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: the impact of the novel
coronavirus ("COVID-19") on our business, including, among other things, online
sales, factory sales, retail sales and royalty and marketing fees, our
liquidity, our cost cutting and capital preservation measures, achievement of
the anticipated potential benefits of the strategic alliance with Edible (as
defined herein), our ability to provide products to Edible under the strategic
alliance, the ability to increase our online sales through the agreements with
Edible, changes in the confectionery business environment, seasonality, consumer
interest in our products, general economic conditions, the success of our frozen
yogurt business, receptiveness of our products internationally, consumer and
retail trends, costs and availability of raw materials, competition, the success
of our co-branding strategy, the success of international expansion efforts and
the effect of government regulations. Government regulations which we and our
franchisees and licensees either are, or may be, subject to and which could
cause results to differ from forward-looking statements include, but are not
limited to: local, state and federal laws regarding health, sanitation, safety,
building and fire codes, franchising, licensing, employment, manufacturing,
packaging and distribution of food products and motor carriers. For a detailed
discussion of the risks and uncertainties that may cause our actual results to
differ from the forward-looking statements contained herein, please see the
section entitled "Risk Factors" contained in Item 1A. of our Annual Report on
Form 10-K for the fiscal year ended February 29, 2020. Additional factors that
might cause such differences include, but are not limited to: the length and
severity of the current COVID-19 pandemic and its effect on among other things,
factory sales, retail sales, royalty and marketing fees and operations, the
effect of any governmental action or mandated employer-paid benefits in response
to the COVID-19 pandemic, our ability to manage costs and reduce expenditures in
the current economic environment and the availability of additional financing if
and when required. 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 (including its operating subsidiary with the same name, Rocky
Mountain Chocolate Factory, Inc., a Colorado corporation ("RMCF")).
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,
2020, there were two Company-owned, 97 licensee-owned and 212 franchised Rocky
Mountain Chocolate Factory stores operating in 37 states, Canada, South Korea,
Panama, and the Philippines. As of November 30, 2020, U-Swirl operated three
Company-owned cafés and 74 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
In December 2019, the Company entered into a strategic alliance (the "Strategic
Alliance") with Edible Arrangements, LLC and its affiliates (collectively,
"Edible"), pursuant to which, among other things, the Company will become the
exclusive provider of certain branded chocolate products to Edible, 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 Edible. In addition, in March
2020, the Company entered into an ecommerce licensing agreement with Edible,
whereby Edible sells a wide variety of chocolates, candies and other
confectionery products produced by the Company or its franchisees through
Edible's websites.
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Bankruptcy of FTD Companies
In June 2019, the Company's largest customer at the time, 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, 2020 will be realized at their full value,
or if any revenue will be received from FTD in the future. See Note 14 to the
consolidated financial statements contained herein for additional information
about the FTD bankruptcy.
COVID-19
As discussed in more detail throughout this Quarterly Report on Form 10-Q for
the three and nine months ended November 30, 2020 (this "Quarterly Report"), we
have experienced significant business disruptions resulting from efforts to
contain the rapid spread of the novel coronavirus ("COVID-19"), including the
vast mandated self-quarantines of customers and closures of non-essential
business throughout the United States and internationally. Nearly all of the
Company-owned and franchise stores were directly and negatively impacted by
public health measures taken in response to COVID-19, with nearly all locations
experiencing reduced operations as a result of, among other things, modified
business hours and store and mall closures. As a result, franchisees and
licensees are not ordering products for their stores in line with historical
amounts. This trend has negatively impacted, and is expected to continue to
negatively impact, among other things, factory sales, retail sales and royalty
and marketing fees. Beginning in May 2020 and continuing through November 2020,
most stores previously closed for much of March 2020 and April 2020 in response
to the COVID-19 pandemic, began to re-open. As of November 30, 2020,
approximately 43 stores have not re-opened and the future of these locations is
uncertain. This is a closure rate significantly higher than historical levels.
By November 30, 2020, certain stores have met or exceeded pre-COVID-19 levels,
however, many retail environments have continued to be adversely impacted by
changes to consumer behavior as a result of COVID-19. Most stores re-opened
subject to various local health restrictions and with reduced operations. It is
unclear when or if store operations will return to pre-COVID-19 levels.
In addition, as previously announced on May 11, 2020, the Board of Directors
decided to suspend the Company's first quarter cash dividend payment to preserve
cash and provide additional flexibility in the current environment impacted by
the COVID-19 pandemic. Furthermore, the Board of Directors has suspended future
quarterly dividends until the significant uncertainty of the current public
health crisis and economic climate has passed, and the Board of Directors
determines that resumption of dividend payments is in the best interest of us
and our stockholders.
During this challenging time, the Company's foremost priority is the safety and
well-being of our employees, customers, franchisees and communities. In addition
to the already stringent practices for the quality and safety of the Company's
confections, the Company is diligently following health and safety guidance
issued by the World Health Organization, the Centers for Disease Control and
state and local governmental agencies. COVID-19 has had an unprecedented impact
on the retail industry as containment measures continue to impact the Company's
operations and the retail industry. Numerous countries, states and local
governments have effected ordinances to protect the public through social
distancing, which has caused, and we expect will continue to cause, a
significant decrease in, among other things, retail traffic and as a result,
factory sales, retail sales and royalty and marketing fees. With that said,
Rocky Mountain Chocolate Factory products remain available for sale online. The
Company's current focus is on supporting its franchisees and licensees during
this challenging time and driving growth in online sales, especially in light of
the ecommerce licensing agreement with Edible, as discussed above, while also
sensibly managing costs. The number of Company-owned and franchise stores
remaining open may change frequently and significantly due to the ever-changing
nature of the COVID-19 outbreak.
In these challenging and unprecedented times, management is taking all necessary
and appropriate action to maximize liquidity as the Company navigates the
current landscape. These actions include significantly reducing operating
expenses and production volume to reflect reduced sales volumes as well as the
elimination of all non-essential spending and capital expenditures. Further, in
an abundance of caution and to maintain ample financial flexibility, the Company
drew down the full amount under our line of credit and the Company received
loans under the Paycheck Protection Program (the "PPP"). The receipt of funds
under the PPP has allowed the Company to temporarily avoid workforce reduction
measures amidst a steep decline in revenue and production volume. While the
Company believes it has sufficient liquidity with its current cash position, the
Company will continue to monitor and evaluate all financing alternatives as
necessary as these unprecedented events evolve. For more information, please see
Item 1A "Risk Factors-The Novel Coronavirus (COVID-19) Pandemic Has, and May
Continue to, Materially and Adversely Affect our Sales, Earnings, Financial
Condition and Liquidity" in our Annual Report on Form 10-K as filed on May 29,
2020 with the United States Securities and Exchange Commission.
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Results of Operations
Three Months Ended November 30, 2020 Compared to the Three Months Ended November
30, 2019
Results Summary
Basic earnings per share increased from a loss of $(0.01) per share in the three
months ended November 30, 2019 to earnings of $0.09 per share in the three
months ended November 30, 2020. Revenues decreased 8.6% from $7.9 million in the
three months ended November 30, 2019 to $7.2 million in the three months ended
November 30, 2020. Operating income increased from an operating loss of $98,000
in the three months ended November 30, 2019 to operating income of $399,000 in
the three months ended November 30, 2020. Net income increased from a net loss
of $72,000 in the three months ended November 30, 2019 to net income of $524,000
in the three months ended November 30, 2020. The decrease in revenue was due
primarily to the continued impacts from the COVID-19 pandemic, including its
impact on our operation and the operations of our franchised, licensed and
Company-owned locations. The increase in operating income was due primarily to
lower general and administrative costs, primarily the result of lower costs
associated with an analysis of strategic alternatives in the prior year period.
The increase in net income was due primarily to the increase in operating
income, a gain on insurance recovery and debt forgiveness income.
Revenues
Three Months Ended
November 30, $ %
($'s in thousands) 2020 2019 Change Change
Factory sales $ 5,570.4 $ 5,786.3 $ (215.9 ) (3.7 )%
Retail sales 531.4 704.3 (172.9 ) (24.5 )%
Franchise fees 46.1 82.3 (36.2 ) (44.0 )%
Royalty and marketing fees 1,081.0 1,340.4 (259.4 ) (19.4 )%
Total $ 7,228.9 $ 7,913.3 $ (684.4 ) (8.6 )%
Factory Sales
The decrease in factory sales for the three months ended November 30, 2020
compared to the three months ended November 30, 2019 was primarily due to a
22.5% decrease in sales of product to our network of franchised and licensed
retail stores, partially offset by a $855,000 increase in shipments of product
to customers outside our network of franchised retail stores. The decrease in
sales of product to our network of franchised and licensed retail stores was
primarily the result of the COVID-19 pandemic and the associated public health
measures in place during the three months ended November 30, 2020, which
significantly reduced traffic in our stores. The increase in shipments of
product to customers outside our network of franchise and licensed retail stores
was primarily the result of sales associated with our strategic alliance with
Edible.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory
franchise and license locations decreased 16.9% in the three months ended
November 30, 2020, compared with the three months ended November 30, 2019 as
result of store closures, reduced operations and reduced demand in stores as a
result of the impacts of the COVID-19 pandemic.
Retail Sales
The decrease in retail sales for the three months ended November 30, 2020
compared to the three months ended November 30, 2019 was primarily the result of
limited operations and limited foot traffic during the three months ended
November 30, 2020. The limited operations at our Company-owned stores was the
result of the COVID-19 pandemic and the associated public health measures in
place during the three months ended November 30, 2020. As of November 30, 2020,
all Company-owned stores had resumed limited operations following COVID-19
related closure. Same store sales at all Company-owned stores and cafés
decreased 16.3% in the three months ended November 30, 2020 compared to the
three months ended November 30, 2019.
Royalties, Marketing Fees and Franchise Fees
The decrease in royalties and marketing fees from the three months ended
November 30, 2019 to the three months ended November 30, 2020 was primarily due
to the COVID-19 pandemic and the associated public health measures in place
during the three months ended November 30, 2020 and a decrease in domestic
franchise units in operation. Nearly all of our franchised locations experienced
reduced operations during the three months ended November 30, 2020. The average
number of total domestic franchise stores in operation decreased 9.4% from 267
in the three months ended November 30, 2019 to 242 during the three months ended
November 30, 2020. This decrease is the result of domestic store closures
exceeding domestic store openings, a trend which has accelerated as a result of
the COVID-19 pandemic. Same store sales at total franchise stores and cafés in
operation decreased 8.5% during the three months ended November 30, 2020
compared to the three months ended November 30, 2019.
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The decrease in franchise fee revenue for the three months ended November 30,
2020 compared to the three months ended November 30, 2019 was the result of a
decrease in revenue resulting from fewer franchise stores in operation and the
associated recognition of revenue over the term of the franchise agreement.
Costs and Expenses
Cost of Sales
Three Months Ended
November 30, $ %
($'s in thousands) 2020 2019 Change Change
Cost of sales - factory $ 4,505.4 $ 4,689.9 $ (184.5 ) (3.9 )%
Cost of sales - retail 182.6 266.3 (83.7 ) (31.4 )%
Franchise costs 440.7 428.2 12.5 2.9 %
Sales and marketing 382.5 435.0 (52.5 ) (12.1 )%
General and administrative 788.7 1,529.3 (740.6 ) (48.4 )%
Retail operating 361.4 445.9 (84.5 ) (19.0 )%
Total $ 6,661.3 $ 7,794.6 $ (1,133.3 ) (14.5 )%
Gross Margin
Three Months Ended
November 30, $ %
($'s in thousands) 2020 2019 Change Change
Factory gross margin $ 1,065.0 $ 1,096.4 $ (31.4 ) (2.9 )%
Retail gross margin 348.8 438.0 (89.2 ) (20.4 )%
Total $ 1,413.8 $ 1,534.4 $ (120.6 ) (7.9 )%
Three Months Ended
November 30, % %
2020 2019 Change Change
(Percent)
Factory gross margin 19.1 % 18.9 % 0.2 % 0.9 %
Retail gross margin 65.6 % 62.2 % 3.4 % 5.5 %
Total 23.2 % 23.6 % (0.4 )% (2.0 )%
Adjusted Gross Margin
Three Months Ended
November 30, $ %
($'s in thousands) 2020 2019 Change Change
Factory gross margin $ 1,065.0 $ 1,096.4 $ (31.4 ) (2.9 )%
Plus: depreciation and amortization 157.6 147.3 10.3 7.0 %
Factory adjusted gross margin 1,222.6 1,243.7 (21.1 ) (1.7 )%
Retail gross margin 348.8 438.0 (89.2 ) (20.4 )%
Total Adjusted Gross Margin $ 1,571.4 $ 1,681.7 $ (110.3 ) (6.6 )%
Factory adjusted gross margin 21.9 % 21.5 % 0.5 % 2.1 %
Retail gross margin 65.6 % 62.2 % 3.4 % 5.5 %
Total Adjusted Gross Margin 25.8 % 25.9 % (0.1 )% (0.6 )%
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Adjusted gross margin and factory adjusted gross margin are non-GAAP measures.
Adjusted gross margin is equal to the sum of our factory adjusted gross margin
plus our retail gross margin calculated in accordance with GAAP. Factory
adjusted gross margin is equal to factory gross margin plus depreciation and
amortization expense. We believe adjusted gross margin and factory adjusted
gross margin are helpful in understanding our past performance as a supplement
to gross margin, factory gross margin and other performance measures calculated
in conformity with GAAP. We believe that adjusted gross margin and factory
adjusted gross margin are useful to investors because they provide a measure of
operating performance and our ability to generate cash that is unaffected by
non-cash accounting measures. Additionally, we use adjusted gross margin and
factory adjusted gross margin rather than gross margin and factory gross margin
to make incremental pricing decisions. Adjusted gross margin and factory
adjusted gross margin have limitations as analytical tools because they exclude
the impact of depreciation and amortization expense and you should not consider
it in isolation or as a substitute for any measure reported under GAAP. Our use
of capital assets makes depreciation and amortization expense a necessary
element of our costs and our ability to generate income. Due to these
limitations, we use adjusted gross margin and factory adjusted gross margin as
measures of performance only in conjunction with GAAP measures of performance
such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins increased 200 basis points in the three months ended November
30, 2020 compared to the three months ended November 30, 2019 due primarily to a
loss on inventory associated with the bankruptcy of FTD in the three months
ended November 30, 2019 with no comparable costs incurred during the three
months ended November 30, 2020. During the three months ended November 30, 2020,
production volume decreased 15.4% in response to a 3.7% decrease in factory
sales and an increase in inventory, primarily due to the impacts of the COVID-19
pandemic.
Retail gross margins increased from 62.2% during the three months ended November
30, 2019 to 65.6% during the three months ended November 30, 2020.
Franchise Costs
The increase in franchise costs in the three months ended November 30, 2020
compared to the three months ended November 30, 2019 is due primarily to an
increase in professional fees, partially offset by lower travel costs, the
result of COVID-19 related travel restrictions. As a percentage of total royalty
and marketing fees and franchise fee revenue, franchise costs increased to 39.1%
in the three months ended November 30, 2020 from 30.1% in the three months ended
November 30, 2019. This increase as a percentage of royalty, marketing and
franchise fees is primarily a result of lower royalty revenues.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended November
30, 2020 compared to the three months ended November 30, 2019 is primarily due
to lower advertising and promotion costs, partially offset by an increase in
online advertising cost.
General and Administrative
The decrease in general and administrative costs for the three months ended
November 30, 2020 compared to the three months ended November 30, 2019 is
primarily due to lower professional fees associated with the Company's review of
strategic alternatives in the 2019 period. 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, 2020. As a percentage of total revenues, general and
administrative expenses decreased to 10.9% in the three months ended November
30, 2020 compared to 19.3% in the three months ended November 30, 2019.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended November
30, 2020 compared to the three months ended November 30, 2019 was due primarily
to reduced operations as a result of the COVID-19 pandemic. Retail operating
expenses, as a percentage of retail sales, increased from 63.3% in the three
months ended November 30, 2019 to 68.0% in the three months ended November 30,
2020. This increase is primarily the result of lower retail sales.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization
included in cost of sales, was $169,000 in the three months ended November 30,
2020, a decrease of 22.1% from $217,000 in the three months ended November 30,
2019. This decrease was the result of lower amortization of franchise rights,
the result of a decrease in frozen yogurt cafés in operation. See Note 7 to the
consolidated 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 7.0%
from $147,000 in the three months ended November 30, 2019 to $158,000 in the
three months ended November 30, 2020. 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.
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Other Income
Other income was $298,000 in the three months ended November 30, 2020 compared
to other income of $4,000 realized in the three months ended November 30, 2019.
This change was primarily the result of a gain on insurance recovery and the
forgiveness of debt partially offset by higher interest expense resulting from
the Company's increased debt as a result of measures taken during the three
months ended May 31, 2020 to ensure adequate liquidity during the COVID-19
pandemic. During the three months ended May 31, 2020, the Company borrowed $3.4
million from its line of credit and borrowed $1.5 million of loans under the
Paycheck Protection Program.
The Company recognized a gain on insurance recovery of $210,500 and recognized
forgiveness of debt in the amount of $108,300 during the three months ended
November 30, 2020, compared with no similar amounts recognized during the three
months ended November 30, 2019. The debt forgiveness was the result of one of
the Company's PPP loans being forgiven during the three months ended November
30, 2020.
Income Tax Expense
Our effective income tax rate for the three months ended November 30, 2020 was
24.8%, compared to 23.7% for the three months ended November 30, 2019. This
change was primarily the result of lower deductions realized during the three
months ended November 30, 2020, compared to the three months ended November 30,
2019.
Nine months Ended November 30, 2020 Compared to the Nine months Ended November
30, 2019
Results Summary
Basic earnings per share decreased from $0.26 per share for the nine months
ended November 30, 2019 to a net loss of $(0.51) per share for the nine months
ended November 30, 2020. Revenues decreased 35.7% from $23.7 million for the
nine months ended November 30, 2019 to $15.3 million for the nine months ended
November 30, 2020. Operating income decreased from $2.1 million for the nine
months ended November 30, 2019 to an operating loss of $(4.3) million for the
nine months ended November 30, 2020. Net income decreased from $1.6 million for
the nine months ended November 30, 2019 to a net loss of $(3.1) million for the
nine months ended November 30, 2020. The decrease in revenue, operating income
and net income was due primarily to the impacts from the COVID-19 pandemic,
including its impact on our operation and the operations of our franchised,
licensed and Company-owned locations.
Revenues
Nine Months Ended
November 30, $ %
($'s in thousands) 2020 2019 Change Change
Factory sales $ 11,203.7 $ 15,874.7 $ (4,671.0 ) (29.4 )%
Retail sales 1,214.4 2,460.5 (1,246.1 ) (50.6 )%
Franchise fees 174.7 270.5 (95.8 ) (35.4 )%
Royalty and marketing fees 2,665.9 5,118.8 (2,452.9 ) (47.9 )%
Total $ 15,258.7 $ 23,724.5 $ (8,465.8 ) (35.7 )%
Factory Sales
The decrease in factory sales for the nine months ended November 30, 2020
compared to the nine months ended November 30, 2019 was primarily due to a 42.2%
decrease in sales of product to our network of franchised and licensed retail
stores partially offset by a 24.2% increase in shipments of product to customers
outside our network of franchised retail stores. Purchases resulting from our
strategic alliance with Edible were approximately $2.1 million, or 13.9%, of the
Company's revenues during the nine months ended November 30, 2020, compared to
no revenue from the strategic alliance during the nine months ended November 30,
2019. Purchases resulting from our strategic alliance with Edible were partially
offset by lower purchases from FTD, the Company's historically largest customer.
There was no revenue from FTD during the nine months ended November 30, 2020
compared to revenue of $1.5 million during the nine months ended November 30,
2019. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. The
decrease in sales of product to our network of franchised and licensed retail
stores was primarily the result of the COVID-19 pandemic and the associated
public health measures in place during the nine months ended November 30, 2020,
which significantly reduced traffic in our stores and increased store closures.
Beginning in May 2020, most stores previously closed for much of March 2020 and
April 2020, in response to COVID-19, began to re-open. Most stores re-opened
subject to various local health restrictions and with reduced operations. It is
unclear when or if store operations will return to pre COVID-19 levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory
franchise and license locations decreased 38.0% in the nine months ended
November 30, 2020, compared with the nine months ended November 30, 2019.
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Retail Sales
The decrease in retail sales for the nine months ended November 30, 2020
compared to the nine months ended November 30, 2019 was primarily due to the
closure of all of our Company-owned stores for much of the three months ended
May 31, 2020. The closure of our Company-owned stores was the result of the
COVID-19 pandemic and the associated public health measures in place during the
three months ended May 31, 2020. As of November 30, 2020, all of our
Company-owned stores had resumed limited operations following the COVID-19
related closures.
Royalties, Marketing Fees and Franchise Fees
The decrease in royalties and marketing fees from the nine months ended November
30, 2019 to the nine months ended November 30, 2020 was primarily due to the
COVID-19 pandemic and the associated public health measures in place during the
nine months ended November 30, 2020. Nearly all of our franchised locations
experienced reduced operations and periods of full closure during the nine
months ended November 30, 2020. The average number of total domestic franchise
stores in operation decreased 7.4% from 272 in the nine months ended November
30, 2019 to 252 during the nine months ended November 30, 2020. This decrease is
the result of domestic store closures exceeding domestic store openings, a trend
which has accelerated as a result of the COVID-19 pandemic.
The decrease in franchise fee revenue for the nine months ended November 30,
2020 compared to the nine months ended November 30, 2019 was the result of a
decrease in revenue resulting from fewer franchise stores in operation and the
associated recognition of revenue over the term of the franchise agreement.
Costs and Expenses
Cost of Sales
Nine Months Ended
November 30, $ %
($'s in thousands) 2020 2019 Change Change
Cost of sales - factory $ 10,203.7 $ 12,451.8 $ (2,248.1 ) (18.1 )%
Cost of sales - retail 421.1 857.6 (436.5 ) (50.9 )%
Franchise costs 1,312.9 1,352.9 (40.0 ) (3.0 )%
Sales and marketing 1,265.5 1,426.4 (160.9 ) (11.3 )%
General and administrative 4,756.7 3,504.4 1,252.3 35.7 %
Retail operating 1,010.0 1,364.1 (354.1 ) (26.0 )%
Total $ 18,969.9 $ 20,957.2 $ (1,987.3 ) (9.5 )%
Gross Margin
Nine Months Ended
November 30, $ %
2020 2019 Change Change
Factory gross margin $ 1,000.0 $ 3,422.9 $ (2,422.9 ) (70.8 )%
Retail gross margin 793.3 1,602.9 (809.6 ) (50.5 )%
Total $ 1,793.3 $ 5,025.8 $ (3,232.5 ) (64.3 )%
Nine Months Ended
November 30, % %
2020 2019 Change Change
Factory gross margin 8.9 % 21.6 % (12.6 )% (58.6 )%
Retail gross margin 65.3 % 65.1 % 0.2 % 0.3 %
Total 14.4 % 27.4 % (13.0 )% (47.3 )%
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Adjusted Gross Margin
Nine Months Ended
November 30, $ %
($'s in thousands) 2020 2019 Change Change
Factory gross margin $ 1,000.0 $ 3,422.9 $ (2,422.9 ) (70.8 )%
Plus: depreciation and amortization 473.3 440.5 32.8 7.4 %
Factory adjusted gross margin 1,473.3 3,863.4 (2,390.1 ) (61.9 )%
Retail gross margin 793.3 1,602.9 (809.6 ) (50.5 )%
Total Adjusted Gross Margin $ 2,266.6 $ 5,466.3 $ (3,199.7 ) (58.5 )%
Factory adjusted gross margin 13.2 % 24.3 % (11.2 )% (46.0 )%
Retail gross margin 65.3 % 65.1 % 0.2 % 0.3 %
Total Adjusted Gross Margin 18.3 % 29.8 % (11.6 )% (38.8 )%
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures.
Adjusted gross margin is equal to the sum of our factory adjusted gross margin
plus our retail gross margin calculated in accordance with GAAP. Factory
adjusted gross margin is equal to factory gross margin plus depreciation and
amortization expense. We believe adjusted gross margin and factory adjusted
gross margin are helpful in understanding our past performance as a supplement
to gross margin, factory gross margin and other performance measures calculated
in conformity with GAAP. We believe that adjusted gross margin and factory
adjusted gross margin are useful to investors because they provide a measure of
operating performance and our ability to generate cash that is unaffected by
non-cash accounting measures. Additionally, we use adjusted gross margin and
factory adjusted gross margin rather than gross margin and factory gross margin
to make incremental pricing decisions. Adjusted gross margin and factory
adjusted gross margin have limitations as analytical tools because they exclude
the impact of depreciation and amortization expense and you should not consider
it in isolation or as a substitute for any measure reported under GAAP. Our use
of capital assets makes depreciation and amortization expense a necessary
element of our costs and our ability to generate income. Due to these
limitations, we use adjusted gross margin and factory adjusted gross margin as
measures of performance only in conjunction with GAAP measures of performance
such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory gross margins decreased to 8.9% in the nine months ended November 30,
2020 compared to 21.6% during the nine months ended November 30, 2019, due
primarily to lower production volume in the nine months ended November 30, 2020
compared to the nine months ended November 30, 2019. During the nine months
ended November 30, 2020, production volume decreased 28.2% in response to a
29.4% decrease in factory sales, primarily due to the impacts of the COVID-19
pandemic. During the nine months ended November 30, 2020, the Company also
incurred approximately $280,000 of production labor costs associated with paying
employees who abided by local stay at home orders related to COVID-19 public
health measures. This excess capacity cost, in the form of idle labor, was
included in cost of sales.
Retail gross margins increased from 65.1% during the nine months ended November
30, 2019 to 65.3% during the nine months ended November 30, 2020.
Franchise Costs
The decrease in franchise costs in the nine months ended November 30, 2020
compared to the nine months ended November 30, 2019 is due primarily to lower
travel costs, the result of COVID-19 related travel restrictions. As a
percentage of total royalty and marketing fees and franchise fee revenue,
franchise costs increased to 46.2% in the nine months ended November 30, 2020
from 25.1% in the nine months ended November 30, 2019. This increase as a
percentage of royalty, marketing and franchise fees is primarily a result of
lower franchise and royalty fees.
Sales and Marketing
The decrease in sales and marketing costs for the nine months ended November 30,
2020 compared to the nine months ended November 30, 2019 was primarily due to
lower advertising and promotion costs, partially offset by an increase in online
advertising cost.
General and Administrative
The increase in general and administrative costs for the nine months ended
November 30, 2020 compared to the nine months ended November 30, 2019 was due
primarily to an increase in bad debt expense, the impairment of certain
intangible assets and higher professional fees. As a percentage of total
revenues, general and administrative expenses increased to 31.2% in the nine
months ended November 30, 2020 compared to 14.8% in the nine months ended
November 30, 2019. Bad debt expense was primarily the result of management's
assessment of the likelihood of collecting accounts and notes receivable. As a
result of this assessment total allowances for potentially uncollectable
accounts and notes receivable increased to $1,876,400 at November 30, 2020,
compared to $638,907 at February 29, 2020. This cost was a direct result of
public health measures in place due to responses to COVID-19 and the financial
burden experienced by the majority of our network of franchised and licensed
locations. See Note 8 to the financial statements for a summary of costs
associated with the impairment of certain intangible assets.
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Retail Operating Expenses
The decrease in retail operating expenses for the nine months ended November 30,
2020 compared to the nine months ended November 30, 2019 was due to the
temporary closure of all of our Company-owned stores for much of the three
months ended May 31, 2020. The closure of our Company-owned stores was the
result of COVID-19 and the associated public health measures in place. Retail
operating expenses, as a percentage of retail sales, increased from 55.4% in the
nine months ended November 30, 2019 to 83.2% in the nine months ended November
30, 2020. This increase is primarily the result of lower retail sales.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization
included in cost of sales, was $531,000 in the nine months ended November 30,
2020, a decrease of 21.2% from $674,000 in the nine months ended November 30,
2019. This decrease was the result of lower amortization of franchise rights,
the result of a decrease in frozen yogurt cafés in operation. See Note 7 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 7.5% from $440,000 in the nine
months ended November 30, 2019 to $473,000 in the nine months ended November 30,
2020. 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
Other income was $261,000 in the nine months ended November 30, 2020 compared to
other income of $5,000 during the nine months ended November 30, 2019. This
change was primarily the result of a gain on insurance recovery and the
forgiveness of debt partially offset by higher interest expense resulting from
the Company's increased debt as a result of measures taken during the nine
months ended November 30, 2020 to ensure adequate liquidity during the COVID-19
pandemic. During the nine months ended November 30, 2020, the Company borrowed
$3.4 million from its line of credit and borrowed $1.5 million of loans under
the Paycheck Protection Program of which approximately $108,000 and associated
interest has been forgiven.
The Company recognized a gain on insurance recovery of $210,500 and recognized
forgiveness of debt in the amount of $108,300 during the nine months ended
November 30, 2019, compared with no similar amounts recognized during the nine
months ended November 30, 2019. The debt forgiveness was the result of one of
the Company's PPP loans being forgiven during the nine months ended November 30,
2020.
Income Tax Expense
Our effective income tax rate for the nine months ended November 30, 2020 was
24.3%, compared to 25.7% for the nine months ended November 30, 2019. The
decrease in the effective income tax rate is primarily the result of lower state
income taxes.
Liquidity and Capital Resources
As discussed below, we have taken several defensive measures to maximize
liquidity in response to the COVID-19 pandemic, including the suspension of our
cash dividend, reducing expenses, extending payment terms with vendors, reducing
production volume and deferring discretionary capital expenditures. Based on
these actions, we believe that cash flows from operations and our cash and cash
equivalents on hand, will be sufficient to meet our ongoing liquidity needs and
capital expenditure requirements for at least the next twelve months. Additional
future financing may be necessary to fund our operations, and there can be no
assurance that, if needed, we will be able to secure additional debt or equity
financing on terms acceptable to us or at all, especially in light of the market
volatility and uncertainty as a result of the COVID-19 pandemic. Although we
believe we have adequate sources of liquidity over the long term, the success of
our operations, the global economic outlook, and the pace of sustainable growth
in our markets, in each case, in light of the market volatility and uncertainty
as a result of the COVID-19 pandemic, among other factors, could impact our
business and liquidity.
As of November 30, 2020, working capital was $6.6 million, compared to $8.0
million as of February 29, 2020, a decrease of $1.4 million. The decrease in
working capital was primarily due to an increase in current liabilities, the
result of the Company's response to COVID-19 and measures taken to ensure
sufficient short-term liquidity.
Cash and cash equivalent balances increased approximately $2.4 million to $7.3
million as of November 30, 2020 compared to $4.8 million as of February 29,
2020, primarily as a result of the use of the line of credit and receipt of
loans under the Paycheck Protection Program, as described below. Our current
ratio was 1.8 to 1 at November 30, 2020 compared to 2.4 to 1 at February 29,
2020. We monitor current and anticipated future levels of cash and cash
equivalents in relation to anticipated operating, financing and investing
requirements.
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During the nine months ended November 30, 2020, we had a net loss of
$(3,067,570). Operating activities used cash of $2,012,609, with the principal
adjustment to reconcile the net income to net cash used by operating activities
being the provision for loss on accounts and notes receivable of $1,468,815,
asset impairment and store closure losses of $544,060, depreciation and
amortization of $1,004,539 and expense related to stock-based compensation of
$399,636. During the comparable 2019 period, we had net income of $1,558,060,
and operating activities provided cash of $4,031,992. The principal adjustment
to reconcile the net income to net cash provided by operating activities was
depreciation and amortization of $1,114,678 and the expense recorded for stock
compensation of $503,210.
During the nine months ended November 30, 2020, investing activities provided
cash of $198,438, primarily due to proceeds from the sale of assets, the result
of insurance proceeds, of $304,962. In comparison, investing activities used
cash of $753,952 during the nine months ended November 30, 2019 primarily due to
the purchase of property and equipment of $864,370.
Financing activities provided cash of $4,263,021 for the nine months ended
November 30, 2020 primarily as a as a result of the use of the line of credit
and receipt of loans under the Paycheck Protection Program, as described below.
In comparison, financing activities used cash of $3,199,389 during the prior
year period primarily due to payments on long-term debt and declared dividends.
Revolving Credit Line
The Company has a $5.0 million credit line for general corporate and working
capital purposes. On March 16, 2020, as a precautionary measure in light of the
COVID-19 pandemic and the related economic impacts, the Company drew the maximum
amount available on the credit line in an amount equal to $3.4 million (the full
amount of $5.0 million under the credit line, subject to the borrowing base of
50% of eligible accounts receivable plus 50% of eligible inventories). The
credit line is secured by substantially all of the Company's assets, except
retail store assets. Interest on borrowings is at LIBOR plus 2.25% (2.4% at
November 30, 2020). Additionally, the line of credit is subject to various
financial ratio and leverage covenants. At November 30, 2020, the Company was
not compliant with a covenant of the line of credit that requires the Company to
have $1.5 million of adjusted earnings before interest, taxes, depreciation and
amortization ("EBITDA") for the trailing twelve months ended November 30, 2020.
As a result of COVID-19, the Company failed to meet the amount of EBITDA
required by this covenant. On June 26, 2020 and on October 5, 2020 Wells Fargo
Bank, NA ("Wells Fargo") delivered to the Company Reservation of Rights Letters
("Bank Letters"). The Bank Letters reserved all rights available to Wells Fargo
under the Credit Agreement dated October 30, 2015 including, but not limited to,
the right of Wells Fargo to demand immediate payment of all amounts outstanding
under the Credit Agreement. The Bank Letters also placed restrictions on the
Company's ability to draw any further funds on the Line of Credit. On December
22, 2020 the Company and Wells Fargo executed an amendment to the credit
agreement. The amendment to the credit agreement reduced the amount of EBITDA
required for the Company to be compliant with the covenant and introduced
certain exemptions for the covenant specific to the impacts of COVID -19. Upon
execution of this amendment, the Company became compliant with covenants
associated with the line of credit and is compliant with such covenants as of
the date of this Quarterly Report on Form 10-Q. The credit line is subject to
renewal in September 2021 and the Company believes it is likely to be renewed on
terms similar to the current terms, subject to the Company's recovery from the
impacts of COVID-19.
PPP Loan
On April 13, 2020 and April 20, 2020, the Company entered into Loan Agreements
and Promissory Notes (collectively, the "SBA Loans") with 1st SOURCE BANK
pursuant to the Paycheck Protection Program (the "PPP") under the recently
enacted Coronavirus Aid, Relief, and Economic Security Act ("CARES Act")
administered by the U.S. Small Business Administration. The Company received
total proceeds of $1.5 million from the SBA Loans. In November 2020 one of the
loans in the amount of $108,000 was fully forgiven. The remaining SBA Loan is
scheduled to mature on April 14, 2022 and has a 1.00% interest rate and is
subject to the terms and conditions applicable to loans administered by the U.S.
Small Business Administration under the CARES Act. The remaining SBA Loan may be
prepaid by the Company at any time prior to maturity with no prepayment
penalties.
The remaining SBA Loan contains customary events of default relating to, among
other things, payment defaults and breaches of representations and warranties.
Subject to certain conditions, the SBA Loan may be forgiven in whole or in part
by applying for forgiveness pursuant to the CARES Act and the PPP. The amount of
loan proceeds eligible for forgiveness is based on a formula based on a number
of factors, including the amount of loan proceeds used by the Company during the
eight-week period after the loan origination for certain purposes, including
payroll costs, interest on certain mortgage obligations, rent payments on
certain leases, and certain qualified utility payments, provided that, among
other things, at least 75% of the loan amount is used for eligible payroll
costs, the employer maintaining or rehiring employees and maintaining salaries
at a certain level. In accordance with the requirements of the CARES Act and the
PPP, the Company has used the proceeds from the SBA Loan primarily for payroll
costs. No assurance can be given that the Company will be granted forgiveness of
the remaining SBA Loan in whole or in part.
Off-Balance Sheet Arrangements
As of November 30, 2020, except for the purchase obligations as described below,
we had no material off-balance sheet arrangements or obligations.
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Purchase obligations: As of November 30, 2020, we had purchase obligations of
approximately $323,000. 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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