PART
I
Item
1. Business
Creative
Learning Corporation, operating under the trade names of Bricks 4 Kidz® and Sew Fun Studios®, offers educational and enrichment
programs to children ages 3 to 13+ through its franchisees. The Company’s business model is to sell franchise territories
and collect a one-time franchise fee, renewal fees and monthly royalty fees from each territory. Through the Company’s franchise
business model, which includes a proprietary curriculum and marketing strategy plus a proprietary franchise management tool, the
Company provides a wide variety of programs designed to enhance students’ problem solving and critical thinking skills.
At September 30, 2018, the Company had 526 Bricks 4 Kidz® and Sew Fun Studios® franchise locations and 31 Bricks 4 Kidz®
master franchises which operate 124 Bricks 4 Kidz® sub-franchises in 45 countries.
Company
Background
The
Company was formed in March 2006 under the name B2 Health, Inc. to design, manufacture and sell chiropractic tables and beds.
The Company generated only limited revenue and essentially abandoned its business plan in March 2008. In July 2010, the Company’s
name was changed to Creative Learning Corporation.
On
July 2, 2010, the Company acquired BFK Franchise Company, LLC (“BFK”), a Nevada limited liability company formed in
May 2009, under a Stock Exchange Agreement with the members of BFK for 9,000,000 shares of the Company’s common stock. BFK
offers a franchise concept known as Bricks 4 Kidz®, a mobile business operated by franchisees within a specific geographic
territory offering project-based programs designed to teach principles and methods of engineering to children ages 3-13+. BFK
began selling franchises in July 2009.
On
January 26, 2015 the Company formed SF Franchise Company, LLC (“SF”) for the purpose of offering a third franchise
concept known as Sew Fun Studios®. Sew Fun Studios® is a mobile business operated by franchisees within a specific geographic
territory offering creative project-based activities, classes, and programs in fashion and interior design and sewing to children
and adults.
BFK
BFK
franchises, which conduct business under the trade name BRICKS 4 KIDZ®, offer programs designed to teach principles and methods
of engineering to children between the ages of 3 and 13 using LEGO® plastic bricks and other LEGO® products through classes,
field trips, and other organized activities that are designed to enhance and enrich the traditional school curriculum, trigger
young children’s lively imaginations and build self-confidence. BFK’s programs foster creativity and provide a unique
atmosphere for students to develop problem-solving and critical-thinking skills by designing and building machines, catapults,
pyramids, race cars, buildings and numerous other systems and devices using LEGO® bricks and other LEGO® products. The
Company may provide training and corporate franchisee support to all franchisees and recognizes revenue from the sale of its franchises
when all initial training, pursuant to the terms of the franchise agreements, is completed.
BFK
franchises are mobile models, with activities scheduled in locations such as preschools, elementary and middle schools, camps,
birthday parties, community centers and churches.
At
September 30, 2018, BFK had 526 franchise territories and 31 master franchises which operate 124 sub-franchises operating in 41
states, the District of Columbia, Puerto Rico, and 45 foreign countries. The following table details franchise activity:
BFK
|
|
|
Franchise
Territories
|
|
|
|
|
|
September 30, 2016
|
|
|
698
|
|
Additions
|
|
|
22
|
|
Terminations and non-renewals and cancellations
|
|
|
(80
|
)
|
September 30, 2017
|
|
|
640
|
|
Additions
|
|
|
7
|
|
Terminations and non-renewals and cancellations
|
|
|
(90
|
)
|
September 30, 2018
|
|
|
557
|
|
Current
BFK Programs
In-school
workshops. One-hour classes during school hours. Classes are correlated to the typical science curriculum for a particular
grade level. Teacher guides, student worksheets, and step-by-step instruction are provided.
After-school
classes. One hour, one day a week class held after school.
Pre-school
classes. Classes can be held in pre-schools for children of pre-school ages.
Classes
for home-schooled children. Classes can be held in the home of one of the parents of a home-schooled child.
Camps.
Normally three hours per day for five days. Camps can take place at schools or at other child-related venues. Children use LEGO®
bricks to explore various science and math concepts while working in an open, friendly environment. The material covered each
session varies depending on students’ ages, experience, and skill level. A new project is built each week. Architectural
concepts are taught while assembling buildings, castles and other structures. Instructional content includes concepts of friction,
gravity and torque, scale, gears, axles and beams. The children work and play with programmable LEGO® bricks along with electric
motors, sensors, system bricks, and LEGO® Technic pieces (i.e. gears, axles, and beams).
Birthday
parties. In the home of the birthday child.
Special
events. Activities with LEGO® bricks can be held in various locations including church centers, lodges, child-related
venues, private schools, pre-schools, etc. Program can include parents, grandparents and all children in the family.
BFK
Franchise Program
BKF
sells franchises both domestically and internationally. International sales can be a single franchise or a master franchise, where
the master franchisee operates a franchise in the territory, and is also able to develop, sell and manage sub-franchises in the
territory under the master franchise agreement. BFK does not offer master franchises in the United States.
Under
a franchise agreement, a franchisee pays a one-time, non-refundable franchise fee upon the execution of the franchise agreement.
Domestically, there can be variations on the franchise fees depending on the size or territories being purchased, and other factors
of the territory. The typical-sized, domestic, single territory franchise fee is $25,900. If the franchisee is granted an additional
geographic area to increase the size of their territory, then the franchisee must pay an additional fee in the amount of $10,000.
If the franchisee is in good standing and is granted a second or additional franchise, then the franchisee must pay a franchise
fee in the amount of $18,000 for each additional franchise.
International
franchise fees vary and are set relative to the potential of the franchised territories. During the fiscal year ended September
30, 2018, BFK sold one master franchise for $36,000. In the case of a master franchise, BFK receives a percentage of the franchise
fee paid to the master franchisee by any sub-franchisee operating in the master franchisee’s territory.
The
Company uses a network of franchise advertising and promotion media to contact prospective franchisees. When a potential contact
is received, the initial information relating to a buyer is passed to a franchise sales broker or director of business development
to initiate contact with the potential new franchisees. The responsibility of the sales broker and/or director of business development
is to vet the potential franchisee for compatibility with the franchise concept, among other things. As part of the process of
vetting potential franchisees, the Company requires all prospective franchisees to complete a Request for Consideration form.
Upon completion of the process the sales broker is paid a commission typically ranging from 20% to 30% of the franchise fee while
the director of business development commission ranges between 5% to 7% and the Marketing Director earns 1%.
The
franchisee is granted a limited exclusive territory and a license to use the “Bricks 4 Kidz®” name, trademarks
and course materials in the franchised territory. The franchisee is required to conform to certain standards of business practices
and comply with all applicable laws. Each franchise is run as an independent business and, as such, is responsible for its operation,
including employment of adequate staff.
The
term of the franchise is for ten years. Subject to any applicable laws, BFK has the right to terminate any franchisee in the event
of the franchisee’s bankruptcy, a default under the franchise agreement, or other events. The franchisee has the right to
renew the franchise for an additional ten years if, at the time of renewal, the franchisee is in good standing and pays a renewal
fee in the amount of $5,000. During FY2018, the Company, in accordance to FTC Franchise Rule 436.7(a), suspended sales of new
franchises in the United States as the Company awaited the completion of its audited financial statements.
Franchise
Disclosure Document
Under
federal law, the Company is required to (a) prepare a franchise disclosure document (“FDD”) including federally mandated
information, (b) provide each prospective franchisee with a copy of the FDD, and (c) wait 14 calendar days before entering into
a binding agreement with the prospective franchisee or collecting any payment from any prospective franchisee. Federal law
does not regulate the franchise relationship or require any filing or registration of the FDD on the part of a franchisor. The
Company is also required to comply with certain state regulations in connection with the offer and sale of franchises, including
the requirement to submit the FDD for registration with a number of states before offering or selling franchises within those
states. The states requiring registration of the FDD are: California, Hawaii, Illinois, Indiana, Maryland, Michigan,
Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington and Wisconsin. In these states, state
regulatory agencies review the FDD to confirm compliance with state statutory requirements. These state agencies can deny registration
of the FDD if they determine that the FDD fails to meet state statutory requirements. If a state denies the issuance of an effective
registration, a franchisor is prohibited from offering or selling franchises in that state. See "Government Regulation"
below for more information.
Royalty
and Marketing Fees
The
Company invoices all applicable franchisees a royalty fee on a monthly basis. Every U.S. franchisee, upon signing a franchise
agreement, has authorized and provided the required banking information to allow the electronic collection of all fees. Approximately
three days after the invoice has been issued to the franchisee, an ACH draft (automatic deduction from the franchisee bank account)
for the royalty fee withdrawal is processed through the Company’s banking system. When the Company changes its royalty structure,
existing franchisees maintain their contractual franchise royalty rate unless they agree to amend those rates.
Based
upon the number of franchise territories owned and the length of time the franchisee has been in operation, historically, domestic
and international franchisees were required to pay BFK a royalty fee amounting to 7% of gross receipts reported in the Franchise
Management Tool (“FMT”). BFK also received a percentage of royalty payments received by master franchisees from their
sub-franchisees. Franchisees were billed monthly for their 7% royalty payments, based upon gross receipts, due to the Company.
The franchisees were required to pay the Company a minimum royalty fee per each franchise territory they own. Billing of the minimum
royalty fee amount to each franchisee took place every 12 weeks and the minimum amount was calculated by comparing the amounts
between the regular royalties billed for the prior 12 weeks to the 12 week minimum royalty payment due to the Company, per the
franchise agreement. The 12-week minimum royalty payment due to the Company was $1,500 for the first franchise territory owned
(equating to a minimum average fee of $500 per month) and $750 for the second franchise territory owned (equating to a minimum
average fee of $250 per month). The minimum amount due for the third franchise territory was $1,500 and the fourth franchise territory
was $750. After the end of each 12-week period, franchisees are required to pay to the Company the amount, if any, by which the
minimum royalty exceeds the sum of the royalties paid over the 12-week period, per the franchise agreements prior to October 1,
2015.
Beginning
October 1, 2015, the Company adopted a flat-fee approach, eliminating the previous approach based upon revenue collections by
the franchisee. The Company made the change to a flat-fee approach for a variety of reasons, including without limitation: to
better enable franchisees to manage their cash flow; to enrich relations with our franchisees by being responsive to their needs;
to facilitate the Company’s ability to collect minimum fees across the board; and to make the Company’s fee structure
more attractive to new potential franchisees.
The
following is the royalty fee structure:
Time Period During the Initial Term of Franchise Agreement
|
|
Royalty Fees Amount (U.S. Dollars)
(per month)
|
|
October 1, 2015 through September 30, 2016
|
|
$
|
400
USD
|
|
October 1, 2016 through September 30, 2017
|
|
$
|
425 USD
|
|
October 1, 2017 through September 30, 2018
|
|
$
|
450 USD
|
|
October 1, 2018 through September 30, 2019
|
|
$
|
475 USD
|
|
October 1, 2019 and for the remainder of the initial term of the Franchise Agreement
|
|
$
|
500 USD
|
|
If
any franchisee owns and operates more than one territory, the royalty fees payable to the Company for the second territory and
each additional territory shall be as follows:
Time Period During the Initial Term of Franchise Agreement
|
|
Royalty Fees Amount
(U.S. Dollars)
(per month)
|
|
October 1, 2015 through September 30, 2016
|
|
$
|
200
USD
|
|
October 1, 2016 through September 30, 2017
|
|
$
|
225 USD
|
|
October 1, 2017 and for the remainder of the initial term of the Franchise Agreement
|
|
$
|
250 USD
|
|
On
September 30, 2016, the Company implemented a new royalty fee structure for all new franchise sales. Sales in progress were grandfathered
in under the previous royalty structure. The new royalty structure is the greater of 7% of gross sales or $500 per month.
Each
franchisee has been given the option to amend their franchise agreement contract and elect this new royalty fee structure. Less
than 2% of franchisees did not agree to amend their franchise agreements to the new program. Any franchisees which did not elect
the new royalty fee structure will remain subject to the historic royalty structure described above.
BFK
administers a marketing fund for domestic and Canadian franchisees for the purpose of building brand awareness in their respective
countries. The marketing fund expenditures are funded by BFK collecting a 2% marketing fee, based upon gross receipts reported
in the Franchise Management Tool (“FMT”), from domestic and Canadian franchisees. The respective franchisees are typically
invoiced the middle of each month for the prior month’s receipts. These marketing fee receipts and expenses are accounted
for separately and are not reported as revenue or expenses for BFK. The collections of these funds are done using the Company’s
ACH program, as agreed to by each franchisee in their Franchise Agreement. The Marketing Fund is segregated into a separate bank
account. In April 2018, the third party provider of the FMT restricted the Company’s access to the software. As a result,
franchisees were instructed to self report their marketing fees, however many franchisees did not comply with this request. The
Company is actively working with these franchisees in the current period to acquire accurate reporting and to bring their accounts
to a current status. The Company has built its own software and franchisees are migrating to the new software. Collection and
reconciliation of marketing fees will be streamlined with the new software.
BFK
Competition
Although
BFK pioneered the LEGO® modeling-based curriculum for after school programs, we believe there are at least two other companies
franchising a model similar to that of Bricks 4 Kidz®, Engineering 4 Kids and Snapology. Play-Well Teknologies offers after-school
classes, camps and birthday parties using LEGO® bricks. Vision Education and Media offers after school classes using LEGO®
bricks in the New York metropolitan area. In addition, several other small businesses around the country offer after-school classes
and vacation camps using LEGO® bricks. These classes and camps are typically held in elementary schools, middle schools and
community colleges.
Sew
Fun Studios
The
Company is in the process of revising SF’s form of franchise agreement to address common franchise issues consistent with
best practices. SF filed state-required initial, amended or renewal franchise materials during the 2nd quarter of fiscal
year 2018. Franchises sold under this franchise concept operate businesses offering creative project-based activities, classes
and programs in fashion and interior design and sewing to children and adults at locations such as elementary and middle schools,
camps, social events, community centers and churches. At September 30, 2018, SF had 4 franchise territories in locations and states
that do not require registration. The franchises are in two states and Puerto Rico, as well as one franchisee in Ireland. The
FDD has been completed and has been filed; the Company has begun sales activities in states that do not require additional registrations.
Franchising
Process
Initial
contact between a potential franchisee and the Company may result from a potential franchisee contacting the Company, either by
phone or electronically. Potential franchisees may also be introduced to the Company by brokers and/or other parties, and the
Company may pay commissions and consulting fees to the brokers. The Company has discontinued its previous practice of introducing
franchisee candidates to third party financing sources to cover franchising expenses, as well as, paying commissions and consulting
fees to the Company’s directors and officers. See Item 11, “Executive Compensation — Summary Compensation Table”
and Item 13, “Certain Relationships and Related Transactions, and Director Independence.”
After
initial contact, one of the Company’s franchise consultants and/or internal sales personnel interviews each prospective
franchisee (the “candidate”) to determine whether the candidate may make a successful franchisee. If the franchise
consultant determines that the candidate may make a successful franchisee, the candidate submits a request for consideration (“RFC”).
The Company reviews the RFC, and if the RFC is approved, the franchise consultant continues the vetting process, which focuses
on financial and other factors.
Upon
receipt of the RFC, the candidate is emailed a copy of the Company’s franchise disclosure document. The franchise consultant
reviews the franchise disclosure document with the candidate and answers any questions concerning the franchise and the franchise
agreement. The Company does not provide projections of a franchise’s financial model or performance to prospective franchisees
Assuming
the candidate has cleared the initial vetting process and remains interested in operating one of the Company’s franchises,
the candidate is invited to attend a “discovery day” held at the Company’s headquarters, or in some instances
at another location, during which representatives of the Company and the candidate meet face to face. If the Company decides that
the candidate meets its objectives for the franchise, the required disclosure waiting period has expired and the candidate wants
to move forward and become a franchisee, the parties execute a franchise agreement.
The
Company will sell a franchise for a particular territory only when the Company has a reasonable belief that the potential franchisee
meets the Company minimum criteria. If a franchisee is not successful, the Company may terminate the franchise agreement by providing
notice to the franchisee or repurchasing the franchise from the franchisee. Until the Company provides a notice of termination
or repurchases the franchise and terminates the franchise by mutual agreement, the Company considers the franchise to be active.
Government
Regulation
The
offer and sale of franchises is regulated by the Federal Trade Commission (the “FTC”) and some state governments.
In
1979, the FTC promulgated what became known as the FTC Franchise Rule. The FTC Franchise Rule requires that the franchisor provide
a FDD to each prospective franchisee prior to execution of a binding franchise agreement or payment of money by the prospective
franchisee. The FTC Franchise Rule does not regulate the franchise relationship or require any filing or registration on the part
of a franchisor.
However,
the FTC Franchise Rule does not preempt state law and, as a result, states may (and, some have) impose additional requirements
on franchisors. For example, the following states require franchisors (i) to register their franchise offerings (or qualify for
an exemption) with the state prior to the offer and sale of franchises in the state, and (ii) subject to certain exemptions, to
provide all prospective franchisees with a registered FDD prior to the offer and sale of a franchise in the state: California,
Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington
and Wisconsin (the “Franchise Registration States”). The registration process is not uniform in each Franchise Registration
State. Most Franchise Registration States require the franchisor to submit an application, which includes a FDD, in order to register
to sell franchises within that state. Many, but not all, of the state regulatory agencies in the Franchise Registration States
review the franchisor’s registration application, the FDD, the proposed franchise agreement and any other agreements franchisees
must sign, the financial condition of the franchisor, and other material information provided by the franchisor in its application.
These state agencies have the authority to deny a franchisor’s application for registration and prohibit the franchisor
from offering or selling franchises in the state.
In
addition, there are numerous states that have laws that regulate the relationship between a franchisor and a franchisee after
the sale of the franchise.
Under
the FTC Franchise Rule, the FTC has the authority to seek civil penalties against a franchisor for violations of the FTC Franchise
Rule. Each of the Franchise Registration States has similar authority to seek penalties for violations of their state franchise
registration and disclosure laws. Violations may include offering or selling an unregistered franchise, failing to timely provide
the disclosure document to a prospective franchisee or making misrepresentations in the FDDs. Additionally, officers, directors
and individuals with management responsibility for the franchisor may have personal liability for violations of franchise laws
if they had knowledge of (or should have had knowledge of) or participated in the violations.
There
is no direct, private right of action for a violation of the FTC Franchise Rule. However, most of the Franchise Registration States
provide for a private right of action for a violation of the state’s franchise registration and disclosure law. Remedies
available under these laws typically include damages, rescission of the franchise agreement and attorneys’ fees.
On
January 29, 2016, the Company temporarily suspended domestic franchise offers and sales of Bricks 4 Kidz® and Sew Fun Studios®
franchises in compliance with FTC Franchise Rule, Section 436.7(a) due to delay in completion of the Company’s fiscal year
2015 consolidated audited financial statements. In turn, this delayed completion of the Company’s 2016 FDDs for the Bricks
4 Kidz® and Sew Fun Studios® franchise offerings. The Company restarted selling efforts of Bricks 4 Kidz in September
of 2016. This temporary suspension of domestic franchise offer and sales did not affect the Company’s international franchise
offer and sales activity or its royalty fee collections from existing franchisees. The Company has also currently temporarily
suspended domestic franchise offers and sales of Bricks 4 Kidz® and Sew Fun Studios® franchises in compliance with FTC
Franchise Rule, Section 436.7(a) due to delay in completion of the Company’s fiscal year 2018 consolidated audited financial
statements. In turn, this delayed completion of the Company’s 2018 and 2019 FDDs for the Bricks 4 Kidz® and Sew Fun
Studios® franchise offerings.
Going
Concern
The
Company had losses of $218,833 in the current year. The Company had incurred accumulated losses of $2,391,525 as of September
30, 2018. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.
Based
on the Company’s cash balance at September 30, 2018 and projected cash needs for the next 12 months from the issuance date
of these financial statements, management believes that the Company will need to increase revenues, reduce costs and/or pursue
other transactions to be able to continue to fund operating and capital requirements. The Company plans to implement cost cutting
measures, including reducing personnel, reducing legal and professional expenses, moving the company’s central location
to Boise, ID, selling Company owned real estate, and incorporating technology where economic opportunity presents. The Company
plans to expand its offerings to allow current franchisees to operate in unoccupied territories for a yearly fee plus a monthly
percentage of revenue (see Note 10). However, should the current legal issues or unforeseen legal actions prevail against
the Company, or a drastic downturn in the economy become actual, the Company expects that profitability would be affected. At
such time, the Company would need to secure loans, lines of credit or other means to raise operating capital. The Company cannot
be sure that it will be able to obtain any such additional funds by any of the foregoing or other means, and any such funds it
may obtain may not be sufficient. If the Company is unable to obtain sufficient funds, it may be unable to continue as a going
concern.
General
The
Company’s offices, consisting of approximately 4,500 square feet, are located in an office/condo complex at 701 Market,
Suite 113, St. Augustine, FL 32095. The Company owns three of the office condominiums and rents one additional unit.
Subsequent
to year end, the Company sold one of its office condominiums in Florida and transitioned to a Boise, Idaho location for which
a new month-to-month office lease was signed.
At
September 30, 2018, the Company had 8 employees on a full time basis.
Available
Information
We
make available free of charge on our Internet website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically
filed with or furnished to the Securities and Exchange Commission, or (the “SEC”). Our corporate website is www.creativelearningcorp.com.
The information in this website is not a part of this report.
Item
1A. Risk Factors
Ownership
of our securities involves a high degree of risk. Holders of our securities should carefully consider the following risk
factors and the other information contained in this Form 10-K, including our historical financial statements and related
notes included herein. The following discussion highlights some of the risks that may affect future operating
results. Additional risks and uncertainties not presently known to us, which we currently deem immaterial or which are similar
to those faced by other companies in our industry or businesses in general, may also impair our businesses operations. If any
of the following risks or uncertainties actually occur, our business, financial condition and operating results could be adversely
affected in a material way. This could cause the trading prices of our common stock to decline, perhaps significantly, and you
may lose part or all of your investment. Please see “Cautionary Notes Regarding Forward-Looking Statements.”
Risks
Related to Our Business
We
may fail to continue as a going concern.
As
discussed elsewhere in this Annual Report on Form 10-K, our management has concluded that certain conditions and events that we
face raise substantial doubt about our ability to continue as a going concern. Our continuation as a going concern depends upon
many factors, including our ability to increase our revenues, reduce our costs and/or pursue other transactions, including seeking
to reduce our operating leverage and sell assets, to be able to continue to fund our operating and capital requirements and meet
our debt obligations. The perception of our ability to continue as a going concern may make it more difficult for us to obtain
financing for the continuation of our operations and could result in the loss of confidence by investors, suppliers and employees.
We cannot be sure that we will be able to obtain any such needed additional funds by any of the foregoing or other means, and
any such funds we may obtain may not be sufficient. If we are unable to obtain sufficient funds, we may be unable to continue
as a going concern.
Our
revenues decreased in fiscal year 2018 as compared to fiscal year 2017
Our
revenues decreased slightly in fiscal year 2018 to $2,416,726 from $2,456,033 in the prior year, a decrease of $39,307 or 2%,
primarily due to lower overall franchise sales. We have incurred losses in current year and prior years, and cannot be certain
that we can generate sufficient revenues to achieve profitability in the future. Continued losses or decreased revenues may impair
our ability to attract new franchisees and maintain positive working relationships with our current franchisees. In addition,
if we continue to incur losses, we may need to seek additional financing which could be dilutive to our stockholders.
Our
financial results are affected by the operating and financial results of and our relationships with our franchisees.
A substantial portion of
our revenues come from royalties, which have been generally based on a percentage of our franchisees’ revenues. As a result,
our financial results have been largely dependent upon the operational and financial results of our franchisees. Negative economic
conditions, including inflation, increased unemployment levels and the effect of decreased consumer confidence or changes in consumer
behavior, could materially harm our franchisees’ financial condition, which would cause our royalty and other revenues to
decline and materially and adversely affect our results of operations and financial condition as a result. In addition, if our
franchisees fail to renew their franchise agreements, stop operating their franchise business or enter into a termination agreement
with the company, these revenues may decrease, which in turn could materially and adversely affect our results of operations and
financial condition. In part to support franchisee growth and financial planning and to enrich relations with our franchisees,
the Company altered its royalty fee structure beginning and effective October 1, 2015, changing it to a fixed monthly charge on
an escalating scale over five years.
Our
franchisees could take actions that harm our business.
Our
franchisees are independent third party business owners who are contractually obligated to operate in accordance with the operational
and other standards set forth in the franchise agreement. Although we engage in a thorough screening process when reviewing potential
franchisee candidates, we cannot be certain that our franchisees will have the business acumen or financial resources necessary
to operate successful franchises in their approved territories. In addition, certain state franchise laws may limit our ability
to terminate, not renew or modify these franchise agreements. As independent business owners, the franchisees oversee their own
daily operations. As a result, the ultimate success and quality of any franchise rests with the franchisee. If franchisees do
not successfully operate in a manner consistent with required standards and comply with local laws and regulations, franchise
fees and royalties paid to us may be adversely affected and our brand image and reputation could be harmed, which in turn could
adversely affect our results of operations and financial condition.
Moreover,
although we believe we generally maintain positive working relationships with our franchisees, disputes with franchisees could
damage our brand image and reputation and our relationships with our franchisees, generally.
Our
success depends substantially on the value of our brand.
Our
success is substantially dependent upon our ability to maintain and enhance the value of our brand, the customers of our franchisees’
connection to our brand and a positive relationship with our franchisees. Brand value can be severely damaged even by isolated
incidents, particularly if the incidents receive considerable negative publicity or result in litigation. Some of these incidents
may relate to the way we manage our relationships with our franchisees, our growth strategies, our development efforts or the
ordinary course of our, or our franchisees’, businesses. Other incidents that could be damaging to our brand may arise from
events that are or may be beyond our ability to control, such as:
|
●
|
actions
taken (or not taken) by one or more franchisees or their employees relating to health,
safety, welfare or otherwise;
|
|
●
|
data
security breaches or fraudulent activities associated with our and our franchisees’
electronic payment systems;
|
|
●
|
litigation
and legal claims;
|
|
●
|
third-party
misappropriation, dilution or infringement of our intellectual property; and
|
|
●
|
illegal
activity targeted at us or others.
|
Consumer
demand for our products and services and our brand’s value could diminish significantly if any such incidents or other matters
erode consumer confidence in us or our products or services, which would likely result in fewer sales of our products and services
and, ultimately, lower royalty revenue, which in turn could materially and adversely affect our results of operations and financial
condition.
If
we fail to successfully implement our growth strategy, our ability to increase our revenues and net income could be adversely
affected.
Our
growth strategy relies in large part upon new business development by existing and new franchisees. Our franchisees face many
challenges in growing their businesses, including:
|
●
|
availability
and cost of financing;
|
|
●
|
securing
required domestic or foreign governmental permits and approvals;
|
|
●
|
trends
in new geographic regions and acceptance of our products and services;
|
|
●
|
competition
with competing franchise systems;
|
|
●
|
employment,
training and retention of qualified personnel; and
|
|
●
|
general
economic and business conditions.
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In
particular, because the majority of our business development is funded by franchisee investment, our growth strategy is dependent
on our franchisees’ (or prospective franchisees’) ability to access funds to finance such development. If our franchisees
(or prospective franchisees) are not able to obtain financing at commercially reasonable rates, or at all, they may be unwilling
or unable to invest in business development, and our future growth could be adversely affected.
Our
growth strategy also relies on our ability to identify, recruit and enter into franchise agreements with a sufficient number of
qualified franchisees. In addition, our ability and the ability of our franchisees to successfully expand into new markets may
be adversely affected by a lack of awareness or acceptance of our brand as well as a lack of existing marketing efforts and operational
execution in these new markets. To the extent that we are unable to implement effective marketing and promotional programs and
foster recognition and affinity for our brand in new markets, our franchisees may not perform as expected and our growth may be
significantly delayed or impaired. In addition, franchisees may have difficulty securing adequate financing, particularly in new
markets, where there may be a lack of adequate history and brand familiarity. Our franchisees’ business development efforts
may not be successful, which could materially and adversely affect our business, results of operations and financial condition.
Our
future growth could place strains on our management, employees, information systems and internal controls, which may
adversely impact our business.
Our
future growth may place significant demands on our administrative, operational, financial and other resources. Any failure
to manage growth effectively could seriously harm our business. To be successful, we will need to continue to implement management
information systems and improve our operating, administrative, financial and accounting systems and controls. We will also need
to train new employees and maintain close coordination among our executive, accounting, finance, legal, human resources, risk
management, marketing, technology, sales and operations functions. These processes are time-consuming and expensive, increase
management responsibilities and divert management attention, and we may not realize a return on our investment in these processes.
Our failure to successfully execute on our planned expansion could materially and adversely affect our results of operations and
financial condition.
Changing
economic conditions, including unemployment rates, may reduce demand for our products and services.
Our
revenues and other financial results are subject to general economic conditions. Our revenues depend, in part, on the number of
dual-income families and working single parents who require child development or educational services. A deterioration of general
economic conditions, including a soft housing market and/or rising unemployment, may adversely impact us because of the tendency
of out-of-work parents to diminish or discontinue utilization of these services. Finally, there can be no assurance that demographic
trends, including the number of dual-income families in the work force, will continue to lead to increased demand for our products
and services.
We
may require additional financing to execute our business plan and fund our other liquidity needs.
We
currently have no revolving credit facility or other committed source of recurring capital. Unless we are able to increase our
revenues or decrease our operating expenses from recent historical run-rate levels, we expect that we may need to obtain additional
capital during fiscal year 2019 to fund our planned operations. If our cash flows from operations do not meet or exceed our projections,
we may need to pursue one or more alternatives, such as to:
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reduce
or delay planned capital expenditures or investments in our business;
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seek
additional financing or restructure or refinance all or a portion of our indebtedness
at or before maturity;
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sell
assets or businesses;
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sell
additional equity; or
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curtail
our operations.
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Any
such actions may materially and adversely affect our future prospects. In addition, we cannot ensure that we will be able to raise
additional equity capital, restructure or refinance any of our indebtedness or obtain additional financing on commercially reasonable
terms or at all. To ensure that the Company has sufficient liquidity, the Company received confirmation letters as further described
under Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity
and Capital Resources.
Any
long-term indebtedness we may incur could adversely affect our business and limit our ability to expand our business or respond
to changes, and we may be unable to generate sufficient cash flow to satisfy our debt service obligations.
We
currently have no outstanding debt, other than the current liabilities reflected in the accompanying consolidated financial statements.
We may incur indebtedness in the future. Any long-term indebtedness we may incur and the fact that a substantial portion of our
cash flow from operating activities could be needed to make payments on this indebtedness could have adverse consequences, including
the following:
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reducing
the availability of our cash flow for our operations, capital expenditures, future business opportunities, and other purposes;
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limiting
our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate, which would place
us at a competitive disadvantage compared to our competitors that may have less debt;
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limiting
our ability to borrow additional funds;
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increasing
our vulnerability to general adverse economic and industry conditions; and
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failing
to comply with the covenants in our debt agreements could result in all of our indebtedness becoming immediately due and payable.
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Our
ability to borrow any funds needed to operate and expand our business will depend in part on our ability to generate cash. Our
ability to generate cash is subject to the performance of our business as well as general economic, financial, competitive, legislative,
regulatory, and other factors that are beyond our control. If our business does not generate sufficient cash flow from operating
activities or if future borrowings are not available to us in amounts sufficient to enable us to fund our liquidity needs, our
operating results, financial condition, and ability to expand our business may be adversely affected. Moreover, our inability
to make scheduled payments on our debt obligations in the future would require us to refinance all or a portion of our indebtedness
on or before maturity, sell assets, delay capital expenditures or seek additional equity
We
are subject to a variety of additional risks associated with our franchisees.
Our
franchise business model subjects us to a number of risks, any one of which may impact our royalty revenues collected from our
franchisees, may harm the goodwill associated with our brand, and may materially and adversely impact our business and results
of operations.
Bankruptcy
of franchisees. A franchisee bankruptcy could have a substantial negative impact on our ability to collect payments due under
such franchisee’s franchise agreement(s). In a franchisee bankruptcy, the bankruptcy trustee may reject its franchise agreement(s)
pursuant to Section 365 under the U.S. bankruptcy code, in which case there would be no further royalty payments from such
franchisee, and we may not ultimately recover those payments in a bankruptcy proceeding of such franchisee in connection with
a damage claim resulting from such rejection.
Franchisee
changes in control. Our franchises are operated by independent business owners. Although we have the right to approve franchise
owners, and any transferee owners, it can be difficult to predict in advance whether a particular franchise owner will be successful.
If an individual franchise owner is unable to successfully establish, manage and operate its business, the performance and quality
of its service could be adversely affected, which could reduce its sales and negatively affect our royalty revenues and brand
image. Although our franchise agreements prohibit “changes in control” of a franchisee without our prior consent as
the franchisor, a franchise owner may desire to transfer a franchise. In addition, in any transfer situation, the transferee may
not be able to successfully operate the business. In such a case the performance and quality of service could be adversely affected,
which could also reduce its sales and negatively affect our royalty revenues and brand image.
Franchisee
insurance. Our franchise agreements require each franchisee to maintain certain insurance types and levels. Losses arising
from certain extraordinary hazards, however, may not be covered, and insurance may not be available (or may be available only
at prohibitively expensive rates) with respect to many other risks. Moreover, any loss incurred could exceed policy limits and
policy payments made to franchisees may not be made on a timely basis. Any such loss or delay in payment could have a material
adverse effect on a franchisee’s ability to satisfy its obligations under its franchise agreement or other contractual obligations,
which could cause a franchisee to terminate its franchise agreement and, in turn, negatively affect our operating and financial
results.
Some
of our franchisees are operating entities. Franchisees may be natural persons or legal entities. Our franchisees that are
operating companies (as opposed to limited purpose entities) are subject to business, credit, financial and other risks, which
may be unrelated to the operation of their franchise businesses. These unrelated risks could materially and adversely affect a
franchisee that is an operating company and its ability to service its customers and maintain its operations while making royalty
payments, which in turn may materially and adversely affect our business and operating results.
Franchise
agreement termination; nonrenewal. Each franchise agreement is subject to termination by us as the franchisor in the event
of a default, generally after expiration of applicable cure periods, although under certain circumstances a franchise agreement
may be terminated by us upon notice without an opportunity to cure. Our right to terminate franchise agreements may be subject
to certain limitations under any applicable state relationship laws that may require specific notice or cure periods despite the
provisions in the franchise agreement. The default provisions under the franchise agreements are drafted broadly and include,
among other things, any failure to meet operating standards and actions that may threaten the licensed intellectual property.
Moreover, a franchisee may have a right to terminate its franchise agreement in certain circumstances.
In
addition, each franchise agreement has an expiration date. Upon the expiration of a franchise agreement, we or the franchisee
may, or may not, elect to renew the franchise agreement. If the franchise agreement is renewed, the franchisee will receive a
“successor” franchise agreement for an additional term. Such option, however, is contingent on the franchisee’s
execution of our then-current form of franchise agreement (which may include increased royalty revenues, advertising fees and
other fees and costs), the satisfaction of certain conditions and the payment of a renewal fee. If a franchisee is unable or unwilling
to satisfy any of the foregoing conditions, the expiring franchise agreement will terminate upon expiration of its term. Our right
to elect to not renew a franchise agreement may be subject to certain limitations under any applicable state relationship laws
that may require specific notice periods or “good cause” for non-renewal despite the provisions in the franchise agreement.
Franchisee
litigation; effects of regulatory efforts. We and our franchisees are subject to a variety of litigation risks, including,
but not limited to, customer claims, personal injury claims, litigation with or involving our relationship with franchisees, litigation
alleging that the franchisees are our employees or that we are the co-employer of our franchisees’ employees, employee allegations
against the franchisee or us of improper termination and discrimination, landlord/tenant disputes and intellectual property claims,
among others. Each of these claims may increase costs, reduce the execution of new franchise agreements and affect the scope and
terms of insurance or indemnifications we and our franchisees may have. In addition, we and our franchisees are subject to various
regulatory enforcement actions regarding among other things franchise and employment laws, such as: failure to comply with franchise
registration and disclosure requirements; the provision to prospective franchisees of business projections; efforts to categorize
franchisors as the co-employers of their franchisees’ employees; legislation to categorize individual franchised businesses
as large employers for the purposes of various employment benefits; and other legislation or regulations that may have a disproportionate
impact on franchisors and/or franchised businesses. These changes may impose greater costs and regulatory burdens on franchising,
and negatively affect our ability to sell new franchises.
Franchise
agreements and franchisee relationships. Our franchisees develop and operate their business under terms set forth in our franchise
agreements. These agreements give rise to long-term relationships that involve a complex set of mutual obligations and mutual
cooperation. We have a standard set of franchise agreements that we typically use with our franchisees, but various franchisees
have negotiated specific terms in these agreements. Furthermore, we may from time to time negotiate terms of our franchise agreements
with individual franchisees or groups of franchisees (e.g., a franchisee association). We seek to have positive relationships
with our franchisees, based in part on our common understanding of our mutual rights and obligations under our agreements, to
enable both the franchisees’ business and our business to be successful. However, we and our franchisees may not always
maintain a positive relationship or always interpret our agreements in the same way. Our failure to have positive relationships
with our franchisees could individually or in the aggregate cause us to change or limit our business practices, which may make
our business model less attractive to our franchisees or our members.
While
our franchisee revenues are not concentrated among one or a small number of parties, the success of our business is significantly
affected by our ability to maintain contractual relationships with profitable franchisees. A typical franchise agreement has a
ten-year term. If we fail to maintain or renew our contractual relationships on acceptable terms, or if one or more significant
franchisees were to become insolvent or otherwise were unwilling to pay amounts due to us, our business, reputation, financial
condition and results of operations could be materially adversely affected.
Our
business is subject to various laws and regulations, and changes in such laws and regulations, or failure to comply with existing
or future laws and regulations, could adversely affect our business.
We
are subject to the FTC Franchise Rule promulgated by the FTC that regulates the offer and sale of franchises in the United States
and that requires us to provide to all prospective franchisees certain mandatory disclosure in a FDD. In addition, we are subject
to state franchise sales laws in 14 states that regulate the offer and sale of franchises by requiring us to make a franchise
filing and, in some instances, or obtain approval by the state franchise agency of that filing prior to our making any offer or
sale of a franchise in those states and to provide a FDD to prospective franchisees in accordance with such laws. We are also
subject to franchise laws in certain provinces in Canada, which, like the FTC Franchise Rule, require presale disclosure to prospective
franchisees prior to the sale of a franchise. We must also comply with international laws, including franchise laws, in the countries
where we have franchise operations or conduct franchise offer and sales activities. Failure to comply with such laws may result
in a franchisee’s right to rescind its franchise agreement and to seek damages, and may result in investigations or actions
from federal or state franchise authorities, civil fines or penalties, and stop orders, among other remedies. We are also subject
to franchise relationship laws in approximately 24 states that regulate many aspects of the franchisor-franchisee relationship,
including renewals and terminations of franchise agreements, franchise transfers, the applicable law and venue in which franchise
disputes must be resolved, discrimination and franchisees’ right to associate, among others. Our failure to comply with
such franchise relationship laws could result in fines, damages, restitution and our inability to enforce franchise agreements
where we have violated such laws. Our non-compliance with federal and state franchise laws could result in liability to franchisees
and regulatory authorities (as described above), inability to enforce our franchise agreements, required rescission of franchise
agreements and a reduction in our anticipated royalty revenue, which in turn may materially and adversely affect our business
and results of operating.
We
and our franchisees are also subject to the Fair Labor Standards Act of 1938, as amended, and various other laws in the United
States and foreign countries governing such matters as minimum-wage requirements, overtime and other working conditions. A significant
number of our and our franchisees’ employees are paid at rates related to the U.S. federal minimum wage, and past increases
in the U.S. federal minimum wage have increased labor costs, as would future increases. Any increases in labor costs might result
in our and our franchisees inadequately staffing stores. Such increases in labor costs and other changes in labor laws could affect
franchisee performance and quality of service, decrease royalty revenues and adversely affect our brand.
We
have identified material weaknesses in our internal controls over financial reporting in the past.
If
our remedial measures are insufficient to address the material weakness or if additional material weaknesses or significant deficiencies
in our internal control are discovered or occur in the future, we may be unable to accurately report our financial results, or
report them within the required timeframes, our consolidated financial statements may contain material misstatements and we could
be required to restate our financial results in the future, which could cause investors and others to lose confidence in our financial
statements, limit our ability to raise capital and could adversely affect our reputation, results of operations and consolidated
financial condition.
The
markets for our services are competitive, and we may be unable to compete successfully.
The
markets for our services are competitive, and we may be subject to increased competition in our markets in the future. We expect
existing competitors and new entrants into the markets where we do business to constantly revise and improve their business models
in light of challenges from us or other companies in the industry. If we cannot respond effectively to advances by our competitors,
our business and financial performance may be adversely affected. Increased competition may result in new products and services
that fundamentally change our markets, reduce prices, reduce margins or decrease our market share. We may be unable to compete
successfully against current or future competitors, some of whom may have significantly greater financial, technical, manufacturing,
marketing, sales and other resources than we do.
Our
quarterly revenues and operating results are difficult to predict and may fluctuate significantly in the future.
Our
quarterly revenues and operating results are difficult to predict and may fluctuate significantly from quarter to quarter. These
fluctuations may cause the market price of our common stock to decline. We base our planned operating expenses in part on expectations
of future revenues, and our expenses are relatively fixed in the short term. If revenues for a particular quarter are lower than
we expect, we may be unable to proportionately reduce our operating expenses for that quarter, which would harm our operating
results for that quarter. In future periods, our revenue and operating results may be below the expectation of analysts and investors,
which may cause the market price of our common stock to decline. Factors that are likely to cause our revenues and operating results
to fluctuate include those discussed elsewhere in this section.
We
rely upon trademark, copyright and trade secret laws and contractual restrictions to protect our proprietary rights, and if these
rights are not sufficiently protected, our ability to compete and generate revenues could be harmed.
We
rely on a combination of trademark, copyright and trade secret laws, and contractual restrictions, such as confidentiality agreements
and licenses, to establish and protect our proprietary rights. The steps taken by us to protect our proprietary information may
not be adequate to prevent misappropriation of our technology. Our proprietary rights may not be adequately protected because:
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laws
and contractual restrictions may not prevent misappropriation of our technologies or
deter others from developing similar technologies; and
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policing
unauthorized use of our products and trademarks is difficult, expensive and time-consuming,
and we may be unable to determine the extent of any unauthorized use.
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The
laws of certain foreign countries may not protect the use of unregistered trademarks or other proprietary rights to the same extent
as do the laws of the United States. As a result, international protection of our image may be limited and our right to use our
trademarks and other proprietary rights outside the United States could be impaired. Other persons or entities may have rights
to trademarks that contain portions of our marks or may have registered similar or competing marks for digital signage in foreign
countries. There may also be other prior registrations of trademarks identical or similar to our trademarks in other foreign countries.
Our inability to register our trademarks or other proprietary rights or purchase or license the right to use the relevant trademarks
or other proprietary rights in these jurisdictions could limit our ability to penetrate new markets in jurisdictions outside the
United States.
Litigation
may be necessary to protect our trademarks and other intellectual property rights, to enforce these rights or to defend against
claims by third parties alleging that we infringe, dilute or otherwise violate third-party trademark or other intellectual property
rights. Any litigation or claims brought by or against us, whether with or without merit, or whether successful or not, could
result in substantial costs and diversion of our resources, which could have a material adverse effect on our business, financial
condition, results of operations or cash flows. Any intellectual property litigation or claims against us could result in the
loss or compromise of our intellectual property rights, could subject us to significant liabilities, require us to seek licenses
on unfavorable terms, if available at all or prevent us from manufacturing or selling certain products, any of which could have
a material adverse effect on our business, financial condition, results of operations or cash flows.
We
may face intellectual property infringement claims that could be time-consuming, costly to defend and result in its loss of significant
rights.
Other
parties may assert intellectual property infringement claims against us, and our products and services may infringe the intellectual
property rights of third parties. We may also initiate claims against third parties to defend our intellectual property. Intellectual
property litigation is expensive and time-consuming and could divert management’s attention from our core business. If there
is a successful claim of infringement against us, we may be required to pay substantial damages to the party claiming infringement,
develop non-infringing technology or enter into royalty or license agreements that may not be available on acceptable terms, if
at all. Our failure to develop non-infringing technologies or license the proprietary rights on a timely basis could harm our
business. Also, we may be unaware of filed patent applications that relate to our products. Parties making infringement claims
may be able to obtain an injunction, which could prevent us from operating portions of our business or using technology that contains
the allegedly infringing intellectual property. Any intellectual property litigation could adversely affect our business, financial
condition or results of operations.
We
depend on key executive management and other key personnel, and may not be able to retain or replace these individuals or recruit
additional personnel, which could harm our business.
On
September 15, 2018, Christian Miller resigned as Chief Operating Officer and Chief Financial Officer of the Company. Accordingly,
the Company recruited additional senior management. Because of the intense competition for these employees and because of other
risk factors identified in this report, we may be unable to retain our management team and other key personnel and may be unable
to find qualified replacements. All of our key employees are employed on an “at will” basis and we do not have key-man
life insurance covering any of our employees. The loss of the services of any of our executive management members or other key
personnel could have a material adverse effect on our business and prospects, as we may not be able to find suitable individuals
to replace such personnel on a timely basis or without incurring increased costs, or at all.
We
could be subject to changes in tax rates, the adoption of new U.S. or international tax legislation or exposure to additional
tax liabilities.
We
are subject to income taxes in the U.S. and other foreign jurisdictions. Significant judgment is required in determining our tax
provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate
tax determination is uncertain. We are subject to the examination of our income tax returns, payroll taxes and other tax
matters by the Internal Revenue Service and other tax authorities and governmental bodies. The Company regularly assesses the
likelihood of an adverse outcome resulting from these examinations to determine the adequacy of its provision for income taxes
and payroll tax accruals. There can be no assurances as to the outcome of these examinations. Although we believe our tax
estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from
our historical tax provisions and payroll accruals. The results of an audit or litigation could have a material effect on
our consolidated financial statements in the period or periods for which that determination is made. Our effective income tax
rate in the future could be adversely affected by a number of factors, including changes in the mix of earnings in countries with
different statutory tax rates, changes in tax laws, the outcome of income tax audits, and any repatriation of non-U.S. earnings
for which we have not previously provided for U.S. taxes.
Risks
Related to Our Common Stock
The
concentration of our capital stock ownership with insiders will likely limit your ability to influence corporate matters.
As
of July 10, 2019, our executive officers, directors, significant shareholders and affiliated persons and entities collectively,
beneficially owned approximately 20.2% of our outstanding common stock. As a result, these persons and entities have the ability
to exercise control over most matters that require approval by our stockholders, including the election of directors and approval
of significant corporate transactions. Corporate action might be taken even if other stockholders oppose them. This concentration
of ownership might also have the effect of delaying or preventing a change in control of our company that other stockholders may
view as beneficial.
Compliance
with the Sarbanes-Oxley Act of 2002 will require substantial financial and management resources.
Section
404 of the Sarbanes-Oxley Act of 2002 requires that we evaluate and report on our system of internal controls and, if and when
we are no longer a “smaller reporting company,” will require that we have such system of internal controls audited.
If we fail to maintain the adequacy of our internal controls, we could be subject to regulatory scrutiny, civil or criminal penalties
and/or Stockholder litigation. Any inability to provide reliable financial reports could harm our business. Furthermore, any failure
to implement required new or improved controls, or difficulties encountered in the implementation of adequate controls over our
financial processes and reporting in the future, could harm our operating results or cause us to fail to meet our reporting obligations.
Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have
a negative effect on the trading price of our securities.
We
currently are eligible to deregister our Common Stock from SEC reporting requirements.
Upon
filing this Form 10-K and Form 10-Qs for the subsequent three quarters, we will be eligible to deregister our securities from
the reporting requirements of the Securities Exchange Act of 1934, as amended as we currently have less than 300 shareholders
of record and our Common Stock is not listed on a stock exchange. If our Common Stock is deregistered, it may be more difficult
to receive information of the Company which could affect the liquidity of our Common Stock.
Provisions
in our charter documents and Delaware law may discourage or delay an acquisition that stockholders may consider favorable, which
could decrease the value of our common stock.
Our
certificate of incorporation, our bylaws, and Delaware corporate law contain provisions that could make it harder for a third
party to acquire us without the consent of our board of directors (the “Board”). These provisions include those that:
authorize the issuance of up to 10,000,000 shares of preferred stock in one or more series without a stockholder vote. In addition,
in certain circumstances, Delaware law also imposes restrictions on mergers and other business combinations between us and any
holder of 15% or more of our outstanding common stock, though we are not currently subject to this limitation because our Common
Stock is not listed on a national securities exchange and we have less than 2,000 stockholders of record.
We
have not paid cash dividends to our shareholders and currently have no plans to pay future cash dividends.
We
plan to retain earnings to finance future growth and have no current plans to pay cash dividends to shareholders. Any indebtedness
that we incur in the future may also limit our ability to pay dividends. Because we have not paid cash dividends, holders of our
securities will experience a gain on their investment in our securities only in the case of an appreciation of value of our securities.
You should neither expect to receive dividend income from investing in our securities nor an appreciation in value.
Item
1B. Unresolved Staff Comments
Not
applicable.
Item
2. Properties
As
of September 30, 2018 the Company’s offices, consisting of approximately 4,500 square feet, were located in an office/condominium
complex in St. Augustine, Florida. The Company owns three of the office condominiums and rents one additional unit.
Subsequent
to year end, the Company sold one of its office condominiums in Florida and transitioned to a Boise, Idaho location for which
a new month-to-month office lease was signed. The Company believes it can streamline its operations by selling their owned facilities
and leasing office space and training space as needed.
Item
3. Legal Proceedings
From
time to time, the Company has been and may become involved in legal proceedings arising in the ordinary course of its business.
Regardless of the outcome, litigation can have an adverse impact on the Company because of defense and settlement costs, diversion
of management resources, and other factors.
On
October 2, 2015, the Company filed suit in the state court in St. John’s County, Florida, Case No. CA 15-1076, against its
former Chief Executive Officer Brian Pappas, Christine Pappas, its former Human Resources officer, and an independent company
controlled by Mr. Pappas named Franventures, LLC (“Franventures”). The lawsuit seeks return of company emails and
other electronic materials in the possession of the defendants, company control over the process by which the company’s
documents are identified, and a court judgment that the property is the Company’s. Mr. and Mrs. Pappas have returned certain
company documents that they have identified, but other issues remain. On December 11, 2017, Brian Pappas filed a counterclaim
alleging the Company is required to indemnify him for a multitude of matters. The Company denies the allegation and is actively
litigating this matter.
In
a separate suit, filed on March 7, 2016 in the state court in St. John’s County, Florida (Case No. CA 16-236), Franventures,
LLC (“FV”) alleged that it is due an unstated amount of money from the Company pursuant to a contract the Company
had previously terminated. On June 23, 2016, the Company filed a counterclaim against Franventures, which also included a complaint
against former Chairman of the Board and Chief Executive Officer Brian Pappas. The counterclaim seeks redress for losses and expenditures
caused by alleged fraud, conversion of company assets, and breaches of fiduciary duty that the Company alleges that defendants
perpetrated upon CLC, including assertions regarding actions by Brian Pappas that the Company alleges occurred while Mr. Pappas
was serving as the Chief Executive Officer of CLC and as a member of its board of directors. The Company is actively litigating
this matter.
On
October 27, 2016, Brian Pappas filed a motion to amend the complaint to add a claim alleging that the Company slandered him by
virtue of a press release issued on or about August 1, 2016, in which the Company reported to shareholders on steps it had taken
and improvements it had implemented. The motion has still not been ruled upon by the Court. If Mr. Pappas does amend his complaint,
the Company will vigorously defend the proposed claim.
On
February 24, 2017, franchisee, Team Kasa, LLC, along with its three owners, filed suit in the Eastern District of New York (Case
No. 2:17-cv-01074) against former CEO Brian Pappas, and Franventures. The same Plaintiffs also initiated arbitration on the same
issues (American Arbitration Association, Case No. 01-17-0001-1968), alleging the Company is jointly and severally liable for
damages resulting from the allegations against Mr. Pappas and Franventures. The Company is contesting the allegations and its
liability for any damages.
On
May 9, 2017, franchisee, Back and 4th, LLC, along with its owner, Kristena Bins-Turner, initiated arbitration against the Company
for breach of contract, alleging that they did not receive adequate value for royalty payments made under the franchise agreement,
for fraud, alleging material misrepresentations and omissions prior to entry into the franchise agreements, and for misrepresentation
violations of Florida Statute 817.416. (American Arbitration Association, Case. No. 01-16-004-3745). Franchisee and its owner
seek an unspecified amount of damages. The Company contested the allegations and its liability for any damages at an evidentiary
hearing held December 5-7, 2017. This matter has been settled for $45,500 and included in other general and administrative expenses
in the consolidated statement of operations the year ended September 30, 2018.
On
August 21, 2017, the SEC filed a Civil Complaint against the Company and certain former executive officers and directors in the
United States District Court for the Middle District of Florida, Jacksonville Division, as Civil Action No. 3:17-cv-00954-TJC-JRK.
The Civil Complaint was in regards to alleged violations of federal securities law occurring between 2011 and 2015. On August
22, 2017, the SEC also filed with the court the Company’s formal Consent to a full resolution of all allegations pertaining
to the Company. Pursuant to the Consent, without admitting or denying the allegations, the Company agreed to the entry of a final
judgment that permanently enjoins it from violating the sections of the federal securities laws listed in the Civil Complaint.
On September 20, 2017, the United States District Court for the Middle District of Florida, Jacksonville Division issued the final
judgment order as to the Company in the Civil Action No. 3:17-cv-00954-TJC-JRK. The entering of the final judgment order has resolved
all allegations pertaining to the Company. The Company was not assessed any monetary penalties. Various law firms worked on this
case. As stated in the above, this matter is resolved and closed.
On
September 21, 2017, the Company filed a notice of voluntary dismissal without prejudice in the United States District Court for
the Middle District of Florida, Jacksonville Division, in its lawsuit against Blake and Anik Furlow relating to their conduct
in the shareholder consent the complaint on May 15, 2017, and after consideration, decided it was not in the best interest of
the Company to proceed with the litigation. Greenbrerg Traurig was the firm used for this action. The action is closed. The dismissal
is public record and is case # 3:17-cv-00552.
On
November 8, 2017, franchisee, Indy Bricks, LLC, along with its two owners, Ben and Kate Schreiber initiated arbitration against
the Company. (American Arbitration Association, Case No. 01-17-0006-8120). Plaintiffs allege breach of contract, fraud, material
misrepresentations and omissions, violations of the Indiana Franchise Act, and violations of the Indiana Deceptive Franchise Practices
Act. The Company is vigorously contesting the allegations and its liability for any damages.
Item
4. Mine Safety Disclosures
Not
applicable.
The accompanying notes are an integral part of the
consolidated financial statements.
The accompanying notes are an integral part of the
consolidated financial statements.
The accompanying notes are an integral part of the
consolidated financial statements.
The accompanying notes are an integral part of the
consolidated financial statements.
Notes
to Consolidated Financial Statements
September
30, 2018 and 2017
(1) Nature
of Organization and Summary of Significant Accounting Policies
Nature
of Organization
Creative
Learning Corporation (“CLC”), formerly B2 Health, Inc., was incorporated March 8, 2006 in the State of Delaware. BFK
Franchise Company LLC (“BFK”) was formed in the State of Nevada on May 19, 2009. Effective July 2, 2010, CLC was acquired
by BFK in a transaction classified as a reverse acquisition. CLC concurrently changed its name from B2 Health, Inc. to Creative
Learning Corporation.
In
addition to the accounts of CLC and BFK, the accompanying consolidated financial statements include the accounts of CLC’s
subsidiaries, BFK Development Company LLC (“BFKD”), and SF LLC (“Sew Fun Studios”).
The
organizational documents for BFK Development Company LLC and SF LLC do not specify a termination date. Each of the above listed
LLC’s has a single member, controlled 100% by CLC.
CLC
operates wholly-owned subsidiaries BFK and SF under the trade names Bricks 4 Kidz® and Sew Fun Studios™ respectively, that
offer children's enrichment and education franchises.
CLC
and its wholly own subsidiaries BFK, BFKD, and SF LLC are hereinafter referred to collectively as the "Company".
Basis
of Presentation
The
Company financial statements are presented on the accrual basis of accounting in accordance with accounting principles generally
accepted in the United States of America (“GAAP”).
International
franchise fees vary and are set relative to the potential of the franchised territories. In addition, the Company awards master
agreements outside of the United States and Canada. The royalty structure is the same for both our US and International franchisees.
Contracts are structured as such that the Company collects revenue from foreign franchises in US dollars. We do not have international
subsidiaries.
The
Company has multiple franchise concepts, but all concepts are managed centrally as one segment and are reviewed by the Company
in total. Accordingly, decision-making regarding the Company's overall operating performance and allocation of Company resources
are assessed on a consolidated basis. As such, the Company operates as one reporting segment.
Principles
of Consolidation
The
accompanying consolidated financial statements include the accounts of CLC and its wholly-owned subsidiaries. All intercompany
balances and transactions have been eliminated in consolidation.
Fiscal
year
The
Company operates on a September 30 fiscal year-end.
Use
of Estimates
The
preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities
at the date of financial statements and the reported amounts of revenues and expenses during the reporting period. The significant
estimates and assumptions made by management include allowance for doubtful accounts, allowance for deferred tax assets, depreciation
of property and equipment, recoverability of long lived assets and fair value of equity instruments. Actual results could differ
from those estimates as the current economic environment has increased the degree of uncertainty inherent in these estimates and
assumptions.
Cash,
Restricted Cash, and Cash Equivalents
The
Company considers all highly liquid securities with original maturities of three months or less when acquired, to be cash equivalents.
We had no cash equivalents at September 30, 2018 and 2017.
The
Company had restricted cash of approximately $23,000 and $118,000, respectively at fiscal years ended September 30, 2018 and 2017,
associated with marketing funds collected from the franchisees. Per the franchise agreements, a marketing fund of 2% of franchisees’
gross cash receipts is collected by the Company and held to be spent on the promotion of the brand (see Note 8).
The
Company maintains cash balances which at times exceed the federally insured limit of $250,000. The Company believes there is no
significant risk with respect to these deposits.
Accounts
Receivable
The
Company reviews accounts receivable periodically for collectability and establishes an allowance for doubtful accounts and records
bad debt expense when deemed necessary. The Company records an allowance for doubtful accounts that is based on historical trends,
customer knowledge, any known disputes, and considers the aging of the accounts receivable balances combined with management’s
estimate of future potential recoverability. Accounts and receivables are written off against the allowance after all attempts
to collect a receivable have failed. The Company believes its allowances for doubtful accounts at September 30, 2018 and 2017
are adequate, but actual write-offs could exceed the recorded allowance. During the years ended September 30, 2018 and 2017 the
balance in the allowance for doubtful accounts was approximately $938,000 and $262,000, respectively.
Notes
Receivable
ASC
310, Receivables, provides guidance for receivables and notes that arise from credit sales, loans or other transactions. Financing
receivable includes loans and notes receivable. Originated loans we hold for which we have the intent and ability to hold for
the foreseeable future or to maturity (or payoff) are classified as held for investment. Financing receivables held for investment
are reported in our consolidated balance sheets at the outstanding principal balance adjusted for any write -offs , allowance
for loan losses, deferred fees or costs, and any unamortized premiums or discounts. Interest income is accrued on outstanding
principal as earned. Unamortized discounts and premiums are amortized using the interest method with the amortization recognized
as part of interest income in the consolidated statements of operations. During the years ended September 30, 2018 and 2017 the
balance in the allowance for doubtful notes receivable was approximately $91,000 and $33,000, respectively.
Long-Lived
Assets
The
Company’s long-lived assets consist of property and equipment, and intangible assets. The Company tests for impairment losses
on long-lived assets used in operations whenever events or changes in circumstances indicate that the carrying amount of the asset
may not be recoverable. Recoverability of an asset to be held and used is measured by a comparison of the carrying
amount of an asset to the future undiscounted cash flows expected to be generated by the asset. If such asset is considered
to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its
fair value. Impairment evaluations involve management’s estimates of asset useful lives and future cash flows. Actual
useful lives and cash flows could be different from those estimated by management which could have a material effect on our reporting
results and financial positions. Fair value is determined through various valuation techniques including discounted
cash flow models, quoted market values and third-party independent appraisals, as considered necessary.
During
fiscal year 2018, the Company recognized an Impairment Loss on long-lived assets relating to concepts and trademarks for SF LLC.
Impairment is included in operating expenses in the consolidated statement of operations. See Note 5 for more information.
Property,
Equipment and Depreciation
Property
and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of
the related assets. Expenditures for additions and improvements are capitalized, while repairs and maintenance costs are expensed
as incurred. The cost and related accumulated depreciation of property and equipment sold or otherwise disposed of are removed
from the accounts and any gain or loss is recorded in the year of disposal.
Property and Equipment
|
|
Useful
Life
|
Equipment
|
|
5 years
|
Furniture and Fixtures
|
|
5 years
|
Property Improvements
|
|
15-40 years
|
Software
|
|
3 years
|
Treasury
stock.
The
Company records treasury stock at cost. Treasury stock is comprised of shares of common stock purchased by the Company in the
secondary market.
Fair
Value of Financial Instruments
The
carrying amounts of cash, accounts receivable, and accounts payable approximate fair value because of the relative short-term
maturity of these items and current payment expected. These fair value estimates are subjective in nature and involve uncertainties
and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly
affect these estimates. The Company does not hold or issue financial instruments for trading purposes, nor does it utilize derivative
instruments. Notes receivable are recorded at par value less allowance for doubtful accounts. The carrying amount is consistent
with fair value based upon similar notes issued to other franchisees.
ASC
825, Financial Instruments, clarifies that fair value is an exit price, representing the amount that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between market participants. It also requires disclosure about
how fair value is determined for assets and liabilities and establishes a hierarchy for which these assets and liabilities must
be grouped, based on significant levels of inputs as follows:
Level
1:
|
Quoted
prices in active markets for identical assets or liabilities.
|
Level
2:
|
Quoted
prices in active markets for similar assets and liabilities and inputs that are observable for the asset or liability.
|
Level
3:
|
Unobservable
inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.
|
The determination of where
assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value
measurement.
The
carrying value of financial assets and liabilities recorded at fair value is measured on a recurring or nonrecurring basis. Financial
assets and liabilities measured on a non-recurring basis are those that are adjusted to fair value when a significant event occurs. The
Company had no financial assets or liabilities carried and measured on a recurring basis during the reporting periods. Financial
assets and liabilities measured on a recurring basis are those that are adjusted to fair value each time a financial statement
is prepared.
Revenue
Recognition
Revenue
is recognized on an accrual basis after services have been performed under contract terms and in accordance with regulatory requirements,
the service price to the client is fixed or determinable, and collectability is reasonably assured.
Since
the Company’s franchises are primarily a mobile concept and do not require finding locations or construction, the franchisees
can begin operations as soon as they complete training. The franchise fees are fully collectible and nonrefundable as of the date
of the signing of the franchise agreement, but the franchise fees are not recognized as revenue until initial training has been
completed and when substantially all of the services required by the franchise agreement have been fulfilled by the Company in
accordance with ASC Topic 952-605 Revenue Recognition-Franchisor. Royalties are recognized as earned on a monthly basis.
At
September 30, 2018 and 2017 the Company had no unearned revenue for franchise fees collected but not yet earned per the revenue
recognition policy.
Advertising
Costs
Advertising
costs are expensed as incurred. The Company incurred advertising costs for the years ended September 30, 2018 and 2017 of approximately
$30,000 and $21,000, respectively.
Income
Taxes
The
provision for income taxes and deferred income taxes are determined using the asset and liability method. Deferred tax assets
and liabilities are determined based on temporary differences between the financial carrying amounts and the tax basis of assets
and liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse. On
a periodic basis, the Company assesses the probability that its net deferred tax assets, if any, will be recovered. If after evaluating
all of the positive and negative evidence, a conclusion is made that it is more likely than not that some portion or all of the
net deferred tax assets will not be recovered, a valuation allowance is provided by a charge to tax expense to reserve the portion
of the deferred tax assets which are not expected to be realized.
The
Company reviews its filing positions for all open tax years in all U.S. federal and state jurisdictions where the Company is required
to file.
When
there are uncertainties related to potential income tax benefits, in order to qualify for recognition, the position the Company
takes has to have at least a “more likely than not” chance of being sustained (based on the position’s technical
merits) upon challenge by the respective authorities. The term “more likely than not” means a likelihood of more than
50 percent. Otherwise, the Company may not recognize any of the potential tax benefit associated with the position. The Company
recognizes a benefit for a tax position that meets the “more likely than not” criterion at the largest amount of tax
benefit that is greater than 50 percent likely of being realized upon its effective resolution. Unrecognized tax benefits involve
management’s judgment regarding the likelihood of the benefit being sustained. The final resolution of uncertain tax positions
could result in adjustments to recorded amounts and may affect our results of operations, financial position and cash flows.
The
Company’s policy is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company
had no accrual for interest or penalties at September 30, 2018 and 2017, respectively, and has not recognized interest and/or
penalties during the years ended September 30, 2018 and 2017, respectively, since there are no material unrecognized tax benefits.
Management believes no material change to the amount of unrecognized tax benefits will occur within the next twelve months.
The
tax years subject to examination by major tax jurisdictions include the years 2015 and forward by the U.S. Internal Revenue Service,
and the years 2014 and forward for various states.
Net
earnings (loss) per share
Basic
earnings (loss) per share are computed by dividing net income (loss) by the weighted average number of common shares outstanding
for the period. Diluted earnings per share reflect the potential dilution that could occur if stock options or other contracts
to issue common stock were exercised or converted during the period. FASB ASC 260, Earnings per Share, requires a
dual presentation of basic and diluted earnings per share. However, because of the Company’s net losses, the effects of
stock options and warrants would be anti-dilutive and, accordingly, are excluded from the computation of earnings per share. The
number of such shares excluded from the computations of diluted loss per share totaled 2,157,709 at September 30, 2018 and 2,143,423
at September 30, 2017.
Stock-based
compensation
The
Company accounts for employee stock awards for services based on the grant date fair value of the instrument issued and those
issued to non-employees are recorded based on the grant date fair value of the consideration received or the fair value of the
equity instrument, whichever is more reliably measurable. Stock Awards are expensed over the service period. Forfeitures are recognized
as they occur.
Reclassifications
Certain
prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect
on the reported results of operations.
Recent
accounting pronouncements
In
May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers”.
ASU 2014-09, as amended by subsequent ASUs on the topic, establishes a single comprehensive model for entities to use in accounting
for revenue arising from contracts with customers and supersedes most of the existing revenue recognition guidance. This standard,
which is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2017, requires an entity
to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration
to which the entity expects to be entitled in exchange for those goods or services and also requires certain additional disclosures.
The Company adopted this standard effective October 1, 2018 using the modified retrospective approach, which requires applying
the new standard to all existing contracts not yet completed as of the effective date and recording a cumulative-effect adjustment
to retained earnings as of the beginning of the fiscal year of adoption. Management has not yet completed the assessment of the
impact the adoption of the standard is expected to have on the financial statements. They do, however, expect the adoption of
Topic 606 to impact the accounting for initial franchise fees. Currently, the Company recognizes revenue from initial franchise
fees in a single, up-front transaction, upon the completion of training of new franchisees, in the period in which all material
obligations and initial services have been performed. Upon the adoption of Topic 606, we believe the Company will need to recognize
the revenue related to initial franchise fees over the term of the related franchise agreement. This will result in less revenue
in the short-term and more deferred revenue recognized over a period of time.
In
February 2016, the FASB issued ASU No. 2016-02, “Leases”, which requires lessees to recognize a right-to-use asset
and a lease obligation for all leases. Lessees are permitted to make an accounting policy election to not recognize an asset and
liability for leases with a term of twelve months or less. Additional qualitative and quantitative disclosures, including significant
judgments made by management, will be required. The new standard will become effective for the Company beginning with the first
quarter 2020 and requires a modified retrospective transition approach and includes a number of practical expedients. Early adoption
of the standard is permitted. The Company is currently evaluating the impacts the adoption of this accounting guidance will have
on the consolidated financial statements.
In
November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires companies to
include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling
beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This guidance will be effective in the
first quarter of the fiscal year ended September 30, 2019 and early adoption is permitted. Management determined that this will
affect the presentation of consolidated statement of cash flows upon adoption in the quarter ended December 31,
2018.
In
June 2016, the FASB issued ASU No. 2016-13—Measurement of Credit Losses on Financial Instruments, which changes how companies
measure credit losses on most financial instruments measured at amortized cost and certain other instruments, such as loans, receivables
and held-to-maturity debt securities. Rather than generally recognizing credit losses when it is probable that the loss has been
incurred, the revised guidance requires companies to recognize an allowance for credit losses for the difference between the amortized
cost basis of a financial instrument and the amount of amortized cost that the company expects to collect over the instrument’s
contractual life. ASU 2016-13 is effective for fiscal periods beginning after December 15, 2019 and must be adopted as a cumulative
effect adjustment to retained earnings. Early adoption is permitted. The Company does not believe adoption of this guidance will
have an impact on its consolidated financial statements
All
other newly issued accounting pronouncements, but not yet effective, have been deemed either immaterial or not applicable.
(2)
Going Concern
The
accompanying consolidated financial statements have been prepared on the basis that the Company will continue as a going concern,
which accordingly assumes, among other things, the realization of assets and the satisfaction of liabilities in the ordinary course
of business. The Company had losses of $218,833 in the current year. The Company had incurred accumulated losses of $2,391,525
as of September 30, 2018. These conditions raise substantial doubt about the Company’s ability to continue
as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome
of this uncertainty.
Based
on the Company’s cash balance at September 30, 2018 and projected cash needs for the next 12 months from the issuance date
of these financial statements, management believes that the Company will need to increase revenues, reduce costs and/or pursue
other transactions to be able to continue to fund operating and capital requirements. The Company plans to implement cost cutting
measures, including reducing personnel, reducing legal and professional expenses, moving the company’s central location
to Boise, ID, selling Company owned real estate, and incorporating technology where economic opportunity presents. The Company
plans to expand its offerings to allow current franchisees to operate in unoccupied territories for a yearly fee plus a monthly
percentage of revenue (see Note 10). However, should the current legal issues or unforeseen legal actions prevail against
the Company, or a drastic downturn in the economy become actual, the Company expects that profitability would be affected. At
such time, the Company would need to secure loans, lines of credit or other means to raise operating capital. The Company cannot
be sure that it will be able to obtain any such additional funds by any of the foregoing or other means, and any such funds it
may obtain may not be sufficient. If the Company is unable to obtain sufficient funds, it may be unable to continue as a going
concern.
(3)
Related Party Transactions
In
December 2017, the Company granted 14,286 warrants to two Directors of the Company. These warrants were granted in conjunction
with the issuance of standby letters of credit from the two directors. The warrants were valued using the Black Scholes method.
The fair value of the warrants on the date of grant were $2,000, and the shares vested immediately. The Company expensed $2,000
in connection with the grant during the quarter ended December 31, 2017.
(4)
Property and Equipment
Property
and equipment consisted of the following:
|
|
September 30,
|
|
Description
|
|
2018
|
|
2017
|
|
Depreciable Property and Equipment:
|
|
|
|
|
|
|
|
Equipment
|
|
$
|
74,456
|
|
$
|
66,969
|
|
Furniture and Fixtures
|
|
|
83,427
|
|
|
83,427
|
|
Property and Improvements
|
|
|
180,878
|
|
|
180,878
|
|
Software
|
|
|
114,884
|
|
|
98,307
|
|
Total Depreciable Property and Equipment
|
|
|
453,645
|
|
|
429,581
|
|
Accumulated Depreciation
|
|
|
(282,541
|
)
|
|
(240,493
|
)
|
Total Net Depreciable Property and Equipment
|
|
|
171,104
|
|
|
189,088
|
|
Non-depreciable Property and Equipment:
|
|
|
|
|
|
|
|
Work in progress
|
|
|
186,826
|
|
|
18,269
|
|
Total Net Property and Equipment
|
|
$
|
357,930
|
|
$
|
207,357
|
|
Prior
to the end of fiscal 2018, the Company listed one of its owned condominiums for sale located at 701 Market Street, Suite 113,
St. Augustine, FL for $98,900. Property and equipment of $43,178 and $52,737 related to the net book value of this asset has been
classified as Assets held for sale in the Consolidated Balance Sheet at September 30, 2018 and 2017 respectively.
Depreciation
expense totaled approximately $52,000 and $57,000, respectively, for the years ended September 30, 2018 and 2017.
(5)
Intangible Assets
Intangible
Assets consist of purchased franchise rights and trademarks. The Intangible assets consists of Sew Fun Trademarks, Business Concepts
and Curriculum which was purchased by the Company.
During
the fiscal year 2017, the Company determined that certain long-lived assets, related to repurchases of BFK territories during
fiscal year 2013 and 2014, were over-valued. The Company determined that these territories and their associated fixed assets had
no fair value outside of their unimproved territory value compared to other unsold territories. The impairment loss of $78,604
related to these assets is included in the other general and administrative expenses line on the Consolidated Statements of Operations
for the year ended September 30, 2017.
The
Company abandoned the revenue stream for SF for which the intangible assets were intended to provide future economic value and
therefore determined that the asset was fully impaired as of September 30, 2018. $23,300 was recorded as an impairment loss in
the other general and administrative expenses line on the Consolidated Statements of Operations for the year ended September 30,
2018.
(6) Notes
and Other Receivables
At
September 30, 2018 and 2017, respectively, the Company held certain notes receivable totaling approximately $106,000 and $95,000
respectively for extended payment terms of franchise fees. The Company had an allowance on notes receivable of $91,000 and $33,000
as of September 30, 2018 and 2017, respectively. The net notes receivable was approximately $15,000 and $62,000 and was included
in the consolidated balance sheet as of September 30, 2018 and 2017 respectively. The notes were generally non-interest-bearing
notes with monthly payments, payable within one to two years.
|
|
2019
|
|
|
2020
|
|
|
Total
|
|
Payment schedules for Notes Receivable
|
|
$
|
11,955
|
|
|
$
|
94,045
|
|
|
$
|
106,000
|
|
(7) Accrued
Marketing Fund
Per
the terms of the franchise agreements, the Company collects 2% of franchisee’s gross revenues for a marketing fund, managed
by the Company, to allocate toward national branding of the Company’s concepts to benefit the franchisees.
The
marketing fund amounts are accounted for as a liability on the balance sheet and the actual collections are deposited into a marketing
fund bank account. Expenses pertaining to the marketing fund activities are paid from the marketing fund and reduce the liability
account.
At
September 30, 2018 and 2017, the accrued marketing fund liability balances were approximately $97,000 and $132,000 respectively.
(8)
Accrued Liabilities
The
Company had accrued liabilities at September 30, 2018, and September 30, 2017 as follows:
Accrued Liabilities
|
|
September 30,
2018
|
|
|
September 30,
2017
|
|
Accrued legal Fees
|
|
$
|
-
|
|
|
$
|
77,719
|
|
Accrued Legal Settlements
|
|
|
-
|
|
|
|
32,143
|
|
Accrued Exit Agreement
|
|
|
-
|
|
|
|
9,739
|
|
Accrued Compensation and payroll taxes
|
|
|
14,605
|
|
|
|
17,950
|
|
Accrued Other
|
|
|
-
|
|
|
|
16,126
|
|
|
|
$
|
14,605
|
|
|
$
|
153,677
|
|
(9)
Stock-Based Compensation
In
December 2017, the Company granted an aggregate of 14,286 warrants to two Directors of the Company. (See Note 3).
The
Company utilized the Black-Scholes valuation model for estimating fair value of the warrants. Each grant was evaluated based upon
assumptions at the time of the grant. The assumptions used in our calculations are no dividend yield, expected volatility of approximately
247%, a risk-free interest rate of 1.76%, and an expected term of 5 years. The dividend yield of zero is based on the fact that
the Company does not pay cash dividends and has no present intention to pay cash dividends. Expected volatility is estimated based
on the Company’s historical stock prices over a period equivalent to the expected life in years. The risk-free interest
rate is based on the U.S. Treasury’s Daily Treasury Yield Curve Rates at the date of grant with a term consistent with the
expected life of the options granted. The expected term calculation is based on the “simplified method” allowed by
the Securities and Exchange Commission (the “SEC”), due to no applicable historical exercise data available.
On
May 14, 2017, the Company granted options consistent with its corporate by-laws to purchase shares of the Company’s common
stock to each of the members of the Company’s then Board, as follows: Charles Grant – 900,000 shares, Joseph Marucci
– 324,000 shares, Michael Gorin – 324,000 shares and JoyAnn Kenny, 216,000 shares. Each of the options has an exercise
price of $0.30 per share, and is exercisable in full at any time during the five-year period commencing on the date of grant.
The option grants were approved by the Board based upon an investigation by an independent compensation consultant, who provided
analysis and compensation recommendations to the Board. Among other things, the report concluded that the directors have: (i)
served entirely without compensation (other than $4,500 paid to Mr. Marucci in or prior to July 2015) – Messrs. Grant and
Marucci since March 2015 and Mr. Gorin and Ms. Kenny since July 2015; (ii) devoted more time and effort than what is to be expected
or considered normal (especially the audit committee); (iii) been confronted by extenuating circumstances regarding the Company’s
affairs that required substantial additional effort. Finally, the analysis indicated that Board Chair, Charles Grant, had expended
a particularly large amount of effort, spending considerably more time performing board services than the other board members.
On
May 13, 2017, pursuant to the employment agreement of Karla Kretsch, the Company’s then President, the Company issued 8,000
shares of the Company’s common stock, and granted options to purchase 28,000 shares of the Company’s common stock
at an exercise price of $0.25 per share, exercisable in full at any time during the five-year period commencing on the date of
the grant. The shares and options were issued pursuant to the terms of Ms. Kretsch’s employment agreement with the Company,
on account of Ms. Kretsch’s service to the Company for the quarter ended March 31, 2017. Based on the same employment agreement,
for the quarter ending June 30, 2017, the Company issued 12,118 shares of the Company’s common stock, and granted options
to purchase 42,414 shares of the Company’s common stock at an exercise price of $0.2063 per share, exercisable in full at
any time during the five-year period commencing on the date of the grant.
On
July 26, 2017, Karla Kretsch informed the Company of her intention to resign as President of the Company. Since Ms. Kretsch’s
employment was terminated by Ms. Kretsch for “Good Reason” (as such term is defined in the Employment Agreement),
Ms. Kretsch will be paid an amount equivalent to her base salary for a period of three months following the date of termination
in equal amounts every two weeks, and will also be entitled to receive the Equity Awards due for the quarter in which termination
occurred, as well as the immediately following three quarters, paid as scheduled at quarter-end. Therefore, for the quarter ending
September 30, 2017, the Company recorded a total of approximately $34,000 in stock-based compensation expense for the fair value
of equity awards according to the Employment Agreement. The Employment Agreement requires the grant of stock options to purchase
190,216 shares of the Company’s common stock at an exercise price of $0.1840 per share, as well as stock grants for 54,348
shares.
On
October 26, 2017, the Board granted options to purchase 118,793 shares of the Company’s common stock at an exercise price
of $0.1840 per share, exercisable in full at any time during the five-year period commencing on the date of the grant to Christian
Miller per his employment agreement from July of 2016. These options were retroactively issued on September 30, 2017 and are included
in salaries and payroll taxes in the consolidated statement of operations as of September 30, 2017.
The
Company utilizes the Black-Scholes valuation model for estimating fair value of stock compensation for options awarded to officers
and members of the Board. Each grant is evaluated based upon assumptions at the time of the grant. The assumptions used in our
calculations are no dividend yield, expected volatility between 129.03% and 134.69%, risk-free interest rate of 1.85% to 1.89%,
and expected term of 2.5 years. The dividend yield of zero is based on the fact that the Company does not pay cash dividends and
has no present intention to pay cash dividends. Expected volatility is estimated based on the Company’s historical stock
prices over a period equivalent to the expected life in years. The risk-free interest rate is based on the U.S. Treasury’s
Daily Treasury Yield Curve Rates at the date of grant with a term consistent with the expected life of the options granted. The
expected term calculation is based on the “simplified method” allowed by the Securities and Exchange Commission (the
“SEC), due to no applicable historical exercise data available.
The
following are activity of options:
|
|
Number of Shares
|
|
|
Average Exercise Price
|
|
|
Expiration Date
|
|
Average Remaining Life
|
|
|
Weighted Average Grant Date Fair Value
|
|
Granted May 13, 2017
|
|
|
1,792,000
|
|
|
$
|
0.30
|
|
|
05/13/22
|
|
44.5 Months
|
|
|
|
0.17
|
|
Granted June 30, 2017
|
|
|
42,414
|
|
|
$
|
0.21
|
|
|
06/30/22
|
|
45 Months
|
|
|
|
0.15
|
|
Granted September 30, 2017
|
|
|
309,009
|
|
|
$
|
0.18
|
|
|
09/30/22
|
|
48 Months
|
|
|
|
0.13
|
|
Vested and Exercisable at September 30, 2018
|
|
|
2,143,423
|
|
|
$
|
0.28
|
|
|
|
|
|
|
|
|
0.16
|
|
No
options were granted or forfeited during the year ended September 30, 2018. The aggregate intrinsic value of the options as of
September 30, 2018 was $0.
(10)
Commitments and Contingencies
Lease
Commitments
The
following table summarizes the Company’s contractual lease obligations at September 30, 2018:
Obligation
|
|
2019
|
|
Total
|
|
Commercial Lease (Suite 114)
|
|
$
|
12,113
|
|
$
|
12,113
|
|
The
lease for Suite 114 expires in June 2019 and will not be renewed. Space will be leased on a month-to-month basis in Boise,
Idaho subsequent to the expiration of the above lease.
Rent
expense was approximately $18,000 and $16,000, respectively, for the years ended September 30, 2018 and 2017.
Litigation
From
time to time, the Company has been and may become involved in legal proceedings arising in the ordinary course of its business.
Regardless of the outcome, litigation can have an adverse impact on the Company because of defense and settlement costs, diversion
of management resources, and other factors.
On
October 2, 2015, the Company filed suit in the state court in St. John’s County, Florida, Case No. CA 15-1076, against its
former Chief Executive Officer Brian Pappas, Christine Pappas, its former Human Resources officer, and an independent company
controlled by Mr. Pappas named Franventures, LLC (“Franventures”). The lawsuit seeks return of company emails and
other electronic materials in the possession of the defendants, company control over the process by which the company’s
documents are identified, and a court judgment that the property is the Company’s. Mr. and Mrs. Pappas have returned certain
company documents that they have identified, but other issues remain. On December 11, 2017, Brian Pappas filed a counterclaim
alleging the Company is required to indemnify him for a multitude of matters. The Company denies the allegation and is actively
litigating this matter.
In
a separate suit, filed on March 7, 2016 in the state court in St. John’s County, Florida (Case No. CA 16-236), Franventures,
LLC (“FV”) alleged that it is due an unstated amount of money from the Company pursuant to a contract the Company
had previously terminated. On June 23, 2016, the Company filed a counterclaim against Franventures, which also included a complaint
against former Chairman of the Board and Chief Executive Officer Brian Pappas. The counterclaim seeks redress for losses and expenditures
caused by alleged fraud, conversion of company assets, and breaches of fiduciary duty that the Company alleges that defendants
perpetrated upon CLC, including assertions regarding actions by Brian Pappas that the Company alleges occurred while Mr. Pappas
was serving as the Chief Executive Officer of CLC and as a member of its board of directors. This case is being actively litigated
by the Company.
On
October 27, 2016, Brian Pappas filed a motion to amend the complaint to add a claim alleging that the Company slandered him by
virtue of a press release issued on or about August 1, 2016, in which the Company reported to shareholders on steps it had taken
and improvements it had implemented. The motion has still not been ruled upon by the Court. If Mr. Pappas does amend his complaint,
the Company will vigorously defend the proposed claim.
On
February 24, 2017, franchisee, Team Kasa, LLC, along with its three owners, filed suit in the Eastern District of New York (Case
No. 2:17-cv-01074) against former CEO Brian Pappas, and Franventures. The same Plaintiffs also initiated arbitration on the same
issues (American Arbitration Association, Case No. 01-17-0001-1968), alleging the Company is jointly and severally liable for
damages resulting from the allegations against Mr. Pappas and Franventures. The Company is contesting the allegations and its
liability for any damages.
On
May 9, 2017, franchisee, Back and 4th, LLC, along with its owner, Kristena Bins-Turner, initiated arbitration against the Company
for breach of contract, alleging that they did not receive adequate value for royalty payments made under the franchise agreement,
for fraud, alleging material misrepresentations and omissions prior to entry into the franchise agreements, and for misrepresentation
violations of Florida Statute 817.416. (American Arbitration Association, Case. No. 01-16-004-3745). Franchisee and its owner
seek an unspecified amount of damages. The Company contested the allegations and its liability for any damages at an evidentiary
hearing held December 5-7, 2017. This matter has been settled for $45,500 and included in other general and administrative expenses
in the consolidated statement of operations the year ended September 30, 2018.
On
August 21, 2017, the SEC filed a Civil Complaint against the Company and certain former executive officers and directors in the
United States District Court for the Middle District of Florida, Jacksonville Division, as Civil Action No. 3:17-cv-00954-TJC-JRK.
The Civil Complaint was in regards to alleged violations of federal securities law occurring between 2011 and 2015. On August
22, 2017, the SEC also filed with the court the Company’s formal Consent to a full resolution of all allegations pertaining
to the Company. Pursuant to the Consent, without admitting or denying the allegations, the Company agreed to the entry of a final
judgment that permanently enjoins it from violating the sections of the federal securities laws listed in the Civil Complaint.
On September 20, 2017, the United States District Court for the Middle District of Florida, Jacksonville Division issued the final
judgment order as to the Company in the Civil Action No. 3:17-cv-00954-TJC-JRK. The entering of the final judgment order has resolved
all allegations pertaining to the Company. The Company was not assessed any monetary penalties. As stated in the above, this matter
is resolved and closed.
On
September 21, 2017, the Company filed a notice of voluntary dismissal without prejudice in the United States District Court for
the Middle District of Florida, Jacksonville Division, in its lawsuit against Blake and Anik Furlow relating to their conduct
in the shareholder consent the complaint on May 15, 2017, and after consideration, decided it was not in the best interest of
the Company to proceed with the litigation. The action is closed. The dismissal is public record and is case # 3:17-cv-00552.
On
November 8, 2017, franchisee, Indy Bricks, LLC, along with its two owners, Ben and Kate Schreiber initiated arbitration against
the Company. (American Arbitration Association, Case No. 01-17-0006-8120). Plaintiffs allege breach of contract, fraud, material
misrepresentations and omissions, violations of the Indiana Franchise Act, and violations of the Indiana Deceptive Franchise Practices
Act. The Company is vigorously contesting the allegations and its liability for any damages.
(11) Income
Taxes
The
components of the deferred tax assets at September 30, 2018 and September 30, 2017 were as follows:
|
|
2018
|
|
|
2017
|
|
Deferred tax assets:
|
|
|
|
|
|
|
Allowance for bad debt
|
|
$
|
159,907
|
|
|
$
|
104,056
|
|
Charitable contributions
|
|
|
127
|
|
|
|
176
|
|
Stock-based compensation
|
|
|
87,675
|
|
|
|
121,919
|
|
Foreign Tax Credit
|
|
|
96,491
|
|
|
|
66,085
|
|
Net operating loss
|
|
|
304,953
|
|
|
|
466,998
|
|
Total gross deferred tax asset
|
|
|
649,153
|
|
|
|
759,234
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Depreciation timing difference
|
|
|
(10,444
|
)
|
|
|
(11,445
|
)
|
Total deferred tax liability
|
|
|
(10,444
|
)
|
|
|
(11,445
|
)
|
Gross net deferred tax asset
|
|
|
638,709
|
|
|
|
747,789
|
|
Less: Valuation allowances
|
|
|
(638,709
|
)
|
|
|
(747,789
|
)
|
Net deferred tax asset
|
|
$
|
-
|
|
|
$
|
-
|
|
The
Company has recorded various deferred tax assets and liabilities as reflected above. In assessing the ability to realize the deferred
tax assets, management considers, whether it is more likely than not, that some portion, or all of the deferred tax assets and
liabilities will be realized. The ultimate realization is dependent on generating sufficient taxable income in future years. The
valuation allowance is equal to 100% of the Net deferred tax asset. Given recurring losses, the Company cannot conclude that it
is more likely than not that such assets will be realized, therefore a full valuation allowance has been recorded.
The
components of the provisions for income taxes for the fiscal years ended September 30, 2018 and 2017 are as follows:
|
|
2018
|
|
|
2017
|
|
Current:
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
(53,587
|
)
|
State
|
|
|
-
|
|
|
|
(10,497
|
)
|
Total
|
|
|
-
|
|
|
|
64,084
|
|
Deferred:
|
|
|
|
|
|
|
|
|
Additional deferred tax related to book tax differences
|
|
|
109,081
|
|
|
|
(56,410
|
)
|
Valuation allowance
|
|
|
(109,081
|
)
|
|
|
485,147
|
|
Total Tax Provision
|
|
$
|
-
|
|
|
$
|
364,653
|
|
A
reconciliation of the provisions for income taxes for the fiscal years ended September 2018 and 2017 as compared to statutory
rates is as follows:
|
|
2018
|
|
|
2017
|
|
|
|
Amount
|
|
|
%
|
|
|
Amount
|
|
|
%
|
|
Provision at statutory rates
|
|
$
|
(53,125
|
)
|
|
|
24.28
|
%
|
|
$
|
(226,559
|
)
|
|
|
34.00
|
%
|
State income tax, net of federal benefit
|
|
|
(7,477
|
)
|
|
|
3.42
|
%
|
|
|
(24,188
|
)
|
|
|
3.63
|
%
|
Penalties
|
|
|
-
|
|
|
|
0.00
|
%
|
|
|
18,815
|
|
|
|
-2.82
|
%
|
Meals & Entertainment
|
|
|
2,158
|
|
|
|
-0.99
|
%
|
|
|
1,040
|
|
|
|
-0.16
|
%
|
Stock-based compensation
|
|
|
-
|
|
|
|
0.00
|
%
|
|
|
130,289
|
|
|
|
-19.55
|
%
|
Tax credits
|
|
|
(23,024
|
)
|
|
|
10.52
|
%
|
|
|
-
|
|
|
|
0.00
|
%
|
Other tax differences
|
|
|
(10,754
|
)
|
|
|
4.91
|
%
|
|
|
(19,891
|
)
|
|
|
2.99
|
%
|
Change in rate
|
|
|
201,303
|
|
|
|
-91.99
|
%
|
|
|
-
|
|
|
|
0.00
|
%
|
Valuation Allowance on deferred tax assets
|
|
|
(109,081
|
)
|
|
|
49.85
|
%
|
|
|
485,147
|
|
|
|
-72.81
|
%
|
Total income tax provision
|
|
$
|
-
|
|
|
|
0
|
%
|
|
$
|
364,653
|
|
|
|
-54.72
|
%
|
In
December 2017, the United States Government passed new tax legislation that, among other provisions, will lower the corporate
tax rate from 35% to 21%. In addition to applying the new lower corporate tax rate in 2018 and thereafter to any taxable income
we may have, the legislation affects the way we can use and carryforward net operating losses previously accumulated and results
in a revaluation of deferred tax assets and liabilities recorded on our balance sheet. Given that current deferred tax assets
are offset by a full valuation allowance, these changes will have no net impact on the balance sheet. However, when we become
profitable, we will receive a reduced benefit from such deferred tax assets. The effect of the legislation is a reduction in deferred
tax assets and the corresponding valuation allowance of approximately $201,000, as of September 30, 2018.
(12) Subsequent
Events
The
Company evaluates subsequent events that occur after the balance sheet date through the financial statements were issued. The
following are subsequent events requiring disclosure:
On
November 14, 2018, the Company completed the sale of its condominium held for sale for proceeds of approximately $86,000 and recorded
a gain of approximately $43,000, which represented the excess of the proceeds over the carrying value on that date.
On
March 27, 2019, the Company issued 13,265 shares of common stock to the former President of the Company due to a calculation error
in relation to her terminated employment agreement. All equity compensation relating to this agreement was properly fully recognized
during the year ended September 30, 2017.
On
June 24, 2019, the Company entered into a business venture with BPL Enterprises for Brickz4Schoolz (BPL) to form Bricks4Schoolz,
LLC, a company that will deliver curriculum to Elementary and Middle School students which serves to help further children’s
academic performance and reduce anxiety in Mathematics and Sciences. The Company will provide access to its curriculum, manuals
and training materials. BPL will develop digital delivery systems, market and act as manager. The Company will receive twelve
percent (12%) royalty from all gross sales generated by Bricks4Schoolz, LLC. The Company did not provide any capital contributions
to the venture.
On
July 9, 2019 the Company completed the sale of a condominium conference space listed for sale subsequent to year end for proceeds
of $60,000 and recorded a gain of approximately $22,000 which represented the excess of the proceeds over the carrying value on
that date.