UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended August 31, 20182019
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ________to________
Commission file number: 001-36865
Rocky Mountain Chocolate Factory, Inc.
(Exact name of registrant as specified in its charter)
Delaware | 47-1535633 |
(State or other jurisdiction of Incorporation or organization) | (I.R.S. Employer Identification No.) |
265 Turner Drive, Durango, CO 81303
(Address of principal executive offices, including zip code)
(970) 259-0554
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading symbol | Name of each exchange on which registered |
Common Stock, $0.001 par value per share | RMCF | Nasdaq Global Market |
Preferred Stock Purchase Rights | RMCF | Nasdaq Global Market |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ☐ | Accelerated filer | ☐ | |
Non-accelerated filer | ☐ | Smaller reporting company | ☒ | |
| ||||
Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
On October 1, 2018,2019, the registrant had outstanding 5,948,6605,994,997 shares of its common stock, $.001$0.001 par value.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
FORM 10-Q
PART I. | 3 |
Item 1. | 3 |
3 | |||
4 | |||
5 | |||
6 | |||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
| 18 |
Item 3. |
| 26 | |
Item 4. |
| 26 | |
PART II. |
| 27 | |
Item 1. |
| 27 | |
Item 1A. |
| 27 | |
Item 2. |
| 27 | |
Item 3. |
| 27 | |
Item 4. |
| 27 | |
Item 5. |
| 27 | |
Item 6. |
| 28 | |
| 29 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
Three Months Ended August 31, | Six Months Ended August 31, | Three Months Ended August 31, | Six Months Ended August 31, | |||||||||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2019 | 2018 | 2019 | 2018 | |||||||||||||||||||||||||
Revenues | ||||||||||||||||||||||||||||||||
Sales | $ | 5,736,319 | $ | 6,063,381 | $ | 12,318,368 | $ | 13,270,320 | $ | 5,384,040 | $ | 5,736,319 | $ | 11,844,651 | $ | 12,318,368 | ||||||||||||||||
Franchise and royalty fees | 2,063,769 | 2,203,310 | 3,847,805 | 4,342,818 | 2,001,230 | 2,063,769 | 3,966,618 | 3,847,805 | ||||||||||||||||||||||||
Total Revenue | 7,800,088 | 8,266,691 | 16,166,173 | 17,613,138 | 7,385,270 | 7,800,088 | 15,811,269 | 16,166,173 | ||||||||||||||||||||||||
Costs and Expenses | ||||||||||||||||||||||||||||||||
Cost of sales | 3,883,884 | 3,852,471 | 8,549,126 | 8,867,436 | 3,738,435 | 3,883,884 | 8,353,179 | 8,549,126 | ||||||||||||||||||||||||
Franchise costs | 582,798 | 558,407 | 1,076,048 | 1,073,199 | 441,638 | 582,798 | 924,651 | 1,076,048 | ||||||||||||||||||||||||
Sales and marketing | 565,212 | 566,031 | 1,153,462 | 1,192,383 | 434,782 | 565,212 | 991,433 | 1,153,462 | ||||||||||||||||||||||||
General and administrative | 813,388 | 976,647 | 1,727,835 | 2,105,353 | 830,451 | 813,388 | 1,975,182 | 1,727,835 | ||||||||||||||||||||||||
Retail operating | 498,856 | 616,927 | 1,061,328 | 1,189,751 | 469,304 | 498,856 | 918,206 | 1,061,328 | ||||||||||||||||||||||||
Depreciation and amortization, exclusive of depreciation and amortization expense of $138,212, $127,882, $274,717 and $253,497, respectively, included in cost of sales | 296,737 | 194,990 | 597,737 | 389,924 | ||||||||||||||||||||||||||||
Restructuring and acquisition related charges | 118,793 | - | 176,981 | - | ||||||||||||||||||||||||||||
Depreciation and amortization, exclusive of depreciation and amortization expense of $147,415, $138,212, $293,114 and $274,717, respectively, included in cost of sales | 225,417 | 296,737 | 457,372 | 597,737 | ||||||||||||||||||||||||||||
Costs associated with Company-owned store closures | - | 118,793 | - | 176,981 | ||||||||||||||||||||||||||||
Total costs and expenses | 6,759,668 | 6,765,473 | 14,342,517 | 14,818,046 | 6,140,027 | 6,759,668 | 13,620,023 | 14,342,517 | ||||||||||||||||||||||||
Income from Operations | 1,040,420 | 1,501,218 | 1,823,656 | 2,795,092 | 1,245,243 | 1,040,420 | 2,191,246 | 1,823,656 | ||||||||||||||||||||||||
Other Income (Expense) | ||||||||||||||||||||||||||||||||
Interest Expense | (19,418 | ) | (32,088 | ) | (42,057 | ) | (67,277 | ) | (3,487 | ) | (19,418 | ) | (15,885 | ) | (42,057 | ) | ||||||||||||||||
Interest Income | 4,627 | 6,213 | 9,204 | 13,431 | 6,007 | 4,627 | 16,186 | 9,204 | ||||||||||||||||||||||||
Other income (expense), net | (14,791 | ) | (25,875 | ) | (32,853 | ) | (53,846 | ) | 2,520 | (14,791 | ) | 301 | (32,853 | ) | ||||||||||||||||||
Income Before Income Taxes | 1,025,629 | 1,475,343 | 1,790,803 | 2,741,246 | 1,247,763 | 1,025,629 | 2,191,547 | 1,790,803 | ||||||||||||||||||||||||
Income Tax Provision | 274,814 | 547,059 | 463,044 | 999,290 | 329,675 | 274,814 | 561,850 | 463,044 | ||||||||||||||||||||||||
Consolidated Net Income | $ | 750,815 | $ | 928,284 | $ | 1,327,759 | $ | 1,741,956 | $ | 918,088 | $ | 750,815 | $ | 1,629,697 | $ | 1,327,759 | ||||||||||||||||
Basic Earnings per Common Share | $ | .13 | $ | 0.16 | $ | .22 | $ | 0.30 | $ | 0.15 | $ | 0.13 | $ | 0.27 | $ | 0.22 | ||||||||||||||||
Diluted Earnings per Common Share | $ | .13 | $ | 0.16 | $ | .22 | $ | 0.29 | $ | 0.15 | $ | 0.13 | $ | 0.26 | $ | 0.22 | ||||||||||||||||
Weighted Average Common Shares Outstanding - Basic | 5,923,351 | 5,876,727 | 5,914,383 | 5,865,549 | 5,977,746 | 5,923,351 | 5,970,012 | 5,914,383 | ||||||||||||||||||||||||
Dilutive Effect of Employee Stock Awards | 59,479 | 104,776 | 68,536 | 114,071 | 279,584 | 59,479 | 275,935 | 68,536 | ||||||||||||||||||||||||
Weighted Average Common Shares Outstanding - Diluted | 5,982,830 | 5,981,503 | 5,982,919 | 5,979,620 | 6,257,330 | 5,982,830 | 6,245,947 | 5,982,919 |
The accompanying notes are an integral part of these consolidated financial statements.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
August 31, | February 28, | August 31, | February 28, | |||||||||||||
2018 | 2018 | 2019 | 2019 | |||||||||||||
| (unaudited) | (unaudited) | ||||||||||||||
Assets | ||||||||||||||||
Current Assets | ||||||||||||||||
Cash and cash equivalents | $ | 5,173,235 | $ | 6,072,984 | $ | 5,753,209 | $ | 5,384,027 | ||||||||
Accounts receivable, less allowance for doubtful accounts of $520,262 and $479,472, respectively | 3,458,476 | 3,897,334 | ||||||||||||||
Notes receivable, current portion, less current portion of the valuation allowance of $12,500 and $9,000, respectively | 73,025 | 105,540 | ||||||||||||||
Accounts receivable, less allowance for doubtful accounts of $585,306 and $489,502, respectively | 4,017,572 | 3,993,262 | ||||||||||||||
Notes receivable, current portion | 134,926 | 110,162 | ||||||||||||||
Refundable income taxes | 85,178 | 342,863 | 44,726 | 190,201 | ||||||||||||
Inventories, less reserve for slow moving inventory of $364,248 and $357,706, respectively | 6,009,845 | 4,842,474 | ||||||||||||||
Inventories, less reserve for slow moving inventory of $178,658 and $371,147, respectively | 4,195,198 | 4,270,357 | ||||||||||||||
Other | 464,477 | 310,173 | 465,876 | 318,126 | ||||||||||||
Total current assets | 15,264,236 | 15,571,368 | 14,611,507 | 14,266,135 | ||||||||||||
Property and Equipment, Net | 5,855,990 | 6,166,240 | 5,857,664 | 5,786,139 | ||||||||||||
Other Assets | ||||||||||||||||
Notes receivable, less current portion and valuation allowance of $14,000 and $17,500, respectively | 199,642 | 235,983 | ||||||||||||||
Notes receivable, less current portion | 317,507 | 281,669 | ||||||||||||||
Goodwill, net | 1,046,944 | 1,046,944 | 1,046,944 | 1,046,944 | ||||||||||||
Franchise rights, net | 4,056,424 | 4,433,927 | 3,363,304 | 3,678,920 | ||||||||||||
Intangible assets, net | 542,307 | 587,377 | 460,865 | 498,337 | ||||||||||||
Deferred income taxes | 494,555 | 835,463 | 505,462 | 607,421 | ||||||||||||
Lease right of use asset | 3,066,826 | - | ||||||||||||||
Other | 70,116 | 63,333 | 56,264 | 56,576 | ||||||||||||
Total other assets | 6,409,988 | 7,203,027 | 8,817,172 | 6,169,867 | ||||||||||||
Total Assets | $ | 27,530,214 | $ | 28,940,635 | $ | 29,286,343 | $ | 26,222,141 | ||||||||
Liabilities and Stockholders' Equity | ||||||||||||||||
Current Liabilities | ||||||||||||||||
Current maturities of long term debt | $ | 1,378,601 | $ | 1,352,893 | $ | 480,445 | $ | 1,176,488 | ||||||||
Accounts payable | 1,351,295 | 1,647,991 | 1,295,732 | 897,074 | ||||||||||||
Accrued salaries and wages | 648,005 | 644,005 | 597,856 | 655,853 | ||||||||||||
Gift card liabilities | 688,572 | 3,057,131 | 648,142 | 742,289 | ||||||||||||
Other accrued expenses | 184,310 | 325,034 | 291,353 | 293,094 | ||||||||||||
Dividend payable | 713,839 | 708,652 | 719,359 | 714,939 | ||||||||||||
Deferred revenue | 291,676 | 471,910 | ||||||||||||||
Contract liabilities | 239,278 | 256,094 | ||||||||||||||
Lease liability | 808,989 | - | ||||||||||||||
Total current liabilities | 5,256,298 | 8,207,616 | 5,081,154 | 4,735,831 | ||||||||||||
Long-Term Debt, Less Current Maturities | 480,372 | 1,176,416 | ||||||||||||||
Deferred Revenue, Less Current Portion | 1,125,017 | - | ||||||||||||||
Lease Liability, Less Current Portion | 2,257,837 | - | ||||||||||||||
Contract Liabilities, Less Current Portion | 976,651 | 1,096,478 | ||||||||||||||
Commitments and Contingencies | ||||||||||||||||
Stockholders' Equity | ||||||||||||||||
Preferred stock, $.001 par value per share; 250,000 authorized; -0- shares issued and outstanding Series A Junior Participating Preferred Stock, authorized 50,000 shares | - | - | ||||||||||||||
Preferred stock, $.001 par value per share; 250,000 authorized; -0- shares issued and outstanding | - | - | ||||||||||||||
Series A Junior Participating Preferred Stock, authorized 50,000 shares | - | - | ||||||||||||||
Undesignated series, authorized 200,000 shares | - | - | - | - | ||||||||||||
Common stock, $.001 par value, 46,000,000 shares authorized, 5,948,660 shares and 5,903,436 shares issued and outstanding, respectively | 5,949 | 5,903 | ||||||||||||||
Common stock, $.001 par value, 46,000,000 shares authorized, 5,991,162 shares and 5,957,827 shares issued and outstanding, respectively | 5,991 | 5,958 | ||||||||||||||
Additional paid-in capital | 6,411,829 | 6,131,147 | 7,037,501 | 6,650,864 | ||||||||||||
Retained earnings | 14,250,749 | 13,419,553 | 13,927,209 | 13,733,010 | ||||||||||||
Total stockholders' equity | 20,668,527 | 19,556,603 | 20,970,701 | 20,389,832 | ||||||||||||
Total Liabilities and Stockholders' Equity | $ | 27,530,214 | $ | 28,940,635 | $ | 29,286,343 | $ | 26,222,141 |
The accompanying notes are an integral part of these consolidated financial statements.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended | Six Months Ended | |||||||||||||||
August 31, | August 31, | |||||||||||||||
2018 | 2017 | 2019 | 2018 | |||||||||||||
Cash Flows From Operating Activities | ||||||||||||||||
Net Income | $ | 1,327,759 | $ | 1,741,956 | $ | 1,629,697 | $ | 1,327,759 | ||||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||||
Depreciation and amortization | 872,454 | 643,421 | 750,486 | 872,454 | ||||||||||||
Provision for obsolete inventory | 57,614 | 43,660 | 47,945 | 57,614 | ||||||||||||
Provision for loss on accounts and notes receivable | 40,800 | 58,800 | 108,283 | 40,800 | ||||||||||||
Asset impairment and store closure losses | 67,822 | - | - | 67,822 | ||||||||||||
Loss on sale or disposal of property and equipment | 26,020 | 17,912 | 5,796 | 26,020 | ||||||||||||
Expense recorded for stock compensation | 280,728 | 324,480 | 386,670 | 280,728 | ||||||||||||
Deferred income taxes | 38,814 | 61,987 | 101,959 | 38,814 | ||||||||||||
Changes in operating assets and liabilities: | ||||||||||||||||
Accounts receivable | 421,162 | 756,766 | (267,491 | ) | 421,162 | |||||||||||
Refundable income taxes | 257,685 | (125,447 | ) | 145,475 | 257,685 | |||||||||||
Inventories | (1,579,686 | ) | (1,421,625 | ) | 212,138 | (1,579,686 | ) | |||||||||
Other current assets | (154,537 | ) | (131,457 | ) | (147,750 | ) | (154,537 | ) | ||||||||
Accounts payable | 58,005 | 56,151 | 213,734 | 58,005 | ||||||||||||
Accrued liabilities | (254,540 | ) | 76,776 | (153,885 | ) | (254,540 | ) | |||||||||
Deferred income | (71,671 | ) | 85,270 | |||||||||||||
Contract liabilities | (130,378 | ) | (71,671 | ) | ||||||||||||
Net cash provided by operating activities | 1,388,429 | 2,188,650 | 2,902,679 | 1,388,429 | ||||||||||||
Cash Flows from Investing Activities | ||||||||||||||||
Addition to notes receivable | - | (14,292 | ) | |||||||||||||
Proceeds received on notes receivable | 55,612 | 135,733 | 74,296 | 55,612 | ||||||||||||
Purchase of intangible assets | - | (8,508 | ) | |||||||||||||
Proceeds from (cost of) sale or distribution of assets | 4,023 | (9,576 | ) | |||||||||||||
Purchases of property and equipment | (246,455 | ) | (283,988 | ) | (480,984 | ) | (242,432 | ) | ||||||||
(Increase) decrease in other assets | (13,717 | ) | 7,697 | 312 | (13,717 | ) | ||||||||||
Net cash used in investing activities | (200,537 | ) | (172,934 | ) | (406,376 | ) | (200,537 | ) | ||||||||
Cash Flows from Financing Activities | ||||||||||||||||
Payments on long-term debt | (670,336 | ) | (645,564 | ) | (696,043 | ) | (670,336 | ) | ||||||||
Dividends paid | (1,417,305 | ) | (1,405,050 | ) | (1,431,078 | ) | (1,417,305 | ) | ||||||||
Net cash used in financing activities | (2,087,641 | ) | (2,050,614 | ) | (2,127,121 | ) | (2,087,641 | ) | ||||||||
Net Decrease in Cash and Cash Equivalents | (899,749 | ) | (34,898 | ) | ||||||||||||
Net Increase (Decrease) in Cash and Cash Equivalents | 369,182 | (899,749 | ) | |||||||||||||
Cash and Cash Equivalents, Beginning of Period | 6,072,984 | 5,779,195 | 5,384,027 | 6,072,984 | ||||||||||||
Cash and Cash Equivalents, End of Period | $ | 5,173,235 | $ | 5,744,297 | $ | 5,753,209 | $ | 5,173,235 |
The accompanying notes are an integral part of these consolidated financial statements.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(unaudited)
Additional | ||||||||||||||||||||
Common Stock | Paid-in | Retained | ||||||||||||||||||
Shares | Amount | Capital | Earnings | Total | ||||||||||||||||
Balance as of May 31, 2018 | 5,905,436 | $ | 5,905 | $ | 6,286,952 | $ | 14,213,773 | $ | 20,506,630 | |||||||||||
Net income | 750,815 | 750,815 | ||||||||||||||||||
Issuance of common stock, vesting of restricted stock units and other | 43,224 | 43 | (43 | ) | - | |||||||||||||||
Share-based compensation | 124,921 | 124,921 | ||||||||||||||||||
Common stock dividends | (713,839 | ) | (713,839 | ) | ||||||||||||||||
Balance as of August 31, 2018 | 5,948,660 | $ | 5,948 | $ | 6,411,830 | $ | 14,250,749 | $ | 20,668,527 | |||||||||||
Balance as of February 28, 2018 | 5,903,436 | $ | 5,903 | $ | 6,131,147 | $ | 13,419,553 | $ | 19,556,603 | |||||||||||
Net income | 1,327,759 | 1,327,759 | ||||||||||||||||||
Issuance of common stock, vesting of restricted stock units and other | 45,224 | 45 | (45 | ) | - | |||||||||||||||
Share-based compensation | 280,728 | 280,728 | ||||||||||||||||||
Common stock dividends | (1,422,492 | ) | (1,422,492 | ) | ||||||||||||||||
Adoption of ASC 606 | 925,929 | 925,929 | ||||||||||||||||||
Balance as of August 31, 2018 | 5,948,660 | $ | 5,948 | $ | 6,411,830 | $ | 14,250,749 | $ | 20,668,527 | |||||||||||
Balance as of May 31, 2019 | 5,962,327 | $ | 5,962 | $ | 6,882,114 | $ | 13,728,480 | $ | 20,616,556 | |||||||||||
Net income | 918,088 | 918,088 | ||||||||||||||||||
Issuance of common stock, vesting of restricted stock units and other | 28,835 | 29 | (29 | ) | - | |||||||||||||||
Share-based compensation | 155,416 | 155,416 | ||||||||||||||||||
Common stock dividends | (719,359 | ) | (719,359 | ) | ||||||||||||||||
Balance as of August 31, 2019 | 5,991,162 | $ | 5,991 | $ | 7,037,501 | $ | 13,927,209 | $ | 20,970,701 | |||||||||||
Balance as of February 28, 2019 | 5,957,827 | 5,958 | $ | 6,650,864 | $ | 13,733,010 | $ | 20,389,832 | ||||||||||||
Net income | 1,629,697 | 1,629,697 | ||||||||||||||||||
Issuance of common stock, vesting of restricted stock units and other | 33,335 | 33 | (33 | ) | - | |||||||||||||||
Share-based compensation | 386,670 | 386,670 | ||||||||||||||||||
Common stock dividends | (1,435,498 | ) | (1,435,498 | ) | ||||||||||||||||
Balance as of August 31, 2019 | 5,991,162 | $ | 5,991 | $ | 7,037,501 | $ | 13,927,209 | $ | 20,970,701 |
The accompanying notes are an integral part of these consolidated financial statements.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Nature of Operations
The accompanying consolidated financial statements include the accounts of Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, its wholly-owned subsidiaries, Rocky Mountain Chocolate Factory, Inc., a Colorado corporation (“RMCF”), Aspen Leaf Yogurt, LLC, a Colorado limited liability company (“ALY”), U-Swirl International, Inc., a Nevada corporation (“U-Swirl”), and its 46%-owned subsidiary, U-Swirl, Inc., a Nevada corporation (“SWRL”) of which, RMCF had financial control until February 29,2016 (collectively, the “Company”). All intercompany balances and transactions have been eliminated in consolidation.
The Company is an international franchisor, confectionery manufacturer and retail operator. Founded in 1981, the Company is headquartered in Durango, Colorado and manufactures an extensive line of premium chocolate candies and other confectionery products. U-Swirl franchises and operates soft-serve frozen yogurt cafés. The Company also sells its candy outside of its system of retail stores and licenses the use of its brand with certain consumer products.
In January 2013, through its wholly-owned subsidiaries, including ALY, the Company entered into two agreements to sell all of the assets of its ALY frozen yogurt stores, along with its interest in the self-serve frozen yogurt franchises and retail units branded as “Yogurtini” which the Company also acquired in January 2013, to SWRL, in exchange for a 60% controlling equity interest in SWRL, which has been subsequently diluted down to 46% as of August 31, 2018 following various issuances of common stock of SWRL. Until February 29,2016, U-Swirl was a wholly-owned subsidiary of SWRL, and was the operating subsidiary for all of SWRL’s operations. The SWRL Board of Directors is composed solely of Board members also serving on the Company’s Board of Directors.
In fiscal year (“FY”) 2014, SWRL acquired the franchise rights and certain other assets of self-serve frozen yogurt concepts under the names “CherryBerry,” “Yogli Mogli Frozen Yogurt” and “Fuzzy Peach Frozen Yogurt.” In connection with these acquisitions, we entered into a credit facility with Wells Fargo Bank, N.A. used to finance the acquisitions by SWRL, and in turn, we entered into a loan and security agreement with SWRL to cover the purchase price and other costs associated with the acquisitions (the “SWRL Loan Agreement”). Borrowings under the SWRL Loan Agreement were secured by all of the assets of SWRL, including all of the outstanding stock of its wholly-owned subsidiary, U-Swirl. As a result of certain defaults under the SWRL Loan Agreement, we issued a demand for payment of all obligations under the SWRL Loan Agreement. SWRL was unable to repay the obligations under the SWRL Loan Agreement, and as a result, we foreclosed on all of the outstanding stock of U-Swirl on February 29,2016 in full satisfaction of the amounts owed under the SWRL Loan Agreement. This resulted in U-Swirl becoming our wholly-owned subsidiary as of February 29,2016, and concurrently we ceased to have financial control of SWRL as of February 29,2016. As of August 31, 2018, SWRL had no operating assets.
U-Swirl operates self-serve frozen yogurt cafés under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!” and “Aspen Leaf Yogurt”.
The Company’s revenues are currently derived from three principal sources:sources, which are similar for its wholly owned subsidiaries RMCF and U-Swirl: (i) sales to franchisees and others of chocolates and other confectionery products manufactured by the Company; (ii) sales at Company-owned stores of chocolates, frozen yogurt, and other confectionery products (including products manufactured by the Company); (iii) the collection of initial franchise fees and royalties from franchisees’ sales of both confectionary products and frozen yogurt; and sales at Company-owned stores of chocolates, frozen yogurt, and other confectionery products.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTSyogurt.
The following table summarizes the number of stores operating under the Rocky Mountain Chocolate Factory brand and frozen yogurt cafés as of August 31, 2018:2019:
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Sold, Not Yet Open | Open | Total | ||||||||||
Rocky Mountain Chocolate Factory | ||||||||||||
Company-owned stores | - | 2 | 2 | |||||||||
Franchise stores - Domestic stores and kiosks | 1 | 179 | 180 | |||||||||
International license stores | 1 | 63 | 64 | |||||||||
Cold Stone Creamery - co-branded | 7 | 95 | 102 | |||||||||
U-Swirl (Including all associated brands) | ||||||||||||
Company-owned stores | - | 1 | 1 | |||||||||
Company-owned stores - co-branded | - | 3 | 3 | |||||||||
Franchise stores - Domestic stores | - | 82 | 82 | |||||||||
Franchise stores - Domestic - co-branded | 1 | 8 | 9 | |||||||||
International license stores | - | 2 | 2 | |||||||||
Total | 10 | 435 | 445 |
*U-Swirl cafés and the brands franchised by U-Swirl have historically utilized a development area sales model. The result is that many areas are under development, and the rights to open cafés within the development areas have been established, but there is no assurance that any individual development area will result in a determinable number of café openings.
Basis of Presentation
The accompanying consolidated financial statements have been prepared by the Company, without audit, and reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting and Securities and Exchange Commission (the “SEC”) regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Certain amounts previously presented for prior periods have been reclassified to conform to the current presentation. In the opinion of management, the consolidated financial statements reflect all adjustments (of a normal and recurring nature) which are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The results of operations for the three and six months ended August 31, 2018 2019 are not necessarily indicative of the results to be expected for the entire fiscal year.year, or any other future period.
These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company's Annual Report on Form 10-K10-K for the fiscal year ended February 28, 2018.2019.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
Subsequent Events
Management evaluated all activity ofOn September 30, 2019 the Company throughexecuted a Revolving Line of Credit Note with Wells Fargo Bank. This document was executed to renew the issueexisting $5 million line of credit and extend the maturity date of the financial statements and concluded that no subsequent events have occurred that would require recognition or disclosure in the financial statements.from September 30, 2019 to September 30, 2021.
Recent Accounting Pronouncements
In August 2018, the SEC adopted amendments to certain disclosure requirements in Securities Act Release No. 33-10532, Disclosure Update and Simplification. These amendments eliminate, modify, or integrate into other SEC requirements certain disclosure rules. Among the amendments is the requirement to present an analysis of changes in stockholders’ equity in the interim financial statements included in Quarterly Reports on Form 10-Q. The analysis, which can be presented as a footnote or separate statement, is required for the current and comparative quarter and year-to-date interim periods. The amendments are effective for all filings made on or after November 5, 2018. The Company adopted these amendments in its Quarterly Report on Form 10-Q for the quarter ended May 31, 2019.
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13,2016-13, Financial Instruments - Credit Losses (Topic 326)326): Measurement of Credit Losses on Financial Instruments. ASU 2016-132016-13 significantly changes the impairment model for most financial assets and certain other instruments. ASU 2016-132016-13 will require immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets, which will generally result in earlier recognition of allowances for credit losses on loans and other financial instruments. ASU 2016-132016-13 is effective for the Company's fiscal year beginning March 1, 2020 and subsequent interim periods. The Company is currently evaluating the impact the adoption of ASU 2016-132016-13 will have on the Company's consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02,2016-02, Leases (Topic 842)842), which requires the recognition of lease assets and lease liabilities on the balance sheet by lessees for those leases currently classified as operating leases under ASC 840 “Leases.” These amendments also require qualitative disclosures along with specific quantitative disclosures. These amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. The Company can elect to record a cumulative-effect adjustment as of the beginning of the year of adoption or apply a modified retrospective transition approach. The Company expects that substantially all of its operating lease commitments will be subject to the new guidance and will be recognized as operating lease liabilities and right-of-use assets upon adoption. The Company anticipates ASU 2016-02 will have a material impact on the consolidated balance sheet. The impact of ASU 2016-02 is non-cash in nature, as such, it will not affect the Company’s cash flows. The Company is currently evaluating the impact of ASU 2016-02 on the consolidated statements of income.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
In May 2014, the FASB issued ASU No.2014-09, Revenue from Contracts with Customers (“ASC 606”). This guidance, as amended by subsequent ASUs on the topic, supersedes current guidance on revenue recognition in Topic 605, Revenue Recognition. ASC 606 provides that revenues are to be recognized when control of promised goods or services is transferred to a customer in an amount that reflects the consideration expected to be received for those goods or services. This new standard does not impact the Company's recognition of revenue from sales of confectionary items to our franchisees and others, or in Company-owned stores as those sales are recognized at the time of the underlying sale and are presented net of sales taxes and discounts. The standard also did not change the recognition of royalties and marketing fees from franchised or licensed locations, which are based on a percent of sales and recognized at the time the sales occur. The standard changed the timing in which the Company recognizes initial fees from franchisees and licensees for new franchise locations and renewals that impact the term of the franchise agreement. The Company's policy for recognizing initial franchise and renewal fees through February 28, 2018, was to recognize initial franchise fees upon new store opening and renewals that impact the term of the franchise agreement upon renewal. In accordance with the new guidance, the initial franchise services are not distinct from the continuing rights or services offered during the term of the franchise agreement, and will be treated as a single performance obligation. Beginning March 1, 2018, initial franchise fees are being recognized as the Company satisfies the performance obligation over the term of the franchise agreement, which is generally 10-15 years.
The Company adopted ASC 606ASU 2016-02 as of March 1, 2018, 2019, using the modified retrospective method. This method allows the new standard to be applied retrospectively through a cumulative catch upcatch-up adjustment recognized upon adoption. As a result, comparative information in the Company’s financial statements has not been restated and continues to be reported under the accounting standards in effect for those periods. The Company recorded a Right of Use Asset and Lease Liability on the Consolidated Balance Sheet of $3.3 million upon adoption. The impact of the new standard did not affect the Company’s cash flows or results of operations. The lease liability reflects the present value of the Company’s estimated future minimum lease payments over the lease term, which includes options that are likely to be exercised, discounted using an incremental borrowing rate or implicit rate. See Note 12 to these financial statements11 - Leasing Arrangements for additional details regarding the adjustments recorded upon adoption of this standard.information.
NOTE 2 – EARNINGS PER SHARE
Basic earnings per share is calculated using the weighted-average number of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through the settlement of restricted stock units. Restricted stock units become dilutive within the period granted and remain dilutive until the units vest and are issued as common stock.
NOTE 3 – INVENTORIES
Inventories consist of the following:
August 31, 2018 | February 28, 2018 | August 31, 2019 | February 28, 2019 | |||||||||||||
Ingredients and supplies | $ | 2,828,131 | $ | 2,764,727 | $ | 2,347,557 | $ | 2,612,954 | ||||||||
Finished candy | 3,487,938 | 2,371,610 | 1,971,270 | 1,983,854 | ||||||||||||
U-Swirl, Inc. food and packaging | 58,024 | 63,843 | ||||||||||||||
U-Swirl food and packaging | 55,029 | 44,696 | ||||||||||||||
Reserve for slow moving inventory | (364,248 | ) | (357,706 | ) | (178,658 | ) | (371,147 | ) | ||||||||
Total inventories | $ | 6,009,845 | $ | 4,842,474 | $ | 4,195,198 | $ | 4,270,357 |
NOTE 4 – PROPERTY AND EQUIPMENT, NET
Property and equipment at August 31, 2018 and February 28, 2018 consists of the following:
August 31, 2018 | February 28, 2018 | |||||||
Land | $ | 513,618 | $ | 513,618 | ||||
Building | 4,803,445 | 4,905,103 | ||||||
Machinery and equipment | 10,180,006 | 10,686,631 | ||||||
Furniture and fixtures | 890,766 | 1,067,788 | ||||||
Leasehold improvements | 1,187,856 | 1,568,260 | ||||||
Transportation equipment | 422,458 | 434,091 | ||||||
Asset impairment | (77,891 | ) | (62,891 | ) | ||||
17,920,258 | 19,112,600 | |||||||
Less accumulated depreciation | (12,064,268 | ) | (12,946,360 | ) | ||||
Property and equipment, net | $ | 5,855,990 | $ | 6,166,240 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 – PROPERTY AND EQUIPMENT, NET
Property and equipment consists of the following:
August 31, 2019 | February 28, 2019 | |||||||
Land | $ | 513,618 | $ | 513,618 | ||||
Building | 5,031,395 | 5,031,395 | ||||||
Machinery and equipment | 10,205,508 | 10,233,119 | ||||||
Furniture and fixtures | 850,934 | 864,944 | ||||||
Leasehold improvements | 1,151,346 | 1,131,659 | ||||||
Transportation equipment | 435,306 | 422,458 | ||||||
18,188,107 | 18,197,193 | |||||||
Less accumulated depreciation | (12,330,443 | ) | (12,411,054 | ) | ||||
Property and equipment, net | $ | 5,857,664 | $ | 5,786,139 |
NOTE 5 – STOCKHOLDERS’ EQUITY
Cash Dividend
The Company paid a quarterly cash dividend of $0.12$0.12 per common share on March 16, 2018 15, 2019 to stockholders of record on March 6, 2018. 5, 2019. The Company paid a quarterly cash dividend of $0.12$0.12 per share of common stock on June 15, 2018 14, 2019 to stockholders of record on June 5, 2018. 4, 2019. The Company declared a quarterly cash dividend of $0.12$0.12 per share of common stock on August 16, 2018, 2019, which was paid on September 14, 2018 13, 2019 to stockholders of record on September 4, 2018.2019.
Future declaration of dividends will depend on, among other things, the Company's results of operations, capital requirements, financial condition and on such other factors as the Board of Directors may in its discretion consider relevant and in the best long-term interest of the Company’s stockholders. The Company is subject to various financial covenants related to its line of credit and other long-term debt, however, those covenants do not restrict the Board of Director’s discretion on the future declaration of cash dividends.
Stock Repurchases
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0$3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000$2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000$2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. 2019. As of August 31, 2018, 2019, approximately $638,000$638,000 remains available under the repurchase plan for further stock repurchases.
Stock-Based Compensation
At The Company’s 2007 Equity Incentive Plan (as amended and restated on August 31, 2018, the Company has stock-based compensation plans for employees and non-employee directors that authorize8, 2013) authorizes the granting of stock awards to employees, non-employee directors, consultants and other participants, including stock options, restricted stock and restricted stock units.
The Company recognized $124,921$155,416 and $280,728$386,670 of stock-based compensation expense during the three-three- and six-monthsix-month periods ended August 31, 2019, respectively, compared to $124,921 and $280,728 during the three- and six-month periods ended August 31, 2018, respectively, compared to $190,065 and $324,480 during the three- and six-month periods ended August 31, 2017, respectively. Compensation costs related to stock-based compensation are generally amortized over the vesting period of the stock awards.
The following table summarizes restricted stock unit activity during the six months ended August 31, 2018 and 2017:
Six Months Ended | ||||||||
August 31, | ||||||||
2018 | 2017 | |||||||
Outstanding non-vested restricted stock units as of February 28: | 77,594 | 123,658 | ||||||
Granted | - | - | ||||||
Vested | (43,224 | ) | (44,064 | ) | ||||
Cancelled/forfeited | (200 | ) | (1,360 | ) | ||||
Outstanding non-vested restricted stock units as of August 31: | 34,170 | 78,234 | ||||||
Weighted average grant date fair value | $ | 12.05 | $ | 12.17 | ||||
Weighted average remaining vesting period (in years) | 0.88 | 1.76 |
The Company issued 2,000 fully vested, unrestricted shares of common stock to non-employee directors during the six months ended August 31, 2018 compared to no shares issued during the six months ended August 31, 2017. In connection with these non-employee director stock issuances, the Company recognized $24,480 and $0 of stock-based compensation expense during the six months ended August 31, 2018 and 2017, respectively.
During the three months ended August 31, 2017, the Company issued 5,000 shares of unrestricted common stock under the Company’s equity incentive plan to an independent contractor providing information technology consulting services to the Company. These shares were issued as a part of the compensation for services rendered to the Company by the contractor. In connection with this stock award, the Company recognized $59,100 in expense during the three months ended August 31, 2017. No comparable shares were issued and no comparable expense was recorded in the three months ended August 31, 2018.
During the three- and six-month periods ended August 31, 2018, the Company recognized $124,921 and $256,248, respectively, of stock-based compensation expense related to restricted stock unit grants. The restricted stock unit grants generally vest between 17% and 20% annually over a period of five to six years. During the six-month periods ended August 31, 2018 and 2017,43,224 and 44,064 restricted stock units vested and were issued as common stock, respectively. Total unrecognized compensation expense of non-vested, non-forfeited restricted stock units granted as of August 31, 2018 was $361,905, which is expected to be recognized over the weighted-average period of 0.9 years.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes restricted stock unit activity during the six months ended August 31, 2019 and 2018:
Six Months Ended | ||||||||
August 31, | ||||||||
2019 | 2018 | |||||||
Outstanding non-vested restricted stock units as of February 28: | 25,002 | 77,594 | ||||||
Granted | 270,000 | - | ||||||
Vested | (28,502 | ) | (43,224 | ) | ||||
Cancelled/forfeited | - | (200 | ) | |||||
Outstanding non-vested restricted stock units as of August 31: | 266,500 | 34,170 | ||||||
Weighted average grant date fair value | $ | 9.40 | $ | 12.05 | ||||
Weighted average remaining vesting period (in years) | 5.14 | 0.88 |
The Company issued an aggregate of 4,833 fully vested, unrestricted shares of common stock to non-employee directors during the six months ended August 31, 2019 compared to an aggregate of 2,000 shares issued during the six months ended August 31, 2018. In connection with these non-employee director stock issuances, the Company recognized $45,652 and $24,480 of stock-based compensation expense during the six months ended August 31, 2019 and 2018, respectively.
During the three- and six-month periods ended August 31, 2019, the Company recognized $152,289 and $341,018, respectively, of stock-based compensation expense related to restricted stock unit grants. The restricted stock unit grants generally vest in equal annual or quarterly installments over a period of five to six years. During the six-month periods ended August 31, 2019 and 2018, 28,502 and 43,224 restricted stock units vested and were issued as common stock, respectively. Total unrecognized compensation expense of non-vested, non-forfeited restricted stock units granted as of August 31, 2019 was $2,309,265, which is expected to be recognized over the weighted-average period of 5.14 years.
The Company has no outstanding stock options as of August 31, 2018.2019.
NOTE 6 – SUPPLEMENTAL CASH FLOW INFORMATION
Six Months Ended | Six Months Ended | |||||||||||||||
August 31, | August 31, | |||||||||||||||
| 2018 | 2017 | 2019 | 2018 | ||||||||||||
Cash paid for: | ||||||||||||||||
Interest, net | $ | 33,006 | $ | 53,345 | $ | 808 | $ | 33,006 | ||||||||
Income taxes | 166,545 | 1,062,750 | 314,417 | 166,545 | ||||||||||||
Non-cash Operating Activities | ||||||||||||||||
Accrued Inventory | 96,454 | 325,922 | 237,842 | 96,454 | ||||||||||||
Non-cash Financing Activities | ||||||||||||||||
Dividend payable | $ | 713,839 | $ | 708,412 | $ | 719,359 | $ | 713,839 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 – OPERATING SEGMENTS
The Company classifies its business interests into five reportable segments: Franchising, Manufacturing, Retail Stores, U-Swirl operations and Other. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1 to these consolidated financial statements and Note 1 to the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K10-K for the fiscal year ended February 28, 2018. 2019. The Company evaluates performance and allocates resources based on operating contribution, which excludes unallocated corporate general and administrative costs and income tax expense or benefit. The Company’s reportable segments are strategic businesses that utilize common merchandising, distribution and marketing functions, as well as common information systems and corporate administration. All inter-segment sales prices are market based. Each segment is managed separately because of the differences in required infrastructure and the difference in products and services:
Three Months Ended August 31, 2018 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||||||||||||||||||||||||||
Three Months Ended August 31, 2019 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||||||||||||||||||||||||||
Total revenues | $ | 1,470,486 | $ | 5,032,787 | $ | 298,359 | $ | 1,250,905 | $ | - | $ | 8,052,537 | $ | 1,515,805 | $ | 4,714,682 | $ | 265,662 | $ | 1,122,751 | $ | - | $ | 7,618,900 | ||||||||||||||||||||||||
Intersegment revenues | (1,732 | ) | (250,717 | ) | - | - | - | (252,449 | ) | (1,321 | ) | (232,309 | ) | - | - | - | (233,630 | ) | ||||||||||||||||||||||||||||||
Revenue from external customers | 1,468,754 | 4,782,070 | 298,359 | 1,250,905 | - | 7,800,088 | 1,514,484 | 4,482,373 | 265,662 | 1,122,751 | - | 7,385,270 | ||||||||||||||||||||||||||||||||||||
Segment profit (loss) | 693,383 | 1,070,613 | (120,262 | ) | 229,818 | (847,923 | ) | 1,025,629 | 828,978 | 955,360 | 7,979 | 296,880 | (841,434 | ) | 1,247,763 | |||||||||||||||||||||||||||||||||
Total assets | 1,199,536 | 13,332,652 | 1,011,649 | 5,920,971 | 6,065,406 | 27,530,214 | 1,445,041 | 11,838,237 | 1,005,356 | 5,620,012 | 9,377,697 | 29,286,343 | ||||||||||||||||||||||||||||||||||||
Capital expenditures | 6 | 61,152 | 1,734 | 9,966 | 43,025 | 115,883 | (2,040 | ) | 162,127 | 23,106 | 1,673 | 12,570 | 197,436 | |||||||||||||||||||||||||||||||||||
Total depreciation & amortization | $ | 11,631 | $ | 142,697 | $ | 11,179 | $ | 241,033 | $ | 28,409 | $ | 434,949 | $ | 10,353 | $ | 151,848 | $ | 2,533 | $ | 185,208 | $ | 22,891 | $ | 372,833 |
Three Months Ended August 31, 2017 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||||||||||||||||||||||||||
Three Months Ended August 31, 2018 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||||||||||||||||||||||||||
Total revenues | $ | 1,492,673 | $ | 5,211,974 | $ | 484,963 | $ | 1,408,678 | $ | - | $ | 8,598,288 | $ | 1,470,486 | $ | 5,032,787 | $ | 298,359 | $ | 1,250,905 | $ | - | $ | 8,052,537 | ||||||||||||||||||||||||
Intersegment revenues | (1,109 | ) | (330,488 | ) | - | - | - | (331,597 | ) | (1,732 | ) | (250,717 | ) | - | - | - | (252,449 | ) | ||||||||||||||||||||||||||||||
Revenue from external customers | 1,491,564 | 4,881,486 | 484,963 | 1,408,678 | - | 8,266,691 | 1,468,754 | 4,782,070 | 298,359 | 1,250,905 | - | 7,800,088 | ||||||||||||||||||||||||||||||||||||
Segment profit (loss) | 667,702 | 1,309,468 | 32,498 | 413,642 | (947,967 | ) | 1,475,343 | 693,383 | 1,070,613 | (120,262 | ) | 229,818 | (847,923 | ) | 1,025,629 | |||||||||||||||||||||||||||||||||
Total assets | 1,236,795 | 13,014,273 | 1,166,435 | 9,055,699 | 4,981,613 | 29,454,815 | 1,199,536 | 13,332,652 | 1,011,649 | 5,920,971 | 6,065,406 | 27,530,214 | ||||||||||||||||||||||||||||||||||||
Capital expenditures | 5,636 | 169,538 | 12,736 | 3,208 | 16,144 | 207,262 | 6 | 61,152 | 1,734 | 9,966 | 39,502 | 112,360 | ||||||||||||||||||||||||||||||||||||
Total depreciation & amortization | $ | 11,554 | $ | 132,144 | $ | 3,832 | $ | 143,188 | $ | 32,154 | $ | 322,872 | $ | 11,631 | $ | 142,697 | $ | 11,179 | $ | 241,033 | $ | 28,409 | $ | 434,949 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
Six Months Ended August 31, 2018 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||
Total revenues | $ | 2,783,691 | $ | 10,903,302 | $ | 659,794 | $ | 2,384,159 | $ | - | $ | 16,730,946 | ||||||||||||
Intersegment revenues | (2,767 | ) | (562,006 | ) | - | - | - | (564,773 | ) | |||||||||||||||
Revenue from external customers | 2,780,924 | 10,341,296 | 659,794 | 2,384,159 | - | 16,166,173 | ||||||||||||||||||
Segment profit (loss) | 1,182,654 | 2,239,948 | (198,756 | ) | 364,973 | (1,798,016 | ) | 1,790,803 | ||||||||||||||||
Total assets | 1,199,536 | 13,332,652 | 1,011,649 | 5,920,971 | 6,065,406 | 27,530,214 | ||||||||||||||||||
Capital expenditures | 3,535 | 172,917 | 3,805 | 13,304 | 52,894 | 246,455 | ||||||||||||||||||
Total depreciation & amortization | $ | 23,556 | $ | 283,724 | $ | 23,854 | $ | 485,084 | $ | 56,236 | $ | 872,454 |
Six Months Ended August 31, 2017 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||
Total revenues | $ | 3,099,159 | $ | 11,710,184 | $ | 846,990 | $ | 2,603,987 | $ | - | $ | 18,260,320 | ||||||||||||
Intersegment revenues | (2,415 | ) | (644,767 | ) | - | - | - | (647,182 | ) | |||||||||||||||
Revenue from external customers | 3,096,744 | 11,065,417 | 846,990 | 2,603,987 | - | 17,613,138 | ||||||||||||||||||
Segment profit (loss) | 1,430,391 | 2,696,507 | (3,933 | ) | 653,838 | (2,035,557 | ) | 2,741,246 | ||||||||||||||||
Total assets | 1,236,795 | 13,014,273 | 1,166,435 | 9,055,699 | 4,981,613 | 29,454,815 | ||||||||||||||||||
Capital expenditures | 5,636 | 218,598 | 16,336 | 5,824 | 37,594 | 283,988 | ||||||||||||||||||
Total depreciation & amortization | $ | 22,946 | $ | 262,006 | $ | 7,658 | $ | 286,278 | $ | 64,533 | $ | 643,421 |
Revenue from one customer of the Company’s Manufacturing segment represented approximately $1.4 million, or 8.8 percent, of the Company’s revenues from external customers during the six months ended August 31, 2018, compared to $2.2 million, or 12.3 percent, of the Company’s revenues from external customers during the six months ended August 31, 2017.
NOTE 8 – GOODWILL AND INTANGIBLE ASSETS
Intangible assets consist of the following:
August 31, 2018 | February 28, 2018 | |||||||||||||||||||||
Amortization Period (in years) | Gross Carrying Value | Accumulated Amortization | Gross Carrying Value | Accumulated Amortization | ||||||||||||||||||
Intangible assets subject to amortization | ||||||||||||||||||||||
Store design | 10 | $ | 220,778 | $ | 213,403 | $ | 220,778 | $ | 212,653 | |||||||||||||
Packaging licenses | 3 | - | 5 | 120,830 | 120,830 | 120,830 | 120,830 | |||||||||||||||
Packaging design | 10 | 430,973 | 430,973 | 430,973 | 430,973 | |||||||||||||||||
Trademark/Non-competition agreements | 5 | - | 20 | 715,339 | 180,407 | 715,339 | 136,087 | |||||||||||||||
Franchise rights | 20 | 5,979,637 | 1,923,213 | 5,979,637 | 1,545,710 | |||||||||||||||||
Total | 7,467,557 | 2,868,826 | 7,467,557 | 2,446,253 | ||||||||||||||||||
Intangible assets not subject to amortization | ||||||||||||||||||||||
Franchising segment- | ||||||||||||||||||||||
Company stores goodwill | $ | 1,099,328 | $ | 267,020 | $ | 1,099,328 | $ | 267,020 | ||||||||||||||
Franchising goodwill | 295,000 | 197,682 | 295,000 | 197,682 | ||||||||||||||||||
Manufacturing segment-goodwill | 295,000 | 197,682 | 295,000 | 197,682 | ||||||||||||||||||
Trademark | 20,000 | - | 20,000 | - | ||||||||||||||||||
Total goodwill | 1,709,328 | 662,384 | 1,709,328 | 662,384 | ||||||||||||||||||
Total Intangible Assets | $ | 9,176,885 | $ | 3,531,210 | $ | 9,176,885 | $ | 3,108,637 |
Six Months Ended August 31, 2019 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||
Total revenues | $ | 2,944,846 | $ | 10,581,154 | $ | 498,081 | $ | 2,282,556 | $ | - | $ | 16,306,637 | ||||||||||||
Intersegment revenues | (2,607 | ) | (492,761 | ) | - | - | - | (495,368 | ) | |||||||||||||||
Revenue from external customers | 2,942,239 | 10,088,393 | 498,081 | 2,282,556 | - | 15,811,269 | ||||||||||||||||||
Segment profit (loss) | 1,446,888 | 2,124,047 | (7,033 | ) | 576,043 | (1,948,398 | ) | 2,191,547 | ||||||||||||||||
Total assets | 1,445,041 | 11,838,237 | 1,005,356 | 5,620,012 | 9,377,697 | 29,286,343 | ||||||||||||||||||
Capital expenditures | 8,500 | 385,679 | 32,624 | 1,673 | 52,508 | 480,984 | ||||||||||||||||||
Total depreciation & amortization | $ | 21,183 | $ | 301,980 | $ | 5,143 | $ | 375,977 | $ | 46,203 | $ | 750,486 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
Six Months Ended August 31, 2018 | Franchising | Manufacturing | Retail | U-Swirl | Other | Total | ||||||||||||||||||
Total revenues | $ | 2,783,691 | $ | 10,903,302 | $ | 659,794 | $ | 2,384,159 | $ | - | $ | 16,730,946 | ||||||||||||
Intersegment revenues | (2,767 | ) | (562,006 | ) | - | - | - | (564,773 | ) | |||||||||||||||
Revenue from external customers | 2,780,924 | 10,341,296 | 659,794 | 2,384,159 | - | 16,166,173 | ||||||||||||||||||
Segment profit (loss) | 1,182,654 | 2,239,948 | (198,756 | ) | 364,973 | (1,798,016 | ) | 1,790,803 | ||||||||||||||||
Total assets | 1,199,536 | 13,332,652 | 1,011,649 | 5,920,971 | 6,065,406 | 27,530,214 | ||||||||||||||||||
Capital expenditures | 3,535 | 172,917 | 3,805 | 13,304 | 48,871 | 242,432 | ||||||||||||||||||
Total depreciation & amortization | $ | 23,556 | $ | 283,724 | $ | 23,854 | $ | 485,084 | $ | 56,236 | $ | 872,454 |
Effective March 1, 2002, under Accounting Standards Codification Topic 350, all goodwill with indefinite lives is no longer subject
Revenue from one customer of the Company’s Manufacturing segment represented approximately $1.5 million, or 9.3 percent, of the Company’s revenues from external customers during the six months ended August 31, 2019, compared to amortization. Accumulated amortization related to intangible$1.4 million, or 8.8 percent, of the Company’s revenues from external customers during the six months ended August 31, 2018.
NOTE 8 – GOODWILL AND INTANGIBLE ASSETS
Intangible assets not subject to amortization is a resultconsist of amortization expense related to indefinite life goodwill incurred prior to March 1, 2002.the following:
August 31, 2019 | February 28, 2019 | ||||||||||||||||||||
Amortization Period (Years) | Gross Carrying Value | Accumulated Amortization | Gross Carrying Value | Accumulated Amortization | |||||||||||||||||
Intangible assets subject to amortization | |||||||||||||||||||||
Store design | 10 | $ | 220,778 | $ | 214,903 | $ | 220,778 | $ | 214,152 | ||||||||||||
Packaging licenses | 3 | - | 5 | 120,830 | 120,830 | 120,830 | 120,830 | ||||||||||||||
Packaging design | 10 | 430,973 | 430,973 | 430,973 | 430,973 | ||||||||||||||||
Trademark/Non-competition agreements | 5 | - | 20 | 715,339 | 260,349 | 715,339 | 223,628 | ||||||||||||||
Franchise rights | 20 | 5,979,637 | 2,616,333 | 5,979,637 | 2,300,717 | ||||||||||||||||
Total | $ | 7,467,557 | $ | 3,643,388 | $ | 7,467,557 | $ | 3,290,300 | |||||||||||||
Intangible assets not subject to amortization | |||||||||||||||||||||
Franchising segment- | |||||||||||||||||||||
Company stores goodwill | $ | 832,308 | $ | 832,308 | |||||||||||||||||
Franchising goodwill | 97,318 | 97,318 | |||||||||||||||||||
Manufacturing segment-goodwill | 97,318 | 97,318 | |||||||||||||||||||
Trademark | 20,000 | 20,000 | |||||||||||||||||||
Total goodwill | 1,046,944 | 1,046,944 | |||||||||||||||||||
Total Intangible Assets | $ | 8,514,501 | $ | 3,643,388 | $ | 8,514,501 | $ | 3,290,300 |
Amortization expense related to intangible assets totaled $422,573$353,088 and $221,381$422,573 during the six months ended August 31, 2018 2019 and 2017,2018, respectively.
At August 31, 2018, 2019, annual amortization of intangible assets, based upon ourthe Company’s existing intangible assets and current useful lives, is estimated to be the following:
2019 | $ | 421,474 | ||||||
2020 | 706,177 | 353,088 | ||||||
2021 | 594,229 | 594,229 | ||||||
2022 | 490,060 | 490,060 | ||||||
2023 | 411,607 | 411,607 | ||||||
2024 | 345,642 | |||||||
Thereafter | 1,975,184 | 1,629,543 | ||||||
Total | $ | 4,598,731 | $ | 3,824,169 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 – RESTRUCTURING AND ACQUISITION RELATED CHARGESCOSTS ASSOCIATED WITH COMPANY-OWNED STORE CLOSURES
Restructuring charges incurredCosts associated with Company-owned store closures were the result of closing certain underperforming Company-owned locations during the three and six months ended August 31, 2018. Restructuring chargesCosts associated with Company-owned store closures of $118,793$118,793 and $176,981$176,981 were incurred during the three and the six months ended August 31, 2018, respectively.
The Company did not record any restructuring charges inThere were no comparable costs incurred during the three and six months ended August 31, 2017.2019.
NOTE 10 – SALE OR DISTRIBUTION OF ASSETS
During the three months ended August 31, 2017, the Company acquired two franchise stores in satisfaction of certain receivables due by the Franchisees to the Company. The Company subsequently sold one of the stores and is operating the other store as a Company-owned store. Associated with these asset disposal activities, the Company recorded the following in the six months ended August 31, 2018 and 2017:
2018 | 2017 | |||||||
Notes receivable | $ | - | $ | 62,609 |
NOTE 11 – NOTE PAYABLE
The Company’s long-term debt is comprised of a promissory note, the proceeds of which were loaned to SWRL and used to finance SWRL’s business acquisitions. The promissory note matures on January 15, 2020.
As of August 31, 2018 2019 and February 28, 2018, 2019, notes payable consisted of the following:
August 31, 2018 | February 28, 2018 | August 31, 2019 | February 28, 2019 | |||||||||||||
Promissory note | $ | 1,858,973 | $ | 2,529,309 | $ | 480,445 | $ | 1,176,488 | ||||||||
Less: current maturities | (1,378,601 | ) | (1,352,893 | ) | (480,445 | ) | (1,176,488 | ) | ||||||||
Long-term obligations | $ | 480,372 | $ | 1,176,416 | $ | - | $ | - |
NOTE 11 – LEASING ARRANGEMENTS
The Company conducts its retail operations in facilities leased under non-cancelable operating leases of up to ten years. Certain leases contain renewal options for between five and ten additional years at increased monthly rentals. Some of the leases provide for contingent rentals based on sales in excess of predetermined base levels.
The Company acts as primary lessee of some franchised store premises, which the Company then subleases to franchisees, but the majority of existing locations are leased by the franchisee directly.
In some instances, the Company has leased space for its Company-owned locations that are now occupied by franchisees. When the Company-owned location was sold or transferred, the store was subleased to the franchisee who is responsible for the monthly rent and other obligations under the lease.
The Company also leases trucking equipment and warehouse space in support of its manufacturing operations. Expense associated with trucking and warehouse leases is included in cost of sales on the consolidated statements of income.
ASU 2016-02 allows, as a practical expedient, the retention of the classification of existing leases as operating or financing. All of the Company’s leases are classified as operating leases and that classification has been retained upon adoption. The Company does not believe the utilization of this practical expedient has a material impact on lease classifications.
The Company accounts for payments related to lease liabilities on a straight-line basis over the lease term. Lease expense recognized for the six months ended August 31, 2019 and 2018 in the Consolidated Statements of Income was $478,707 and $522,181, respectively.
The amount of the ‘Right of Use Asset’ and ‘Lease Liability’ recorded in the Consolidated Balance Sheets upon the adoption of ASU 2016-02 was $3.3 million. The lease liability reflects the present value of the Company’s estimated future minimum lease payments over the life of its leases. This includes known escalations and renewal option periods reasonably assured of being exercised. Typically, renewal options are considered reasonably assured of being exercised if the sales performance of the location remains strong. Therefore, the ‘Right of Use Asset’ and ‘Lease Liability’ include an assumption on renewal options that have not yet been exercised by the Company, and are not currently a future obligation. The Company has separated non-lease components from lease components in the recognition of the ‘Right of Use Asset’ and ‘Lease Liability’ except in instances where such costs were not practical to separate. To the extent that occupancy costs, such as site maintenance, are included in the ‘Right of Use Asset’ and ‘Lease Liability,’ the impact is immaterial. For franchised locations, the related occupancy costs including property taxes, insurance and site maintenance are generally required to be paid by the franchisees as part of the franchise arrangement. In addition, the Company is the lessee under non-store related leases such as storage facilities and trucking equipment. For leases where the implicit rate is not readily determinable, the Company uses an incremental borrowing rate to calculate the lease liability that represents an estimate of the interest rate the Company would incur to borrow on a collateralized basis over the term of a lease. The weighted average discount rate used for operating leases was 3.4% as of August 31, 2019. The total estimated future minimum lease payments is $3.4 million.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes annualAs of August 31, 2019, maturities of our notes payablelease liabilities for the Company’s operating leases were as of August 31, 2018:follows:
Amount | ||||
2019 | $ | 682,533 | ||
2020 | 1,176,440 | |||
Total minimum payments | 1,858,973 | |||
Less: current maturities | (1,378,601 | ) | ||
Long-term obligations | $ | 480,372 |
FY 20 | $ | 416,147 | ||
FY 21 | 819,004 | |||
FY 22 | 694,755 | |||
FY 23 | 437,446 | |||
FY 24 | 315,963 | |||
Thereafter | 717,039 | |||
Total | $ | 3,400,354 | ||
Less: imputed interest | (333,528 | ) | ||
Present value of lease liabilities: | $ | 3,066,826 | ||
Weighted average lease term (years) | 7.0 |
During the three months ended August 31, 2019 the Company entered into a lease amendment to extend the term of a lease for a Company-owned location. This lease amendment resulted in the Company recognizing a present value of future lease liability of $476,611 based upon a total lease liability of $532,811.
NOTE 12 – ADOPTION OF ASU 2014-09, “REVENUE –REVENUE FROM CONTRACTS WITH CUSTOMERS” (“ASC 606”)CUSTOMERS
As described in Note 1, effective Effective March 1, 2018, the Company adopted ASC 606. ASC 606 provides that revenues are to be recognized when control of promised goods or services is transferred to a customer in an amount that reflects the consideration expected to be received for those goods or services. This new standard does not impact the Company's recognition of revenue from sales of confectionary items to ourthe Company’s franchisees and others, or in ourits Company-owned stores as those sales are recognized at the time of the underlying sale and are presented net of sales taxes and discounts. The standard also does not change the recognition of royalties and marketing fees from franchised or licensed locations, which are based on a percent of sales and recognized at the time the sales occur. The standard does change the timing in which the Company recognizes initial fees from franchisees and licensees for new franchise locations and renewals that affect the term of the franchise agreement.
Initial Franchise Fees, License Fees, Transfer Fees and Renewal Fees
The Company's policy for recognizing initial franchise and renewal fees through February 28, 2018 was to recognize initial franchise fees upon new store openings and renewals that impact the term of the franchise agreement upon renewal. In accordance with the new guidance, the initial franchise services are not distinct from the continuing rights or services offered during the term of the franchise agreement, and will be treated as a single performance obligation. Beginning March 1, 2018, initial franchise fees are being recognized as the Company satisfies the performance obligation over the term of the franchise agreement, which is generally 10-1510-15 years.
At August 31, 2019, annual revenue expected to be recognized in the future, related to performance obligations that are not yet fully satisfied, are estimated to be the following:
FY 20 | $ | 117,608 | ||
FY 21 | 188,664 | |||
FY 22 | 175,465 | |||
FY 23 | 162,496 | |||
FY 24 | 131,911 | |||
Thereafter | 439,785 | |||
Total | $ | 1,215,929 |
Gift Cards
The Company’s franchisees sell gift cards, which do not have either expiration dates or non-usage fees. The proceeds from the sale of gift cards by the franchisees are accumulated by the Company and paid out to the franchisees upon customer redemption. The Company has historically accumulated gift card liabilities and has not recognized breakage associated with the gift card liability. The adoption of ASC 606 requires the use of the “proportionate” method for recognizing breakage, which the Company has not historically utilized. Upon adoption of ASC 606 the Company began recognizing breakage from gift cards when the gift card is redeemed by the customer or the Company determines the likelihood of the gift card being redeemed by the customer is remote (“gift card breakage”). The determination of the gift card breakage rate is based upon Company-specific historical redemption patterns.
Impact to Prior Periods
The cumulative adjustment recorded upon adoption of ASC 606 consisted of net contract liabilities of approximately $1,022,720, a reduction in gift card liability of $2,250,743 and approximately $302,094 of associated adjustments to the deferred tax balances which are recorded in deferred income taxes. The Company did not record any contract assets. The following table outlines the adjustments to the consolidated financial statements made upon adoption of ASC 606 on March 1, 2018:
Amount | ||||
Increase in deferred revenue | $ | (1,022,720 | ) | |
Reduction in gift card liabilities | 2,250,743 | |||
Adjustment to deferred income tax assets | (302,094 | ) | ||
Cumulative increase to retained earnings | $ | 925,929 |
The Company adopted ASC 606 as of March 1, 2018, using the modified retrospective method. This method allows the new standard to be applied retrospectively through a cumulative catch up adjustment recognized upon adoption. As a result, comparative information in the Company’s financial statements has not been restated and continues to be reported under the accounting standards in effect for those periods.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
The adoption of ASC 606 impacted the Company’s previously reported financial statements as follows:
CONSOLIDATED BALANCE SHEET | ||||||||||||
AS OF FEBRUARY 28, 2018 | ||||||||||||
Previously Reported | Adjustments | Restated | ||||||||||
Assets | ||||||||||||
Current Assets | ||||||||||||
Cash and cash equivalents | $ | 6,072,984 | $ | - | $ | 6,072,984 | ||||||
Accounts receivable, net | 3,897,334 | - | 3,897,334 | |||||||||
Notes receivable, current portion, net | 105,540 | - | 105,540 | |||||||||
Refundable income taxes | 342,863 | - | 342,863 | |||||||||
Inventories, net | 4,842,474 | - | 4,842,474 | |||||||||
Other | 310,173 | - | 310,173 | |||||||||
Total current assets | 15,571,368 | - | 15,571,368 | |||||||||
Property and Equipment, Net | 6,166,240 | - | 6,166,240 | |||||||||
Other Assets | ||||||||||||
Notes receivable, less current portion, net | 235,983 | - | 235,983 | |||||||||
Goodwill, net | 1,046,944 | - | 1,046,944 | |||||||||
Franchise rights, net | 4,433,927 | - | 4,433,927 | |||||||||
Intangible assets, net | 587,377 | - | 587,377 | |||||||||
Deferred income taxes | 835,463 | (302,094 | ) | 533,369 | ||||||||
Other | 63,333 | - | 63,333 | |||||||||
Total other assets | 7,203,027 | (302,094 | ) | 6,900,933 | ||||||||
Total Assets | $ | 28,940,635 | $ | (302,094 | ) | $ | 28,638,541 | |||||
Liabilities and Stockholders' Equity | ||||||||||||
Current Liabilities | ||||||||||||
Current maturities of long-term debt | $ | 1,352,893 | - | $ | 1,352,893 | |||||||
Accounts payable | 1,647,991 | - | 1,647,991 | |||||||||
Accrued salaries and wages | 644,005 | - | 644,005 | |||||||||
Gift card liabilities | 3,057,131 | (2,250,743 | ) | 806,388 | ||||||||
Other accrued expenses | 325,034 | - | 325,034 | |||||||||
Dividend payable | 708,652 | - | 708,652 | |||||||||
Deferred revenue | 471,910 | (143,445 | ) | 328,465 | ||||||||
Total current liabilities | 8,207,616 | (2,394,188 | ) | 5,813,428 | ||||||||
Long-Term Debt, Less Current Maturities | 1,176,416 | - | 1,176,416 | |||||||||
Deferred Revenue, Less Current Portion | - | 1,166,165 | 1,166,165 | |||||||||
Commitments and Contingencies | ||||||||||||
Stockholders' Equity | ||||||||||||
Preferred stock | ||||||||||||
Common stock | 5,903 | - | 5,903 | |||||||||
Additional paid-in capital | 6,131,147 | - | 6,131,147 | |||||||||
Retained earnings | 13,419,553 | 925,929 | 14,345,482 | |||||||||
Total stockholders' equity | 19,556,603 | 925,929 | 20,482,532 | |||||||||
Total Liabilities and Stockholders' Equity | $ | 28,940,635 | $ | (302,094 | ) | $ | 28,638,541 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 – DISAGGREGATION OF REVENUE
The following table contains a reconciliationpresents disaggregated revenue by method of revenue reported for the current periodrecognition and revenue had the Company reported under the prior method for revenue recognition:segment:
Three Months Ended August 31, 2019 |
Revenues recognized over time under ASC 606: |
Three Months Ended August 31, | Six Months Ended August 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
Franchise Fees contained within the Statement of Income: | $ | 107,538 | $ | 163,000 | $ | 200,673 | $ | 412,125 | ||||||||
Adjustment required to conform revenue to prior period method: | (18,538 | ) | - | (10,173 | ) | - | ||||||||||
Comparable franchise fees: | $ | 89,000 | $ | 163,000 | $ | 190,500 | $ | 412,125 |
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Franchise fees | $ | 65,327 | $ | - | $ | - | $ | 16,602 | $ | 81,929 |
At August 31, 2018, annual revenue expected to be recognized in the future, related to performance obligations that are not yet fully satisfied, are estimated to be the following:
Revenues recognized at a point in time: |
2019 | $ | 127,919 | ||
2020 | 246,670 | |||
2021 | 196,548 | |||
2022 | 184,300 | |||
2023 | 170,171 | |||
Thereafter | 491,084 | |||
Total | $ | 1,416,692 |
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Factory sales | - | 4,482,373 | - | - | 4,482,373 | |||||||||||||||
Retail sales | - | - | 265,662 | 636,005 | 901,667 | |||||||||||||||
Royalty and marketing fees | 1,449,157 | - | - | 470,144 | 1,919,301 | |||||||||||||||
Total | $ | 1,514,484 | $ | 4,482,373 | $ | 265,662 | $ | 1,122,751 | $ | 7,385,270 |
Three Months Ended August 31, 2018 |
Revenues recognized over time under ASC 606: |
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Franchise fees | $ | 36,005 | $ | - | $ | - | $ | 71,533 | $ | 107,538 |
Revenues recognized at a point in time: | ||||||||||||||||||||
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Factory sales | - | 4,782,070 | - | - | 4,782,070 | |||||||||||||||
Retail sales | - | - | 298,359 | 655,890 | 954,249 | |||||||||||||||
Royalty and marketing fees | 1,432,749 | - | - | 523,482 | 1,956,231 | |||||||||||||||
Total | $ | 1,468,754 | $ | 4,782,070 | $ | 298,359 | $ | 1,250,905 | $ | 7,800,088 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 – DISAGGREGATION OF REVENUE
The following table presents disaggregated revenue by method of recognition and segment:
Six Months Ended August 31, 2019 |
Three Months Ended August 31, 2018 | ||||||||||||||||||||||||||||||||||||||||
Revenues recognized over time under ASC 606: | Revenues recognized over time under ASC 606: | Revenues recognized over time under ASC 606: | ||||||||||||||||||||||||||||||||||||||
Franchising | Manufacturing | Retail | U-Swirl | Total | Franchising | Manufacturing | Retail | U-Swirl | Total | |||||||||||||||||||||||||||||||
Franchise fees | $ | 36,005 | $ | - | $ | - | $ | 71,533 | $ | 107,538 | $ | 145,346 | $ | - | $ | - | $ | 42,863 | $ | 188,209 |
Revenues recognized at a point in time: | Revenues recognized at a point in time: | |||||||||||||||||||||||||||||||||||||||
Franchising | Manufacturing | Retail | U-Swirl | Total | Franchising | Manufacturing | Retail | U-Swirl | Total | |||||||||||||||||||||||||||||||
Factory sales | - | 4,782,070 | - | - | 4,782,070 | - | 10,088,393 | - | - | 10,088,393 | ||||||||||||||||||||||||||||||
Retail sales | - | - | 298,359 | 655,890 | 954,249 | - | - | 498,081 | 1,258,177 | 1,756,258 | ||||||||||||||||||||||||||||||
Royalty and marketing fees | 1,432,749 | - | - | 523,482 | 1,956,231 | 2,796,893 | - | - | 981,516 | 3,778,409 | ||||||||||||||||||||||||||||||
Total | $ | 1,468,754 | $ | 4,782,070 | $ | 298,359 | $ | 1,250,905 | $ | 7,800,088 | $ | 2,942,239 | $ | 10,088,393 | $ | 498,081 | $ | 2,282,556 | $ | 15,811,269 |
Six Months Ended August 31, 2018 |
Revenues recognized over time under ASC 606: |
Six Months Ended August 31, 2018 | ||||||||||||||||||||
Revenues recognized over time under ASC 606: | ||||||||||||||||||||
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Revenues recognized over time under ASC 606: | ||||||||||||||||||||
Franchise fees | $ | 110,521 | $ | - | $ | - | $ | 90,152 | $ | 200,673 |
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Franchise fees | $ | 110,521 | $ | - | $ | - | $ | 90,152 | $ | 200,673 |
Revenues recognized at a point in time: | ||||||||||||||||||||
Franchising | Manufacturing | Retail | U-Swirl | Total | ||||||||||||||||
Factory sales | - | 10,341,296 | - | - | 10,341,296 | |||||||||||||||
Retail sales | - | - | 659,794 | 1,317,278 | 1,977,072 | |||||||||||||||
Royalty and marketing fees | 2,670,403 | - | - | 976,729 | 3,647,132 | |||||||||||||||
Total | $ | 2,780,924 | $ | 10,341,296 | $ | 659,794 | $ | 2,384,159 | $ | 16,166,173 |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 – LOSS CONTINGENCY
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 an auction to multiple buyers.
The Company has historically conducted business with FTD under a Gourmet Foods Supplier Agreement (the “Supplier Agreement”), that among other provisions, provided assurance that custom inventory purchased by the Company and developed specifically for FTD would be purchased by FTD upon termination of the Supplier Agreement. On September 23, 2019, the Company received notice that the bankruptcy court had approved FTD to reject and not enforce the Supplier Agreement as part of the proceedings.
As a result of FTD’s bankruptcy, the sale of certain assets, and the court’s approval to reject and not enforce the terms of the Supplier Agreement, the Company is uncertain if accounts receivable and inventory balances associated with FTD at August 31, 2019 will be realized at their full value, or if any revenue will be received from FTD in the future. A potential loss associated with these balances is not probable and/or is not able to be estimated as of the date of these consolidated financial statements.
As of August 31, 2019, balances associated with FTD consist of the following:
August 31, 2019 | ||||
Ingredients and supplies | $ | 382,656 | ||
Finished candy | 76,688 | |||
Accounts receivable | 73,232 | |||
Total potential loss, contingent upon the bankruptcy proceedings | $ | 532,576 |
FTD represented approximately $1.5 million, or 9.3%, of the Company’s revenues during the six months ended August 31, 2019, compared to $1.4 million, or 8.8%, of the Company’s revenues during the six months ended August 31, 2018. FTD represented approximately $3.1 million or 9% of our total revenues during the year ended February 28, 2019 compared to revenue of approximately $5.1 million or 13% of our total revenues during the year ended February 28, 2018. Our future results may be adversely impacted by decreases in the purchases of this customer or the loss of this customer entirely.
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q (“Quarterly Report”) includes statements of our expectations, intentions, plans and beliefs that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, 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 outcome of our ongoing evaluation of strategic alternatives, including, but not limited to, the time table for identifying potential transactions or transaction candidates and whether any transaction will be completed, 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, 20189. 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 August 31, 2018,2019, there were threetwo Company-owned, 8995 licensee-owned and 249242 franchised Rocky Mountain Chocolate Factory stores operating in 3837 states, Canada, South Korea, Panama, and the Philippines. As of August 31, 2018,2019, U-Swirl operated four Company-owned cafés and 10792 franchised cafés located in 2724 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”.
In January 2013, through our wholly-owned subsidiaries, including Aspen Leaf Yogurt, LLC (“ALY”), we entered into two agreements to sell allBankruptcy of the assets of our ALY frozen yogurt stores, along with our interest in the self-serve frozen yogurt franchises and retail units branded as “Yogurtini” which we also acquired in January 2013, to U-Swirl, Inc., a publicly traded company (OTCQB: SWRL) (“SWRL”), in exchange for a 60% controlling equity interest in SWRL, which was subsequently diluted down to 46% as of August 31, 2018 following various issuances of common stock of SWRL. Until February 29, 2016, U-Swirl was a wholly-owned subsidiary of SWRL, and was the operating subsidiary for all of SWRL’s operations.FTD Companies
In fiscal yearJune 2019, the Company’s largest customer, FTD Companies, Inc. and its domestic subsidiaries (“FY”FTD”) 2014, SWRL acquired the franchise rights, filed for Chapter 11 bankruptcy proceedings. As a part of such bankruptcy proceedings, divisions of FTD’s business and certain otherrelated assets, of self-serve frozen yogurt concepts underincluding the names “CherryBerry,” “Yogli Mogli Frozen Yogurt”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 “Fuzzy Peach Frozen Yogurt.” In connection with these acquisitions, we entered into a credit facility with Wells Fargo Bank, N.A. used to finance the acquisitions by SWRL, and in turn, we entered into a loan and security agreement with SWRL to cover the purchase price and other costsinventory balances associated with the acquisitions (the “SWRL Loan Agreement”). Borrowings under the SWRL Loan Agreement were secured by all of the assets of SWRL, including all of the outstanding stock of its wholly-owned subsidiary, U-Swirl. As a result of certain defaults under the SWRL Loan Agreement, we issued a demand for payment of all obligations under the SWRL Loan Agreement. SWRL was unable to repay the obligations under the SWRL Loan Agreement, and as a result, we foreclosed on all of the outstanding stock of U-Swirl on February 29, 2016 in full satisfaction of the amounts owed under the SWRL Loan Agreement. This resulted in U-Swirl becoming our wholly-owned subsidiary as of February 29, 2016, and concurrently we ceased to have financial control of SWRL as of February 29, 2016. As ofFTD at August 31, 2018, SWRL had no operating assets.2019 will be realized at their full value, or if any revenue will be received from FTD in the future.
Results of Operations
Three Months Ended August 31, 20189 Compared to the Three Months Ended August 31, 20178
Results Summary
Basic earnings per share decreased 18.8%increased 15.4% from $0.16 in the three months ended August 31, 2017 to $0.13 in the three months ended August 31, 2018. Revenues decreased 5.6% from $8.3 million2018 to $0.15 in the three months ended August 31, 2017 to2019. Revenues decreased (5.3)% from $7.8 million in the three months ended August 31, 2018. Operating income decreased 30.7% from $1.52018 to $7.4 million in the three months ended August 31, 2017 to2019. Operating income increased 19.7% from $1.0 million in the three months ended August 31, 2018. Net income decreased 19.1% from $928,0002018 to $1.2 million in the three months ended August 31, 2017 to2019. Net income increased 22.3% from $751,000 in the three months ended August 31, 2018.2018 to $918,000 in the three months ended August 31, 2019. The decreaseincrease in operating income was due primarily to lower revenueoperating expenses in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018.
Revenues
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 4,782.1 | $ | 4,881.5 | $ | (99.4 | ) | (2.0 | )% | |||||||
Retail sales | 954.3 | 1,181.9 | (227.6 | ) | (19.3 | )% | ||||||||||
Franchise fees | 107.5 | 163.0 | (55.5 | ) | (34.0 | )% | ||||||||||
Royalty and marketing fees | 1,956.2 | 2,040.3 | (84.1 | ) | (4.1 | )% | ||||||||||
Total | $ | 7,800.1 | $ | 8,266.7 | $ | (466.6 | ) | (5.6 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 4,482.4 | $ | 4,782.1 | $ | (299.7 | ) | (6.3 | )% | |||||||
Retail sales | 901.7 | 954.3 | (52.6 | ) | (5.5 | )% | ||||||||||
Franchise fees | 81.9 | 107.5 | (25.6 | ) | (23.8 | )% | ||||||||||
Royalty and marketing fees | 1,919.3 | 1,956.2 | (36.9 | ) | (1.9 | )% | ||||||||||
Total | $ | 7,385.3 | $ | 7,800.1 | $ | (414.8 | ) | (5.3 | )% |
Factory Sales
The decrease in factory sales for the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 was primarily due to a 13.3%32.4% decrease in shipments of product to customers outside our network of franchise and licensed retail locations and a 0.3%2.7% decrease in purchases by our network of franchised and licensed stores. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, FTD, decreased during the three months ended August 31, 2018,2019, with revenue from such customer decreasing to approximately $100,000,$103,000, or 1.8%1.4%, of the Company’s revenues during the three months ended August 31, 2018,2019, compared to $300,000,$144,000, or 3.4%1.8% of the Company’s revenues during the three months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historicalhistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 2.2%5.0% in the three months ended August 31, 2018,2019, compared with the three months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation resulting from the salebecause of certain Company-owned locations and the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%1.7% in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decrease in royalties and marketing fees from the three months ended August 31, 20172018 to the three months ended August 31, 20182019 was primarily due to a 10.2%6.5% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 324291 in the three months ended August 31, 20172018 to 291272 during the three months ended August 31, 2018.2019. This decrease is the result of domestic store closures exceeding domestic store openings. Same store sales at total franchise stores and cafés in operation increased 0.1% during the three months ended August 31, 20182019 compared to the three months ended August 31, 2017. Franchise fee revenues decreased as a result of a2018.
The decrease in international license fees recognized duringfranchise fee revenue for the three months ended August 31, 20182019 compared to the three months ended August 31, 2017. During2018 was the three months ended August 31, 2017, U-Swirl entered intoresult of a master license agreement fordecrease in revenue resulting from fewer franchise stores in operation and the Stateassociated recognition of Qatar.revenue over the term of the franchise agreement.
Costs and Expenses
Cost of Sales
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory sales
Retail sales
Franchise fees
Royalty and marketing fees
Total
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Plus: depreciation and amortization
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Plus: depreciation and amortization
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory sales
Retail sales
Franchise fees
Royalty and marketing fees
Total
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Plus: depreciation and amortization
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Plus: depreciation and amortization
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Plus: depreciation and amortization
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory sales
Retail sales
Franchise fees
Royalty and marketing fees
Total
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Plus: depreciation and amortization
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
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32.1** |
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101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Plus: depreciation and amortization
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
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____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory sales
Retail sales
Franchise fees
Royalty and marketing fees
Total
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Plus: depreciation and amortization
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Factory adjusted gross margin
Retail gross margin
Total Adjusted Gross Margin
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Factory gross margin
Retail gross margin
Total
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
|
|
32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
28
29
s in thousands)2018
2017
Change
Change
2019
2018
Change
Change
Cost of sales - factory
Cost of sales - retail
Franchise costs
Sales and marketing
General and administrative
Retail operating
Total
Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total | $ | 1,852.5 | $ | 2,210.9 | $ | (358.4 | ) | (16.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total | $ | 1,645.7 | $ | 1,852.5 | $ | (206.8 | ) | (11.2 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 25.2 | % | 29.1 | % | (3.9 | )% | (13.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total | 32.3 | % | 36.5 | % | (4.2 | )% | (11.4 | )% |
Three Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
(Percent) | ||||||||||||||||
Factory gross margin | 23.4 | % | 25.2 | % | (1.9 | )% | (7.4 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total | 30.6 | % | 32.3 | % | (1.7 | )% | (5.4 | )% |
Adjusted Gross Margin
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,206.7 | $ | 1,420.3 | $ | (213.6 | ) | (15.0 | )% | |||||||
Plus: depreciation and amortization | 138.2 | 127.9 | 10.3 | 8.1 | % | |||||||||||
Factory adjusted gross margin | 1,344.9 | 1,548.2 | (203.3 | ) | (13.1 | )% | ||||||||||
Retail gross margin | 645.8 | 790.6 | (144.8 | ) | (18.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,990.7 | $ | 2,338.8 | $ | (348.1 | ) | (14.9 | )% | |||||||
Factory adjusted gross margin | 28.1 | % | 31.7 | % | (3.6 | )% | (11.3 | )% | ||||||||
Retail gross margin | 67.7 | % | 66.9 | % | 0.8 | % | 1.2 | % | ||||||||
Total Adjusted Gross Margin | 34.7 | % | 38.6 | % | (3.9 | )% | (10.0 | )% |
Three Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 1,047.1 | $ | 1,206.7 | $ | (159.6 | ) | (13.2 | )% | |||||||
Plus: depreciation and amortization | 147.4 | 138.2 | 9.2 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 1,194.5 | 1,344.9 | (150.4 | ) | (11.2 | )% | ||||||||||
Retail gross margin | 598.6 | 645.8 | (47.2 | ) | (7.3 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 1,793.1 | $ | 1,990.7 | $ | (197.6 | ) | (9.9 | )% | |||||||
Factory adjusted gross margin | 26.6 | % | 28.1 | % | (1.5 | )% | (5.2 | )% | ||||||||
Retail gross margin | 66.4 | % | 67.7 | % | (1.3 | )% | (1.9 | )% | ||||||||
Total Adjusted Gross Margin | 33.3 | % | 34.7 | % | (1.4 | )% | (4.0 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 390190 basis points in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.8%costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production volume and an increase in transportation fuel costs infor the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. The increasedecrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 20182019 compared to the prior year.
Franchise Costs
The increasedecrease in franchise costs in the three months ended August 31, 20182019 versus the three months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expense in the three months ended August 31, 20182019 compared to the three months ended August 31, 2017.2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018 from 25.3% in the three months ended August 31, 2017.2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirl franchise locationsplanned cost reductions as a result of fewer domestic franchise units in operation. operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The decreaseincrease in general and administrative costs for the three months ended August 31, 21082019 compared to the three months ended August 31, 20172018 is primarily due to a decrease in legalhigher professional fees associated with the Company’s previously announced process to explore and professional expensereview strategic alternatives to maximize shareholder value and position the Company for long-term success. During the three months ended August 31, 2019, the Company incurred approximately $92,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in the three months ended August 31, 2018 compared to the three months ended August 31, 2017.2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018 compared to 11.8% in the three months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 20182019 compared to the three months ended August 31, 20172018 was due primarily to changes in units in operation as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, increaseddecreased from 52.2% in the three months ended August 31, 2017 to 52.3% in the three months ended August 31, 2018.2018 to 52.0% in the three months ended August 31, 2019. This slight increasedecrease 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 $225,000 in the three months ended August 31, 2019, a decrease of 24.0% from $297,000 in the three months ended August 31, 2018, an increase of 52.2% from $195,000 in the three months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.1%6.7% from $128,000 in the three months ended August 31, 2017 to $138,000 in the three months ended August 31, 2018.2018 to $147,000 in the three months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and Acquisition Related ChargesCosts Associated with Company-Owned Store Closures
There was $119,000 in restructuring chargescosts associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no restructuring chargescosts associated with company-owned store closures incurred during the three months ended August 31, 2017.2019. The increase in restructuring costs wasincurred during the three months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Net interest expenseincome was $15,000$3,000 in the three months ended August 31, 20182019 compared to net interest expense of $26,000$15,000 incurred in the three months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Income Tax Expense
Our effective income tax rate for the three months ended August 31, 20182019 was 26.8%26.4%, compared to 37.1%26.8% for the three months ended August 31, 2017. The decrease of 10.5% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Six Months Ended August 31, 20182019 Compared to the Six Months Ended August 31, 20172018
Results Summary
Basic earnings per share decreased 26.7%increased 22.7% to $0.27 for the six months ended August 31, 2019 compared to $0.22 for the six months ended August 31, 2018 compared2018. Revenues decreased (2.2)% to $0.30 for the six months ended August 31, 2017. Revenues decrease 8.2% to $16.2$15.8 million for the six months ended August 31, 20182019 compared to $17.6$16.2 million in the six months ended August 31, 2017.2018. Operating income decreased 34.8%increased 20.2% from $2.8 million in the six months ended August 31, 2017 to $1.8 million in the six months ended August 31, 2018. Net income decreased 23.8% from $1.72018 to $2.2 million in the six months ended August 31, 2017 to2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018.2018 to $1.6 million in the six months ended August 31, 2019. The decreaseincrease in operating income and net income was due primarily to lower revenue and lower margins partially offset by a decrease in operating expenses and a lower effective income tax rate.in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Revenues
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory sales | $ | 10,341.3 | $ | 11,065.4 | $ | (724.1 | ) | (6.5 | )% | |||||||
Retail sales | 1,977.1 | 2,204.9 | (227.8 | ) | (10.3 | )% | ||||||||||
Franchise fees | 200.7 | 412.1 | (211.4 | ) | (51.3 | )% | ||||||||||
Royalty and marketing fees | 3,647.1 | 3,930.7 | (283.6 | ) | (7.2 | )% | ||||||||||
Total | $ | 16,166.2 | $ | 17,613.1 | (1,446.9 | ) | (8.2 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory sales | $ | 10,088.4 | $ | 10,341.3 | $ | (252.9 | ) | (2.4 | )% | |||||||
Retail sales | 1,756.3 | 1,977.1 | (220.8 | ) | (11.2 | )% | ||||||||||
Franchise fees | 188.2 | 200.7 | (12.5 | ) | (6.2 | )% | ||||||||||
Royalty and marketing fees | 3,778.4 | 3,647.1 | 131.3 | 3.6 | % | |||||||||||
Total | $ | 15,811.3 | $ | 16,166.2 | $ | (354.9 | ) | (2.2 | )% |
Factory Sales
The decrease in factory sales for the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 was primarily due to a 26.0%10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. This changeThe 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 decreasedecline in purchasesrevenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, during the six months ended August 31, 2018, with revenue from such customer decreasing toFTD, were approximately $1.4$1.5 million, or 8.8%9.3%, of the Company’s revenues during the six months ended August 31, 2018,2019, compared to $2.2$1.4 million, or 12.3%8.8% of the Company’s revenues during the six months ended August 31, 2017 for this same customer. The2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company believeswill realize any revenue from FTD in the decrease in orders is due to lower sales of its customer. If future, purchases from this customer decrease or remain at current levels, our sales could continue to decline, and there is no assurance that sales toif so, whether such customerrevenues will return to historical levelshistoric levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 1.4%5.3% in the six months ended August 31, 2018,2019, compared with the six months ended August 31, 2017.2018.
Retail Sales
The decrease in retail sales for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 was primarily due to changes in retailfewer Company-owned units in operation as a resultbecause of the closure of certain underperforming Company-owned locations.locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 0.1%increased 0.2% in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018.
Royalties, Marketing Fees and Franchise Fees
The decreaseincrease in royalties and marketing fees from the six months ended August 31, 20172018 to the threesix months ended August 31, 20182019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 10.4%6.5% decrease in domestic franchise units in operation and lower same store sales.operation. The average number of total domestic franchise stores in operation decreased from 327293 in the six months ended August 31, 20172018 to 293274 during the six months ended August 31, 2018.2019. 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 0.6%increased 0.5% during the six months ended August 31, 20182019 compared to the six months ended August 31, 2017. Franchise fee revenues decreased as a result of international license fees recognized during the six months ended August 31, 2017 with no comparable international fees recognized during the six months ended August 31, 2018. During the six months ended August 31, 2017, U-Swirl entered into a master license agreement covering the State of Qatar and Rocky Mountain Chocolate Factory entered into master license agreements covering the countries of Vietnam and Panama. There were no international license agreements entered into during the six months ended August 31, 2018.
The decrease in franchise fee revenue for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,846.1 | $ | 8,119.8 | $ | (273.7 | ) | (3.4 | )% | |||||||
Cost of sales - retail | 703.0 | 747.6 | (44.6 | ) | (6.0 | )% | ||||||||||
Franchise costs | 1,076.0 | 1,073.2 | 2.8 | 0.3 | % | |||||||||||
Sales and marketing | 1,153.5 | 1,192.4 | (38.9 | ) | (3.3 | )% | ||||||||||
General and administrative | 1,727.8 | 2,105.4 | (377.6 | ) | (17.9 | )% | ||||||||||
Retail operating | 1,061.3 | 1,189.8 | (128.5 | ) | (10.8 | )% | ||||||||||
Total | $ | 13,567.7 | $ | 14,428.2 | $ | (860.5 | ) | (6.0 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Cost of sales - factory | $ | 7,761.8 | $ | 7,846.1 | $ | (84.3 | ) | (1.1 | )% | |||||||
Cost of sales - retail | 591.3 | 703.0 | (111.7 | ) | (15.9 | )% | ||||||||||
Franchise costs | 924.7 | 1,076.0 | (151.3 | ) | (14.1 | )% | ||||||||||
Sales and marketing | 991.4 | 1,153.5 | (162.1 | ) | (14.1 | )% | ||||||||||
General and administrative | 1,975.2 | 1,727.8 | 247.4 | 14.3 | % | |||||||||||
Retail operating | 918.2 | 1,061.3 | (143.1 | ) | (13.5 | )% | ||||||||||
Total | $ | 13,162.6 | $ | 13,567.7 | $ | (405.1 | ) | (3.0 | )% |
Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total | $ | 3,769.3 | $ | 4,402.9 | $ | (633.6 | ) | (14.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total | $ | 3,491.6 | $ | 3,769.3 | $ | (277.7 | ) | (7.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2018 | 2017 | Change | Change | |||||||||||||
Factory gross margin | 24.1 | % | 26.6 | % | (2.5 | )% | (9.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total | 30.6 | % | 33.2 | % | (2.6 | )% | (7.8 | )% |
Six Months Ended | ||||||||||||||||
August 31, | % | % | ||||||||||||||
2019 | 2018 | Change | Change | |||||||||||||
Factory gross margin | 23.1 | % | 24.1 | % | (1.1 | )% | (4.4 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total | 29.5 | % | 30.6 | % | (1.1 | )% | (3.7 | )% |
Adjusted Gross Margin
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2018 | 2017 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,495.2 | $ | 2,945.6 | $ | (450.4 | ) | (15.3 | )% | |||||||
Plus: depreciation and amortization | 274.7 | 253.5 | 21.2 | 8.4 | % | |||||||||||
Factory adjusted gross margin | 2,769.9 | 3,199.1 | (429.2 | ) | (13.4 | )% | ||||||||||
Retail gross margin | 1,274.1 | 1,457.3 | (183.2 | ) | (12.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 4,044.0 | $ | 4,656.4 | $ | (612.4 | ) | (13.2 | )% | |||||||
Factory adjusted gross margin | 26.8 | % | 28.9 | % | (2.1 | )% | (7.4 | )% | ||||||||
Retail gross margin | 64.4 | % | 66.1 | % | (1.7 | )% | (2.5 | )% | ||||||||
Total Adjusted Gross Margin | 32.8 | % | 35.1 | % | (2.3 | )% | (6.4 | )% |
Six Months Ended | ||||||||||||||||
August 31, | $ | % | ||||||||||||||
($'s in thousands) | 2019 | 2018 | Change | Change | ||||||||||||
Factory gross margin | $ | 2,326.6 | $ | 2,495.2 | $ | (168.6 | ) | (6.8 | )% | |||||||
Plus: depreciation and amortization | 293.1 | 274.7 | 18.4 | 6.7 | % | |||||||||||
Factory adjusted gross margin | 2,619.7 | 2,769.9 | (150.2 | ) | (5.4 | )% | ||||||||||
Retail gross margin | 1,165.0 | 1,274.1 | (109.1 | ) | (8.6 | )% | ||||||||||
Total Adjusted Gross Margin | $ | 3,784.7 | $ | 4,044.0 | $ | (259.3 | ) | (6.4 | )% | |||||||
Factory adjusted gross margin | 26.0 | % | 26.8 | % | (0.8 | )% | (3.1 | )% | ||||||||
Retail gross margin | 66.3 | % | 64.4 | % | 1.9 | % | 2.9 | % | ||||||||
Total Adjusted Gross Margin | 32.0 | % | 32.8 | % | (0.9 | )% | (2.7 | )% |
Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin.
Cost of Sales and Gross Margin
Factory margins decreased 250110 basis points in the six months ended August 31, 20182019 compared to the six months ended August 31, 2017 due primarily to lower efficiencies2018 because of a charge associated with an 11.3%costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production volume infor the six months ended August 31, 20182019 compared to the six months ended August 31, 2017.2018. The decreaseincrease in retail gross margins was primarily the result of inventory discounts prior to closing certainthe closure of underperforming Company-owned locations.locations during the prior fiscal year.
FranchiseFranchise Costs
The increasedecrease in franchise costs in the six months ended August 31, 20182019 versus the six months ended August 31, 20172018 is due primarily to an increasea decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increaseddecreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018 from 24.7%in the six months ended August 31, 2017.2018. This increasedecrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise revenues.costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to lower marketing-related costs associated with U-Swirlplanned cost reductions as a result of fewer domestic franchise locations.units in operation.
General and Administrative
The decreaseincrease in general and administrative costs for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 is primarily due to a decreasehigher professional fees associated with the Company’s previously announced process to explore and review strategic alternatives to maximize shareholder value and position the Company for long-term success. During the six months ended August 31, 2019, the Company incurred approximately $347,000 of costs associated with the review of strategic alternatives, compared with no comparable costs incurred in legal and professional expenses.the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses decreasedincreased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018 compared to 12.0% in the six months ended August 31, 2017.2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 20182019 compared to the six months ended August 31, 20172018 was due primarily to changes in units in operation, as a result of the closure of certain underperforming Company-owned units. Retail operating expenses, as a percentage of retail sales, decreased from 54.0% in the six months ended August 31, 2017 to 53.7% in the six months ended August 31, 2018.2018 to 52.3% in the six months ended August 31, 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 $457,000 in the six months ended August 31, 2019, a decrease of 23.5% from $598,000 in the six months ended August 31, 2018, an increase of 53.3% from $390,000 in the six months ended August 31, 2017.2018. This increasedecrease was the result of lower amortization of franchise rights, the result of a changedecrease in management’s estimates relatedfrozen yogurt cafés in operation. See Note 8 to the future valuefinancial statements for a summary of U-Swirl intangiblesannual amortization of intangible assets based upon existing intangible assets and the associated acceleration of amortization expense.current useful lives. Depreciation and amortization included in cost of sales increased 8.4%6.7% from $254,000 in the six months ended August 31, 2017 to $275,000 in the six months ended August 31, 2018.2018 to $293,000 in the six months ended August 31, 2019. This increase was the result of an increase in production assets in service.service primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Restructuring and acquisition related charges
Costs Associated with Company-Owned Store Closures
There were no restructuring and acquisition related chargeswas $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2017 compared to $177,0002018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2018.2019. The increase in restructuring costs wasincurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
NetInterest income was approximately equal to interest expense wasin the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018, a decrease of 39.0% compared to net interest expense of $54,000 in the six months ended August 31, 2017.2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2018.2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 20182019 was 25.9%25.6%, compared to 36.5%25.9% for the six months ended August 31, 2017. The decrease of 10.6% is primarily due to the lower enacted U.S. corporate tax rate of 21% under the recent Tax Cuts and Jobs Act.2018.
Liquidity and Capital Resources
As of August 31, 2018,2019 and February 28, 2019, working capital was $10.0 million, compared with $7.4 million as of February 28, 2018, an increase of $2.6$9.5 million. The increase in working capital was primarily due to the impact of the adoption of certain recent accounting pronouncements and positive operating results partially offset by the payment of dividends.
Cash and cash equivalent balances declinedincreased approximately $900,000$400,000 to $5.2$5.8 million as of August 31, 20182019 compared to $6.1$5.4 million as of February 28, 20182019, 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 exceeding cash flow generated by operating activities.dividends. Our current ratio was 2.9 to 1 at August 31, 20182019 compared to 1.93.0 to 1 at February 28, 2018.2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2018,2019, we had net income of $1,327,759.$1,629,697. Operating activities provided cash of $1,388,429,$2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $872,454$750,486 and the increase in inventoryexpense recorded for stock compensation of $1,579,686.$386,670. During the comparable 20172018 period, we had net income of $1,741,956,$1,327,759, and operating activities provided cash of $2,188,650.$1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $643,421$872,454 and the increase in inventory of $1,421,625.$1,579,686.
During the six months ended August 31, 2018,2019, investing activities used cash of $200,537,$406,376, primarily due to the purchases of property, equipment of $246,455.$480,984. In comparison, investing activities used cash of $172,934$200,537 during the six months ended August 31, 20172018 primarily due to the purchase of property and equipment of $283,988.$242,432.
Financing activities used cash of $2,087,641$2,127,121 for the six months ended August 31, 20182019 and used cash of $2,050,614$2,087,641 during the prior year period. The Company’s financing activities consist primarily of payments on long-term debt and declared dividends.
We have a $5.0 million ($5.0 million available as of August 31, 2018)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 August 31, 2018,2019, 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 2019.2021. As of August 31, 2018,2019, 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 August 31, 20182019 of $1.9 million)$480,000). 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 August 31, 2018,2019, we were in compliance with all such covenants.
On July 15, 2014, we publicly announced a plan to repurchase up to $3.0 million of our common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, we announced a plan to purchase up to an additional $2,058,000 of our common stock under the repurchase plan, and on May 21, 2015, we announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of our common stock under the repurchase plan. We did not repurchase any shares during the three and six months ended August 31, 2018.2019. As of August 31, 2018,2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.
We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements.
Off-Balance Sheet Arrangements
As of August 31, 2018,2019, except for the purchase obligations as described below, we had no material off-balance sheet arrangements or obligations.
Purchase obligations: As of August 31, 2019, we had purchase obligations of approximately $714,000. 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.
We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of August 31, 2018,2019, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $199,000$71,000 favorable or unfavorable price benefit or cost, respectively, resulting from our contracts.
We have a $5 million bank line of credit that bears interest at a variable rate. As of August 31, 2018,2019, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this line of credit.
We also entered into a $7.0 million promissory note with interest at a fixed rate of 3.75% annually that was used to finance the previous acquisitions by SWRL. As of August 31, 2018, $1.9 million2019, $480,445 was outstanding under this promissory note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the “Exchange Act”)Exchange Act) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of August 31, 2018.2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended August 31, 20182019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
OTHER INFORMATION |
Legal Proceedings |
The Company is party to various legal proceedings arising in the ordinary course of business from time to time. Management believes that the resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.
Unregistered Sales of Equity Securities and Use of Proceeds |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three and six months ended August 31, 2018. As of August 31, 2018, approximately $638,000 remains available under the repurchase plan for further stock repurchases.None.
The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.
Defaults Upon Senior Securities |
None.
Mine Safety Disclosures |
Not Applicable.
Other Information |
None.
Exhibits |
3.1 |
3.2 |
3.3 |
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32.1** |
|
101.INS | *XBRL Instance Document. |
101.SCH | *XBRL Taxonomy Extension Schema Document. |
101.CAL | *XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | *XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | *XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | *XBRL Taxonomy Extension Presentation Linkbase Document. |
____________________________
* Filed herewith.
** Furnished herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October | /s/ Bryan J. Merryman | |
Bryan J. Merryman, Chief Chief Financial Officer, Treasurer and |
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