UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

X	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended November 30, 2014

 

___	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: 0-14749

 

 

 

Rocky Mountain Chocolate Factory, Inc.

(Exact name of registrant as specified in its charter)

 

Colorado	84-0910696
(State or other jurisdiction	(I.R.S. Employer Identification No.)
of incorporation or organization)

 

 

265 Turner Drive, Durango, CO 81303

(Address of principal executive offices, including zip code)

 

(970) 259-0554

(Registrant’s telephone number, including area code)

 

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  X   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  X   No ___

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

	Large accelerated filer			Accelerated filer
	Non-accelerated filer			Smaller reporting company	X

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ____ No  X 

 

On January 14, 2015, the registrant had outstanding 6,092,626 shares of its common stock, $.03 par value.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

FORM 10-Q

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION	3
ITEM 1.	FINANCIAL STATEMENTS	3
CONSOLIDATED STATEMENTS OF INCOME		3
CONSOLIDATED BALANCE SHEETS		4
CONSOLIDATED STATEMENTS OF CASH FLOWS		5
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS		6
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	14
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	21
ITEM 4.	CONTROLS AND PROCEDURES	22
PART II.	OTHER INFORMATION	22
ITEM 1.	LEGAL PROCEEDINGS	22
ITEM 1A.	RISK FACTORS	22
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	22
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	23
ITEM 4.	MINE SAFETY DISCLOSURES	23
ITEM 5.	OTHER INFORMATION	23
ITEM 6.	EXHIBITS	24
SIGNATURES		25

 

 

PART I.     FINANCIAL INFORMATION

 

Item 1.     Financial Statements

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

 

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)

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Cautionary Note Regarding Forward-Looking Statements

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited financial statements and related notes of the Company included elsewhere in this report. The statements included in this report other than statements of historical fact, are 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, and within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, and include statements regarding our cash flow, dividends, operating income and future growth. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as "will," "believe," "expect," "anticipate," "estimate," "potential," or similar expressions. Factors which could cause results to differ include, but are not limited to: changes in the confectionery business environment, seasonality, consumer interest in our products, general economic conditions, the success of U-Swirl, Inc., receptiveness of our products internationally, consumer trends, costs and availability of raw materials, competition, the success of our co-branding strategy 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 our Annual Report on Form 10-K for the fiscal year ended February 28, 2014 which can be viewed at the SEC’s website at www.sec.gov or through our website at www.rmcf.com. These forward-looking statements apply only as of the date of this report. Readers are cautioned not to place undue reliance on the forward-looking statements in this Quarterly Report on Form 10-Q. Except as required by law, we are not obligated to release publicly any revisions to these forward-looking statements that might reflect events or circumstances occurring after the date of this 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. and its consolidated subsidiaries, which includes its 39% owned subsidiary, U-Swirl, Inc.

 

Overview

 

We are a product-based international franchisor, confectionery manufacturer and retail operator. Our revenues and profitability are derived principally from our franchised/licensed system of retail stores that feature chocolate, frozen yogurt, and other confectionery products. We also sell our candy in selected locations outside our system of retail stores and license the use of our brand with certain consumer products. We own and operate fourteen retail units as a laboratory to test marketing, design and operational initiatives.

 

The most important factors in continued growth in our earnings are ongoing unit growth, increased same-store sales and increased same-store pounds purchased from the factory. Historically, unit growth has more than offset decreases in same-store sales and same-store pounds purchased.

 

Our ability to successfully achieve expansion of our Rocky Mountain Chocolate Factory and frozen yogurt franchise systems depends on many factors not within our control, including the availability of suitable sites for new store establishment, the availability of adequate financing options and the availability of qualified franchisees to support such expansion.

 

Efforts to reverse the decline in same-store pounds purchased from the factory by franchised stores and to increase total factory sales depend on many factors, including new store openings, same-store sales, and the receptivity of our franchise system to our product introductions and promotional programs.

 

In January 2013, we, through a newly formed wholly-owned subsidiary of the Company (“Newco”), entered into an agreement to acquire substantially all of the assets of YHI, Inc. and Yogurtini International, LLC (collectively, “Yogurtini”), which are the franchisors of self-serve frozen yogurt retail units branded as “Yogurtini.” In addition, in January 2013, we entered into two agreements to sell all of our membership interests in Newco and substantially all of our assets in Aspen Leaf Yogurt, LLC to U-Swirl, Inc. (“U-Swirl”), a publicly traded company (OTCQB: SWRL), in exchange for a 60% controlling equity interest in U-Swirl. Upon completion of these transactions, we ceased to operate any Company-owned Aspen Leaf Yogurt locations or sell and support franchise locations. U-Swirl is in the business of offering consumers frozen desserts such as yogurt and sorbet. U-Swirl launched a national chain of self-serve frozen yogurt cafés called U-Swirl Frozen Yogurt and is franchising this concept. U-Swirl has built and operates cafés owned and operated by U-Swirl and franchises to others the right to own and operate U-Swirl cafés. In January 2014 and February 2014, U-Swirl acquired the franchise systems of self-serve frozen yogurt retail units branded as “CherryBerry,” “Yogli Mogli Frozen Yogurt” and “Fuzzy Peach Frozen Yogurt.” U-Swirl also acquired self-serve frozen yogurt retail units branded as “Josie’s Frozen Yogurt.” As of November 30, 2014, we own approximately 39% of U-Swirl’s outstanding common stock, and the results of U-Swirl are consolidated in our results.

 

 

On November 10, 2014, we entered into an Agreement and Plan of Merger (the “Reorganization Agreement”) with Rocky Mountain Chocolate Factory, Inc., a Delaware corporation and wholly-owned subsidiary of the Company (“Newco”) and RKB Merger Corp., a Colorado corporation and wholly-owned subsidiary of Newco (“MergerCo”), pursuant to which our organizational structure would be reorganized into a holding company structure. Pursuant to the Reorganization Agreement, the Company will merge with MergerCo, with the Company surviving as a wholly-owned subsidiary of Newco (the “Reorganization”). Upon completion of the Reorganization, Newco, a Delaware corporation, would, in effect, replace the Company, a Colorado corporation, as the publicly held corporation traded on the NASDAQ Global Select Market under the symbol “RMCF”, and the holders of the Company’s common stock would hold the same number of shares and same ownership percentage of Newco after the Reorganization as they held of the Company immediately prior to the Reorganization. The Reorganization is subject to shareholder approval at the upcoming annual meeting of shareholders to be held on February 19, 2015. If approved by the Company’s shareholders, we expect that the Reorganization would be completed on or about March 1, 2015. If the Reorganization is completed, we will be subject to a Delaware franchise tax of approximately $99,000 per year.

 

Results of Operations

 

Three Months Ended November 30, 2014 Compared to the Three Months Ended November 30, 2013

 

Basic earnings per share increased 45.5% from $.11 in the three months ended November 30, 2013 to $.16 in the three months ended November 30, 2014. Revenues increased 13.8% from $9.3 million in the three months ended November 30, 2013 to $10.6 million in the three months ended November 30, 2014. Operating income increased 54.7% from $1.0 million in the three months ended November 30, 2013 to $1.6 million in the three months ended November 30, 2014. Net income increased 37.6% from $699,000 in the three months ended November 30, 2013 to $962,000 in the three months ended November 30, 2014. The increase in revenues, operating income and net income was primarily the result of an increase in factory sales, an increase in royalty and marketing fees resulting from the U-Swirl acquisition of franchise rights in fiscal year 2014 and an increase in franchise fees as a result of international license agreements.

 

Revenues		Three Months Ended
		November 30,								$				%
($’s in thousands)		2014				2013				Change				Change
Factory sales		$	7,537.6			$	6,622.1			$	915.5				13.8	%
Retail sales			1,046.3				1,179.2				( 132.9	)			(11.3%	)
Franchise fees			275.1				52.7				222.4				422.0	%
Royalty and Marketing fees			1,702.6				1,426.0				276.6				19.4	%
Total		$	10,561.6			$	9,280.0			$	1,281.6				13.8	%

 

Factory Sales

 

The increase in factory sales for the three months ended November 30, 2014 versus the three months ended November 30, 2013 was primarily due to a 105.4% increase in shipments of product to customers outside our network of franchise retail locations and a 0.3% increase in same-store pounds purchased by our network of domestic franchised stores, partially offset by a 5.1% decrease in shipments to our system of franchise retail locations, the result of a 5.8% decline in domestic Rocky Mountain Chocolate Factory units in operation. Same store sales at domestic Rocky Mountain Chocolate Factory locations increased 1.9% in the three months ended November 30, 2014, compared with the three months ended November 30, 2013.

 

Retail Sales

 

The decrease in retail sales was primarily due to increased performance of Company-owned locations acquired or commencing operation during the prior fiscal year offset by the closure or sales of certain under-performing locations. Same store sales at Company-owned stores increased 2.8% in the three months ended November 30, 2014 compared to the three months ended November 30, 2013.

 

Royalties, Marketing Fees and Franchise Fees

 

The increase in royalties and marketing fees from the three months ended November 30, 2013 to the three months ended November 30, 2014 resulted from a 60.7% increase in domestic franchise stores in operation from the three months ended November 30, 2013 compared to the three months ended November 30, 2014, primarily as a result of U-Swirl’s acquisition of CherryBerry, Yogli Mogli and Fuzzy Peach franchise systems in January 2014 and February 2014 and the associated increase in franchise revenues due to such acquisitions. This increase was partially offset by a decrease in the number of domestic Rocky Mountain Chocolate Factory franchises in operation. The average number of domestic Rocky Mountain Chocolate Factory franchise stores in operation decreased from 223 in the three months ended November 30, 2013 to 210 during the three months ended November 30, 2014. Franchise fees increased 422% during the three months ended November 30, 2014 compared to the three months ended November 30, 2013. This increase in franchise fees was the result of the execution of two international master license agreements in the three months ended November 30, 2014 compared with no master license agreements in the three months ended November 30, 2013.

 

 

Costs and Expenses		Three Months Ended
		November 30,								$				%
($’s in thousands)		2014				2013				Change				Change
Cost of sales – factory adjusted		$	5,134.6			$	4,582.1			$	552.5				12.1	%
Cost of sales - retail			393.3				479.5				( 86.2	)			(18.0	%)
Franchise costs			558.6				510.1				48.5				9.5	%
Sales and marketing			608.5				555.8				52.7				9.5	%
General and administrative			1,230.5				1,146.2				84.3				7.4	%
Retail operating			724.6				803.4				( 78.8	)			(9.8	%)
Total		$	8,650.1			$	8,077.1			$	573.0				7.1	%

 

Adjusted Gross Margin		Three Months Ended
		November 30,								$				%
($’s in thousands)		2014				2013				Change				Change
Factory adjusted gross margin		$	2,403.0			$	2,040.0			$	363.0				17.8	%
Retail			653.0				699.7				( 46.7	)			(6.7	%)
Total		$	3,056.0			$	2,739.7			$	316.3				11.5	%

 

 

Adjusted Gross Margin		Three Months Ended
		November 30,								%				%
		2014				2013				Change				Change
(Percent)
Factory adjusted gross margin			31.9	%			30.8	%			1.1	%			3.6	%
Retail			62.4	%			59.3	%			3.1	%			5.2	%
Total			35.6	%			35.1	%			0.5	%			1.4	%

 

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 minus 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. The following table provides a reconciliation of factory adjusted gross margin to factory gross margin, the most comparable performance measure under GAAP:

 

		Three Months Ended
		November 30,
($’s in thousands)		2014				2013
Factory adjusted gross margin		$	2,403.0			$	2,040.0
Less: Depreciation and Amortization			102.2				73.8
Factory GAAP gross margin		$	2,300.8			$	1,966.2

 

Cost of Sales

 

Factory margins increased 110 basis points in the three months ended November 30, 2014 compared to the three months ended November 30, 2013 due primarily to a shift in product mix to higher margins products and a decrease in transportation costs, partially offset by the increased costs of certain raw materials. The decrease in Company-owned store margin is due primarily to the increase in U-Swirl units in operation during the previously year and associated lower margins at U-Swirl units during the three months ended November 30, 2014.

 

 

Franchise Costs

 

Franchise costs increased 9.5% in the three months ended November 30, 2014 compared to the three months ended November 30, 2013 due primarily to an increase in franchise costs associated with supporting the additional U-Swirl franchise units acquired through business acquisitions in the prior year. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 28.2% in the three months ended November 30, 2014 from 34.5% in the three months ended November 30, 2013. This decrease is primarily a result of higher franchise and royalty revenues during the three months ended November 30, 2014.

 

Sales and Marketing

 

The increase in sales and marketing costs for the three months ended November 30, 2014 compared to the three months ended November 30, 2013 is primarily due to an increase in marketing costs associated with the increased U-Swirl franchise locations.

 

General and Administrative

 

The increase in general and administrative costs for the three months ended November 30, 2014 compared to the three months ended November 30, 2013 is due primarily to the consolidation of U-Swirl general and administrative costs. For the three months ended November 30, 2014, approximately $391,000 of U-Swirl general and administrative costs were consolidated within our results, compared with $316,000 in the three months ended November 30, 2013. As a percentage of total revenues, general and administrative expenses decreased to 11.7% in the three months ended November 30, 2014 compared to 12.4% in the three months ended November 30, 2013.

 

Retail Operating Expenses

 

The decrease in retail operating expense was primarily due to a decrease in the average number of Company-owned stores in operation. The average number of Company-owned stores in operation decreased from 18 during the three months ended November 30, 2013 to 14 units in the three months ended November 30, 2014 as a result of the closing or sale of Company-owned stores. Retail operating expenses, as a percentage of retail sales, increased from 68.1% in the three months ended November 30, 2013 to 69.3% in the three months ended November 30, 2014. This increase is primarily the result of the change in units in operation from the prior year.

 

Depreciation and Amortization

 

Depreciation and amortization of $358,000 in the three months ended November 30, 2014 increased 80.3% from $198,000 incurred in the three months ended November 30, 2013. This increase was the result of additional factory assets in service and an increase in amortization related to intangible assets acquired in the prior fiscal year.

 

Other Income

 

Net interest expense was $44,500 in the three months ended November 30, 2014 compared to net interest income of $16,700 realized in the three months ended November 30, 2013. This change was the result of increased interest expense associated with a promissory note entered into in January 2014 to fund business acquisitions.

 

Income Tax Expense

 

Our effective income tax rate for the three months ended November 30, 2014 was 36.7%, compared to 39.8% for the three months ended November 30, 2013. The decrease of 3.1% was primarily the result of the consolidation of a lower U-Swirl net operating loss. During the three months ended November 30, 2014 and November 30, 2013 there was no income tax benefit recognized on the U-Swirl net loss. U-Swirl has significant net operating loss carryovers. In accordance with Section 382 of the Internal Revenue Code, deductibility of U-Swirl’s U.S. net operating loss carryovers may be subject to annual limitation in the event of a change in control. We have performed a preliminary evaluation as to whether a change in control has taken place, and have concluded that there was a change of control with respect to the net operating losses of U-Swirl when the Company acquired a 60% ownership interest in January 2013. Our effective income tax rate may increase in future periods, or for the full year as a result of estimates related to the income tax liability arising from the income before income taxes of U-Swirl.

 

Nine Months Ended November 30, 2014 Compared to the Nine Months Ended November 30, 2013

 

Basic earnings per share decreased 14.6% from $.48 for the nine months ended November 30, 2013 to $.41 for the nine months ended November 30, 2014. Revenues increased 7.9% to $30.3 million for the nine months ended November 30, 2014 compared to $28.1 million in the nine months ended November 30, 2013. Operating income decreased 1.9% from $4.4 million in the nine months ended November 30, 2013 to $4.3 million in the nine months ended November 30, 2014. Net income decreased 12.2% from $2.9 million in the nine months ended November 30, 2013 to $2.6 million in the nine months ended November 30, 2014. The decrease in operating income and net income was due primarily to restructuring and acquisition related charges associated with the restructuring and business acquisitions of U-Swirl.

 

 

Revenues		Nine Months Ended
		November 30,								$				%
($’s in thousands)		2014				2013				Change				Change
Factory sales		$	18,183.6			$	17,703.7			$	479.9				2.7	%
Retail sales			4,925.0				4,962.4				( 37.4	)			(0.8%	)
Franchise fees			480.4				390.9				89.5				22.9	%
Royalty and marketing fees			6,752.2				5,064.0				1,688.2				33.3	%
Total		$	30,341.2			$	28,121.0			$	2,220.2				7.9	%

 

Factory Sales

 

The increase in factory sales for the nine months ended November 30, 2014 versus the nine months ended November 30, 2013 was primarily due to a 33.2% increase in shipments of product to customers outside our network of franchised retail stores, partially offset by a 2.1% decrease in same-store pounds purchased by our network of franchised stores and a 6.2% decrease in the average number of domestic Rocky Mountain Chocolate Factory franchised stores in operation.

 

Retail Sales

 

The decrease in retail sales was primarily due to increased performance of Company-owned locations acquired or commencing operation during the prior fiscal year, offset by the closure or sale of certain under-performing locations. Same store sales at all Company-owned stores and cafés decreased 0.2% in the nine months ended November 30, 2014 compared to the nine months ended November 30, 2013.

 

Royalties, Marketing Fees and Franchise Fees

 

The increase in royalties and marketing fees from the nine months ended November 30, 2013 to the nine months ended November 30, 2014 resulted from a 61.2% increase in domestic franchise stores in operation from the nine months ended November 30, 2013 compared to the nine months ended November 30, 2014, primarily as a result of U-Swirl’s acquisition of CherryBerry, Yogli Mogli and Fuzzy Peach franchise systems in January 2014 and February 2014 and the associated increase in franchise revenues due to such acquisitions. This increase was partially offset by a decrease in the number of domestic Rocky Mountain Chocolate Factory franchises in operation. The average number of domestic Rocky Mountain Chocolate Factory franchise stores in operation decreased from 225 in the nine months ended November 30, 2013 to 211 during the nine months ended November 30, 2014. Franchise fee revenues increased as a result of the sale of three Company-owned U-Swirl Cafés and the associated franchise fees recognized in the nine months ended November 30, 2014 and no sales of Company-owned cafés and similar fees being recognized in the nine months ended November 30, 2013.

 

Costs and Expenses		Nine Months Ended
		November 30,								$				%
($’s in thousands)		2014				2013				Change				Change
Cost of sales – factory adjusted		$	12,530.5			$	12,036.8			$	493.7				4.1	%
Cost of sales - retail			1,698.5				1,752.9				( 54.4	)			(3.1	%)
Franchise costs			1,623.5				1,508.6				114.9				7.6	%
Sales and marketing			1,838.4				1,524.0				314.4				20.6	%
General and administrative			3,817.0				3,625.0				192.0				5.3	%
Retail operating			2,697.2				2,588.3				108.9				4.2	%
Total		$	24,205.1			$	23,035.6			$	1,169.5				5.1	%

 

Adjusted gross margin		Nine Months Ended
		November 30,								$				%
($’s in thousands)		2014				2013				Change				Change
Factory adjusted gross margin		$	5,653.1			$	5,666.9			$	( 13.8	)			(0.2%	)
Retail			3,226.5				3,209.5				17.0				0.5	%
Total		$	8,879.6			$	8,876.4			$	3.2				0.0	%

 

 

Adjusted Gross Margin		Nine Months Ended
		November 30,								%				%
		2014				2013				Change				Change
(Percent)
Factory adjusted gross margin			31.1	%			32.0	%			(0.9%	)			(2.8%	)
Retail			65.5	%			64.7	%			0.8	%			1.2	%
Total			38.4	%			39.2	%			(0.8%	)			(2.0%	)

 

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 minus 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. The following table provides a reconciliation of factory adjusted gross margin to factory gross margin, the most comparable performance measure under GAAP:

 

		Nine Months Ended
		November 30,
($’s in thousands)		2014				2013
Factory adjusted gross margin		$	5,653.1			$	5,666.9
Less: Depreciation and Amortization			292.6				218.2
Factory GAAP gross margin		$	5,360.5			$	5,448.7

 

Costs and Expenses

 

Cost of Sales

 

Factory margins decreased 90 basis points in the nine months ended November 30, 2014 compared to the nine months ended November 30, 2013 due primarily to the increased costs of certain raw materials and a decline in manufacturing efficiencies associated with 2.3% lower production volume in the nine months ended November 30, 2014 compared to the nine months ended November 30, 2013. Company-owned store margins increased 80 basis points in the nine months ended November 30, 2014 compared to the nine months ended November 30, 2013.

 

Franchise Costs

 

The increase in franchise costs in the nine months ended November 30, 2014 versus the nine months ended November 30, 2013 is due primarily to an increase in franchise costs associated with supporting the additional U-Swirl franchise units acquired through business acquisitions in the prior year. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 22.4% in the nine months ended November 30, 2014 from 27.7% in the nine months ended November 30, 2013. This decrease as a percentage of royalty, marketing and franchise fees is primarily a result of higher franchise and royalty revenues.

 

Sales and Marketing

 

The increase in sales and marketing costs for the nine months ended November 30, 2014 compared to the nine months ended November 30, 2013 is primarily due to an increase in marketing costs associated with the increased U-Swirl franchise locations compared to the prior year.

 

General and Administrative

 

The increase in general and administrative costs for the nine months ended November 30, 2014 compared to the nine months ended November 30, 2013 is due primarily to the consolidation of U-Swirl’s general and administrative costs and an increase in compensation related expenses. For the nine months ended November 30, 2014, approximately $1,378,700 of U-Swirl general and administrative costs were consolidated within our results, compared with $1,031,000 in the nine months ended November 30, 2013. As a percentage of total revenues, general and administrative expenses decreased to 12.6% in the nine months ended November 30, 2014 compared to 12.9% in the same period of the prior year.

 

 

Retail Operating Expenses

 

The increase in retail operating expenses for the nine months ended November 30, 2014 compared to the nine months ended November 30, 2013 was due primarily to changes in units in operation, resulting from the acquisition of six Company-owned locations in the prior year. This increase was offset by the closure of five underperforming locations in the prior year and the sale of four Company-owned locations in the nine months ended November 30, 2014. Retail operating expenses, as a percentage of retail sales, increased from 52.2% in the nine months ended November 30, 2013 to 54.8% in the nine months ended November 30, 2014.

 

Depreciation and Amortization

 

Depreciation and amortization of $1,097,000 in the nine months ended November 30, 2014 increased 63.7% from $670,000 incurred in the nine months ended November 30, 2013 due to additional depreciable assets in service. This increase was the result of additional factory assets in service and an increase in amortization related to intangible assets acquired in the prior fiscal year.

 

Other Income

 

Net interest expense was $140,000 in the nine months ended November 30, 2014 compared to net interest income of $44,000 realized in the nine months ended November 30, 2013. This change was the result of an increase in outstanding debt from a promissory note entered into in January 2014 to fund business acquisitions.

 

Income Tax Expense

 

Our effective income tax rate for the nine months ended November 30, 2014 was 32.7%, compared to 33.7% for the nine months ended November 30, 2013. The decrease of 1.0% was primarily the result of the consolidation of the U-Swirl, Inc. net operating income and associated provision for income taxes. U-Swirl, Inc. has significant net operating loss carryovers and no income tax expense was recognized in the nine months ended November 30, 2014 or November 30, 2013. In accordance with Section 382 of the Internal Revenue Code, deductibility of U-Swirl, Inc.’s U.S. net operating loss carryovers may be subject to annual limitation in the event of a change in control. We have performed a preliminary evaluation as to whether a change in control has taken place, and have concluded that there was a change of control with respect to the net operating losses of U-Swirl, Inc. when the Company acquired its 60% ownership interest in January 2013. Our effective income tax rate may increase in future periods, or for the full year as a result of estimates related to the income tax liability arising from the income before income taxes of U-Swirl, Inc.

 

Liquidity and Capital Resources

 

As of November 30, 2014, working capital was $10.5 million, compared with $9.0 million as of February 28, 2014, an increase of $1.5 million. The change in working capital was due primarily to operating results less the payment of dividends, an increase in notes receivable and the purchase of equipment.

 

Cash and cash equivalent balances increased $2.0 million from $5.86 million as of February 28, 2014 to $7.86 million as of November 30, 2014 as a result of cash flow generated by operating activities. Net cash provided by operating activities increased from $1.58 million during the nine months ended November 30, 2013 to $4.49 million in the nine months November 30, 2014. This increase was primarily the result of a greater reduction in accounts receivable and lower accounts payable and accrued liabilities at February 28, 2014 compared to February 28, 2013. Our current ratio was 2.2 to 1 at November 30, 2014 in comparison with 2.1 to 1 at February 28, 2014. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.

 

We have a $5.0 million (no amount was outstanding as of November 30, 2014) working capital line of credit collateralized by substantially all of our assets with the exception of our retail store assets. Additionally, the line of credit is subject to various financial ratio and leverage covenants. As of November 30, 2014, we were in compliance with all such covenants. The line is subject to renewal on July 31, 2015.

 

The Company’s current long-term debt is comprised of a promissory note used to finance the Company’s business acquisitions (unpaid balance as of November 30, 2014 was $6.4 million. The note allows the Company 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%. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of November 30, 2014, we were in compliance with all such covenants.

 

We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations at least through the end of fiscal 2015.

 

 

Stock Repurchase Plan Authorizations

 

We continue to evaluate options to maximize the returns on our cash and maintain an appropriate capital structure, including, among other alternatives, repurchases of our common stock. In July 2015, our Board of Directors authorized the repurchase up to $3.0 million of our common stock. The number, price, structure and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs and other factors. Share repurchases may be made in the open market, block trades or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.

 

Between July 15, 2014 and July 31, 2014, we repurchased 55,000 shares under the repurchase plan at an average price of $12.58 per share. Between September 26, 2014 and November 30, 2014, we repurchased 99,511 shares under the repurchase plan at an average price of $12.19 per share. As of November 30, 2014, approximately $1,095,200 remains available under the repurchase plan for further stock repurchases.

 

New Accounting Pronouncements

 

In May 2014, FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers,” which supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605),” and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and is to be applied retrospectively, with early application not permitted. The Company is currently evaluating the new standard.

 

In August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements—Going Concern.” This guidance requires management to evaluate whether there are conditions or events that raise substantial doubt about an entity's ability to continue as a going concern. If such conditions or events exist, disclosures are required that enable users of the financial statements to understand the nature of the conditions or events, management's evaluation of the circumstances and management's plans to mitigate the conditions or events that raise substantial doubt about the entity's ability to continue as a going concern. We will be required to perform an annual assessment of our ability to continue as a going concern when this standard becomes effective for us in the first quarter of our fiscal year ended February 28, 2017. The adoption of this guidance is not expected to impact our financial position, results, operations or cash flows.

 

Off-Balance Sheet Arrangements

 

As of November 30, 2014, we had no off-balance sheet arrangements or obligations.

 

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 confectionary products have occurred during the Christmas holiday through Mother’s Day. We believe the strongest sales of frozen yogurt products will occur during the summer months. 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 November 30, 2014, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in a $22,000 favorable or unfavorable price benefit or cost, respectively, resulting from our purchase contracts.

 

We have a $5.0 million bank line of credit that bears interest at a variable rate. As of November 30, 2014, 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 credit facility.

 

We have a $7.0 million promissory note with interest at a fixed rate or 3.75% annually. As of November 30, 2014, $6.4 million was outstanding under the note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.

 

 

Item 4.     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 Securities Exchange Act of 1934 (the “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 SEC’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.

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Exchange Act. Based upon this evaluation as of November 30, 2014, our management has concluded that those disclosure controls and procedures are effective.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting that occurred during the quarter ended November 30, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II.     OTHER INFORMATION

 

Item 1.     Legal Proceedings

 

We are not currently involved in any material legal proceedings other than routine litigation incidental to our business.

 

Item 1A.     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, 2014. 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, 2014.

 

Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds

 

Issuer Purchases of Equity Securities

 

Period		Total Number of Shares (or Units) Purchased (1)				Average Price Paid per Share (or Unit) (1)				Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs (1)				Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs (1)
September 1, 2014-September 30, 2014			23,000			$	12.47				23,000			$	2,021,300
October 1, 2014-October 31, 2014			49,800			$	11.97				49,800			$	1,424,900
November 1, 2014-November 30, 2014			26,711			$	12.35				26,711			$	1,095,200
Total			99,511			$	12.19				99,511			$	1,095,200

 

---

(1)

On July 15, 2014, we announced that our Board of Directors had approved the repurchase of up to $3.0 million shares of our common stock. Between September 1, 2014 and November 30, 2014, we repurchased 99,511 shares under the repurchase plan at an average price of $12.19. The number, price, structure and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs and other factors. The stock repurchases may be made in the open market, block trades or privately negotiated transactions. The primary purpose of the share repurchase program is to allow us the flexibility to repurchase our common stock to return value to stockholders.  The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock.  Our Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.

 

 

Item 3.     Defaults Upon Senior Securities

 

None.

 

Item 4.     Mine Safety Disclosures

 

Not Applicable.

 

Item 5.     Other Information

 

None.

 

 

Item 6.     Exhibits

 

2.1

Agreement and Plan of Merger, dated November 10, 2014, among Rocky Mountain Chocolate Factory, Inc., Colorado corporation, Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, and RKB Merger Corp. (incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K of the Registrant filed on November 10, 2014)

 

3.1

Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Annual Report on Form 10-K of the Registrant for the year ended February 28, 2009)

 

3.2

Articles of Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of the Registrant filed on May 22, 2009)

 

3.3

Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of the Registrant filed on December 14, 2007)

 

10.1

Stock Purchase Agreement, dated October 28, 2014, between Rocky Mountain Chocolate Factory, Inc. and Franklin E. Crail (incorporated by reference to Exhibit 99.1 to the Current Report on Form 8-K of the Registrant filed on October 28, 2014)

 

31.1*

Certification of Chief Executive Officer Filed Pursuant To Section 302 of The Sarbanes-Oxley Act of 2002

 

31.2*

Certification of Chief Financial Officer Filed Pursuant To Section 302 of The Sarbanes-Oxley Act of 2002

 

32.1**

Certification of Chief Executive Officer Furnished Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002

 

32.2**

Certification of Chief Financial Officer Furnished Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002

 

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.          

 

 

 

Signatures

 

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: January 14, 2015		/s/ Bryan J. Merryman
		Bryan J. Merryman, Chief Operating Officer,
		Chief Financial Officer, Treasurer and Director

 

 

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