The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes thereto, included elsewhere in this Annual Report on Form 10-K. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results may differ materially from those contained in or implied by any forward-looking statements. See "Cautionary Note Regarding Forward-Looking Statements." Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Item 1A. "Risk Factors." Overview
Rocky Mountain Chocolate Factory, Inc., a Delawarecorporation, and its subsidiaries (including its operating subsidiary with the same name, Rocky Mountain Chocolate Factory, Inc., a Coloradocorporation ("RMCF") (collectively, the "Company," "we," "us," or "our") is an international franchisor, confectionery manufacturer and retail operator. Founded in 1981, we are headquartered in Durango, Coloradoand manufacture an extensive line of premium chocolate candies and other confectionery products. Our wholly-owned subsidiary, U-Swirl International, Inc.("U-Swirl"), franchises and operates self-serve frozen yogurt stores. Our revenues and profitability are derived principally from our franchised/license system of retail stores that feature chocolate, frozen yogurt and other confectionary products. We also sell our candy in select locations outside of our system of retail stores and license the use of our brand with certain consumer products. We are also party to strategic alliance and ecommerce agreements with Edible Arrangements®, LLC and its affiliates ("Edible"), whereby we sell our candy in their store locations and through their ecommerce platform. As of March 31, 2022, there were two Company-owned, 99 licensee-owned and 159 franchised Rocky Mountain Chocolate Factorystores operating in 37 states, South Korea, Panama, and the Philippines. As of March 31, 2022, U-Swirloperated three Company-owned stores and 63 franchised and licensed stores located in 22 states and Qatar. U-Swirloperates self-serve frozen yogurt cafes under the names " U-Swirl," " Yogurtini," "CherryBerry," "Yogli Mogli Frozen Yogurt," "Fuzzy Peach Frozen Yogurt," "Let's Yo!" and " AspenLeaf Yogurt". 25
In FY 2020 and early FY 2021, we entered into a long-term strategic alliance and ecommerce agreements, respectively, with Edible Arrangements®, LLC and its affiliates ("Edible"), whereby it is 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 Factorybranded products are intended to be 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 have also executed an ecommerce licensing agreement with Edible, whereby Edible is 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 RMCF 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 FY 2022 and FY 2021 were approximately $1.7 millionand $3.5 million, or 5.3% and 15.1% of the Company's revenues, respectively. There can be no assurance historical revenue levels will be indicative of future revenues. Current Trends and Outlook As discussed in more detail throughout this Annual Report on Form 10-K for FY 2022 (this "Annual 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 of customers throughout the United Statesand internationally. During FY 2021, nearly all of the Company-owned and franchise stores were 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 were not ordering products for their stores in line with historical amounts. This trend has negatively impacted, and may continue to negatively impact, among other things, factory sales, retail sales and royalty and marketing fees. Although most stores that previously temporarily closed in early 2020 in response to the COVID-19 pandemic have re-opened, during FY 2021, approximately 53 stores closed and have not re-opened and the future of these locations is uncertain. This closure rate is significantly higher than historical levels. As of the date of this report, most stores have met or exceeded pre-COVID-19 sales levels; however, many retail environments have continued to be adversely impacted by changes to consumer behavior as a result of COVID-19. Most stores re-opened subject to various local health restrictions and often with reduced operations. Strong consumer spending and other macro-economic trends as well as the roll out of vaccines and relaxing of most local health restrictions have resulted in significant increases in sales at our franchise stores during FY 2022. Our ability to meet the increase in franchise store demand has been partially constrained by labor and supply chain constraints. We are unsure how the emergence of COVID-19 variants, such as Delta and Omicron, will impact the positive recovery trends. In addition, as previously announced on May 11, 2020, the Board of Directors suspended future quarterly dividends until the Board of Directors determines that resumption of dividend payments is in the best interest of the Company and our stockholders. As a result of macro-economic inflationary trends and disruptions to the global supply chain, we have experienced and expect to continue experiencing higher raw material, labor, and freight costs. We have seen labor and logistics challenges, which we believe have contributed to lower factory, retail and e-commerce sales of our products due to the availability of material, labor and freight. In addition, we could experience additional lost sale opportunities if our products are not available for purchase as a result of continued disruptions in our supply chain relating to an inability to obtain ingredients or packaging, labor challenges at our logistics providers or our manufacturing facility, or if we or our franchisees experience delays in stocking our products. During FY 2022, the Company incurred substantial costs associated with a stockholder's contested solicitation of proxies in connection with our 2021 annual meeting of stockholders. During FY 2022, the Company incurred approximately $1.7 millionof costs associated with the contested solicitation of proxies, compared with no comparable costs incurred in FY 2021. These costs are recognized as general and administrative expense in the Consolidated Statement of Operations. Additionally, as a result of the contested solicitation of proxies and the resulting changes to the composition of the Company's Board of Directors, the Company incurred $2.0 millionof accrued severance costs and accelerated restricted stock unit expense during FY 2022. As previously announced, Bryan J. Merrymanagreed to voluntarily step down as President and Chief Executive Officer ("CEO") of the Company upon the hiring of a new President and CEO for the Company. On May 5, 2022the Company concluded its search for a new CEO with the announcement that Robert Sarllswill succeed Mr. Merrymanas the Company's CEO beginning on May 9, 2022. Limited financing alternatives for domestic franchise growth has led us to pursue a strategy of expansion through co-branding with complimentary concepts such as ice cream and frozen yogurt, international development, sale of our products to specialty markets, licensing the Rocky Mountain Chocolate Factory brand for use with other appropriate consumer products, and selected entry of Rocky Mountain Chocolate Factorybranded products into other wholesale channels, along with business acquisitions as primary drivers of growth. This is a trend that continued in FY 2021 and we expect to continue into the foreseeable future. Going forward in FY 2023, we are taking a conservative view of market conditions in the United States. We intend to continue to focus on our long-term objectives while seeking to maintain flexibility to respond to market conditions. We are subject to seasonal fluctuations in sales because of key holidays and the location of our franchisees, which have traditionally been located in resort or tourist locations, and the nature of the products we sell, which are highly seasonal. As we expanded our geographical diversity to include regional centers and our franchise offerings to include frozen desserts, we have seen some moderation to our seasonal sales mix. Seasonal fluctuation in sales causes fluctuations in quarterly results of operations. Historically, the strongest sales of our products have occurred during key holidays and summer vacation seasons. Additionally, 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. 26
The most important factors in continued growth in our earnings are macroeconomic and retail sector post-COVID 19 recovery, ongoing online revenue growth, a shift in consumer behavior as a result of the COVID-19 pandemic, unit growth, increased same store sales and increased same store pounds purchased from the factory. Our ability to successfully achieve growth as a result of our strategic alliance with Edible depends on many factors not within our control, including customer receptiveness to our products, Edible franchisee's receptiveness to our products, logistical considerations and technological integration. Our ability to successfully achieve expansion of our franchise systems depends on many factors not within our control including the availability of suitable sites for new store establishment 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, competition, the receptivity of our franchise system to our product introductions and promotional programs. In FY 2021, same store pounds purchased from the factory by franchised and co-branded licensed stores was significantly impacted by COVID-19 and the impact it had on store operations. During FY 2022, same store pounds purchased from the factory by franchised and co-branded licensed stores increased approximately 325.5% in the first quarter, increased approximately 63.8% in the second quarter, increased approximately 20.9% in the third quarter, increased approximately 21.1% in the fourth quarter, and increased 58.9% overall in FY 2022 as compared to the same periods in FY 2021. We have expanded co-branding as a way to offset low franchise growth through a relationship with
Cold Stone Creamery. We have additionally developed co-branded locations through U-Swirl brands. We believe that if this co-branding strategy continues to prove financially viable it could represent a significant future growth opportunity. As of February 28, 2022, Cold Stone licensees operated 97 co-branded locations, our U-Swirlfranchisees operated 6 co-branded locations and we have co-branded 3 of our Company-owned cafés. Results of Operations
Fiscal 2022 vs. Fiscal 2021
Results Summary Basic earnings per share increased from a net loss of
$(0.15)per share in FY 2021 to a net loss of $(0.06)per share in FY 2022. Revenues increased 37.7% from $23.5 millionfor FY 2021 to $32.3 millionfor FY 2022. Operating loss decreased from an operating loss of $(3.5) millionin FY 2021 to an operating loss of $(484,000)in FY 2022. Net loss decreased from a net loss of $(900,000)in FY 2021 to a net loss of $(342,000)in FY 2022. The increase in revenue was due primarily to the impacts from the COVID-19 pandemic during FY 2021, including its impact on our operation and the operations of our franchised, licensed and Company-owned locations. During FY 2022, many of the disruptions experienced as a result of the COVID-19 pandemic were no longer impacting our network of franchised and licensed retail stores and many of our locations had returned to, or exceeded, pre-pandemic levels. These increases were partially offset by the costs associated with the contested solicitation of proxies incurred during FY 2022 with no comparable costs in FY 2021. The decrease in loss from operations and net loss was due primarily to recovery from the COVID-19 pandemic and the associated impact on revenue FY 2021 partially offset by the costs associated with the contested solicitation of proxies and the associated accrued severance and stock compensation costs during FY 2022. REVENUES For the Year Ended ($'s in thousands) February 28, $ % 2022 2021 Change Change Factory sales $ 22,374.2 $ 17,321.0 $ 5,053.229.2 % Retail sales 2,853.3 1,858.5 994.8 53.5 % Franchise fees 213.9 226.7 (12.8 ) (5.6 )% Royalty and marketing fees 6,901.2 4,074.5 2,826.7 69.4 % Total $ 32,342.6 $ 23,480.7 $ 8,861.937.7 % Factory Sales The increase in factory sales for FY 2022 compared FY 2021 was primarily due to an 70.0% increase in sales of product to our network of franchised and licensed retail stores partially offset by a 40.7% decrease in shipments of product to customers outside our network of franchised retail stores. Purchases by the Company's largest customer, Edible, during FY 2022 were approximately $1.7 million, or 5.3% of the Company's revenues, compared to $3.5 million, or 15.1% of the Company's revenues during FY 2021. The increase in sales of product to our network of franchised and licensed retail stores was primarily the result of the COVID-19 pandemic and the associated public health measures in place during FY 2021, which significantly reduced traffic in our stores. During FY 2022 most of the disruptions experienced as a result of the COVID-19 pandemic were no longer impacting our network of franchised and licensed retail stores and many of our locations had returned to, or exceeded, pre-pandemic levels. During FY 2022, certain disagreements arose between RMCF and Edible related to the strategic alliance and ecommerce agreements resulting in continuing discussions, the result of which are not currently determinable. There can be no assurance historical revenue levels will be indicative of future revenues. Same store pounds purchased by domestic franchise and licensed locations increased 11.7% during FY 2022 when compared to FY 2020 (the most recent comparable period prior to the business disruptions of COVID-19). 27
Table of Contents Retail Sales The increase in retail sales for FY 2022 compared to FY 2021 was primarily due to all of our Company-owned stores being open during FY 2022 compared to the closure or limited operations of all of our Company-owned stores for much of FY 2021. The closure or limited operations of our Company-owned stores in the prior year period was the result of the COVID-19 pandemic and the associated public health measures in place during FY 2021. As of
February 28, 2022most Company-owned stores had resumed full operations following COVID-19 related closure.
Royalties, marketing fees and franchise fees
The increase in royalty and marketing fees during FY 2022 compared to FY 2021 was primarily due to the majority of our franchise locations having resumed normal operations during FY 2022, due to the relaxing of restrictions related to the COVID-19 pandemic and the associated public health measures in place during FY 2021 as well as the rollout of vaccines at the beginning of FY 2022. Nearly all of our franchised locations experienced reduced operations and periods of full closure during FY 2021. Same store sales at domestic franchise locations increased 18.9% in FY 2022 when compared to FY 2020 (the most recent comparable period prior to the business disruptions of COVID-19). The decrease in franchise fee revenue during FY 2022 compared to FY 2021 was the result of a decrease in revenue resulting from the closure of franchise locations and the associated recognition of revenue in FY 2021, with fewer comparable closures during FY 2022 and fewer franchise stores in operation and the associated recognition of revenue over the term of the various franchise agreements. COSTS AND EXPENSES Cost of Sales For the Year Ended February 28, $ % ($'s in thousands) 2022 2021 Change Change Cost of sales - factory
$ 18,153.8 $ 15,473.8 $ 2,680.017.3 % Cost of sales - retail 1,013.9 644.8 369.1 57.2 % Franchise costs 2,183.7 1,715.6 468.1 27.3 % Sales and marketing 1,610.7 1,712.8 (102.1 ) (6.0 )% General and administrative 7,551.0 5,258.0 2,293.0 43.6 % Retail operating 1,727.7 1,381.8 345.9 25.0 % Total $ 32,240.8 $ 26,186.8 $ 6,054.023.1 % Gross Margin For the Year Ended February 28, $ % ($'s in thousands) 2022 2021 Change Change Factory gross margin $ 4,220.4 $ 1,847.2 $ 2,373.2128.5 % Retail gross margin 1,839.4 1,213.7 625.7 51.6 % Total $ 6,059.8 $ 3,060.9 $ 2,998.998.0 % 28
Table of Contents Gross Margin For the Year Ended February 28, % % 2022 2021 Change Change (Percent) Factory gross margin 18.9 % 10.7 % 8.2 % 76.6 % Retail gross margin 64.5 % 65.3 % (0.8 )% (1.2 )% Total 24.0 % 16.0 % 8.0 % 50.0 % Adjusted Gross Margin For the Year Ended (a non-GAAP measure) February 28, $ % ($'s in thousands) 2022 2021 Change Change Factory gross margin
$ 4,220.4 $ 1,847.2 $ 2,373.2128.5 % Plus: depreciation and amortization 620.8 625.5 (4.7 ) (0.8 )% Factory adjusted gross margin 4,841.2 2,472.7 2,368.5 95.8 % Retail gross margin 1,839.4 1,213.7 625.7 51.6 % Total Adjusted Gross Margin $ 6,680.6 $ 3,686.4 $ 2,994.281.2 % Factory adjusted gross margin 21.6 % 14.3 % 7.3 % 51.0 % Retail gross margin 64.5 % 65.3 % (0.8 )% (1.2 )% Total Adjusted Gross Margin 26.5 % 19.2 % 7.3 % 38.0 % Adjusted gross margin and factory adjusted gross margin are non-GAAP measures. Adjusted gross margin is equal to the sum of our factory adjusted gross margin plus our retail gross margin calculated in accordance with GAAP. Factory adjusted gross margin is equal to factory gross margin plus 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.
Cost of sales and gross margin
Factory gross margins increased to 18.9% in FY 2022 compared to a gross margin of 10.7% during FY 2021, due primarily to a 27.4% increase in production volume, higher average sell prices, and the impacts of Employee Retention Credits in FY 2022 compared to FY 2021, partially offset by increased costs of materials and labor. The increase in production volume was in response to a 29.2% increase in factory sales, primarily due to a resumption of normal factory operations during FY 2022 compared to significantly reduced operations during FY 2021. Operations during FY 2021 were lower than historical levels as a result of the impacts of the COVID-19 pandemic. As a result of the decrease in production volume, factory fixed costs, including idle labor, did not decrease proportionate to factory revenue during FY 2021. During FY 2021 the Company incurred approximately
$280,000of production labor costs associated with paying employees who abided by local stay at home orders related to COVID-19 public health measures. This excess capacity cost, in the form of idle labor, was included in cost of sales.
Retail gross margins decreased from 65.3% in fiscal 2021 to 64.5% in fiscal 2022. The decline in retail gross margins was primarily due to higher costs.
Franchise Costs The increase in franchise costs in FY 2022 compared to FY 2021 was due primarily to an increase in professional fees, the result of litigation with IC, our licensee in
Canada. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 30.7% in FY 2022 from 39.9% in FY 2021. This decrease as a percentage of royalty, marketing and franchise fees is primarily a result of higher royalty fees partially offset by higher costs. 29
Table of Contents Sales and Marketing
The decrease in sales and marketing expenses in fiscal 2022 compared to fiscal 2021 is mainly due to lower online advertising expenses.
General and Administrative The increase in general and administrative costs during FY 2022 compared to FY 2021 is primarily due to costs associated with a stockholder's contested solicitation of proxies in connection with our 2021 annual meeting of stockholders and the compensation costs associated with the letter agreement between the Company and
Mr. Merryman. These increases were partially offset by a decrease in bad debt expense during FY 2022 compared to FY 2021 and an absence of impairment expense related to certain intangible assets during FY 2022 compared with impairment expense of $533,000incurred during FY 2021. During FY 2022, the Company incurred approximately $1.7 millionof costs associated with the contested solicitation of proxies and $2.0 millionin change in control severance expense, compared with no comparable costs incurred in FY 2021. As a percentage of total revenues, general and administrative expenses increased to 23.3% in FY 2022 compared to 22.4% in FY 2021. Retail Operating Expenses The increase in retail operating expenses during FY 2022 compared to FY 2021 was a result of the re-opening of all of our Company-owned stores so that all stores were open during FY 2022 compared to the closure or limited operation of all of our Company-owned stores for much of FY 2021. The closure or limited operation of our Company-owned stores was the result of COVID-19 and the associated public health measures in place during the FY 2021. Retail operating expenses, as a percentage of retail sales, decreased from 74.4% during FY 2021 to 60.6% in FY 2022. This decrease is primarily the result of higher retail sales partially offset by higher retail operating expenses.
Depreciation and amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was
$586,000during FY 2022, a decrease of 17.5% from $711,000incurred during FY 2021. This decrease was the result of a decrease in frozen yogurt cafés in operation and lower amortization of the associated franchise rights. See Note 7 to the financial statements for a summary of annual amortization of intangible assets based upon existing intangible assets and current useful lives. Depreciation and amortization included in cost of sales decreased 0.8% from $626,000during FY 2021 to $621,000during FY 2022. This decrease was the result of certain assets becoming fully depreciated, partially offset by depreciation related to new assets acquired. Other Income (Expense) Other income decreased to $178,000during FY 2022 compared to other income of $1.7 millionduring FY 2021. This change was primarily the result of debt forgiveness income during FY 2021 with no comparable amounts realized during FY 2022. Net interest income was $11,000in FY 2022 compared to net interest expense of $77,000during FY 2021. This change was primarily the result of the Company's increased debt as a result of measures taken during the three months ended May 31, 2020to ensure adequate liquidity during the COVID-19 pandemic. During FY 2021, the Company borrowed $3.4 millionfrom its line of credit and borrowed $1.5 millionof loans under the Paycheck Protection Program. The line of credit was paid in full and Paycheck Protection Program loans were fully forgiven during FY 2021. The Company recognized a gain on insurance recovery of $167,100during FY 2022, compared with $210,500recognized during FY 2021. The Company recognized forgiveness of debt of $1.5 millionduring FY 2021, with no comparable amount recognized during FY 2022. Income Tax Expense We incurred $35,400of income tax expense in FY 2022 on a loss before income taxes of $306,000, compared to an income tax benefit of $891,900realized in FY 2021 on a loss before income taxes of $1.8 million. The income tax benefit in FY 2021 was primarily the result of debt forgiveness income being realized in FY 2021 with no associated income tax expense and the revaluation of a portion of deferred tax assets as a result of the Company realizing a taxable loss during FY 2021 that can be carried back to prior periods with a higher effective income tax rate. The income tax expense in FY 2022 was primarily the result of differences in the valuation of restricted stock awards and the realization of $155,000of employee retention credits that reduced the loss that could be carried back to prior periods.
Fiscal 2021 vs. Fiscal 2020
A discussion of our results of operations for fiscal year 2021 compared to fiscal year 2020 has been omitted from this annual report, but can be found in item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended
Annual Report on Form 10-K/A for the fiscal year ended
February 28, 2021, filed with the SECon June 28, 2021, which are available free of charge on the SEC'swebsite at www.sec.gov and our corporate website (www.rmcf.com). 30
Cash and capital resources
As discussed below, we have taken several defensive measures to maximize liquidity in response to the COVID-19 pandemic, including the suspension of our cash dividend, reducing expenses, extending payment terms with vendors, reducing production volume and deferring discretionary capital expenditures. Based on these actions, we believe that cash flows from operations and our cash and cash equivalents on hand, will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. Additional future financing may be necessary to fund our operations, and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all, especially in light of the market volatility and uncertainty as a result of the COVID-19 pandemic. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets, in each case, in light of the market volatility and uncertainty as a result of the COVID-19 pandemic, among other factors, could impact our business and liquidity. As of
February 28, 2022, working capital was $9.7 millioncompared with $9.0 millionas of February 28, 2021. The increase in working capital was due primarily to our efforts to preserve liquidity during the COVID-19 pandemic, including the receipt of PPP funds and the suspension of our quarterly dividend. We have historically generated excess operating cash flow. We review our working capital needs and projections and when we believe that we have greater working capital than necessary we have historically utilized that excess working capital to repurchase common stock and pay dividends to our stockholders. Cash and cash equivalent balances increased from $5.6 millionas of February 28, 2021to $7.6 millionas of February 28, 2022as a result of cash flows generated by financing activities. Our current ratio was 2.8 to 1.0 at February 28, 2022compared to 3.4 to 1.0 at February 28, 2021. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements. During FY 2022, we had a net loss of $342,000. Operating activities provided cash of $2.9 million, with the principal adjustment to reconcile net income to net cash provided by operating activities being an increase in accrued liabilities of $1.3 million, depreciation and amortization of $1.2 millionand stock compensation expense of $1.1 million. During FY 2021, we had a net loss of $900,000. Operating activities provided cash of $67,000, with the principal adjustment to reconcile net income to net cash provided by operating activities being depreciation and amortization of $1.3 millionand stock compensation expense of $512,000. During FY 2022, investing activities used cash of $605,000, primarily due to the purchases of property and equipment of $950,000, partially offset by proceeds received from an insurance recovery of $206,000. In comparison, investing activities used cash of $71,000during FY 2021 primarily due to the purchases of property and equipment, intangible assets and deposits on future asset purchases of $461,000partially offset by proceeds received from an insurance recovery of $305,000. Financing activities used cash of $299,000during FY 2022 and provided cash of $815,000during the prior year. The change in cash used in financing activities was primarily due to the receipt of PPP proceeds in FY 2021. Revolving Credit Line The Company has a $5.0 millioncredit line for general corporate and working capital purposes, of which $5.0 millionwas available for borrowing (subject to certain borrowing base limitations) as of February 28, 2022. In March 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 millionunder the credit line, subject to the borrowing base of 50% of eligible accounts receivable plus 50% of eligible inventories). In February 2021, the Company repaid the credit line in full as a result of improving economic conditions and the full forgiveness of PPP loans. The credit line is secured by substantially all of the Company's assets, except retail store assets. Interest on borrowings is at SOFR plus 2.37% (2.42% at February 28, 2022). Additionally, the line of credit is subject to various financial ratio and leverage covenants. At February 28, 2022, the Company was in compliance with all such covenants. The credit line is subject to renewal in September 2022and the Company believes it is likely to be renewed on terms similar to the current terms. PPP Loan In April 2020, the Company entered into a Loan Agreements and Promissory Notes (collectively the "SBA Loans") with 1st SOURCE BANKpursuant to the Paycheck Protection Program (the "PPP") under the recently enacted Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") administered by the U.S. Small Business Administration. The Company received total proceeds of $1.5 millionfrom the SBA Loans. These loans were forgiven during FY 2021. 31
Table of Contents Contractual Obligations The table below presents significant contractual obligations of the Company at
February 28, 2022. (Amounts in thousands) Less than 1 More Than Contractual Obligations Total year 2-3 Years 4-5 years 5 years Operating leases $ 1,859$ 579 $ 630 $ 211 $ 439Purchase contracts 45 45 - - - Other long-term obligations 127 28 57 42 - Total $ 2,031$ 652 $ 687 $ 253 $ 439The Company made an average of $695,000per year in capital expenditures during FY 2020 to FY 2022. For FY 2023 the Company anticipates making approximately $1.7 millionof capital expenditures. The planned increase is the result of expected investment in machinery and equipment to replace equipment that has reached the end of its useful life. Impact of Inflation Inflationary factors such as increases in the costs of ingredients and labor directly affect the Company's operations. Most of the Company's leases provide for cost-of-living adjustments and require it to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally, the Company's future lease cost for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that the Company will be able to pass on increased costs to its customers. Depreciation expense is based on the historical cost to the Company of its 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.
Critical accounting estimates
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in
the United States of America. The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosures. Estimates and assumptions include, but are not limited to, the carrying value of accounts and notes receivable from franchisees, inventories, the useful lives of fixed assets, goodwill, and other intangible assets, income taxes, contingencies and litigation. We base our estimates on analyses, of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
We believe that the following represent our most critical estimates and assumptions used in the preparation of our consolidated financial statements, although they are not exhaustive.
Accounts and Notes Receivable - In the normal course of business, we extend credit to customers, primarily franchisees, that satisfy pre-defined credit criteria. We believe that we have a limited concentration of credit risk primarily because our receivables are secured by the assets of the franchisees to which we ordinarily extend credit, including, but not limited to, their franchise rights and inventories. An allowance for doubtful accounts is determined through analysis of the aging of accounts receivable, assessments of collectability based on historical trends, and an evaluation of the impact of current and projected economic conditions. The process by which we perform our analysis is conducted on a customer by customer, or franchisee by franchisee, basis and takes into account, among other relevant factors, sales history, outstanding receivables, customer financial strength, as well as customer specific and geographic market factors relevant to projected performance. The Company monitors the collectability of its accounts receivable on an ongoing basis by assessing the credit worthiness of its customers and evaluating the impact of reasonably likely changes in economic conditions that may impact credit risks. Estimates with regard to the collectability of accounts receivable are reasonably likely to change in the future. We may experience the failure of our wholesale customers, including our franchisees, to whom we extend credit to pay amounts owed to us on time, or at all, particularly if such customers are significantly impacted by COVID-19. We recorded an average expense of approximately
$485,000per year for potential uncollectible accounts over the three fiscal years ended February 28, 2022. Write-offs of uncollectible accounts net of recoveries averaged approximately $358,000over the same period. The provision for uncollectible accounts is recognized as general and administrative expense in the Statements of Income. Over the past three fiscal years, the allowances for doubtful notes and accounts have ranged from 13.6% to 44.25% of gross receivables. As a result of COVID-19 and the associated impact on the liquidity of our customers, we recorded higher expense for potentially uncollectable accounts and a higher allowance as a percentage of gross receivables during FY 2021. 32
Revenue Recognition - We recognize revenue on sales of products to franchisees and other customers at the time of delivery. Beginning in FY 2019, upon adoption of ASC 606, the Company began recognizing franchise fees and license fees over the term of the associated agreement, which is generally a period of 10-15 years. Prior to FY 2019, franchise fee revenue was recognized upon opening of the franchise store, or upon execution of an international license agreement. We recognize a marketing and promotion fee of one percent (1%) of the
Rocky Mountain Chocolate Factoryand U-Swirlfranchised stores' gross retail sales and a royalty fee based on gross retail sales. The Company recognizes no royalty on franchised stores' retail sales of products purchased from the Company and recognizes a ten percent (10%) royalty on all other sales of product sold at franchise locations. Royalty fees for U-Swirlcafés are based on the rate defined in the acquired contracts for the franchise rights and range from 2.5% to 6% of gross retail sales. Rebates received from purveyors that supply products to our franchisees are included in franchise royalties and fees. Product rebates are recognized in the period in which they are earned. Rebates related to Company-owned locations are offset against operating costs. Inventories - Our inventories are stated at the lower of cost or net realizable value and are reduced for slow-moving, excess, discontinued and shelf-life expired inventories. Our estimate for such reduction is based on our review of inventories on hand compared to estimated future usage and demand for our products. Such review encompasses not only potentially perishable inventories but also specialty packaging, much of it specific to certain holiday seasons. If actual future usage and demand for our products are less favorable than those projected by our review, further inventory adjustments may be required. We closely monitor our inventory, both perishable and non-perishable, and related shelf and product lives. Historically we have experienced low levels of obsolete inventory or returns of products that have exceeded their shelf life. Over the three fiscal years ended February 28, 2022, the Company recorded expense averaging $313,000per year for potential inventory losses, or approximately 1.8% of total cost of sales for that period. Goodwill- Goodwillconsists of the excess of purchase price over the fair market value of acquired assets and liabilities. Effective March 1, 2002, under ASC Topic 350, all goodwill with indefinite lives is no longer subject to amortization. ASC Topic 350 requires that an impairment test be conducted annually or in the event of an impairment indicator. Our testing and impairment is described in Note 7 to the financial statements. We may be required to revise certain accounting estimates and judgments related to Goodwillas a result of the COVID-19 pandemic and its impact on economic conditions.
Franchise Fees – Franchise fees include the purchase price paid for certain rights associated with franchise agreements. These franchise agreements provide for the future payment to the franchisor of royalties and marketing expenses. We consider franchise rights to have a lifespan of 20 years.
Other accounting estimates inherent in the preparation of our consolidated financial statements include estimates associated with its evaluation of the recoverability of deferred tax assets, as well as those used in the determination of liabilities related to litigation and taxation. Various assumptions and other factors underlie the determination of these significant estimates. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, current and expected economic conditions, and product mix. The Company constantly re-evaluates these significant factors and makes adjustments where facts and circumstances dictate. Historically, actual results have not significantly deviated from those determined using the estimates described above.
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