Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q (“Quarterly Report”) includes statements of
our expectations, intentions, plans and beliefs that constitute “forward-looking
statements” within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the
“Exchange Act”), and are intended to come within the safe harbor protection
provided by those sections. These forward-looking statements involve various
risks and uncertainties. The nature of our operations and the environment in
which we operate subject us to changing economic, competitive, regulatory and
technological conditions, risks and uncertainties. The statements, other than
statements of historical fact, included in this Quarterly Report are
forward-looking statements. Many of the forward-looking statements contained in
this document may be identified by the use of forward-looking words such as
“will,” “intend,” “believe,” “expect,” “anticipate,” “should,” “plan,”
“estimate,” “potential,” or similar expressions. Factors which could cause
results to differ include, but are not limited to: the impact of the novel
coronavirus (COVID-19) on our business, including, among other things, online
sales, factory sales, retail sales and royalty and marketing fees, our
liquidity, our cost cutting and capital preservation measures, achievement of
the anticipated potential benefits of the strategic alliance with Edible (as
defined herein), our ability to provide products to Edible under the strategic
alliance, the ability to increase our online sales throught the agreements with
Edible, changes in the confectionery business environment, seasonality, consumer
interest in our products, general economic conditions, the success of our frozen
yogurt business, receptiveness of our products internationally, consumer and
retail trends, costs and availability of raw materials, competition, the success
of our co-branding strategy, the success of international expansion efforts and
the effect of government regulations. Government regulations which we and our
franchisees and licensees either are, or may be, subject to and which could
cause results to differ from forward-looking statements include, but are not
limited to: local, state and federal laws regarding health, sanitation, safety,
building and fire codes, franchising, licensing, employment, manufacturing,
packaging and distribution of food products and motor carriers. For a detailed
discussion of the risks and uncertainties that may cause our actual results to
differ from the forward-looking statements contained herein, please see the
section entitled “Risk Factors” contained in Item 1A. of our Annual Report on
Form 10-K for the fiscal year ended
might cause such differences include, but are not limited to: the length and
severity of the current COVID-19 pandemic and its effect on among other things,
factory sales, retail sales, royalty and marketing fees and operations, the
effect of any governmental action or mandated employer-paid benefits in response
to the COVID-19 pandemic, our ability to manage costs and reduce expenditures in
the current economic environment and the availability of additional financing if
and when required. These forward-looking statements apply only as of the date of
this Quarterly Report. As such they should not be unduly relied upon for more
current circumstances. Except as required by law, we undertake no obligation to
release publicly any revisions to these forward-looking statements that might
reflect events or circumstances occurring after the date of this Quarterly
Report or those that might reflect the occurrence of unanticipated events.
Unless otherwise specified, the “Company,” “we,” “us” or “our” refers to
Mountain Chocolate Factory, Inc.
subsidiaries (including its operating subsidiary with the same name,
Mountain Chocolate Factory, Inc.
Overview
We are an international franchisor, confectionery manufacturer and retail
operator. Founded in 1981, we are headquartered in
manufacture an extensive line of premium chocolate candies and other
confectionery products. Our wholly-owned subsidiary,
(“U-Swirl”), franchises and operates soft-serve frozen yogurt cafés. 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. As of
licensee-owned and 232 franchised
operating in 37 states,
Philippines
83 franchised cafés located in 25 states and
frozen yogurt cafés under the names “U-Swirl,” “
“Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!” and “Aspen
Leaf Yogurt”.
On
“
(“Farids,” and together with EA and any permitted transferees, “Edible”),
pursuant to which, among other things, the Company will become the exclusive
provider of certain branded chocolate products to Edible, its affiliates and its
franchisees. In connection with the
a strategic alliance agreement, an exclusive supplier operating agreement and a
warrant agreement with Edible. In addition, on
entered into 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.
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Table of Contents Bankruptcy ofFTD Companies
In
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 the auction to multiple buyers. The Company is
uncertain if accounts receivable and inventory balances associated with FTD at
received from FTD in the future. See Note 13 to the financial statements
contained herein for additional information about the FTD bankruptcy.
COVID-19
As discussed in more detail throughout this Quarterly Report on Form 10-Q for
the quarter ended
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
States
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
2020
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
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
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,
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 a
loan under the Paycheck Protection Program (the “PPP”). 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
2020
Results of Operations
Three Months Ended
Results Summary
Basic earnings per share decreased from
ended
ended
Operating income decreased from
to an operating loss of
Net income decreased from
net loss of
decrease in revenue, operating income and net income was due primarily to the
impacts from the COVID-19 pandemic, including its impact on our operation and
the operations of our franchised, licensed and Company-owned locations.
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Revenues
Three Months Ended
($'s in thousands) May 31, $ %
2020 2019 Change Change
Factory sales $ 2,134.6 $ 5,606.0 $ (3,471.4 ) (61.9 )%
Retail sales 187.6 854.6 (667.0 ) (78.0 )%
Franchise fees 55.0 106.3 (51.3 ) (48.3 )%
Royalty and marketing fees 325.2 1,859.1 (1,533.9 ) (82.5 )%
Total $ 2,702.4 $ 8,426.0 $ (5,723.6 ) (67.9 )%
Factory Sales
The decrease in factory sales for the three months ended
to the three months ended
sales of product to our network of franchised and licensed retail stores and a
30.5% decrease in shipments of product to customers outside our network of
franchised retail stores. Purchases by the Company’s largest customer during the
three months ended
Company’s revenues, compared to
during the three months ended
above, FTD declared Chapter 11 bankruptcy in
proceedings are complete, it is unclear whether the Company will realize any
revenue from FTD in the future, and if so, whether such revenues will return to
historic levels. The decrease 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 the three months ended
31, 2020
were partially offset by increases in factory sales associated with our
strategic alliance with Edibile and by an increase in revenue from online sales
of our products directly to consumers. Beginning in
previously closed for much of
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.
Retail Sales
Retail sales at Company-owned stores decreased for the three months ended
31, 2020
closure of all of our Company-owned stores for much of the three months ended
COVID-19 pandemic and the associated public health measures in place during the
three months ended
store had resumed limited operations following COVID-19 related closure.
Royalty, Marketing Fees and Franchise Fees
The decrease in royalty and marketing fees for the three months ended
2020
COVID-19 pandemic and the associated public health measures in place during the
three months ended
experienced reduced operations and periods of full closure during the three
months ended
The decrease in franchise fees for the three months ended
to the three months ended
resulting from store closures and the termination of any future contract
liability associated with the closure.
Costs and Expenses
Cost of Sales
Three Months Ended
May 31, $ %
($'s in thousands) 2020 2019 Change Change
Cost of sales - factory $ 2,790.6 $ 4,326.5 $ (1,535.9 ) (35.5 )%
Cost of sales - retail 92.6 288.2 (195.6 ) (67.9 )%
Franchise costs 421.2 483.0 (61.8 ) (12.8 )%
Sales and marketing 474.1 556.7 (82.6 ) (14.8 )%
General and administrative 3,179.5 1,144.7 2,034.8 177.8 %
Retail operating 319.2 448.9 (129.7 ) (28.9 )%
Total $ 7,277.2 $ 7,248.0 $ 29.2 0.4 %
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Gross Margin
Three Months Ended
May 31, $ %
($’s in thousands) 2020 2019 Change Change
Factory gross margin$ (656.0 ) $ 1,279.5 $ (1,935.5 ) (151.3 )% Retail gross margin 95.0 566.4 (471.4 ) (83.2 )% Total$ (561.0 ) $ 1,845.9 $ (2,406.9 ) (130.4 )% Three Months Ended May 31, % % 2020 2019 Change Change (Percent) Factory gross margin -30.7 % 22.8 % (53.5 )% (234.6 )% Retail gross margin 50.6 % 66.3 % (15.7 )% (23.7 )% Total -24.2 % 28.6 % (52.8 )% (184.6 )% Adjusted Gross Margin Three Months Ended May 31, $ % ($'s in thousands) 2020 2019 Change Change Factory gross margin$ (656.0 ) $ 1,279.5 $ (1,935.5 ) (151.3 )% Plus: depreciation and amortization 157.5 145.7 11.8 8.1 % Factory adjusted gross margin (498.5 ) 1,425.2 (1,923.7 ) (135.0 )% Retail gross margin 95.0 566.4 (471.4 ) (83.2 )% Total Adjusted Gross Margin$ (403.5 ) $ 1,991.6 $ (2,395.1 ) (120.3 )% Factory adjusted gross margin -23.4 % 25.4 % (48.8 )% (192.1 )% Retail gross margin 50.6 % 66.3 % (15.7 )% (23.7 )% Total Adjusted Gross Margin -17.4 % 30.8 % (48.2 )% (156.5 )%
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
them 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 decreased to negative gross margin of (23.4)% in the three
months ended
three months ended
three months ended
During the three monthd ended
response to a 61.9% decrease in factory sales, primarily due to the impacts of
the COVID-19 pandemic. As a result of the decrease in production volume, factory
fixed costs, including idle labor, exceeded revenue during the three months
ended
incurred approximately
employees
health measures. This excess capacity cost, in the form of idle labor, was
included in cost of sales.
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Retail gross margins decreased from 66.3% during the three months ended
2019
gross margins was primarily the result of the temporary closure of all of our
Company-owned stores for much of the three months ended
COVID-19 pandemic, and the associated impact on perishable inventory.
Franchise Costs
The decrease in franchise costs in the three months ended
to the three months ended
the result of COVID-19 related travel restrictions. As a percentage of total
royalty and marketing fees and franchise fee revenue, franchise costs increased
to 90.3% in the three months ended
ended
franchise fees is primarily a result of lower royalty revenues.
Sales and Marketing
The decrease in sales and marketing costs for the three months ended
2020
advertising and promotion costs, partially offset by an increase in online
advertising cost.
General and Administrative
The increase in general and administrative costs for the three months ended
31, 2020
increase in bad debt expense, the impairment of certain intangible assets and
higher professional fees. As a percentage of total revenues, general and
administrative expenses increased to 117.7% in the three months ended
2020
was primarily the result of management’s assessment of the likelihood of
collecting accounts and notes receivable as of
assessment total allowances for potentially uncollectable accounts and notes
receivable increased to
place due to responses to COVID-19 and the financial burden experienced by the
majority of our network of franchised and licensed locations. See Note 8 to the
financial statements for a summary of costs associated with the impairment of
certain intangible assets.
Retail Operating Expenses
The decrease in retail operating expenses for the three months ended
2020
closure of all of our Company-owned stores for much of the three months ended
and the associated public health measures in place during the three months ended
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization
included in cost of sales, was
a decrease of 20.0% from
2019
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 increased 8.1% from
ended
assets in service.
Other Income (Expense)
Net interest expense was
to net interest expense of
This change was primarily the result of the Company’s increased debt as a result
of measures taken during the three months ended
liquidity during the COVID-19 pandemic. During the three months ended
2020
Income Tax Expense
Our effective income tax rate was 24.3% for the three months ended
and was 24.6% for the three months ended
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Liquidity 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
as of
capital was primarily due to an increase in current liabilities, the result of
the Company’s response to COVID-19 and measures taken to ensure sufficient
short-term liquidity.
Cash and cash equivalent balances increased
the use of the line of credit and receipt of loans under the Paycheck Protection
Program, as described below. Our current ratio was 1.5 to 1 at
compared to 2.4 to 1 at
future levels of cash and cash equivalents in relation to anticipated operating,
financing and investing requirements.
During the three months ended
accounts and notes receivable of
losses of
accounts payble of
provided cash of
depreciation and amortization of
and expense related to stock-based compensation of
For the three months ended
assets of
during the three months ended
property and equipment of
Financing activities provided cash of
31, 2020
receipt of loans under the Paycheck Protection Program, as described below. In
comparison, financing activitied used cash of
ended
during the three months ended
Revolving Credit Line
The Company has a
capital purposes. On
COVID-19 pandemic and the related economic impacts, the Company drew the maximum
amount available on the credit line in an amount equal to
amount 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
31, 2020
ratio and leverage covenants. At
with a covenant of the line of credit that requires the Company to have
million
amortization (“EBITDA”) for the trailing twelve months ended
result of COVID-19, the Company failed to meet the amount of EBITDA required by
this covenant. On
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
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
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.
PPP Loan
On
and Promissory Notes (collectively, the “SBA Loans”) with
pursuant to the Paycheck Protection Program (the “PPP”) under the recently
enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”)
administered by the
total proceeds of
to mature on
subject to the terms and conditions applicable to loans administered by the
Small Business Administration
by the Company at any time prior to maturity with no prepayment penalties.
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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
eight-week 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 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 primarily for
payroll costs. No assurance can be given that the Company will be granted
forgiveness of the SBA Loans in whole or in part.
Off-Balance Sheet Arrangements
Purchase obligations: As of
approximately
contractual obligations for future purchases of commodities for use in our
manufacturing.
Impact of Inflation
Inflationary factors such as increases in the costs of ingredients and labor
directly affect our operations. Most of our leases provide for cost-of-living
adjustments and require us to pay taxes, insurance and maintenance expenses, all
of which are subject to inflation. Additionally, our future lease costs for new
facilities may include potentially escalating costs of real estate and
construction. There is no assurance that we will be able to pass on increased
costs to our customers.
Depreciation expense is based on the historical cost to us of fixed assets, and
is therefore potentially less than it would be if it were based on current
replacement cost. While property and equipment acquired in prior years will
ultimately have to be replaced at higher prices, it is expected that replacement
will be a gradual process over many years.
Seasonality
We are subject to seasonal fluctuations in sales, which cause fluctuations in
quarterly results of operations. Historically, the strongest sales of our
products have occurred during key holidays and the summer vacation season. In
addition, quarterly results have been, and in the future are likely to be,
affected by the timing of new store openings and sales of franchises. Because of
the seasonality of our business and the impact of new store openings and sales
of franchises, results for any quarter are not necessarily indicative of results
that may be achieved in other quarters or for a full fiscal year.
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