
(246.0
|
)
|
|
|
(12.5
|
)%
|
Total Adjusted Gross Margin
|
|
$
|
6,066.9
|
|
|
$
|
7,102.3
|
|
|
$
|
(1,035.4
|
)
|
|
|
(14.6
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Factory adjusted gross margin
|
|
|
25.3
|
%
|
|
|
27.7
|
%
|
|
|
(2.4
|
)%
|
|
|
(8.6
|
)%
|
Retail gross margin
|
|
|
63.6
|
%
|
|
|
64.4
|
%
|
|
|
(0.8
|
)%
|
|
|
(1.3
|
)%
|
Total Adjusted Gross Margin
|
|
|
30.5
|
%
|
|
|
32.8
|
%
|
|
|
(2.4
|
)%
|
|
|
(7.2
|
)%
|
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin 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 margins decreased 270 basis points in the nine months ended November 30, 2018 compared to the nine months ended November 30, 2017 due primarily to lower efficiencies associated with a 13.4% decrease in production volume in the nine months ended November 30, 2018 compared to the nine months ended November 30, 2017. The decrease in retail gross margins was primarily the result of sales discounts prior to closing certain underperforming Company-owned locations.
Fr
anchise Costs
The decrease in franchise costs in the nine months ended November 30, 2018 versus the nine months ended November 30, 2017 is due primarily to a decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increased to 29.5% in the nine months ended November 30, 2018 from 26.7% in the nine months ended November 30, 2017. This increase as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.
Sales and Marketing
The decrease in sales and marketing costs for the nine months ended November 30, 2018 compared to the nine months ended November 30, 2017 is primarily due to lower marketing-related costs associated with U-Swirl franchise locations.
General and Administrative
The decrease in general and administrative costs for the nine months ended November 30, 2018 compared to the nine months ended November 30, 2017 is primarily due to a decrease in legal and professional expenses. As a percentage of total revenues, general and administrative expenses decreased to 10.3% in the nine months ended November 30, 2018 compared to 10.6% in the nine months ended November 30, 2017.
Retail Operating Expenses
The decrease in retail operating expenses for the nine months ended November 30, 2018 compared to the nine months ended November 30, 2017 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 58.3% in the nine months ended November 30, 2017 to 55.9% in the nine months ended November 30, 2018. This decrease is primarily the result of the change in units in operation from the prior year.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $880,000 in the nine months ended November 30, 2018, an increase of 48.6% from $592,000 in the nine months ended November 30, 2017. This increase was the result of a change in management’s estimates related to the future value of U-Swirl intangibles and the associated acceleration of amortization expense. Depreciation and amortization included in cost of sales increased 6.9% from $388,000 in the nine months ended November 30, 2017 to $415,000 in the nine months ended November 30, 2018. This increase was the result of an increase in production assets in service.
Restructuring charges
There were no restructuring and acquisition related charges during the nine months ended November 30, 2017 compared to $177,000 during the nine months ended November 30, 2018. The increase in restructuring costs was the result of charges related to closing certain underperforming Company-owned locations.
Other Income
(Expense)
Net interest expense was $44,000 in the nine months ended November 30, 2018, a decrease of 42.0% compared to net interest expense of $76,000 in the nine months ended November 30, 2017. This decrease in interest expense is due to lower average outstanding promissory note balances for the nine months ended November 30, 2018.
Income Tax Expense
Our effective income tax rate for the nine months ended November 30, 2018 was 24.6%, compared to 36.4% for the nine months ended November 30, 2017. The decrease of 11.8% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.
Liquidity and Capital Resources
As of November 30, 2018, working capital was $9.6 million, compared with $7.4 million as of February 28, 2018, an increase of $2.2 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declined approximately $1.9 million to $4.2 million as of November 30, 2018 compared to $6.1 million as of February 28, 2018 as a result of cash flow used by financing activities, including repayment of debt and payment of dividends exceeding cash flow generated by operating activities. Our current ratio was 2.7 to 1.0 at November 30, 2018 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 the nine months ended November 30, 2018, we had net income of $1,853,120 . Operating activities provided cash of $1,699,053 , with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $1,294,241 and the increase in inventory of $1,471,361. During the comparable 2017 period, we had net income of $2,493,012, and operating activities provided cash of $1,647,658. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $979,712 and the increase in accounts receivable of $1,307,149.
During the nine months ended November 30, 2018, investing activities used cash of $419,014, primarily due to the purchases of property and equipment of $498,252. In comparison, investing activities used cash of $274,052 during the nine months ended November 30, 2017 primarily due to the purchase of property and equipment of $446,935.
Financing activities used cash of $3,141,084 for the nine months ended November 30, 2018 and used cash of $3,085,883 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of November 30, 2018) working capital line of credit collateralized by substantially all of our assets with the exception of our retail store assets. Additionally, the line of credit is subject to various financial ratio and leverage covenants. As of November 30, 2018, we were in compliance with all such covenants. The line of credit is subject to renewal in September 2019. As of November 30, 2018, no amount was outstanding under this line of credit.
Our outstanding long-term debt is comprised of a promissory note used to finance business acquisitions of SWRL (unpaid balance as of November 30, 2018 of $1.5 million). The promissory note allowed us to borrow up to a maximum of $7.0 million to finance business acquisitions and bears interest at a fixed annual rate of 3.75%. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of November 30, 2018, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and nine months ended November 30, 2018. As of November 30, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
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 November 30, 2018, we had purchase obligations of approximately $1.4 million. 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 our operations. Most of our leases provide for cost-of-living adjustments and require us to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally, our future lease costs for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that we will be able to pass on increased costs to our customers.
Depreciation expense is based on the historical cost to us of our fixed assets, and is therefore potentially less than it would be if it were based on current replacement cost. While property and equipment acquired in prior years will ultimately have to be replaced at higher prices, it is expected that replacement will be a gradual process over many years.
Seasonality
We are subject to seasonal fluctuations in sales, which cause fluctuations in quarterly results of operations. Historically, the strongest sales of our products have occurred during key holidays and the summer vacation season. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and sales of franchises. Because of the seasonality of our business and the impact of new store openings and sales of franchises, results for any quarter are not necessarily indicative of results that may be achieved in other quarters or for a full fiscal year.