Attached files
| file | filename |
|---|---|
| EX-32.2 - EXHIBIT 32.2 - CREATIVE LEARNING Corp | s108511_ex32-2.htm |
| EX-32.1 - EXHIBIT 32.1 - CREATIVE LEARNING Corp | s108511_ex32-1.htm |
| EX-31.2 - EXHIBIT 31.2 - CREATIVE LEARNING Corp | s108511_ex31-2.htm |
| EX-31.1 - EXHIBIT 31.1 - CREATIVE LEARNING Corp | s108511_ex31-1.htm |
| EX-21 - EXHIBIT 21 - CREATIVE LEARNING Corp | s108511_ex21.htm |
| EX-10.2 - EXHIBIT 10.2 - CREATIVE LEARNING Corp | s108511_ex10-2.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
| ☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the fiscal year ended September 30, 2017 |
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number: 000-52883
CREATIVE LEARNING CORPORATION
| Delaware | 20-4456503 | |
| (State or other jurisdiction of | (I.R.S. Employer | |
| incorporation or organization) | Identification Number) |
701 Market Street, Suite 113
St. Augustine, FL 32095
(904) 824-3133
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.0001 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☒.
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐
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 or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| 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 provided 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 ☒.
As of December 15, 2017, the aggregate market value of the common stock held by nonaffiliates of the registrant, based on the $0.15 closing price of the registrant’s common stock as reported on the OTC bulletin board on that date, was approximately $1.8 million. For purposes of this computation, all officers, directors and 10% beneficial owners of the registrant are deemed to be affiliates. Such determination should not be deemed to be an admission that such officers, directors or 10% beneficial owners are, in fact, affiliates of the registrant.
At December 12, 2017, there are 12,075,875 shares of common stock of the registrant outstanding.
TABLE OF CONTENTS
i
Unless the context otherwise requires, when we use the words the “Company,” “Creative Learning,” “CLC” “we,” “us,” “our” or “our Company” in this Form 10-K, we are referring to Creative Learning Corporation, a Delaware corporation, and its subsidiaries.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K (the “Report”) includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements can be identified by the use of forward-looking terminology, including the words “believes,” “estimates,” “anticipates,” “expects,” “intends,” “plans,” “may,” “will,” “potential,” “projects,” “predicts,” “continue,” or “should,” or, in each case, their negative or other variations or comparable terminology. There can be no assurance that actual results will not materially differ from expectations. You should read statements that contain these words carefully because they:
| ● | discuss future expectations; |
| ● | contain projections of future results of operations or financial condition; or |
| ● | state other “forward-looking” information. |
We believe it is important to communicate our expectations to our stockholders. However, there may be events in the future that we are not able to accurately predict or over which we have no control. The risk factors and cautionary language discussed in this Form 10-K provide examples of risks, uncertainties and events that may cause actual results to differ materially from the expectations described by us in our forward-looking statements, including among other things:
| ● | the operating and financial results of and our relationships with our franchisees; |
| ● | actions taken by our franchisees that may harm our business; |
| ● | incidents that may impair the value of our brand; |
| ● | our failure to successfully implement our growth strategy; |
| ● | changing economic conditions; |
| ● | our need for additional financing; |
| ● | risks associated with our franchisees; |
| ● | litigation and regulatory issues; and |
| ● | our failure to comply with current or future laws or regulations. |
You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Form 10-K. Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual future results to differ materially from those projected or contemplated in the forward-looking statements.
All forward-looking statements included herein attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to above. Except to the extent required by applicable laws and regulations, we undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events. You should be aware that the occurrence of the events described in the “Risk Factors” section and elsewhere in this Form 10-K could have a material adverse effect on us.
ii
Creative Learning Corporation, operating under the trade names of Bricks 4 Kidz® and Sew Fun Studios®, offers educational and enrichment programs to children ages 3 to 13+ through its franchisees. The Company’s business model is to sell franchise territories and collect a one-time franchise fee, renewal fees and monthly royalty fees from each territory. Through the Company’s franchise business model, which includes a proprietary curriculum and marketing strategy plus a proprietary franchise management tool, the Company provides a wide variety of programs designed to enhance students’ problem solving and critical thinking skills. At September 30, 2017, the Company had 531 Bricks 4 Kidz® and Sew Fun Studios® franchises, 30 Bricks 4 Kidz® master franchises, and 91 Bricks 4 Kidz® sub-franchises operating in 44 countries.
Company Background
The Company was formed in March 2006 under the name B2 Health, Inc. to design, manufacture and sell chiropractic tables and beds. The Company generated only limited revenue and essentially abandoned its business plan in March 2008. In July 2010, the Company’s name was changed to Creative Learning Corporation.
On July 2, 2010, the Company acquired BFK Franchise Company, LLC (“BFK”), a Nevada limited liability company formed in May 2009, under a Stock Exchange Agreement with the members of BFK for 9,000,000 shares of the Company’s common stock. BFK offers a franchise concept known as Bricks 4 Kidz®, a mobile business operated by franchisees within a specific geographic territory offering project-based programs designed to teach principles and methods of engineering to children ages 3-13+. BFK began selling franchises in July 2009.
On January 26, 2015 the Company formed SF Franchise Company, LLC (“SF”) for the purpose of offering a third franchise concept known as Sew Fun Studios®. Sew Fun Studios® is a mobile business operated by franchisees within a specific geographic territory offering creative project-based activities, classes, and programs in fashion and interior design and sewing to children and adults.
BFK
BFK franchises, which conduct business under the trade name BRICKS 4 KIDZ®, offer programs designed to teach principles and methods of engineering to children between the ages of 3 and 13 using LEGO® plastic bricks and other LEGO® products through classes, field trips, and other organized activities that are designed to enhance and enrich the traditional school curriculum, trigger young children’s lively imaginations and build self-confidence. BFK’s programs foster creativity and provide a unique atmosphere for students to develop problem-solving and critical-thinking skills by designing and building machines, catapults, pyramids, race cars, buildings and numerous other systems and devices using LEGO® bricks and other LEGO® products. The Company may provide training and corporate franchisee support to all franchisees and recognizes revenue from the sale of its franchises when all initial training, pursuant to the terms of the franchise agreements, is completed.
BFK franchises are mobile models, with activities scheduled in locations such as preschools, elementary and middle schools, camps, birthday parties, community centers and churches.
1
At September 30, 2017, BFK had 519 franchise territories, 30 master franchises, and 91 sub-franchises operating in 41 states, the District of Columbia, Puerto Rico, and 44 foreign countries. The following table details franchise activity:
BFK
| Franchise Territories | ||||
| September 30, 2015 | 679 | |||
| Additions | 19 | |||
| Terminations and non-renewals | — | |||
| September 30, 2016 | 698 | |||
| Additions | 22 | |||
| Terminations and non-renewals | 80 | |||
| September 30, 2017 | 640 |
Current BFK Programs
In-school workshops. One-hour classes during school hours. Classes are correlated to the typical science curriculum for a particular grade level. Teacher guides, student worksheets, and step-by-step instruction are provided.
After-school classes. One hour, one day a week class held after school.
Pre-school classes. Classes can be held in pre-schools for children of pre-school ages.
Classes for home-schooled children. Classes can be held in the home of one of the parents of a home-schooled child.
Camps. Normally three hours per day for five days. Camps can take place at schools or at other child-related venues. Children use LEGO® bricks to explore various science and math concepts while working in an open, friendly environment. The material covered each session varies depending on students’ ages, experience, and skill level. A new project is built each week. Architectural concepts are taught while assembling buildings, castles and other structures. Instructional content includes concepts of friction, gravity and torque, scale, gears, axles and beams. The children work and play with programmable LEGO® bricks along with electric motors, sensors, system bricks, and LEGO® Technic pieces (i.e. gears, axles, and beams).
Birthday parties. In the home of the birthday child.
Special events. Activities with LEGO® bricks can be held in various locations including church centers, lodges, child-related venues, private schools, pre-schools, etc. Program can include parents, grandparents and all children in the family.
BFK Franchise Program
BKF sells franchises both domestically and internationally. International sales can be a single franchise or a master franchise, where the master franchisee operates a franchise in the territory, and is also able to develop, sell and manage sub-franchises in the territory under the master franchise agreement. BFK does not offer master franchises in the United States.
Under a franchise agreement, a franchisee pays a one-time, non-refundable franchise fee upon the execution of the franchise agreement. Domestically, there can be variations on the franchise fees depending on the size or territories being purchased, and other factors of the territory. The typical-sized, domestic, single territory franchise fee is $25,900. If the franchisee is granted an additional geographic area to increase the size of their territory, then the franchisee must pay an additional fee in the amount of $10,000. If the franchisee is in good standing and is granted a second or additional franchise, then the franchisee must pay a franchise fee in the amount of $18,000 for each additional franchise.
International franchise fees vary and are set relative to the potential of the franchised territories. During the fiscal year ended September 30, 2017, BFK sold three master franchises at an average price of approximately $62,000. In the case of a master franchise, BFK receives a percentage of the franchise fee paid to the master franchisee by any sub-franchisee operating in the master franchisee’s territory.
2
The Company uses a network of franchise advertising and promotion media to contact prospective franchisees. When a potential contact is received, the initial information relating to a buyer is passed to a franchise sales broker or director of business development to initiate contact with the potential new franchisees. The responsibility of the sales broker and/or director of business development is to thoroughly vet the potential franchisee for compatibility with the franchise concept, among other things. As part of the process of vetting potential franchisees, the Company requires all prospective franchisees to complete a Request for Consideration form. Upon completion of the process the sales broker is paid a commission typically ranging from 20% to 30% of the franchise fee while the director of business development commission ranges between 5% to 7%.
The franchisee is granted a limited exclusive territory and a license to use the “Bricks 4 Kidz®” name, trademarks and course materials in the franchised territory. The franchisee is required to conform to certain standards of business practices and comply with all applicable laws. Each franchise is run as an independent business and, as such, is responsible for its operation, including employment of adequate staff.
The term of the franchise is for ten years. Subject to any applicable laws, BFK has the right to terminate any franchisee in the event of the franchisee’s bankruptcy, a default under the franchise agreement, or other events. The franchisee has the right to renew the franchise for an additional ten years if, at the time of renewal, the franchisee is in good standing and pays a renewal fee in the amount of $5,000. The Company was suspended from selling franchises in the United States for a portion of the 2016 fiscal year. The Company had temporarily suspended domestic franchise offers and sales of Bricks 4 Kidz® in compliance with FTC Franchise Rule, Section 436.7(a) due to delay in completion of the Company’s FY2015 consolidated audited financial statements.
Franchise Disclosure Document
Under federal law, the Company is required to (a) prepare a franchise disclosure document (“FDD”) including federally mandated information, (b) provide each prospective franchisee with a copy of the FDD, and (c) wait 14 calendar days before entering into a binding agreement with the prospective franchisee or collecting any payment from any prospective franchisee. Federal law does not regulate the franchise relationship or require any filing or registration of the FDD on the part of a franchisor. The Company is also required to comply with certain state regulations in connection with the offer and sale of franchises, including the requirement of the Company to submit the FDD for registration with a number of states before offering or selling franchises within those states. The states requiring registration of the FDD are: California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington and Wisconsin. In these states, state regulatory agencies review the FDD to confirm compliance with state statutory requirements. These state agencies can deny registration of the FDD if they determine that the FDD fails to meet state statutory requirements. If a state denies the issuance of an effective registration, a franchisor is prohibited from offering or selling franchises in that state. See “Government Regulation” below for more information.
Royalty and Marketing Fees
The Company invoices all applicable franchisees a royalty fee on a monthly basis. Every U.S. franchisee, upon signing a franchise agreement, has authorized and provided the required banking information to allow the electronic collection of all fees. Approximately three days after the invoice has been issued to the franchisee, an ACH draft (automatic deduction from the franchisee bank account) for the royalty fee withdrawal is processed through the Company’s banking system. When the Company changes its royalty structure, existing franchisees maintain their contractual franchise royalty rate unless they agree to amend those rates.
3
Based upon the number of franchise territories owned and the length of time the franchisee has been in operations, historically, domestic and international franchisees were required to pay BFK a royalty fee amounting to 7% of gross receipts reported in the Franchise Management Tool (“FMT”). BFK also received a percentage of royalty payments received by master franchisees from their sub-franchisees. Franchisees were billed monthly for their 7% royalty payments, based upon gross receipts, due to the Company. The franchisees were required to pay the Company a minimum royalty fee per each franchise territory they own. Billing of the minimum royalty fee amount to each franchisee took place every 12 weeks and the minimum amount was calculated by comparing the amounts between the regular royalties billed for the prior 12 weeks to the 12 week minimum royalty payment due to the Company, per the franchise agreement. The 12-week minimum royalty payment due to the Company was $1,500 for the first franchise territory owned (equating to a minimum average fee of $500 per month) and $750 for the second franchise territory owned (equating to a minimum average fee of $250 per month). The minimum amount due for the third franchise territory was $1,500 and the fourth franchise territory was $750. After the end of each 12-week period, franchisees are required to pay to the Company the amount, if any, by which the minimum royalty exceeds the sum of the royalties paid over the 12-week period, per the franchise agreements prior to October 1, 2015.
Beginning October 1, 2015, the Company adopted a flat-fee approach, eliminating the previous approach based upon revenue collections by the franchisee. The Company made the change to a flat-fee approach for a variety of reasons, including without limitation: to better enable franchisees to manage their cash flow; to enrich relations with our franchisees by being responsive to their needs; to facilitate the Company’s ability to collect minimum fees across the board; and to make the Company’s fee structure more attractive to new potential franchisees.
The following is the royalty fee structure:
| Time Period During the Initial Term of Franchise Agreement |
Royalty Fees Amount (U.S. Dollars)
(per month) |
| October 1, 2015 through September 30, 2016 | $400 USD |
| October 1, 2016 through September 30, 2017 | $425 USD |
| October 1, 2017 through September 30, 2018 | $450 USD |
| October 1, 2018 through September 30, 2019 | $475 USD |
| October 1, 2019 and for the remainder of the initial term of the Franchise Agreement | $500 USD |
If any franchisee owns and operates more than one territory, the royalty fees payable to the Company for the second territory and each additional territory shall be as follows:
| Time Period During the Initial Term of Franchise Agreement |
Royalty Fees Amount (U.S. Dollars)
(per month) |
| October 1, 2015 through September 30, 2016 | $200 USD |
| October 1, 2016 through September 30, 2017 | $225 USD |
| October 1, 2017 and for the remainder of the initial term of the Franchise Agreement | $250 USD |
4
On September 30, 2016, the Company implemented a new royalty fee structure for all new franchise sales. Sales in progress were grandfathered in under the previous royalty structure. The new royalty structure is the greater of 7% of gross sales or $500 per month.
Each franchisee has been given the option to amend their franchise agreement contract and elect this new royalty fee structure. Less than 2% of franchisees did not agree to amend their franchise agreements to the new program. Any franchisees which did not elect the new royalty fee structure will remain subject to the historic royalty structure described above.
BFK administers a marketing fund for domestic and Canadian franchisees for the purpose of building brand awareness in their respective countries. The marketing fund expenditures are funded by BFK collecting a 2% marketing fee, based upon gross receipts reported in the FMT, from domestic and Canadian franchisees. The respective franchisees are typically invoiced the middle of each month for the prior month’s receipts. These marketing fee receipts and expenses are accounted for separately and are not reported as revenue or expenses for BFK. The collections of these funds are done using the Company’s ACH program, as agreed to by each franchisee in their Franchise Agreement. The Marketing Fund is segregated into a separate bank account.
BFK Competition
Although BFK pioneered the LEGO® modeling-based curriculum for after school programs, we believe there are at least two other companies franchising a model similar to that of Bricks 4 Kidz®, Engineering 4 Kids and Snapology. In addition, Play-Well Teknologies offers after-school classes, camps and birthday parties using LEGO® bricks. Vision Education and Media offers after school classes using LEGO® bricks in the New York metropolitan area. In addition, several other small businesses around the country offer after-school classes and vacation camps using LEGO® bricks. These classes and camps are typically held in elementary schools, middle schools and community colleges.
Sew Fun Studios
The Company is in the process of revising SF’s form of franchise agreement to address common franchise issues consistent with best practices. SF expects to file state-required initial, amended or renewal franchise materials during the 2nd quarter of fiscal year 2018. Franchises sold under this franchise concept operate businesses offering creative project-based activities, classes and programs in fashion and interior design and sewing to children and adults at locations such as elementary and middle schools, camps, social events, community centers and churches. At September 30, 2017, SF had 12 franchise territories in locations and states that do not require registration. The franchises are in five states and Puerto Rico, as well as one franchisee in each Canada and Ireland. When the Company finalizes the disclosure document and it is accepted by the regulatory states, we expect that general sales of franchises will begin in those regulatory states.
Franchising Process
Initial contact between a potential franchisee and the Company may result from a potential franchisee contacting the Company, either by phone or electronically. Potential franchisees may also be introduced to the Company by brokers and/or other parties, and the Company may pay commissions and consulting fees to the brokers. The Company has discontinued its previous practice of introducing franchisee candidates to third party financing sources to cover franchising expenses, as well as, paying commissions and consulting fees to the Company’s directors and officers. See Item 11, “Executive Compensation — Summary Compensation Table” and Item 13, “Certain Relationships and Related Transactions and Director Independence.”
After initial contact, one of the Company’s franchise consultants and/or internal sales personnel interviews each prospective franchisee (the “candidate”) to determine whether the candidate may make a successful franchisee. If the franchise consultant determines that the candidate may make a successful franchisee, the candidate submits a request for consideration (“RFC”). The Company reviews the RFC, and if the RFC is approved, the franchise consultant continues the vetting process, which focuses on financial and other factors.
5
Upon receipt of the RFC, the candidate is emailed a copy of the Company’s franchise disclosure document. The franchise consultant reviews the franchise disclosure document with the candidate and answers any questions concerning the franchise and the franchise agreement. The Company does not provide projections of a franchise’s financial model or performance to prospective franchisees.
Assuming the candidate has cleared the initial vetting process and remains interested in operating one of the Company’s franchises, the candidate is invited to attend a “discovery day” held at the Company’s headquarters, or in some instances at another location, during which representatives of the Company and the candidate meet face to face. If the Company decides that the candidate meets its objectives for the franchise, the required disclosure waiting period has expired and the candidate wants to move forward and become a franchisee, the parties execute a franchise agreement.
The Company will sell a franchise for a particular territory only when the Company has a reasonable belief that the potential franchisee meets the Company minimum criteria. If a franchisee is not successful, the Company may terminate the franchise agreement by providing notice to the franchisee or repurchasing the franchise from the franchisee. Until the Company provides a notice of termination or repurchases the franchise and terminates the franchise by mutual agreement, the Company considers the franchise to be active.
Government Regulation
The offer and sale of franchises is regulated by the Federal Trade Commission (the “FTC”) and some state governments.
In 1979, the Federal Trade Commission promulgated what became known as the FTC Franchise Rule. The FTC Franchise Rule requires that the franchisor provide a FDD to each prospective franchisee prior to execution of a binding franchise agreement or payment of money by the prospective franchisee. The FTC Franchise Rule does not regulate the franchise relationship or require any filing or registration on the part of a franchisor.
However, the FTC Franchise Rule does not preempt state law and, as a result, states may (and, some have) imposed additional requirements on franchisors. For example, the following states require franchisors (i) to register their franchise offerings (or qualify for an exemption) with the state prior to the offer and sale of franchises in the state, and (ii) subject to certain exemptions, to provide all prospective franchisees with a registered FDD prior to the offer and sale of a franchise in the state: California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington and Wisconsin (the “Franchise Registration States”). The registration process is not uniform in each Franchise Registration State. Most Franchise Registration States require the franchisor to submit an application, which includes a FDD, in order to register to sell franchises within that state. Many, but not all, of the state regulatory agencies in the Franchise Registration States review the franchisor’s registration application, the FDD, the proposed franchise agreement and any other agreements franchisees must sign, the financial condition of the franchisor, and other material information provided by the franchisor in its application. These state agencies have the authority to deny a franchisor’s application for registration and prohibit the franchisor from offering or selling franchises in the state.
In addition, there are numerous states that have laws that regulate the relationship between a franchisor and a franchisee after the sale of the franchise.
Under the FTC Franchise Rule, the FTC has the authority to seek civil penalties against a franchisor for violations of the FTC Franchise Rule. Each of the Franchise Registration States has similar authority to seek penalties for violations of their state franchise registration and disclosure laws. Violations may include offering or selling an unregistered franchise, failing to timely provide the disclosure document to a prospective franchisee or making misrepresentations in the FDDs. Additionally, officers, directors and individuals with management responsibility for the franchisor may have personal liability for violations of franchise laws if they had knowledge of (or should have had knowledge of) or participated in the violations.
6
There is no direct, private right of action for a violation of the FTC Franchise Rule. However, most of the Franchise Registration States provide for a private right of action for a violation of the state’s franchise registration and disclosure law. Remedies available under these laws typically include damages, rescission of the franchise agreement and attorneys’ fees.
On January 29, 2016, the Company had temporarily suspended domestic franchise offers and sales of Bricks 4 Kidz® and Sew Fun Studios® franchises in compliance with FTC Franchise Rule, Section 436.7(a) due to delay in completion of the Company’s fiscal year 2015 consolidated audited financial statements. In turn, this delayed completion of the Company’s 2016 FDDs for the Bricks 4 Kidz® and Sew Fun Studios® franchise offerings. The Company restarted selling efforts of Bricks 4 Kidz in September of 2016. This temporary suspension of domestic franchise offer and sales did not affect the Company’s international franchise offer and sales activity or its royalty fee collections from existing franchisees.
General
The Company’s offices, consisting of approximately 4,500 square feet, are located in an office/condo complex at 701 Market, Suite 113, St. Augustine, FL 32095. The Company owns three of the office condominiums and rents one additional unit.
At September 30, 2017, the Company had 9 employees on a full time basis.
Available Information
We make available free of charge on our Internet website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission, or (the “SEC”). Our corporate website is www.creativelearningcorp.com. The information in this website is not a part of this report.
7
Ownership of our securities involves a high degree of risk. Holders of our securities should carefully consider the following risk factors and the other information contained in this Form 10-K, including our historical financial statements and related notes included herein. The following discussion highlights some of the risks that may affect future operating results. Additional risks and uncertainties not presently known to us, which we currently deem immaterial or which are similar to those faced by other companies in our industry or businesses in general, may also impair our businesses operations. If any of the following risks or uncertainties actually occur, our business, financial condition and operating results could be adversely affected in a material way. This could cause the trading prices of our common stock to decline, perhaps significantly, and you may lose part or all of your investment. Please see “Cautionary Notes Regarding Forward-Looking Statements.”
Risks Related to Our Business
Our revenues decreased in fiscal year 2017 as compared to fiscal year 2016
Our revenues decreased materially in fiscal year 2017 to $2,456,033 from $3,238,359 in the prior year, a decrease of $782,326 or 24%, primarily due to lower Initial franchise sales, as the Company did not sell any new U.S. Franchises during the year and sold less International Franchises than the previous year. We may incur losses in the future and cannot be certain that we can generate sufficient revenues to achieve profitability. Continued losses or decreased revenues may impair our ability to attract new franchisees and maintain positive working relationships with our current franchisees. In addition, if we continue to incur losses, we may need to seek additional financing which could be dilutive to our stockholders.
Our financial results are affected by the operating and financial results of and our relationships with our franchisees.
A substantial portion of our revenues come from royalties, which have been generally based on a percentage of our franchisees’ revenues. As a result, our financial results have been largely dependent upon the operational and financial results of our franchisees. Negative economic conditions, including inflation, increased unemployment levels and the effect of decreased consumer confidence or changes in consumer behavior, could materially harm our franchisees’ financial condition, which would cause our royalty and other revenues to decline and materially and adversely affect our results of operations and financial condition as a result. In addition, if our franchisees fail to renew their franchise agreements, these revenues may decrease, which in turn could materially and adversely affect our results of operations and financial condition. In part to support franchisee growth and financial planning and to enrich relations with our franchisees, the Company altered its royalty fee structure beginning and effective October 1, 2015, changing it to a fixed monthly charge on an escalating scale over five years.
Our franchisees could take actions that harm our business.
Our franchisees are independent third party business owners who are contractually obligated to operate in accordance with the operational and other standards set forth in the franchise agreement. Although we engage in a thorough screening process when reviewing potential franchisee candidates, we cannot be certain that our franchisees will have the business acumen or financial resources necessary to operate successful franchises in their approved territories. In addition, certain state franchise laws may limit our ability to terminate, not renew or modify these franchise agreements. As independent business owners, the franchisees oversee their own daily operations. As a result, the ultimate success and quality of any franchise rests with the franchisee. If franchisees do not successfully operate in a manner consistent with required standards and comply with local laws and regulations, franchise fees and royalties paid to us may be adversely affected and our brand image and reputation could be harmed, which in turn could adversely affect our results of operations and financial condition.
Moreover, although we believe we generally maintain positive working relationships with our franchisees, disputes with franchisees could damage our brand image and reputation and our relationships with our franchisees, generally.
8
Our success depends substantially on the value of our brand.
Our success is substantially dependent upon our ability to maintain and enhance the value of our brand, the customers of our franchisees’ connection to our brand and a positive relationship with our franchisees. Brand value can be severely damaged even by isolated incidents, particularly if the incidents receive considerable negative publicity or result in litigation. Some of these incidents may relate to the way we manage our relationships with our franchisees, our growth strategies, our development efforts or the ordinary course of our, or our franchisees’, businesses. Other incidents that could be damaging to our brand may arise from events that are or may be beyond our ability to control, such as:
| ● | actions taken (or not taken) by one or more franchisees or their employees relating to health, safety, welfare or otherwise; |
| ● | data security breaches or fraudulent activities associated with our and our franchisees’ electronic payment systems; |
| ● | litigation and legal claims; |
| ● | third-party misappropriation, dilution or infringement of our intellectual property; and |
| ● | illegal activity targeted at us or others. |
Consumer demand for our products and services and our brand’s value could diminish significantly if any such incidents or other matters erode consumer confidence in us or our products or services, which would likely result in fewer sales of our products and services and, ultimately, lower royalty revenue, which in turn could materially and adversely affect our results of operations and financial condition.
If we fail to successfully implement our growth strategy, our ability to increase our revenues and net income could be adversely affected.
Our growth strategy relies in large part upon new business development by existing and new franchisees. Our franchisees face many challenges in growing their businesses, including:
| ● | availability and cost of financing; |
| ● | securing required domestic or foreign governmental permits and approvals; |
| ● | trends in new geographic regions and acceptance of our products and services; |
| ● | competition with competing franchise systems; |
| ● | employment, training and retention of qualified personnel; and |
| ● | general economic and business conditions. |
In particular, because the majority of our business development is funded by franchisee investment, our growth strategy is dependent on our franchisees’ (or prospective franchisees’) ability to access funds to finance such development. If our franchisees (or prospective franchisees) are not able to obtain financing at commercially reasonable rates, or at all, they may be unwilling or unable to invest in business development, and our future growth could be adversely affected.
Our growth strategy also relies on our ability to identify, recruit and enter into franchise agreements with a sufficient number of qualified franchisees. In addition, our ability and the ability of our franchisees to successfully expand into new markets may be adversely affected by a lack of awareness or acceptance of our brand as well as a lack of existing marketing efforts and operational execution in these new markets. To the extent that we are unable to implement effective marketing and promotional programs and foster recognition and affinity for our brand in new markets, our franchisees may not perform as expected and our growth may be significantly delayed or impaired. In addition, franchisees may have difficulty securing adequate financing, particularly in new markets, where there may be a lack of adequate history and brand familiarity. Our franchisees’ business development efforts may not be successful, which could materially and adversely affect our business, results of operations and financial condition.
9
Our planned growth could place strains on our management, employees, information systems and internal controls, which may adversely impact our business.
Our planned future growth may place significant demands on our administrative, operational, financial and other resources. Any failure to manage growth effectively could seriously harm our business. To be successful, we will need to continue to implement management information systems and improve our operating, administrative, financial and accounting systems and controls. We will also need to train new employees and maintain close coordination among our executive, accounting, finance, legal, human resources, risk management, marketing, technology, sales and operations functions. These processes are time-consuming and expensive, increase management responsibilities and divert management attention, and we may not realize a return on our investment in these processes. Our failure to successfully execute on our planned expansion could materially and adversely affect our results of operations and financial condition.
Changing economic conditions, including unemployment rates, may reduce demand for our products and services.
Our revenues and other financial results are subject to general economic conditions. Our revenues depend, in part, on the number of dual-income families and working single parents who require child development or educational services. A deterioration of general economic conditions, including a soft housing market and/or rising unemployment, may adversely impact us because of the tendency of out-of-work parents to diminish or discontinue utilization of these services. Finally, there can be no assurance that demographic trends, including the number of dual-income families in the work force, will continue to lead to increased demand for our products and services.
We may require additional financing to execute our business plan and fund our other liquidity needs.
We currently have no revolving credit facility or other committed source of recurring capital. Unless we are able to increase our revenues or decrease our operating expenses from recent historical run-rate levels, we expect that we may need to obtain additional capital during fiscal year 2018 to fund our planned operations. If our cash flows from operations do not meet or exceed our projections, we may need to pursue one or more alternatives, such as to:
| ● | reduce or delay planned capital expenditures or investments in our business; |
| ● | seek additional financing or restructure or refinance all or a portion of our indebtedness at or before maturity; |
| ● | sell assets or businesses; |
| ● | sell additional equity; or |
| ● | curtail our operations. |
Any such actions may materially and adversely affect our future prospects. In addition, we cannot ensure that we will be able to raise additional equity capital, restructure or refinance any of our indebtedness or obtain additional financing on commercially reasonable terms or at all. To ensure that the Company has sufficient liquidity, the Company received confirmation letters as further described under Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.
Any long-term indebtedness we may incur could adversely affect our business and limit our ability to expand our business or respond to changes, and we may be unable to generate sufficient cash flow to satisfy our debt service obligations.
We currently have no outstanding debt, other than the current liabilities reflected in the accompanying consolidated financial statements. We may incur indebtedness in the future. Any long-term indebtedness we may incur and the fact that a substantial portion of our cash flow from operating activities could be needed to make payments on this indebtedness could have adverse consequences, including the following:
| ● | reducing the availability of our cash flow for our operations, capital expenditures, future business opportunities, and other purposes; |
| ● | limiting our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate, which would place us at a competitive disadvantage compared to our competitors that may have less debt; |
| ● | limiting our ability to borrow additional funds; |
10
| ● | increasing our vulnerability to general adverse economic and industry conditions; and |
| ● | failing to comply with the covenants in our debt agreements could result in all of our indebtedness becoming immediately due and payable. |
Our ability to borrow any funds needed to operate and expand our business will depend in part on our ability to generate cash. Our ability to generate cash is subject to the performance of our business as well as general economic, financial, competitive, legislative, regulatory, and other factors that are beyond our control. If our business does not generate sufficient cash flow from operating activities or if future borrowings are not available to us in amounts sufficient to enable us to fund our liquidity needs, our operating results, financial condition, and ability to expand our business may be adversely affected. Moreover, our inability to make scheduled payments on our debt obligations in the future would require us to refinance all or a portion of our indebtedness on or before maturity, sell assets, delay capital expenditures or seek additional equity
We are subject to a variety of additional risks associated with our franchisees.
Our franchise business model subjects us to a number of risks, any one of which may impact our royalty revenues collected from our franchisees, may harm the goodwill associated with our brand, and may materially and adversely impact our business and results of operations.
Bankruptcy of franchisees. A franchisee bankruptcy could have a substantial negative impact on our ability to collect payments due under such franchisee’s franchise agreement(s). In a franchisee bankruptcy, the bankruptcy trustee may reject its franchise agreement(s) pursuant to Section 365 under the U.S. bankruptcy code, in which case there would be no further royalty payments from such franchisee, and we may not ultimately recover those payments in a bankruptcy proceeding of such franchisee in connection with a damage claim resulting from such rejection.
Franchisee changes in control. Our franchises are operated by independent business owners. Although we have the right to approve franchise owners, and any transferee owners, it can be difficult to predict in advance whether a particular franchise owner will be successful. If an individual franchise owner is unable to successfully establish, manage and operate its business, the performance and quality of its service could be adversely affected, which could reduce its sales and negatively affect our royalty revenues and brand image. Although our franchise agreements prohibit “changes in control” of a franchisee without our prior consent as the franchisor, a franchise owner may desire to transfer a franchise. In addition, in any transfer situation, the transferee may not be able to successfully operate the business. In such a case the performance and quality of service could be adversely affected, which could also reduce its sales and negatively affect our royalty revenues and brand image.
Franchisee insurance. Our franchise agreements require each franchisee to maintain certain insurance types and levels. Losses arising from certain extraordinary hazards, however, may not be covered, and insurance may not be available (or may be available only at prohibitively expensive rates) with respect to many other risks. Moreover, any loss incurred could exceed policy limits and policy payments made to franchisees may not be made on a timely basis. Any such loss or delay in payment could have a material adverse effect on a franchisee’s ability to satisfy its obligations under its franchise agreement or other contractual obligations, which could cause a franchisee to terminate its franchise agreement and, in turn, negatively affect our operating and financial results.
Some of our franchisees are operating entities. Franchisees may be natural persons or legal entities. Our franchisees that are operating companies (as opposed to limited purpose entities) are subject to business, credit, financial and other risks, which may be unrelated to the operation of their franchise businesses. These unrelated risks could materially and adversely affect a franchisee that is an operating company and its ability to service its customers and maintain its operations while making royalty payments, which in turn may materially and adversely affect our business and operating results.
Franchise agreement termination; nonrenewal. Each franchise agreement is subject to termination by us as the franchisor in the event of a default, generally after expiration of applicable cure periods, although under certain circumstances a franchise agreement may be terminated by us upon notice without an opportunity to cure. Our right to terminate franchise agreements may be subject to certain limitations under any applicable state relationship laws that may require specific notice or cure periods despite the provisions in the franchise agreement. The default provisions under the franchise agreements are drafted broadly and include, among other things, any failure to meet operating standards and actions that may threaten the licensed intellectual property. Moreover, a franchisee may have a right to terminate its franchise agreement in certain circumstances.
11
In addition, each franchise agreement has an expiration date. Upon the expiration of a franchise agreement, we or the franchisee may, or may not, elect to renew the franchise agreement. If the franchise agreement is renewed, the franchisee will receive a “successor” franchise agreement for an additional term. Such option, however, is contingent on the franchisee’s execution of our then-current form of franchise agreement (which may include increased royalty revenues, advertising fees and other fees and costs), the satisfaction of certain conditions and the payment of a renewal fee. If a franchisee is unable or unwilling to satisfy any of the foregoing conditions, the expiring franchise agreement will terminate upon expiration of its term. Our right to elect to not renew a franchise agreement may be subject to certain limitations under any applicable state relationship laws that may require specific notice periods or “good cause” for non-renewal despite the provisions in the franchise agreement.
Franchisee litigation; effects of regulatory efforts. We and our franchisees are subject to a variety of litigation risks, including, but not limited to, customer claims, personal injury claims, litigation with or involving our relationship with franchisees, litigation alleging that the franchisees are our employees or that we are the co-employer of our franchisees’ employees, employee allegations against the franchisee or us of improper termination and discrimination, landlord/tenant disputes and intellectual property claims, among others. Each of these claims may increase costs, reduce the execution of new franchise agreements and affect the scope and terms of insurance or indemnifications we and our franchisees may have. In addition, we and our franchisees are subject to various regulatory enforcement actions regarding among other things franchise and employment laws, such as: failure to comply with franchise registration and disclosure requirements; the provision to prospective franchisees of business projections; efforts to categorize franchisors as the co-employers of their franchisees’ employees; legislation to categorize individual franchised businesses as large employers for the purposes of various employment benefits; and other legislation or regulations that may have a disproportionate impact on franchisors and/or franchised businesses. These changes may impose greater costs and regulatory burdens on franchising, and negatively affect our ability to sell new franchises.
Franchise agreements and franchisee relationships. Our franchisees develop and operate their business under terms set forth in our franchise agreements. These agreements give rise to long-term relationships that involve a complex set of mutual obligations and mutual cooperation. We have a standard set of franchise agreements that we typically use with our franchisees, but various franchisees have negotiated specific terms in these agreements. Furthermore, we may from time to time negotiate terms of our franchise agreements with individual franchisees or groups of franchisees (e.g., a franchisee association). We seek to have positive relationships with our franchisees, based in part on our common understanding of our mutual rights and obligations under our agreements, to enable both the franchisees’ business and our business to be successful. However, we and our franchisees may not always maintain a positive relationship or always interpret our agreements in the same way. Our failure to have positive relationships with our franchisees could individually or in the aggregate cause us to change or limit our business practices, which may make our business model less attractive to our franchisees or our members.
While our franchisee revenues are not concentrated among one or a small number of parties, the success of our business is significantly affected by our ability to maintain contractual relationships with profitable franchisees. A typical franchise agreement has a ten-year term. If we fail to maintain or renew our contractual relationships on acceptable terms, or if one or more significant franchisees were to become insolvent or otherwise were unwilling to pay amounts due to us, our business, reputation, financial condition and results of operations could be materially adversely affected.
12
Our business is subject to various laws and regulations, and changes in such laws and regulations, or failure to comply with existing or future laws and regulations, could adversely affect our business.
We are subject to the FTC Franchise Rule promulgated by the FTC that regulates the offer and sale of franchises in the United States and that requires us to provide to all prospective franchisees certain mandatory disclosure in a FDD. In addition, we are subject to state franchise sales laws in 14 states that regulate the offer and sale of franchises by requiring us to make a franchise filing and, in some instances, or obtain approval by the state franchise agency of that filing prior to our making any offer or sale of a franchise in those states and to provide a FDD to prospective franchisees in accordance with such laws. We are also subject to franchise laws in certain provinces in Canada, which, like the FTC Franchise Rule, require presale disclosure to prospective franchisees prior to the sale of a franchise. We must also comply with international laws, including franchise laws, in the countries where we have franchise operations or conduct franchise offer and sales activities. Failure to comply with such laws may result in a franchisee’s right to rescind its franchise agreement and to seek damages, and may result in investigations or actions from federal or state franchise authorities, civil fines or penalties, and stop orders, among other remedies. We are also subject to franchise relationship laws in approximately 24 states that regulate many aspects of the franchisor-franchisee relationship, including renewals and terminations of franchise agreements, franchise transfers, the applicable law and venue in which franchise disputes must be resolved, discrimination and franchisees’ right to associate, among others. Our failure to comply with such franchise relationship laws could result in fines, damages, restitution and our inability to enforce franchise agreements where we have violated such laws. Our non-compliance with federal and state franchise laws could result in liability to franchisees and regulatory authorities (as described above), inability to enforce our franchise agreements, required rescission of franchise agreements and a reduction in our anticipated royalty revenue, which in turn may materially and adversely affect our business and results of operating.
We and our franchisees are also subject to the Fair Labor Standards Act of 1938, as amended, and various other laws in the United States and foreign countries governing such matters as minimum-wage requirements, overtime and other working conditions. A significant number of our and our franchisees’ employees are paid at rates related to the U.S. federal minimum wage, and past increases in the U.S. federal minimum wage have increased labor costs, as would future increases. Any increases in labor costs might result in our and our franchisees inadequately staffing stores. Such increases in labor costs and other changes in labor laws could affect franchisee performance and quality of service, decrease royalty revenues and adversely affect our brand.
We have identified material weaknesses in our internal controls over financial reporting in the past.
If our remedial measures are insufficient to address the material weakness or if additional material weaknesses or significant deficiencies in our internal control are discovered or occur in the future, we may be unable to accurately report our financial results, or report them within the required timeframes, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results in the future, which could cause investors and others to lose confidence in our financial statements, limit our ability to raise capital and could adversely affect our reputation, results of operations and consolidated financial condition.
The markets for our services are competitive, and we may be unable to compete successfully.
The markets for our services are competitive, and we may be subject to increased competition in our markets in the future. We expect existing competitors and new entrants into the markets where we do business to constantly revise and improve their business models in light of challenges from us or other companies in the industry. If we cannot respond effectively to advances by our competitors, our business and financial performance may be adversely affected. Increased competition may result in new products and services that fundamentally change our markets, reduce prices, reduce margins or decrease our market share. We may be unable to compete successfully against current or future competitors, some of whom may have significantly greater financial, technical, manufacturing, marketing, sales and other resources than we do.
Our quarterly revenues and operating results are difficult to predict and may fluctuate significantly in the future.
Our quarterly revenues and operating results are difficult to predict and may fluctuate significantly from quarter to quarter. These fluctuations may cause the market price of our common stock to decline. We base our planned operating expenses in part on expectations of future revenues, and our expenses are relatively fixed in the short term. If revenues for a particular quarter are lower than we expect, we may be unable to proportionately reduce our operating expenses for that quarter, which would harm our operating results for that quarter. In future periods, our revenue and operating results may be below the expectation of analysts and investors, which may cause the market price of our common stock to decline. Factors that are likely to cause our revenues and operating results to fluctuate include those discussed elsewhere in this section.
13
We rely upon trademark, copyright and trade secret laws and contractual restrictions to protect our proprietary rights, and if these rights are not sufficiently protected, our ability to compete and generate revenues could be harmed.
We rely on a combination of trademark, copyright and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights. The steps taken by us to protect our proprietary information may not be adequate to prevent misappropriation of our technology. Our proprietary rights may not be adequately protected because:
| ● | laws and contractual restrictions may not prevent misappropriation of our technologies or deter others from developing similar technologies; and |
| ● | policing unauthorized use of our products and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of any unauthorized use. |
The laws of certain foreign countries may not protect the use of unregistered trademarks or other proprietary rights to the same extent as do the laws of the United States. As a result, international protection of our image may be limited and our right to use our trademarks and other proprietary rights outside the United States could be impaired. Other persons or entities may have rights to trademarks that contain portions of our marks or may have registered similar or competing marks for digital signage in foreign countries. There may also be other prior registrations of trademarks identical or similar to our trademarks in other foreign countries. Our inability to register our trademarks or other proprietary rights or purchase or license the right to use the relevant trademarks or other proprietary rights in these jurisdictions could limit our ability to penetrate new markets in jurisdictions outside the United States.
Litigation may be necessary to protect our trademarks and other intellectual property rights, to enforce these rights or to defend against claims by third parties alleging that we infringe, dilute or otherwise violate third-party trademark or other intellectual property rights. Any litigation or claims brought by or against us, whether with or without merit, or whether successful or not, could result in substantial costs and diversion of our resources, which could have a material adverse effect on our business, financial condition, results of operations or cash flows. Any intellectual property litigation or claims against us could result in the loss or compromise of our intellectual property rights, could subject us to significant liabilities, require us to seek licenses on unfavorable terms, if available at all or prevent us from manufacturing or selling certain products, any of which could have a material adverse effect on our business, financial condition, results of operations or cash flows.
We may face intellectual property infringement claims that could be time-consuming, costly to defend and result in its loss of significant rights.
Other parties may assert intellectual property infringement claims against us, and our products and services may infringe the intellectual property rights of third parties. We may also initiate claims against third parties to defend our intellectual property. Intellectual property litigation is expensive and time-consuming and could divert management’s attention from our core business. If there is a successful claim of infringement against us, we may be required to pay substantial damages to the party claiming infringement, develop non-infringing technology or enter into royalty or license agreements that may not be available on acceptable terms, if at all. Our failure to develop non-infringing technologies or license the proprietary rights on a timely basis could harm our business. Also, we may be unaware of filed patent applications that relate to our products. Parties making infringement claims may be able to obtain an injunction, which could prevent us from operating portions of our business or using technology that contains the allegedly infringing intellectual property. Any intellectual property litigation could adversely affect our business, financial condition or results of operations.
14
We depend on key executive management and other key personnel, and may not be able to retain or replace these individuals or recruit additional personnel, which could harm our business.
On August 7, 2017, Karla Kretsch resigned as President of the Company. Accordingly, the Company is actively recruiting additional experienced senior management. Because of the intense competition for these employees and because of other risk factors identified in this report, we may be unable to retain our management team and other key personnel and may be unable to find qualified replacements. All of our key employees are employed on an “at will” basis and we do not have key-man life insurance covering any of our employees. The loss of the services of any of our executive management members or other key personnel could have a material adverse effect on our business and prospects, as we may not be able to find suitable individuals to replace such personnel on a timely basis or without incurring increased costs, or at all.
We could be subject to changes in tax rates, the adoption of new U.S. or international tax legislation or exposure to additional tax liabilities.
We are subject to income taxes in the U.S. and other foreign jurisdictions. Significant judgment is required in determining our tax provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We are subject to the examination of our income tax returns, payroll taxes and other tax matters by the Internal Revenue Service and other tax authorities and governmental bodies. The Company regularly assesses the likelihood of an adverse outcome resulting from these examinations to determine the adequacy of its provision for income taxes and payroll tax accruals. There can be no assurances as to the outcome of these examinations. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical tax provisions and payroll accruals. The results of an audit or litigation could have a material effect on our consolidated financial statements in the period or periods for which that determination is made. Our effective income tax rate in the future could be adversely affected by a number of factors, including changes in the mix of earnings in countries with different statutory tax rates, changes in tax laws, the outcome of income tax audits, and any repatriation of non-U.S. earnings for which we have not previously provided for U.S. taxes.
Risks Related to Our Common Stock
The concentration of our capital stock ownership with insiders will likely limit your ability to influence corporate matters.
As of December 15, 2017, our executive officers directors, significant shareholders and affiliated persons and entities collectively, beneficially owned approximately 31% of our outstanding common stock. As a result, these persons and entities have the ability to exercise control over most matters that require approval by our stockholders, including the election of directors and approval of significant corporate transactions. Corporate action might be taken even if other stockholders oppose them. This concentration of ownership might also have the effect of delaying or preventing a change in control of our company that other stockholders may view as beneficial.
Compliance with the Sarbanes-Oxley Act of 2002 will require substantial financial and management resources.
Section 404 of the Sarbanes-Oxley Act of 2002 requires that we evaluate and report on our system of internal controls and, if and when we are no longer a “smaller reporting company,” will require that we have such system of internal controls audited. If we fail to maintain the adequacy of our internal controls, we could be subject to regulatory scrutiny, civil or criminal penalties and/or Stockholder litigation. Any inability to provide reliable financial reports could harm our business. Furthermore, any failure to implement required new or improved controls, or difficulties encountered in the implementation of adequate controls over our financial processes and reporting in the future, could harm our operating results or cause us to fail to meet our reporting obligations. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our securities.
15
Provisions in our charter documents and Delaware law may discourage or delay an acquisition that stockholders may consider favorable, which could decrease the value of our common stock.
Our certificate of incorporation, our bylaws, and Delaware corporate law contain provisions that could make it harder for a third party to acquire us without the consent of our board of directors (the “Board”). These provisions include those that: authorize the issuance of up to 10,000,000 shares of preferred stock in one or more series without a stockholder vote. In addition, in certain circumstances, Delaware law also imposes restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock.
We have not paid cash dividends to our shareholders and currently have no plans to pay future cash dividends.
We plan to retain earnings to finance future growth and have no current plans to pay cash dividends to shareholders. Any indebtedness that we incur in the future may also limit our ability to pay dividends. Because we have not paid cash dividends, holders of our securities will experience a gain on their investment in our securities only in the case of an appreciation of value of our securities. You should neither expect to receive dividend income from investing in our securities nor an appreciation in value.
Item 1B. Unresolved Staff Comments
Not applicable.
The Company’s offices, consisting of approximately 4,500 square feet, are located in an office/condominium complex in St. Augustine, Florida. The Company owns three of the office condominiums and rents one additional unit. We believe this facility is adequate to meet our current needs.
From time to time, the Company has been and may become involved in legal proceedings arising in the ordinary course of its business. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense and settlement costs, diversion of management resources, and other factors.
On October 2, 2015, the Company filed suit in the state court in St. John’s County, Florida, Case No. CA 15-1076, against its former Chief Executive Officer Brian Pappas, Christine Pappas, its former Human Resources officer, and an independent company controlled by Mr. Pappas named Franventures, LLC (“FV”). The lawsuit seeks return of company emails and other electronic materials in the possession of the defendants, company control over the process by which the company’s documents are identified, and a court judgment that the property is the Company’s. Mr. and Mrs. Pappas have returned certain company documents that they have identified, but other issues remain.
On December 11, 2017, Brian Pappas filed a counterclaim alleging the Company is required to indemnify him for a multitude of matters. The Company denies the allegation and intends to vigorously litigate this matter.
In a separate suit, filed on March 7, 2016 in the state court in St. John’s County, Florida (Case No. CA 16-236), Franventures, LLC (“FV”) alleged that it is due an unstated amount of money from the Company pursuant to a contract the Company had previously terminated.
On June 23, 2016, the Company filed a counterclaim against FV, which also included a complaint against former Chairman of the Board and Chief Executive Officer Brian Pappas. The counterclaim seeks redress for losses and expenditures caused by alleged fraud, conversion of company assets, and breaches of fiduciary duty that the Company alleges that defendants perpetrated upon CLC, including assertions regarding actions by Brian Pappas that the Company alleges occurred while Pappas was serving as the Chief Executive Officer of CLC and as a member of its board of directors.
On October 27, 2016, Brian Pappas filed a motion to amend the complaint to add a claim alleging that the Company slandered him by virtue of a press release issued on or about August 1, 2016, in which the Company reported to shareholders on steps it had taken and improvements it had implemented. The motion has still not been ruled upon by the Court. If Pappas does amend his complaint, the Company will vigorously defend the proposed claim.
On February 24, 2017, franchisee, Team Kasa, LLC, along with its three owners, filed suit in the Eastern District of New York (Case No. 2:17-cv-01074) against former CEO Brian Pappas, and Franventures, LLC. The same Plaintiffs also initiated arbitration on the same issues (American Arbitration Association, Case No. 01-17-0001-1968), alleging the Company is jointly and severally liable for damages resulting from the allegations against Mr. Pappas and Franventures. The Company is contesting the allegations and its liability for any damages.
16
On May 9, 2017, franchisee, Back and 4th, LLC, along with its owner, Kristena Bins-Turner, initiated arbitration against the Company for breach of contract, alleging that they did not receive adequate value for royalty payments made under the franchise agreement, for fraud, alleging material misrepresentations and omissions prior to entry into the franchise agreements, and for misrepresentation violations of Florida Statute 817.416. (American Arbitration Association, Case. No. 01-16-004-3745). Franchisee and its owner seek an unspecified amount of damages. The Company contested the allegations and its liability for any damages at an evidentiary hearing held December 5-7, 2017. A final determination on the matter is pending.
On November 8, 2017, franchisee, Indy Bricks, LLC, along with its two owners, Ben & Kate Schreiber initiated arbitration against the Company. (American Arbitration Association, Case No. 01-17-0006-8120). Plaintiffs allege breach of contract, fraud, material misrepresentations and omissions, violations of the Indiana Franchise Act, and violations of the Indiana Deceptive Franchise Practices Act. The Company is vigorously contesting the allegations and its liability for any damages.
On August 21, 2017, the SEC filed a Civil Complaint against the Company and certain former executive officers and directors in the United States District Court for the Middle District of Florida, Jacksonville Division, as Civil Action No. 3:17-cv-00954-TJC-JRK. The Civil Complaint was in regards to alleged violations of federal securities law occurring between 2011 and 2015. On August 22, 2017, the SEC also filed with the court the Company’s formal Consent to a full resolution of all allegations pertaining to the Company. Pursuant to the Consent, without admitting or denying the allegations, the Company agreed to the entry of a final judgment that permanently enjoins it from violating the sections of the federal securities laws listed in the Civil Complaint. On September 20, 2017, the United States District Court for the Middle District of Florida, Jacksonville Division issued the final judgment order as to the Company in the Civil Action No. 3:17-cv-00954-TJC-JRK. The entering of the final judgment order has resolved all allegations pertaining to the Company. The Company was not assessed any monetary penalties.
On September 21, 2017, the Company filed a notice of voluntary dismissal without prejudice in the United States District Court for the Middle District of Florida, Jacksonville Division, in its lawsuit against Blake and Anik Furlow relating to their conduct in the shareholder consent. The Company filed the complaint on May 15, 2017, and after consideration, decided it was not in the best interest of the Company to proceed with the litigation.
Item 4. Mine Safety Disclosures
Not applicable.
17
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Market Price for Equity Securities
Our common stock is quoted on the OTC bulletin board under the symbol “CLCN.” The following table sets forth the high and low bid prices for our common stock as quoted on the OTC bullet board for the periods indicated. The market quotations reflect inter-dealer prices, without retail mark-up, markdown or commissions and may not necessarily represent actual transactions.
| Quarter Ending | High | Low | ||
| 9/30/17 | $ 0.18 | $ 0.18 | ||
| 6/30/17 | $ 0.21 | $ 0.21 | ||
| 3/31/17 | $ 0.15 | $ 0.15 | ||
| 12/31/16 | $ 0.15 | $ 0.15 | ||
| 09/30/16 | $ 0.23 | $ 0.11 | ||
| 06/30/16 | $ 0.22 | $ 0.13 | ||
| 03/31/16 | $ 0.32 | $ 0.13 | ||
| 12/31/15 | $ 0.32 | $ 0.32 |
At December 18, 2017, the Company had 12,075,875 outstanding shares (12,140,975 shares issued less 65,100 shares held by the Company as treasury) of common stock and 131 shareholders of record.
Dividends
Holders of common stock are entitled to receive dividends as may be declared by the Company’s Board. The Company’s Board is not restricted from paying any dividends but is not obligated to declare a dividend. No dividends have ever been declared, and it is not anticipated that dividends will be paid in the foreseeable future. Any indebtedness the Company incurs in the future may also limit its ability to pay dividends. Investors should not purchase the Company’s common stock with the expectation of receiving cash dividends.
Recent Sales of Unregistered Securities
None
Purchase of Equity Securities by the Issuer and Affiliated Purchasers
We did not purchase any of our equity securities during the fourth quarter of the fiscal year covered by this report.
Item 6. Selected Financial Data
As a smaller reporting company, we are not required to provide the information required by this Item.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Form 10-K. All information presented herein is based on the Company’s fiscal year, which ends September 30. Unless otherwise stated, references to particular years, quarters, months or periods refer to the Company’s fiscal years ended in September and the associated quarters, months and periods of those fiscal years.
18
Overview
The Company experienced a year of decline in the number of franchises, compared to fiscal year 2016, decreasing from 710 franchise territories to 652, within the two brands. The reduction in the growth rate of franchises sold in fiscal year 2017 resulted in a decrease in Initial franchise fees of approximately $725,000, in a year-to-year comparison. The decrease in franchise sales was due to a lack of marketing sales worldwide and a more stringent qualification procedures. The loss of the territories during the period is the result of the company work to discharge our non-performing franchisees from the system.
The Company’s Revenue decreased to $2,456,033 in fiscal year 2017 from $3,238,359 in the prior year, a decrease of $782,326 (-24%), primarily due to lower Initial franchise sales, as the Company did not sell any new U.S. Franchises during the year and sold less International Franchises than the previous year. Operating Expenses decreased to $3,148,485 in fiscal year 2017 from $5,634,073 in the prior year, a decrease of $2,485,588 due to significant decreases in all categories, including professional fees & legal settlements of $1,393,861, advertising of $414,194, consulting and commissions of $375,333, and other general and administrative expenses of $366,609 year over year, offset by an increase in stock-based compensation of $360,738, year over year. The Company’s Net Loss decreased to a loss of $1,031,002 in fiscal year 2017 from a loss of $1,808,849 the prior year, a change of $777,847, primarily due to the lower operating expenses.
On December 9, 2015, the Company completed the sale of the Challenge Island business to the prior owner of the business, pursuant to an asset sale and purchase agreement entered into on that date. See Note 12 to the Consolidated Financial Statements.
On January 29, 2016, the Company temporarily suspended domestic franchise offer and sales of Bricks 4 Kidz® and Sew Fun Studios® franchises in compliance with FTC Franchise Rule, Section 436.7(a) due to delay in completion of the Company’s FY2015 consolidated audited financial statements. In turn, this delayed completion of the Company’s 2016 FDDs for the Bricks 4 Kidz® and Sew Fun Studios® franchise offerings. The Company restarted sales efforts in September of 2016. It expects to resume sales effort of Sew Fun Studios® in 3rd Quarter of 2018 in 70% of the states in which Sew Fun Studios® currently sell franchises immediately upon completion of the FDD, and in the rest of the states upon either filing or approval of the franchise initial, amended or renewal applications, based upon the applicable rules of each such state. In a number of these states, the Company did not have active franchise offer and sales efforts even before the temporary suspension. This temporary suspension of domestic franchise offer and sales does not affect the Company’s international franchise offer and sales activity or its royalty fee collections from existing franchisees.
19
Results of Operation
The following table represents the Company’s franchise sales activity for the fiscal years ended September 30, 2017 and 2016:
| Franchises Sold | ||||||||
| Franchise Activity | Fiscal Years Ended | |||||||
| September 30, | ||||||||
| Creative Learning Corporation | 2017 | 2016 | ||||||
| BFK Franchise Company LLC | ||||||||
| (a) US First Territories | — | 4 | ||||||
| (b) US Second Territories | — | 1 | ||||||
| Total US | — | 5 | ||||||
| International First Territories | — | 6 | ||||||
| International Second Territories | — | 2 | ||||||
| Master Agreements | 3 | 5 | ||||||
| Master Sub-franchise | 19 | — | ||||||
| Total International | 22 | 13 | ||||||
| Total BFK | 22 | 18 | ||||||
| SF Franchise Company LLC | ||||||||
| US First Territories | — | — | ||||||
| International Territories | — | — | ||||||
| Total SF | — | — | ||||||
| Total Franchises Sold | 22 | 18 | ||||||
| (a) | US First Territory is the original territory purchased with the Franchise Agreement, for example, the franchisee would be charged $25,900 for the first territory. |
| (b) | Second Territory is a secondary territory purchased in addition to the territory purchased with the Franchise Agreement, for example, the franchisee would be charged $10,000 for a second territory. |
Material changes of items in the Company’s Statement of Operations for the fiscal year ended September 30, 2017 as compared to the prior year are discussed below.
Initial franchise fees, Royalty fees and Merchandise sales
| Fiscal Year Ended | ||||||||||||||||||||
| Increase/ | (rounded to $1,000) | Change | ||||||||||||||||||
| Item Description | Decrease | 09/30/17 | 09/30/16 | Amount | % | |||||||||||||||
| Revenue: | ||||||||||||||||||||
| Initial franchise fees | Decrease | $ | 207,000 | $ | 932,000 | (725,000 | ) | -78 | % | |||||||||||
| Royalties fees | Decrease | 2,249,000 | 2,306,000 | (57,000 | ) | -2 | % | |||||||||||||
| Merchandise sales | Decrease | — | 1,000 | (1,000 | ) | -100 | % | |||||||||||||
| Total Revenue | $ | 2,456,000 | $ | 3,239,000 | $ | (783,000 | ) | -24 | % | |||||||||||
Contributing to the decline in Initial franchise fees of approximately $725,000, or 78%, was the lack of US franchise sales in 2017 due to the slow progression of resuming US sales after their suspension from January through September of 2016. The domestic franchise sales decreased approximately $113,000 from the prior year. The international sales decreased approximately $612,000 from the prior year, due to a lack of marketing sales worldwide and a more stringent qualification procedures. The decrease in royalty fees is only 2% from the prior year. This fluctuation is due to the loss of some franchisees that the Company has not been able to replace with the sales of new franchises. The loss of the territories during the period is the result of the company work to discharge our non-performing franchisees from the system.
20
Although the Company had a significant increase in our sub-franchise sales over the prior year, the revenue recognized for these sales is much smaller than for our full territories. The Company usually only receives 30% of the sale, and sometimes in the case of new Master franchisees, their contract allows them 100% revenue on the first sub-franchisee. The Company had approximately $21,000 revenue from the sub-franchise agreements in 2017, compared to $0 in 2016.
Operating Expenses
Total operating expenses for the comparable periods ended September 30, 2017 and 2016 were approximately $3,148,000 and $5,634,000, respectively, a decrease of approximately $2,486,000.
| Fiscal Year Ended | |||||||||||||||||||
| Increase/ | (rounded to $1,000) | Change | |||||||||||||||||
| Item Description | Decrease | 09/30/17 | 09/30/16 | Amount | % | ||||||||||||||
| Total Operating Expenses | Decrease | $ | 3,148,000 | $ | 5,634,000 | $ | (2,486,000 | ) | -44.1 | % | |||||||||
The changes in operating expenses are explained as follows:
Franchise consulting and commissions
| Fiscal Year Ended | |||||||||||||||||||
| Increase/ | (rounded to $1,000) | Change | |||||||||||||||||
| Item Description | Decrease | 09/30/17 | 09/30/16 | Amount | % | ||||||||||||||
| Operating expense: | |||||||||||||||||||
| Consulting and Commissions | Decrease | $ | 162,000 | $ | 537,000 | $ | (375,000 | ) | -70 | % | |||||||||
The Company paid commissions and consulting fees for the fiscal years ended September 30, 2017 and 2016 of approximately $162,000 and $537,000 respectively, a decrease of approximately $375,000, or 70%. The payments for commissions and consulting fees declined primarily as a result of the reduction in the sales of new franchises during fiscal year 2017 and the use of fewer consultants in 2017. In most cases, the commission paid to a sales broker was 25% of the franchise fee.
Franchise training and expenses
| Fiscal Year Ended | |||||||||||||||||||
| Increase/ | (rounded to $1,000) | Change | |||||||||||||||||
| Item Description | Decrease | 09/30/17 | 09/30/16 | Amount | % | ||||||||||||||
| Operating expense: | |||||||||||||||||||
| Training and expenses | Decrease | $ | 16,000 | $ | 207,000 | $ | (191,000 | ) | -92 | % | |||||||||
For the fiscal years ended September 30, 2017 and 2016, the Company paid franchise training and expense fees of approximately, $16,000 and $207,000, respectively, a decrease of approximately $191,000, or 92%. The net reduction in franchise training and expense fees is partially due to the reduction in the number of franchises sold during the fiscal years ended September 30, 2017 and 2016. The decrease resulted in fewer start-up materials and supplies provided to franchises and decreased field visits. Also there was a reduction from the prior year in printed material expense and website related expenses.
Salaries and payroll taxes
| Fiscal Year Ended | |||||||||||||||||||
| Increase/ | (rounded to $1,000) | Change | |||||||||||||||||
| Item Description | Decrease | 09/30/17 | 09/30/16 | Amount | % | ||||||||||||||
| Operating expense: | |||||||||||||||||||
| Salaries and payroll taxes | Decrease | $ | 717,000 | $ | 888,000 | $ | (171,000 | ) | -19 | % | |||||||||
The Company paid salaries and payroll expenses for the fiscal years ended September 30, 2017 and 2016 of approximately $717,000 and $888,000, respectively, a decrease of approximately $171,000, or 19%. The decrease in total payroll expenses reflects the decrease in the Company’s staff levels during the fiscal years ended September 30, 2017 and 2016, with average full-time employees of approximately 10 and 13 during fiscal 2017 and fiscal 2016, respectively.
21
Stock-based compensation
| Fiscal Year Ended | |||||||||||||||||||
| Increase/ | (rounded to $1,000) | Change | |||||||||||||||||
| Item Description | Decrease | 09/30/17 | 09/30/16 | Amount | % | ||||||||||||||
| Operating expense: | |||||||||||||||||||
| Stock-based compensation | Increase | $ | 361,000 | $ | — | $ | 361,000 | ||||||||||||
The Company awarded stock options to the Board during the 2017 fiscal year. Discussion of these amounts is contained in Part III, Item 11 “Executive Compensation” of this report. The Company also awarded stock grants and options to Company officers pursuant to the employment agreements. The Company did not have these expenses in fiscal year 2016.
Advertising expenses
| Fiscal Year Ended | |||||||||||||||||||
| Increase/ | (rounded to $1,000) | Change | |||||||||||||||||
| Item Description | Decrease | 09/30/17 | 09/30/16 | Amount | % | ||||||||||||||
| Operating expense: | |||||||||||||||||||
| Advertising | Decrease | $ | 21,000 | $ | 435,000 | $ | (414,000 | ) | -95 | % | |||||||||
The Company paid advertising expenses for the fiscal years ended September 30, 2017 and 2016 of approximately $21,000 and $435,000, respectively, a decrease of approximately $414,000, or 95%. The decrease related to the decline in lead advertising. The Company slowed lead advertising during fiscal 2017 to further evaluate its effectiveness and to strategically choose the most efficient use of these dollars.
Professional fees & legal settlements
| Fiscal Year Ended | |||||||||||||||||||
| Increase/ | (rounded to $1,000) | Change | |||||||||||||||||
| Item Description | Decrease | 09/30/17 | 09/30/16 | Amount | % | ||||||||||||||
| Operating expense: | |||||||||||||||||||
| Professional fees & legal settlements | Decrease | $ | 1,317,000 | $ | 2,711,000 | $ | (1,394,000 | ) | -51 | % | |||||||||
The Company paid professional fees and legal settlements for the fiscal years ended September 30, 2017 and 2016 of approximately $1,317,000 and $2,711,000, respectively, a decrease of approximately $1,394,000, or 52%.
The professional legal fees portion was approximately $1,147,000 and $2,224,000, respectively in 2017 and 2016, a decrease of approximately $1,077,000. The decrease in professional legal fees is primarily due to the elevated level of professional fees in the prior year. The excessive professional fees in fiscal year 2016 were due predominantly to SEC related matters, Franchise regulatory matters and corporate governance matters that resulted from the prior management’s decisions.
Also included in this account were accounting fees of approximately $114,000 and $324,000, respectively, in fiscal year 2017 and 2016, which decreased by $210,000 from the prior year. The decrease in professional accounting fees is also primarily due to the increased level in the prior year. The prior year accounting fees were increased by approximately $100,000 related to the filing the 2015 Form 10-K in fiscal year 2016.
22
Other operating expenses
| Fiscal Year Ended | |||||||||||||||||||
| Increase/ | (rounded to $1,000) | Change | |||||||||||||||||
| Item Description | Decrease | 09/30/17 | 09/30/16 | Amount | % | ||||||||||||||
| Operating expense: | |||||||||||||||||||
| Other operating expenses | Decrease | $ | 556,000 | $ | 855,000 | $ | (299,000 | ) | -35 | % | |||||||||
The Company paid other operating expenses for the fiscal years ended September 30, 2017 and 2016 of approximately $556,000 and $855,000, respectively, a decrease of approximately $299,000, or 35%. During the comparable periods, the net decrease in operating expenses was mostly composed of an increase in bad debt of $89,000 offset by a decrease in general and administrative expenses of $367,000. The increase in bad debt expense is due to our increase in the allowance for doubtful accounts on some receivables and notes compared to the prior year. This was due to the Company’s thorough review of our receivables during the fiscal year as a step in our collection efforts, which led to more specific allowances of 100% for some receivables.
The decrease in general and administrative expense is partially due to a decrease in insurance expense, investor relations expense, and conference expense totaling approximately $289,000 between the three, offset by the Impairment loss on long-lived assets of approximately $79,000. The conference from fiscal year 2016 was held in April 2016, while the conference this year was not held until November 2017, after the fiscal year-end. See note 4 of the Financial statements for discussion of the Impairment loss on long-lived assets.
Liquidity and Capital Resources
The Company’s primary source of liquidity is from cash generated through operations. From January of 2016 through August 2016, the Company was not able to sell franchises in the United States at the same time the Company had significant professional fees and regulatory cash outlays which put adverse pressure on the Company’s liquidity. The Company believes its cash outlays related to professional fees and regulatory functions will return to traditional levels for a similar business. The Company will seek a line of credit in the upcoming period, but there can be no assurance that the Company will be successful in obtaining a line of credit.
The Company has received a confirmation letter from certain Directors and Officers providing that, at the request of the Company and subject to certain conditions, such Directors and Officers will individually enter into Letters of Credit for the benefit of the Company. The aggregate value of the Letters of Credit will be for a total of $100,000 and will be subject to market rates and terms. The obligation of any Director or Officer to enter into a Letter of Credit is conditioned on the Company providing certain agreed upon documentation and reimbursements. In connection with a Director or Officer providing a Letter of Credit, the Company will issue to such Director or Officer a warrant. A form of the letter of confirmation from certain Directors and Officers is attached hereto as Exhibit 10.2.
Cash funds are used for ongoing operating expenses, the purchase of equipment, property improvement, and software development. During the fiscal year ended September 30, 2017, the Company purchased property and equipment totaling approximately $19,349, and no intangible property.
At September 30, 2017, the Company’s liabilities, recorded on the balance sheet, consisted primarily of trade payables of approximately $148,000; accrued payroll of approximately $18,000; the franchisee-funded marketing fund of approximately $132,000; and accrued expenses of approximately $136,000 (see footnote 7 of Notes to Consolidated Financial Statements).
As of January 29, 2016, the Company temporarily suspended domestic franchise offer and sales of Bricks 4 Kidz® and Sew Fun Studios® franchises in compliance with FTC Franchise Rule, Section 436.7(a) due to delay in completion of the Company’s fiscal year 2015 consolidated audited financial statements. In turn, this delayed completion of the Company’s 2016 FDDs for the Bricks 4 Kidz® and Sew Fun Studios® franchise offerings. The Company restarted selling efforts of Bricks 4 Kidz in September of 2016 and expects that offer and sales efforts will resume for Sew Fun Studios® in 3rd quarter of 2018 in approximately 70% of the states in which Sew Fun Studios® previously sold franchises immediately upon completion of the FDD, and in the rest of the states upon either filing or approval of the franchise initial, amended or renewal applications, based upon the applicable rules of each such state. In a number of these states, the Company did not have active franchise offer and sales efforts even before the temporary suspension. This temporary suspension of domestic franchise offer and sales did not affect the Company’s international franchise offer and sales activity or its royalty fee collections from existing franchisees. Notwithstanding the current suspension, Sew Fun Studios® can receive and answer from prospective franchisees generalized questions that do not amount to offer and sale activity, e.g., the Company’s history, the types of courses the Sew Fun Studios® offer, the location of the Company’s securities filings, etc. In the fiscal year ended September 30, 2017, the Company’s average weekly Bricks 4 Kidz® franchise submissions for domestic sales averaged just over 1 new franchisee per week.
23
The Company is dependent upon both franchise sales and royalty fees to continue current business operations and liquidity.
The Company used $63,000 in cash for operations, investing and financing activities in the fiscal year ending September 30, 2017.
Historically, an additional source of liquidity has been the issuance of the Company’s common stock.
Contractual Obligations
The Company entered into a Business Lease with Village Square at Palencia in July 2014, to lease unit 114 located at 701 Market Street, St. Augustine, Florida. The contract period began July 1, 2014 and ends June 15, 2019. The monthly rent is $1,425.
The following table summarizes the Company’s contractual obligations at September 30, 2017:
| Obligation | 2018 | 2019 | Total | |||||||||
| Commercial Lease (Suite 114) | $ | 17,100 | $ | 12,113 | $ | 29,213 | ||||||
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on the Company’s financial condition, changes in financial condition, and results of operations, liquidity or capital resources.
Related Party Transactions
Refer to Part III, Item 13 of this Form 10-K for disclosure regarding certain related party transactions.
Critical Accounting Policies
General
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of our consolidated financial statements requires management to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, net sales and expenses and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We describe in this section certain critical accounting policies that require us to make significant estimates, assumptions and judgments. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are uncertain at the time the estimate is made and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. Management believes the following critical accounting policies reflect its most significant estimates and assumptions used in the preparation of the consolidated financial statements. For further information on the critical accounting policies, see Note 1 of the Consolidated Financial Statements.
24
Revenue Recognition
Revenue is recognized on an accrual basis after services have been performed under contract terms and in accordance with regulatory requirements, the service price to the client is fixed or determinable, and collectability is reasonably assured. Since these franchises are primarily a mobile concept and do not require finding locations or construction, the franchisees can begin operations as soon as they complete training. The franchise fees are fully collectible and nonrefundable as of the date of the signing of the franchise agreement, but the franchise fees are not recognized as revenue until initial training has been completed and when substantially all of the services required by the franchise agreement have been fulfilled by the Company in accordance with ASC Topic 952-605 Revenue Recognition-Franchisor. Royalties are recognized in the period earned. Changes in franchise agreement terms and types of services provided can have an impact on the recording of revenue in a period.
Allowance for Doubtful Accounts — Methodology
The Company evaluates the collectability of trade accounts and notes receivable based on a combination of factors. The Company estimates an allowance for doubtful accounts and notes as a percentage of net sales based on historical bad debt experience and periodically adjusts this estimate when the Company becomes aware of a specific customer’s inability to meet its financial obligations (e.g., bankruptcy filing) or as a result of changes in the overall aging of accounts receivable. While the Company has a large customer base that is geographically dispersed, a general economic downturn could result in higher than expected defaults and, therefore, the need to revise estimates for bad debts. As of September 30, 2017 and 2016, the Company has an allowance for doubtful accounts of approximately $262,000 and $218,000, respectively.
Impairment of Property, Plant and Equipment and Goodwill and Other Intangible Assets
At least annually, the Company evaluates property, plant and equipment, goodwill and other intangible assets for potential impairment indicators. The Company’s judgments regarding the existence of impairment indicators are based on market conditions and operational performance, among other factors. Future events could cause the Company to conclude that impairment indicators exist and that assets associated with a particular operation are impaired. Evaluating for impairment also requires the Company to estimate future operating results and cash flows which require judgment by management. Any resulting impairment loss could have a material adverse impact on the Company’s financial condition and results of operations.
Income Taxes
The net deferred tax assets primarily relate to temporary differences in profitable U.S. federal and state jurisdictions. In evaluating our ability to recover our deferred tax assets, we consider future taxable income in the various jurisdictions as well as carryforward periods and restrictions on usage. The estimation of future taxable income in these jurisdictions and our resulting ability to utilize deferred tax assets can significantly change based on future events, including our determinations as to feasibility of certain tax planning strategies. Thus, recorded valuation allowances may be subject to material future changes. As a matter of course, we may be audited by federal, state and foreign tax authorities. We recognize the benefit of positions taken or expected to be taken in our tax returns in our Income Tax Provision when it is more likely than not that the position would be sustained upon examination by these tax authorities. A recognized tax position is then measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon settlement. At September 30, 2017 we had no unrecognized tax benefits. We evaluate unrecognized tax benefits, including interest thereon, on a quarterly basis to ensure that they have been appropriately adjusted for events, including audit settlements, which may impact our ultimate payment for such exposures.
Share-based compensation
The Company has a share-based compensation plan which authorizes the granting of various equity-based incentives including stock options to employees and nonemployee directors. The expense for these equity-based incentives is based on their fair value at date of grant and generally amortized over their vesting period. The fair value of each stock option granted is estimated on the date of grant using a closed-form pricing model. The pricing model requires assumptions, which impact the assumed fair value, including the expected life of the stock option, the risk-free interest rate, expected volatility of the Company’s stock over the expected life and the expected dividend yield. The Company uses historical data to determine these assumptions and if these assumptions change significantly for future grants, share-based compensation expense will fluctuate in future years.
25
Litigation accruals
In the ordinary course of business, the Company is subject to proceedings, lawsuits and other claims primarily related to competitors, customers, employees, franchisees, government agencies, intellectual property, shareholders and suppliers. The Company is required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of accrual required, if any, for these contingencies is made after careful analysis of each matter. The required accrual may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy in dealing with these matters. The Company does not believe that any such matter currently being reviewed will have a material adverse effect on its financial condition or results of operations.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09 “Revenue with Contracts from Customers (Topic 606).” ASU 2014-09 supersedes the current revenue recognition guidance, including industry-specific guidance. The guidance introduces a five-step model to achieve its core principal of the entity recognizing revenue to depict the transfer of goods or services to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In March 2016, the FASB issued ASU 2016-08, “Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net).” ASU 2016-08 provides specific guidance to determine whether an entity is providing a specified good or service itself or is arranging for the good or service to be provided by another party. In April 2016, the FASB issued ASU 2016-10, “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing.” ASU 2016-10 provides clarification on the subjects of identifying performance obligations and licensing implementation guidance.
The requirements for these standards relating to Topic 606 will be effective for interim and annual periods beginning after December 15, 2017, which means the Company must adopt this standard effective October 1, 2018 for our fiscal year ending September 30, 2019. Management does not expect the new revenue recognition standard to materially impact the recognition of continuing royalty fees from franchisees. They do, however, expect the adoption of Topic 606 to impact the accounting for initial franchise fees. Currently, the Company recognizes revenue from initial franchise fees in a single, up-front transaction, upon the completion of training of new franchisees, in the period in which all material obligations and initial services have been performed. Upon the adoption of Topic 606, we believe the Company will need to recognize the revenue related to initial franchise fees over the term of the related franchise agreement. This will result in less revenue in the short-term and more deferred revenue recognized over a period of time. The company has not completed its analysis to estimate the impact of this standard on the consolidated financial statements, but we are considering early adoption of this accounting standard utilizing the full retrospective approach during our upcoming fiscal year. Management will continue to finalize these accounting policies, quantify the impact of adopting this standard, and design and implement internal controls for this change during the fiscal year ending September 30, 2018,
In March 2016 the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which is intended to improve and simplify several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Under the new standard, income tax benefits and deficiencies are to be recognized as income tax expense or benefit in the income statement and the tax effects of exercised or vested awards should be treated as discrete items in the reporting period in which they occur. An entity should also recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. Excess tax benefits should be classified along with other income tax cash flows as an operating activity. In regards to forfeitures, the entity may make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur. This ASU is effective for fiscal years beginning after December 15, 2016 including interim periods within that reporting period, however early adoption is permitted. The Company has chosen early adoption of this standard, and there was no material effect on the consolidated financial statements.
26
In November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classification of Deferred Taxes”. The guidance requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. The guidance becomes effective for annual reporting periods beginning after December 15, 2016 with early adoption permitted. The Company adopted this guidance retrospectively as of October 1, 2015 in fiscal year 2016 and reclassified $90,727 from short-term deferred costs to long-term deferred tax liability in September of 2016.
In February 2016, the FASB issued ASU No. 2016-02, “Leases”, which requires lessees to recognize a right-to-use asset and a lease obligation for all leases. Lessees are permitted to make an accounting policy election to not recognize an asset and liability for leases with a term of twelve months or less. Additional qualitative and quantitative disclosures, including significant judgments made by management, will be required. The new standard will become effective for the Company beginning with the first quarter 2020 and requires a modified retrospective transition approach and includes a number of practical expedients. Early adoption of the standard is permitted. The Company is currently evaluating the impacts the adoption of this accounting guidance will have on the consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
As a smaller reporting company, we are not required to provide the information required by this Item.
Item 8. Financial Statements and Supplementary Data
Our consolidated financial statements and related notes required by this item are set forth as a separate section of this Report. See Part IV, Item 15 of this Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Effective as of July 6, 2016, the Company engaged Hancock, Askew & Co., LLP as the Company’s new independent registered public accounting firm. During the fiscal years ended September 30, 2015 and 2014, and through July 6, 2016, the date of Hancock, Askew & Co., LLP’s engagement, the Company did not consult with Hancock, Askew & Co., LLP regarding any of the matters or events set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer, principal financial officer and chief accounting officer, we conducted an evaluation of our disclosure controls and procedures, as such terms is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on this evaluation, our principal executive officer, our principal financial officer and our chief accounting officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Annual Report.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in the Internal Control-Integrated Framework (2013), our management concluded that our internal control over financial reporting was effective as of September 30, 2017.
27
This Annual Report does not include an attestation report of our Independent Registered Certified Public Accounting Firm, Hancock Askew & Co., LLP, regarding internal control over financial reporting. Management’s report was not subject to attestation by our Independent Registered Certified Public Accounting Firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this Annual Report.
Change In Internal Control Over Financial Reporting
During the fourth quarter of 2017, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations Over Internal Controls
Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:
i. pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
ii. provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated and combined financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
iii. provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the consolidated financial statements.
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations, including the possibility of human error and circumvention by collusion or overriding of controls. Accordingly, even an effective internal control system may not prevent or detect material misstatements on a timely basis. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
Dawn Davis (50) joined the Company in August 2016 as the Corporate Accounting Manager, and in December 2017 was appointed Controller and in such capacity she has been designated the principal accounting officer of the Company. Prior to August 2016, Ms. Davis was a Senior Staff Accountant at Adecco Group N.A. from April 2013 to August 2016, beginning her time in various other accounting positions at Adecco Group N.A. in August 2011. She has a BMA degree from the University of Oklahoma in Piano and Accounting, and is a certified public accountant in Oklahoma (inactive).
28
Item 10. Directors, Executive Officers and Corporate Governance
Directors and Executive Officers
Our directors and executive officers and their ages at December 15, 2017, are listed in the following table:
| Name | Age | Title | ||
| Christian Miller | 44 | Chief Operating Officer and Chief Financial Officer | ||
| Blake Furlow | 35 | Chairman of the Board | ||
| Gary Herman | 53 | Director | ||
| JoyAnn Kenny-Charlton | 40 | Director | ||
| Bart Mitchell | 45 | Director |
Christian Miller joined the Company in July 2016 as the Chief Financial Officer and in August of 2017 was also appointed Chief Operating Officer. Mr. Miller served as President of Miller Home Health Agency, Inc., a home health agency he co-founded, from May 2013 through July 2016. Prior to that, he served as Corporate Controller at Pinova Holdings, Inc., a specialty chemical manufacturer, from April 2012 through May 2013, as Controller at Pilot Pen Corporation of America from September 2008 through April 2012, and in various positions, including Director of Accounting and Reporting, at Trailer Bridge, Inc. Mr. Miller holds a Masters of Business Administration from Jacksonville University, and an Accounting Degree from Florida State University. Mr. Miller is a certified public accountant in Florida (inactive).
Blake Furlow became de facto Chairman of the Board of the Company in July 2017, formally effectuated in August of 2017. Mr. Furlow, in February 2015, co-founded Boise Escape LLC (“Boise Escape”). Boise Escape is a private company that offers an escape the room game, which is a real-life team-based puzzle game. Since founding Boise Escape, Mr. Furlow has served as President. In addition, Mr. Furlow has invested privately in commercial real estate and development since March 2009. In 2006, Mr. Furlow founded an internet lending company, Pay Day Loan Rescue, Inc., which offered borrowers relief from short-term loans and provided consumer finance education, where he worked until July 2013. Mr. Furlow’s history of building entrepreneurial initiatives and operating small businesses successfully with a focus on cash flow and operations will be of immense value to the Company.
Gary Herman became a de facto director of the Company in July 2017, formally effectuated in August of 2017. Mr. Herman has many years of investment experience with a focus on undervalued public companies. Since 2002, Mr. Herman has been a managing member of Galloway Capital Management, LLC, which, through its fund, Strategic Turnaround Equity Partners, LP (Cayman) has focused on investments primarily in undervalued securities. From January 2011 to August 2013, Mr. Herman was a managing member of Abacoa Capital Management, LLC, which, through its fund, Abacoa Capital Master Fund, Ltd. focused on a Global-Macro investment strategy. Since 2005, Mr. Herman has been a registered representative with Arcadia Securities LLC, a FINRA-registered broker-dealer based in New York. From 1997 to 2002, he was an investment banker with Burnham Securities, Inc. From 1993 to 1997, he was a managing partner of Kingshill Group, Inc., a merchant banking and financial firm with offices in New York and Tokyo. Mr. Herman also has franchising experience, having served on the boards of several franchised concepts, including Arthur Treacher’s Fish & Chips, Wall Street Deli Systems, Inc., Shells Seafood Restaurants, Inc., and Miami Subs Corporation where he also served as President from 2007 to 2009. Mr. Herman has a B.S. from the State University of New York at Albany with a major in Political Science and minors in Business and Music. Mr. Herman has served on the boards of public and private companies for many years, including Tumbleweed Holdings, Inc., since 2001. His experience has included board membership, corporate officer, advisory, capital raising and restructuring roles. We believe that these experiences make Mr. Herman well-qualified to serve as a member of the Board.
29
Bart Mitchell became a de facto director of the Company in July 2017, formally effectuated in August of 2017. Mr. Mitchell, is a founding member and partner of Greenbrier Academy for Girls (“GBA”), a residential therapeutic boarding school. He served as the Chief Operating Officer and Chief Financial Officer from June 2007 through August 2016, successfully navigating the company through startup and establishing it as a thought leader and premier academy in its highly competitive niche. Prior to his time at GBA, Mr. Mitchell was an officer and managing member of TAS Development, LLC from 2005 until 2007. From 2002 until 2005, he was department director for the Alldredge Academy. Previously, Mr. Mitchell served as a manager for Xlear Inc., from 2000 until 2002. Currently, he is the owner of Escape Game Coeur d’Alene, which provides live interactive adventure games focused on cooperative teamwork to solve puzzles and accomplish tasks to escape a themed game space. Mr. Mitchell holds degrees in philosophy from Brigham Young University and English from Dixie State University. Mr. Mitchell’s experience with both the financial and operations of GBA, including working with a curriculum team to provide flexible, engaging academics, give him unique and valuable insights that will prove to be an asset as a board member for the Company.
JoyAnn Kenny-Charlton has served as a director of the Company since July 2015. Ms. Kenny-Charlton is an attorney with Marks & Klein LLP and the owner of Kenny Law LLC. Ms. Kenny-Charlton concentrates her practice in commercial transactions, general corporate, and franchise, licensing and distribution law. Ms. Kenny-Charlton is a member of the International Franchise Association and was named a “Legal Eagle” (2013, 2014 and 2015) by the Franchise Times for her work in the field of franchise law. Ms. Kenny-Charlton is a graduate of Villanova University School of Law and holds a B.A. from Villanova University.
Board Structure
The Company’s Board has concluded that each of the following directors, constituting a majority of the Board, is independent, as defined in Section 803 of the listing standards of the NYSE MKT: Blake Furlow, Gary Herman, JoyAnn Kenny-Charlton and Bart Mitchell.
In December 2015, the Company established an Executive Committee which is currently composed of the following board members: Blake Furlow, Gary Herman and JoyAnn Kenny-Charlton.
The Board has established an Audit Committee which is currently composed of the following board members: Blake Furlow, Gary Herman and Bart Mitchell.
In December 2015, the Company established a Compensation Committee which is currently composed of the following board members: JoyAnn Kenny-Charlton, Bart Mitchell and Gary Herman.
The following Company directors are considered “financial expert” as that term is defined in the regulations of the SEC: Bart Mitchell.
Director Nominees
Our Board is responsible for overseeing the selection of persons to be nominated to serve on our Board. The Board does not have a formal policy on Board candidate qualifications. The Board may consider those factors it deems appropriate in evaluating director nominees made either by the Board or stockholders, including judgment, skill, strength of character, experience with businesses and organizations comparable in size or scope to the Company, experience and skill relative to other Board members, and specialized knowledge or experience. Depending upon the current needs of the Board, certain factors may be weighed more or less heavily. In considering candidates for the Board, the directors evaluate the entirety of each candidate’s credentials and do not have any specific minimum qualifications that must be met. “Diversity,” as such, is not a criterion that the Board considers. The directors will consider candidates from any reasonable source, including current Board members, stockholders, professional search firms or other persons. The directors will not evaluate candidates differently based on who has made the recommendation.
Code of Ethics
The Company has adopted a Code of Ethics applicable to its principal executive, financial and accounting officers and persons performing similar functions, as well as all directors and employees of the Company. A copy of the Code of Ethics is filed as an exhibit to this report.
30
Communication with the Board of Directors
Our stockholders and other interested parties may send written communications directly to the Board or to specified individual directors, including the Chairman or any other non-management directors, by sending such communications to our corporate headquarters. Such communications will be reviewed by our outside legal counsel and, depending on the content, will be:
| ● | forwarded to the addressees or distributed at the next scheduled board meeting; | |
| ● | if they relate to financial or accounting matters, forwarded to the audit committee or distributed at the next scheduled audit committee meeting; | |
| ● | if they relate to executive officer compensation matters, forwarded to the compensation committee or discussed at the next scheduled compensation committee meeting; | |
| ● | if they relate to the recommendation of the nomination of an individual, forwarded to the full Board or discussed at the next scheduled Board meeting; or | |
| ● | if they relate to our operations, forwarded to the appropriate officers of our company, and the response or other handling of such communications reported to the Board at the next scheduled board meeting. |
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16 of the Exchange Act requires our directors and executive officers and persons who own more than 10% of our outstanding common stock to file reports of ownership and changes in ownership of our common stock. Based solely upon a review of the copies of such reports furnished to the Company, and on written representations from the reporting persons, the Company believes that all required reports were filed on time with the SEC during fiscal 2017. However, Mr. Mitchell and Mr. Herman filed Forms 3 in November 2017 and December 2017, respectively that should have been filed within ten days of their becoming directors on August 18, 2017.
Item 11. Executive Compensation
The following identifies the elements of compensation for fiscal years 2017 and 2016 with respect to our “named executive officers,” which term is defined by Item 402 of the SEC’s Regulation S-K to include (i) all individuals serving as our principal executive officer at any time during fiscal year 2017, (ii) our two most highly compensated executive officers other than the principal executive officer who were serving as executive officers at September 30, 2017 and whose total compensation (excluding nonqualified deferred compensation earnings) exceeded $100,000, and (iii) up to two additional individuals for whom disclosure would have been provided pursuant to the foregoing item (ii) but for the fact that the individual was not serving as an executive officer of the Company at September 30, 2017. Our named executive officers for fiscal years 2016 and 2017 are Rod Whiton, who served as our Interim Chief Executive Officer until May 11, 2017, Michelle Cote, who served as our President until May 11, 2017, Dan O’Donnell, who served as our Chief Operating Officer and Director until his resignation on April 6, 2016, Christian Miller, who has served as our Chief Financial Officer since July 5, 2016 and our Chief Operating Officer since August 28, 2017, and Karla Kretsch, who served as our Chief Operating Officer from January 25, 2017 until August 7, 2017 and our President from May 11, 2017 until August 7, 2017.
The Company does not provide its officers or employees with pension, stock appreciation rights, long-term incentive or other plans. The Company does not have a defined benefit, pension, profit sharing plan but does offer a 401(k) plan.
31
Summary Compensation Table
The following table shows the compensation paid or accrued to the Company’s named executive officers during the fiscal years ended September 30, 2017 and 2016.
| All Other | ||||||||||||||||
| Name and | Fiscal | Salary | Compensation | |||||||||||||
| Principal Position | Year | (1) | (6)(7) | Total | ||||||||||||
| Rod Whitten | 2017 | $ | — | $ | — | $ | — | |||||||||
| Interim CEO | 2016 | $ | — | $ | — | $ | — | |||||||||
| Karla Kretsch (2)(3) | 2017 | $ | 68,016 | $ | 51,499 | $ | 119,515 | |||||||||
| President and COO | 2016 | $ | — | $ | — | $ | — | |||||||||
| Michelle Cote, (4) | 2017 | $ | 68,071 | $ | 2,720 | $ | 70,791 | |||||||||
| President | 2016 | $ | 88,000 | $ | 1,500 | $ | 89,500 | |||||||||
| Christian Miller (5) | 2017 | $ | 110,000 | $ | 17,603 | $ | 127,603 | |||||||||
| CFO and COO | 2016 | $ | 24,635 | $ | — | $ | 24,635 | |||||||||
| 1) | The dollar value of base salary (cash and non-cash) earned. | |
| 2) | Karla Kretsch became the COO in January of 2017 and President in May of 2017 | |
| 3) | Karla Kretsch resigned from her position in August of 2017 | |
| 4) | Michelle Cote resigned from her position in May of 2017 | |
| 5) | Christian Miller became the CFO in July of 2016 and COO in August of 2017. | |
| 6) | All other compensation: In January 2014 the Company established a 401(k) plan and instituted a dollar for dollar Company match of employee contributions, up to 4% of employee wages. During the fiscal years ended September 30, 2017 and 2016 the Company contributed: $-0- and $2,719 respectively to the 401(k) account of Ms. Cote | |
| 7) | Includes option grants and stock grants. Stock and Option grants for Karla Kretch of $49,812 and Christian Miller of $15,000. |
Outstanding Equity Awards At Fiscal Year-End
The following table shows information regarding outstanding equity awards (consisting of option awards) held by each of the Company’s named executive officers as of September 30, 2017.
| Option Awards | ||||||||||||||
| Name | Number of Securities Underlying Unexercised Options (#) Exercisable | Number of Securities Underlying Unexercised Options (#) Unexercisable | Option Exercise Price ($) | Option Expiration Date | ||||||||||
| Christian Miller | 118,793 | -0- | $ | 0.1840 | 09/30/22 | |||||||||
| Karla Kretsch | 28,000 | -0- | $ | 0.25 | 05/13/22 | |||||||||
32
Director Compensation
On May 14, 2017, the Company granted options consistent with its corporate by-laws to purchase shares of the Company’s common stock to each of the then members of the Company’s Board, as follows: Charles Grant – 900,000 shares, Joseph Marucci – 324,000 shares, Michael Gorin – 324,000 shares and JoyAnn Kenny, 216,000 shares. Each of the options has an exercise price of $0.30 per share, and is exercisable in full at any time during the five-year period commencing on the date of grant The option grants were approved by the Board based upon an investigation by an independent compensation consultant, who provided analysis and compensation recommendations to the Board. Among other things, the report concluded that the directors have: (i) served entirely without compensation (other than $4,500 paid to Mr. Marucci in or prior to July 2015) – Messrs. Grant and Marucci since March 2015 and Mr. Gorin and Ms. Kenny since July 2015; (ii) devoted more time and effort than what is to be expected or considered normal (especially the audit committee); (iii) been confronted by extenuating circumstances regarding the Company’s affairs that required substantial additional effort. Finally, the analysis indicated that Board Chair, Charles Grant, had expended a particularly large amount of effort, spending considerably more time performing board services than the other board members.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table shows, as of December 15, 2017, information with respect to those persons owning beneficially 5% or more of the Company’s common stock and the number and percentage of outstanding shares owned by each Director and named executive officer and by all current executive officers and directors as a group.
Applicable percentage ownership is based on 12,075,875 shares of common stock outstanding at December 15, 2017. In computing the number of shares of common stock beneficially owned by a person and the percentage ownership of that person, we deemed to be outstanding all shares of common stock subject to options, restricted stock units (RSUs) or other convertible securities held by that person or entity that are currently exercisable or releasable or that will become exercisable or releasable within 60 days of September 30, 2017. We did not deem these shares outstanding, however, for the purpose of computing the percentage ownership of any other person. Unless otherwise indicated, each owner has sole voting and investment powers over their shares of common stock, and the address of each owner listed is c/o the Company, 701 Market Street, Suite 113, St. Augustine, Florida 32095.
| Percent of | ||||||||
| Shares | Outstanding | |||||||
| Name | Owned | Shares | ||||||
| Michele Cote | 1,401,700 | (1) | 11.6 | % | ||||
| Brian Pappas | 1,123,429 | (2) | 9.3 | % | ||||
| Blake Furlow | 1,030,129 | (3) | 8.6 | % | ||||
| Rod Whiton | 498,501 | 4.1 | % | |||||
| Christian Miller | — | 0.0 | % | |||||
| JoyAnn Kenny-Charlton | — | 0.0 | % | |||||
| Gary Herman | — | 0.0 | % | |||||
| Bart Mitchel | — | 0.0 | % | |||||
| All officers and directors as a group (total excluding B Pappas) | 1,030,129 | 8.5 | % | |||||
* Includes shares owned by directors elected pursuant to the written consent described herein.
| (1) | Shares are held of record by Cote Trading Company, LLC, a limited liability company controlled by Ms. Cote. |
| (2) | This information is based solely on the Form 4 filed by Mr. Pappas on August 17, 2017. |
| (3) | Includes 51,029 shares owned by Mr. Furlow’s wife, which he may be deemed to beneficially
own. |
33
Item 13. Certain Relationships and Related Transactions, and Director Independence
During the years ended September 30, 2017 and 2016, the Company incurred the following related party consulting fees and commissions:
| Commissions and Consulting | ||||||||
| Fiscal Year Ending | ||||||||
| September 30, | ||||||||
| Related Party | 2017 | 2016 | ||||||
| Leap Ahead Learning Company (owned by Dan O’Donnell)(1) | $ | — | $ | 2,275 | ||||
| $ | — | $ | 2,275 | |||||
| (1) Leap Ahead Learning Company is 100% owned by by Dan O’Donnell, who was a director and the Chief Operating Officer of the Company until his resignation on April 6, 2016. The related party payable was approximately $-0- and $2,275, respectively at September 30 2017 and 2016. | |||
In addition, all franchisees pay fees directly to Leap Ahead Learning Company for set-up and monthly support for the FMT (Franchise Management Tool) which is a software package. The set-up fee is a one-time charge of $250 for domestic and Canadian franchisees and a range of $250 to $3,000 for international franchisees. The monthly support fee, for all franchisees, is $75. Also, all domestic franchisees that wish to accept credit card payments in the FMT must be set-up for processing credit cards through a third-party servicer, authorize.net. Leap Ahead Learning Company receives a monthly administrative fee of $7.95 for each franchisee using the credit card processing services of authorize.net. Leap Ahead Learning Company is the broker and administrator on behalf of authorize.net.
To ensure that the Company has sufficient liquidity, the Company received confirmation letters from certain Directors and Officers of the Company. Please see further discussion under Part II, Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” of this 10-K report.
Item 14. Principal Accountant Fees and Services.
Hartley Moore Accountants previously served as the Company’s independent registered public accountants for the year ended September 30, 2015 and 2014 until their resignation in June of 2016.
In July 2016, Hancock, Askew & Co., LLP was hired as new accountants. Such accounting firm was the Company’s principal accounting firm for the fiscal years ended September 30, 2016 and September 30, 2017.
The following table shows the fees billed aggregate to the Company for the period shown:
| Fiscal Year End | ||||||||||
| September 30, | ||||||||||
| Firm | Service | 2017 | 2016 | |||||||
| Hancock Askew & Co., LLP | Audit & Tax Related Fees | 135,825 | 108,132 | |||||||
| $ | 135,825 | $ | 108,132 | |||||||
Audit fees represent amounts invoiced for professional services rendered for the audit of the Company’s annual financial statements, including the Form 10-K report, and the reviews of the quarter ending financial statements included in the Company’s Form 10-Q reports.
34
Item 15. Exhibits, Financial Statement Schedules.
The following documents are filed as part of this report:
(1) Financial Statements
Consolidated Financial Statements:
| ● | Report of Independent Registered Public Accounting Firm; |
| ● | Consolidated Balance Sheets as of September 30, 2017 and September 30, 2016; |
| ● | Consolidated Statements of Operations for the years ended September 30, 2017 and September 30, 2016; |
| ● | Consolidated Statements of Cash Flows for the years ended September 30, 2017 and September 30, 2016; |
| ● | Consolidated Statements of Stockholders’ Equity for the years ended September 30, 2017 and September 30, 2016. |
(3) Exhibits
The accompanying Index to Exhibits is incorporated herein by reference.
35
Report of Independent Registered Certified Public Accounting Firm
Board of Directors and Stockholders
Creative Learning Corporation
We have audited the accompanying consolidated balance sheets of Creative Learning Corporation as of September 30, 2017 and 2016, and the related consolidated statements of operations, stockholder’s equity, and cash flows for each of the years in the two-year period ended September 30, 2017. Creative Learning Corporation’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Creative Learning Corporation as of September 30, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the two-year period ended September 30, 2017, in conformity with accounting principles generally accepted in the United States of America.
Respectfully submitted,
/s/ Hancock Askew & Co., LLP
Savannah, Georgia
December 29, 2017
F-1
CREATIVE LEARNING CORPORATION
Consolidated Balance Sheets
| September 30, | September 30, | |||||||
| 2017 | 2016 | |||||||
| Assets | ||||||||
| Current Assets: | ||||||||
| Cash | $ | 213,950 | $ | 276,685 | ||||
| Restricted cash (marketing fund) | 118,337 | 162,447 | ||||||
| Accounts receivable, less allowance for doubtful accounts of approximately $262,000 and $218,000, respectively | 356,830 | 240,640 | ||||||
| Prepaid expenses | 73,337 | 120,000 | ||||||
| Notes receivables - current portion, less allowance for doubtful accounts of approximately $33,000 and $26,000, respectively | 2,730 | 16,595 | ||||||
| Income tax receivable | — | 424,938 | ||||||
| Total Current Assets | 765,184 | 1,241,305 | ||||||
| Notes receivables - net of current portion | 59,150 | 60,150 | ||||||
| Property and equipment, net of accumulated depreciation of approximately $240,000 and $188,000, respectively | 260,094 | 299,320 | ||||||
| Intangible assets | 23,300 | 100,504 | ||||||
| Deposits | 15,053 | 1,425 | ||||||
| Deferred tax assets | — | 343,444 | ||||||
| Total Assets | $ | 1,122,781 | $ | 2,046,148 | ||||
| Liabilities and Stockholders’ Equity | ||||||||
| Current Liabilities: | ||||||||
| Accounts payable | $ | 148,021 | $ | 171,828 | ||||
| Payroll accruals | 17,950 | 15,844 | ||||||
| Accrued liabilities | 135,727 | 346,623 | ||||||
| Unearned revenue | — | 188 | ||||||
| Accrued marketing fund | 131,909 | 147,227 | ||||||
| Customer deposits | — | 5,000 | ||||||
| Total Current Liabilities | 433,607 | 686,710 | ||||||
| Commitments and Contingencies - Note 10 | ||||||||
| Stockholders’ Equity: | ||||||||
| Creative Learning Corporation stockholders’ equity: | ||||||||
| Preferred stock, $.0001 par value; 10,000,000 shares authorized; -0- and -0- shares issued and outstanding, respectively | — | — | ||||||
| Common stock, $.0001 par value; 50,000,000 shares authorized; 12,075,875 and 12,001,409 issued and outstanding, respectively | 1,207 | 1,200 | ||||||
| Additional paid-in capital | 2,895,285 | 2,534,554 | ||||||
| Treasury Stock 65,100 shares (cost method) | (34,626 | ) | (34,626 | ) | ||||
| Accumulated deficit | (2,172,692 | ) | (1,141,690 | ) | ||||
| Total Stockholders’ Equity | 689,174 | 1,359,438 | ||||||
| Total Liabilities and Stockholders’ Equity | $ | 1,122,781 | $ | 2,046,148 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
F-2
CREATIVE
LEARNING CORPORATION
Consolidated Statements of Operations
| For The Fiscal Years Ended | ||||||||
| September 30, | September 30, | |||||||
| 2017 | 2016 | |||||||
| Revenues: | ||||||||
| Initial franchise fees | $ | 206,950 | $ | 931,638 | ||||
| Royalties fees | 2,249,023 | 2,306,124 | ||||||
| Merchandise sales | 60 | 597 | ||||||
| 2,456,033 | 3,238,359 | |||||||
| Operating expenses: | ||||||||
| Franchise consulting and commissions | 161,776 | 537,109 | ||||||
| Franchise training and expenses | 15,710 | 207,399 | ||||||
| Salaries and payroll taxes | 716,610 | 888,477 | ||||||
| Stock-based compensation | 360,738 | — | ||||||
| Advertising | 21,027 | 435,221 | ||||||
| Professional fees & legal settlements | 1,316,838 | 2,710,699 | ||||||
| Office expense | 8,514 | 34,202 | ||||||
| Bad debt expense | 177,288 | 87,837 | ||||||
| Depreciation | 57,175 | 53,711 | ||||||
| Other general and administrative expenses | 312,809 | 679,418 | ||||||
| Total operating expenses | 3,148,485 | 5,634,073 | ||||||
| Loss from operations | (692,452 | ) | (2,395,714 | ) | ||||
| Other income | ||||||||
| Interest income - net | 87 | 3,323 | ||||||
| Other income | 26,016 | 23,144 | ||||||
| Total other income | 26,103 | 26,467 | ||||||
| Loss before benefit from income taxes | (666,349 | ) | (2,369,247 | ) | ||||
| (Provision for) benefit from income taxes | (364,653 | ) | 560,398 | |||||
| Net loss from continuing operations | (1,031,002 | ) | (1,808,849 | ) | ||||
| Discontinued operations: | ||||||||
| Operating loss from discontinued operations | — | (12,087 | ) | |||||
| Income tax benefit | — | 2,859 | ||||||
| Loss from discontinued operations | — | (9,228 | ) | |||||
| Net Loss | $ | (1,031,002 | ) | $ | (1,818,077 | ) | ||
| Net loss per share | ||||||||
| Basic and diluted | ||||||||
| Continuing operations | $ | (0.09 | ) | $ | (0.15 | ) | ||
| Discontinued operations | $ | — | $ | (0.00 | ) | |||
| Total | $ | (0.09 | ) | $ | (0.15 | ) | ||
| Basic and diluted weighted average number of common shares outstanding | 12,007,736 | 12,001,409 | ||||||
The accompanying notes are an integral part of the consolidated financial statements.
F-3
CREATIVE
LEARNING CORPORATION
Consolidated Statements of Cash Flows
| For the Fiscal Years Ended | ||||||||
| September 30, | September 30, | |||||||
| 2017 | 2016 | |||||||
| Cash flows from operating activities: | ||||||||
| Net Loss | $ | (1,031,002 | ) | $ | (1,818,077 | ) | ||
| Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
| Loss from discontinued operations | — | 9,228 | ||||||
| Depreciation | 57,175 | 53,711 | ||||||
| Bad debt expense | 177,288 | 87,837 | ||||||
| Deferred income taxes | 343,444 | (261,861 | ) | |||||
| Stock issued for compensation | 14,500 | — | ||||||
| Stock options issued for compensation | 50,312 | — | ||||||
| Stock options issued for directors’ fees | 295,926 | — | ||||||
| Impairment loss on Long-lived assets | 78,604 | — | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Restricted cash | 44,110 | 86,330 | ||||||
| Accounts receivable | (285,604 | ) | 43,962 | |||||
| Prepaid expenses | 46,663 | (108,722 | ) | |||||
| Notes receivable | 6,991 | 89,684 | ||||||
| Deposits | (13,628 | ) | 10,000 | |||||
| Accounts payable - related parties | — | (240 | ) | |||||
| Accounts payable - 3rd parties | (23,807 | ) | 52,715 | |||||
| Accrued liabilities | (210,896 | ) | (81,435 | ) | ||||
| Unearned revenue | (188 | ) | (35,712 | ) | ||||
| Payroll accruals | 2,106 | (20,646 | ) | |||||
| Accrued marketing | (15,318 | ) | (48,684 | ) | ||||
| Customer deposits | (5,000 | ) | (14,982 | ) | ||||
| Income tax receivable | 424,938 | (167,552 | ) | |||||
| Net cash used in operating activates | (43,386 | ) | (2,124,444 | ) | ||||
| Net cash (used in) provided by discontinued operations | — | 19,596 | ||||||
| Cash flows from investing activities: | ||||||||
| Acquisition of property and equipment | (19,349 | ) | (69,076 | ) | ||||
| Net cash (used in) provided by investing activities | (19,349 | ) | (69,076 | ) | ||||
| Net change in cash | (62,735 | ) | (2,173,924 | ) | ||||
| Cash, beginning of period | 276,685 | 2,450,609 | ||||||
| Cash, end of period | $ | 213,950 | $ | 276,685 | ||||
| Supplemental disclosure of cash flow information: | ||||||||
| Supplemental non-cash investing and financing activities: | ||||||||
| Acquisition of treasury stock in connection with disposition of CI | — | 16,500 | ||||||
The accompanying notes are an integral part of the consolidated financial statements.
F-4
CREATIVE
LEARNING CORPORATION
Consolidated Statements of Stockholder’s Equity
| Additional | ||||||||||||||||||||||||||||
| Treasury Stock | Common Stock | Paid-in | Accumulated | |||||||||||||||||||||||||
| Shares | Value | Shares | Par Value | Capital | Deficit | Total | ||||||||||||||||||||||
| Balance, October 1, 2015 | (15,100 | ) | $ | (18,126 | ) | 12,001,409 | $ | 1,200 | $ | 2,534,554 | $ | 676,387 | $ | 3,194,015 | ||||||||||||||
| Treasury stock (cost) | (50,000 | ) | (16,500 | ) | (16,500 | ) | ||||||||||||||||||||||
| Net loss | (1,818,077 | ) | (1,818,077 | ) | ||||||||||||||||||||||||
| Balance, September 30, 2016 | (65,100 | ) | (34,626 | ) | 12,001,409 | 1,200 | 2,534,554 | (1,141,690 | ) | 1,359,438 | ||||||||||||||||||
| Compensatory stock issuances | 74,466 | 7 | 14,493 | 14,500 | ||||||||||||||||||||||||
| Compensatory stock options issuances | 346,238 | 346,238 | ||||||||||||||||||||||||||
| Net loss | (1,031,002 | ) | (1,031,002 | ) | ||||||||||||||||||||||||
| Balance, September 30, 2017 | (65,100 | ) | $ | (34,626 | ) | 12,075,875 | $ | 1,207 | $ | 2,895,285 | $ | (2,172,692 | ) | $ | 689,174 | |||||||||||||
The accompanying notes are an integral part of the consolidated financial statements
F-5
CREATIVE LEARNING CORPORATION
Notes to Consolidated Financial Statements
September 30, 2017 and 2016
(1) Nature of Organization and Summary of Significant Accounting Policies
Nature of Organization
Creative Learning Corporation (“CLC”), formerly B2 Health, Inc., was incorporated March 8, 2006 in the State of Delaware. BFK Franchise Company LLC (“BFK”) was formed in the State of Nevada on May 19, 2009. Effective July 2, 2010, CLC was acquired by BFK in a transaction classified as a reverse acquisition. CLC concurrently changed its name from B2 Health, Inc. to Creative Learning Corporation. BFK and CLC are hereinafter referred to collectively as the “Company”.
In addition to the accounts of CLC and BFK, the accompanying consolidated financial statements include the accounts of CLC’s subsidiaries, BFK Development Company LLC (“BFKD”), and SF LLC (“Sew Fun Studios”).
The organizational documents for BFK Development Company LLC and SF LLC do not specify a termination date. Each of the above listed LLC’s has a single member, controlled 100% by the Company.
CLC operates wholly-owned subsidiaries BFK and SF under the trade names Bricks 4 Kidz® and Sew Fun Studios™ respectively, that offer children’s enrichment and education franchises. BFK Franchisees operated in 640 territories in 41 states and 44 countries. SF Franchisees operated in 12 territories in 5 states and 2 countries.
Until December 2015, CLC operated the wholly-owned subsidiary CI Franchise Company, LLC (“CI”) under the trade name Challenge Island®. The Company sold the CI concept on December 9, 2015, and as a result the Company is reporting CI as Discontinued Operations in the consolidated financial statements - see Note 12.
Basis of Presentation
This summary of significant accounting policies is presented to assist the reader in understanding and evaluating the Company’s financial statements. The financial statements and notes are representation of the Company’s management, which is responsible for their integrity and objectivity.
The Company financial statements are presented on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America (“GAAP”).
The Company has franchisees in 44 countries. International franchise fees vary and are set relative to the potential of the franchised territories. In addition, the Company awards master agreements outside of the United States and Canada. The royalty structure is the same for both our US and International franchisees. We recognize our revenue from foreign operations in US Dollars. We do not have international subsidiaries.
The Company operates multiple franchise concepts, but all concepts are managed centrally as one segment based upon the Company’s organizational structure, the way in which the operations and investments are managed and evaluated by the COO, as well as the lack of availability of discrete financial information at a lower level. The Company’s COO reviews revenue by franchise concept but operating expenses such as rent, overhead and management salaries and other corporate expense are not allocated among the franchise concepts and net income is measured at the Company wide level to allocate resources and assess the Company’s overall performance. The Company shares common, centralized support functions, including finance, human resources, legal, information technology, and corporate marketing, all of which report directly to the COO. Accordingly, decision-making regarding the Company’s overall operating performance and allocation of Company resources is assessed on a consolidated basis. As such, the Company operates as one reporting segment.
F-6
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
Fiscal year
The Company operates on a September 30 fiscal year-end.
Related Parties
The Company has been involved in transactions with related parties. A party is considered to be related to the Company if the party directly or indirectly or through one or more intermediaries, controls, is controlled by, or is under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of principal owners of the Company and its management, and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. A party which can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests is also a related party.
Use of Estimates
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of financial statements and the reported amounts of revenues and expenses during the reporting period. The more significant estimates and assumptions made by management include allowance for doubtful accounts, allowance for deferred tax assets, depreciation of property and equipment, amortization of intangible assets, recoverability of long lived assets and fair market value of equity instruments. Actual results could differ from those estimates as the current economic environment has increased the degree of uncertainty inherent in these estimates and assumptions.
Cash and Cash Equivalents
The Company considers all highly liquid securities with original maturities of three months or less when acquired, to be cash equivalents. We had no cash equivalents at September 30, 2017 and 2016.
The Company has restricted cash of approximately $118,000 and $162,000, respectively at fiscal years ended September 30, 2017 and 2016, associated with marketing funds collected from the franchisees. Per the franchise agreements, a marketing fund of 2% of franchisees’ gross cash receipts is collected by the Company and held to be spent on the promotion of the brand (see Note 6).
The Company maintains cash balances which at times exceed the federally insured limit of $250,000. The Company believes there is no significant risk with respect to these deposits.
Accounts and Note Receivables
The Company reviews accounts and notes receivable periodically for collectability and establishes an allowance for doubtful accounts and records bad debt expense when deemed necessary. The Company records an allowance for doubtful accounts and notes that is based on historical trends, customer knowledge, any known disputes, and considers the aging of the accounts receivable balances combined with management’s estimate of future potential recoverability. Receivables and notes are written off against the allowance after all attempts to collect a receivable have failed. The Company believes its allowance for doubtful accounts at September 30, 2017 and 2016 are adequate, but actual write-offs could exceed the recorded allowance. During the years ended September 30, 2017 and September 30, 2016, the values of accounts written-off to the reserve were approximately $125,000 and $89,000, respectively.
F-7
Long-Lived Assets
The Company’s long-lived assets consist of property and equipment, and intangible assets. The Company tests for impairment losses on long-lived assets used in operations whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of an asset to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the asset. If such asset is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. Impairment evaluations involve management’s estimates of asset useful lives and future cash flows. Actual useful lives and cash flows could be different from those estimated by management which could have a material effect on our reporting results and financial positions. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. However, there can be no assurances that demand for the Company’s products or services will continue, which could result in an impairment of long-lived assets in the future.
In connection with the sale of CI, the Company recorded a loss on assets held for sale in fiscal year 2016 (see Note 12 “Assets Held for Sale”).
During fiscal year 2017, the Company recognized an Impairment loss on long-lived assets on assets and goodwill related to territory repurchases made in fiscal years 2013 & 2014. See Note 4 for more information.
Property, Equipment and Depreciation
Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the related assets. Expenditures for additions and improvements are capitalized, while repairs and maintenance costs are expensed as incurred. The cost and related accumulated depreciation of property and equipment sold or otherwise disposed of are removed from the accounts and any gain or loss is recorded in the year of disposal.
| Fixed Assets | Useful Life | |
| Equipment | 5 years | |
| Furniture and Fixtures | 5 years | |
| Property Improvements | 15-40 years | |
| Software | 3 years |
Fair Value of Financial Instruments
The carrying amounts of cash, accounts receivable, deposits, and accounts payable approximate fair value because of the relative short-term maturity of these items and current payment expected. These fair value estimates are subjective in nature and involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect these estimates. The Company does not hold or issue financial instruments for trading purposes, nor does it utilize derivative instruments. Notes receivable are recorded at par value less allowance for uncollectible notes. The carrying amount is consistent with fair value based upon similar notes issued to other franchisees.
ASC 825, Financial Instruments, clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. It also requires disclosure about how fair value is determined for assets and liabilities and establishes a hierarchy for which these assets and liabilities must be grouped, based on significant levels of inputs as follows:
| Level 1: | Quoted prices in active markets for identical assets or liabilities. |
| Level 2: | Quoted prices in active markets for similar assets and liabilities and inputs that are observable for the asset or liability. |
F-8
| Level 3: | Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. |
The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
The carrying value of financial assets and liabilities recorded at fair value is measured on a recurring or nonrecurring basis. Financial assets and liabilities measured on a non-recurring basis are those that are adjusted to fair value when a significant event occurs. The Company had no financial assets or liabilities carried and measured on a recurring basis during the reporting periods. Financial assets and liabilities measured on a recurring basis are those that are adjusted to fair value each time a financial statement is prepared.
Revenue Recognition
Revenue is recognized on an accrual basis after services have been performed under contract terms and in accordance with regulatory requirements, the service price to the client is fixed or determinable, and collectability is reasonably assured
Since the Company’s franchises are primarily a mobile concept and do not require finding locations or construction, the franchisees can begin operations as soon as they complete training. The franchise fees are fully collectible and nonrefundable as of the date of the signing of the franchise agreement, but the franchise fees are not recognized as revenue until initial training has been completed and when substantially all of the services required by the franchise agreement have been fulfilled by the Company in accordance with ASC Topic 952-605 Revenue Recognition-Franchisor. Royalties are recognized as earned on a monthly basis.
At September 30, 2017 and 2016 the Company had approximately $-0- and $200, respectively, in unearned revenue for franchise fees collected but not yet earned per the revenue recognition policy.
Advertising Costs
Advertising costs are expensed as incurred. The Company incurred advertising costs for the years ended September 30, 2017 and 2016 of approximately $21,000 and $435,000, respectively.
Income Taxes
The provision for income taxes and deferred income taxes are determined using the asset and liability method. Deferred tax assets and liabilities are determined based on temporary differences between the financial carrying amounts and the tax basis of assets and liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse. On a periodic basis, the Company assesses the probability that its net deferred tax assets, if any, will be recovered. If after evaluating all of the positive and negative evidence, a conclusion is made that it is more likely than not that some portion or all of the net deferred tax assets will not be recovered, a valuation allowance is provided by a charge to tax expense to reserve the portion of the deferred tax assets which are not expected to be realized.
The Company reviews its filing positions for all open tax years in all U.S. federal and state jurisdictions where the Company is required to file.
When there are uncertainties related to potential income tax benefits, in order to qualify for recognition, the position the Company takes has to have at least a “more likely than not” chance of being sustained (based on the position’s technical merits) upon challenge by the respective authorities. The term “more likely than not” means a likelihood of more than 50 percent. Otherwise, the Company may not recognize any of the potential tax benefit associated with the position. The Company recognizes a benefit for a tax position that meets the “more likely than not” criterion at the largest amount of tax benefit that is greater than 50 percent likely of being realized upon its effective resolution. Unrecognized tax benefits involve management’s judgment regarding the likelihood of the benefit being sustained. The final resolution of uncertain tax positions could result in adjustments to recorded amounts and may affect our results of operations, financial position and cash flows.
F-9
The Company’s policy is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had no accrual for interest or penalties at September 30, 2017 and 2016, respectively, and has not recognized interest and/or penalties during the years ended September 30, 2017 and 2016, respectively, since there are no material unrecognized tax benefits. Management believes no material change to the amount of unrecognized tax benefits will occur within the next twelve months.
The tax years subject to examination by major tax jurisdictions include the years 2014 and forward by the U.S. Internal Revenue Service, and the years 2013 and forward for various states.
Net earnings (loss) per share
Basic earnings per share are computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted during the period. Dilutive securities having an anti-dilutive effect on diluted earnings per share are excluded from the calculation.
Stock-based compensation
The Company accounts for employee stock awards for services based on the grant date fair value of the instrument issued and those issued to non-employees are recorded based on the grant date fair value of the consideration received or the fair value of the equity instrument, whichever is more reliably measurable. Stock Awards are expensed over the service period.
Recent accounting pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09 “Revenue with Contracts from Customers (Topic 606).” ASU 2014-09 supersedes the current revenue recognition guidance, including industry-specific guidance. The guidance introduces a five-step model to achieve its core principal of the entity recognizing revenue to depict the transfer of goods or services to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In March 2016, the FASB issued ASU 2016-08, “Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net).” ASU 2016-08 provides specific guidance to determine whether an entity is providing a specified good or service itself or is arranging for the good or service to be provided by another party. In April 2016, the FASB issued ASU 2016-10, “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing.” ASU 2016-10 provides clarification on the subjects of identifying performance obligations and licensing implementation guidance.
The requirements for these standards relating to Topic 606 will be effective for interim and annual periods beginning after December 15, 2017, which means the Company must adopt this standard effective October 1, 2018 for our fiscal year ending September 30, 2019. Management does not expect the new revenue recognition standard to materially impact the recognition of continuing royalty fees from franchisees. They do, however, expect the adoption of Topic 606 to impact the accounting for initial franchise fees. Currently, the Company recognizes revenue from initial franchise fees in a single, up-front transaction, upon the completion of training of new franchisees, in the period in which all material obligations and initial services have been performed. Upon the adoption of Topic 606, we believe the Company will need to recognize the revenue related to initial franchise fees over the term of the related franchise agreement. This will result in less revenue in the short-term and more deferred revenue recognized over a period of time. The company has not completed its analysis to estimate the impact of this standard on the consolidated financial statements, but we are considering early adoption of this accounting standard utilizing the full retrospective approach during our upcoming fiscal year. Management will continue to finalize these accounting policies, quantify the impact of adopting this standard, and design and implement internal controls for this change during the fiscal year ending September 30, 2018,
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which is intended to improve and simplify several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Under the new standard, income tax benefits and deficiencies are to be recognized as income tax expense or benefit in the income statement and the tax effects of exercised or vested awards should be treated as discrete items in the reporting period in which they occur. An entity should also recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. Excess tax benefits should be classified along with other income tax cash flows as an operating activity. In regards to forfeitures, the entity may make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur. This ASU is effective for fiscal years beginning after December 15, 2016 including interim periods within that reporting period, however early adoption is permitted. This ASU is effective for fiscal years beginning after December 15, 2016 including interim periods within that reporting period, however early adoption is permitted. The Company has chosen early adoption of this standard, and there was no material effect on the consolidated financial statements.
F-10
In November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classification of Deferred Taxes”. The guidance requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. The guidance becomes effective for annual reporting periods beginning after December 15, 2016 with early adoption permitted. The Company adopted this guidance retrospectively as of October 1, 2015 in fiscal year 2016 and reclassified $90,727 from short-term deferred costs to long-term deferred tax liability in September of 2016.
In February 2016, the FASB issued ASU No. 2016-02, “Leases”, which requires lessees to recognize a right-to-use asset and a lease obligation for all leases. Lessees are permitted to make an accounting policy election to not recognize an asset and liability for leases with a term of twelve months or less. Additional qualitative and quantitative disclosures, including significant judgments made by management, will be required. The new standard will become effective for the Company beginning with the first quarter 2020 and requires a modified retrospective transition approach and includes a number of practical expedients. Early adoption of the standard is permitted. The Company is currently evaluating the impacts the adoption of this accounting guidance will have on the consolidated financial statements.
(2) Related Party Transactions
During the years ended September 30, 2017 and 2016, the Company incurred the following related party consulting fees and commissions:
| Commissions and Consulting | ||||||||
| Fiscal Year Ending | ||||||||
| September 30, | ||||||||
| Related Party | 2017 | 2016 | ||||||
| Leap Ahead Learning Company (owned by Dan O’Donnell)(1) | $ | — | $ | 2,275 | ||||
| $ | — | $ | 2,275 | |||||
| (1) Leap Ahead Learning Company is 100% owned by Dan O’Donnell, who was a director and the Chief Operating Officer of the Company until his resignation on April 6, 2016. The related party payable was approximately $-0- and $2,275, respectively at September 30 2017 and 2016. | ||||||||
In addition, all franchisees pay fees directly to Leap Ahead Learning Company for set-up and monthly support for the FMT (Franchise Management Tool) which is a software package. The set-up fee is a one-time charge of $250 for domestic and Canadian franchisees and a range of $250 to $3,000 for international franchisees. The monthly support fee, for all franchisees, is $75. Also, all domestic franchisees that wish to accept credit card payments in the FMT must be set-up for processing credit cards through a third-party servicer, authorize.net. Leap Ahead Learning Company receives a monthly administrative fee of $7.95 for each franchisee using the credit card processing services of authorize.net. Leap Ahead Learning Company is the broker and administrator on behalf of authorize.net.
To ensure that the Company has sufficient liquidity, the Company received confirmation letters from certain Directors and Officers of the Company. Please see further discussion under Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources of this 10-K report.
F-11
(3) Property and Equipment
Property and equipment consisted of the following:
| September 30, | September 30, | |||||||
| Description | 2017 | 2016 | ||||||
| Depreciable Fixed Assets: | ||||||||
| Equipment | $ | 66,969 | $ | 71,889 | ||||
| Furniture and Fixtures | 83,427 | 83,427 | ||||||
| Property Improvements | 233,615 | 233,615 | ||||||
| Software | 98,307 | 98,307 | ||||||
| Total Depreciable Fixed Assets | 482,318 | 487,238 | ||||||
| Accumulated Depreciation | (240,493 | ) | (187,918 | ) | ||||
| Total Net Depreciable Fixed Assets | 241,825 | 299,320 | ||||||
| Non-depreciable Fixed Assets: | ||||||||
| Work In Progress | 18,269 | — | ||||||
| Total Net Fixed Assets | $ | 260,094 | $ | 299,320 | ||||
Depreciation expense totaled approximately $57,000 and $54,000, respectively, for the years ended September 30, 2017 and 2016.
(4) Intangible Assets
Intangible Assets consist of purchased franchise rights and trademarks. The Intangible assets consists of Sew Fun Trademarks, Business Concepts and Curriculum which was purchased by the company.
During the fiscal year 2017, the Company determined that certain long-lived assets, related to repurchases of BFK territories during fiscal year 2013 and 2014, were over-valued. The Company determined that these territories and their associated fixed assets had no fair market value outside of their unimproved territory value compared to other unsold territories. Below is a table listing the assets, and the Impairment loss related to each:
| Net Book | Impairment | Corrected | |||||||||||||
| Date acquired | Value | Loss | Value | ||||||||||||
| Intangible Asset | |||||||||||||||
| Denver Territory - Repurchase | 6/3/2013 | 20,000 | (20,000 | ) | — | ||||||||||
| Auburn, AL Territory - Repurchase | 9/30/2013 | 6,720 | (6,720 | ) | — | ||||||||||
| Las Vegas Territory - Repurchase | 12/26/2013 | 40,484 | (40,484 | ) | — | ||||||||||
| St. Peters, MO Territory - Repurchase | 2/26/2014 | 10,000 | (10,000 | ) | — | ||||||||||
| Equipment | |||||||||||||||
| Exterior signs - Las Vegas territory | 12/26/2013 | 1,400 | (1,400 | ) | — | ||||||||||
| Total Adjusted Value | 78,604 | (78,604 | ) | — | |||||||||||
The impairment loss of $78,604 related to the above assets is included in the other general and administrative expenses line on the Consolidated Statements of Operations.
F-12
(5) Notes and Other Receivables
At September 30, 2017 and 2016 respectively, the Company held certain notes receivable totaling approximately $95,000 and $102,000 respectively for extended payment terms of franchise fees. The notes were generally non-interest-bearing notes with monthly payments, payable within one to two years.
| 2018 | 2019 | 2020 | 2021 | 2022 | Thereafter | Total | ||||||||||||||||||||||
| Payment schedule for Notes Receivable | $ | 36,184 | $ | 19,000 | $ | 12,950 | $ | 12,950 | $ | 12,950 | $ | 1,300 | $ | 95,334 | ||||||||||||||
(6) Accrued Marketing Fund
Per the terms of the franchise agreements, the Company collects 2% of franchisee’s gross revenues for a marketing fund, managed by the Company, to allocate toward national branding of the Company’s concepts to benefit the franchisees.
The marketing fund amounts are accounted for as a liability on the balance sheet and the actual collections are deposited into a marketing fund bank account. Expenses pertaining to the marketing fund activities are paid from the marketing fund and reduce the liability account.
At September 30, 2017 and 2016, the accrued marketing fund liability balances were approximately $132,000 and $147,000 respectively.
(7) Accrued Liabilities
The Company had accrued liabilities at September 30, 2017, and September 30, 2016 as follows:
| September 30, | September 30, | |||||||
| Accrued Liabilities | 2017 | 2016 | ||||||
| Accrued Accounting Fees | — | 13,753 | ||||||
| Accrued Legal Fees | 77,719 | 131,504 | ||||||
| Accrued Legal Settlements | 32,143 | 17,000 | ||||||
| Accrued State Regulatory Settlement | — | 149,366 | ||||||
| Accrued Exit Agreement | 9,739 | — | ||||||
| Accrued Other | 16,126 | 35,000 | ||||||
| $ | 135,727 | $ | 346,623 | |||||
The Company accrued $149,366 for state regulatory settlements in 2016, which included $35,500 in state penalties and costs and $113,866 in reimbursement of 5 franchisees in 2016.
(8) Common Stock Repurchases
On January 26, 2015, the Company’s board of directors (the “Board”) approved a plan pursuant to SEC Rule 10b-18 to purchase 100,000 shares of its common stock in the secondary market. At September 30, 2017 the Company has repurchased 15,100 shares of CLC common stock at a cumulative cost of approximately $18,000. The value of the treasury stock, based upon cost, is recorded in the equity section of the condensed consolidated balance sheet.
In conjunction with the Company’s sale of the CI business in December 2015, the Company acquired 50,000 shares of the Company’s common stock that had been held by the purchaser. The shares are valued at $16,500. These shares are included in the equity section of the consolidated balance sheet.
(9) Stock-Based Compensation
On May 14, 2017, the Company granted options consistent with its corporate by-laws to purchase shares of the Company’s common stock to each of the members of the Company’s then Board, as follows: Charles Grant – 900,000 shares, Joseph Marucci – 324,000 shares, Michael Gorin – 324,000 shares and JoyAnn Kenny, 216,000 shares. Each of the options has an exercise price of $0.30 per share, and is exercisable in full at any time during the five-year period commencing on the date of grant. The option grants were approved by the Board based upon an investigation by an independent compensation consultant, who provided analysis and compensation recommendations to the Board. Among other things, the report concluded that the directors have: (i) served entirely without compensation (other than $4,500 paid to Mr. Marucci in or prior to July 2015) – Messrs. Grant and Marucci since March 2015 and Mr. Gorin and Ms. Kenny since July 2015; (ii) devoted more time and effort than what is to be expected or considered normal (especially the audit committee); (iii) been confronted by extenuating circumstances regarding the Company’s affairs that required substantial additional effort. Finally, the analysis indicated that Board Chair, Charles Grant, had expended a particularly large amount of effort, spending considerably more time performing board services than the other board members.
F-13
On May 13, 2017, pursuant to the employment agreement of Karla Kretsch, the Company’s then President, the Company issued 8,000 shares of the Company’s common stock, and granted options to purchase 28,000 shares of the Company’s common stock at an exercise price of $0.25 per share, exercisable in full at any time during the five-year period commencing on the date of the grant. The shares and options were issued pursuant to the terms of Ms. Kretsch’s employment agreement with the Company, on account of Ms. Kretsch’s service to the Company for the quarter ended March 31, 2017. Based on the same employment agreement, for the quarter ending June 30, 2017, the Company issued 12,118 shares of the Company’s common stock, and granted options to purchase 42,414 shares of the Company’s common stock at an exercise price of $0.2063 per share, exercisable in full at any time during the five-year period commencing on the date of the grant.
On July 26, 2017, Karla Kretsch informed the Company of her intention to resign as President of the Company. Since Ms. Kretsch’s employment was terminated by Ms. Kretsch for “Good Reason” (as such term is defined in the Employment Agreement), Ms. Kretsch will be paid an amount equivalent to her base salary for a period of three months following the date of termination in equal amounts every two weeks, and will also be entitled to receive the Equity Awards due for the quarter in which termination occurred, as well as the immediately following three quarters, paid as scheduled at quarter-end. Therefore, for the quarter ending September 30, 2017, the Company recorded a total of approximately $34,000 in stock-based compensation expense for the fair value of equity awards according to the Employment Agreement. The Employment Agreement requires the grant of stock options to purchase 190,216 shares of the Company’s common stock at an exercise price of $0.1840 per share, as well as stock grants for 54,348 shares.
On October 26, 2017, the Board granted options to purchase 118,793 shares of the Company’s common stock at an exercise price of $0.1840 per share, exercisable in full at any time during the five-year period commencing on the date of the grant to Christian Miller per his employment agreement from July of 2016. These options were retroactively issued on September 30, 2017.
The Company utilizes the Black-Scholes valuation model for estimating fair value of stock compensation for options awarded to officers and members of the Board. Each grant is evaluated based upon assumptions at the time of the grant. The assumptions used in our calculations are no dividend yield, expected volatility between 129.03% and 134.69%, risk-free interest rate of 1.85% to 1.89%, and expected term of 2.5 years. The dividend yield of zero is based on the fact that the Company does not pay cash dividends and has no present intention to pay cash dividends. Expected volatility is estimated based on the Company’s historical stock prices over a period equivalent to the expected life in years. The risk-free interest rate is based on the U.S. Treasury’s Daily Treasury Yield Curve Rates at the date of grant with a term consistent with the expected life of the options granted. The expected term calculation is based on the “simplified method” allowed by the SEC, due to no applicable historical exercise data available.
The following are activity of options:
| Weighted | |||||||||||||||||
| Average | |||||||||||||||||
| Number of | Average | Expiration | Average | Grant Date | |||||||||||||
| Shares | Exercise Price | Date | Remaining Life | Fair Value | |||||||||||||
| Outstanding October 1, 2015 | 120,000 | 1.15 | |||||||||||||||
| Granted Fiscal Year 2016 | — | — | |||||||||||||||
| Forfeited shares | (100,000 | ) | 1.55 | ||||||||||||||
| Vested and Exercisable at September 30, 2016 | 20,000 | 1.55 | 2 Months | — | |||||||||||||
| Forfeited shares | (20,000 | ) | 1.55 | ||||||||||||||
| Granted May 13, 2017 | 1,792,000 | 0.30 | 05/13/22 | 56.5 Months | 0.17 | ||||||||||||
| Granted June 30, 2017 | 42,414 | 0.21 | 06/30/22 | 57 Months | 0.15 | ||||||||||||
| Granted September 30, 2017 | 309,009 | 0.18 | 09/30/22 | 60 Months | 0.13 | ||||||||||||
| Vested and Exercisable at September 30, 2017 | 2,143,423 | 0.29 | 0.16 | ||||||||||||||
F-14
(10) Commitments and Contingencies
Lease Commitments
The following table summarizes the Company’s contractual lease obligations at September 30, 2017:
| Obligation | 2018 | 2019 | Total | |||||||||
| Commercial Lease (Suite 114) | $ | 17,100 | $ | 12,113 | $ | 29,213 | ||||||
Rent expense was approximately $16,000 and $26,000, respectively, for the years ended September 30, 2017 and 2016.
Litigation
From time to time, the Company has been and may become involved in legal proceedings arising in the ordinary course of its business. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense and settlement costs, diversion of management resources, and other factors.
On October 2, 2015, the Company filed suit in the state court in St. John’s County, Florida, Case No. CA 15-1076, against its former Chief Executive Officer Brian Pappas, Christine Pappas, its former Human Resources officer, and an independent company controlled by Mr. Pappas named Franventures, LLC (“FV”). The lawsuit seeks return of company emails and other electronic materials in the possession of the defendants, company control over the process by which the company’s documents are identified, and a court judgment that the property is the Company’s. Mr. and Mrs. Pappas have returned certain company documents that they have identified, but other issues remain.
On December 11, 2017, Brian Pappas filed a counterclaim alleging the Company is required to indemnify him for a multitude of matters. The Company denies the allegation and intends to vigorously litigate this matter.
In a separate suit, filed on March 7, 2016 in the state court in St. John’s County, Florida (Case No. CA 16-236), Franventures, LLC (“FV”) alleged that it is due an unstated amount of money from the Company pursuant to a contract the Company had previously terminated.
On June 23, 2016, the Company filed a counterclaim against FV, which also included a complaint against former Chairman of the Board and Chief Executive Officer Brian Pappas. The counterclaim seeks redress for losses and expenditures caused by alleged fraud, conversion of company assets, and breaches of fiduciary duty that the Company alleges that defendants perpetrated upon CLC, including assertions regarding actions by Brian Pappas that the Company alleges occurred while Pappas was serving as the Chief Executive Officer of CLC and as a member of its board of directors.
On October 27, 2016, Brian Pappas filed a motion to amend the complaint to add a claim alleging that the Company slandered him by virtue of a press release issued on or about August 1, 2016, in which the Company reported to shareholders on steps it had taken and improvements it had implemented. The motion has still not been ruled upon by the Court. If Pappas does amend his complaint, the Company will vigorously defend the proposed claim.
On February 24, 2017, franchisee, Team Kasa, LLC, along with its three owners, filed suit in the Eastern District of New York (Case No. 2:17-cv-01074) against former CEO Brian Pappas, and Franventures, LLC. The same Plaintiffs also initiated arbitration on the same issues (American Arbitration Association, Case No. 01-17-0001-1968), alleging the Company is jointly and severally liable for damages resulting from the allegations against Mr. Pappas and Franventures. The Company is contesting the allegations and its liability for any damages.
On May 9, 2017, franchisee, Back and 4th, LLC, along with its owner, Kristena Bins-Turner, initiated arbitration against the Company for breach of contract, alleging that they did not receive adequate value for royalty payments made under the franchise agreement, for fraud, alleging material misrepresentations and omissions prior to entry into the franchise agreements, and for misrepresentation violations of Florida Statute 817.416. (American Arbitration Association, Case. No. 01-16-004-3745). Franchisee and its owner seek an unspecified amount of damages. The Company contested the allegations and its liability for any damages at an evidentiary hearing held December 5-7, 2017. A final determination on the matter is pending.
On November 8, 2017, franchisee, Indy Bricks, LLC, along with its two owners, Ben & Kate Schreiber initiated arbitration against the Company. (American Arbitration Association, Case No. 01-17-0006-8120). Plaintiffs allege breach of contract, fraud, material misrepresentations and omissions, violations of the Indiana Franchise Act, and violations of the Indiana Deceptive Franchise Practices Act. The Company is vigorously contesting the allegations and its liability for any damages.
On August 21, 2017, the SEC filed a Civil Complaint against the Company and certain former executive officers and directors in the United States District Court for the Middle District of Florida, Jacksonville Division, as Civil Action No. 3:17-cv-00954-TJC-JRK. The Civil Complaint was in regards to alleged violations of federal securities law occurring between 2011 and 2015. On August 22, 2017, the SEC also filed with the court the Company’s formal Consent to a full resolution of all allegations pertaining to the Company. Pursuant to the Consent, without admitting or denying the allegations, the Company agreed to the entry of a final judgment that permanently enjoins it from violating the sections of the federal securities laws listed in the Civil Complaint. On September 20, 2017, the United States District Court for the Middle District of Florida, Jacksonville Division issued the final judgment order as to the Company in the Civil Action No. 3:17-cv-00954-TJC-JRK. The entering of the final judgment order has resolved all allegations pertaining to the Company. The Company was not assessed any monetary penalties.
On September 21, 2017, the Company filed a notice of voluntary dismissal without prejudice in the United States District Court for the Middle District of Florida, Jacksonville Division, in its lawsuit against Blake and Anik Furlow relating to their conduct in the shareholder consent. The Company filed the complaint on May 15, 2017, and after consideration, decided it was not in the best interest of the Company to proceed with the litigation.
F-15
(11) Income Taxes
Components of Deferred Taxes are:
| 2017 | 2016 | |||||||
| Deferred tax assets: | ||||||||
| Allowance for bad debt | $ | 104,056 | $ | 87,542 | ||||
| Charitable contributions | 176 | 180 | ||||||
| Stock-based compensation | 121,919 | — | ||||||
| Foreign Tax Credit | 66,085 | — | ||||||
| Benefit from net operating loss carryovers | 466,998 | 525,283 | ||||||
| Total gross deferred tax asset | 759,234 | 613,004 | ||||||
| Deferred tax liabilities: | ||||||||
| Depreciation timing difference | (11,445 | ) | (6,919 | ) | ||||
| Total deferred liability | (11,445 | ) | (6,919 | ) | ||||
| Gross net deferred tax asset | 747,789 | 606,086 | ||||||
| Less: Valuation allowances | (747,789 | ) | (262,642 | ) | ||||
| Net deferred tax asset | $ | — | $ | 343,444 | ||||
The Company has recorded various deferred tax assets and liabilities as reflected above. In assessing the ability to realize the deferred tax assets, management considers, whether it is more likely than not, that some portion, or all of the deferred tax assets and liabilities will be realized. The ultimate realization is dependent on generating sufficient taxable income in future years. The valuation allowance is equal to 100% of the Net deferred tax asset. Given recurring losses, the Company cannot conclude that it is more likely than not that such assets will be realized, therefore a full valuation allowance has been recorded.
The components of the provisions for income taxes for fiscal years 2017 and 2016 are as follows:
| 2017 | 2016 | |||||||
| Current: | ||||||||
| Federal | ||||||||
| Continuing operations | $ | (53,587 | ) | $ | (176,492 | ) | ||
| Discontinued operations | — | (2,287 | ) | |||||
| Total | (53,587 | ) | (178,779 | ) | ||||
| State | ||||||||
| Continuing operations | (10,497 | ) | (121,988 | ) | ||||
| Discontinued operations | — | (615 | ) | |||||
| Total | (10,497 | ) | (122,603 | ) | ||||
| Total | ||||||||
| Continuing operations | (64,084 | ) | (298,480 | ) | ||||
| Discontinued operations | — | (2,902 | ) | |||||
| Total Current Tax | (64,084 | ) | (301,382 | ) | ||||
| Deferred: | ||||||||
| Additional deferred tax related to book tax differences | (56,410 | ) | (524,516 | ) | ||||
| Valuation allowance provision | 485,147 | 262,642 | ||||||
| Total Tax Provision | $ | 364,653 | $ | (563,256 | ) | |||
F-16
A reconciliation of the provisions for income taxes for the fiscal years ended September 2017 and 2016 as compared to statutory rates is as follows:
| 2017 | 2016 | |||||||||||||||
| Amount | % | Amount | % | |||||||||||||
| Provision at statutory rates | $ | (226,559 | ) | 34.00 | % | $ | (789,534 | ) | 34.00 | % | ||||||
| State income tax, net of federal benefit | (24,188 | ) | 3.63 | % | (84,294 | ) | 3.63 | % | ||||||||
| Non-Deductible items | ||||||||||||||||
| Penalties | 18,815 | -2.82 | % | 48,165 | -2.07 | % | ||||||||||
| Meals & Entertainment | 1,040 | -0.16 | % | 1,440 | -0.06 | % | ||||||||||
| Stock-based compensation | 130,289 | -19.55 | % | — | 0.00 | % | ||||||||||
| Other tax differences | (19,891 | ) | 2.99 | % | (1,674 | ) | 0.07 | % | ||||||||
| Valuation allowance on net operating loss carryover | 485,147 | -72.81 | % | 262,641 | -11.31 | % | ||||||||||
| Total income tax provision | $ | 364,653 | -54.72 | % | $ | (563,256 | ) | 24.26 | % | |||||||
In December 2017, the United States Government passed new tax legislation that, among other provisions, will lower the corporate tax rate from 35% to 21%. In addition to applying the new lower corporate tax rate in 2018 and thereafter to any taxable income we may have, the legislation affects the way we can use and carryforward net operating losses previously accumulated and results in a revaluation of deferred tax assets and liabilities recorded on our balance sheet. Given that current deferred tax assets are offset by a full valuation allowance, these changes will have no net impact on the balance sheet. However, when we become profitable, we will receive a reduced benefit from such deferred tax assets. Had this legislation passed prior to our September 30 fiscal year-end, the effect of the legislation would have been a reduction in deferred tax assets and the corresponding valuation allowance of approximately $179,000, as of September 30, 2017.
(12) Assets Held For Sale
In September 2015, management committed to a plan to sell the CI concept because it was not a strategic fit with the Company’s existing BFK franchise brand.
The Company executed a purchase and sale agreement on December 9, 2015. The sale included substantially all of the assets of the CI business, which were sold on an “as is where is” basis, with no Company representations or warranties surviving the consummation of the sale. The purchase price for the assets consisted of the transfer to the Company of 50,000 shares of the Company’s common stock that had been held by the purchaser, reversal of an accrual to issue 25,000 shares of the Company’s common stock and the assumption of certain liabilities related to the acquired assets.
The following table lists the operating loss on the assets held for sale for September 30, 2016:
| FY ended | ||||
| Operating Loss on discontinued operations | 09/30/16 | |||
| Revenue | 10,785 | |||
| Advertising and promotion | (7,635 | ) | ||
| General and administrative expenses | (15,237 | ) | ||
| Operating Loss on discontinued operations | (12,087 | ) | ||
F-17
(13) Earnings Per Share
The following table sets for the computation of basic and diluted net loss per share:
| Fiscal Years Ended | ||||||||
| September 30, | ||||||||
| Net loss attributed to common stockholders | 2017 | 2016 | ||||||
| Net loss from continuing operations | $ | (1,031,002 | ) | $ | (1,808,849 | ) | ||
| Net loss from discontinued operations | — | (9,228 | ) | |||||
| Net loss | $ | (1,031,002 | ) | $ | (1,818,077 | ) | ||
| Net loss per share | ||||||||
| Continuing operations | $ | (0.09 | ) | $ | (0.15 | ) | ||
| Discontinued operations | — | (0.00 | ) | |||||
| Total | $ | (0.09 | ) | $ | (0.15 | ) | ||
| Basic weighted average number of common shares outstanding | 12,007,736 | 12,001,409 | ||||||
Potentially dilutive shares were excluded as the items were anti-dilutive as of September 30, 2017 and September 30, 2016.
F-18
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
| CREATIVE LEARNING CORPORATION |
| By: | /s/ Christian Miller | |
|
Christian Miller Chief Financial Officer and Chief Operations Officer |
| By: | /s/ Dawn Davis |
|
Dawn Davis Controller |
Date: January 4, 2018
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Christian Miller and Dawn Davis, jointly and severally, his attorney-in-fact, each with the full power of substitution, for such person, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might do or could do in person hereby ratifying and confirming all that said attorneys-in-fact and agents, or his substitute, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
| Signature | Title | Date | ||
| /s/ Christian Miller | Chief Financial Officer and Chief Operations Officer | January 4, 2018 | ||
| Christian Miller | (Principal Executive Officer, Principal Financial Officer) | |||
| /s/ Dawn Davis | Controller | January 4, 2018 | ||
| Dawn Davis | (Principal Accounting Officer) | |||
| /s/ Blake Furlow | Director | January 4, 2018 | ||
| Blake Furlow | ||||
| /s/ JoyAnn Kenny-Charlton | Director | January 4, 2018 | ||
| JoyAnn Kenny-Charlton | ||||
| /s/ Gary Herman | Director | January 4, 2018 | ||
| Gary Herman | ||||
| /s/ Bart Mitchell | Director | January 4, 2018 | ||
| Bart Mitchell |
36
INDEX TO EXHIBITS
| 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.
37