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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended February 28, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-14749
Rocky Mountain Chocolate Factory, Inc.
(Exact name of registrant as specified in its charter)
Colorado 84-0910696
(State of Incorporation) (I.R.S. Employer Identification No.)
265 Turner Drive, Durango, CO 81301
(Address of principal executive offices)
(970) 259-0554
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT
Common Stock, $.03 par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
On May 29, 1998, there were 2,591,449 shares of Common Stock outstanding. The
aggregate market value of the Common Stock (based on the average of the closing
bid and asked prices as quoted on the NASDAQ National Market System on May 29,
1998) held by non-affiliates was $14,404,142.
Documents incorporated by reference: None
The Exhibit Index is located on page 55.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
FORM 10-K
TABLE OF CONTENTS
Page No.
PART I.
Item 1 Business 3
Item 2 Properties 15
Item 3 Legal Proceedings 16
Item 4 Submission of Matters to a Vote of Security Holders 16
PART II.
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters 16
Item 6 Selected Financial Data 17
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
Item 8 Financial Statements 26
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 44
PART III.
Item 10 Directors and Executive Officers of the Registrant 44
Item 11 Executive Compensation 47
Item 12 Security Ownership of Certain Beneficial Owners and 49
Management
Item 13 Certain Relationships and Related Transactions 50
PART IV.
Item 14 Exhibits, Financial Statement Schedules and Reports on
Form 8-K 50
SIGNATURES 54
PART I.
ITEM 1. BUSINESS
General
Founded in 1981 and incorporated in Colorado in 1982, Rocky Mountain Chocolate
Factory, Inc. (the "Company") is a manufacturer, international franchiser and
retail operator. The Company is headquartered in Durango, Colorado and
manufactures an extensive line of premium chocolate candies and other
confectionery products. As of April 30, 1998 there were 37 Company-owned and
185 franchised Rocky Mountain Chocolate Factory stores operating in 43 states,
Canada and Guam. Additionally, the Company recently completed a master
franchise agreement to establish a number of Rocky Mountain Chocolate Factory
stores in Taiwan.
Approximately 40% of the products sold at the Company-owned and franchised Rocky
Mountain Chocolate Factory stores are prepared on the premises. The Company
believes this in-store preparation creates a special store ambiance and the
aroma and sight of products being made attracts foot traffic and assures
customers that products are indeed fresh.
The Company believes that its principal competitive strengths lie in its name
recognition, its reputation for the quality, variety and the taste of its
products; the special ambiance of its stores; its knowledge and experience in
applying criteria for selection of new store locations; its expertise in the
manufacture of chocolate candy products and the merchandising and marketing of
chocolate and other candy products; and the control and training infrastructures
it has implemented to assure consistent customer service and execution of
successful practices and techniques at its franchised and Company-owned stores.
The Company believes its manufacturing expertise and reputation for quality has
facilitated the sale of selected product through new distribution channels. The
Company is currently testing and evaluating a number of alternative distribution
channel programs including wholesaling to major national retailers, fundraising,
corporate sales, mail order and direct response advertising.
The Company's revenues are currently derived from three principal sources: (i)
sales to franchisees and others of chocolates and other confectionery products
manufactured by the Company (43-41-44%); (ii) sales at Company-owned stores of
chocolates and other confectionery products (including product manufactured by
the Company) (44-47-42%) and (iii) the collection of initial franchise fees and
royalties from franchisees (13-12-14%). The figures in parentheses show the
percentage of total revenues attributable to each source for fiscal years ended
February 28 or 29, 1998, 1997 and 1996, respectively.
According to the National Confectionery Association the total U.S. candy market
exceeded $21.1 billion of sales in 1996. Candy sales have risen 29% since 1988,
with an average annual growth rate of between 4% and 6%, according to United
States Department of Commerce figures. According to the Department of Commerce,
per capita consumption of chocolate exceeds 11 pounds per year nationally,
generating annual
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sales of approximately $11.7 billion. Sales of chocolate products are expected
to grow at a rate of 3% to 4% annually, according to The Candy Market.
In December 1997, the Company decided its Fuzziwig's Candy Factory store segment
did not meet its strategic long-term goals, and accordingly, adopted a plan to
divest itself of these operations. The Company expects to complete the
divestiture on or about July 31, 1998. Fuzziwig's Candy Factory stores sell
hard conventional and nostalgic candies purchased from third party suppliers.
As of April 30, 1998 there were 10 Company-owned and 3 franchised Fuzziwig's
Candy Factory stores, which have been operating for periods ranging from
approximately three months to three years.
BUSINESS STRATEGY
The Company's objective is to build on its position as a leading international
franchiser, manufacturer of high quality chocolate and other confectionery
products, and operator of retail chocolate stores. The Company continually
seeks opportunities to profitably expand its business. To accomplish this
objective, the Company employs a business strategy that includes the following
elements:
Product Quality and Variety
The Company maintains the unsurpassed taste and quality of its chocolate candies
by using only the finest chocolate and other wholesome ingredients. The Company
uses its own proprietary recipes, primarily developed by its master candy maker.
A typical Rocky Mountain Chocolate Factory store offers up to 100 of the
Company's chocolate candies throughout the year and as many as 200, including
many packaged candies, during the holiday seasons. Individual stores also offer
several varieties of premium fudge and gourmet caramel apples, as well as other
products prepared in the store from Company recipes. The Company, in fiscal
1998, implemented a major program to improve factory sales through development
and sale of an expanded line of new products, including its own sugar-free line
and themed, branded and novelty chocolate candies.
Store Atmosphere and Ambiance
The Company seeks to establish an enjoyable and inviting atmosphere in each
Rocky Mountain Chocolate Factory store. Each store prepares certain products,
including fudge, brittles and caramel apples, in the store. In-store preparation
is designed both to be fun and entertaining for customers and to convey an image
of freshness and homemade quality. The special ambiance of Rocky Mountain
Chocolate Factory stores is also achieved through the use of distinctive decor
designed to give the store an attractive country Victorian look. The Company's
design staff has developed easily replicable designs and specifications to
ensure that the Rocky Mountain Chocolate Factory concept is consistently
implemented throughout the system.
Site Selection
Careful selection of a site is critical to the success of a Rocky Mountain
Chocolate Factory store. Many factors are considered by the Company in
identifying suitable sites, including tenant mix, visibility, attractiveness,
accessibility, level of foot traffic and occupancy costs. Final site selection,
for both franchised and Company-owned stores, occurs only after the Company's
senior management has approved the site. The Company believes that the
experience of its management team in evaluating a potential site is one of the
Company's competitive strengths.
Customer Service Commitment
The Company emphasizes excellence in customer service and seeks to employ and to
sell franchises to motivated and energetic people. The Company has implemented
sales incentive programs for the employees of Company-owned stores so that the
store personnel having direct contact with customers share in the success of
their stores. The Company also fosters enthusiasm for its customer service
philosophy and the Rocky Mountain Chocolate Factory concept through its annual
franchisee convention, annual regional meetings and other frequent contacts with
its franchisees and store managers.
4
Increase Same Store Retail Sales at Existing Locations
The Company seeks to increase profitability of its store system through
increasing sales at existing store locations. System wide same store retail
sales have grown each year for the last 5 fiscal years, except for fiscal 1997:
1994 1.3%
1995 3.4%
1996 2.9%
1997 (0.5%)
1998 7.4%
The Company feels that same store retail sales growth can be accelerated though
store redesign to provide a more attractive and effective retail sales
environment embodying more shelf space and accessibility/visibility of products
while retaining the Rocky Mountain Chocolate Factory store ambiance and theme.
The Company believes that development and sale of superior new products, such as
its new line of sugar-free products, will also prove to be conducive to the goal
of enhanced same store retail sales growth.
Increase Same Store Pounds Purchased by Existing Locations
In fiscal 1998, the Company experienced a same store pounds purchased decline of
1.7% versus a decline of 3.6% in fiscal 1997. The Company believes the
improvement in this trend resulted from implementation in fiscal 1998 of a
program designed to reverse this decline and to increase same store pounds
purchased from the factory through new product development and introduction, new
packaging development, active promotion of new and existing products and to
assess and assure enhanced customer service.
Enhanced Operating Efficiencies
The Company seeks to improve its profitability by controlling costs and
increasing the efficiency of its operations. Efforts in the last several years
include the purchase of additional automated factory equipment, implementation
of a comprehensive MRP II forecasting, planning, scheduling and reporting system
and the closure or sale of underperforming Company-owned stores. In the spring
of calendar year 1995, the Company completed a factory expansion and expanded
its operation of a small fleet of trucks for the shipment of its products. These
measures have significantly improved the Company's ability to deliver its
products to franchised and Company-owned stores safely, quickly and
cost-effectively.
EXPANSION STRATEGY
Key elements of the Company's expansion strategy include:
Alternative Distribution Channels
In fiscal 1998, the Company began aggressively pursuing distribution of its
products outside its franchised and Company-owned store system. With limited
viable real estate available domestically for the establishment of new franchise
and Company-owned store locations the Company believes a significant portion of
its revenue growth and profitability goals will be achieved through distribution
of products to major national retail, fundraising and corporate sales
organizations.
During the fourth quarter of fiscal 1998, a major pilot program was launched
with Sam's Club. Selected Company products are offered in approximately eighty
(80) Sam's Club locations throughout the United States. The Company's products
are merchandised on high quality and attractive carts to maintain the Company's
image as a premium chocolate manufacturer.
5
If the pilot is successful for the Company and Sam's Club, the Company expects
to expand distribution of its product into additional Sam's Club locations.
The Company believes that its strategy to distribute selected Rocky Mountain
Chocolate Factory products through alternative distribution channels such as
Sam's Club will build its brand awareness and customer base and ultimately
increase the Company's and its franchise partners' market share.
International Franchise Development
With the opening of a franchised store in Guam and the signing of a master
franchise agreement for Taiwan the Company has begun a planned process of
international expansion. In calendar 1998 the Company plans to deploy
additional resources towards developing a market internationally for Rocky
Mountain Chocolate Factory stores. In May 1998, the Company attended the
International Franchise Expo in Chicago, Illinois, and will attend two
additional shows in the fall of 1998. Attendance at these international events
strengthens and expands what the Company believes is a solid base of contacts in
the international franchise network. Presently the Company is in discussions
with a potential master franchisee for China and has received indications of
preliminary interest from potential European, Asian and South American
franchisees. Currently, the international agreements and activities described in
this paragraph are not material to the Company's operations or financial
position.
Army Air Force Exchange Services (AAFES)
The Company has received a commitment from AAFES to test two Company-owned Rocky
Mountain Chocolate Factory stores in two of its largest domestic bases.
Depending on the sales volume and profitability of these test stores, there may
be a unit growth opportunity in some of the approximately 160 bases both in the
United States and internationally. The Company anticipates that the two initial
test stores will be operational in mid-to-late summer of 1998.
Unit Growth for Rocky Mountain Chocolate Factory
The Company is experiencing constraints in the growth in the number of its Rocky
Mountain Chocolate Factory locations posed by a slowdown in the pace of
establishment of new factory outlet centers and availability of existing premium
locations in existing factory outlet and other environments where its concept
has proven successful. Despite such constraints, the Company is continuing to
seek locations in its traditional operating environments such as prime tourist
areas, regional malls, and mixed use and factory outlet centers. Additionally,
the Company will continue to purchase strategic premium locations from its
franchise system, as they become available, to convert to Company-owned stores.
High Traffic Environments
The Company currently establishes franchised and Company-owned stores in three
primary environments: factory outlet malls, tourist environments and regional
malls. The Company, over the last several years, has had a particular focus on
factory outlet mall locations. Although each of these environments has a number
of attractive features, including a high level of foot traffic, the factory
outlet mall environment has historically offered the best combination of tenant
mix, customer spending characteristics and favorable occupancy costs. The
Company has established a business relationship with the major outlet mall
developers in the United States and believes that these relationships provide it
with the opportunity to take advantage of attractive sites in new and existing
outlet malls.
6
Name Recognition and New Market Penetration
The Company believes the visibility of its stores and the high foot traffic at
its factory outlet mall and tourist locations has generated strong name
recognition of Rocky Mountain Chocolate Factory and demand for its franchises.
The Rocky Mountain Chocolate Factory system has historically been concentrated
in the western United States and the Rocky Mountains, but recent growth has
generated a gradual easterly momentum as new Company-owned and franchised stores
have been opened in the eastern half of the country. This growth has further
increased the Company's name recognition and demand for its franchises.
Distribution of Rocky Mountain Chocolate Factory products through new channels,
such as major national retail chains, also increases name recognition and brand
awareness in areas of the country in which the Company has not previously had a
significant presence. The Company believes that by distributing selected Rocky
Mountain Chocolate Factory products through alternative distribution channels
its name recognition will improve and benefit its entire franchised and
Company-owned store systems.
STORE CONCEPT
The Company seeks to establish a fun and inviting atmosphere in its Rocky
Mountain Chocolate Factory store locations.
Unlike most other confectionery stores, each Rocky Mountain Chocolate Factory
store prepares certain products, including fudge and caramel apples, in the
store. Customers can observe store personnel make fudge from start to finish,
including the mixing of ingredients in old-fashioned copper kettles and the
cooling of the fudge on large marble tables, and are often invited to sample the
store's products. The Company believes that an average of approximately 40% of
the revenues of Company-owned and franchised stores are generated by sales of
products prepared on the premises. The Company believes the in-store preparation
and aroma of its products enhance the ambiance at Rocky Mountain Chocolate
Factory stores, are fun and entertaining for its customers and convey an image
of freshness and homemade quality.
Rocky Mountain Chocolate Factory stores have a distinctive country Victorian
decor, which further enhances their friendly and enjoyable atmosphere. Each
store includes finely-crafted wood cabinetry, copper and brass accents, etched
mirrors and large marble tables on which fudge and other products are made. To
ensure that all stores conform to the Rocky Mountain Chocolate Factory image,
the Company's design staff provides working drawings and specifications and
approves the construction plans for each new franchised or Company-owned store.
The Company also controls the signage and building materials that may be used in
the stores.
The average store size is approximately 1,000 square feet, approximately 650
square feet of which is selling space. Most stores are open seven days a week.
Typical hours are 10 a.m. to 9 p.m., Monday through Saturday, and 12 noon to 6
p.m. on Sundays. Store hours in tourist areas may vary depending upon the
tourist season.
PRODUCTS AND PACKAGING
The Company typically produces approximately 250 chocolate candies and other
confectionery products, using proprietary recipes developed primarily by the
Company's master candy maker. These products include many varieties of clusters,
caramels, creams, mints and truffles. The Company continues to engage in a
major effort to expand its product line by developing additional exciting and
attractive new products. During the Christmas, Easter and Valentine's Day
holiday seasons, the Company may make as many as 200 additional items, including
many candies offered in packages specially designed for the holidays. A typical
Rocky Mountain Chocolate Factory store offers up
7
to 100 of these candies throughout the year and up to 200 during holiday
seasons. Individual stores also offer more than 15 premium fudges and other
products prepared in the store. The Company believes that approximately 50% of
the revenues of Rocky Mountain Chocolate Factory stores are generated by
products manufactured at the Company's factory, 40% by products made in the
store using Company recipes and ingredients purchased from the Company or
approved suppliers and the remaining 10% by products, such as ice cream, soft
drinks and other sundries, purchased from approved suppliers.
The Company uses only the finest chocolates, nut meats and other wholesome
ingredients in its candies. In February 1995 the Company's Valentine's Day
gift-boxed chocolates were awarded MONEY MAGAZINE's top rating and were
described as having "superior flavor" which is "intense" and "natural." The
Company continually strives to offer new confectionery products in order to
maintain the excitement and appeal of its products.
Chocolate candies manufactured by the Company are sold at Company-owned and
franchised stores at prices ranging from $12.90 to $14.90 per pound, with an
average price of $13.50 per pound. Franchisees set their own retail prices,
though the Company does recommend prices for all its products.
The Company's in-house graphics designers create packaging that reflects the
country Victorian theme of its stores. The Company develops special packaging
for the Christmas, Valentine's Day and Easter holidays, and customers can have
their purchases packaged in decorative boxes and fancy tins throughout the year.
The Company's new packaging for its Rocky Mountain Mints in 1995 received the
AWARD OF EXCELLENCE from the National Paperbox Association.
OPERATING ENVIRONMENT
The Company currently establishes franchised and Company-owned Rocky Mountain
Chocolate Factory stores in three primary environments: factory outlet malls,
tourist areas and regional malls. Each of these environments has a number of
attractive features, including high levels of foot traffic.
Factory Outlet Malls
There are approximately 330 factory outlet malls in the United States, and as of
February 28, 1998, there were Rocky Mountain Chocolate Factory stores in 110 of
these malls in 43 states. The Company has established business relationships
with the major outlet mall developers in the United States. Although not all
factory outlet malls provide desirable locations for the Company's stores,
management believes the Company's relationships with these developers will
provide it with the opportunity to take advantage of attractive sites in new and
existing outlet malls.
Tourist Areas
As of February 28, 1998, there were approximately 55 Rocky Mountain Chocolate
Factory stores in franchised locations considered to be tourist areas, including
Aspen, Colorado; Fisherman's Wharf in San Francisco, California; and the
Riverwalk in San Antonio, Texas. Tourist areas are very attractive locations
because they offer high levels of foot traffic and favorable customer spending
characteristics, and greatly increase the Company's visibility and name
recognition. The Company believes there are significant opportunities to expand
into additional tourist areas with high levels of foot traffic.
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Regional Malls
There are approximately 2,500 regional malls in the United States, and as of
February 28, 1998, there were Rocky Mountain Chocolate Factory stores in
approximately 33 of these, including the franchised locations in the Mall of
America in Bloomington, Minnesota; Escondido, California; Fort Collins,
Colorado; and West Palm Beach, Florida. Although often providing favorable
levels of foot traffic, regional malls typically involve more expensive rent
structures and more competing food and beverage concepts.
The Company believes there are a number of other environments that have the
characteristics necessary for the successful operation of Rocky Mountain
Chocolate Factory stores such as airports and sports arenas. Three franchised
Rocky Mountain Chocolate Factory stores exist at airport locations: two at
Denver International Airport and one at Vancouver International Airport in
Canada. As described above, the Company has also recently begun aggressively
pursuing the distribution of its products through alternative distribution
channels such as major national retail, fundraising and corporate sales
organizations.
FRANCHISING PROGRAM
General
The Company's franchising philosophy is one of service and commitment to its
franchise system, and it continuously seeks to improve its franchise support
services. The Company's concept has consistently been rated as an outstanding
franchise opportunity by publications and organizations rating such
opportunities. In February 1995, Rocky Mountain Chocolate Factory was rated
seventh in SUCCESS MAGAZINE's "Franchise Gold 100" most desirable franchises. As
of April 30, 1998, there were 185 franchised stores in the Rocky Mountain
Chocolate Factory system.
Franchisee Sourcing and Selection
The majority of new franchises are awarded to persons referred by existing
franchisees, to interested consumers who have visited Rocky Mountain Chocolate
Factory stores and to existing franchisees. The Company also advertises for new
franchisees in national and regional newspapers as suitable potential store
locations come to the Company's attention. Franchisees are approved by the
Company on the basis of the applicant's net worth and liquidity, together with
an assessment of work ethic and personality compatibility with the Company's
operating philosophy.
In fiscal 1992, the Company entered into a franchise development agreement
covering Canada with Immaculate Confections, Ltd. of Vancouver, British
Columbia. Pursuant to this agreement, Immaculate Confections purchased the
exclusive right to franchise and operate Rocky Mountain Chocolate Factory stores
in Canada. Immaculate Confections, as of April 30, 1998, operated 19 stores
under the agreement.
Training and Support
Each domestic franchisee owner/operator and each store manager for a domestic
franchisee is required to complete a 7-day comprehensive training program in
store operations and management. The Company has established a training center
at its Durango headquarters in the form of a full-sized replica of a properly
configured and merchandised Rocky Mountain Chocolate Factory store. Topics
covered in the training course include the Company's philosophy of store
operation and management, customer service, merchandising, pricing, cooking,
inventory and cost control, quality standards, record keeping, labor scheduling
and personnel management. Training is
9
based on standard operating policies and procedures contained in an operations
manual provided to all franchisees, which the franchisee is required to follow
by terms of the franchise agreement. Additionally, and importantly, trainees are
provided with a complete orientation to Company operations by working in key
factory operational areas and by meeting with each member of the senior
management of the Company. Training continues through the opening of the store,
where Company field consultants assist and guide the franchisee in all areas of
operation.
The Company's operating objectives include providing Company knowledge and
expertise in merchandising, marketing and customer service to all front-line
store level employees to maximize their skills and ensure that they are fully
versed in the Company's proven techniques.
The Company provides ongoing support to franchisees through its field
consultants, who maintain regular and frequent communication with the stores by
phone and by site visits. The field consultants also review and discuss with the
franchisee store operating results and provide advice and guidance in improving
store profitability and in developing and executing store marketing and
merchandising programs. The Company has developed a handbook containing a
"pre-packaged" local store marketing plan, which allows franchisees to implement
cost-effective promotional programs that have proven successful in other Rocky
Mountain Chocolate Factory stores.
Regional conferences are held each fall with a focus on holiday merchandising
techniques in preparation for the fall and Christmas holidays. "Town Meetings"
are held each March with the goal of furthering communication and obtaining
franchisee feedback in anticipation of the Company's annual Franchisee
Convention. The Company holds its annual convention each May, at which seminars
and workshops are presented on subjects considered vital to continuing
improvement in operating results of Rocky Mountain Chocolate Factory stores.
Quality Standards and Control
The franchise agreement for Rocky Mountain Chocolate Factory franchisees
requires franchisees to comply with the Company's procedures of operation and
food quality specifications and to permit audits and inspections by the Company.
Operating standards for Rocky Mountain Chocolate Factory stores are set forth in
operating manuals. These manuals cover general operations, factory ordering,
merchandising, advertising and accounting procedures. Through their regular
visits to franchised stores, Company field consultants audit performance and
adherence to Company standards. The Company has the right to terminate any
franchise agreement for non-compliance with the Company's operating standards.
Products sold at the stores and ingredients used in the preparation of products
approved for on-site preparation must be purchased from the Company or from
approved suppliers.
The Franchise Agreement: Terms and Conditions
The domestic offer and sale of Rocky Mountain Chocolate Factory franchises is
made pursuant to the Uniform Franchise Offering Circular prepared in accordance
with federal and state laws and regulations. States that regulate the sale and
operation of franchises require a franchiser to register or file certain notices
with the state authorities prior to offering and selling franchises in those
states.
Under the current form of domestic Rocky Mountain Chocolate Factory franchise
agreement, franchisees pay the Company (i) an initial franchise fee of $19,500
for each store, (ii) royalties equal to 5% of monthly gross sales, and (iii) a
marketing fee equal to 1% of monthly gross sales. Franchisees are generally
granted exclusive
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territory with respect to the operation of Rocky Mountain Chocolate Factory
stores only in the immediate vicinity of their stores. Chocolate products not
made on the premises by franchisees must be purchased from the Company or
approved suppliers.
The franchise agreements require franchisees to comply with the Company's
procedures of operation and food quality specifications, to permit inspections
and audits by the Company and to remodel stores to conform with standards in
effect. The Company may terminate the franchise agreement upon the failure of
the franchisee to comply with the conditions of the agreement and upon the
occurrence of certain events, such as insolvency or bankruptcy of the franchisee
or the commission by the franchisee of any unlawful or deceptive practice, which
in the judgment of the Company is likely to adversely affect the Rocky Mountain
Chocolate Factory system. The Company's ability to terminate franchise
agreements pursuant to such provisions is subject to applicable bankruptcy and
state laws and regulations. See "Business - Regulation."
The agreements prohibit the transfer or assignment of any interest in a
franchise without the prior written consent of the Company. The agreements also
give the Company a right of first refusal to purchase any interest in a
franchise if a proposed transfer would result in a change of control of that
franchise. The refusal right, if exercised, would allow the Company to purchase
the interest proposed to be transferred under the same terms and conditions and
for the same price as offered by the proposed transferee.
The term of each Rocky Mountain Chocolate Factory franchise agreement is five
years, and franchisees have the right to renew for two successive five-year
terms.
Franchise Financing
The Company does not provide prospective franchisees with financing for their
stores, but has developed relationships with two national sources of franchisee
financing to whom it will refer franchisees. Typically, franchisees have
obtained their own sources of such financing and have not required the Company's
assistance.
COMPANY STORE PROGRAM
As of April 30, 1998, there were 37 Company-owned Rocky Mountain Chocolate
Factory stores. Company-owned stores provide a training ground for
Company-owned store personnel and district managers and a controllable testing
ground for new products and promotions, operating and training methods and
merchandising techniques. In many cases, the Company has been able to take
advantage of a promising new location by establishing a Company-owned store when
a delay in finding a qualified franchisee might have jeopardized the Company's
ability to secure the site.
Managers of Company-owned stores are required to comply with all Company
operating standards and undergo training and receive support from the Company
similar to the training and support provided to franchisees. See "Franchising
Program-Training and Support" and "Franchising Program-Quality Standards and
Control."
Additionally, the Company will continue to purchase strategic premium locations
from its franchise system, as they become available, to convert to Company-owned
stores.
MANUFACTURING OPERATIONS
General
The Company manufactures its chocolate candies at its factory in Durango,
Colorado. All products are produced consistent with the Company's philosophy of
using only the
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finest, highest quality ingredients with no artificial preservatives to achieve
its marketing motto of "the peak of perfection in handmade chocolates."
It has always been the belief of management that the Company should control the
manufacturing of its own chocolate products. By controlling manufacturing, the
Company can better maintain its high product quality standards, offer unique,
proprietary products, manage costs, control production and shipment schedules
and potentially pursue new or under-utilized distribution channels.
Manufacturing Processes
The manufacturing process primarily involves cooking or preparing candy centers,
including nuts, caramel, peanut butter, creams and jellies, and then coating
them with chocolate or other toppings. All of these processes are conducted in
carefully controlled temperature ranges, and the Company employs strict quality
control procedures at every stage of the manufacturing process. The Company uses
a combination of manual and automated processes at its factory. Although the
Company believes that it is currently preferable to perform certain
manufacturing processes, such as dipping of some large pieces, by hand,
automation increases the speed and efficiency of the manufacturing process. The
Company has from time to time automated processes formerly performed by hand
where it has become cost-effective for the Company to do so without compromising
product quality or appearance.
The Company seeks to ensure the freshness of products sold in Rocky Mountain
Chocolate Factory stores with frequent shipments and production schedules that
are closely coordinated with projected and actual orders. Most Rocky Mountain
Chocolate Factory stores do not have significant space for the storage of
inventory, and the Company encourages franchisees and store managers to order
only the quantities that they can reasonably expect to sell within approximately
two to four weeks. For these reasons, the Company generally does not have a
significant backlog of orders.
Ingredients
The principal ingredients used by the Company are chocolate, nuts, sugar, corn
syrup, peanut butter, cream and butter. The factory receives shipments of
ingredients daily. To ensure the consistency of its products, the Company buys
ingredients from a limited number of reliable suppliers. In order to assure a
continuous supply of chocolate and certain nuts, the Company frequently enters
into purchase contracts for these products having durations of six to 18 months.
Because prices for these products may fluctuate, the Company may benefit if
prices rise during the terms of these contracts, but it may be required to pay
above-market prices if prices fall. The Company has one or more alternative
sources for all essential ingredients and therefore believes that the loss of
any supplier would not have a material adverse effect on the Company and its
results of operations. The Company currently also purchases small amounts of
finished candy from third parties on a private label basis for sale in Rocky
Mountain Chocolate Factory stores.
Factory and Trucking Operations
The Company in fiscal 1996 expanded its factory from 27,000 square feet to
53,000 square feet, which provided space for additional automated equipment and
for warehousing of ingredients and finished candies prior to shipment. Beginning
in fiscal 1994, the Company also began operating several trucks and now ships a
substantial
12
portion of its products from the factory on its fleet of trucks. The Company's
trucking operations and factory expansion have significantly improved the
Company's ability to deliver its products to the stores quickly and
cost-effectively. In addition, the Company back-hauls its own ingredients and
supplies, as well as product from third parties, on return trips as a basis for
increasing trucking program economics.
In January 1998, the Company acquired a two acre parcel adjacent to its factory
to ensure the availability of adequate space to expand the factory as volume
demands.
MARKETING
The Company relies primarily on in-store promotion and point-of-purchase
materials to promote the sale of its products. The monthly marketing fees
collected from franchisees are used by the Company to develop new packaging and
in-store promotion and point-of-purchase materials, and to create and update the
Company's local store marketing handbooks.
The Company focuses on local store marketing efforts by providing customizable
marketing materials, including advertisements, coupons, flyers and mail order
catalogs generated by its in-house Creative Services department. The department
works directly with franchisees to implement local store marketing programs.
The Company aggressively seeks low cost, high return publicity opportunities
through its in-house public relations staff by participating in local and
regional events, sponsorships and charitable causes. The Company has not
historically and does not intend to engage in national advertising in the near
future.
COMPETITION
The retailing of confectionery products is highly competitive. The Company and
its franchisees compete with numerous businesses that offer confectionery
products. Many of these competitors have greater name recognition and financial,
marketing and other resources than the Company. In addition, there is intense
competition among retailers for real estate sites, store personnel and qualified
franchisees. Competitive market conditions could adversely affect the Company
and its results of operations and its ability to expand successfully.
The Company believes that its principal competitive strengths lie in its name
recognition and its reputation for the quality, value, variety and taste of its
products and the special ambiance of its stores; its knowledge and experience in
applying criteria for selection of new store locations; its expertise in
merchandising and marketing of chocolate and other candy products; and the
control and training infrastructures it has implemented to assure execution of
successful practices and techniques at its franchised and Company-owned store
locations. In addition, by controlling the manufacturing of its own chocolate
products, the Company can better maintain its high product quality standards for
those products, offer proprietary products, manage costs, control production and
shipment schedules and pursue new or under-utilized distribution channels.
TRADE NAME AND TRADEMARKS
The trade name "Rocky Mountain Chocolate Factory," the phrases "The Peak of
Perfection in Handmade Chocolates" and "America's Chocolatier", as well as all
other trademarks, service marks, symbols, slogans, emblems, logos and designs
used in the Rocky Mountain Chocolate Factory system, are proprietary rights of
the Company. All of the foregoing are believed to be of material importance to
the Company's business. The registration
13
for the trademark Rocky Mountain Chocolate Factory has been granted in the
United States and Canada. Applications have been filed to register the Rocky
Mountain Chocolate Factory trademark in certain foreign countries.
The Company has not attempted to obtain patent protection for the proprietary
recipes developed by the Company's master candy-maker and is relying upon its
ability to maintain the confidentiality of those recipes.
EMPLOYEES
At April 30, 1998, the Company employed 361 persons. Most employees, with the
exception of store, factory and corporate management, are paid on an hourly
basis. The Company also employs some people on a temporary basis during peak
periods of store and factory operations. The Company seeks to assure that
participatory management processes, mutual respect and professionalism and high
performance expectations for the employee exist throughout the organization.
The Company believes that it provides working conditions, wages and benefits
that compare favorably with those of its competitors. The Company's employees
are not covered by a collective bargaining agreement. The Company considers its
employee relations to be good.
SEASONAL FACTORS
The Company's sales and earnings are seasonal, with significantly higher sales
and earnings occurring during the Christmas holiday and summer vacation seasons
than at other times of the year, which causes fluctuations in the Company's
quarterly results of operations. In addition, quarterly results have been, and
in the future are likely to be, affected by the timing of new store openings and
the sale of franchises. Because of the seasonality of the Company's business and
the impact of new store openings and sales of franchises, results for any
quarter are not necessarily indicative of the results that may be achieved in
other quarters or for a full fiscal year.
REGULATION
Each of the Company-owned and franchised stores is subject to licensing and
regulation by the health, sanitation, safety, building and fire agencies in the
state or municipality where located. Difficulties or failures in obtaining the
required licensing or approvals could delay or prevent the opening of new
stores. New stores must also comply with landlord and developer criteria.
Many states have laws regulating franchise operations, including registration
and disclosure requirements in the offer and sale of franchises. The Company is
also subject to the Federal Trade Commission regulations relating to disclosure
requirements in the sale of franchises and ongoing disclosure obligations.
Additionally, certain states have enacted and others may enact laws and
regulations governing the termination or non-renewal of franchises and other
aspects of the franchise relationship that are intended to protect franchisees.
Although these laws and regulations, and related court decisions may limit the
Company's ability to terminate franchises and alter franchise agreements, the
Company does not believe that such laws or decisions will have a material
adverse effect on its franchise operations. However, the laws applicable to
franchise operations and relationships continue to develop, and the Company is
unable to predict the effect on its intended operations of additional
requirements or restrictions that may be enacted or of court decisions that may
be adverse to franchisers.
14
Federal and state environmental regulations have not had a material impact on
the Company's operations but more stringent and varied requirements of local
governmental bodies with respect to zoning, land use and environmental factors
could delay construction of new stores.
Companies engaged in the manufacturing, packaging and distribution of food
products are subject to extensive regulation by various governmental agencies. A
finding of a failure to comply with one or more regulations could result in the
imposition of sanctions, including the closing of all or a portion of the
Company's facilities for an indeterminate period of time.
The Nutrition Labeling and Education Act of 1990 became effective May 8, 1994.
Pursuant to the Act, the Company filed a "Small Business Food Labeling Exemption
Notice" with the U.S. Food and Drug Administration, which provides a phased
timeline for implementing labeling compliant with the Act. The Company is
currently implementing product labeling in fulfillment of the Act within the
timeline allowed under its Small Business exemption.
The Company provides a limited amount of trucking services to third parties, to
fill available space on the Company's trucks. The Company's trucking operations
are subject to various federal and state regulations, including regulations of
the Federal Highway Administration and other federal and state agencies
applicable to motor carriers, safety requirements of the Department of
Transportation relating to interstate transportation and federal, state and
Canadian provincial regulations governing matters such as vehicle weight and
dimensions.
The Company believes it is operating in substantial compliance with all
applicable laws and regulations.
ITEM 2. PROPERTIES
The Company's manufacturing operations and corporate headquarters are located at
its 53,000 square foot manufacturing facility, which it owns, in Durango,
Colorado. During fiscal 1998, the Company's factory produced approximately 2.0
million pounds of chocolate candies, up from 1.7 million pounds in fiscal 1997.
The factory has the capacity to produce approximately 3.5 million pounds per
year. In January 1998, the Company acquired a two acre parcel adjacent to its
factory to ensure the availability of adequate space to expand the factory as
volume demands.
As of April 30, 1998, all 37 Company-owned stores were occupied pursuant to
non-cancelable leases of five to ten years having varying expiration dates, most
of which contain optional five-year renewal rights. The Company does not deem
any individual store lease to be significant in relation to its overall
operations.
The Company acts as primary lessee of some franchised store premises, which it
then subleases to franchisees, but the majority of existing locations are leased
by the franchisee directly. Current Company policy is not to act as primary
lessee on any further franchised locations. At April 30, 1998, the Company was
the primary lessee at 50 of its 185 franchised stores. The subleases for such
stores are on the same terms as the Company's leases of the premises. For
information as to the amount of the Company's rental obligations under leases on
both Company-owned and franchised stores, see Note 6 of Notes to financial
statements.
15
ITEM 3. LEGAL PROCEEDINGS
LEGAL PROCEEDINGS
The Company is not currently involved in any legal proceedings that are material
to the Company's business or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth quarter
of fiscal 1998.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) MARKET INFORMATION
The Company's Common Stock trades on the National Market System of The NASDAQ
Stock Market under the trading symbol "RMCF".
On May 18, 1998 the Company purchased 336,000 shares of its common stock at
$5.15 per share in a private transaction and on January 17, 1996 the Company
purchased on the open market 125,000 shares of its Common Stock at $8.09 per
share. The Company made these purchases because the Company felt that its
Common Stock was undervalued and that such purchases would therefore be in the
best interest of the Company and its stockholders.
The table below sets forth high and low bid information for the Common Stock as
quoted on NASDAQ for each quarter of fiscal years 1998 and 1997. The quotations
reflect inter-dealer prices, without retail mark-up, mark-down, or commission
and may not necessarily represent actual transactions.
FISCAL YEAR ENDED FEBRUARY 28, 1998
HIGH LOW
First Quarter $ 5.125 $ 2.750
Second Quarter 5.250 4.000
Third Quarter 7.125 4.250
Fourth Quarter 6.594 4.500
FISCAL YEAR ENDED FEBRUARY 28, 1997
HIGH LOW
First Quarter $ 8.250 $ 7.000
Second Quarter 10.875 7.500
Third Quarter 7.750 5.750
Fourth Quarter 6.750 4.375
On May 29, 1998 the closing bid price for the Common Stock as reported on the
NASDAQ Stock Market was $6.375.
16
(b) HOLDERS
On May 29, 1998 there were approximately 405 record holders of the Company's
Common Stock. The Company believes that there are more than 1,620 beneficial
owners of its Common Stock.
(c) DIVIDENDS
The Company has not paid cash dividends on its Common Stock since its inception
and does not intend to pay cash dividends for the foreseeable future. Any
future earnings will be retained for use in the Company's business.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below for the fiscal years ended
February 28 or 29, 1994 through 1998, are derived from the Financial Statements
of the Company, which have been audited by Grant Thornton LLP, independent
auditors. The selected financial data should be read in conjunction with the
Financial Statements and related Notes thereto included elsewhere in this Report
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(Amounts in thousands, except per share data)
YEARS ENDED FEBRUARY 28 OR 29,
SELECTED STATEMENT OF
OPERATIONS DATA 1994 1995 1996 1997 1998
Total revenues $ 9,361 $ 13,616 $ 18,552 $ 22,281 $ 23,764
Operating income (loss) 1,251 2,270 2,157 (1,026) 2,599
Income (loss) from
continuing operations 862 1,350 1,207 (1,010) 1,260
Income (loss) from
discontinued operations
(net of income taxes) - - 1 (356) (1,020)
Net income (loss) $ 862 $ 1,350 $ 1,208 $ (1,366) $ 240
BASIC EARNINGS (LOSS) PER
COMMON SHARE
Continuing Operations $ .44 $ .53 $ .43 $ (.35) $ .43
Discontinued Operations - - - (.12) (.35)
Net Income (loss) $ .44 $ .53 $ .43 $ (.47) $ .08
DILUTED EARNINGS (LOSS) PER
COMMON SHARE
Continuing Operations $ .33 $ .50 $ .42 $ (.35) $ .43
Discontinued Operations - - - (.12) (.35)
Net Income (loss) $ .33 $ .50 $ .42 $ (.47) $ .08
Weighted average common
shares outstanding 1,739 2,515 2,797 2,908 2,913
Weighted average common
shares outstanding,
assuming dilution 2,500 2,718 2,887 2,908 2,930
SELECTED BALANCE SHEET DATA
Working capital $ 1,889 $ 1,627 $ 2,043 $ 2,664 $ 3,949
Total assets 6,024 10,181 16,308 18,666 19,868
Long-term debt 604 2,314 2,184 5,737 5,993
Stockholders' equity 4,143 5,907 11,117 9,779 10,019
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the financial condition and results of
operations of the Company should be read in conjunction with the audited
financial statements and related Notes of the Company included elsewhere in this
report. This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other parts of this Annual Report on Form 10-K contain
forward-looking statements that involve risks and uncertainties.
The Company's ability to successfully achieve expansion of its Rocky Mountain
Chocolate Factory franchise system depends on many factors not within the
Company's 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 depends on many factors
not within the Company's control including the receptivity of its franchise
system and of customers in potential new distribution channels of its product
introductions and promotional programs.
As a result, the actual results realized by the Company could differ materially
from the results discussed in or contemplated by the forward-looking statements
made herein. Words or phrases such as "will," "anticipate," "expect,"
"believe," "intend," "estimate," "project," "plan" or similar expressions are
intended to identify forward-looking statements. Readers are cautioned not to
place undue reliance on the forward-looking statements in this Annual Report on
Form 10-K.
RESULTS OF OPERATIONS
FISCAL 1998 COMPARED TO FISCAL 1997
Continuing Operations Results Summary
The Company posted record revenues and operating income. Revenues rose 6.7%
from 1997 to 1998, operating income increased $3.6 million from a loss of
$1.0 million in 1997 to $2.6 million in 1998 and income from continuing
operations increased $2.3 million from a loss of $1.0 million in 1997 to
income of $1.3 million in 1998. Diluted earnings per share from continuing
operations increased from a loss of $.35 per share in 1997 to income of $.43
per share in 1998.
Revenues
($'s in thousands) 1998 1997 Change % Change
Factory Sales $ 10,198.6 $ 9,188.2 $ 1,010.4 11.0%
Retail Sales 10,460.5 10,494.4 (33.9) (.3%)
Royalty and Marketing Fees 2,747.6 2,342.4 405.2 17.3%
Franchise Fees 357.3 255.6 101.7 39.8%
Total $ 23,764.0 $ 22,280.6 $ 1,483.4 6.7%
Factory Sales
Factory sales increased $1.0 million or 11% to $10.2 million in fiscal 1998,
compared to $9.2 million in 1997. This increase was due to: (1) an increase in
the number of franchised stores from 170 as of February 28, 1997 to 183 as of
February 28, 1998;
18
(2) the commencement in fiscal 1998 of wholesale sales of product to
alternative distribution channels and (3) a 2.6% price increase in April of
1997. Same store pounds purchased from the factory by franchised stores
declined 2.2% in fiscal 1998 versus fiscal 1997 partially offsetting the above
increases. The Company believes the decline in same store pounds purchased from
the factory resulted primarily from increased retail sales of store-made product
and product purchased from authorized vendors relative to factory-made products.
Same store pounds purchased is a comparison of pounds purchased from the factory
by franchised stores open for 12 months in each fiscal year.
In response to the trend of decreasing same store pounds purchased from the
factory and the limited number of suitable locations available for new
Company-owned and franchised stores, the Company is focusing on developing
alternative distribution channels, and new product introductions that replace
products from authorized outside vendors, to continue and accelerate its
improving factory sales trends.
Retail Sales
Retail sales decreased $34,000 or 0.3% to $10.46 million in fiscal 1998,
compared to $10.49 million in fiscal 1997. This decrease resulted primarily
from the closure and sale of certain under-performing stores in fiscal 1998 and
was substantially offset by an increase of 7.1% in comparable store retail sales
in 1998 versus fiscal 1997.
During fiscal 1998 the Company sold 7 and closed 6 Company-owned stores. During
fiscal 1999 the Company plans to continue selective unit growth for its retail
store system focusing on developing its retail management infrastructure and
building on the substantial increase in profitability realized in fiscal 1998
versus fiscal 1997.
Additionally, the Company will continue to purchase strategic premium locations
from its franchise system, as they become available, to convert to Company-owned
stores.
Royalties, Marketing Fees and Franchise Fees
Royalties and marketing fees increased $405,000 or 17.3% to $2.7 million in
fiscal 1998, compared to $2.3 million in fiscal 1997. This increase resulted
from an increase in the number of franchised stores operating to 183 in fiscal
1998 compared to 170 in fiscal 1997 and an increase in same store sales at
franchised stores of 7.4%. Franchise fee revenues increased $102,000 in fiscal
1998 compared to fiscal 1997 due to an increase in the number of new franchises
sold.
The Company is currently experiencing a constraint in the number of viable new
locations available for establishment of its Rocky Mountain Chocolate Factory
stores due to a lack of quality locations in environments where the concept has
proven successful.
The Company is currently examining alternatives to stand-alone Rocky Mountain
Chocolate Factory stores to further penetrate established operating environments
and venues that have yet to be exploited.
Costs and Expenses
Cost of Sales
Cost of sales as a percentage of sales decreased to 53.1% in fiscal 1998 versus
56.0% in fiscal 1997. This improvement resulted from increased margins on both
factory and retail sales. Company-owned store margins for fiscal 1998 improved
to 63.0% in fiscal 1998 from 60.4% in fiscal 1997 as a result of an increase in
retail prices, a focus on
19
higher margin products and reduced inventory shrinkage. Factory margins
improved to 30.5% in fiscal 1998 from 25.4% in fiscal 1997 as a result of
improved manufacturing efficiencies and a 2.6% price increase in April of 1997.
The Company continues to seek improvement in factory margins through further
automation to reduce cost and to improve factory sales and production volumes
through its programs to improve same store pounds purchased and sale of products
to alternative distribution channels.
Franchise Costs
Franchise costs decreased $152,000 or 12.1% in fiscal 1998 compared to fiscal
1997. As a percentage of total royalty and marketing fees and franchise fee
revenue, franchise costs decreased to 35.6% in fiscal 1998 from 48.4% in fiscal
1997. This decrease is due primarily to reductions in design and construction
staffing.
Sales & Marketing
Sales and Marketing increased 74% to $1.3 million in fiscal 1998 from $742,000
in fiscal 1997. This increase is due to: (1) expansion of the Company's sales
and marketing group to support a larger base of franchised and Company-owned
stores; (2) expansion of promotional programs and marketing materials available
to franchised and Company-owned stores; (3) establishment of a sales force
focused on alternative distribution opportunities; and (4) enhanced customer
service and new product marketing programs.
General and Administrative
General and administrative expenses decreased 11.7% from $2.0 million in fiscal
1997 to $1.8 million in fiscal 1998, primarily as a result of reduced bad debt
expense. As a percentage of total revenues, general and administrative expense
declined from 9% in fiscal 1997 to 7.4% in fiscal 1998.
Retail Operating Expenses
Retail operating expenses decreased from $6.5 million in fiscal 1997 to $6.0
million in fiscal 1998; a decrease of 6.4%. This decrease resulted from closing
and selling certain under-performing Company-owned stores. As a result of this
decrease and the improvement in same store retail sales, retail operating
expenses, as a percentage of retail sales, decreased from 61.5% in fiscal 1997
to 57.8% in fiscal 1998.
Provision for Store Closures, Impairment Loss and Loss on Write-down of Assets
In fiscal 1997, a non-recurring restructuring charge of $1.8 million was
recorded representing the loss expected to result from the sale or closure of
certain Company-owned stores and from write-down of certain other store assets
considered impaired under provisions of Financial Accounting Standard (FAS) 121
"Accounting for the Impairment of Long-Lived Assets."
As a result of the Company's restructuring efforts, the Company's retail
operations achieved what the Company deems to be an acceptable level of
profitability in fiscal 1998.
Other Expense
Other expense of $550,000 incurred in fiscal 1998 decreased 8.2% from the
$599,000 incurred in fiscal 1997. This decrease resulted from a non-recurring
litigation
20
settlement charge of $154,000 in fiscal 1997 for early lease terminations on
certain Company-owned stores, and increased interest income on excess cash
balances in fiscal 1998, offset by increased interest expense related to
borrowings in support of the Company's fiscal 1996 and 1997 Company-owned store
expansion.
Income Tax Expense
The Company's effective income tax rate in fiscal 1997 was 37.9% in comparison
with the 38.5% in 1998. The increase resulted from utilization of remaining
available state net operating loss carryforwards in fiscal 1997.
Discontinued Operations
In December 1997, the Company decided its Fuzziwig's Candy Factory Store
("Fuzziwig's") segment did not meet its long-term strategic goals, and
accordingly, adopted a plan to discontinue its operations. On June 5, 1998, the
Company entered into a definitive agreement to sell substantially all the assets
of its Fuzziwig's segment for $1.6 million. The Company expects this
transaction to close on or about July 31, 1998.
The estimated loss on disposition of Fuzziwig's of $929,000 (inclusive of
estimated losses during the phase out period of $250,000), net of applicable
income tax benefit of $587,000, has been recorded in the accompanying statement
of operations for the year ending February 28, 1998.
The operating results of Fuzziwig's, including provisions for estimated
disposition costs, lease termination costs and operating losses during the
phase-out period totaling $1.5 million have been segregated from continuing
operations and reported as separate line items net of applicable income taxes in
the statements of operations for all periods reported.
Loss from discontinued operations was $.35 per diluted share in fiscal 1998
versus $.12 in fiscal 1997.
Net Income
Net Income including discontinued operations was $.08 per diluted share in
fiscal 1998 versus a loss of $.47 per diluted share in fiscal 1997.
FISCAL 1997 COMPARED TO 1996
Continuing Operations Results Summary
The Company reported an increase in revenues of 20.1% and a loss from continuing
operations of $1.0 million for fiscal 1997 compared with income from continuing
operations of $1.2 million for fiscal 1996; a decrease of $2.2 million.
Primary causes for this shortfall in operating results were a non-recurring
restructuring charge of $1.8 million, representing the loss expected to result
from the sale or closure of certain Company-owned stores, write-down of certain
other store assets considered impaired, Company-owned store losses resulting
primarily from stores to be closed, lack of new locations for unit growth
adversely impacting franchise fee revenues and decreased same store pounds
purchased from the factory.
21
Revenues
Revenue results by revenue component for fiscal 1997 in comparison with fiscal
1996 are as follows ($000):
($'s in thousands) 1997 1996 Change % Change
Factory Sales $ 9,188.2 $ 8,156.5 $ 1,031.7 12.6%
Royalty and Marketing Fees 2,342.4 2,034.0 308.4 15.2%
Franchise Fees 255.6 614.3 (358.7) (58.4%)
Retail Sales 10,494.4 7,747.3 2,747.1 35.5%
Total $22,280.6 $18,552.1 $ 3,728.5 20.1%
Factory Sales
Significantly increased factory sales resulted primarily from the larger number
of franchised Rocky Mountain Chocolate Factory stores in existence throughout
the year (170 Rocky Mountain Chocolate Factory stores franchised at February 28,
1997 in comparison with 150 at February 29, 1996) as augmented by the impact of
an approximate 2.6% price increase effected in January 1996. Same store pounds
purchased declined by 3.6% in fiscal 1997, partially offsetting the impact of
the increased number of stores and the price increase.
Royalties, Marketing Fees and Franchise Fees
Increased royalty and marketing fees resulted from the impact of a larger number
of franchised stores in existence throughout the year. Same store sales at
franchised stores were approximately the same as in fiscal 1996. The Company
sold 19 new franchise locations in fiscal 1997 in comparison with 41 in fiscal
1996 resulting in the decreased franchise fee revenue shown above.
Retail Sales
Retail sales of Company-owned stores increased as a result of a larger number of
Company stores in existence throughout the year (45 stores existed at February
28, 1997, in comparison with 40 in existence at February 29, 1996) in fiscal
1997 in comparison with the prior fiscal year as partially offset by the impact
of a same store retail sales decline of 2.7%. The decline in same store sales
is believed to result from the effect of lower foot traffic in the factory
outlet mall environment in which most Company-owned stores operate, and as a
result of a decline in revenues in the second year of operation from grand
opening levels of revenue at stores established in the last fiscal year at new
factory outlet malls.
Costs and Expenses
Cost of Sales
Cost of sales as a percentage of sales increased to 56.0% in fiscal 1997 versus
54.8% in fiscal 1996. This deterioration resulted from decreased margins on
both factory and retail sales. Company-owned store margins for fiscal 1997
decreased to 60.4% in fiscal 1997 from 60.8% in fiscal 1996 as a result of an
increase in shrinkage and a less favorable product mix. Factory margins
decreased to 25.4% in fiscal 1997 from 30.3% in fiscal 1996 as a result of lower
than planned volume levels, increased overhead spending, provisions for obsolete
inventory and labor inefficiencies.
22
Franchise Costs
Franchise costs increased $16,000 or 1.3% in fiscal 1997 compared to fiscal
1996. As a percentage of total royalty and marketing fees and franchise fee
revenue, franchise costs increased to 48.4% in fiscal 1997 from 46.9% in fiscal
1996. This increase resulted from a significant reduction in the number of new
franchises sold in fiscal 1997 versus 1996 without an attendant reduction in the
franchise infrastructure.
Sales & Marketing
Sales and Marketing increased 32.2% to $742,000 in fiscal 1997 from $561,000 in
fiscal 1996. The addition of an expanded marketing group to support corporate
public relations, promotional programs and marketing materials in support of the
Company's larger base of stores are the primary causes of this increase.
General and Administrative Expenses
General and Administrative expenses increased 39.0% from $1.4 million in fiscal
1996 to $2.0 million in fiscal 1997, primarily as a result of increased bad debt
expense, additional administrative support personnel and increased depreciation
expense related to investment in computer hardware and software. As a
percentage of total revenues, general and administrative expense increased from
7.7% in fiscal 1996 to 9.0% in 1997.
Retail Operating Expenses
Retail operating expenses increased from $4.4 million in fiscal 1996 to $6.5
million in fiscal 1997; an increase of 45.7%. This increase resulted primarily
from the effect of the larger number of Company-owned stores in existence
throughout the year and partially as a result of amortization of capitalized
expenditures incurred in the "start-up" phase of many new stores established in
late fiscal 1996. As a percentage of retail sales, retail operating expenses
increased from 57.2% in fiscal 1996 to 61.5% in fiscal 1997. This increase is a
result of a decline in same store retail sales at Company-owned Rocky Mountain
Chocolate Factory stores, increased expenses from the "start-up" effect
discussed above and as a result of sales volumes at many Company-owned stores
significantly below Company expectations.
Provision for Store Closures, Impairment Loss and Loss on Write-down of Assets
In fiscal 1997, a non-recurring restructuring charge of $1.8 million was
recorded representing the loss expected to result from the sale or closure of
certain Company-owned stores and from write-down of certain other store assets
considered impaired under provisions of Financial Accounting Standard (FAS) 121
"Accounting for the Impairment of Long-Lived Assets."
Other Expense
Other expense of $599,000 incurred in fiscal 1997 increased 147.5% from the
$242,200 incurred in fiscal 1996. Other expense increased as a result of
increased interest expense resulting from borrowings in support of the Company's
Company-owned store expansion and a non-recurring litigation settlement charge
of $154,000 for early lease terminations on certain Company-owned stores in
fiscal 1997.
Income Tax Expense
The Company's effective income tax rate in fiscal 1997 of 37.9% approximated the
37.0% in fiscal 1996.
23
Discontinued Operations
In December 1997, the Company decided its Fuzziwig's Candy Factory Store
("Fuzziwig's") segment did not meet its long-term strategic goals, and
accordingly, adopted a plan to discontinue its operations. On June 5, 1998, the
Company entered into a definitive agreement to sell substantially all the assets
of its Fuzziwig's segment for $1.6 million. The Company expects this
transaction to close on or about July 31, 1998.
The estimated loss on disposition of Fuzziwig's of $929,000 (inclusive of
estimated losses during the phase out period of $250,000), net of applicable
income tax benefit of $587,000, has been recorded in the accompanying statement
of operations for the year ending February 28, 1998.
The operating results of Fuzziwig's, including provisions for estimated
disposition costs, lease termination costs and operating losses during the
phase-out period totaling $1.5 million have been segregated from continuing
operations and reported as separate line items net of applicable income taxes in
the statements of operations for all periods reported.
Loss from discontinued operations was $.12 per diluted share in fiscal 1997
versus $.00 in fiscal 1996.
Net Income (Loss)
Net loss including discontinued operations was $.47 per diluted share in fiscal
1997 versus income of $.42 per diluted share in fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES
As of February 28, 1998, working capital was $3.9 million compared with $2.6
million as of February 28, 1997, a $1.3 million increase. This increase is
primarily the result of cash flows generated by operating and financing
activities in excess of cash flows used in investing activities.
Cash and cash equivalent balances increased from $793,000 as of February 28,
1997 to $1,795,000 as of February 28, 1998 as a result of cash flows generated
by operating and financing activities in excess of cash flows used in investing
activities. The Company's current ratio was 2.1 to 1 at February 28, 1998 in
comparison with 1.9 to 1 at February 29, 1997.
The Company's long-term debt is comprised primarily of a real estate mortgage
facility used to finance the Company's factory expansion (unpaid balance as
of February 28, 1998, $2.0 million), and chattel mortgage notes (unpaid
balance as of February 28, 1998, $5.1 million) used to fund the fiscal 1996
and 1997 Company-owned store expansion.
The Company had an unused $2.0 million credit line secured by substantially
all of the Company's assets except retail store assets and is subject to
renewal in July, 1998.
On May 15, 1998, the Company used its credit line to purchase and cancel 336,000
shares of its common stock for a purchase price of $1,730,000. The Company is
currently negotiating an extension of and an increase in its line of credit.
The Company is also in the process of securing certain fixed asset based
financings, the proceeds of which will be used to reduce amounts outstanding on
its credit line.
For fiscal 1999, the Company anticipates making capital expenditures of
approximately $900,000, $600,000 of which will be used for new store buildouts
and remodels, with
24
the balance used to maintain and improve existing factory and administrative
infrastructure. The Company believes that cash flow from operations and
available bank lines of credit will be sufficient to fund capital expenditures
and working capital requirements for fiscal 1999.
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.
SEASONALITY
The Company is subject to seasonal fluctuations in sales, which cause
fluctuations in quarterly results of operations. Historically, the strongest
sales of the Company's products have occurred during the Christmas holiday and
summer vacation seasons. 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 the Company's 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.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards (SFAS) No. 130, Reporting Comprehensive Income,
which requires that an enterprise report, by major components and as a single
total, the change in its net assets during the period from non-owner sources;
and SFAS No. 131, Disclosures About Segments of an Enterprise and Related
Information, which establishes annual and interim reporting standards for an
enterprise's operating segments and related disclosures about its products,
services, geographic areas and major customers. Adoption of these standards
will not impact the Company's financial position, results of operations or cash
flows, and any effect will be limited to the form and content of its
disclosures. Both statements are effective for fiscal years beginning after
December 15, 1997, with earlier application permitted.
25
ITEM 8. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
Page
Report of Independent Certified Public Accountants 27
Statements of Operations 28
Balance Sheets 30
Statements of Changes in Stockholders Equity 31
Statements of Cash Flows 32
26
REPORT OF INDEPENDENT
CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Rocky Mountain Chocolate Factory, Inc.
We have audited the accompanying balance sheets of Rocky Mountain Chocolate
Factory, Inc. as of February 28, 1998 and 1997, and the related statements of
income, stockholders' equity, and cash flows for each of the three years in
the period ended February 28, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe our audits provide a reasonable
basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Rocky Mountain Chocolate
Factory, Inc. as of February 28, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period
ended February 28, 1998, in conformity with generally accepted accounting
principles.
GRANT THORNTON LLP
Dallas, Texas
April 24, 1998 (except for notes 11 and 13
as to which the dates are June 5, 1998
and May 15, 1998, respectively)
27
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED FEBRUARY 28 OR 29,
1998 1997 1996
REVENUES
Sales $ 20,659,076 $ 19,682,622 $ 15,903,838
Franchise and royalty fees 3,104,906 2,597,985 2,648,303
Total revenues 23,763,982 22,280,607 18,552,141
COSTS AND EXPENSES
Cost of sales 10,960,966 11,017,119 8,723,011
Franchise costs 1,106,172 1,258,361 1,242,674
Sales & marketing 1,290,516 741,603 560,832
General and administrative 1,763,757 1,996,476 1,436,551
Retail operating expenses 6,043,810 6,454,999 4,431,712
Provision for store closures - 1,358,398 -
Impairment loss - 149,000 -
Loss on write-down of assets - 330,587 -
Total costs and expenses 21,165,221 23,306,543 16,394,780
OPERATING INCOME (LOSS) 2,598,761 (1,025,936) 2,157,361
OTHER INCOME (EXPENSE)
Interest expense (664,852) (473,618) (299,792)
Litigation settlements - (154,300) -
Interest income 114,732 28,637 57,620
Other, net (550,120) (599,281) (242,172)
INCOME (Loss) FROM CONTINUING
OPERATIONS BEFORE INCOME TAXES 2,048,641 (1,625,217) 1,915,189
INCOME TAX EXPENSE (BENEFIT) 788,640 (615,506) 708,110
INCOME (Loss) FROM CONTINUING
OPERATIONS 1,260,001 (1,009,711) 1,207,079
DISCONTINUED OPERATIONS
Income (loss) from
discontinued operations (net
of income taxes) (90,849) (355,991) 666
Provision for estimated loss
on disposition, including
provision for operating
losses during phase out
period of $153,250 (net of
income taxes) (929,234) - -
Total (1,020,083) (355,991) 666
NET INCOME (Loss) $ 239,918 $ (1,365,702)$ 1,207,745
(CONTINUED)
The accompanying notes are an integral part of these statements.
28
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
STATEMENTS OF OPERATIONS (CONTINUED)
FOR THE YEARS ENDED FEBRUARY 28 OR 29,
1998 1997 1996
BASIC EARNINGS (LOSS) PER COMMON
SHARE
Continuing Operations $ .43 $ (.35) $ .43
Discontinued Operations (.35) (.12) -
Net Income $ .08 $ (.47) $ .43
DILUTED EARNINGS (LOSS) PER
COMMON SHARE
Continuing Operations $ .43 $ (.35) $ .42
Discontinued Operations (.35) (.12) -
Net Income $ .08 $ (.47) $ .42
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING 2,912,387 2,908,492 2,797,201
DILUTIVE EFFECT OF EMPLOYEE
STOCK OPTIONS 17,158 - 89,769
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING, ASSUMING DILUTION 2,929,545 2,908,492 2,886,970
The accompanying notes are an integral part of these statements.
29
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
BALANCE SHEETS
AS OF FEBRUARY 28,
1998 1997
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,795,381 $ 792,606
Accounts and notes receivable, less allowance for
doubtful accounts of $214,152 and $202,029 2,174,618 1,496,682
Refundable income taxes 483,448 233,289
Inventories 2,567,966 2,082,566
Deferred income taxes 257,176 722,595
Other 103,195 178,067
Net current assets of discontinued operations 44,351 231,821
Total current assets 7,426,135 5,737,626
PROPERTY AND EQUIPMENT, NET 9,672,443 9,740,341
OTHER ASSETS
Net non-current assets of discontinued operations 1,555,681 2,360,211
Accounts and notes receivable 279,122 82,774
Goodwill, less accumulated amortization of $325,848
and 277,344 596,152 312,656
Other 338,359 432,522
Total other assets 2,769,314 3,188,163
Total assets $19,867,892 $18,666,130
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt $ 1,132,900 $ 847,881
Accounts payable 1,296,769 799,671
Accrued salaries and wages 707,737 465,338
Other accrued expenses 339,481 867,961
Deferred income - 93,000
Total current liabilities 3,476,887 3,073,851
LONG-TERM DEBT, LESS CURRENT MATURITIES 5,993,273 5,737,312
DEFERRED INCOME TAXES 378,272 76,025
COMMITMENTS AND CONTINGENCIES - -
STOCKHOLDERS' EQUITY
Common stock, $.03 par value; 7,250,000 shares
authorized; 2,912,449 and 2,912,299 shares issued
and outstanding 87,373 87,369
Additional paid-in capital 8,719,604 8,719,008
Retained earnings 1,212,483 972,565
Total stockholders' equity 10,019,460 9,778,942
Total liabilities and stockholders' equity $19,867,892 $18,666,130
The accompanying notes are an integral part of these statements.
30
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED FEBRUARY 28 OR 29,
1998 1997 1996
COMMON STOCK
Balance at beginning of year $ 87,369 $ 87,155 $ 78,900
Repurchase and redemption of common
stock - - (3,750)
Issuance of common stock 4 4 10,130
Conversion of preferred stock to common - - 435
Exercise of stock options - 210 1,440
Balance at end of year 87,373 87,369 87,155
PREFERRED STOCK
Balance at beginning of year - - 1,462
Conversion of preferred stock to common - - (1,309)
Redemption of preferred stock - - (153)
Balance at end of year - - -
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year 8,719,008 8,691,960 4,695,923
Repurchase and redemption of common
stock - - (1,007,581)
Issuance of common stock 596 1,008 4,848,180
Conversion of preferred stock to common - - 874
Exercise of stock options - 26,040 180,435
Redemption of preferred stock - - (25,871)
Balance at end of year 8,719,604 8,719,008 8,691,960
RETAINED EARNINGS
Balance at beginning of year 972,565 2,338,267 1,130,522
Net income (loss) for the year 239,918 (1,365,702) 1,207,745
Balance at end of year 1,212,483 972,565 2,338,267
TOTAL STOCKHOLDERS EQUITY $10,019,460 $ 9,778,942 $11,117,382
COMMON SHARES
Balance at beginning of year 2,912,299 2,905,149 2,629,986
Repurchase and redemption of common
stock - - (125,000)
Issuance of common stock 150 150 337,650
Conversion of preferred stock to common - - 14,513
Exercise of stock options - 7,000 48,000
Balance at end of year 2,912,449 2,912,299 2,905,149
PREFERRED SHARES
Balance at beginning of year - - 14,610
Redemption of preferred stock - - (1,532)
Conversion of preferred stock to common - - (13,078)
Balance at end of year - - -
The accompanying notes are an integral part of these statements.
31
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED FEBRUARY 28 OR 29,
1998 1997 1996
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 239,918 $(1,365,702) $ 1,207,745
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
(Gain) loss from discontinued operations 90,849 355,991 (666)
Provision for estimated loss on
disposition of business 929,234 - -
Depreciation and amortization 1,335,715 1,383,212 787,296
Asset impairment and store closure losses - 1,781,985 -
Gain on sale of assets (76,474) (72,707) -
Changes in operating assets and liabilities:
Accounts and notes receivable (158,353) 232,733 (260,338)
Refundable income taxes (250,159) (233,289) -
Inventories (485,400) 378,020 (773,570)
Other assets 74,872 45,934 (113,896)
Accounts payable 497,098 (198,849) 159,403
Income taxes payable - (287,518) (229,101)
Deferred income taxes 767,666 (856,020) 118,173
Accrued liabilities (286,081) 220,270 55,080
Deferred income (93,000) 93,000 -
Net cash provided by operating activities
of continuing operations 2,585,885 1,477,060 950,126
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of assets 8,602 310,690 -
Purchase of other assets (233,380) (328,940) (65,535)
Purchase of property and equipment (1,984,940) (2,251,598) (4,853,283)
Net cash used in investing activities (2,209,718) (2,269,848) (4,918,818)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in line of credit - (1,000,000) 1,000,000
Proceeds from long-term debt 1,522,043 7,071,852 1,500,000
Payments on long-term debt (981,063) (2,805,074) (1,678,332)
Proceeds from issuance of common stock 600 1,012 4,858,310
Proceeds from exercise of stock options - 26,250 181,875
Redemption of preferred stock - - (26,024)
Repurchase and redemption of common stock - - (1,011,331)
Net cash provided by financing activities 541,580 3,294,040 4,824,498
NET CASH PROVIDED BY (USED IN)
DISCONTINUED OPERATIONS 85,028 (2,237,433) (709,924)
NET INCREASE IN CASH AND CASH EQUIVALENTS 1,002,775 263,819 145,882
CASH AND CASH EQUIVALENTS AT BEGINNING OF
YEAR 792,606 528,787 382,905
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 1,795,381 $ 792,606 $ 528,787
The accompanying notes are an integral part of these statements.
32
NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
The Company is a manufacturer of an extensive line of premium chocolate candy
for sale to its franchised and Company-owned Rocky Mountain Chocolate Factory
stores located throughout the United States, Guam, and Canada. The Company is
also a retail operator and international franchiser. The majority of the
Company's revenues are generated from wholesale and retail sales of candy. The
balance of the Company's revenues are generated from royalties and marketing
fees, based on a franchisee's monthly gross sales, and from franchise fees,
which consist of fees earned from the sale of franchises.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method.
Property and Equipment
Property and equipment are recorded at cost. Depreciation and amortization are
computed using the straight-line method based upon the estimated useful life of
the asset. Leasehold improvements are amortized on the straight-line method
over the lives of the respective leases or the service lives of the
improvements, whichever is shorter.
Amortization of Goodwill
Goodwill is amortized on the straight-line method over ten to twenty-five years.
Franchise and Royalty Fees
Franchise fee revenue is recognized upon completion of all significant initial
services provided to the franchisee and upon satisfaction of all material
conditions of the franchise agreement. In addition to the initial franchise
fee, the Company receives a royalty fee of five percent (5%) and a marketing and
promotion fee of one percent (1%) of the Rocky Mountain Chocolate Factory
franchised stores' gross sales.
Use of Estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets, liabilities, the disclosure of
contingent assets and liabilities, at the date of the financial statements, and
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Additionally, estimates of losses anticipated to result from store closure and
impairment are based on the best information currently available to management.
Such estimates may differ materially from results actually produced by store
closure as a result of uncertainties in the amount of finally negotiated lease
settlements, the amount of operating losses sustained by the stores to their
dates of closure and in the amount recoverable by sale or redeployment of assets
of stores to be closed. Estimates of impairment losses on underperforming
Company-owned stores to remain open have been made based on forecasts of future
operating results and cash flows of such stores, which forecasts are also
susceptible to uncertainties and may change materially in the near term.
33
Vulnerability Due to Certain Concentrations
The Company's stores are concentrated (50%) in the factory outlet mall
environment. At February 28, 1998, 34 Company-owned stores and 76 franchise
stores of 220 total stores are located in this environment. The Company is,
therefore, vulnerable to changes in consumer traffic in this market environment
and to changes in the level of construction of additional, new factory outlet
mall locations.
Cash Equivalents
Cash equivalents include cash in excess of daily requirements which is invested
in various financial instruments having an original maturity of three months or
less.
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for
Stock-Based Compensation" encourages, but does not require, companies to record
compensation cost for stock-based employee compensation plans at fair value.
The Company has chosen to continue to account for stock-based compensation using
the intrinsic value method prescribed in Accounting Principles Board Opinion No.
25 (APB 25), "Accounting for Stock Issued to Employees" and provides the
required pro forma disclosures prescribed by SFAS 123.
Earnings (Loss) Per Share
In fiscal 1998, the Company adopted the provisions of Statement of Financial
Accounting Standards (SFAS) No. 128, Earnings per Share. SFAS No. 128 requires
companies to present basic earnings per share and diluted earnings per share.
Basic earnings per share is computed as net earnings (loss) divided by the
weighted average number of common shares outstanding during each year of
2,912,387, 2,908,492 and 2,797,201, for the fiscal years ended February 28 or
29, 1998, 1997 and 1996. Diluted earnings per share reflects the potential
dilution that could occur from common shares issuable through stock options,
adjusted for 17,158 and 89,769 incremental shares assumed issued on the exercise
of common stock options during the fiscal years ended February 28, 1998 and
February 29, 1996. The effect of stock options in 1997 would be antidilutive.
Fair Value of Financial Instruments
The Company's financial instruments consist of cash and cash equivalents,
short-term investments in money market funds, other liquid assets, trade
receivables, payables, notes receivable, and debt. The fair value of all
instruments approximates the carrying value.
Reclassifications
Certain reclassifications have been made to prior years' financial statements in
order to conform with the presentation of the February 28, 1998 financial
statements.
NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS
In 1997, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 130, Reporting Comprehensive Income,
which prescribes standards for reporting comprehensive income and its
components. Comprehensive income consists of net income or loss for the current
period and other comprehensive income (income, expenses, gains and losses that
currently bypass the income statement and are reported directly as a separate
component of equity). SFAS No. 130 requires that components of comprehensive
income be reported in a financial statement that is displayed with the same
prominence as other financial statements.
34
NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS - CONTINUED
In 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, which establishes annual and interim
reporting standards for an enterprise's operating segments and related
disclosures about its products, services, geographical areas and major
customers.
Adoption of these statements will not impact the Company's financial position,
results of operations or cash flows and any effect will be limited to the form
and content of disclosures. Both SFAS No. 130 and SFAS No. 131 are effective
for the Company in fiscal 1999.
NOTE 3 - INVENTORIES
Inventories consist of the following at February 28:
1998 1997
Ingredients and supplies $1,153,433 $1,041,367
Finished candy 1,414,533 1,041,199
$2,567,966 $2,082,566
NOTE 4 - PROPERTY AND EQUIPMENT, NET
Property and equipment consists of the following at February 28:
Property and equipment 1998 1997
Land $ 513,618 $ 122,558
Building 3,665,581 3,644,357
Machinery and equipment 6,023,347 5,449,261
Furniture and fixtures 2,072,208 2,267,437
Leasehold improvements 1,389,608 1,410,948
Transportation equipment 293,357 246,499
13,957,719 13,141,060
Less accumulated depreciation 4,285,276 3,400,719
Property and equipment, net $ 9,672,443 $ 9,740,341
NOTE 5 - LINE OF CREDIT AND LONG-TERM DEBT
Line of Credit
At February 28, 1998 the Company had a $2,000,000 line of credit from a bank,
collateralized by substantially all of the Company's assets with exception of
the Company's retail store assets. Draws may be made under the line at 75% of
eligible accounts receivable plus 30% of eligible inventory up to $500,000.
Interest on borrowings is at prime (8.5% at February 28, 1998 and 8.25% at
February 28, 1997). Terms of the line require that the line be rested (that is,
that there be no outstanding balance) for a period of 60 consecutive days during
the term of the loan. The credit line expires in July, 1998.
The terms of the Line of Credit and notes payable with the bank provide for the
maintenance of certain financial covenants. Due to the level of capital
spending the Company was out of compliance with one covenant for the year ended
February 28, 1998. The Company received a waiver for such non-compliance.
35
NOTE 5 - LINE OF CREDIT AND LONG-TERM DEBT - CONTINUED
Line of Credit - Continued
On May 15, 1998, the Company used its line of credit to fund the purchase of
336,000 shares and to lend certain officers and directors funds to acquire
40,000 shares of its issued and outstanding common stock. See Note 13.
Long-Term Debt
Long-term debt consists of the following at February 28:
1998 1997
Chattel mortgage note payable in monthly installments of $10,500 through
March, 2001 including interest at 8.25% per annum, collateralized by
machinery, equipment, furniture and fixtures. $ 320,793 $ 415,557
Real estate mortgage note payable in monthly installments of $17,490
through April, 2011; interest rate of 8.25%; collateralized by land and
factory building. Interest adjusted to prime in May, 2001 and every five
years thereafter until maturity in April 2016.
1,969,930 1,614,033
Chattel mortgage note payable in monthly
installments of $12,359 through April, 2002
including interest at 8.25% per annum,
collateralized by equipment 521,427 622,158
Chattel mortgage note payable in monthly installments of $24,613 through
April, 2003 including interest at 8.94% per annum, collateralized by
machinery, equipment, furniture and fixtures. 1,251,663 1,434,090
Chattel mortgage note payable in monthly installments of $5,472 through
January, 2002; interest rate of
10.36%; collateralized by machinery, equipment, furniture and fixtures. 210,669 248,849
Chattel mortgage note payable in monthly installments of $6,396 through
April, 2003 including interest at 9.72% per annum, collateralized by
equipment, furniture and fixtures 326,001 368,783
Chattel mortgage note payable in monthly installments of $10,177 through
October, 2001 including interest at 10.35% per annum, collateralized by
machinery, equipment, furniture and fixtures. 371,265 450,432
Chattel mortgage notes payable in monthly
installments of $43,031 through March 2002 including interest at 8.75% to
9.44% per annum, collateralized by equipment, furniture and fixtures. 1,604,344 1,431,291
36
NOTE 5 - LINE OF CREDIT AND LONG-TERM DEBT - CONTINUED
Long-Term Debt - Continued
Chattel mortgage notes payable in monthly installments of $13,251 through
July, 2002 including interest at 10.5% per annum, collateralized by
machinery, equipment, furniture and fixtures. 550,081 -
7,126,173 6,585,193
Less current maturities 1,132,900 847,881
$ 5,993,273 $ 5,737,312
Maturities of long-term debt are as follows for the years ending February 28 or
29:
1999 $ 1,132,900
2000 1,241,915
2001 1,345,878
2002 1,132,483
2003 531,827
Thereafter 1,741,170
$ 7,126,173
NOTE 6 - OPERATING LEASES
The Company conducts its retail sales operations in facilities leased under five
to ten year noncancelable operating leases. Certain leases contain renewal
options for between two and ten additional years at increased monthly rentals.
The majority of the leases provide for contingent rentals based on sales in
excess of predetermined base levels.
The following is a schedule by year of future minimum rental payments required
under such leases for the year ending February 28 or 29:
1999 $ 1,168,423
2000 1,067,964
2001 966,151
2002 566,743
2003 366,306
Thereafter 442,562
$ 4,578,149
In some instances, in order to retain the right to site selection or because of
requirements imposed by the lessor, the Company has leased space for its
proposed franchise outlets. When a franchise was sold, the store was subleased
to the franchisee who is responsible for the monthly rent and other obligations
under the lease. The Company's liability as primary lessee on sublet franchise
outlets, all of which is offset by sublease rentals, is as follows for the years
ending February 28 or 29:
1999 $ 1,239,663
2000 1,067,406
2001 848,167
2002 563,461
2003 307,461
Thereafter 577,264
$ 4,603,422
37
NOTE 6 - OPERATING LEASES - CONTINUED
The following is a schedule of lease expense for all operating leases for the
three years ended February 28 or 29:
1998 1997 1996
Minimum rentals $ 2,454,744 $ 2,278,591 $ 1,547,817
Less sublease rentals (1,294,202) (1,184,301) (982,780)
Contingent rentals 100,771 47,116 56,037
$ 1,261,313 $ 1,141,406 $ 621,074
NOTE 7 - INCOME TAXES
Income tax expense (benefit) relating to continuing operations is comprised of
the following for the years ending February 28 or 29:
1998 1997 1996
Current
Federal $ 18,520 $ 230,618 $ 533,052
State 2,454 9,896 56,885
Total Current 20,974 240,514 589,937
Deferred
Federal 677,849 (768,992) 110,327
State 89,817 (87,028) 7,846
Total Deferred 767,666 (856,020) 118,173
Total $ 788,640 $ (615,506) $ 708,110
A reconciliation of the statutory federal income tax rate and the effective rate
as a percentage of pretax income is as follows for the years ending February 28
or 29:
1998 1997 1996
Statutory rate 34.0% 34.0% 34.0%
Goodwill amortization .4% .4% .4%
State income taxes, net of federal
benefit 3.1% 3.0% 2.2%
Other 1.0% .5% .4%
Effective Rate 38.5% 37.9% 37.0%
The components of deferred income taxes at February 28, 1998 and 1997 are as
follows:
Deferred Tax Assets 1998 1997
Allowance for doubtful accounts $ 82,877 $ 99,728
Accrued compensation 70,774 63,666
Deferred income - 35,944
Contribution carryover 26,511 9,610
Loss provisions 206,902 767,796
Alternative minimum tax carryforward 85,689 85,689
Deferred lease rentals 26,167 33,914
498,920 1,096,347
Deferred Tax Liabilities - Depreciation (620,016) (449,777)
Net deferred tax asset (liability) $ (121,096) $ 646,570
38
NOTE 8 - PREFERRED STOCK
On February 15, 1995, the Company called for redemption all outstanding shares
of its $1.00 Cumulative Convertible Preferred Stock at a redemption price of
$10.41, including $.21 in unpaid, accrued dividends. As of March 17, 1995, all
preferred shares had been converted or redeemed.
Each share of the $1.00 Cumulative Convertible Preferred stock was entitled to a
cumulative annual dividend of $1.00 and was convertible into common stock at
$9.00 per share of common stock with each share of preferred stock being valued
at $10.00 for the purpose of such conversion. The conversion price was subject
to adjustment in certain events. The value of each share of preferred stock for
the purpose of conversion was increased by the amount of all unpaid cumulative
dividends. The preferred stock was redeemable at the option of the Company at a
call price of $10.20 per share plus cumulative dividends.
NOTE 9 - STOCK OPTION PLANS
Under the Company's 1985 Incentive Stock Option Plan (the "1985 Plan") options
to purchase 215,000 shares of the Company's common stock were granted at prices
not less than market value at the date of grant. The 1985 Plan expired in
October 1995. Options granted under the 1985 Plan could not have a term
exceeding ten years. Options representing the right to purchase 90,000 shares of
the Company's common stock remained outstanding under the 1985 Plan at February
28, 1998.
Under the 1995 Stock Option Plan (the "1995 Plan") and the Nonqualified Stock
Option Plan for Nonemployee Directors (the "Director's Plan"), options to
purchase up to 150,000 and 90,000 shares, respectively, of the Company's common
stock may be granted at prices not less than market value at the date of grant.
Options granted may not have a term exceeding ten years. Options representing
the right to purchase 160,000 and 40,000 shares of the Company's common stock
were outstanding under the 1995 Plan and Director's Plan, respectively, at
February 28, 1998.
Options become exercisable over a one to five year period from the date of the
grant. The options outstanding under these plans will expire, if not exercised,
in March 1998 through January 2007. Options for 151,000 shares were exercisable
at February 28, 1998.
The Company has adopted the disclosure-only provisions of Financial Accounting
Standard No. 123 "Accounting for Stock-Based Compensation". In accordance with
those provisions, the Company applies APB opinion 25 and related interpretations
in accounting for its stock option plans and, accordingly, does not recognize
compensation cost if the exercise price is not less than market. If the Company
had elected to recognize compensation cost based on the fair value of the
options granted at grant date as prescribed by Financial Accounting Standard
123, net income (loss) and diluted income (loss) per share would have been
reduced to the pro-forma amounts indicated in the table below for the years
ending February 28 (in 000's except per share amounts):
1998 1997 1996
Net Income (Loss)-as reported $ 240 $ (1,366) $ 1,208
Net Income (Loss)-pro forma $ 177 $ (1,530) $ 876
Basic Income (Loss) per Share-as reported $ .08 $ (.47) $ .43
Diluted Income (Loss) per Share-as reported $ .08 $ (.47) $ .42
Basic Income (Loss) per Share-pro forma $ .06 $ (.53) $ .31
Diluted Income (Loss) per Share-pro forma $ .06 $ (.53) $ .30
39
NOTE 9 - STOCK OPTION PLANS - CONTINUED
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model utilizing the following assumptions:
1998 1997 1996
Expected dividend yield 0% 0% 0%
Expected stock price volatility 65% 50% 50%
Risk-free interest rate 6.0% 6.5% 6.5%
Expected life of options 7 years 7 years 7 years
Additional information with respect to options outstanding under the Plans at
February 28, 1998, and changes for the three years then ended was as follows:
1998
Weighted
Average
Shares Exercise Price
Outstanding at beginning of year 272,000 $ 9.01
Granted 55,000 4.55
Forfeited (37,000) 11.80
Outstanding at end of year 290,000 7.81
Options exercisable at February 28,
1998 151,000 9.22
Weighted average fair value per share
of options granted during 1998 was
$3.44.
1997
Weighted
Average
Shares Exercise Price
Outstanding at beginning of year 224,000 $ 11.95
Granted 111,000 7.05
Exercised (7,000) 3.75
Canceled (56,000) 18.25
Outstanding at end of year 272,000 9.01
Options exercisable at February 28,
1997 161,000 10.11
Weighted average fair value per share
of options granted during 1997 was
$4.04.
40
NOTE 9 - STOCK OPTION PLANS - CONTINUED
1996
Weighted
Average
Shares Exercise Price
Outstanding at beginning of year 186,000 $ 6.95
Granted 87,000 18.19
Exercised (48,000) 3.79
Forfeited (1,000) 18.25
Outstanding at end of year 224,000 11.95
Options exercisable at February 28,
1997 200,000 11.19
Weighted average fair value per share
of options granted during 1996 was
$10.79.
Information about stock options outstanding at February 28, 1998 is summarized
as follows:
Options Outstanding
Weighted average
Number remaining Weighted average
Range of exercise prices outstanding contractual life exercise price
$3.125 to 4.50 105,000 6.19 years $ 4.06
$5.125 to 7.75 117,000 8.05 years 7.11
$11.50 to 18.00 68,000 6.40 years 14.79
290,000
Options Exercisable
Weighted
Number average
Range of exercise prices exercisable exercise price
$3.125 to 4.50 53,000 $ 3.62
$5.125 to 7.75 30,800 6.62
$11.50 to 18.00 67,200 14.83
151,000
NOTE 10 - LOSS PROVISIONS
Loss provisions were provided as follows in the fiscal year ended February 28,
1997:
Store Closures
On February 11, 1997 the Company adopted a plan to close eight underperforming
Company-owned stores. The Company made a loss provision in February, 1997 for
closure of these stores in the total amount of $1,302,000 including $138,000 for
estimated operating losses to date of closure, $473,000 for estimated cost of
settlement of leases, and $691,000 for writedown of store assets to their
estimated recoverable values. A loss provision of $56,000 was made in February,
1997 for estimated cost of settlement of leases relating to the Company's
liability as primary lessee on sublet franchise outlets (also see Note 6).
41
NOTE 10 - LOSS PROVISIONS - CONTINUED
Long-Lived Asset Impairments
An impairment loss for retail operations was recognized in the amount of
$597,000 for six underperforming Company-owned stores to remain open. Current
and historical operating and cash flow losses indicate that recorded asset
values for these stores are not fully recoverable. Assets with net book value
of $885,000 were reduced to their estimated fair value based on prices of
similar assets or estimated present value of future net cash flows expected to
be generated from the stores.
Asset Obsolescence and Dispositions
A loss provision was made in the amount of $331,000 for estimated loss on future
disposition of certain obsolete factory assets and to reduce to net realizable
value certain surplus fixtures and equipment utilized in Company-owned stores.
Litigation Settlements
In fiscal 1997 the Company settled in the amount of $154,000, litigation brought
against it for premature lease termination resulting from closure in fiscal 1996
of one Company-owned store and of one franchised store where the Company was the
primary lessee on the franchisee-sublet location.
NOTE 11 - DISCONTINUED OPERATION
In December 1997, the Company decided its Fuzziwig's Candy Factory Store
("Fuzziwig's") segment did not meet its long-term strategic goals, and
accordingly, adopted a plan to discontinue its operations.
On June 5, 1998, the Company entered into a definitive agreement to sell
substantially all the assets of its Fuzziwig's segment for $1.6 million. The
Company expects this transaction to close on or about July 31, 1998 (the
"Closing Date"). The purchase price includes $180,000 cash, $100,000 of
which is payable at the Closing Date and the remaining $80,000 due six
months from the Closing Date. Pursuant to the agreement, the Company will
receive four Rocky Mountain Chocolate Factory stores currently operated as
franchised stores by one of the purchasers and valued at approximately $1.42
million.
The estimated loss on disposition of Fuzziwig's of $929,000 (inclusive of
estimated losses during the phase out period of $250,000), net of applicable
income tax benefit of $587,000, has been recorded in the accompanying statement
of operations for the year ending February 28, 1998. Losses related to the
disposition amounted to $653,234 for the fourth quarter.
Operating results of the discontinued operation have been reclassified from
amounts previously reported and have been reported separately in the statements
of operations.
42
NOTE 11 - DISCONTINUED OPERATION - CONTINUED
Summarized financial information for the discontinued operation for the years
ended February 28 or 29 follow:
1998 1997 1996
Revenues $ 2,928,403 $ 1,991,863 $ 191,157
Income (loss) from the discontinued
operation, net of income tax (benefit)
expense of ($57,235), ($217,008), (90,849) (355,991) 666
and $390
Provision for loss on disposal, net of
income tax benefit of $586,766 (929,234) - -
The net assets of the discontinued operation have been segregated in the
February 28, 1998 and 1997 balance sheets as follows:
1998 1997
Net current assets:
Inventories $ 178,765 $ 228,755
Other current assets 29,803 3,066
Deferred income taxes 103,673 -
Current liabilities (267,890) -
$ 44,351 $ 231,821
Net non-current assets:
Net property, plant and equipment $ 1,159,969 $ 2,035,027
Other assets 38,067 206,115
Deferred income taxes 357,645 119,069
$ 1,555,681 $ 2,360,211
NOTE 12 - SUPPLEMENTAL CASH FLOW INFORMATION
For the three years ended February 28 or 29:
1998 1997 1996
Interest Paid $ 658,700 $ 469,237 $ 301,481
Income Taxes Paid (Received) (30,619) 436,932 812,589
Non-Cash Financing Activities:
Company Financed Sales of Retail Store
Assets 715,931 110,000 -
Conversion of Preferred Stock into
Common Stock 1,309
NOTE 13 - SUBSEQUENT EVENT
On May 15, 1998, the Company purchased 336,000 shares and certain of its
directors and executive officers purchased 104,000 shares of the Company's
issued and outstanding common stock at $5.15 per share from La Salle National
Bank of Chicago, Illinois, which obtained these shares through foreclosure from
certain shareholders. The Company loaned certain officers and directors the
funds to acquire 40,000 of the 104,000 shares purchased by them. The loans are
secured by the related shares, bear interest payable annually at 7.5% and are
due May 15, 2003.
43
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executive Officers and Directors
NAME AGE POSITION
Franklin E. Crail......... 56 Chairman of the Board, President,
Treasurer and Director
Edward L. Dudley.......... 34 Vice President - Sales and Marketing
Gary S. Hauer............. 53 Vice President - Manufacturing and
Director
Clifton W. Folsom......... 44 Vice President - Franchise Support
Jay B. Haws............... 47 Vice President - Creative Services
Bryan J. Merryman......... 37 Vice President - Finance and Chief
Financial Officer
Virginia M. Perez......... 60 Corporate Secretary
Lee N. Mortenson.......... 62 Director
Fred M. Trainor........... 59 Director
Gerald A. Kien............ 67 Director
Everett A. Sisson......... 77 Director
Franklin E. Crail
Mr. Crail co-founded the first Rocky Mountain Chocolate Factory store in
May 1981. Since the incorporation of the Company in November 1982, he has served
as its President and a Director, and since September 1981 as its Treasurer. He
was elected Chairman of the Board in March 1986. Prior to founding the Company,
Mr. Crail was co-founder and president of CNI Data Processing, Inc., a software
firm which developed automated billing systems for the cable television
industry.
Edward L. Dudley
Mr. Dudley joined the Company in January 1997 to spearhead the Company's
newly-formed Product Sales Development function as Vice President - Sales and
Marketing, with the goal of increasing the Company's factory and retail sales.
During his 10 year career with Baxter Healthcare Corporation, Mr. Dudley served
in a number of senior marketing and sales management capacities, including most
recently that of Director, Distribution Services from March 1996 to January
1997. Mr. Dudley holds B.S. degrees in Finance and Accounting from the
University of Colorado.
Gary S. Hauer
Mr. Hauer joined the Company in May 1996 as Vice President of Manufacturing and
has served as a Director of the Company since June 1996. Mr. Hauer has served
in a number of manufacturing management capacities over a 28 year career in the
chocolate candy and confectionery industries, including 18 years with See's
Candies, the last 10 years of which he served as plant manager. Mr. Hauer
possesses a B.S. in business administration from San Jose State University.
Clifton W. Folsom
Mr. Folsom has served as Vice President of Franchise Support of the Company
since June 1989. He joined the Company in May 1983 as Director of Franchise
Sales and Support, and was promoted in March 1985 to Vice President of Franchise
Sales, a
44
position he held until he began serving in his current capacity in June 1989.
From March 1978 until joining the Company, Mr. Folsom was employed as a sales
representative by Sears Roebuck & Company.
Jay B. Haws
Mr. Haws joined the Company in August 1991 as Vice President of Creative
Services. Since 1981, Mr. Haws had been closely associated with the Company
both as a franchisee and marketing/graphic design consultant. From 1986 to
1991 he was Vice-President and President of Chocolate Factory, Inc., which
operated two Rocky Mountain Chocolate Factory franchises located in San
Francisco, California. From 1983 to 1989 he served as Vice President of
Marketing for Image Group, Inc., a marketing communications firm based in
Northern California. Concurrently, Mr. Haws was co-owner of two other Rocky
Mountain Chocolate Factory franchises located in Sacramento and Walnut Creek,
California. From 1973 to 1983 he was principal of Jay Haws and Associates, an
advertising and graphic design agency. Mr. Haws holds a B.A. in graphics
design and communication from California State University.
Bryan J. Merryman
Mr. Merryman joined the Company in December 1997 as Vice President-Finance
and Chief Financial Officer. Prior to joining the Company, Mr. Merryman was a
principal in Knightsbridge Holdings, Inc. (a leveraged buyout firm) from January
1997 to December 1997. Mr. Merryman also served as Chief Financial Officer of
Super Shops, Inc., a retailer and manufacturer of aftermarket auto parts
from July 1996 to November 1997 and was employed for more than eleven years by
Deloitte and Touche LLP, most recently as a senior manager.
Virginia M. Perez
Ms. Perez joined the Company in June 1996 and has served as the Company's
corporate secretary since February, 1997. From 1992 until joining the Company,
she was employed by Huettig & Schromm, Inc., a property management and
development firm in Palo Alto, California as executive assistant to the
president and owner. Huettig & Schromm developed, owned and managed over
1,000,000 square feet of office space in business parks and office buildings on
the San Francisco peninsula. Ms. Perez is a paralegal and has held various
administrative positions during her career including executive assistant to the
Chairman and owner of Sunset Magazine & Books, Inc.
Gerald A. Kien
Dr. Kien was first elected as a Director of the Company in August 1995. From
1993 to 1995 Dr. Kien served as President and Chief Executive Officer of Remote
Sensing Technologies, Inc., a subsidiary of Envirotest Systems, Inc., a company
engaged in the development of instrumentation for vehicle emissions testing.
From 1989 to 1993 Dr. Kien served as Chairman, President and Chief Executive
Officer of Sun Electric Corporation, a manufacturer of automotive test
equipment, and has served as a Director and as Chairman of the Executive
Committee of that Company since 1980. Sun Electric merged with Snap-On Tools in
1993, and Dr. Kien remained as President of the Sun Electric division of Snap-On
Tools until his retirement in 1994. Dr. Kien was a co-founder of the First
National Bank of Hoffman Estates and remained as a Director from 1979 to 1990,
and was a Director of the Charter Bank and Trust of Illinois from 1984 to 1990.
He served as a Director of Systems Control, Inc. and Vehicle Test Technologies,
Inc., from 1989 to 1993, both of which are engaged in emissions testing of motor
vehicles. Dr. Kien received his Ph.D. from the University of Illinois Graduate
College of Medicine, in 1959.
45
Lee N. Mortenson
Mr. Mortenson has served on the Board of Directors of the Company since 1987.
Mr. Mortenson has served as President, Chief Operating Officer and a Director of
Telco Capital Corporation of Chicago, Illinois since January 1984. Telco Capital
Corporation is principally engaged in the manufacturing and real estate
businesses. He was President, Chief Executive Officer and a Director of
Sunstates Corporation (formerly Acton Corporation) from May 1988 to December
1990 and he has been President, Chief Operating Officer and a Director of
Sunstates Corporation since December 1990. Sunstates Corporation is a publicly
traded company primarily engaged in real estate development and manufacturing.
Mr. Mortenson has been a Director of Alba-Waldensian, Inc., which is principally
engaged in the manufacturing of apparel and medical products, since 1984 and has
served as its President and Chief Executive Officer since February 1997. Mr.
Mortenson has also served as a Director of NRG Inc., a leasing company, since
1987. On December 24, 1996, an Agreed Order of Liquidation with a finding of
insolvency was entered under the Illinois Insurance Code against the principal
subsidiary of Sunstates Corporation, Coronet Insurance Company ("Coronet"), and
Coronet's subsidiaries, National Assurance Indemnity Company ("National
Assurance") and Crown Casualty Company ("Crown"), pursuant to which, among other
things, all of the assets of Coronet, National Assurance and Crown were
transferred to the Office of the Special Deputy for the purposes of winding up
the affairs of such companies. On February 27, 1997, a consent order appointing
the Florida Department of Insurance as Receiver for purposes of liquidation was
entered under the Florida Insurance Code against Casualty Insurance Company of
Florida ("Casualty"), a subsidiary of Coronet. Mr. Mortenson, prior to March
14, 1997, was a Director and President of each of Coronet, National Assurance,
Crown and Casualty. On January 24, 1997, Hickory White Company, a furniture
manufacturing subsidiary of Sunstates Corporation, filed a voluntary petition
under Chapter 11 of the Federal Bankruptcy Code. All of the assets of Hickory
White Company were sold to an unrelated party on March 11, 1997. Mr. Mortenson
is Vice President and a Director of Hickory White Company.
Everett A. Sisson
Mr. Sisson was first elected as a Director of the Company in August 1995.
Mr. Sisson is President of The American Growth Group, which is engaged in land
development, investment, management services and management consulting, a
position he has held since he formed the firm in 1966. Mr. Sisson served as a
Director of the Century Companies of America, a company providing life insurance
and related financial products, from 1962 until 1991, and Chairman of the Board
from 1977 until 1983. Mr. Sisson was a Director of Coronet from 1992 through
February 1997. During various periods over the past 20 years, Mr. Sisson served
as a Director and member of several Board committees of Libco Corporation,
Wisconsin Real Estate Investment Trust, Hickory Furniture Company, Telco Capital
Corporation, Greater Heritage Corporation, Indiana Financial Investors Inc.,
Sunstates Corporation and Acton Corporation.
Fred M. Trainor
Mr. Trainor has served as a Director since August 1992. Mr. Trainor is the
founder, and since 1984 has served as Chief Executive Officer and President of
AVCOR Health Care Products, Inc., Fort Worth, Texas, a manufacturer and marketer
of specialty dressings products. Prior to founding AVCOR Health Care Products,
Inc., in 1984, Mr. Trainor was a founder, Chief Executive Officer and President
of Tecnol, Inc. of Fort Worth, Texas, also a company involved with the health
care industry. Before founding Tecnol, Inc., Mr. Trainor was with American
Hospital Supply Corporation (AHSC) for 13 years in a number of management
capacities.
46
The Board of Directors has a standing Audit Committee and Compensation
Committee, each consisting of Messrs. Mortenson, Trainor, Sisson and Kien.
Currently, all Directors of the Company are elected annually by the stockholders
and hold office until their respective successors are elected and qualified.
SECTION 16 (a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
The Company has no knowledge that any Director, executive officer or 10%
stockholder was required to file a Form 5 for fiscal 1998 and failed to do so,
and the Company has received a written representation that a Form 5 was not
required from each such person. In making these disclosures, the Company has
relied solely on written representations of its directors, executive officers
and 10% stockholders and copies of the reports filed by them with the Securities
and Exchange Commission.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information with respect to annual
compensation paid for the years indicated to the Company's "Named Officers". No
other executive officers of the Company met the minimum compensation threshold
of $100,000 for inclusion in the table.
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
AWARDS-
ANNUAL COMPENSATION SECURITIES
UNDERLYING
NAME AND PRINCIPAL OPTIONS ALL OTHER
POSITION YEAR SALARY(1) BONUS (#)(2) COMPENSATION(3)
Franklin E. Crail,
Chairman of the Board
and President 1998 $150,000 - - $2,250
1997 $150,000 - - $2,250
1996 $146,538 $10,000 - $1,833
Gary S. Hauer,
Vice President -
Manufacturing 1998 $100,000 $12,500 - $2,250
1997(4) $ 75,071 - 30,000 -
1996 - - - -
(1) Includes amounts deferred at the Named Officers' election pursuant to
the Company's 401(k) Plan.
(2) Options to acquire shares of Common Stock under the 1995 Stock Option
Plan. All options have ten-year terms. The options granted vest with
respect to one-fifth of the shares covered thereby annually beginning
on the date of grant.
(3) Represents Company contributions on behalf of the Named Officers under
the Company's 401(k) Plan.
(4) Mr. Hauer joined the Company as an officer in May 1996.
Additional columns required by Securities and Exchange Commission rules to be
included in the foregoing table, and certain additional tables required by such
rules, have been omitted because no compensation required to be disclosed
therein was paid or awarded to the Named Officers.
47
OPTION GRANTS DURING FISCAL 1998
Neither of the Named Officers received grants in fiscal 1998.
AGGREGATED OPTION EXERCISES DURING FISCAL 1998 AND FISCAL YEAR END OPTION VALUES
The following table provides information regarding the number and value of
options held by the Named Officers at fiscal year end. No options were
exercised by the Named Officers during fiscal 1998. The Company does not have
any outstanding stock appreciation rights.
Number of Securities
Shares Underlying Unexercised Value of Unexercised In-
Acquired on Value Options at Fiscal the-Money Options at Fiscal
Exercise Realized Year End (#) Year End ($) (1)
Name (#) (#) Exercisable Unexercisable Exercisable Unexercisable
Franklin E. Crail - - - - - -
Gary S. Hauer - - 6,000 24,000 - -
(1) The closing bid price of the Common Stock on the Nasdaq Stock Market on
February 27, 1998, was $4.75 per share. None of the options held
by the Named Officers were in the money on that date.
COMPENSATION OF DIRECTORS
Directors of the Company do not receive any compensation for serving on the
Board or on committees. Directors who are not officers or employees are entitled
to receive stock option awards under the Company's 1990 Nonqualified Stock
Option Plan for Nonemployee Directors (the "Director's Plan").
The Director's Plan, as amended, provides for automatic grants of nonqualified
stock options covering a maximum of 90,000 shares of Common Stock of the Company
to Directors of the Company who are not also employees or officers of the
Company and who have not made an irrevocable, one-time election to decline to
participate in the plan. The Director's Plan provides that during the term of
the plan options will be granted automatically to new nonemployee Directors upon
their election. Each such option permits the nonemployee Director to purchase
10,000 shares of Common Stock at an exercise price equal to the fair market
value of the Common Stock on the date of grant of the option. Each nonemployee
Director's option may be exercised in full during the period beginning one year
after the grant date of such option and ending ten years after such grant date,
unless the option expires sooner due to termination of service or death.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of the Company's Board of Directors consists of Lee
N. Mortenson, Fred M. Trainor, Gerald A. Kien, and Everett A. Sisson. None of
the foregoing persons is or has been an officer of the Company.
48
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The following table sets forth information, at May 29, 1998, with respect to (i)
each person known to the Company to be the beneficial owner of more than 5% of
the Company's Common Stock, (ii) the shares of the Company's Common Stock
beneficially owned by each Director and nominee (which includes the Named
Officers) and (iii) by Directors and executive officers of the Company as a
group.
The number of shares beneficially owned includes shares of Common Stock in which
the persons named below have either investment or voting power. A person is
also deemed to be the beneficial owner of a security if that person has the
right to acquire beneficial ownership of that security within sixty (60) days
through the exercise of an option or through the conversion of another security.
Except as noted, each beneficial owner has sole investment and voting power with
respect to the Common Stock.
Common Stock not outstanding that is subject to options is deemed to be
outstanding for the purpose of computing the percentage of Common Stock
beneficially owned by the person holding such options, but is not deemed to be
outstanding for the purpose of computing the percentage of Common Stock
beneficially owned by any other person.
Common Stock
Amount and
Name of Nature of Percent
Beneficial Beneficial of
Owner Ownership Class
Franklin E. Crail (1) 298,107 11.5%
Clyde Wm. Engle et al. (1) 219,357 (2) 8.5%
Fred M. Trainor 70,000 (4) 2.7%
Gary S. Hauer 31,991 (3) 1.2%
Everett A. Sisson 10,000 (4) .4%
Gerald A. Kien 10,000 (4) .4%
Lee N. Mortenson 21,000 (4) .8%
All executive officers
and directors as a
group (10 persons) 565,502 (5) 21.8%
(1) Mr. Engle's address is 4433 West Touhy Avenue, Lincolnwood, Illinois
60646. Mr. Crail's address is the same as the Company's address.
(2) The following information was provided to the Company by Mr. Engle. Of the
219,357 shares indicated as being beneficially owned by Mr. Engle, 115,000
shares are owned by GSC Enterprises, Inc., a corporation in which Mr. Engle
owns a majority interest, and 10,000 shares are owned beneficially by
members of Mr. Engle's immediate family. Mr. Engle disclaims beneficial
ownership of the shares owned by his family members.
(3) Includes 12,000 shares Mr. Hauer has the right to acquire within 60 days
through the exercise of employee stock options previously granted to him
and 5,991 shares beneficially owned by his wife. Mr. Hauer disclaims
beneficial ownership of the shares owned by his wife. Mr. Hauer has
pledged 8,000 shares owned by him to the Company to secure payment of
certain indebtedness to the Company incurred by Mr. Hauer in connection
with his purchase of such shares.
(4) Includes 10,000 shares that Messrs. Mortenson, Trainor, Sisson and Kien
each has the right to acquire within 60 days through the exercise of
options granted
49
pursuant to the Director's Plan. Mr. Mortenson has pledged 8,000 shares
owned by him to the Company to secure payment of certain indebtedness to
the Company incurred by Mr. Mortenson in connection with his purchase of
such shares.
(5) Includes shares which officers and directors as a group have the right to
acquire through the exercise of options granted pursuant to the Company's
1985 Incentive Stock Option Plan, 1995 Stock Option Plan, and the
Director's Plan.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
NONE
PART IV.
ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. Financial Statements
Page
Report of Independent Certified Public Accountants 27
Statements of Operations 28
Balance Sheets 30
Statements of Changes in Stockholders' Equity 31
Statements of Cash Flows 32
2. Financial Statement Schedules
Schedules have been omitted because the required information is not
present or not present in amounts sufficient to require submission of
the schedule, or because the information required is included in the
financial statements or the notes thereto.
50
3. Exhibits
Exhibit Incorporated by
Number Description Reference to
3.1 Articles of Incorporation of Exhibit 3.1 to Current Report
the Registrant, as amended on Form 8-K of the Registrant
filed on August 1, 1988.
3.2 By-laws of the Registrant, as Filed herewith.
amended on November 25, 1997
4.1 Specimen Common Stock Exhibit 4.1 to Current Report
Certificate on Form 8-K of the Registrant
filed on August 1, 1988.
4.2 Term Loan and Credit Agreement Exhibit 4.18 to the Annual
dated April 5, 1996 in the amount Report on Form 10-K of
of $2,000,000 between Norwest Registrant for the fiscal year
Banks and the Registrant ended February 29, 1996.
4.3 Amendments dated February 5, 1997, Exhibit 4.12 to the Annual
May 2, 1997, and May 22, 1997 to Report on Form 10-K of the
Term Loan and Credit Agreement Registrant for the fiscal year
dated April 5, 1996 in the amount ended February 28, 1997.
of $2,000,000 between Norwest
Banks and the Registrant
4.4 Amendments dated December 23, Filed herewith.
1997, March 9, 1998, & May 6,
1998 to Term Loan and Credit
Agreement dated April 5, 1996
in the amount of $2,000,000
between Norwest Banks and the
Registrant
4.5 Instruments with respect to
long-term debt not exceeding
10% of the total assets of the
Company have not been filed.
The Company agrees to furnish
a copy of such instruments to
the Securities and Exchange
Commission upon request.
10.1 Form of Stock Option Agreement Exhibit 10.3 to the Annual
for Incentive Stock Option Report on Form 10-K of the
Plan of the Registrant * Registrant for the fiscal
year ended February 28, 1986.
10.2 Incentive Stock Option Plan of Exhibit 10.2 to the Annual
the Registrant as amended July Report on Form 10-K of the
27, 1990 * Registrant for the fiscal year
ended February 28, 1991.
10.4 Current form of franchise Exhibit 10.4 to the Annual
agreement used by the Report on Form 10-K of the
Registrant Registrant for the fiscal
year ended February 28, 1997.
10.5 Form of Real Estate Lease Exhibit 10.7 to Registration
51
Exhibit Incorporated by
Number Description Reference to
between the Registrant as Statement on Form S-18
Lessee and franchisee as (Registration No. 33-2016-D).
Sublessee
10.7 Form of Nonqualified Stock Exhibit 10.8 to the Annual
Option Agreement for Report on Form 10-K of the
Nonemployee Directors of the Registrant for the fiscal
Registrant * year ended February 28, 1991.
10.8 Nonqualified Stock Option Plan Exhibit 10.9 to the Annual
for Nonemployee Directors Report on Form 10-K of the
dated March 20, 1990 * Registrant for the fiscal
year ended February 28, 1991.
10.9 1995 Stock Option Plan of the Exhibit 10.9 to Registration
Registrant* Statement on Form S-1
(Registration No. 33-62149)
filed August 25, 1995.
10.10 Forms of Incentive Stock Exhibit 10.10 to Registration
Option Agreement for 1995 Statement on Form S-1
Stock Option Plan* (Registration No. 33-62149)
filed on August 25, 1995.
10.11 Forms of Nonqualified Stock Exhibit 10.11 to Registration
Option Agreement for 1995 Statement on Form S-1
Stock Option Plan* (Registration No. 33-62149)
filed on August 25, 1995.
10.12 Form of Indemnification Filed herewith.
Agreement between the
Registrant and its directors
10.13 Form of Indemnification Filed herewith.
Agreement between the
Registrant and its officers
10.14 Form of Promissory Note and Filed herewith.
Stock Pledge Agreement between
the Registrant and certain
of its officers and directors
10.15 Asset Purchase Agreement dated Filed herewith.
June 5, 1998 between the
Registrant as seller and
Resort Confections, Inc. et al.,
as purchasers
11.1 Statement re: computation of Filed herewith.
per share earnings
23.1 Consent of Independent Public Filed herewith.
Accountants
27.1 Fiscal 1998 Financial Data Filed herewith.
52
Exhibit Incorporated by
Number Description Reference to
Schedule
27.2 Restated fiscal 1997 Financial Filed herewith.
Data Schedule
27.3 Restated fiscal 1996 Financial Filed herewith.
Data Schedule.
* Management contract or compensatory plan
(b) REPORTS ON FORM 8-K.
-------------------
No reports on Form 8-K were filed by the Registrant during the fourth
quarter of the year ended February 28, 1998.
53
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE
FACTORY, INC.
By/S/ Bryan J. Merryman
-------------------
BRYAN J. MERRYMAN
Vice-President - Finance
Chief Financial Officer
Date: June 10, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: June 10, 1998 /S/ Franklin E. Crail
--------------------------
FRANKLIN E. CRAIL
Chairman of the Board of
Directors, President,
Treasurer and Director
(principal executive officer)
Date: June 10, 1998 /S/ Bryan J. Merryman
--------------------------
BRYAN J. MERRYMAN
Vice President - Finance
Chief Financial Officer
(principal financial and
accounting officer)
Date: June 10, 1998 /S/ Gary S. Hauer
--------------------------
GARY S. HAUER
Vice President - Manufacturing,
Director
Date: June 10, 1998 /S/ Gerald A Kien
--------------------------
GERALD A. KIEN, Director
Date: June 10, 1998 /S/ Lee N. Mortenson
--------------------------
LEE N. MORTENSON, Director
Date: June 10, 1998 /S/ Everett A. Sisson
--------------------------
EVERETT A. SISSON, Director
Date: June 10, 1998 /S/ Fred M. TRAINOR
--------------------------
FRED M. TRAINOR, Director
54
EXHIBIT INDEX
Sequentially
Exhibit Incorporated by Numbered
Number Description Reference to Page
3.1 Articles of Exhibit 3.1 to Current Report
Incorporation of the on Form 8-K of the Registrant
Registrant, as amended filed on August 1, 1988.
3.2 By-laws of the Filed herewith.
Registrant, as amended
on November 25, 1997
4.1 Specimen Common Stock Exhibit 4.1 to Current Report
Certificate on Form 8-K of the Registrant
filed on August 1, 1988.
4.2 Term Loan and Credit Exhibit 4.18 to the Annual
Agreement dated April 5, Report on Form 10-K of
1996 in the amount of Registrant for the fiscal
$2,000,000 between year ended February 29, 1996.
Norwest Banks and the
Registrant
4.3 Amendments dated Exhibit 4.12 to the Annual
February 5, 1997, May 2, Report on Form 10-K of the
1997, and May 22, 1997 Registrant for the fiscal year
to Term Loan and Credit ended February 28, 1997.
Agreement dated April 15,
1996 in the amount of
$2,000,000 between
Norwest Banks and the
Registrant
4.4 Amendments dated Filed herewith.
December 23, 1997,
March 9, 1998, & May 6,
1998 to Term Loan and
Credit Agreement dated
April 5, 1996 in the
amount of $2,000,000
between Norwest Banks and
the Registrant
4.5 Instruments with
respect to long-term
debt not exceeding 10%
of the total assets of
the Company have not
been filed. The
Company agrees to
furnish a copy of such
instruments to the
Securities and Exchange
Commission upon
request.
10.1 Form of Stock Option Exhibit 10.3 to The Annual
Agreement for the Report on Form 10-K of the
Registrant * Registrant for the fiscal year
ended February 28, 1986.
10.2 Incentive Stock Option Exhibit 10.2 to the Annual
Plan of the Registrant Report on Form 10-K of the
as amended July 27, Registrant for the fiscal year
1990 * ended February 28, 1991.
10.4 Current form of Exhibit 10.4 to the Annual
franchise agreement Report on Form 10-K of the
used by the Registrant Registrant for the fiscal year
ended February 28, 1997.
55
Sequentially
Exhibit Incorporated by Numbered
Number Description Reference to Page
10.5 Form of Real Estate Exhibit 10.7 to Registration
Lease between the Statement on Form S-18
Registrant as Lessee (Registration No. 33-2016-D).
and franchisee as
Sublessee
10.7 Form of Nonqualified Exhibit 10.8 to the Annual
Stock Option Agreement Report on Form 10-K of the
for Nonemployee Registrant for the fiscal year
Directors for the ended February 28, 1991.
Registrant *
10.8 Nonqualified Stock Exhibit 10.9 to the Annual
Option Plan for Report on Form 10-K of the
Nonemployee Directors Registrant for the fiscal year
dated March 20, 1990 * ended February 28, 1991.
10.9 1995 Stock Option Plan Exhibit 10.9 to Registration
of the Registrant* Statement on Form S-1
(Registration No. 33-62149)
filed August 25, 1995.
10.10 Forms of Incentive Exhibit 10.10 to Registration
Stock Option Agreement Statement on Form S-1
for 1995 Stock Option (Registration No. 33-62149)
Plan* filed on August 25, 1995.
10.11 Forms of Nonqualified Exhibit 10.11 to Registration
Stock Option Agreement Statement on Form S-1
for 1995 Stock Option (Registration No. 33-62149)
Plan* filed on August 25, 1995.
10.12 Form of Indemnification Filed herewith.
Agreement between the
Registrant and its
directors
10.13 Form of Indemnification Filed herewith.
Agreement between the
Registrant and its
officers
10.14 Form of Promissory Note Filed herewith.
and Stock Pledge Agreement
between the Registrant and
certain of its officers
and directors
10.15 Asset Purchase Filed herewith.
Agreement dated June 5,
1998 between the
Registrant as seller and
Resort Confections, Inc.
et al., as purchasers
56
Sequentially
Exhibit Incorporated by Numbered
Number Description Reference to Page
11.1 Statement re: Filed herewith.
computation of per
share earnings
23.1 Consent of Independent Filed herewith.
Public Accountants
27.1 Fiscal 1998 Financial Filed herewith.
Data Schedule
27.2 Restated fiscal 1997 Filed herewith.
Financial Data Schedule
27.3 Restated fiscal 1996 Filed herewith.
Financial Data Schedule
57