Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q (“Quarterly Report”) includes statements of our expectations, intentions, plans and beliefs that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, 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, 2019. These forward-looking statements apply only as of the date of this Quarterly Report. As such they should not be unduly relied upon for more current circumstances. Except as required by law, we undertake no obligation to release publicly any revisions to these forward-looking statements that might reflect events or circumstances occurring after the date of this Quarterly Report or those that might reflect the occurrence of unanticipated events.
Unless otherwise specified, the “Company,” “we,” “us” or “our” refers to Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, and its consolidated subsidiaries.
Overview
We are an international franchisor, confectionery manufacturer and retail operator. Founded in 1981, we are headquartered in Durango, Colorado and manufacture an extensive line of premium chocolate candies and other confectionery products. Our subsidiary, U-Swirl International, Inc. (“U-Swirl”), franchises and operates soft-serve frozen yogurt cafés. Our revenues and profitability are derived principally from our franchised/license system of retail stores that feature chocolate, frozen yogurt and other confectionary products. We also sell our candy outside of our system of retail stores and license the use of our brand with certain consumer products. As of August 31, 2019, there were two Company-owned, 95 licensee-owned and 242 franchised Rocky Mountain Chocolate Factory stores operating in 37 states, Canada, South Korea, Panama, and the Philippines. As of August 31, 2019, U-Swirl operated four Company-owned cafés and 92 franchised cafés located in 24 states and Qatar. U-Swirl operates self-serve frozen yogurt cafés under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!” and “Aspen Leaf Yogurt”.
Bankruptcy of FTD Companies
In June 2019, the Company’s largest customer, FTD Companies, Inc. and its domestic subsidiaries (“FTD”), filed for Chapter 11 bankruptcy proceedings. As a part of such bankruptcy proceedings, divisions of FTD’s business and certain related assets, including the divisions that the Company has historically sold product to, were sold through the auction to multiple buyers. The Company is uncertain if accounts receivable and inventory balances associated with FTD at August 31, 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, 2019 Compared to the Three Months Ended August 31, 2018
Results Summary
Basic earnings per share increased 15.4% from $0.13 in the three months ended August 31, 2018 to $0.15 in the three months ended August 31, 2019. Revenues decreased (5.3)% from $7.8 million in the three months ended August 31, 2018 to $7.4 million in the three months ended August 31, 2019. Operating income increased 19.7% from $1.0 million in the three months ended August 31, 2018 to $1.2 million in the three months ended August 31, 2019. Net income increased 22.3% from $751,000 in the three months ended August 31, 2018 to $918,000 in the three months ended August 31, 2019. The increase in operating income was due primarily to lower operating expenses in the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Revenues
|
|
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, 2019 versus the three months ended August 31, 2018 was primarily due to a 32.4% decrease in shipments of product to customers outside our network of franchise and licensed retail locations and a 2.7% decrease in purchases by our network of franchised and licensed stores. The decrease in shipments of product to customers outside our network of franchise and licensed retail stores was primarily the result of product rationalization and a decline in revenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, FTD, decreased during the three months ended August 31, 2019, with revenue from such customer decreasing to approximately $103,000, or 1.4%, of the Company’s revenues during the three months ended August 31, 2019, compared to $144,000, or 1.8% of the Company’s revenues during the three months ended August 31, 2018. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company will realize any revenue from FTD in the future, and if so, whether such revenues will return to historic levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 5.0% in the three months ended August 31, 2019, compared with the three months ended August 31, 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 fewer Company-owned units in operation because of the closure of certain underperforming Company-owned locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés decreased 1.7% in the three months ended August 31, 2019 compared to the three months ended August 31, 2018.
Royalties, Marketing Fees and Franchise Fees
The decrease in royalties and marketing fees from the three months ended August 31, 2018 to the three months ended August 31, 2019 was primarily due to a 6.5% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 291 in the three months ended August 31, 2018 to 272 during the three months ended August 31, 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, 2019 compared to the three months ended August 31, 2018.
The decrease in franchise fee revenue for the three months ended August 31, 2019 compared to the three 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
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
August 31,
|
|
|
$
|
|
|
%
|
|
($'s in thousands)
|
|
2019
|
|
|
2018
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales - factory
|
|
$
|
3,435.3
|
|
|
$
|
3,575.4
|
|
|
$
|
(140.1
|
)
|
|
|
(3.9
|
)%
|
Cost of sales - retail
|
|
|
303.1
|
|
|
|
308.5
|
|
|
|
(5.4
|
)
|
|
|
(1.8
|
)%
|
Franchise costs
|
|
|
441.6
|
|
|
|
582.8
|
|
|
|
(141.2
|
)
|
|
|
(24.2
|
)%
|
Sales and marketing
|
|
|
434.8
|
|
|
|
565.2
|
|
|
|
(130.4
|
)
|
|
|
(23.1
|
)%
|
General and administrative
|
|
|
830.5
|
|
|
|
813.4
|
|
|
|
17.1
|
|
|
|
2.1
|
%
|
Retail operating
|
|
|
469.3
|
|
|
|
498.9
|
|
|
|
(29.6
|
)
|
|
|
(5.9
|
)%
|
Total
|
|
$
|
5,914.6
|
|
|
$
|
6,344.2
|
|
|
$
|
(429.6
|
)
|
|
|
(6.8
|
)%
|
Gross Margin
|
|
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,
|
|
|
%
|
|
|
%
|
|
|
|
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)
|
|
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 190 basis points in the three months ended August 31, 2019 compared to the three months ended August 31, 2018 because of a charge associated with costs of excess capacity. Excess capacity was the result of a 14.8% decrease in production for the three months ended August 31, 2019 compared to the three months ended August 31, 2018. The decrease in Company-owned store margin is due primarily to a change in units in operation during the three months ended August 31, 2019 compared to the prior year.
Franchise Costs
The decrease in franchise costs in the three months ended August 31, 2019 versus the three months ended August 31, 2018 is due primarily to a decrease in legal and professional expense in the three months ended August 31, 2019 compared to the three months ended August 31, 2018. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 22.1% in the three months ended August 31, 2019 from 28.2% in the three months ended August 31, 2018.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to planned cost reductions as a result of fewer domestic franchise units in operation and lower revenue associated with sales to customers outside of our network of franchised and licensed RMCF locations.
General and Administrative
The increase in general and administrative costs for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 is primarily due to higher 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 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. As a percentage of total revenues, general and administrative expenses increased to 11.2% in the three months ended August 31, 2019 compared to 10.4% in the three months ended August 31, 2018.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended August 31, 2019 compared to the three months ended August 31, 2018 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 52.3% in the three months ended August 31, 2018 to 52.0% in the three 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 $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. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation. See Note 8 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7% from $138,000 in the three months ended August 31, 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 primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Costs Associated with Company-Owned Store Closures
There was $119,000 in costs associated with Company-owned store closures incurred during the three months ended August 31, 2018 and no costs associated with company-owned store closures incurred during the three months ended August 31, 2019. The costs incurred 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 income was $3,000 in the three months ended August 31, 2019 compared to net interest expense of $15,000 incurred in the three months ended August 31, 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, 2019 was 26.4%, compared to 26.8% for the three months ended August 31, 2018.
Six Months Ended August 31, 2019 Compared to the Six Months Ended August 31, 2018
Results Summary
Basic earnings per share 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. Revenues decreased (2.2)% to $15.8 million for the six months ended August 31, 2019 compared to $16.2 million in the six months ended August 31, 2018. Operating income increased 20.2% from $1.8 million in the six months ended August 31, 2018 to $2.2 million in the six months ended August 31, 2019. Net income increased 22.7% from $1.3 million in the six months ended August 31, 2018 to $1.6 million in the six months ended August 31, 2019. The increase in operating income and net income was due primarily to lower operating expenses 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)
|
|
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, 2019 versus the six months ended August 31, 2018 was primarily due to a 10.2% decrease in shipments of product to customers outside our network of franchise and licensed retail locations. The decrease in shipments of product to customers outside our network of franchise and licensed retail stores was primarily the result of product rationalization and a decline in revenue associated with products no longer offered for sale. Purchases by the Company’s largest customer, FTD, were approximately $1.5 million, or 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. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy proceedings are complete, it is unclear whether the Company will realize any revenue from FTD in the future, and if so, whether such revenues will return to historic levels.
Same store pounds purchased by domestic Rocky Mountain Chocolate Factory franchise and license locations decreased 5.3% in the six months ended August 31, 2019, compared with the six months ended August 31, 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 fewer Company-owned units in operation because of the closure of certain underperforming Company-owned locations during the prior fiscal year. Same store sales at all Company-owned stores and cafés increased 0.2% in the six months ended August 31, 2019 compared to the six months ended August 31, 2018.
Royalties, Marketing Fees and Franchise Fees
The increase in royalties and marketing fees from the six months ended August 31, 2018 to the six months ended August 31, 2019 was primarily due to an increase in royalty revenue associated with the Company’s purchase-based royalty structure, partially offset by a 6.5% decrease in domestic franchise units in operation. The average number of total domestic franchise stores in operation decreased from 293 in the six months ended August 31, 2018 to 274 during the six months ended August 31, 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 0.5% during the six months ended August 31, 2019 compared to 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)
|
|
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,
|
|
|
$
|
|
|
%
|
|
|
|
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,
|
|
|
%
|
|
|
%
|
|
|
|
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)
|
|
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 110 basis points in the six months ended August 31, 2019 compared to the six months ended August 31, 2018 because of a charge associated with costs of excess capacity partially offset by certain cost reductions. Excess capacity was the result of a 10.6% decrease in production for the six months ended August 31, 2019 compared to the six months ended August 31, 2018. The increase in retail gross margins was primarily the result of the closure of underperforming Company-owned locations during the prior fiscal year.
Franchise Costs
The decrease in franchise costs in the six months ended August 31, 2019 versus the six months ended August 31, 2018 is due primarily to a decrease in legal and professional expenses. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 23.3% in the six months ended August 31, 2019 from 28.0% in the six months ended August 31, 2018. This decrease as a percentage of royalty, marketing and franchise fees is primarily a result of lower franchise costs.
Sales and Marketing
The decrease in sales and marketing costs for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 is primarily due to planned cost reductions as a result of fewer domestic franchise units in operation.
General and Administrative
The increase in general and administrative costs for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 is primarily due to higher 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 the six months ended August 31, 2018. As a percentage of total revenues, general and administrative expenses increased to 12.5% in the six months ended August 31, 2019 compared to 10.7% in the six months ended August 31, 2018.
Retail Operating Expenses
The decrease in retail operating expenses for the six months ended August 31, 2019 compared to the six months ended August 31, 2018 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 53.7% in the six months ended August 31, 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. This decrease was the result of lower amortization of franchise rights, the result of a decrease in frozen yogurt cafés in operation. See Note 8 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales increased 6.7% from $275,000 in the six months ended August 31, 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 primarily resulting from the replacement of obsolete equipment or equipment at the end of its operating life.
Costs Associated with Company-Owned Store Closures
There was $177,000 in costs associated with Company-owned store closures incurred during the six months ended August 31, 2018 and no costs associated with Company-owned store closures incurred during the six months ended August 31, 2019. The costs incurred during the six months ended August 31, 2018 were the result of charges related to closing certain underperforming Company-owned locations.
Other Income (Expense)
Interest income was approximately equal to interest expense in the six months ended August 31, 2019, compared to net interest expense of $33,000 in the six months ended August 31, 2018. This decrease in interest expense is due to lower average outstanding promissory note balances for the six months ended August 31, 2019.
Income Tax Expense
Our effective income tax rate for the six months ended August 31, 2019 was 25.6%, compared to 25.9% for the six months ended August 31, 2018.
Liquidity and Capital Resources
As of August 31, 2019 and February 28, 2019, working capital was $9.5 million.
Cash and cash equivalent balances increased approximately $400,000 to $5.8 million as of August 31, 2019 compared to $5.4 million as of February 28, 2019, primarily as a result of cash flow generated by operating activities exceeding cash flow used by financing activities, including repayment of debt and payment of dividends. Our current ratio was 2.9 to 1 at August 31, 2019 compared to 3.0 to 1 at February 28, 2019. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the six months ended August 31, 2019, we had net income of $1,629,697. Operating activities provided cash of $2,902,679, with the principal adjustment to reconcile the net income to net cash provided by operating activities being depreciation and amortization of $750,486 and the expense recorded for stock compensation of $386,670. During the comparable 2018 period, we had net income of $1,327,759, and operating activities provided cash of $1,388,429. The principal adjustment to reconcile the net income to net cash provided by operating activities was depreciation and amortization of $872,454 and the increase in inventory of $1,579,686.
During the six months ended August 31, 2019, investing activities used cash of $406,376, primarily due to the purchases of property, equipment of $480,984. In comparison, investing activities used cash of $200,537 during the six months ended August 31, 2018 primarily due to the purchase of property and equipment of $242,432.
Financing activities used cash of $2,127,121 for the six months ended August 31, 2019 and used cash of $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, 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, 2019, we were in compliance with all such covenants. The line of credit was renewed in September 2019 and is subject to renewal again in September 2021. As of August 31, 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, 2019 of $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, 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, 2019. As of August 31, 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, 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.