What changed in Rocky Mountain Chocolate Factory, Inc.'s 10-K — 2023 vs 2024

Item 1. Legal Proceedings We are not aware of any pending legal actions that would, if determined adversely to us, have a material adverse effect on our business and operations. We may, from time to time, become involved in disputes and proceedings arising in the ordinary course of business.

In addition, as a public company, we are also potentially susceptible to litigation, such as asserting violations of 24 Table of Contents securities laws. Any such claims, with or without merit, if not resolved, could be time-consuming and result in costly litigation.

There can be no assurance that an adverse result in any future proceeding would not have a potentially material adverse effect on our business, results of operations, and financial condition. ITE M 4. MINE SAFETY DISCLOSURES Not Applicable. 25 Table of Contents PA RT II.

Unregistered sales of equity securities In connection with the appointment of Scott Ouellet as Senior Vice President, Manufacturing and Supply Chain, the Compensation Committee of the Board of Directors approved an inducement award, in accordance with Nasdaq Listing Rule 5635(c)(4), to Mr. Ouellet, granted on September 18, 2023, consisting of an aggregate of 19,591 restricted stock units ("RSUs”).

The RSUs were granted as an inducement material to Mr. Ouellet’s acceptance of employment as Senior Vice President, Manufacturing and Supply Chain, and were granted outside of the Company’s 2007 Equity Incentive Plan (as amended and restated).

The issuance of the above securities was deemed to be exempt from registration under the Securities Act in reliance upon Section 4(a)(2) of the Securities Act as a transaction by an issuer not involving any public offering. ITEM 6. RESERVED 26 Table of Contents ITEM 7.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Management ’ s Discussion and Analysis of Financial Condition and Results of Operations (this “ MD&A ” ) is intended to assist in an understanding of our financial condition and should be read in conjunction with our Consolidated Financial Statements and accompanying Notes included in Item 8 of this Annual Report.

The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs, and involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed elsewhere in this Annual Report, particularly in Item 1A.

“ Risk Factors. ” Overview Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, and its subsidiaries (including its operating subsidiary with the same name, Rocky Mountain Chocolate Factory, Inc., a Colorado corporation (“RMCF”) (referred to as the “Company,” “we,” “us,” or “our”) is an international franchisor, confectionery producer and retail operator.

Founded in 1981, we are headquartered in Durango, Colorado and produce an extensive line of premium chocolate products and other confectionery products (“Durango Products”). Our revenues and profitability are derived principally from our franchised/licensed system of retail stores that feature chocolate and other confectionary products including gourmet caramel apples.

We also sell our confectionary products in select locations outside of our system of retail stores and license the use of our brand with certain consumer products. As of February 29, 2024, there was 2 Company-owned, 115 licensee-owned and 152 franchised Rocky Mountain Chocolate Factory stores operating in 36 states and the Philippines.

Recent Developments On November 10, 2023, our board of directors adopted stock ownership guidelines for our non-employee directors and executive officers.

Under the guidelines, non-employee directors are required to own certain eligible securities (“Eligible Shares”) of the Company worth three (3) times the cash portion of their annual directors’ base fees paid in cash, not including any retainers for service as the Board Chair or as a Board Committee Chair.

Our Chief Executive Officer is required to own Eligible Shares worth three (3) times their base salary. Other executive officers of the Company are required to own Eligible Shares worth one (1) times their base salary. Non-employee directors elected prior to November 16, 2021 will have five (5) years from November 16, 2021 to meet the holding requirements.

Non-employee directors elected after November 16, 2021 and up to November 10, 2023, will have five (5) years from the date of his or her election to meet the holding requirements. Executive officers serving as of November 10, 2023 will have five (5) years from that date to meet the minimum ownership requirement.

All directors and executive officers who are elected or appointed after November 10, 2023 will have five (5) years from the time they are elected or appointed to meet the minimum ownership requirement.

On May 1, 2023, subsequent to the end of FY 2023, the Company completed the sale of substantially all of the assets of its wholly-owned subsidiary and frozen yogurt business, U-Swirl International, Inc. The aggregate sale price of U-Swirl was $2.75 million, consisting of (i) $1.75 million in cash and (ii) $1.0 million evidenced by a three-year secured promissory note.

The business divestiture of the U-Swirl segment was preceded by a separate sale of the Company’s three owned U-Swirl locations on February 24, 2023. The consolidated financial statements present the historical financial results of the former U-Swirl segment as discontinued operations for all periods presented.

See Note 17 of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data“, of this Annual Report for information on this divestiture.

With the sale of U-Swirl, we continue to focus on our confectionery business to further enhance our competitive position and operating margin, simplify our business model, and deliver sustainable value to our stockholders.

Current Trends Affecting Our Business and Outlook As a result of recent macroeconomic 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 27 Table of Contents 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 production facility, or if we or our franchisees experience delays in stocking our products.

During FY 2023, the Company incurred substantial costs associated with a stockholder’s contested solicitation of proxies in connection with our 2022 annual meeting of stockholders. During FY 2023, the Company incurred approximately $4.1 million of costs associated with the contested solicitation of proxies, however there were no such comparable costs in FY 2024.

The Company also incurred $1.2 million of severance and retirement related costs for certain of our executives in FY 2024, compared to $1.1 million in FY 2023.

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. 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.

The most important factors in continued growth in our earnings are our ability to increase the sales of premium chocolate products produced in our Durango production facility, the ability to produce more efficiently, supporting our franchisees in increasing the frequency and average value of customer transactions, ongoing online revenue growth, and franchise store growth.

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 our production facility by franchised stores and to increase total Durango production depend on many factors, including new store openings, competition, the receptivity of our franchise system to our product introductions and promotional programs.

Results of Continuing Operations Fiscal 2024 Compared To Fiscal 2023 Results Summary Basic loss per share decreased from a loss from continuing operations of $(0.88) per share in FY 2023 to a loss from continuing operations of $(0.77) per share in FY 2024. Revenues decreased by 8.2% from $30.4 million for FY 2023 to $28.0 million for FY 2024.

Operating loss was $4.9 million in FY 2023 compared to an operating loss of $4.9 million in FY 2024. Loss from continuing operations decreased from a loss of $5.5 million in FY 2023 to a loss of $4.9 million in FY 2024.

REVENUES For the Year Ended February 29 or 28, $ % ($'s in thousands) 2024 2023 Change Change Durango product and retail sales $ 22,022.3 $ 24,456.9 (2,434.6 ) (10.0 )% Franchise fees 167.8 204.7 (36.9 ) (18.0 )% Royalty and marketing fees 5,760.6 5,770.8 (10.2 ) (0.2 )% Total $ 27,950.7 $ 30,432.4 $ (2,481.7 ) (8.2 )% Durango Product and Retail Sales The decrease in total sales for FY 2024 compared to FY 2023 was primarily due to a 10%, or $2.4 million, decrease in sales of product to our network of franchised and licensed retail stores resulting from disruptions in our consumer 28 Table of Contents packaged product availability to our franchise system due to a relocation of our packaging line to Salt Lake City, Utah in October as part of our plan to address labor shortages in the Durango area In FY 2024, same store pounds purchased by franchisees and licensees declined slightly compared to the prior fiscal year.

We continue to add new products and focus our existing product lines in an effort to increase same store pounds purchased by existing locations. Royalties, Marketing Fees and Franchise Fees Royalty and marketing fees were approximately unchanged during FY 2024 compared to FY 2023.

The slight decrease in franchise fee revenue during FY 2024 compared to FY 2023 was primarily the result of store closures offset by the acceleration of unrecognized franchise fee revenue.

COSTS AND EXPENSES Cost of Sales For the Year Ended February 29 or 28, $ % ($'s in thousands) 2024 2023 Change Change Total cost of sales $ 20,655.6 $ 20,455.4 $ 200.2 1.0 % Franchise costs 2,582.4 1,825.8 756.6 41.4 % Sales and marketing 2,131.7 2,060.2 71.5 3.5 % General and administrative 6,673.9 10,325.7 (3,651.8 ) (35.4 )% Retail operating 671.5 537.5 134.0 24.9 % Total $ 32,715.1 $ 35,204.6 $ (2,489.5 ) (7.1 )% Gross Margin For the Year Ended February 29 or 28, $ % ($'s in thousands) 2024 2023 Change Change Total gross margin $ 1,366.7 $ 4,001.5 $ (2,634.8 ) (65.8 )% Gross margin percentage 6.2 % 16.4 % (10.2 )% (62.1 )% Adjusted Gross Margin For the Year Ended (a non-GAAP measure) February 29 or 28, $ % ($'s in thousands) 2024 2023 Change Change Total gross margin $ 1,366.7 $ 4,001.5 $ (2,634.8 ) (65.8 )% Plus: depreciation and amortization 749.6 646.4 $ 103.2 16.0 % Total Adjusted Gross Margin (non-GAAP measure) $ 2,116.3 $ 4,647.9 $ (2,531.6 ) (54.5 )% Total Adjusted Gross Margin (non-GAAP measure) 9.6 % 19.0 % (9.4 )% (49.4 )% Non-GAAP Measures In addition to the results provided in accordance with U.S.

GAAP, we provide certain non-GAAP measures, which present results on an adjusted basis. These are supplemental measures of performance that are not required by or presented in accordance with U.S. GAAP. Adjusted gross margin is a non-GAAP measure. Adjusted gross margin is equal to the sum of our total gross margin plus depreciation and amortization calculated in accordance with GAAP.

We believe adjusted gross margin is helpful in understanding our past performance as a supplement to gross margin, and other performance measures calculated in conformity with GAAP. We believe that adjusted gross margin is 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 rather than gross margin to make incremental pricing decisions. Adjusted gross margin has 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 29 Table of Contents element of our costs and our ability to generate income. Due to these limitations, we use adjusted gross margin as measures of performance only in conjunction with GAAP measures of performance such as gross margin.

Cost of Sales and Gross Margin Total gross margin decreased to 6.2% in FY 2024 compared to a gross margin of 16.4% during FY 2023, due primarily to an increase in overhead costs, a sharp increase in the cost of cocoa as a raw material as well as other inflationary pressures we were unable to capture through price increases, and a reduction in production volume.

Additionally, production volume decreased and expense incurred increased as a result of the Company undertaking actions to relocated its consumer packaging operations to Salt Lake City, Utah in response to limited labor ability in the Durango labor pool, which lead to delays in order fulfillment going into our busy holiday sales season.

Franchise Costs The increase in franchise costs in FY 2024 compared to FY 2023 was due primarily to investments in human capital and the ongoing brand update and store redesign expense. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increased to 43.6% in FY 2024 from 30.6% in FY 2023.

This increase as a percentage of royalty, marketing and franchise fees is primarily a result of higher royalty fees partially offset by higher costs.

Sales and Marketing The increase in sales and marketing costs during FY 2024 compared to FY 2023 was due primarily to an increase in equity compensation costs and contract labor associated with the retirement of our former Senior Vice President of Sales and Marketing, and an increase in advertising costs.

General and Administrative The decrease in general and administrative costs during FY 2024, compared to FY 2023, was due primarily to costs associated with a stockholder’s contested solicitation of proxies in connection with our 2023 annual meeting of stockholders.

During FY 2024, the Company did not incur material costs associated with the contested solicitation of proxies, compared with $4.1 million of costs associated with a contested solicitation of proxies during FY 2023.

The Company also incurred increased professional fees related to legal support for our Board of Directors and legal costs associated with compensation agreements for our former Chief Executive Officer and Chief Financial Officer and legal and professional costs associated with the search for, and appointment of, a new Chief Executive Officer and a new Chief Financial Officer.

Additionally, due to a stockholder's contested solicitation of proxies in connection with our 2021 annual meeting of stockholders, the Company had become contingently liable for certain change in control severance payments to our former Senior Vice President of Sales and Marketing if a triggering termination was to occur.

As a result of our former Senior Vice President of Sales and Marketing's retirement in September 2022, the Company incurred $1.1 million of associated severance costs. As a percentage of total revenues, general and administrative expenses decreased to 23.9% during FY 2024, compared to 33.9% during FY 2023.

Retail Operating Expenses Retail operating expenses increased 24.9% during FY 2024 compared to FY 2023. This increase is primarily the result of the Company's new Corpus Christi, TX location. In November 2022 we sold a Company-owned store located in Peoria, Illinois, to a franchisee. The result is that as of February 29, 2024, we operated two Company-owned locations.

Depreciation and Amortization Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales was $0.1 million during FY 2024, relatively unchanged from $0.1 million during FY 2023. Depreciation and amortization included in cost of sales increased 16.0% from $0.6 million during FY 2023 to $0.7 million during FY 2024.

This increase was the result of investment in production equipment. Other Income (Expense) 30 Table of Contents Other income was $26,400 during FY 2024, compared to other income of $16,500 during FY 2023.

This represents interest income of $79,836 during FY 2024 compared to $26,921 during FY 2023, and interest expense of $53,397 during FY 2024 compared to $10,431 during FY 2023.

Income Tax Expense During FY 2024, we did not incur any income tax expense on a loss from continuing operations before income taxes of $4.9 million compared to an income tax expense of $0.6 million on a loss from continuing operations before income taxes of $4.9 million during FY 2023.

The FY 2023 expense was the result of recording a full valuation allowance on our deferred income tax assets. See Note 13 to the financial statements for a description of income taxes, deferred tax assets, and associated reserves.

Liquidity and Capital Resources As of February 29, 2024, working capital was $1.5 million compared with $6.2 million as of February 28, 2023.

The decrease in working capital was due primarily to a strategic reduction of inventory on hand commensurate with the current product assortments actively marketed by us and our franchisees, and continued capital investment in the Durango production facility. We have historically generated excess operating cash flow.

Cash and cash equivalent balances decreased from $4.7 million as of February 28, 2023 to $2.1 million as of February 29, 2024 primarily as a result of cash used by operating and investing activities. Our current ratio was 1.19 to 1.0 on February 29, 2024 compared to 2.24 to 1.0 on February 28, 2023.

We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements. During FY 2024, we had a consolidated net loss of $4.2 million, less net loss from discontinued operations of $0.7 million.

Operating activities used cash of $2.4 million, with the principal adjustment to reconcile net income to net cash provided by operating activities being depreciation and amortization of $0.9 million, provision for obsolete inventory of $0.2 million and stock compensation expense of $0.4 million. During FY 2023, we had a consolidated net loss of $5.7 million.

Operating activities used cash of $2.1 million, with the principal adjustment to reconcile net income to net cash provided by operating activities being expense associated with establishing a full reserve of deferred tax assets of $0.7 million, depreciation and amortization of $0.8 million, provision for obsolete inventory of $0.7 million and stock compensation expense of $0.7 million.

During FY 2024, investing activities used cash of $1.45 million, primarily due to the purchases of property and equipment of $3.0 million, partially offset by investing cash flow from discontinued operations (the result of the sale of U-Swirl assets) of $1.4 million.

In comparison, investing activities used cash of $0.8 million during FY 2023 primarily due to the purchases of property and equipment of $1.0 million, partially offset by investing cash flow from discontinued operations of $0.2 million. There were $1.25 million cash flows from financing activities during FY 2024 compared to no cash flows from financing activities during the prior year.

The Company drew down $1.25 million on its revolving line of credit during FY 2024 as discussed further below. The conditions above raise substantial doubt regarding our ability to continue as a going concern for a period of at least one year from the date of issuance of these financial statements.

In addition, our independent registered public accounting firm, in their report on the Company’s February 29, 2024, audited financial statements, raised substantial doubt about the Company’s ability to continue as a going concern. Revolving Line of Credit Pursuant to a credit agreement, as amended (the “Credit Agreement”), with Wells Fargo Bank N.A.

(the “Lender”), we have a $4.0 million credit line for general corporate and working capital purposes, of which $2.75 million was available for borrowing (subject to certain borrowing-based limitations) as of February 29, 2024 (the “Credit Line”). The Credit Line is secured by substantially all of our assets, except retail store assets.

Interest on borrowings is at the Secured Overnight Financing Rate plus 2.37% (7.69% at February 29, 2024 and 6.92% at February 28, 2023). Additionally, the Credit Line is subject to various financial ratio and leverage covenants.

Per the Credit Agreement, the maturity date is September 30, 2024. 31 Table of Contents As of February 29, 2024 we were not in compliance with the requirement under the Credit Agreement to maintain a ratio of total current assets to total current liabilities of at least 1.5 to 1.

Our current ratio as of February 29, 2024 was 1.19 to 1. We have requested a waiver from the Lender and received approval as of the date of this Annual Report. We were in compliance, however, with all other aspects of the Credit Agreement.

As a result of our noncompliance, under the terms of the Credit Agreement, the Lender has the option, but not the obligation, to immediately demand repayment of all funds drawn down under the Credit Line.

As of the date of this Annual Report, we do not have enough cash on hand to satisfy our obligations under the Credit Line if the Lender exercised its option to demand repayment.

If the Lender exercises its option and demands repayment at some time in the future, however, we may not have sufficient funds available to make the payments required. If we are unable to repay amounts owed, the Lender may be entitled to foreclose on and sell substantially all of our assets, which secure our borrowings under the Credit Agreement.

In addition, the Lender retains the right to act on covenant violations that occur after the date of delivery of any waiver.

If the Lender were to decline to grant us a waiver and instead demand repayment in the future, we may need to seek alternative financing to pay these obligations as the Company may not have sufficient facilities or sufficient cash on hand at that time to satisfy these obligations.

The Company is exploring various means of strengthening its liquidity position and ensuring compliance with its debt financing covenants, which may include the obtaining of waivers from the Lender and/or amending our Credit Line facility. We are also exploring supplemental debt facilities for other operational activities which could give us the ability to repay the Credit Line as needed.

Contractual Obligations The table below presents significant contractual obligations of the Company at February 29, 2024.

(Amounts in thousands) Contractual Obligations Total Less than 1 year 2-3 Years 4-5 years More Than 5 years Operating leases $ 1,874,640 $ 514,169 $ 781,133 $ 238,208 $ 341,130 Purchase contracts 269,808 269,808 - - - Total $ 2,144,448 $ 783,977 $ 781,133 $ 238,208 $ 341,130 The Company made an average of $1.7 million per year in capital expenditures during FY 2022 to FY 2024.

For FY 2025 the Company anticipates making similar levels of capital expenditures. The planned increase is the result of expected investment in an updated Enterprise Resource Planning (ERP) management system, and machinery and equipment to replace equipment that has reached the end of its useful life.