Rocky Mountain Chocolate Factory, Inc. - Quarter Report: 2015 May (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended May 31, 2015

For the transition period from ________to________

Commission file number: 001-36865

 Rocky Mountain Chocolate Factory, Inc.

(Exact name of registrant as specified in its charter)

265 Turner Drive, Durango, CO 81303

(Address of principal executive offices, including zip code)

(970) 259-0554

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X   No         

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes X   No         

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

(Do not check if a smaller reporting company)

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

On June 30, 2015, the registrant had outstanding 5,943,351 shares of its common stock, $.001 par value.

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.

 FORM 10-Q

 TABLE OF CONTENTS

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

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

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

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

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

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

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q (“Quarterly Report”) includes statements of our expectations, intentions, plans and beliefs that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are intended to come within the safe harbor protection provided by those sections. These forward-looking statements involve various risks and uncertainties. The nature of our operations and the environment in which we operate subject us to changing economic, competitive, regulatory and technological conditions, risks and uncertainties. The statements, other than statements of historical fact, included in this Quarterly Report are forward-looking statements. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as "will," "intend," "believe," "expect," "anticipate," "should," "plan," "estimate," "potential," or similar expressions. Factors which could cause results to differ include, but are not limited to: changes in the confectionery business environment, seasonality, consumer interest in our products, general economic conditions, the success of U-Swirl, Inc., receptiveness of our products internationally, consumer and retail trends, costs and availability of raw materials, competition, the success of our co-branding strategy, the success of international expansion efforts and the effect of government regulations. Government regulations which we and our franchisees either are or may be subject to and which could cause results to differ from forward-looking statements include, but are not limited to: local, state and federal laws regarding health, sanitation, safety, building and fire codes, franchising, employment, manufacturing, packaging and distribution of food products and motor carriers. For a detailed discussion of the risks and uncertainties that may cause our actual results to differ from the forward-looking statements contained herein, please see the “Risk Factors” contained in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended February 28, 2015. These forward-looking statements apply only as of the date of this Quarterly Report. As such they should not be unduly relied upon for more current circumstances. Except as required by law, we undertake no obligation to release publicly any revisions to these forward-looking statements that might reflect events or circumstances occurring after the date of this Quarterly Report or those that might reflect the occurrence of unanticipated events.

Unless otherwise specified, the “Company,” “we,” “us” or “our” refers to Rocky Mountain Chocolate Factory, Inc, a Delaware corporation and its consolidated subsidiaries.

Overview

Effective March 1, 2015, we reorganized to create a holding company structure. Our operating subsidiary with the same name, Rocky Mountain Chocolate Factory, Inc., a Colorado corporation (“RMCF”), which was previously the public company, became a wholly-owned subsidiary of a newly formed entity, Rocky Mountain Chocolate Factory, Inc., a Delaware corporation (“Newco”), and all of the outstanding shares of common stock of RMCF were exchanged on a one-for-one basis for shares of common stock of Newco. Our new holding company began trading on March 2, 2015 on the NASDAQ Global Market under the symbol “RMCF”, which was the same symbol used by RMCF prior to the holding company reorganization.

In January 2013, through our wholly-owned subsidiaries, including Aspen Leaf Yogurt, LLC (“ALY”), we entered into two agreements to sell all of the assets of our ALY frozen yogurt stores, along with our interest in the self-serve frozen yogurt franchises and retail units branded as “Yogurtini” which we also acquired in January 2013, to U-Swirl, a publicly traded company (OTCQB: SWRL), in exchange for a 60% controlling equity interest in U-Swirl. Upon completion of these transactions, RMCF ceased to directly operate any Company-owned Aspen Leaf Yogurt locations or sell and support frozen yogurt franchise locations, which are now being supported by U-Swirl. As of May 31, 2015, we held a 39% controlling interest in U-Swirl. Additionally, we have the right to acquire approximately 27,146,000 shares of common stock of U-Swirl through the conversion of convertible debt owed by U-Swirl to our company. If the Company exercised this conversion right, we believe we would hold approximately 72% of U-Swirl’s common stock.

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

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

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

Results of Operations

Three Months Ended May 31, 2015 Compared to the Three Months Ended May 31, 2014

Basic earnings per share increased 8.3% from $.12 per share during the three months ended May 31, 2014 to $.13 per share during the three months ended May 31, 2015. Revenues increased by $41,800 in the three months ended May 31, 2015 compared to the three months ended May 31, 2014. This increase in revenues was due primarily to an increase in factory sales and franchise fees, mostly offset by a decline in retail sales. Operating income increased 4.8% from $1.36 million for the three months ended May 31, 2014 to $1.41 million for the three months ended May 31, 2015. Net income increased 7.3% from $711,000 in the three months ended May 31, 2014 to $763,000 in the three months ended May 31, 2015. The increase in operating income and net income was due primarily to restructuring and acquisition charges in the three months ended May 31, 2014 with no comparable expense in the three months ended May 31, 2015.

Factory Sales

The increase in factory sales for the three months ended May 31, 2015 versus the three months ended May 31, 2014 was primarily due to a 32.5% increase in shipments of product to customers outside our network of franchised retail stores. This increase was partially offset by a 5.7% decrease in the average number of domestic Rocky Mountain Chocolate Factory franchised stores in operation and a 1.0% decrease in same-store pounds purchased by our network of franchise and license stores.

Retail Sales

The decrease in retail sales was primarily due to changes in retail units in operation resulting from the sale of certain Company-owned locations and the closure of a certain underperforming Company-owned location. Same store sales at all Company-owned stores and cafés decreased 3.4% in the three months ended May 31, 2015 compared to the three months ended May 31, 2014. Same-store sales at U-Swirl cafés decreased 4.2% in the three months ended May 31, 2015 compared to the three months ended May 31, 2014, which management believes reflects the impact of store overcapacity within the self-serve frozen yogurt market.

Royalties, Marketing Fees and Franchise Fees

The decrease in royalties and marketing fees from the three months ended May 31, 2014 to the three months ended May 31, 2015 resulted from a 9.0% decrease in franchise units in operation and lower same store sales. The average number of total franchise stores in operation decreased from 488 in the three months ended May 31, 2014 to 444 during the three months ended May 31, 2015. This decrease is the result of domestic store closures exceeding domestic store openings. Same store sales at total franchise stores and cafés in operation decreased 1.1% during the three months ended May 31, 2015 compared to the three months ended May 31, 2014. Franchise fee revenues increased as a result of the license fees associated with the license agreements for the development and franchising of CherryBerry stores in the Canadian province of Ontario being recognized in the three months ended May 31, 2015 and no international license fees being recognized in the three months ended May 31, 2014.

Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin minus depreciation and amortization expense. We believe adjusted gross margin and factory adjusted gross margin are helpful in understanding our past performance as a supplement to gross margin, factory gross margin and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin and factory adjusted gross margin are useful to investors because they provide a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use adjusted gross margin and factory adjusted gross margin rather than gross margin and factory gross margin to make incremental pricing decisions. Adjusted gross margin and factory adjusted gross margin have limitations as analytical tools because they exclude the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin and factory adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin and factory gross margin. The following table provides a reconciliation of factory adjusted gross margin to factory gross margin, the most comparable performance measure under GAAP:

Cost of Sales

Factory margins decreased 320 basis points in the three months ended May 31, 2015 compared to the three months ended May 31, 2014 due primarily to increased costs of certain materials and a shift in product mix and customer mix in the three months ended May 31, 2015 compared to the three months ended May 31, 2014. This change in customer and product mix resulted from a decrease in domestic franchise customers and an increase in sales of products to customers outside our franchise system during the three months ended May 31, 2015, compared to the three months ended May 31, 2014. Company-owned store margin during the three months ended May 31, 2015 was nearly unchanged from the three months ended May 31, 2014.

Franchise Costs

The increase in franchise costs in the three months ended May 31, 2015 versus the three months ended May 31, 2014 is due primarily to franchise costs associated with supporting U-Swirl franchise units. In the six months ended February 28, 2015 U-Swirl was reorganized resulting in additional resources being allocated to the support of U-Swirl franchisees. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increased to 23.0% in the three months ended May 31, 2015 from 22.1% in the three months ended May 31, 2014. This increase as a percentage of royalty, marketing and franchise fees is primarily a result of higher franchise costs partially offset by higher franchise and royalty revenues.

Sales and Marketing

The decrease in sales and marketing costs for the three months ended May 31, 2015 compared to the three months ended May 31, 2014 is primarily due to lower marketing-related costs associated with U-Swirl franchise locations.

General and Administrative

The decrease in general and administrative costs for the three months ended May 31, 2015 compared to the three months ended May 31, 2014 is due primarily to the reorganization of U-Swirl in the prior year and the associated focus on reduction of duplicative general and administrative costs. For the three months ended May 31, 2015, approximately $403,000 of U-Swirl general and administrative costs were consolidated within our results, compared with $548,000 in the three months ended May 31, 2014. As a percentage of total revenues, general and administrative expenses decreased to 12.8% in the three months ended May 31, 2015 compared to 13.5% in the three months ended May 31, 2014.

Retail Operating Expenses

Depreciation and Amortization

Depreciation and amortization of $365,000 in the three months ended May 31, 2015 decreased 2.4% from $374,000 incurred in the three months ended May 31, 2014. This decrease was the result of fewer Company-owned store assets in service mostly offset by an increase in depreciation associated with factory asset additions.

Other Income

Net interest expense was $45,300 in the three months ended May 31, 2015 compared to net interest expense of $48,800 realized in the three months ended May 31, 2014. This change was the result of less interest expense incurred on lower average outstanding promissory note balances.

Income Tax Expense

Our effective income tax rate for the three months ended May 31, 2015 was 31.7%, compared to 27.8% for the three months ended May 31, 2014. The increase of 3.9% was primarily the result of the consolidation of the U-Swirl net operating income. There was no income tax expense recognized on U-Swirl income before income taxes for the three months ended May 31, 2014 while income tax expense was recognized during the three months ended May 31, 2015 on U-Swirl income before income taxes. U-Swirl has significant net operating loss carryovers. In accordance with section 382 of the Internal Revenue Code, deductibility of U-Swirl’s U.S. net operating loss carryovers may be subject to annual limitation in the event of a change in control. We have performed a preliminary evaluation as to whether a change in control has taken place, and have concluded that there was a change of control with respect to the net operating losses of U-Swirl when the Company acquired a 60% ownership interest in January 2013. Our effective income tax rate may increase in future periods, or for the full year as a result of estimates related to the income tax liability arising from the income before income taxes of U-Swirl.

Liquidity and Capital Resources

As of May 31, 2015, working capital was $8.8 million, compared with $9.4 million as of February 28, 2015, a decrease of $600,000. The decrease in working capital was primarily due to positive operating results more than offset by the payment of dividends and repurchases of common stock.

Cash and cash equivalent balances increased $1.21 million from $7.16 million as of February 28, 2015 to $8.37 million as of May 31, 2015 as a result of cash flow generated by operating activities. Our current ratio was 2.1 to 1 at May 31, 2015 and February 28, 2015. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.

For the three months ended May 31, 2015, we had net income of $933,359. Operating activities provided cash of $3,365,246, with the principal adjustment to reconcile the net income to net cash provided by operating activities being a change in inventories of $1,111,144 and the change in accounts receivable of $766,824. During the comparable 2014 period, we had net income of $937,272, and operating activities provided cash of $3,678,071. The principal adjustment to reconcile the net income to net cash provided by operating activities was the change in inventories of $355,877 and the change in accounts receivable of $1,337,281.

For the three months ended May 31, 2015, investing activities used cash of $109,344, primarily due to the purchases of property, equipment, goodwill and other intangible assets of $200,386. In comparison, investing activities used cash of $166,640 during the three months ended May 31, 2014 primarily due to the purchase of property and additions to notes receivable.

Financing activities used cash of $2,044,975 for the three months ended May 31, 2015 and provided cash of $423,813 during the prior year period. This was primarily due to increased cash used to repurchase common stock during the three months ended May 31, 2015 and less proceeds from the exercise of stock warrants in our subsidiary.

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

The Company’s long-term debt is comprised of a promissory note used to finance business acquisitions of U-Swirl (unpaid balance as of May 31, 2015, $6.0 million). The promissory note allows the Company to borrow up to a maximum of $7.0 million to finance business acquisitions and bears interest at a fixed annual rate of 3.75%. The promissory note matures on January 15, 2020, with amortized principal and accrued interest due monthly on the promissory note. Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of May 31, 2015, we were in compliance with all such covenants.

At the time the Company entered into the promissory note used to finance the acquisitions of U-Swirl described above, the Company also entered into a loan and security agreement with U-Swirl (the “U-Swirl Loan Agreement”), pursuant to which U-Swirl could borrow up to $7.75 million from the Company to fund acquisitions. At May 31, 2015, $6.8 million was outstanding under the U-Swirl Loan Agreement. Any outstanding amounts under the U-Swirl Loan Agreement are convertible at any time at the Company’s option into shares of preferred stock of U-Swirl. Borrowings under the U-Swirl Loan Agreement are secured by all of the assets of U-Swirl. In addition, the U-Swirl Loan Agreement is subject to various financial and leverage covenants. U-Swirl was not compliant with the covenants at May 31, 2015. The loan covenants required U-Swirl to maintain consolidated adjusted EBITDA of $1,804,000 for the twelve months ended May 31, 2015. At May 31, 2015 U-Swirl had reported $1,532,000 of adjusted EBITDA. In an event of default, we may charge interest on all amounts due under the U-Swirl Loan Agreement at the default rate of 15% per annum, accelerate payment of all amounts due under the U-Swirl Loan Agreement, and foreclose on our security interest.

On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. During the three months ended May 31, 2015 the Company repurchased 75,968 shares under the repurchase plan at an average price of $13.62 per share. As of May 31, 2015, approximately $2,986,000 remains available under the repurchase plan for further stock repurchases.

Off-Balance Sheet Arrangements

As of May 31, 2015, we had no off-balance sheet arrangements or obligations.

Impact of Inflation

Inflationary factors such as increases in the costs of ingredients and labor directly affect our operations. Most of our leases provide for cost-of-living adjustments and require us to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally, our future lease costs for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that we will be able to pass on increased costs to our customers.

Depreciation expense is based on the historical cost to us of fixed assets, and is therefore potentially less than it would be if it were based on current replacement cost. While property and equipment acquired in prior years will ultimately have to be replaced at higher prices, it is expected that replacement will be a gradual process over many years.

Seasonality

We are subject to seasonal fluctuations in sales, which cause fluctuations in quarterly results of operations. Historically, the strongest sales of our confectionary products have occurred during the Christmas holiday through Mother’s Day. We believe the strongest sales of frozen yogurt products will occur during the summer months. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and sales of franchises. Because of the seasonality of our business and the impact of new store openings and sales of franchises, results for any quarter are not necessarily indicative of results that may be achieved in other quarters or for a full fiscal year.

We do not engage in commodity futures trading or hedging activities and do not enter into derivative financial instrument transactions for trading or other speculative purposes. We also do not engage in transactions in foreign currencies or in interest rate swap transactions that could expose us to market risk. However, we are exposed to some commodity price and interest rate risks.

We frequently enter into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit us to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. Because prices for these products may fluctuate, we may benefit if prices rise during the terms of these contracts, but we may be required to pay above-market prices if prices fall and we are unable to renegotiate the terms of the contract. As of May 31, 2015, based on future contractual obligations for ingredients, we estimate that a 10.0% change in the prices of contracted ingredients would result in an $87,000 favorable or unfavorable price benefit resulting from our contracts.

We have a $5.0 million bank line of credit that bears interest at a variable rate. As of May 31, 2015, no amount was outstanding under the line of credit. We do not believe that we are exposed to any material interest rate risk related to this credit facility.

We have a $7.0 million promissory note with interest at a fixed rate of 3.75% annually. As of May 31, 2015, $6.0 million was outstanding under the note. We do not believe that we are exposed to any material interest rate risk related to this promissory note.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) that are designed to ensure that material information relating to us is made known to the officers who certify as to our financial reports and to other members of senior management and the Board of Directors. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Management, with the participation of our CEO and CFO, has evaluated the effectiveness, as of May 31, 2015, of our disclosure controls and procedures.  Based on that evaluation, our CEO and CFO have concluded that our disclosure controls and procedures were effective as of May 31, 2015.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended May 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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

In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2015. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2015.

Issuer Purchases of Equity Securities

(1)     On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company plans to continue the repurchase plan until it has been completed. The number, price, structure and timing of the repurchases, if any, will be at the Company’s sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. The repurchase authorization does not have an expiration date and does not oblige the Company to acquire any particular amount of its common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice.

None.

Not applicable.

None.

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.

Signature

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.

(Registrant)

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