Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q ("Quarterly Report") includes statements of
our expectations, intentions, plans and beliefs that constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and are intended to come within the safe harbor protection
provided by those sections. These forward-looking statements involve various
risks and uncertainties. The nature of our operations and the environment in
which we operate subject us to changing economic, competitive, regulatory and
technological conditions, risks and uncertainties. The statements, other than
statements of historical fact, included in this Quarterly Report are
forward-looking statements. Many of the forward-looking statements contained in
this document may be identified by the use of forward-looking words such as
"will," "intend," "believe," "expect," "anticipate," "should," "plan,"
"estimate," "potential," or similar expressions. Factors which could cause
results to differ include, but are not limited to: achievement of the
anticipated potential benefits of the strategic alliance with Edible
Arrangements (as defined below), the Company's ability to provide products to EA
(as defined below) under the strategic alliance, relationships and changes in
our customers, changes in the confectionery business environment, seasonality,
consumer interest in our products, general economic conditions, the success of
our frozen yogurt business, receptiveness of our products internationally,
consumer and retail trends, costs and availability of raw materials,
competition, the success of our co-branding strategy, the success of
international expansion efforts and the effect of government regulations.
Government regulations which we and our franchisees either are or may be subject
to and which could cause results to differ from forward-looking statements
include, but are not limited to: local, state and federal laws regarding health,
sanitation, safety, building and fire codes, franchising, employment,
manufacturing, packaging and distribution of food products and motor carriers.
For a detailed discussion of the risks and uncertainties that may cause our
actual results to differ from the forward-looking statements contained herein,
please see the "Risk Factors" contained in Item 1A. of our Annual Report on Form
10-K for the fiscal year ended February 28, 2019. These forward-looking
statements apply only as of the date of this Quarterly Report. As such they
should not be unduly relied upon for more current circumstances. Except as
required by law, we undertake no obligation to release publicly any revisions to
these forward-looking statements that might reflect events or circumstances
occurring after the date of this Quarterly Report or those that might reflect
the occurrence of unanticipated events.
Unless otherwise specified, the "Company," "we," "us" or "our" refers to Rocky
Mountain Chocolate Factory, Inc., a Delaware corporation, and its consolidated
subsidiaries.
Overview
We are an international franchisor, confectionery manufacturer and retail
operator. Founded in 1981, we are headquartered in Durango, Colorado and
manufacture an extensive line of premium chocolate candies and other
confectionery products. Our subsidiary, U-Swirl International, Inc. ("U-Swirl"),
franchises and operates soft-serve frozen yogurt cafés. Our revenues and
profitability are derived principally from our franchised/license system of
retail stores that feature chocolate, frozen yogurt and other confectionary
products. We also sell our candy outside of our system of retail stores and
license the use of our brand with certain consumer products. As of November 30,
2019, there were two Company-owned, 97 licensee-owned and 242 franchised Rocky
Mountain Chocolate Factory stores operating in 37 states, Canada, South Korea,
Panama, and the Philippines. As of November 30, 2019, U-Swirl operated four
Company-owned cafés and 88 franchised cafés located in 24 states and Qatar.
U-Swirl operates self-serve frozen yogurt cafés under the names "U-Swirl,"
"Yogurtini," "CherryBerry," "Yogli Mogli Frozen Yogurt," "Fuzzy Peach Frozen
Yogurt," "Let's Yo!" and "Aspen Leaf Yogurt".
Strategic Alliance with Edible Arrangements
On December 20, 2019, the Company entered into a strategic alliance (the
"Strategic Alliance") with Edible Arrangements, LLC ("EA") and Farids & Co. LLC
("Farids," and together with EA and any permitted transferees, "Edible
Arrangements"), pursuant to which, among other things, the Company will become
the exclusive provider of certain branded chocolate products to EA, its
affiliates and its franchisees. In connection with the Strategic Alliance, the
Company entered into a strategic alliance agreement, an exclusive supplier
operating agreement and a warrant agreement with EA and Farids. For more
information, please see Note 1 to the financial statements for a summary of the
strategic alliance agreement, the exclusive supplier operating agreement and the
warrant agreement.
Bankruptcy of FTD Companies
In June 2019, the Company's largest customer, FTD Companies, Inc. and its
domestic subsidiaries ("FTD"), filed for Chapter 11 bankruptcy proceedings. As a
part of such bankruptcy proceedings, divisions of FTD's business and certain
related assets, including the divisions that the Company has historically sold
product to, were sold through the auction to multiple buyers. The Company is
uncertain if accounts receivable and inventory balances associated with FTD at
November 30, 2019 will be realized at their full value, or if any revenue will
be received from FTD in the future. See Note 7 and Note 14 to the financial
statements contained herein for additional information about the FTD bankruptcy.
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Results of Operations
Three Months Ended November 30, 2019 Compared to the Three Months Ended November
30, 2018
Results Summary
Basic earnings per share decreased from $0.09 in the three months ended November
30, 2018 to a loss of $(0.01) in the three months ended November 30, 2019.
Revenues decreased 11.6% from $8.9 million in the three months ended November
30, 2018 to $7.9 million in the three months ended November 30, 2019. Operating
income decreased from $678,000 in the three months ended November 30, 2018 to an
operating loss of $(98,000) in the three months ended November 30, 2019. Net
income decreased from $525,000 in the three months ended November 30, 2018 to a
net loss of $(72,000) in the three months ended November 30, 2019. The decreases
in operating income and net income were due primarily to costs associated with
the Company's previously announced review of strategic alternatives, which
formally concluded upon the Company's entry into the Strategic Alliance, costs
associated with a stockholder's contested solicitation of proxies, which was
terminated in December 2019, and costs associated with the bankruptcy of the
Company's largest customer.
Revenues
Three Months Ended
($'s in thousands) November 30, $ %
2019 2018 Change Change
Factory sales $ 5,786.3 $ 6,862.0 $ (1,075.7 ) (15.7 )%
Retail sales 704.3 721.3 (17.0 ) (2.4 )%
Franchise fees 82.3 61.7 20.6 33.4 %
Royalty and marketing fees 1,340.4 1,304.8 35.6 2.7 %
Total $ 7,913.3 $ 8,949.8 $ (1,036.5 ) (11.6 )%
Factory Sales
The decrease in factory sales for the three months ended November 30, 2019
versus the three months ended November 30, 2018 was primarily due to a 58.0%
decrease in shipments of product to customers outside our network of franchise
and licensed retail locations, partially offset by a 3.8% increase in purchases
by our network of franchised and licensed stores. The decrease in shipments of
product to customers outside our network of franchise and licensed retail stores
was primarily the result of product rationalization and a decline in revenue
associated with products no longer offered for sale. Purchases by the Company's
largest customer, FTD, decreased during the three months ended November 30,
2019, with no revenue from such customer during the three months ended November
30, 2019, compared to $374,000, or 4.2% of the Company's revenues during the
three months ended November 30, 2018. As discussed above, FTD declared Chapter
11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is
unclear whether the Company will realize any revenue from FTD in the future, and
if so, whether such revenues will return to historic levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory
franchise and license locations decreased 3.6% in the three months ended
November 30, 2019, compared with the three months ended November 30, 2018.
Retail Sales
The decrease in retail sales for the three months ended November 30, 2019
compared to the three months ended November 30, 2018 was primarily due to a
decrease in same-store sales at Company-owned locations. Same store sales at all
Company-owned stores and cafés decreased 1.6% in the three months ended November
30, 2019 compared to the three months ended November 30, 2018.
Royalties, Marketing Fees and Franchise Fees
The increase in royalties and marketing fees from the three months ended
November 30, 2018 to the three months ended November 30, 2019 was primarily due
to an increase in royalty revenue associated with the Company's purchase-based
royalty structure, partially offset by a 6.3% decrease in domestic franchise
units in operation. The average number of total domestic franchise stores in
operation decreased from 285 in the three months ended November 30, 2018 to 267
during the three months ended November 30, 2019. This decrease is the result of
domestic store closures exceeding domestic store openings. Same store sales at
total franchise stores and cafés in operation decreased 1.1% during the three
months ended November 30, 2019 compared to the three months ended November 30,
2018.
The increase in franchise fee revenue for the three months ended November 30,
2019 compared to the three months ended November 30, 2018 was the result of an
increase in revenue resulting from store closures and the reversal of the
remaining contract liabilities and corresponding recognition of revenue.
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Costs and Expenses
Cost of Sales
Three Months Ended
November 30, $ %
($'s in thousands) 2019 2018 Change Change
Cost of sales - factory $ 4,689.9 $ 5,419.8 $ (729.9 ) (13.5 )%
Cost of sales - retail 266.3 280.5 (14.2 ) (5.1 )%
Franchise costs 428.2 463.1 (34.9 ) (7.5 )%
Sales and marketing 435.0 519.2 (84.2 ) (16.2 )%
General and administrative 1,529.3 860.9 668.4 77.6 %
Retail operating 445.9 446.1 (0.2 ) (0.0 )%
Total $ 7,794.6 $ 7,989.6 $ (195.0 ) (2.4 )%
Gross Margin
Three Months Ended
November 30, $ %
($'s in thousands) 2019 2018 Change Change
Factory gross margin $ 1,096.4 $ 1,442.2 $ (345.8 ) (24.0 )%
Retail gross margin 438.0 440.8 (2.8 ) (0.6 )%
Total $ 1,534.4 $ 1,883.0 $ (348.6 ) (18.5 )%
Three Months Ended
November 30, % %
2019 2018 Change Change
(Percent)
Factory gross margin 18.9 % 21.0 % (2.1 )% (9.8 )%
Retail gross margin 62.2 % 61.1 % 1.1 % 1.8 %
Total 23.6 % 24.8 % (1.2 )% (4.8 )%
Adjusted Gross Margin
Three Months Ended
November 30, $ %
($'s in thousands) 2019 2018 Change Change
Factory gross margin $ 1,096.4 $ 1,442.2 $ (345.8 ) (24.0 )%
Plus: depreciation and amortization 147.3 140.0 7.3 5.2 %
Factory adjusted gross margin 1,243.7 1,582.2 (338.5 ) (21.4 )%
Retail gross margin 438.0 440.8 (2.8 ) (0.6 )%
Total Adjusted Gross Margin $ 1,681.7 $ 2,023.0 $ (341.3 ) (16.9 )%
Factory adjusted gross margin 21.5 % 23.1 % (1.6 )% (6.8 )%
Retail gross margin 62.2 % 61.1 % 1.1 % 1.8 %
Total Adjusted Gross Margin 25.9 % 26.7 % (0.8 )% (2.9 )%
Adjusted gross margin and factory adjusted gross margin are non-GAAP financial
measures. Adjusted gross margin is equal to the sum of our factory adjusted
gross margin plus our retail gross margin calculated in accordance with GAAP.
Factory adjusted gross margin is equal to factory gross margin plus depreciation
and amortization expense. We believe adjusted gross margin and factory adjusted
gross margin are helpful in understanding our past performance as a supplement
to gross margin, factory gross margin and other performance measures calculated
in conformity with GAAP. We believe that adjusted gross margin and factory
adjusted gross margin are useful to investors because they provide a measure of
operating performance and our ability to generate cash that is unaffected by
non-cash accounting measures. Additionally, we use adjusted gross margin and
factory adjusted gross margin rather than gross margin and factory gross margin
to make incremental pricing decisions. Adjusted gross margin and factory
adjusted gross margin have limitations as analytical tools because they exclude
the impact of depreciation and amortization expense and you should not consider
it in isolation or as a substitute for any measure reported under GAAP. Our use
of capital assets makes depreciation and amortization expense a necessary
element of our costs and our ability to generate income. Due to these
limitations, we use adjusted gross margin and factory adjusted gross margin as
measures of performance only in conjunction with GAAP measures of performance
such as gross margin and factory gross margin.
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Cost of Sales and Gross Margin
Factory margins decreased 210 basis points in the three months ended November
30, 2019 compared to the three months ended November 30, 2018, primarily because
of charges associated with costs of excess capacity and an estimated loss on
inventory associated with the bankruptcy of FTD, the Company's largest customer.
These costs were partially offset by improvements in margins resulting from
product rationalization. Excess capacity was the result of a 25.6% decrease in
production for the three months ended November 30, 2019 compared to the three
months ended November 30, 2018. The increase in retail gross margins was
primarily the result of the closure of underperforming Company-owned locations
during the prior fiscal year.
Franchise Costs
The decrease in franchise costs in the three months ended November 30, 2019
versus the three months ended November 30, 2018 is due primarily to a decrease
in legal and professional expense in the three months ended November 30, 2019
compared to the three months ended November 30, 2018. As a percentage of total
royalty and marketing fees and franchise fee revenue, franchise costs decreased
to 30.1% in the three months ended November 30, 2019 from 33.9% in the three
months ended November 30, 2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended November
30, 2019 compared to the three months ended November 30, 2018 is primarily due
to planned cost reductions as a result of fewer domestic franchise units in
operation and lower revenue associated with sales to customers outside of our
network of franchised and licensed Rocky Mountain Chocolate Factory locations.
General and Administrative
The increase in general and administrative costs for the three months ended
November 30, 2019 compared to the three months ended November 30, 2018 is
primarily due to higher professional fees associated with the Company's
previously announced process to explore and review strategic alternatives, which
formally concluded upon the Company's entry into the Strategic Alliance, and
costs associated with a stockholder's contested solicitation of proxies, which
was terminated in December 2019. During the three months ended November 30,
2019, the Company incurred approximately $771,000 of costs associated with the
review of strategic alternatives and the contested solicitation of proxies,
compared with no comparable costs incurred in the three months ended November
30, 2018. As a percentage of total revenues, general and administrative expenses
increased to 19.3% in the three months ended November 30, 2019 compared to 9.6%
in the three months ended November 30, 2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended November
30, 2019 compared to the three months ended November 30, 2018 was due primarily
to changes in units in operation as a result of the closure of certain
underperforming Company-owned units in the prior fiscal year. Retail operating
expenses, as a percentage of retail sales, increased from 61.8% in the three
months ended November 30, 2018 to 63.3% in the three months ended November 30,
2019. This increase is primarily the result of the change in units in operation
from the prior fiscal year.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization
included in cost of sales, was $217,000 in the three months ended November 30,
2019, a decrease of 23.0% from $282,000 in the three months ended November 30,
2018. This decrease was the result of a decrease in frozen yogurt cafés in
operation and lower amortization of the associated franchise rights. See Note 8
to the financial statements for a summary of annual amortization of intangible
assets based upon existing intangible assets and current useful lives.
Depreciation and amortization included in cost of sales increased 5.3% from
$140,000 in the three months ended November 30, 2018 to $147,000 in the three
months ended November 30, 2019. This increase was the result of an increase in
production assets in service primarily resulting from the replacement of
obsolete equipment or equipment at the end of its operating life.
Other Income (Expense)
Net interest income was $4,000 in the three months ended November 30, 2019
compared to net interest expense of $11,000 incurred in the three months ended
November 30, 2018. This change in interest from net interest expense to net
interest income is due to lower average outstanding promissory note balances for
the three months ended November 30, 2019 compared to the three months ended
November 30, 2018.
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Income Tax Expense
Our effective income tax rate for the three months ended November 30, 2019 was
23.7%, compared to 21.2% for the three months ended November 30, 2018. This
change was primarily the result of higher deductions realized during the three
months ended November 30, 2018, compared to the three months ended November 30,
2019.
Nine Months Ended November 30, 2019 Compared to the Nine Months Ended November
30, 2018
Results Summary
Basic earnings per share decreased 16.1% to $0.26 for the nine months ended
November 30, 2019 compared to $0.31 for the nine months ended November 30, 2018.
Revenues decreased (5.5)% to $23.7 million for the nine months ended November
30, 2019 compared to $25.1 million in the nine months ended November 30, 2018.
Operating income decreased 16.3% from $2.5 million in the nine months ended
November 30, 2018 to $2.1 million in the nine months ended November 30, 2019.
Net income decreased 15.9% from $1.9 million in the nine months ended November
30, 2018 to $1.6 million in the nine months ended November 30, 2019. The
decrease in operating income and net income was due primarily to costs
associated with the Company's previously announced review of strategic
alternatives, which formally concluded upon the Company's entry into the
Strategic Alliance, costs associated with a stockholder's contested solicitation
of proxies, which was terminated in December 2019, and costs associated with the
bankruptcy of the Company's largest customer.
Revenues
Nine Months Ended
($'s in thousands) November 30, $ %
2019 2018 Change Change
Factory sales $ 15,874.7 $ 17,203.3 $ (1,328.6 ) (7.7 )%
Retail sales 2,460.5 2,698.4 (237.9 ) (8.8 )%
Franchise fees 270.5 262.3 8.2 3.1 %
Royalty and marketing fees 5,118.8 4,951.9 166.9 3.4 %
Total $ 23,724.5 $ 25,115.9 (1,391.4 ) (5.5 )%
Factory Sales
The decrease in factory sales for the nine months ended November 30, 2019 versus
the nine months ended November 30, 2018 was primarily due to a 34.3% decrease in
shipments of product to customers outside our network of franchise and licensed
retail locations. The decrease in shipments of product to customers outside our
network of franchise and licensed retail stores was primarily the result of
product rationalization and a decline in revenue associated with products no
longer offered for sale. Purchases by the Company's largest customer, FTD, were
approximately $1.5 million, or 6.3%, of the Company's revenues during the nine
months ended November 30, 2019, compared to $1.8 million, or 7.1% of the
Company's revenues during the nine months ended November 30, 2018. As discussed
above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy
proceedings are complete, it is unclear whether the Company will realize any
revenue from FTD in the future, and if so, whether such revenues will return to
historic levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory
franchise and license locations decreased 4.6% in the nine months ended November
30, 2019, compared with the nine months ended November 30, 2018.
Retail Sales
The decrease in retail sales for the nine months ended November 30, 2019
compared to the nine months ended November 30, 2018 was primarily due to fewer
Company-owned units in operation because of the closure of certain
underperforming Company-owned locations during the prior fiscal year. Same store
sales at all Company-owned stores and cafés decreased 0.3% in the nine months
ended November 30, 2019 compared to the nine months ended November 30, 2018.
Royalties, Marketing Fees and Franchise Fees
The increase in royalties and marketing fees from the nine months ended November
30, 2018 to the nine months ended November 30, 2019 was primarily due to an
increase in royalty revenue associated with the Company's purchase-based royalty
structure, partially offset by a 6.2% decrease in domestic franchise units in
operation. The average number of total domestic franchise stores in operation
decreased from 290 in the nine months ended November 30, 2018 to 272 during the
nine months ended November 30, 2019. This decrease is the result of domestic
store closures exceeding domestic store openings. Same store sales at total
franchise stores and cafés in operation decreased 0.1% during the nine months
ended November 30, 2019 compared to the nine months ended November 30, 2018.
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The increase in franchise fee revenue for the nine months ended November 30,
2019 compared to the nine months ended November 30, 2018 was the result of an
increase in revenue resulting from store closures and the reversal of the
remaining contract liabilities and corresponding recognition of revenue.
Costs and Expenses
Cost of Sales
Nine Months Ended
November 30, $ %
($'s in thousands) 2019 2018 Change Change
Cost of sales - factory $ 12,451.8 $ 13,266.0 $ (814.2 ) (6.1 )%
Cost of sales - retail 857.6 983.5 (125.9 ) (12.8 )%
Franchise costs 1,352.9 1,539.1 (186.2 ) (12.1 )%
Sales and marketing 1,426.4 1,672.6 (246.2 ) (14.7 )%
General and administrative 3,504.4 2,588.8 915.6 35.4 %
Retail operating 1,364.1 1,507.4 (143.3 ) (9.5 )%
Total $ 20,957.2 $ 21,557.4 $ (600.2 ) (2.8 )%
Gross Margin
Nine Months Ended
November 30, $ %
($'s in thousands) 2019 2018 Change Change
Factory gross margin $ 3,422.9 $ 3,937.3 $ (514.4 ) (13.1 )%
Retail gross margin 1,602.9 1,714.9 (112.0 ) (6.5 )%
Total $ 5,025.8 $ 5,652.2 $ (626.4 ) (11.1 )%
Nine Months Ended
November 30, % %
2019 2018 Change Change
Factory gross margin 21.6 % 22.9 % (1.3 )% (5.8 )%
Retail gross margin 65.1 % 63.6 % 1.6 % 2.5 %
Total 27.4 % 28.4 % (1.0 )% (3.5 )%
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Adjusted Gross Margin
Nine Months Ended
November 30, $ %
($'s in thousands) 2019 2018 Change Change
Factory gross margin $ 3,422.9 $ 3,937.3 $ (514.4 ) (13.1 )%
Plus: depreciation and amortization 440.5 414.7 25.8 6.2 %
Factory adjusted gross margin 3,863.4 4,352.0 (488.6 ) (11.2 )%
Retail gross margin 1,602.9 1,714.9 (112.0 ) (6.5 )%
Total Adjusted Gross Margin $ 5,466.3 $ 6,066.9 $ (600.6 ) (9.9 )%
Factory adjusted gross margin 24.3 % 25.3 % (1.0 )% (3.8 )%
Retail gross margin 65.1 % 63.6 % 1.6 % 2.5 %
Total Adjusted Gross Margin 29.8 % 30.5 % (0.7 )% (2.2 )%
Adjusted gross margin and factory adjusted gross margin are non-GAAP financial
measures. Adjusted gross margin is equal to the sum of our factory adjusted
gross margin plus our retail gross margin calculated in accordance with GAAP.
Factory adjusted gross margin is equal to factory gross margin plus depreciation
and amortization expense. We believe adjusted gross margin and factory adjusted
gross margin are helpful in understanding our past performance as a supplement
to gross margin, factory gross margin and other performance measures calculated
in conformity with GAAP. We believe that adjusted gross margin and factory
adjusted gross margin are useful to investors because they provide a measure of
operating performance and our ability to generate cash that is unaffected by
non-cash accounting measures. Additionally, we use adjusted gross margin and
factory adjusted gross margin rather than gross margin and factory gross margin
to make incremental pricing decisions. Adjusted gross margin and factory
adjusted gross margin have limitations as analytical tools because they exclude
the impact of depreciation and amortization expense and you should not consider
it in isolation or as a substitute for any measure reported under GAAP. Our use
of capital assets makes depreciation and amortization expense a necessary
element of our costs and our ability to generate income. Due to these
limitations, we use adjusted gross margin and factory adjusted gross margin as
measures of performance only in conjunction with GAAP measures of performance
such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 130 basis points in the nine months ended November 30,
2019 compared to the nine months ended November 30, 2018, primarily because of
charges associated with costs of excess capacity and an estimated loss on
inventory associated with the bankruptcy of FTD, the Company's largest customer.
These costs were partially offset by improvements to margins resulting from
product rationalization. Excess capacity was the result of a 15.9% decrease in
production for the nine months ended November 30, 2019 compared to the nine
months ended November 30, 2018. The increase in retail gross margins was
primarily the result of the closure of underperforming Company-owned locations
during the prior fiscal year.
Franchise Costs
The decrease in franchise costs in the nine months ended November 30, 2019
versus the nine months ended November 30, 2018 is due primarily to a decrease in
legal and professional expenses. As a percentage of total royalty and marketing
fees and franchise fee revenue, franchise costs decreased to 25.1% in the nine
months ended November 30, 2019 from 29.5% in the nine months ended November 30,
2018. This decrease as a percentage of royalty, marketing and franchise fees is
primarily a result of lower franchise costs.
Sales and Marketing
The decrease in sales and marketing costs for the nine months ended November 30,
2019 compared to the nine months ended November 30, 2018 is primarily due to
planned cost reductions as a result of fewer domestic franchise units in
operation.
General and Administrative
The increase in general and administrative costs for the nine months ended
November 30, 2019 compared to the nine months ended November 30, 2018 is
primarily due to higher professional fees associated with the Company's
previously announced process to explore and review strategic alternatives, which
formally concluded upon the Company's entry into the Strategic Alliance, and
costs associated with a stockholder's contested solicitation of proxies, which
was terminated in December 2019. During the nine months ended November 30, 2019,
the Company incurred approximately $1,119,000 of costs associated with the
review of strategic alternatives and the contested solicitation of proxies,
compared with no comparable costs incurred in the nine months ended November 30,
2018. As a percentage of total revenues, general and administrative expenses
increased to 14.8% in the nine months ended November 30, 2019 compared to 10.3%
in the nine months ended November 30, 2018.
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Retail Operating Expenses
The decrease in retail operating expenses for the nine months ended November 30,
2019 compared to the nine months ended November 30, 2018 was due primarily to
changes in units in operation, as a result of the closure of certain
underperforming Company-owned units in the prior fiscal year. Retail operating
expenses, as a percentage of retail sales, decreased from 55.9% in the nine
months ended November 30, 2018 to 55.4% in the nine months ended November 30,
2019. This decrease is primarily the result of the change in units in operation
from the prior year.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization
included in cost of sales, was $674,000 in the nine months ended November 30,
2019, a decrease of 23.3% from $880,000 in the nine months ended November 30,
2018. This decrease was the result of a decrease in frozen yogurt cafés in
operation and lower amortization of the associated franchise rights. See Note 8
to the financial statements for a summary of annual amortization of intangible
assets based upon existing intangible assets and current useful lives.
Depreciation and amortization included in cost of sales increased 6.2% from
$415,000 in the nine months ended November 30, 2018 to $440,000 in the six
months ended November 30, 2019. This increase was the result of an increase in
production assets in service primarily resulting from the replacement of
obsolete equipment or equipment at the end of its operating life.
Costs Associated with Company-Owned Store Closures
There was $177,000 in costs associated with Company-owned store closures
incurred during the nine months ended November 30, 2018 and no costs associated
with Company-owned store closures incurred during the nine months ended November
30, 2019. The costs incurred during the nine months ended November 30, 2018 were
the result of charges related to closing certain underperforming Company-owned
locations.
Other Income (Expense)
Interest income was approximately $5,000 in the nine months ended November 30,
2019, compared to net interest expense of $44,000 in the nine months ended
November 30, 2018. This change in interest from net interest expense to net
interest income is due to lower average outstanding promissory note balances for
the nine months ended November 30, 2019.
Income Tax Expense
Our effective income tax rate for the nine months ended November 30, 2019 was
25.7%, compared to 24.6% for the nine months ended November 30, 2018. This
change was primarily the result of higher deductions realized during the three
months ended November 30, 2018, compared to the three months ended November 30,
2019.
Liquidity and Capital Resources
As of November 30, 2019 working capital was $9.0 million compared to $9.5
million at February 28, 2019.
Cash and cash equivalent balances increased approximately $100,000 to $5.5
million as of November 30, 2019 compared to $5.4 million as of February 28,
2019, primarily as a result of cash flow generated by operating activities
exceeding cash flow used by financing activities, including repayment of debt
and payment of dividends. Our current ratio was 2.6 to 1 at November 30, 2019
compared to 3.0 to 1 at February 28, 2019. We monitor current and anticipated
future levels of cash and cash equivalents in relation to anticipated operating,
financing and investing requirements.
During the nine months ended November 30, 2019, we had net income of $1,558,060.
Operating activities provided cash of $4,031,992, with the principal adjustments
to reconcile the net income to net cash provided by operating activities being
depreciation and amortization of $1,114,678, an increase in accounts payable of
$1,206,354 and the expense recorded for stock compensation of $503,210. During
the comparable 2018 period, we had net income of $1,853,120, and operating
activities provided cash of $1,699,053. The principal adjustment to reconcile
the net income to net cash provided by operating activities was depreciation and
amortization of $1,294,241 and the increase in inventory of $1,471,361.
During the nine months ended November 30, 2019, investing activities used cash
of $753,952, primarily due to the purchases of property, equipment of $864,370.
In comparison, investing activities used cash of $419,014 during the nine months
ended November 30, 2018 primarily due to the purchase of property and equipment
of $498,252.
Financing activities used cash of $3,199,389 for the nine months ended November
30, 2019 and used cash of $3,141,084 during the prior year period. The Company's
financing activities consist primarily of payments on long-term debt and
declared dividends.
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Table of Contents
We have a $5.0 million ($5.0 million available as of November 30, 2019) working
capital line of credit collateralized by substantially all of our assets with
the exception of our retail store assets. Additionally, the line of credit is
subject to various financial ratio and leverage covenants. As of November 30,
2019, we were in compliance with all such covenants. The line of credit was
renewed in September 2019 and is subject to renewal again in September 2021. As
of November 30, 2019, no amount was outstanding under this line of credit.
Our outstanding long-term debt is comprised of a promissory note used to finance
business acquisitions of SWRL (unpaid balance as of November 30, 2019 of
approximately $128,000). The promissory note allowed us to borrow up to a
maximum of $7.0 million to finance business acquisitions and bears interest at a
fixed annual rate of 3.75%. The promissory note matures on January 15, 2020.
Additionally, the promissory note is subject to various financial ratio and
leverage covenants. As of November 30, 2019, we were in compliance with all such
covenants. We expect to pay off the remaining balance of this promissory note at
maturity.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million
of our common stock in the open market or in private transactions, whenever
deemed appropriate by management. On January 13, 2015, we announced a plan to
purchase up to an additional $2,058,000 of our common stock under the repurchase
plan, and on May 21, 2015, we announced a further increase to the repurchase
plan by authorizing the purchase of up to an additional $2,090,000 of our common
stock under the repurchase plan. We did not repurchase any shares during the
three and nine months ended November 30, 2019. As of November 30, 2019,
approximately $638,000 remained available under the repurchase plan for further
stock repurchases.
We believe cash flows generated by operating activities and available financing
will be sufficient to fund our operations for at least the next twelve months.
If necessary, the Company has an available bank line of credit to help meet
these requirements.
Off-Balance Sheet Arrangements
As of November 30, 2019, except for the purchase obligations as described below,
we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of November 30, 2019, we had purchase obligations of
approximately $90,000. These purchase obligations primarily consist of
contractual obligations for future purchases of commodities for use in our
manufacturing.
Impact of Inflation
Inflationary factors such as increases in the costs of ingredients and labor
directly affect our operations. Most of our leases provide for cost-of-living
adjustments and require us to pay taxes, insurance and maintenance expenses, all
of which are subject to inflation. Additionally, our future lease costs for new
facilities may include potentially escalating costs of real estate and
construction. There is no assurance that we will be able to pass on increased
costs to our customers.
Depreciation expense is based on the historical cost to us of our fixed assets,
and is therefore potentially less than it would be if it were based on current
replacement cost. While property and equipment acquired in prior years will
ultimately have to be replaced at higher prices, it is expected that replacement
will be a gradual process over many years.
Seasonality
We are subject to seasonal fluctuations in sales, which cause fluctuations in
quarterly results of operations. Historically, the strongest sales of our
products have occurred during key holidays and the summer vacation season. In
addition, quarterly results have been, and in the future are likely to be,
affected by the timing of new store openings and sales of franchises. Because of
the seasonality of our business and the impact of new store openings and sales
of franchises, results for any quarter are not necessarily indicative of results
that may be achieved in other quarters or for a full fiscal year.
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