Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
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 February 29, 2020. Additional factors that 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 Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, and its consolidated subsidiaries (including its operating subsidiary with the same name, Rocky Mountain Chocolate Factory, Inc., a Colorado corporation (“RMCF”)).
Overview
We are an international franchisor, confectionery manufacturer and retail operator. Founded in 1981, we are headquartered in Durango, Colorado and 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 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 May 31, 2020, there were two Company-owned, 98 licensee-owned and 232 franchised Rocky Mountain Chocolate Factory stores operating in 37 states, Canada, South Korea, the republic of Panama, and the Philippines. As of May 31, 2020, U-Swirl operated three Company-owned cafés and 83 franchised cafés located in 25 states and Qatar. U-Swirl operates self-serve frozen yogurt cafés under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!” and “Aspen Leaf Yogurt”.
Strategic Alliance with Edible Arrangements
On December 20, 2019, the Company entered into a strategic alliance (the “Strategic Alliance”) with Edible Arrangements, LLC (“EA”) and Farids & Co. LLC (“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 Strategic Alliance, the Company entered into a strategic alliance agreement, an exclusive supplier operating agreement and a warrant agreement with Edible. In addition, on March 7, 2020, the Company 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.
Bankruptcy of FTD Companies
In June 2019, the Company’s largest customer, FTD Companies, Inc. and its domestic subsidiaries (“FTD”), filed for Chapter 11 bankruptcy proceedings. As a part of such bankruptcy proceedings, divisions of FTD’s business and certain related assets, including the divisions that the Company has historically sold product to, were sold through the auction to multiple buyers. The Company is uncertain if accounts receivable and inventory balances associated with FTD at May 31, 2020 will be realized at their full value, or if any revenue will be received from FTD in the future. 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 May 31, 2020 (this “Quarterly Report”), we have experienced significant business disruptions resulting from efforts to contain the rapid spread of the novel coronavirus (COVID-19), including the vast mandated self-quarantines and closures of non-essential business throughout the United States and internationally. Nearly all of the Company-owned and franchise stores have been directly and negatively impacted by public health measures taken in response to COVID-19, with nearly all locations experiencing reduced operations as a result of, among other things, modified business hours and store and mall closures. As a result, franchisees and licensees are not ordering products for their stores in line with historical amounts. This trend has negatively impacted, and is expected to continue to negatively impact, among other things, factory sales, retail sales and royalty and marketing fees. Beginning in May 2020 most stores previously closed for much of March 2020 and April 2020 in response to COVID-19 began to re-open. Most stores re-opened subject to various local health restrictions and reduced operations. It is unclear when or if store operations will return to pre COVID-19 levels.
In addition, as previously announced on May 11, 2020, the Board of Directors decided to suspend the Company’s first quarter cash dividend payment to preserve cash and provide additional flexibility in the current environment impacted by the COVID-19 pandemic. Furthermore, the Board of Directors has suspended future quarterly dividends until the significant uncertainty of the current public health crisis and economic climate has passed, and the Board of Directors determines that resumption of dividend payments is in the best interest of us and our stockholders.
During this challenging time, the Company’s foremost priority is the safety and well-being of our employees, customers, franchisees and communities. In addition to the already stringent practices for the quality and safety of the Company’s confections, the Company is diligently following health and safety guidance issued by the World Health Organization, the Centers for Disease Control and state and local governmental agencies. COVID-19 has had an unprecedented impact on the retail industry as containment measures continue to impact the Company’s operations and the retail industry. Numerous countries, states and local governments have effected ordinances to protect the public through social distancing, which has caused, and we expect will continue to cause, a significant decrease in, among other things, retail traffic and as a result, factory sales, retail sales and royalty and marketing fees. With that said, Rocky Mountain Chocolate Factory products remain available for sale online. The Company’s current focus is on supporting its franchisees and licensees during this challenging time and driving growth in online sales, especially in light of the ecommerce licensing agreement with Edible, as discussed below, while also sensibly managing costs. The number of Company-owned and franchise stores remaining open may change frequently and significantly due to the ever-changing nature of the COVID-19 outbreak.
In these challenging and unprecedented times, management is taking all necessary and appropriate action to maximize liquidity as the Company navigates the current landscape. These actions include significantly reducing operating expenses and production volume to reflect reduced sales volumes as well as the elimination of all non-essential spending and capital expenditures. Further, in an abundance of caution and to maintain ample financial flexibility, the Company drew down the full amount under our line of credit and the Company received 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 May 29, 2020 with the United States Securities and Exchange Commission.
Results of Operations
Three Months Ended May 31, 2020 Compared to the Three Months Ended May 31, 2019
Results Summary
Basic earnings per share decreased from $0.12 per share for the three months ended May 31, 2019 to a net loss of $(0.61) per share for the three months ended May 31, 2020. Revenues decreased 67.9% from $8.43 million for the three months ended May 31, 2019 to $2.70 million for the three months ended May 31, 2020. Operating income decreased from $946,000 for the three months ended May 31, 2019 to an operating loss of $(4.83) million for the three months ended May 31, 2020. Net income decreased from $712,000 for the three months ended May 31, 2019 to a net loss of $(3.67) million for the three months ended May 31, 2020. The decrease in revenue, operating income and net income was due primarily to the impacts from the COVID-19 pandemic, including its impact on our operation and the operations of our franchised, licensed and Company-owned locations.
Revenues
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
($'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 May 31, 2020 compared to the three months ended May 31, 2019 was primarily due to a 73.6% decrease in 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 May 31, 2020 were approximately $144,000, or 5.3% of the Company’s revenues, compared to $1.4 million, or 16.3% of the Company’s revenues during the three months ended May 31, 2019 for this same customer. As discussed above, FTD declared Chapter 11 bankruptcy in June 2019. Until the bankruptcy 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 May 31, 2020, which significantly reduced traffic in our stores. These decreases 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 May 2020 most stores previously closed for much of March 2020 and April 2020, in response to COVID-19, began to re-open. Most stores re-opened subject to various local health restrictions and reduced operations. It is unclear when or if store operations will return to pre COVID-19 levels.
Retail Sales
Retail sales at Company-owned stores decreased for the three months ended May 31, 2020 compared to the three months ended May 31, 2019 as a result of the closure of all of our Company-owned stores for much of the three months ended May 31, 2020. The closure of our Company-owned stores was the result of the COVID-19 pandemic and the associated public health measures in place during the three months ended May 31, 2020. As of May 31, 2020 all but one Company-owned 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 May 31, 2020 compared to the three months ended May 31, 2019 was primarily due to the COVID-19 pandemic and the associated public health measures in place during the three months ended May 31, 2020. Nearly all of our franchised locations experienced reduced operations and periods of full closure during the three months ended May 31, 2020.
The decrease in franchise fees for the three months ended May 31, 2020 compared to the three months ended May 31, 2019 was the result of a decrease in revenue 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
|
%
|
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 May 31, 2020 compared to positive gross margin of 25.4% during the three months ended May 31, 2019, due primarily to lower production volume in the three months ended May 31, 2020 compared to the three months ended May 31, 2019. During the three monthd ended May 31, 2020, production volume decreased 56.7% in 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 May 31, 2020. During the three months ended May 31, 2020 the Company incurred approximately $280,000 of 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 66.3% during the three months ended May 31, 2019 to 50.6% during the three months ended May 31, 2020. The decrease in retail gross margins was primarily the result of the temporary closure of all of our Company-owned stores for much of the three months ended May 31, 2020 due to the COVID-19 pandemic, and the associated impact on perishable inventory.
Franchise Costs
The decrease in franchise costs in the three months ended May 31, 2020 compared to the three months ended May 31, 2019 was due primarily to lower travel costs, 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 May 31, 2020 from 24.6% in the three months ended May 31, 2019. This increase as a percentage of royalty, marketing and 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 May 31, 2020 compared to the three months ended May 31, 2019 was primarily due to lower 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 May 31, 2020 compared to the three months ended May 31, 2019 was due primarily to an 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 May 31, 2020 compared to 13.6% in the three months ended May 31, 2019. Bad debt expense was primarily the result of management’s assessment of the likelihood of collecting accounts and notes receivable as of May 31, 2020. As a result of this assessment total allowances for potentially uncollectable accounts and notes receivable increased to $2,108,912 at May 31, 2020, compared to $557,916 at February 29, 2020. This cost was a direct result of public health measures in 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 May 31, 2020 compared to the three months ended May 31, 2019 was due to the temporary closure of all of our Company-owned stores for much of the three months ended May 31, 2020. The closure of our Company-owned stores was the result of COVID-19 and the associated public health measures in place during the three months ended May 31, 2020.
Depreciation and Amortization
Depreciation and amortization, exclusive of depreciation and amortization included in cost of sales, was $186,000 in the three months ended May 31, 2020, a decrease of 20.0% from $232,000 incurred in the three months ended May 31, 2019. 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 increased 8.1% from $145,700 in the three months ended May 31, 2019 to $157,500 in the three months ended May 31, 2020. This increase was the result of an increase in production assets in service.
Other Income (Expense)
Net interest expense was $17,800 in the three months ended May 31, 2020 compared to net interest expense of $2,200 during the three months ended May 31, 2019. 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, 2020 to ensure adequate liquidity during the COVID-19 pandemic. During the three months ended May 31, 2020, the Company borrowed $3.4 million from its line of credit and borrowed $1.5 million of loans under the Paychecks Protection Program.
Income Tax Expense
Our effective income tax rate was 24.3% for the three months ended May 31, 2020 and was 24.6% for the three months ended May 31, 2019.
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 May 31, 2020, working capital was $5.1 million, compared to $8.0 million as of February 29, 2020, a decrease of $2.9 million. The decrease in working 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 $2.6 million from $4.8 million as of February 29, 2020 to $7.4 million as of May 31, 2020, primarily as a result of 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 May 31, 2020 compared to 2.4 to 1 at February 29, 2020. We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, financing and investing requirements.
During the three months ended May 31, 2020, operating activities used cash of $1,598,042, primarily the result of operating results, the provision for loss on accounts and notes receivable of $1,468,815, asset impairment and store closure losses of $544,060, depreciation and amortization of $343,115, an increase in accounts payble of $680,748 and expense related to stock-based compensation of $143,718. During the three months ended May 31, 2019, operating activities provided cash of $1,828,109, primarily the result of operating results, depreciation and amortization of $377,654, a decrease in inventories of $344,058 and expense related to stock-based compensation of $231,254.
For the three months ended May 31, 2020, investing activities used cash of $46,127, primarily due to the purchases of property and equipment and intangible assets of $63,952. In comparison, investing activities used cash of $254,836 during the three months ended May 31, 2019, primarily due to the purchase of property and equipment of $283,548.
Financing activities provided cash of $4,236,021 for the three months ended May 31, 2020, primarily as a as a result of the use of the line of credit and receipt of loans under the Paycheck Protection Program, as described below. In comparison, financing activitied used cash of $1,061,726 during the three months ended May 31, 2019, primarily due to dividend payments and payments on debt during the three months ended May 31, 2019.
Revolving Credit Line
The Company has a $5.0 million credit line for general corporate and working capital purposes. On March 16, 2020, as a precautionary measure in light of the COVID-19 pandemic and the related economic impacts, the Company drew the maximum amount available on the credit line in an amount equal to $3.4 million (the full amount of $5.0 million under the credit line, subject to the borrowing base of 50% of eligible accounts receivable plus 50% of eligible inventories). The credit line is secured by substantially all of the Company’s assets, except retail store assets. Interest on borrowings is at LIBOR plus 2.25% (2.4% at May 31, 2020). Additionally, the line of credit is subject to various financial ratio and leverage covenants. At May 31, 2020, the Company was not compliant with a covenant of the line of credit that requires the Company to have $1.5 million of adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the trailing twelve months ended May 31, 2020. As a result of COVID-19, the Company failed to meet the amount of EBITDA required by this covenant. On June 26, 2020 Wells Fargo Bank, NA (“Wells Fargo”) delivered to the Company a Reservation of Rights Letter (“Bank Letter”). The Bank Letter reserved all rights available to Wells Fargo under the Credit Agreement dated October 30, 2015 including, but not limited to, the right of Wells Fargo to demand immediate payment of all amounts outstanding under the Credit Agreement. The letter also placed restrictions on the Company’s ability to draw any further funds on the Line of Credit. The Company intends to work with Wells Fargo to amend the associated covenants as the trends related to COVID-19 begin become clear. There is no assurance that Wells Fargo will agree to any proposed amendment. The credit line is subject to renewal in September 2021 and the Company believes it is likely to be renewed on terms similar to the current terms, subject to the Company’s recovery from the impacts of COVID-19.
PPP Loan
On April 13, 2020 and April 20, 2020, the Company entered into a Loan Agreements and Promissory Notes (collectively, the “SBA Loans”) with 1st SOURCE BANK pursuant 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 million from the SBA Loans. The SBA Loans are scheduled to mature on April 14 and April 20, 2022 and have a 1.00% interest rate and are subject to the terms and conditions applicable to loans administered by the U.S. Small Business Administration under the CARES Act. The SBA Loan may be prepaid by the Company at any time prior to maturity with no prepayment penalties.
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 May 31, 2020, we had purchase obligations of approximately $227,000. These purchase obligations primarily consist of 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.