The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
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 U-Swirl, Inc. (“SWRL”) (collectively, the “Company,” “we,” “us” or “our”).
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: (i) sales to franchisees and others of chocolates and other confectionery products manufactured by the Company; (ii) the collection of franchise fees and royalties from franchisees’ sales; and (iii) sales at Company-owned stores of chocolates, frozen yogurt, and other confectionery products.
In FY 2020 and early FY 2021 we entered into long-term strategic alliance and ecommerce agreements with Edible Arrangements®, LLC and its affiliates (“Edible”), whereby it was intended that we would become the exclusive provider of certain branded chocolate products to Edible, its affiliates and its franchisees. Under the strategic alliance, Rocky Mountain Chocolate Factory branded products are available for purchase both on Edible’s website as well as through over 1,000 franchised Edible locations nationwide. In addition, due to Edible’s significant e-commerce expertise and scale, we also executed an ecommerce licensing agreement with Edible, whereby Edible was expected to sell a wide variety of chocolates, candies and other confectionery products produced by the Company or its franchisees through Edible’s websites. There is no assurance that the strategic alliance and ecommerce agreements will be deployed into our operations and to our satisfaction, or that we will achieve the expected full benefits from these agreements. During FY 2022, certain disagreements arose between the Company and Edible related to the strategic alliance and ecommerce agreements resulting in continuing discussions, the result of which are not currently determinable. Purchases by Edible during the three months ended May 31, 2022 and 2021 were approximately $311,000 and $484,000, or 4.0% and 6.4% of the Company’s revenues, respectively. There can be no assurance historical revenue levels will be indicative of future revenues.
The following table summarizes the number of stores operating under the Rocky Mountain Chocolate Factory brand and frozen yogurt cafés at May 31, 2022:
| | Sold, Not Yet Open | | | Open | | | Total | |
Rocky Mountain Chocolate Factory | | | | | | | | | | | | |
Company-owned stores | | | - | | | | 2 | | | | 2 | |
Franchise stores - Domestic stores and kiosks | | | 5 | | | | 154 | | | | 159 | |
International license stores | | | 1 | | | | 5 | | | | 6 | |
Cold Stone Creamery - co-branded | | | 4 | | | | 100 | | | | 104 | |
U-Swirl (Including all associated brands) | | | | | | | | | | | - | |
Company-owned stores - co-branded | | | - | | | | 3 | | | | 3 | |
Franchise stores - Domestic stores | | | - | | | | 56 | | | | 56 | |
Franchise stores - Domestic - co-branded | | | 1 | | | | 6 | | | | 7 | |
International license stores | | | - | | | | 1 | | | | 1 | |
Total | | | 11 | | | | 327 | | | | 338 | |
During FY 2021 the Company initiated formal legal proceedings against Immaculate Confections (“IC”), the operator of RMCF locations in Canada. In its complaint, the Company alleged, among other things, that IC has utilized the Company’s trademarks and other intellectual property without authority to do so and that IC has been unjustly enriched by their use of the Company’s trademarks and intellectual property.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
In June 2021 a court order was issued declaring the original 1991 Development Agreement for Canada between RMCF and IC had expired. In September 2021, the Company and IC reached a Settlement Agreement (the “IC Agreement”) whereby the parties agreed to a six month negotiation period to explore alternative solutions. The six month period lapsed in March 2022, however the parties have continued negotiations and negotiations continue as of the date of this filing. The IC Agreement contains provisions that would require IC to de-identify its locations if a solution is not reached. IC operates approximately 49 locations in Canada. During the three months ended May 31, 2022 the Company recognized approximately $30,000 of factory revenue from locations operated by IC in Canada compared with no revenue recognized from locations operated by IC in Canada during the three months ended May 31, 2021.
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, 2022 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 28, 2022 filed on May 27, 2022. The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.
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.
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.
NOTE 2 – SUPPLEMENTAL CASH FLOW INFORMATION
|
|
Three Months Ended |
|
|
|
May 31, |
|
|
|
2022 |
|
|
2021 |
|
Cash paid (received) for: |
|
|
|
|
|
|
Interest |
|
$ |
- |
|
|
$ |
- |
|
Income taxes |
|
|
(316,937 |
) |
|
|
(49,952 |
) |
NOTE 3 – REVENUE FROM CONTRACTS WITH CUSTOMERS
The Company recognizes revenue from contracts with its customers in accordance with Accounting Standards Codification® (“ASC”) 606, which provides that revenues are 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. 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 initial franchise services are not distinct from the continuing rights or services offered during the term of the franchise agreement, and are treated as a single performance obligation. Initial franchise fees are being recognized as the Company satisfies the performance obligation over the term of the franchise agreement, which is generally 10 years.
The following table summarizes contract liabilities as of May 31, 2022 and May 31, 2021:
| | Three Months Ended | |
| | May 31: | |
| | 2022 | | | 2021 | |
Contract liabilities at the beginning of the year: | | $ | 1,146,808 | | | $ | 1,119,646 | |
Revenue recognized | | | (67,220 | ) | | | (56,213 | ) |
Contract fees received | | | 36,500 | | | | 50,000 | |
Amortized gain on the financed sale of equipment | | | - | | | | (3,133 | ) |
Contract liabilities at the end of the period: | | $ | 1,116,088 | | | $ | 1,110,300 | |
On May 31, 2022, 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:
FYE 23 | | $ | 154,951 | |
FYE 24 | | | 172,857 | |
FYE 25 | | | 157,873 | |
FYE 26 | | | 145,751 | |
FYE 27 | | | 129,060 | |
Thereafter | | | 355,596 | |
Total | | $ | 1,116,088 | |
Gift Cards
The Company’s franchisees sell gift cards, which do not have 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. ASC 606 requires the use of the “proportionate” method for recognizing breakage. The Company recognizes 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.
Factory Sales of Confectionary Items, Retail Sales and Royalty and Marketing Fees
Confectionary items sold to the Company’s franchisees, others and its Company-owned stores sales are recognized at the time of the underlying sale, based on the terms of the sale and when ownership of the inventory is transferred, and are presented net of sales taxes and discounts. 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.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 – DISAGGREGATION OF REVENUE
The following table presents disaggregated revenue by method of recognition and segment:
Three Months Ended May 31, 2022 | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Revenues recognized over time under ASC 606: | | | | | | | | | |
| | Franchising | | | Manufacturing | | | Retail | | | U-Swirl | | | Total | |
| | | | | | | | | | | | | | | | | | | | |
Franchise fees | | $ | 53,853 | | | $ | - | | | $ | - | | | $ | 13,367 | | | $ | 67,220 | |
| | | | | | | | | | | | | | | | | | | | |
Revenues recognized at a point in time: | | | | | | | | | |
| | Franchising | | | Manufacturing | | | Retail | | | U-Swirl | | | Total | |
Factory sales | | | - | | | | 5,157,610 | | | | - | | | | - | | | | 5,157,610 | |
Retail sales | | | - | | | | - | | | | 250,410 | | | | 542,218 | | | | 792,628 | |
Royalty and marketing fees | | | 1,440,327 | | | | - | | | | - | | | | 368,787 | | | | 1,809,114 | |
Total | | $ | 1,494,180 | | | $ | 5,157,610 | | | $ | 250,410 | | | $ | 924,372 | | | $ | 7,826,572 | |
Three Months Ended May 31, 2021 | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Revenues recognized over time under ASC 606: | | | | | | | | | |
| | Franchising | | | Manufacturing | | | Retail | | | U-Swirl | | | Total | |
| | | | | | | | | | | | | | | | | | | | |
Franchise fees | | $ | 41,245 | | | $ | - | | | $ | - | | | $ | 14,968 | | | $ | 56,213 | |
| | | | | | | | | | | | | | | | | | | | |
Revenues recognized at a point in time: | | | | | | | | | |
| | Franchising | | | Manufacturing | | | Retail | | | U-Swirl | | | Total | |
Factory sales | | | - | | | | 5,040,723 | | | | - | | | | - | | | | 5,040,723 | |
Retail sales | | | - | | | | - | | | | 282,978 | | | | 506,497 | | | | 789,475 | |
Royalty and marketing fees | | | 1,392,482 | | | | - | | | | - | | | | 314,818 | | | | 1,707,300 | |
Total | | $ | 1,433,727 | | | $ | 5,040,723 | | | $ | 282,978 | | | $ | 836,283 | | | $ | 7,593,711 | |
NOTE 5 – INVENTORIES
Inventories consist of the following inventory at May 31, 2022 and February 28, 2022:
| | May 31, 2022 | | | February 28, 2022 | |
Ingredients and supplies | | $ | 2,908,856 | | | $ | 2,753,068 | |
Finished candy | | | 2,777,054 | | | | 2,168,084 | |
U-Swirl food and packaging | | | 44,548 | | | | 56,319 | |
Reserve for slow moving inventory | | | (670,696 | ) | | | (623,269 | ) |
Total inventories | | $ | 5,059,762 | | | $ | 4,354,202 | |
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, 2022 and February 28, 2022 consisted of the following:
| | May 31, 2022 | | | February 28, 2022 | |
Land | | $ | 513,618 | | | $ | 513,618 | |
Building | | | 5,148,854 | | | | 5,148,854 | |
Machinery and equipment | | | 10,492,716 | | | | 10,207,182 | |
Furniture and fixtures | | | 790,197 | | | | 787,921 | |
Leasehold improvements | | | 985,914 | | | | 985,914 | |
Transportation equipment | | | 479,701 | | | | 479,701 | |
| | | 18,411,000 | | | | 18,123,190 | |
| | | | | | | | |
Less accumulated depreciation | | | (12,808,136 | ) | | | (12,623,300 | ) |
Property and equipment, net | | $ | 5,602,864 | | | $ | 5,499,890 | |
Depreciation expense related to property and equipment totaled $184,836 and $178,575 during the three months ended May 31, 2022 and 2021, respectively.
NOTE 7 – GOODWILL AND INTANGIBLE ASSETS
Intangible assets at May 31, 2022 and February 28, 2022 consist of the following:
| | | May 31, 2022 | | | February 28, 2022 | |
| Amortization Period | | Gross Carrying Value | | | Accumulated Amortization | | | Gross Carrying Value | | | Accumulated Amortization | |
Intangible assets subject to amortization | | | | | | | | | | | | | | | | | |
Store design | 10 Years | | $ | 394,826 | | | $ | 245,135 | | | $ | 394,826 | | | $ | 240,409 | |
Packaging licenses | 3-5 Years | | | 120,830 | | | | 120,830 | | | | 120,830 | | | | 120,830 | |
Packaging design | 10 Years | | | 430,973 | | | | 430,973 | | | | 430,973 | | | | 430,973 | |
Trademark/Non-competition agreements | 5-20 Years | | | 556,339 | | | | 362,261 | | | | 556,339 | | | | 357,071 | |
Franchise rights | 20 Years | | | 5,979,637 | | | | 3,994,003 | | | | 5,979,637 | | | | 3,901,571 | |
Total | | | 7,482,605 | | | | 5,153,202 | | | | 7,482,605 | | | | 5,050,854 | |
Goodwill and intangible assets not subject to amortization | | | | | | | | | | | | | | | | |
Franchising segment- | | | | | | | | | | | | | | | | | |
Company stores goodwill | | $ | 515,065 | | | | | | | $ | 515,065 | | | | | |
Franchising goodwill | | | 97,318 | | | | | | | | 97,318 | | | | | |
Manufacturing segment-goodwill | | | 97,318 | | | | | | | | 97,318 | | | | | |
Trademark | | | 20,000 | | | | | | | | 20,000 | | | | | |
Total | | | 729,701 | | | | | | | | 729,701 | | | | | |
| | | | | | | | | | | | | | | | | |
Total Goodwill and Intangible Assets | | $ | 8,212,306 | | | $ | 5,153,202 | | | $ | 8,212,306 | | | $ | 5,050,854 | |
Amortization expense related to intangible assets totaled $102,348 and $121,339 during the three months ended May 31, 2022 and 2021, respectively.
At May 31, 2022, 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:
FYE 23 | | $ | 307,045 | |
FYE 24 | | | 346,672 | |
FYE 25 | | | 294,427 | |
FYE 26 | | | 251,342 | |
FYE 27 | | | 215,382 | |
Thereafter | | | 914,535 | |
Total | | $ | 2,329,403 | |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 – LINE OF CREDIT
Revolving Credit Line
The Company has a $5.0 million credit line for general corporate and working capital purposes, of which $5.0 million was available for borrowing (subject to certain borrowing base limitations) as of May 31, 2022 (the “Credit Line”). The Credit Line is secured by substantially all of the Company’s assets, except retail store assets. Interest on borrowings is at the Secured Overnight Financing Rate plus 2.37% (3.2% at May 31, 2022 and 2.42% at February 28, 2022). Additionally, the Credit Line is subject to various financial ratio and leverage covenants. At May 31, 2022, the Company was in compliance with all such covenants. The Credit Line is subject to renewal in September 2022 and the Company believes it is likely to be renewed on terms similar to the current terms.
NOTE 9 - STOCKHOLDERS’ EQUITY
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. As of May 31, 2022 no warrants have vested.
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.
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 $131,597 of stock-based compensation expense during the three months ended May 31, 2022 compared with $146,157 during the three months ended May 31, 2021. 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, 2022 and 2021:
| | Three Months Ended | |
| | May 31, | |
| | 2022 | | | 2021 | |
Outstanding non-vested restricted stock units as of February 28 or 29: | | | 105,978 | | | | 209,450 | |
Granted | | | 55,336 | | | | - | |
Vested | | | (27,326 | ) | | | (37,702 | ) |
Cancelled/forfeited | | | - | | | | (900 | ) |
Outstanding non-vested restricted stock units as of May 31: | | | 133,988 | | | | 170,848 | |
| | | | | | | | |
Weighted average grant date fair value | | $ | 6.65 | | | $ | 9.40 | |
Weighted average remaining vesting period (in years) | | | 2.36 | | | | 3.41 | |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes stock option activity during during the three months ended May 31, 2022 and 2021:
| | Three Months Ended | |
| | May 31, | |
| | 2022 | | | 2021 | |
Outstanding stock options as of February 28: | | | - | | | | - | |
Granted | | | 27,668 | | | | - | |
Exercised | | | - | | | | - | |
Cancelled/forfeited | | | - | | | | - | |
Outstanding stock options as of May 31: | | | 27,668 | | | | - | |
| | | | | | | | |
Weighted average exercise price | | | 6.38 | | | | n/a | |
Weighted average remaining contractual term (in years) | | | 9.95 | | | | n/a | |
The Company did not issue any unrestricted shares of stock to non-employee directors during the three months ended May 31, 2022 compared with 7,000 shares issued during the three months ended May 31, 2021. In connection with these non-employee director stock issuances, the Company recognized $0 and $34,650 of stock-based compensation expense during the three months ended May 31, 2022 and 2021, respectively.
During the three months ended May 31, 2022, the Company issued 27,668 stock options and issued up to 55,336 performance-based restricted stock units subject to vesting based on the achievement of performance goals. These issuances were made to the Company’s new Chief Executive Officer as a part of the incentive compensation structure for Mr. Sarlls. The stock options were issued with an aggregate grant date fair value of $58,213 or $2.10 per share. The performance-based restricted stock units were issued with an aggregate grant date fair value of $168,304 or $6.08 per share, based upon a target issuance of 27,668 shares. The stock options granted vest with respect to one-third of the shares on the last day of the Company’s current fiscal year ending February 28, 2023, and vest as to remaining shares in equal quarterly increments on the last day of each quarter thereafter. The performance-based restricted stock units will vest following the end of the Company’s fiscal year ending February 2025 with respect to the target number of performance-based restricted stock units if the Company achieves an annualized total shareholder return of 12.5% during the performance period, subject to continued service through the end of the performance period. The Compensation Committee has discretion to determine the number of performance-based restricted stock units between 0-200% of the target number that will vest based on achievement of performance below or above the target performance goal.
During the three months ended May 31, 2022, the Company recognized $131,597 of stock-based compensation expense related to outstanding restricted stock units and stock options, compared to $111,507 during the three months ended May 31, 2021. Except as noted above, 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, 2022, was $865,549, which is expected to be recognized over the weighted average period of 2.36 years.
NOTE 10 - 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, 2022, 960,677 shares of common stock warrants and 137,082 shares of issuable common stock were excluded from the computation of diluted earnings per share because their effect would have been anti-dilutive. During the three months ended May 31, 2021, 960,677 shares of common stock warrants and no shares of issuable common stock were excluded from the computation of diluted earnings per share because their effect would have been anti-dilutive.
NOTE 11 – 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.
The Company acts as primary lessee of some franchised store premises, which the Company then subleases to franchisees, but the majority of existing franchised locations are leased by the franchisee directly.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
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.
The Company accounts for payments related to lease liabilities on a straight-line basis over the lease term. As of May 31, 2022 and 2021, lease expense recognized in the Consolidated Statements of Operations was $190,108 and $209,025, respectively.
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 3.3% as of May 31, 2022. The total estimated future minimum lease payments is $2.3 million.
As of May 31, 2022, maturities of lease liabilities for our operating leases were as follows:
FYE 23 | | $ | 519,117 | |
FYE 24 | | | 518,508 | |
FYE 25 | | | 369,545 | |
FYE 26 | | | 271,903 | |
FYE 27 | | | 181,947 | |
Thereafter | | | 462,121 | |
Total | | $ | 2,323,141 | |
| | | | |
Less: imputed interest | | | (203,865 | ) |
Present value of lease liabilities: | | $ | 2,119,276 | |
| | | | |
Weighted average lease term | | | 6.4 | |
During the three months ended May 31, 2022 the Company entered into a lease for trailers used in the Company’s trucking operations. This lease resulted in the Company recognizing a present value of future lease liability of $456,885 based upon a total lease liability of $502,894.
NOTE 12 – COMMITMENTS AND CONTINGENCIES
Employment Agreement Payments upon a Change in Control
We have entered into employment agreements with certain of our executives which contain, among other things, "change in control" severance provisions. The employment agreements for executives (other than Mr. Sarlls and Mr. Merryman) generally provide that, if the Company or the executive terminates the executive's employment under circumstances constituting a "triggering termination," the executive will be entitled to receive, among other benefits, 2.99 times the sum of (i) the executive's annual salary and (ii) the lesser of (a) two times the bonus that would be payable to the executive for the bonus period in which the change in control occurred or (b) 25% of the executive's annual salary. The executive will also receive an additional payment of $18,000, which represents the estimated cost to the executive of obtaining accident, health, dental, disability and life insurance coverage for the 18-month period following the expiration of COBRA coverage. Additionally, all of the named executive officer’s unvested restricted stock units will immediately vest and become exercisable and payable.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
A “change in control,” as used in these employment agreements, generally means a change in the control of the Company following any number of events, but specifically a proxy contest in which our Board of Directors prior to the transaction constitutes less than a majority of our Board of Directors after the transaction or the members of our Board of Directors during any consecutive two-year period who at the beginning of such period constituted the Board of Directors cease to be the majority of the Board of Directors at the conclusion of that period. We have determined that a change in control has taken place. A “triggering termination” generally occurs when an executive is terminated during a specified period preceding a change in control of us, or if the executive or the Company terminates the executive’s employment under circumstances constituting a triggering termination during a specified period after a change in control. A triggering termination may also include a voluntary termination under certain scenarios.
As a result of the changes in our Board of Directors over the past 12 months, the Company may be liable to each executive for change in control payments contingent upon a triggering termination event. As of May 31, 2022 the amount of the unrecorded cash severance payments and benefits contingent upon a subsequent triggering termination event are estimated to be approximately $859,000 and the acceleration of unvested restricted stock units with an unrecognized expense of approximately $108,000. The Company may further be liable for outplacement services obligations, consulting fees, and certain tax consequences associated with severance payments, benefits payments and stock awards. These additional obligations may have a material impact on the liability of the Company upon a triggering termination.
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, 2022, the Company was contracted for approximately $141,000 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 13 - 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 28, 2022 filed on May 27, 2022. 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:
Three Months Ended May 31, 2022 | | Franchising | | | Manufacturing | | | Retail | | | U-Swirl | | | Other | | | Total | |
Total revenues | | $ | 1,495,454 | | | $ | 5,404,278 | | | $ | 250,410 | | | $ | 924,372 | | | $ | - | | | $ | 8,074,514 | |
Intersegment revenues | | | (1,274 | ) | | | (246,668 | ) | | | - | | | | - | | | | - | | | | (247,942 | ) |
Revenue from external customers | | | 1,494,180 | | | | 5,157,610 | | | | 250,410 | | | | 924,372 | | | | - | | | | 7,826,572 | |
Segment profit (loss) | | | 707,096 | | | | 608,232 | | | | (12,232 | ) | | | 168,257 | | | | (1,618,049 | ) | | | (146,696 | ) |
Total assets | | | 1,201,855 | | | | 10,751,227 | | | | 637,637 | | | | 4,903,780 | | | | 9,997,092 | | | | 27,491,591 | |
Capital expenditures | | | 1,182 | | | | 249,315 | | | | 317 | | | | 29,475 | | | | 10,071 | | | | 290,360 | |
Total depreciation & amortization | | $ | 8,919 | | | $ | 161,188 | | | $ | 1,412 | | | $ | 98,291 | | | $ | 17,374 | | | $ | 287,184 | |
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES
NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended May 31, 2021 | | Franchising | | | Manufacturing | | | Retail | | | U-Swirl | | | Other | | | Total | |
Total revenues | | $ | 1,435,366 | | | $ | 5,285,106 | | | $ | 282,978 | | | $ | 836,283 | | | $ | - | | | $ | 7,839,733 | |
Intersegment revenues | | | (1,639 | ) | | | (244,383 | ) | | | - | | | | - | | | | - | | | | (246,022 | ) |
Revenue from external customers | | | 1,433,727 | | | | 5,040,723 | | | | 282,978 | | | | 836,283 | | | | - | | | | 7,593,711 | |
Segment profit (loss) | | | 644,866 | | | | 668,024 | | | | 18,265 | | | | 145,542 | | | | (659,099 | ) | | | 817,598 | |
Total assets | | | 1,430,823 | | | | 10,075,833 | | | | 638,670 | | | | 5,379,850 | | | | 8,277,451 | | | | 25,802,627 | |
Capital expenditures | | | 1,182 | | | | 432,411 | | | | 1,068 | | | | 1,399 | | | | 21,375 | | | | 457,435 | |
Total depreciation & amortization | | $ | 9,498 | | | $ | 153,620 | | | $ | 1,401 | | | $ | 116,730 | | | $ | 18,665 | | | $ | 299,914 | |
NOTE 14 – CONTESTED SOLICITATION OF PROXIES AND CHANGE IN CONTROL PAYMENTS
Contested Solicitation of Proxies
During the three months ended May 31, 2022, the Company incurred costs associated with a stockholder’s contested solicitation of proxies in connection with its 2022 annual meeting of stockholders. During the three months ended May 31, 2022, the Company incurred approximately $305,000 of costs associated with the contested solicitation of proxies, compared with no comparable costs incurred in the three months ended May 31, 2021. These costs are recognized as general and administrative expense in the Consolidated Statement of Operations.
NOTE 15 – RESTRICTED CASH
In accordance with the Letter Agreement between the Company and Bryan J. Merryman, the Company’s former Chief Executive Officer, in March 2022, the Company established a rabbi trust with an outside third-party trustee, and contributed $1,344,813 to the trust, which represents the aggregate amount of the termination payment and the cash payment for insurance coverage to be paid to Mr. Merryman upon his termination of his employment. This obligation is included in accrued salaries and wages at May 31, 2022 and February 28, 2022 on the accompanying consolidated balance sheet. This trust balance is classified as restricted cash on the accompanying consolidated balance sheet as of May 31, 2022.
Cash, cash equivilants and restricted cash as of May 31, 2022 and February 28, 2022 consisted of the following:
| | May 31, 2022 | | | February 28, 2022 | |
Cash and cash equivalents | | $ | 5,989,510 | | | $ | 7,587,374 | |
Restricted cash | | | 1,344,813 | | | | - | |
Total cash, cash equivalents and restricted cash | | $ | 7,334,323 | | | $ | 7,587,374 | |