Rocky Mountain Chocolate Factory, Inc. - Quarter Report: 2020 May (Form 10-Q)

 

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

 

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

 

For the quarterly period ended May 31, 2020

 

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

 

For the transition period from ________to________

 

Commission file number: 001-36865

 

Rocky Mountain Chocolate Factory, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware	47-1535633
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

265 Turner Drive, Durango, CO 81303

(Address of principal executive offices, including zip code)

 

(970) 259-0554

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class	Trading symbol	Name of each exchange on which registered
Common Stock, $0.001 par value per share	RMCF	Nasdaq Global Market
Preferred Stock Purchase Rights	RMCF	Nasdaq Global Market

 

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

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

 

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

 

Large accelerated filer ☐	Accelerated filer ☐
Non-accelerated filer ☐	Smaller reporting company ☒
	Emerging growth company ☐

                                

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

On June 25, 2020, the registrant had outstanding 6,065,138 shares of its common stock, $0.001 par value.

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

FORM 10-Q

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION	3
Item 1.	Financial Statements	3
CONSOLIDATED STATEMENTS OF INCOME		3
CONSOLIDATED BALANCE SHEETS		4
CONSOLIDATED STATEMENTS OF CASH FLOWS		5
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY		6
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS		7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	25
Item 4.	Controls and Procedures	25
PART II.	OTHER INFORMATION	26
Item 1.	Legal Proceedings	26
Item 1A.	Risk Factors	26
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.	Defaults Upon Senior Securities	27
Item 4.	Mine Safety Disclosures	27
Item 5.	Other Information	27
Item 6.	Exhibits	28
Signature		29

 

		Three Months Ended May 31,
		2020				2019
Revenues
Sales		$	2,322,211			$	6,460,611
Franchise and royalty fees			380,226				1,965,388
Total Revenue			2,702,437				8,425,999
Costs and Expenses
Cost of sales			2,883,216				4,614,744
Franchise costs			421,245				483,013
Sales and marketing			474,090				556,651
General and administrative			3,179,475				1,144,731
Retail operating			319,211				448,902
Depreciation and amortization, exclusive of depreciation and amortization expense of $157,510, $145,699, respectively, included in cost of sales			185,605				231,955
Costs associated with Company-owned store closures			68,558				-
Total costs and expenses			7,531,400				7,479,996
(Loss) Income from Operations			(4,828,963	)			946,003
Other Income (Expense)
Interest Expense			(23,562	)			(12,398	)
Interest Income			5,800				10,179
Other income (expense), net			(17,762	)			(2,219	)
(Loss) Income Before Income Taxes			(4,846,725	)			943,784
Income Tax (Benefit) Provision			(1,179,328	)			232,175
Consolidated Net (Loss) Income		$	(3,667,397	)		$	711,609
Basic (Loss) Earnings per Common Share		$	(0.61	)		$	0.12
Diluted (Loss) Earnings per Common Share		$	(0.61	)		$	0.11
Weighted Average Common Shares
Outstanding - Basic			6,058,851				5,962,278
Dilutive Effect of Employee
Stock Awards			-				272,286
Weighted Average Common Shares
Outstanding - Diluted			6,058,851				6,234,564

 

		May 31,				February 29,
		2020				2020
Assets		(unaudited)
Current Assets
Cash and cash equivalents		$	7,440,923			$	4,822,071
Accounts receivable, less allowance for doubtful accounts of $1,908,912 and $638,907, respectively			2,320,580				4,049,959
Notes receivable, current portion, less current portion of the valuation allowance of $50,814 and $0, respectively			110,624				160,700
Refundable income taxes			417,979				418,319
Inventories			4,140,827				3,750,978
Other			397,311				409,703
Total current assets			14,828,244				13,611,730
Property and Equipment, Net			5,703,584				5,938,013
Other Assets
Notes receivable, less current portion and valuation allowance of $149,186 and $0, respectively			124,912				289,515
Goodwill, net			729,701				1,046,944
Franchise rights, net			2,915,707				3,047,688
Intangible assets, net			421,864				498,393
Deferred income taxes			1,809,407				630,078
Lease right of use asset			2,518,444				2,698,765
Other			56,263				56,262
Total other assets			8,576,298				8,267,645
Total Assets		$	29,108,126			$	27,817,388
Liabilities and Stockholders' Equity
Current Liabilities
Current maturities of long term debt		$	590,377			$	-
Line of credit			3,448,165				-
Accounts payable			2,965,103				2,241,506
Accrued salaries and wages			779,037				716,860
Gift card liabilities			605,437				609,842
Other accrued expenses			294,434				316,751
Dividend payable			-				722,344
Contract liabilities			193,492				195,658
Lease liability			803,106				803,861
Total current liabilities			9,679,151				5,606,822
Lease Liability, Less Current Portion			1,715,338				1,894,904
Long-Term Debt, Less Current Portion			948,047				-
Contract Liabilities, Less Current Portion			933,758				960,151
Commitments and Contingencies
Stockholders' Equity
Preferred stock, $.001 par value per share; 250,000 authorized; -0- shares issued and outstanding			-				-
Series A Junior Participating Preferred Stock, 50,000 authorized; -0- shares issued and outstanding			-				-
Undesignated series, 200,000 shares authorized; -0- shares issued and outstanding			-				-
Common stock, $.001 par value, 46,000,000 shares authorized, 6,060,663 shares and 6,019,532 shares issued and outstanding, respectively			6,061				6,020
Additional paid-in capital			7,603,608				7,459,931
Retained earnings			8,222,163				11,889,560
Total stockholders' equity			15,831,832				19,355,511
Total Liabilities and Stockholders' Equity		$	29,108,126			$	27,817,388

 

		Three Months Ended
		May 31,
		2020				2019
Cash Flows From Operating Activities
Net (loss) income		$	(3,667,397	)		$	711,609
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			343,115				377,654
Provision for loss on accounts and notes receivable			1,468,815				81,283
Asset impairment and store closure losses			544,060				-
Loss on sale or disposal of property and equipment			4,956				2,867
Expense recorded for stock compensation			143,718				231,254
Deferred income taxes			(1,179,329	)			38,028
Changes in operating assets and liabilities:
Accounts receivable			476,533				(100,089	)
Refundable income taxes			340				185,667
Inventories			(433,932	)			367,824
Contract Liabilities			(27,515	)			(90,248	)
Other current assets			12,393				(122,047	)
Accounts payable			680,748				115,667
Accrued liabilities			35,453				28,640
Net cash (used in) provided by operating activities			(1,598,042	)			1,828,109
Cash Flows from Investing Activities
Proceeds received on notes receivable			17,825				28,400
Purchase of intangible assets			(41,464	)			-
Purchases of property and equipment			(22,488	)			(283,548	)
Decrease in other assets			-				312
Net cash used in investing activities			(46,127	)			(254,836	)
Cash Flows from Financing Activities
Payments on long-term debt			-				(346,547	)
Proceeds from long-term debt			1,537,200				-
Proceeds from the line of credit			3,448,165				-
Dividends paid			(722,344	)			(715,179	)
Net cash provided by (used in) financing activities			4,263,021				(1,061,726	)
Net Increase in Cash and Cash Equivalents			2,618,852				511,547
Cash and Cash Equivalents, Beginning of Period			4,822,071				5,384,027
Cash and Cash Equivalents, End of Period		$	7,440,923			$	5,895,574

 

		Three Months Ended
		May 31,
		2020				2019
Common Stock
Balance at February 28 or 29:		$	6,020			$	5,958
Issuance of common stock			-				-
Equity compensation, restricted stock units			41				4
Balance at May 31:			6,061				5,962
Additional Paid-in Capital
Balance at February 28 or 29:			7,459,931				6,650,864
Issuance of common stock			-				-
Equity compensation, restricted stock units			143,677				231,250
Balance at May 31:			7,603,608				6,882,114
Retained Earnings
Balance at February 28 or 29:			11,889,560				13,733,010
Consolidated net (loss) income			(3,667,397	)			711,609
Cash dividends declared			-				(716,139	)
Balance at May 31:			8,222,163				13,728,480
Total Stockholders' Equity		$	15,831,832			$	20,616,556
Common Shares
Balance at February 28 or 29:			6,019,532				5,957,827
Equity compensation, restricted stock units			41,131				4,500
Balance at May 31:			6,060,663				5,962,327

 

NOTE 1 – NATURE OF OPERATIONS AND BASIS OF PRESENTATION

 

Nature of Operations

 

The accompanying consolidated financial statements include the accounts of Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, its wholly-owned subsidiaries, Rocky Mountain Chocolate Factory, Inc. (a Colorado corporation), Aspen Leaf Yogurt, LLC (“ALY”), and U-Swirl International, Inc. (“U-Swirl”), and its 46%-owned subsidiary, U-Swirl, Inc. (“SWRL”) (collectively, the “Company”).

 

The Company is an international franchisor, confectionery manufacturer and retail operator. Founded in 1981, the Company is headquartered in Durango, Colorado and manufactures an extensive line of premium chocolate candies and other confectionery products. U-Swirl franchises and operates self-serve frozen yogurt cafés. The Company also sells its candy in selected locations outside of its system of retail stores and licenses the use of its brand with certain consumer products.

 

U-Swirl operates self-serve frozen yogurt cafés under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!” and “Aspen Leaf Yogurt.”

 

The Company’s revenues are currently derived from three principal sources: sales to franchisees and others of chocolates and other confectionery products manufactured by the Company; the collection of initial franchise fees and royalties from franchisees’ sales; and sales at Company-owned stores of chocolates, frozen yogurt, and other confectionery products.

 

In FY 2020, we entered into a long-term strategic alliance with Edible Arrangements®, LLC and its affiliates (“Edible”) whereby we became the exclusive provider of certain branded chocolate products to Edible, its affiliates and its franchisees. In connection with the Strategic Alliance, the Company entered into a strategic alliance agreement, an exclusive supplier operating agreement and a warrant agreement with EA and Farids. Rocky Mountain Chocolate Factory branded products are available for purchase both on Edible’s website as well as through over 1,000 franchised Edible Arrangement locations nationwide. In addition, due to Edible’s significant e-commerce expertise and scale, we have also executed an ecommerce licensing agreement with Edible, whereby Edible sells a wide variety of chocolates, candies and other confectionery products produced by the Company or its franchisees through Edible’s websites. Edible is also responsible for all ecommerce marketing and sales for the broader Rocky Mountain ecommerce ecosystem. In January 2020 the founder of Edible was elected to the Company’s Board of Directors pursuant to a vote by stockholders held at the Company’s Annual Meeting of Stockholders.

 

The following table summarizes the number of stores operating¹ under the Rocky Mountain Chocolate Factory brand and frozen yogurt cafés at May 31, 2020:

 

 

---

¹ Stores open and operating includes stores that have closed temporarily, the result of COVID-19.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

Basis of Presentation

 

The accompanying consolidated financial statements have been prepared by the Company, without audit, and reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting and Securities and Exchange Commission (the “SEC”) regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the consolidated financial statements reflect all adjustments (of a normal and recurring nature) which are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The results of operations for the three months ended May 31, 2020 are not necessarily indicative of the results to be expected for the entire fiscal year.

 

These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended February 29, 2020.

 

Subsequent Events

 

Management evaluated all activity of the Company through the issue date of the financial statements and concluded that no subsequent events have occurred that would require recognition or disclosure in the financial statements.

 

COVID-19 Update

 

As discussed in more detail throughout this Quarterly Report on Form 10-Q for the quarter ended May 31, 2020 (this “Quarterly Report”), we have experienced significant business disruptions resulting from efforts to contain the rapid spread of the novel coronavirus (COVID-19), including the vast mandated self-quarantines and closures of non-essential business throughout the United States and internationally. Nearly all of the Company-owned and franchise stores have been directly and negatively impacted by public health measures taken in response to COVID-19, with nearly all locations experiencing reduced operations as a result of, among other things, modified business hours and store and mall closures. As a result, franchisees and licensees are not ordering products for their stores in line with historical amounts. This trend has negatively impacted, and is expected to continue to negatively impact, among other things, factory sales, retail sales and royalty and marketing fees. Beginning in May 2020 most stores previously closed for much of March 2020 and April 2020, in response to COVID-19, began to re-open. Most stores re-opened subject to various local health restrictions and reduced operations. It is unclear when or if store operations will return to pre COVID-19 levels.

 

In addition, as previously announced on May 11, 2020, the Board of Directors decided to suspend the Company’s first quarter cash dividend payment to preserve cash and provide additional flexibility in the current environment impacted by the COVID-19 pandemic. Furthermore, the Board of Directors has suspended future quarterly dividends until the significant uncertainty of the current public health crisis and economic climate has passed, and the Board of Directors determines that resumption of dividend payments is in the best interest of us and our stockholders.

 

During this challenging time, the Company’s foremost priority is the safety and well-being of our employees, customers, franchisees and communities. In addition to the already stringent practices for the quality and safety of the Company’s confections, the Company is diligently following health and safety guidance issued by the World Health Organization, the Centers for Disease Control and state and local governmental agencies. COVID-19 has had an unprecedented impact on the retail industry as containment measures continue to impact the Company’s operations and the retail industry. Numerous countries, states and local governments have effected ordinances to protect the public through social distancing, which has caused, and we expect will continue to cause, a significant decrease in, among other things, retail traffic and as a result, factory sales, retail sales and royalty and marketing fees. With that said, Rocky Mountain Chocolate Factory products remain available for sale online. The Company’s current focus is on supporting its franchisees and licensees during this challenging time and driving growth in online sales, especially in light of the ecommerce licensing agreement with Edible, as discussed below, while also sensibly managing costs. The number of Company-owned and franchise stores remaining open may change frequently and significantly due to the ever-changing nature of the COVID-19 outbreak.

 

In these challenging and unprecedented times, management is taking all necessary and appropriate action to maximize liquidity as the Company navigates the current landscape. These actions include significantly reducing operating expenses and production volume to reflect reduced sales volumes as well as the elimination of all non-essential spending and capital expenditures. Further, in an abundance of caution and to maintain ample financial flexibility, the Company drew down the full amount under our line of credit and the Company received loans under the Paycheck Protection Program (the “PPP”). At May 31, 2020 PPP loans totaled $1.54 million and are presented on the balance sheet as current maturities of long-term debt, and long-term debt based upon the schedule of repayments and excluding any possible foregiveness of the loans. The receipt of funds under the PPP has allowed the Company to temporarily avoid workforce reduction measures amidst a steep decline in revenue and production volume. While the Company believes it has sufficient liquidity with its current cash position, the Company will continue to monitor and evaluate all financing alternatives as necessary as these unprecedented events evolve. For more information, please see Item 1A “Risk Factors—The Novel Coronavirus (COVID-19) Pandemic Has, and May Continue to, Materially and Adversely Affect our Sales, Earnings, Financial Condition and Liquidity” in our Annual Report on Form 10-K as filed on May 29, 2020 with the United States Securities and Exchange Commission.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

Recent Accounting Pronouncements

 

Except for the recent accounting pronouncements described below, other recent accounting pronouncements are not expected to have a material impact on our condensed consolidated financial statements.

 

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 significantly changes the impairment model for most financial assets and certain other instruments. ASU 2016-13 will require immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets, which will generally result in earlier recognition of allowances for credit losses on loans and other financial instruments. ASU 2016-13 is effective for the Company's fiscal year beginning March 1, 2023 and subsequent interim periods. The Company is currently evaluating the impact the adoption of ASU 2016-13 will have on the Company's consolidated financial statements.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This ASU simplifies the manner in which an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Under the amendments in this ASU, an entity should (1) perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and (2) recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, with theunderstanding that the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, ASU 2017-04 requires any reporting unit with a zero or negative carrying amount to perform Step 2 of the goodwill impairment test. The amendments in this ASU are effective for annual periods beginning after December 15, 2019. We adopted this ASU effective March 1, 2020 (the first quarter of our 2021 fiscal year). The adoption of the ASU did not have a material impact on our consolidated financial statements.

 

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which simplifies the accounting for income taxes. This guidance will be effective for entities for the fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020 on a prospective basis, with early adoption permitted. We will adopt the new standard effective March 1, 2021 and do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

 

NOTE 2 – SUPPLEMENTAL CASH FLOW INFORMATION

 

 

 

NOTE 3 – REVENUE FROM CONTRACTS WITH CUSTOMERS

 

Effective March 1, 2018, the Company adopted ASC 606, whichprovides that revenues are to be recognized when control of promised goods or services is transferred to a customer in an amount that reflects the consideration expected to be received for those goods or services. This new standard does not impact the Company's recognition of revenue from sales of confectionary items to the Company’s franchisees and others, or in its Company-owned stores as those sales are recognized at the time of the underlying sale and are presented net of sales taxes and discounts. The standard also does not change the recognition of royalties and marketing fees from franchised or licensed locations, which are based on a percent of sales and recognized at the time the sales occur. The standard does change the timing in which the Company recognizes initial fees from franchisees and licensees for new franchise locations and renewals that affect the term of the franchise agreement. The Company generally receives a fee associated with the Franchise Agreement or License Agreement (collectively “Customer Contracts”) at the time that the Customer Contract is entered. These Customer Contracts have a term of up to 20 years, however the majority of Customer Contracts have a term of 10 years. During the term of the Customer Contract the Company is obligated to many performance obligations that the Company has not determined are distinct. The resulting treatment of revenue from Customer Contracts is that the revenue is recognized proportionately over the life of the Customer Contract.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

Initial Franchise Fees, License Fees, Transfer Fees and Renewal Fees

 

The Company's policy for recognizing initial franchise and renewal fees through February 28, 2018 was to recognize initial franchise fees upon new store openings and renewals.In accordance with the new guidance, the initial franchise services are not distinct from the continuing rights or services offered during the term of the franchise agreement, and will be treated as a single performance obligation. Beginning March 1, 2018, initial franchise fees are being recognized as the Company satisfies the performance obligation over the term of the franchise agreement, which is generally 10-15 years.

 

The following table summarizes contract liabilities as of May 31, 2020 and May 31, 2019:

 

 

On May 31, 2020, annual revenue expected to be recognized in the future, related to performance obligations that are not yet fully satisfied, are estimated to be the following:

 

 

Gift Cards

 

The Company’s franchisees sell gift cards which do not have either expiration dates, or non-usage fees. The proceeds from the sale of gift cards by the franchisees are accumulated by the Company and paid out to the franchisees upon customer redemption. The Company has historically accumulated gift card liabilities and has not recognized breakage associated with the gift card liability. The adoption of ASC 606 requires the use of the “proportionate” method for recognizing breakage, which the Company has not historically utilized. Upon adoption of ASC 606 the Company began recognizing breakage from gift cards when the gift card is redeemed by the customer or the Company determines the likelihood of the gift card being redeemed by the customer is remote (“gift card breakage”). The determination of the gift card breakage rate is based upon Company-specific historical redemption patterns.

 

NOTE 4 – DISAGGREGATION OF REVENUE

 

The following table presents disaggregated revenue by method of recognition and segment:

 

Three Months Ended May 31, 2020

 

Revenues recognized over time under ASC 606:

 

 

Revenues recognized at a point in time:

 

 

Three Months Ended May 31, 2019

 

Revenues recognized over time under ASC 606:

 

 

Revenues recognized at a point in time:

 

 

 

NOTE 5 – INVENTORIES

 

Inventories consist of the following inventory at May 31, 2019 and February 28, 2019:

 

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6 - PROPERTY AND EQUIPMENT, NET

 

Property and equipment at May 31, 2020 and February 29, 2020 consisted of the following:

 

 

 

Depreciation expense related to property and equipment totaled $194,557 and $201,110 during the three months ended May 31, 2020 and 2019, respectively.

 

NOTE 7 – GOODWILL AND INTANGIBLE ASSETS

 

Intangible assets at May 31, 2020 and February 28, 2020 consist of the following:

 

 

Amortization expense related to intangible assets totaled $148,557 and $176,544 during the three months ended May 31, 2020 and 2019, respectively.

 

At May 31, 2020, annual amortization of placed in service intangible assets, based upon the Company’s existing intangible assets and current useful lives, is estimated to be the following:

 

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

During FY 2020, the Company initiated a store design project. The initiative is expected to add approximately $250,000 of intangible assets, of which, $174,000 was recorded as of May 31, 2020. This amount will be subject to amortization upon conclusion of the project.

 

NOTE 8 – IMPAIRMENT OF LONG-LIVED AND INTANGIBLE ASSETS

 

We assess the potential impairment of our long-lived assets on an annual basis or whenever events or changes in circumstances indicate the carrying value of the assets or asset group may not be recoverable. Due to the significant impact of the COVID-19 pandemic on our operations, we determined it was necessary to perform an interim test of our long-lived assets during the three months ended May 31, 2020. Based on the results of these assessments, we recorded $545,000 of expense. This expense is presented within general and administrative expense on the Consolidated Statements of Operations.

 

The assessment of our goodwill, trademark and long lived asset fair values includes many assuptions that are subject to risk and uncertainties.  The primary assumptions, which are all Level 3 inputs of the fair value hierarchy (inputs to the valuation methodology that are unobservable and significant to the fair value measurement), used in our impairment testing consist of:

 

●	Expected future cash flows from operation of our Company-owned units.

●	Forecasted future royalty revenue, marketing revenue and associated expenses.

●	Projected rate of royalty savings on trademarks.

●	Our cost of capital.

 

As of May 31, 2020 costs associated with the impairment of long-lived and intangible assets consist of the following:

 

 

Certain interim tests did not indicate a need for impairment. Franchise rights, store design, manufacturing segment goodwill and franchising goodwill tests succeeded during the interim period. We believe we have made reasonable estimates and judgements, however, further COVID-19 related impacts could cause interim testing to be performed in future periods and further impairments recorded if testing of impairment is not successful in future periods.

 

NOTE 9 – LINE OF CREDIT AND LONG-TERM DEBT

 

The Company has a $5.0 million credit line for general corporate and working capital purposes. On March 16, 2020, as a precautionary measure in light of the COVID-19 pandemic and the related economic impacts, the Company drew the maximum amount available on the credit line in an amount equal to $3.4 million (the full amount of $5.0 million under the credit line, subject to the borrowing base of 50% of eligible accounts receivable plus 50% of eligible inventories). The credit line is secured by substantially all of the Company’s assets, except retail store assets. Interest on borrowings is at LIBOR plus 2.25% (2.4% at May 31, 2020). Additionally, the line of credit is subject to various financial ratio and leverage covenants. At May 31, 2020, the Company was not compliant with a covenant of the line of credit that requires the Company to have $1.5 million of adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the trailing twelve months ended May 31, 2020. As a result of COVID-19, the Company failed to meet the amount of EBITDA required by this covenant. On June 26, 2020 Wells Fargo Bank, NA (“Wells Fargo”) delivered to the Company a Reservation of Rights Letter (“Bank Letter”). The Bank Letter reserved all rights available to Wells Fargo under the Credit Agreement dated October 30, 2015 including, but not limited to, the right of Wells Fargo to demand immediate payment of all amounts outstanding under the Credit Agreement. The letter also placed restrictions on the Company’s ability to draw any further funds on the Line of Credit. The Company intends to work with Wells Fargo to amend the associated covenants as the trends related to COVID-19 begin become clear. There is no assurance that Wells Fargo will agree to any proposed amendment. The credit line is subject to renewal in September 2021 and the Company believes it is likely to be renewed on terms similar to the current terms, subject to the Company’s recovery from the impacts of COVID-19.

 

The Company’s long-term debt is comprised of promissory notes pursuant to the Paycheck Protection Program, under the recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) administered by the U.S. Small Business Administration (the “SBA Loans”). The Company received total proceeds of $1.5 million from the SBA Loans. The SBA Loans are scheduled to mature in April 2022 and have a 1.00% interest rate, and are subject to the terms and conditions applicable to loans administered by the U.S. Small Business Administration under the CARES Act. The SBA Loans may be prepaid by the Company at any time prior to maturity with no prepayment penalties. As of May 31, 2020 the Company is in compliance with all provisions related to the SBA Loans.

 

The SBA Loans contains customary events of default relating to, among other things, payment defaults and breaches of representations and warranties. Subject to certain conditions, the SBA Loans may be forgiven in whole or in part by applying for forgiveness pursuant to the CARES Act and the PPP. The amount of loan proceeds eligible for forgiveness is based on a formula based on a number of factors, including the amount of loan proceeds used by the Company during the period after the loan origination for certain purposes, including payroll costs, interest on certain mortgage obligations, rent payments on certain leases, and certain qualified utility payments, provided that, among other things, at least 60-75% of the loan amount is used for eligible payroll costs, the employer maintaining or rehiring employees and maintaining salaries at certain level. In accordance with the requirements of the CARES Act and the PPP, the Company intends to use the proceeds from the SBA Loans for qualifying expenses. No assurance can be given that the Company will be granted forgiveness of the SBA Loans in whole or in part. As of May 31, 2020 the Company had recorded approximately $3,200 of interest expense payable relate to the SBA Loans.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

As of May 31, 2020 and February 28, 2020, notes payable consisted of the following:

 

 

 

NOTE 10 - STOCKHOLDERS’ EQUITY

 

Cash Dividend

 

The Company paid a quarterly cash dividend of $0.12 per common share on March 15, 2019 to stockholders of record on March 5, 2019. The Company paid a quarterly cash dividend of $0.12 per share of common stock on June 14, 2019 to stockholders of record on June 4, 2019. The Company paid a quarterly cash dividend of $0.12 per share of common stock on September 13, 2019 to stockholders of record on September 4, 2019. The Company paid a quarterly cash dividend of $0.12 per share of common stock on December 6, 2019 to stockholders of record on November 22, 2019. The Company paid a quarterly cash dividend of $0.12 per share of common stock on March 13, 2020 to stockholders of record on February 28, 2020.

 

Future declarations of dividends will depend on, among other things, the Company's results of operations, financial condition, capital requirements, and on such other factors as the Company's Board of Directors may in its discretion consider relevant and in the best long-term interest of the Company’s stockholders.

 

As previously announced on May 11, 2020, the Board of Directors suspended the Company’s first quarter cash dividend payment to preserve cash and provide additional flexibility in the current environment as a result of the economic impact of COVID-19. Furthermore, the Board of Directors has suspended future quarterly dividends until the significant uncertainty of the current public health crisis and global economic climate has passed, and the Board of Directors determines that resumption of dividend payments is in the best interest of the Company and its stockholders.

 

Stock Repurchases

 

On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three months ended May 31, 2020 or 2019. As of May 31, 2020, approximately $638,000 remains available under the repurchase plan for further stock repurchases.

 

Warrants

 

In consideration of Edible entering into the exclusive supplier agreement and the performance of its obligations therein, on December 20, 2019, the Company issued Edible a warrant (the “Warrant”) to purchase up to 960,677 shares of the Company’s common stock (the “Warrant Shares”) at an exercise price of $8.76 per share. The Warrant Shares vest in annual tranches in varying amounts following each contract year under the exclusive supplier agreement, subject to, and only upon, Edible’s achievement of certain revenue thresholds on an annual or cumulative five-year basis in connection with its performance under the exclusive supplier agreement. The Warrant expires six months after the final and conclusive determination of revenue thresholds for the fifth contract year and the cumulative revenue determination in accordance with the terms of the Warrant.

 

The Company determined that the grant date fair value of the warrants was de minimis and did not record any amount in consideration of the warrants. The Company utilized a Monte Carlo model for purposes of determining the grant date fair value.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

Stock-Based Compensation

 

Under the Company’s 2007 Equity Incentive Plan (as amended and restated) (the “2007 Plan”), the Company may authorize and grant stock awards to employees, non-employee directors and certain other eligible participants, including stock options, restricted stock and restricted stock units.

 

The Company recognized $143,718 of stock-based compensation expense during the three months ended May 31, 2020 compared with $231,254 during the three months ended May 31, 2019. Compensation costs related to stock-based compensation are generally amortized over the vesting period of the stock awards.

 

The following table summarizes non-vested restricted stock unit transactions for common stock during the three months ended May 31, 2020 and 2019:

 

 

The Company did not issue any unrestricted shares of stock to non-employee directors during the three months ended May 31, 2020 compared to 4,500 shares issued during the three months ended May 31, 2019. In connection with these non-employee director stock issuances, the Company recognized $0 and $42,525 of stock-based compensation expense during the three months ended May 31, 2020 and 2019, respectively.

 

During the three months ended May 31, 2020, the Company recognized $143,718 of stock-based compensation expense related to non-vested, non-forfeited restricted stock unit grants compared to $188,729 during the three months ended May 31, 2019. The restricted stock units generally vest in equal annual installments over a period of five to six years. Total unrecognized stock-based compensation expense of non-vested, non-forfeited restricted stock units, as of May 31, 2020, was $1,994,662, which is expected to be recognized over the weighted average period of 4.33 years.

 

During the three months ended May 31, 2019, the Company granted 270,000 shares of restricted stock units with a grant date fair value of $2,536,100 or $9.39 per share, compared with no restricted stock units awarded in the three months ended May 31, 2020. The restricted stock unit grants vest in equal annual installments over a period of five to six years.

 

The Company has no outstanding stock options as of May 31, 2020.

 

NOTE 11 - EARNINGS PER SHARE

 

Basic earnings per share is calculated using the weighted-average number of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through the settlement of restricted stock units. Restricted stock units become dilutive within the period granted and remain dilutive until the units vest and are issued as common stock.

 

The weighted-average number of shares outstanding used in the computation of diluted earnings per share does not include outstanding common shares issuable if their effect would be anti-dilutive. During the three months ended May 31, 2020, 960,677 shares of common stock warrants and 209,960 shares of issuable common stock were excluded from the computation of diluted earnings per share because their effect would have been anti-dilutive.

 

NOTE 12 – LEASING ARRANGEMENTS

 

The Company conducts its retail operations in facilities leased under non-cancelable operating leases of up to ten years. Certain leases contain renewal options for between five and ten additional years at increased monthly rentals. Some of the leases provide for contingent rentals based on sales in excess of predetermined base levels. 

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

The Company acts as primary lessee of some franchised store premises, which the Company then subleases to franchisees, but the majority of existing locations are leased by the franchisee directly. Currently, there are not indications that the Company will be required to make any payments on behalf of franchisees.

 

In some instances, the Company has leased space for its Company-owned locations that are now occupied by franchisees. When the Company-owned location was sold or transferred, the store was subleased to the franchisee who is responsible for the monthly rent and other obligations under the lease.

 

The Company also leases trucking equipment and warehouse space in support of its manufacturing operations. Expense associated with trucking and warehouse leases is included in cost of sales on the consolidated statements of operations.

 

ASU 2016-02 allows, as a practical expedient, the retention of the classification of existing leases as operating or financing. All of the Company’s leases are classified as operating leases and that classification has been retained upon adoption. The Company does not believe the utilization of this practical expedient has a material impact on lease classifications.

 

The Company accounts for payments related to lease liabilities on a straight-line basis over the lease term. As of May 31, 2020 and 2019, lease expense recognized in the Consolidated Statements of Income was $212,063 and $238,666, respectively.

 

The amount of the Right of Use Asset and Lease Liability recorded upon the adoption of ASU 2016-02 was $3.3 million. The lease liability reflects the present value of the Company’s estimated future minimum lease payments over the life of its leases. This includes known escalations and renewal option periods reasonably assured of being exercised. Typically, renewal options are considered reasonably assured of being exercised if the sales performance of the location remains strong. Therefore, the Right of Use Asset and Lease Liability include an assumption on renewal options that have not yet been exercised by the Company, and are not currently a future obligation. The Company has separated non-lease components from lease components in the recognition of the Asset and Liability except in instances where such costs were not practical to separate. To the extent that occupancy costs, such as site maintenance, are included in the Asset and Liability, the impact is immaterial. For franchised locations, the related occupancy costs including property taxes, insurance and site maintenance are generally required to be paid by the franchisees as part of the franchise arrangement. In addition, the Company is the lessee under non-store related leases such as storage facilities and trucking equipment. For leases where the implicit rate is not readily determinable, the Company uses an incremental borrowing rate to calculate the lease liability that represents an estimate of the interest rate the Company would incur to borrow on a collateralized basis over the term of a lease. The weighted average discount rate used for operating leases was 3.4% as of May 31, 2020. The total estimated future minimum lease payments is $2.8 million.

 

As of May 31, 2020, maturities of lease liabilities for our operating leases were as follows:

 

 

 

NOTE 13 – COMMITMENTS AND CONTINGENCIES

 

Purchase contracts

 

The Company frequently enters into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit the Company 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, the Company may benefit if prices rise during the terms of these contracts, but it may be required to pay above-market prices if prices fall and it is unable to renegotiate the terms of the contract. As of May 31, 2020, the Company was contracted for approximately $227,000 of raw materials under such agreements. The Company has designated these contracts as normal under the normal purchase and sale exception under the accounting standards for derivatives. These contracts are not entered into for speculative purposes.

 

NOTE 14 – FTD LOSS CONTINGENCY

 

In June 2019, the Company’s largest customer, FTD Companies, Inc. and its domestic subsidiaries (“FTD”), filed for Chapter 11 bankruptcy proceedings. As a part of such bankruptcy proceedings, divisions of FTD’s business and certain related assets, including the divisions that the Company has historically sold product to, were sold through an auction to multiple buyers.

 

The Company has historically conducted business with FTD under a Gourmet Foods Supplier Agreement (the “Supplier Agreement”), that among other provisions, provided assurance that custom inventory purchased by the Company and developed specifically for FTD would be purchased by FTD upon termination of the Supplier Agreement. On September 23, 2019, the Company received notice that the bankruptcy court had approved FTD to reject and not enforce the Supplier Agreement as part of the proceedings.

 

As a result of FTD’s bankruptcy, the sale of certain assets, and the court’s approval to reject and not enforce the terms of the Supplier Agreement, the Company is uncertain if accounts receivable and inventory balances associated with FTD at May 31, 2020 will be realized at their full value, or if any revenue will be received from FTD in the future. During FY 2020, the Company recognized an estimated loss of $230,384 associated with inventory specific to FTD as the Company determined that it was probable that a loss on certain inventory would be realized. A potential loss associated with the remaining balances is not probable and/or is not able to be estimated as of the date of these consolidated financial statements.

 

As of May 31, 2020, balances associated with FTD consist of the following:

 

 

 

NOTE 15 – INCOME TAXES

 

Under the recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) a net operating loss (“NOL”) arising during the Company’s fiscal year 2021 can be carried back for five years to offset the Company’s taxable income for fiscal years 2016-2020. This five-year period spans Federal effective tax rates for the Company ranging from 21% to 34%, the result of the Tax Cuts and Jobs Act enacted during the Company’s fiscal year ended February 28, 2018.

 

The Company’s deferred tax assets are valued at the current federally enacted rate of 21%. If the Company were to continue to realize NOL’s in future periods, or inclur a NOL for all of fiscal year 2021 the loss carryback provisions of the CARES Act may enable the Company to offset taxable income from prior years when federally enacted tax rates were higher than 21%. Under such a scenario, the Company would incur a gain associated with the revaluation of the Company’s deferred tax assets to the extent that prior taxable income during periods of higher enacted federal tax rates could be offset by current NOLs.

 

As of May 31, 2020, no amount has been recorded in anticipation of offsetting prior period’s taxable income with current NOLs as it is not possible for the Company to reasonably estimate the likelihood of such a scenario and the impact if realized.

 

NOTE 16 - OPERATING SEGMENTS

 

The Company classifies its business interests into five reportable segments: Franchising, Manufacturing, Retail Stores, U-Swirl and Other. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1 to the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended February 29, 2020. The Company evaluates performance and allocates resources based on operating contribution, which excludes unallocated corporate general and administrative costs and income tax expense or benefit. The Company’s reportable segments are strategic businesses that utilize common merchandising, distribution, and marketing functions, as well as common information systems and corporate administration. All inter-segment sales prices are market based. Each segment is managed separately because of the differences in required infrastructure and the differences in products and services:

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS