-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BFuK8m42u5JrqYX9GMKzICDLu7jdYgJcxS1heNG7vo1jmwbmVcDIrbGKgEs3w0X0 1GUHcOEGLi/1tA4XCoPT8A== 0000912057-97-018976.txt : 19970723 0000912057-97-018976.hdr.sgml : 19970723 ACCESSION NUMBER: 0000912057-97-018976 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19970228 FILED AS OF DATE: 19970529 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ROCKY MOUNTAIN CHOCOLATE FACTORY INC CENTRAL INDEX KEY: 0000785815 STANDARD INDUSTRIAL CLASSIFICATION: 2060 IRS NUMBER: 840910696 STATE OF INCORPORATION: CO FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-14749 FILM NUMBER: 97615769 BUSINESS ADDRESS: STREET 1: 265 TURNER DR CITY: DURANGO STATE: CO ZIP: 81301 BUSINESS PHONE: 3032590554 MAIL ADDRESS: STREET 1: 265 TURNER DRIVE CITY: DURANGO STATE: CO ZIP: 81301 10-K 1 FORM 10-K UNITED STATES 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, 1997 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 or other jurisdiction of (I.R.S.Employer incorporation or organization) Identification No.) 265 Turner Drive, Durango, Colorado 81301 - - - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (970) 259-0554 --------------- (Registrant's telephone number) 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. [ ] At May 12, 1997, there were 2,912,299 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 12, 1997) held by non-affiliates was $5,368,698. Documents incorporated by reference: None The Exhibit Index is located on page 55. This document contains 159 pages including exhibits. ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. 1997 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS PART I ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 ITEM 2. PROPERTIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 ITEM 3. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . . . . . 18 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . . . . . . 18 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. . . . . . . . . . . . . . . . . . 18 ITEM 6. SELECTED FINANCIAL DATA. . . . . . . . . . . . . . . . . . . . . . 20 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS . . . . . . . . . 21 ITEM 8. FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . 30 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE . . . . . . . . 49 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT . . . . . . . . 49 ITEM 11. EXECUTIVE COMPENSATION . . . . . . . . . . . . . . . . . . . . . . 51 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. . . . . . . . . . . . . . . . . . . . . . . 52 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS . . . . . . . . . . 54 PART IV ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . . . . . . . . 55 2 PART I. ITEM 1. BUSINESS GENERAL Founded in 1981 and incorporated in Colorado in 1982, Rocky Mountain Chocolate Factory, Inc. is a manufacturer, franchiser and operator of two retail concepts: Rocky Mountain Chocolate Factory-TM- and Fuzziwig's Candy Factory-TM-. Headquartered in Durango, Colorado, the Company manufactures an extensive line of premium chocolate candies and other confectionery products for sale at its franchised and Company-owned Rocky Mountain Chocolate Factory stores. Fuzziwig's Candy Factory is a new concept store that sells hard conventional and nostalgic/unusual candies (which are not manufactured by the Company, but procured from wholesale candy suppliers) in a themed, self-serve environment featuring animation, movement, music, color and entertainment. As of April 30, 1997 there were 43 Company-owned and 172 franchised Rocky Mountain Chocolate Factory stores operating in 42 states and Canada, and 12 Company-owned and 1 franchised Fuzziwig's store operating in 11 states. Approximately 30% 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 ambiance at "Rocky Mountain Chocolate Factory" stores. The aroma and sight of products being made attract passersby and assures them that those products are indeed fresh. Fuzziwig's Candy Factory stores sell only pre-made candies. No candies are prepared on Fuzziwig's premises. The Company believes that its principal competitive strengths lie in its name recognition, and its reputation for the quality, variety and 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. In addition, the Company believes it derives a competitive strength by manufacturing its own chocolate candy products, through which the Company can better maintain its high product quality standards, offer proprietary products, manage costs, control production and shipment schedules and potentially pursue new or under-utilized distribution channels for its Rocky Mountain Chocolate Factory candy line. The Company's revenues come from three principal sources: (i) sales to franchisees of chocolates and other confectionery products manufactured by the Company (38-44-47%); (ii) sales to the public at Company-owned stores of chocolates and other confectionery products (51-42-37%) and (iii) the collection of initial fees and royalties from franchisees (11-14-16%). The figures in parentheses show the percentage of total revenues attributable to each source for fiscal years 1997, 1996 and 1995, respectively. The total U.S. candy market exceeded $14.0 billion of sales in 1994, according to the National Confectionery Association. 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 10 pounds per year nationally, generating annual sales of approximately $7.0 billion. Sales of chocolate products are expected to grow at a rate of 3 to 4% annually, according to THE CANDY MARKET. The Company's executive offices are located at 265 Turner Drive, Durango, Colorado 81301 and its telephone number is (970) 259-0554. 3 BUSINESS STRATEGY The Company's objective is to build on its position as a leading franchiser and operator of retail chocolate stores in the United States and to continually seek 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, who has over 40 years of experience in the confectionery industry. 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, is executing a major program designed 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. Candy sold in its Fuzziwig's stores is purchased from wholesale candy suppliers to provide a broad variety of hard conventional and unusual/nostalgic candies of a level of quality competitive with that provided by other themed or bulk hard candy stores. STORE ATMOSPHERE AND AMBIANCE. The Company seeks to establish an enjoyable and inviting atmosphere in each Rocky Mountain Chocolate Factory and Fuzziwig's Candy Factory store. Each Rocky Mountain Chocolate Factory 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. Fuzziwig's Candy Factory stores, although not providing in-store candy preparation, provide a fun-filled experience for the customer through the use of animation, color, music and movement in this themed, stylized "candy factory". The Company's design staff has developed easily replicable designs and specifications to ensure that the Rocky Mountain Chocolate Factory and Fuzziwig's Candy Factory concepts are consistently implemented throughout the system. The Company in fiscal 1998 will be testing new store designs for both Rocky Mountain Chocolate Factory and Fuzziwig's concepts with the goal of increasing same store retail sales and improving store economics. Included in the new designs is use of an animated store front window at Rocky Mountain Chocolate Factory stores to attract consumer interest and a potential modified design of the existing Fuzziwig's Candy Factory store window. SITE SELECTION. Careful selection of a site is critical to the success of a Rocky Mountain Chocolate Factory or Fuzziwig's Candy 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 years, except for fiscal 1997: 1993 1.0% 1994 1.3% 1995 3.4% 1996 2.9% 1997 (.52%) 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 and Fuzziwig's store ambiances and themes. The Company has developed and will be testing a redesigned store concept in the second quarter of fiscal 1998. The Company is currently developing an animated front window for its Rocky Mountain Chocolate Factory stores and redesigning its existing Fuzziwig's Candy Factory store window to add more movement, color and music to attract the consumer into the store. It is felt that development and sale of superior new products such as its new line of sugar-free products as discussed above, 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 1997, the Company experienced a same store pounds purchased decline of 3.6%. The decline in same store pounds purchased from the factory continued what appears to be a trend of a shift in sales mix toward store-made and authorized vendor products and away from factory made products. The Company has implemented a program designed to reverse the decline and to increase same store pounds purchased from the factory through new product development and introduction, new packaging development and purchase-volume-based rebates on factory product purchased by its franchisees. The Company has, at the same time, hired a new Vice President - Product Sales Development with extensive product and marketing management experience to spearhead the new product and packaging development effort. His charter, in addition to new product development, is to emphasize active sales promotion of new and existing products, to assess and assure the provision of enhanced customer service and to evaluate the potential of alternative channels of distribution for the Company as discussed below. The Company believes that a one-time increase of 10% in same store pounds purchased is possible based upon historically achieved relationships between retail revenues and pounds purchased from the factory, followed by modest growth or stability. Such an increase would provide a strong element to promote factory revenue growth. No guarantee can be given, however, that such an increase will in fact be achieved. COMPANY STORES. The Company, in fiscal 1997, experienced financial losses in its Company-owned store program primarily as a result of disappointing results of new Rocky Mountain Chocolate Factory stores established in fiscal 1997 and 1996, together with same store retail sales declines at a number of its existing stores. A same store sales decline of 2.7% partially offset the impact of an increased number of stores (57 at February 28, 1997 in comparison with 42 at February 29, 1996) on total revenues generated by Rocky Mountain Chocolate Factory and Fuzziwig's Company-owned stores. Poor sales volume results occurred largely because of lower foot traffic than expected 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. Disappointing sales volumes resulted in insufficient sales volume leveraging of expenses producing financial losses for the program. The Company in fiscal 1998 will close an estimated 8 underperforming Rocky Mountain Chocolate Factory stores (no Fuzziwig's stores are currently slated for closure) and sell to potential franchisees certain other stores with the goal of improving Company-owned store program profitability and of reducing the number of Company-owned stores to a nucleus of more profitable store locations. Additionally, the Company in fiscal 1997 made impairment provisions reducing the asset values on its books for "impaired" Company-owned stores. 5 The Company in fiscal 1998 anticipates opening few Company-owned stores and to refocus its efforts to continue to improve the profitably of the smaller number of remaining stores. In particular, the Company is testing a new store design in conjunction with a program of new product introduction with the goal of increasing same store retail sales. It is coupling this effort with a focused continued program of improving store margins and reducing expenses by optimizing product mix, effecting control and motivational policies, practices and programs to reduce theft and through further emphasis on a financial control and bonus program to assure achievement of expense targets. 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 equipment including a computer-controlled shell-filling machine for truffles, a candy bar molding machine, an automated pre-mixer to mix chocolate and nuts and an automated tempering machine to control the tempering of the chocolate used in the manufacture of the Company's chocolate products. These items enable the Company to produce certain of its products much more quickly and at a lower cost than previously. In March 1996, the Company implemented a comprehensive MRP II forecasting, planning, scheduling and reporting system to improve the efficiency of manufacturing operations. The Company in the spring of calendar year 1995, 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 The Company opened its first Rocky Mountain Chocolate Factory store in 1981 and at the end of fiscal 1993 had a total of 88 stores, most of which were franchised. Over the last four years, the Company has increased its total number of stores to 228. Key elements of the Company's expansion strategy include: SELECTIVE 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 saturation of 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, mixed use and factory outlet centers to satisfy demand for franchises through establishment of additional stores as prime locations become available. The Company believes, however, that further growth in revenues will come primarily from development and execution of sales through the potential opening of new channels of distribution (see "New Channels of Distribution," below) and through increased same store factory and retail sales from/at existing locations, as discussed below. 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. As discussed above, the Company is experiencing a slowdown in the availability of new factory outlet locations and saturation of other environments where its concept has proven to be successful. The Company is exploring new channels of distribution, expansion of its Fuzziwig's concept, and is seeking to secure increased purchases of its products from existing store locations as a basis for its continued growth. 6 NAME RECOGNITION AND NEW MARKET PENETRATION. The Company believes the visibility of its stores and the high tourist 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. The Company believes this growing name recognition will facilitate its future growth. POSITION FUZZIWIG'S FOR FASTER GROWTH. The Company believes the new, Fuzziwig's Candy Factory-TM- store concept, may allow it to expand its presence in the Company's existing market environments. The concept uses creative lighting, music, animation and movement to entertain customers and to appeal to both children and adults. A total of 13 Fuzziwigs-TM- stores (12 Company-owned and 1 franchised) were in operation at April 30, 1997. The new self-serve store concept sells a line of hard conventional and unusual/nostalgic candies much different from candies sold at existing Rocky Mountain Chocolate Factory stores. The Company is currently in process of redesigning of the Fuzziwig's store plan including fixtures and animation with the goal of reducing cost, allowing "scalability" to lower space requirements, particularly in the regional mall environment, with the goal of improving store economics. Evidence from operation of Fuzziwig's stores in locations where Rocky Mountain Chocolate Factory stores also exist is that the concept does not compete with or detract significantly from the sales volume of existing Rocky Mountain Chocolate Factory stores. The Company believes this is due to the different line of candies sold by Fuzziwig's stores relative to that sold by its Rocky Mountain Chocolate Factory Stores. NEW CHANNELS OF DISTRIBUTION. The Company is currently exploring the opening of new channels of distribution to increase sales of its products. The Company believes, as discussed above, that availability of locations where its Rocky Mountain Chocolate Factory store concept has proven successful is imposing constraint to its future growth. The Company feels that distribution of its products through vehicles such as: Fund-raising Mail order Corporate sales may help restore the Company's growth momentum. The Company is currently gathering facts preparatory to a test of fund raising at several test sites throughout the U.S. and is beginning to assess the potential of a Corporate sales program for the Company. The Company anticipates within the second quarter of fiscal 1998 development of a mail order catalogue for use during the Christmas holiday selling season. The Company believes that, should initial assessment of these distribution concepts produce positive results, that (with the exception of a Christmas catalogue to be developed and utilized in the third quarter of fiscal 1998) that they will be developed commercially in the first quarter of fiscal 1999. The Company anticipates that execution of distribution through these alternative channels will not compete with existing Rocky Mountain Chocolate Factory stores both due to a geographical focus of the programs away from areas of Rocky Mountain Chocolate Factory store concentration and due to distribution through these channels of a small, select group of Rocky Mountain Chocolate Factory products. The following tables set forth the number of Rocky Mountain Chocolate Factory stores opened and closed during the last five fiscal years: 7
Rocky Mountain Chocolate Factory Stores --------------------------------------- YEAR ENDED FEBRUARY 28 OR 29, ----------------------------- 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- Company-owned stores: Opened . . . . . . . . . . . . . . . . . . . 1 8 13 18 11 Closed . . . . . . . . . . . . . . . . . . . 1 1 1 2 3 Acquired from franchisees. . . . . . . . . . 0 0 1 2 0 Sold to franchisees. . . . . . . . . . . . . 2 1 4 0 3 Total open at year end . . . . . . . . 7 13 22 40 45 Franchised stores: . . . . . . . . . . . . . . . Opened . . . . . . . . . . . . . . . . . . . 18 30 30 27 22 Closed . . . . . . . . . . . . . . . . . . . 2 6 8 5 6 Acquired from Company . . . . . . . . . . . 2 1 4 0 3 Sold to Company. . . . . . . . . . . . . . . 0 0 1 2 0 Total open at year end . . . . . . . . 81 106 131 151 170 System-wide stores: Opened . . . . . . . . . . . . . . . . . . . 19 38 43 45 33 Closed . . . . . . . . . . . . . . . . . . . 3 7 9 7 9 Total open at year end. . . . . . . . . 88 119 153 191 215
Fuzziwig's Candy Factory Stores ------------------------------- YEAR ENDED FEBRUARY 28 OR 29, ------------------ 1996 1997 ---- ---- Company-owned stores:. . . . . . . . . . Opened. . . . . . . . . . . . . . . . 2 10 Closed. . . . . . . . . . . . . . . . - - Acquired from franchisees . . . . . . - - Sold to franchisees . . . . . . . . . - - Total open at year end. . . . . . . 2 12 Franchised stores: Opened. . . . . . . . . . . . . . . . - 1 Closed. . . . . . . . . . . . . . . . - - Acquired from Company . . . . . . . . - - Sold to Company . . . . . . . . . . . - - Total open at year end. . . . . . . - 1 System-wide stores:. . . . . . . . . . . Opened. . . . . . . . . . . . . . . . 2 11 Closed. . . . . . . . . . . . . . . . - - Total open at year end. . . . . . . 2 13 As of April 30, 1997, the Company had signed leases for 3 additional Rocky Mountain Chocolate Factory and 2 Fuzziwig's planned to open as Company-owned stores and no leases for additional franchised stores. The Company is not in the process of negotiating leases for any further Company-owned or franchised stores. STORE CONCEPT The Company seeks to establish a fun and inviting atmosphere in its Rocky Mountain Chocolate Factory and Fuzziwig's store locations. 8 ROCKY MOUNTAIN CHOCOLATE FACTORY STORES: 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 30% 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. As discussed above, the Company is executing a program of store redesign to provide a more attractive and effective retail sales environment embodying more shelf space, accessibility/visibility of products, and animation, while retaining the Rocky Mountain Chocolate Factory ambiance and theme. 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. FUZZIWIG'S CANDY FACTORY STORES: Fuzziwig's Candy Factory stores have been designed to provide an entertaining, fun-filled experience for the customer whether child or adult. The stores are colorful and animated. The front window provides an attractive display of "Kayo" a monkey peddling his bicycle providing the "power source" for the "machinery" and "conveyors" producing and transporting the candy "manufactured" in the store. Upon entering the store, the customer immediately sees the animated Professor Fuzziwig character pulling the lever "controls" governing the "factory operations" together with the array of "machinery", "conveyors" and other "transport mechanisms" through which the candy "travels" to the clear yellow plastic candy bins containing the merchandise for sale. Within the store, favorite fun-filled tunes are heard to emphasize the atmosphere of fun and excitement in the store. Traveling from candy bin to candy bin with the clear "Fuzzibag" provided, the customer makes their selections from over 200 popular hard and "pan" candies displayed. The customer is serviced at check out in friendly, courteous fashion by a colorfully costumed service representative trained to complete their enjoyable experience. Fuzziwig's stores average 1,200 square feet. Stores are open 7 days per week. Typical operating hours are 10 a.m. to 9:00 p.m. Monday thru Saturday and 12 noon to 6:00 p.m. on Sundays. As discussed above, the Company is currently in process of redesign of the Fuzziwig's store plan to reduce the required initial investment, allowing "scalability" to lower space requirements, but with retention of the Fuzziwig's theme including animation, music, color and entertainment to maintain the tone and quality of the shopping experience. As with Rocky Mountain Chocolate Factory stores, the Company maintains rigorous procedures to assure that all Fuzziwig's stores conform to the Fuzziwig's Candy Factory image and theme, the Company's design staff provides working drawings and specifications and approves the construction plans for each new franchised or Company-owned store and controls the signage and building materials that may be used in the stores. 9 PRODUCTS AND PACKAGING ROCKY MOUNTAIN CHOCOLATE FACTORY: 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 also produces custom-molded theme candy bars tailored to promotional concepts of individual stores. As discussed above, the Company in fiscal 1998, is engaging 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 300 additional items, including many candies offered in packages specially designed for the holidays. A typical Rocky Mountain Chocolate Factory store offers up 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, 30% by products made in the store using Company recipes and ingredients purchased from the Company or approved suppliers and the remaining 20% 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. FUZZIWIG'S CANDY FACTORY: Fuzziwig's Candy Factory stores offer over 200 hard and "pan" candies. Fuzziwig's Candy Factory candies, unlike Rocky Mountain Chocolate Factory product, are purchased from outside vendors and represent the best quality of such candies available on the market. Candies sold at Company-owned Fuzziwig's Candy Factory stores are sold at one price, $6.95 per pound. Franchisees set their own retail prices, though the Company recommends that the franchisee sell all of its products at one price utilizing the same pricing concept as Company-owned stores. OPERATING ENVIRONMENTS The Company currently establishes franchised and Company-owned Rocky Mountain Chocolate Factory and Fuzziwig's 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 325 factory outlet malls in the United States, and as of April 30, 1997, there were Rocky Mountain Chocolate Factory or Fuzziwig's stores in 125 of these malls in 41 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 10 attractive sites in new and existing outlet malls. As discussed above, however, the Company is experiencing a constraint posed by a national slowdown in the establishment of new factory outlet centers and saturation of existing factory outlet centers with Rocky Mountain Chocolate Factory stores. The factory outlet environment remains largely untapped, however, as an environment for the Company's Fuzziwig's Candy Factory stores. TOURIST AREAS. As of April 30, 1997, there were approximately 62 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. Although some have short selling seasons, many 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 by both its Rocky Mountain Chocolate Factory and Fuzziwig's Candy Factory stores. Currently there are no Fuzziwig's stores in tourist areas. REGIONAL MALLS. There are approximately 2,500 regional malls in the United States, and as of April 30, 1997, there were Rocky Mountain Chocolate Factory stores in approximately 29 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 expensive rent structures rendering economic criteria for investment in such locations more difficult to satisfy. 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 or the sale of the Company's products, such as airports, sports arenas and corporate sales. Three franchised Rocky Mountain Chocolate Factory stores exist at airport locations: two at Denver International Airport and one at Vancouver International Airport in Canada. FRANCHISING PROGRAM GENERAL. The Company believes it has excellent relations with its franchisees. The Company's 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, 1997, there were 172 franchised stores in the Rocky Mountain Chocolate Factory system and 1 franchised Fuzziwig's store location. 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 or Fuzziwig's 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, 1997, operated 17 stores under the agreement. 11 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 operation 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. Training for Fuzziwig's Candy Factory franchisees occurs in the Company training center and at the Fuzziwig's candy store in Durango, Colorado. Topics covered in the training course include the Company's philosophy of store operation and management, customer service, merchandising, pricing, cooking (for Rocky Mountain Chocolate Factory franchisees), inventory and cost control, quality standards, record keeping, labor scheduling and personnel management. Training is 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 (Rocky Mountain Chocolate Factory franchisees only) and by meeting with each member of the senior management of the Company. Training continues through the opening of the store, where Company field personnel 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 district managers, who maintain regular and frequent communication with the stores by phone and by site visits. The district managers 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 and Fuzziwig's 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 both Rocky Mountain Chocolate Factory and Fuzziwig's 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 and Fuzziwig's Candy Factory stores are set forth in operating manuals. These manuals cover general operations, factory ordering (Rocky Mountain Chocolate Factory stores only), merchandising and advertising and accounting procedures. Through their regular visits to franchised stores, Company district managers 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. In the case of Fuzziwig's Candy Factory stores, all products sold in the stores are purchased from one or more of 39 approved suppliers. THE FRANCHISE AGREEMENT: TERMS AND CONDITIONS. The domestic offer and sale of Rocky Mountain Chocolate Factory and Fuzziwig's Candy Factory franchises is made by its respective Uniform Franchise Offering Circular for each franchise prepared in accordance with federal and 12 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 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 agreement for the Company's Fuzziwig's-TM- store concept provides for an initial franchise fee of $25,000 for each new store and royalties equal to 7% of monthly gross sales. As with Rocky Mountain Chocolate Factory franchises, Fuzziwig's franchises grant an exclusive territory only in the immediate vicinity of their stores. 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 from time to time for the Rocky Mountain Chocolate Factory and Fuzziwig's systems. 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. The term of each Fuzziwig's franchise agreement is ten years, and franchisees have the right to renew for two additional terms of 5 years each. The Company's agreements with 15 franchisees will expire in fiscal year 1998. The Company anticipates that substantially all such agreements will be renewed. 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 GENERAL. As of April 30, 1997, there were 43 Company-owned Rocky Mountain Chocolate Factory and 12 Company-owned Fuzziwig's Candy Factory stores. As discussed above, the Company in fiscal 1998 will close an estimated 8 underperforming Rocky Mountain Chocolate Factory Company-owned stores and sell to potential franchisees certain other Company-owned stores with the goal of improving Company-owned store program profitability and of reducing the number of stores to a nucleus of more profitable store locations. The Company, in fiscal 1998 anticipates opening few Company-owned stores and to refocus its efforts to improve the profitability of its smaller number of remaining stores. 13 Company-owned stores provide a training ground for Company-owned store 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 "-Quality Standards and Control." The Company's Director of Company Stores and her staff regularly visit Company-owned stores to ensure compliance with Company standards and procedures and to provide advice and support. MANUFACTURING OPERATIONS GENERAL. The Company manufactures its chocolate candies at its factory in Durango, Colorado for sale to Rocky Mountain Chocolate Factory franchisees and for retail sale at Rocky Mountain Chocolate Factory Company-owned stores. All products are produced consistent with the Company's philosophy of using only the finest, highest quality ingredients with no artificial preservatives to achieve its marketing motto of "the peak of perfection in handmade chocolates." In fiscal 1997, the Company produced approximately 1.7 million pounds of candy and anticipates producing approximately 1.9 million pounds in fiscal 1998. Current factory capacity is approximately 3.5 million pounds per year. 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. The Company conducts summer tours of its factory for the many tourists from throughout the U.S. arriving in Durango each summer, as a vehicle for increasing Company and brand awareness. 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 manufacture certain products by hand, such as dipping of some large pieces, 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. Recent examples include the purchase of a computer-controlled shell filling machine for truffles and a molding machine for candy bars and peanut butter cups, which enable the Company to produce these candies much more quickly and at a lower cost. 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. In March of 1996, the Company implemented a comprehensive MRP II forecasting, planning, scheduling and reporting system to improve the efficiency of manufacturing scheduling of production. Franchised and Company-owned stores place orders to the Company's factory one or two times per month, on average, and the Company generally ships its candies within five working days after the order is received. Finished candies remain in 14 inventory an average of four weeks or less prior to shipment. 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 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. 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. The Company is evaluating the feasibility of a co-operative local radio and television advertising program with its franchisees for possible implementation in fiscal 1998. 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. 15 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 potentially pursue new or under-utilized distribution channels. TRADE NAME AND TRADEMARKS The trade names "Rocky Mountain Chocolate Factory" and "Fuzziwig's Candy Factory" and 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 for the trademark Rocky Mountain Chocolate Factory has been granted in the United States and Canada. An application has been filed and is pending to register the trademark Fuzziwig's in the United States. Applications have also 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, 1997, the Company employed 412 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 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 16 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 nonrenewal 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. 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 1997, the Company's factory produced approximately 1.7 million pounds of chocolates, up from 1.6 million pounds in fiscal 1996 and 1.3 million pounds in fiscal 1995. The factory has the capacity to produce approximately 3.5 million pounds per year. As of April 30, 1997, all 55 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. 17 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, 1997, the Company was the primary lessee at 55 of its 172 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 E to the Financial Statements contained elsewhere in this Report. 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 the fiscal year covered by this Report. 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 January 17, 1996 the Company purchased on the open market 125,000 shares of its Common Stock at a price of $8.09 per share. The Company made this purchase because the Company felt and continues to feel that its Common Stock is undervalued. The table below sets forth high and low bid information for the Common Stock as quoted on NASDAQ for each quarter of fiscal years 1996 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 29, 1996 HIGH LOW ---- --- FIRST QUARTER.......................... 15 3/4 13 1/2 SECOND QUARTER......................... 18 1/2 15 3/4 THIRD QUARTER.......................... 17 1/2 12 FOURTH QUARTER......................... 12 1/4 8 FISCAL YEAR ENDED FEBRUARY 28, 1997 HIGH LOW ---- --- FIRST QUARTER........................... 8 1/4 7 SECOND QUARTER.......................... 10 7/8 7 1/2 18 THIRD QUARTER........................... 7 3/4 5 3/4 FOURTH QUARTER.......................... 6 3/4 4 3/8 On May 12, 1997 the closing bid price for the Common Stock as reported on the NASDAQ Stock Market was $3.25. (b) HOLDERS On May 12, 1997 there were approximately 410 record holders of the Company's Common Stock. The Company believes that there are more than 1860 beneficial owners of its Common Stock. (c) DIVIDENDS The Company has not paid since its inception, nor does it intend to pay in the foreseeable future, cash dividends on its Common Stock. Any future earnings will be retained for use in the Company's business. 19 ITEM 6. SELECTED FINANCIAL DATA (In thousands, except per share data and store data) The selected financial data presented below for the fiscal years ended February 28 or 29, 1993 through 1997, 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."
YEAR ENDED FEBRUARY 28 OR 29, -------------------------------------------------------- 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- STATEMENT OF INCOME DATA: Revenues: Factory sales $3,798 $4,998 $6,399 $8,156 $9,188 Retail sales 1,763 2,642 5,028 7,939 12,486 Royalties and marketing fees 1,000 1,233 1,607 2,034 2,342 Franchise fees 437 488 582 614 256 ------- ------- ------- ------- ------- Total revenues 6,998 9,361 13,616 18,743 24,272 ------- ------- ------- ------- ------- Costs and expenses: Cost of chocolate sales 3,506 4,530 5,986 8,599 11,508 Franchise costs 929 1,008 1,377 1,803 2,000 General and administrative expense 815 969 1,234 1,437 1,990 Retail operating expenses 1,245 1,603 2,749 4,746 8,087 Provision for store closures 1,358 Impairment loss - retail operations - - - - 597 Loss on obsolete and disposed assets - - - - 331 ------- ------- ------- ------- ------- Total costs and expenses 6,495 8,110 11,346 16,585 25,871 ------- ------- ------- ------- ------- Operating income (loss) 503 1,251 2,270 2,158 (1,599) Other income (expense): Interest expense (101) (88) (153) (300) (474) Interest income 5 10 23 58 29 ------- ------- ------- ------- ------- Total other income (expense) (96) (78) (130) (242) (445) ------- ------- ------- ------- ------- Litigation settlements (154) Income (loss) before income tax expense 407 1,173 2,140 1,916 (2,198) Income tax expense (benefit) 3 311 790 708 (832) ------- ------- ------- ------- ------- Net income (loss) $404 $862 $1,350 $1,208 $(1,366) ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Income (loss) per common share-fully diluted $.14 $.32 $.49 $.42 ($.46) ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Weighted average number of common shares outstanding - fully diluted 2,459 2,533 2,726 2,890 2,952 STORE DATA: Number of stores open at end of period: Company-owned 7 13 22 42 57 Franchised 81 106 131 151 171 ------- ------- ------- ------- ------- Total 88 119 153 193 228 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- SYSTEM-WIDE REVENUES: $19,886 $26,011 $35,612 $46,880 $57,505 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- FEBRUARY 28 OR 29 ----------------- 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- BALANCE SHEET DATA: Working capital $1,716 $1,889 $1,627 $ 2,043 $2,664 Total assets 4,496 6,024 10,181 16,314 18,590 Long-term debt (excluding current portion) 1,000 604 2,314 2,184 5,737 Stockholders' equity 2,881 4,143 5,907 11,117 9,779
20 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS 1997 COMPARED TO 1996 RESULTS SUMMARY The Company reported net loss of $1,365,702 for fiscal 1997 in comparison with a $1,207,745 profit for fiscal 1996; a decrease of $2,573,447 and 213%. Primary causes for this shortfall in operating results are as follows: 1. A restructuring loss provision of $2.2 million representing planned fiscal 1998 shutdown of 9 unprofitable Company-owned Rocky Mountain Chocolate Factory stores ($1.4 million) and an impairment provision on 4 Rocky Mountain Chocolate Factory stores and 2 Fuzziwig's stores ($800,000) considered impaired under the provisions of Financial Accounting Standard (FAS) 121, together with writedown of other miscellaneous store assets; 2. Company-owned store losses resulting primarily from stores to be closed, located in underperforming factory outlet centers with diminished foot traffic; 3. Lack of new locations for unit growth adversely impacting franchise fee revenues; 4. Decreased same store pounds purchased from its factory. As discussed below, the Company anticipates the combination of store closure of underperforming Company-owned stores with actions it is taking to improve same store retail sales will improve ongoing profitability of its Company-owned store program. The Company intends to explore alternative channels of distribution (e.g. fund raising, mail order, corporate sales) as a means of increasing factory revenues and as a replacement of limited franchise fee revenue growth resulting from location limitations. The Company has also embarked upon a program to increase same store pounds purchased though new product introduction to replace products (such as sugar free products) currently purchased by its stores from outside vendors. It has also effected a rebate program rewarding stores increasing purchases of factory product with a purchase-volume-based rebate. Before the restructure loss provision, the Company earned a fiscal year 1997 profit of $39,400. Below is a detailed analysis of financial results by revenue, cost of revenue and expense item: REVENUES Revenue results by revenue component for fiscal 1997 in comparison with fiscal 1996 are as follows ($000): 21 Revenue Component 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 12,486.3 7,938.5 4,547.8 57.3% --------- --------- --------- ------ Total $24,272.5 $18,743.3 $ 5,529.2 29.5% --------- --------- --------- ------ --------- --------- --------- ------ FACTORY SALES Factory sales represent candy sales to the Company's Rocky Mountain Chocolate Factory franchised store locations. Significantly increased factory sales resulted primarily from the larger number of franchised Rocky Mountain Chocolate Factory stores in existence throughout the year (170 franchised Rocky Mountain Chocolate Factory stores franchised at February 28, 1997 in comparison with 151 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 increased stores and the price increase. The decline in same store pounds purchased from the factory continued what appears to be a trend of a shift in sales mix toward store-made and authorized vendor products and away from factory made products. When computing same store pounds purchased from the factory, purchases by franchised stores open for 12 months in each period are compared. The Company has effected a program of new product introduction to replace products (such as sugar free products) currently purchased by its stores from outside vendors as a basis for increasing same store pounds purchased from its factory. It has also effected a rebate program rewarding stores increasing purchases of factory product with a purchase-volume-based rebate. ROYALTY AND 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 constant, neither increasing nor decreasing. 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, in combination with the effect of lower balance - due revenue recognition on franchises previously sold. As discussed above (see "Business" - "Selective unit growth for Rocky Mountain Chocolate Factory"), the Company is experiencing a constraint 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 saturation of existing factory outlet and other environments where its concept has proven successful. Such location availability limitations provide an associated constraint in the growth of franchise fee and royalty revenues. The number of locations available to establish Fuzziwig's Candy Factory stores is not location limited due to the small number of currently existing Fuzziwig's locations and due to the fact that (due to its sale of a different product line than Rocky Mountain Chocolate Factory stores) Fuzziwig's locations do not compete with or detract significantly from sales volumes of existing Rocky Mountain Chocolate Factory locations where both stores exist together at one mall or other site. 22 RETAIL SALES Retail sales of Company-owned stores increased as a result of a larger number of Company stores in existence throughout the year (57 stores existed at February 29, 1997, in comparison with 42 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. Company-owned store sales revenues are anticipated to decline somewhat in fiscal 1998 from fiscal 1997 levels as a result of closure and sale of stores, as discussed above, coupled with a conscious decision to selectively limit Company-owned store additions in fiscal 1998. COSTS AND EXPENSES COST OF CHOCOLATE SALES. Cost of chocolate sales, which include costs incurred by the Company to manufacture candy sold by its Company-owned stores and to its franchised stores, increased 33.8% to $11.5 million in fiscal 1997 from $8.6 million in fiscal 1996. Cost of chocolate sales as a percentage of total chocolate sales (defined as the total of factory sales and retail sales) decreased to 53.1% in 1997 from 53.4% in 1996. Cost of chocolate sales as a percentage of total chocolate sales improved modestly in fiscal 1997 as a result of a significant increase in higher margin retail sales as a percentage of total chocolate sales brought about by the increase in the number of Company-owned stores, coupled with full year operation of a large number of stores open for only a partial year in the previous year. This "mix effect" was substantially offset by an absolute 1.4% decline in factory margins brought about by large obsolete inventory loss provisions coupled with the manufacturing overhead volume impact of factory sales/production volumes below planned levels (resulting largely from the decline in same store pounds purchased from the factory referenced above). As such volume shortfalls result in "overhead underabsorption", such underabsorbed overhead is charged to cost of chocolate sales, adversely affecting factory margins. The Company in fiscal 1996 experienced a decline of factory margins of 4% absolute for the full year and 6.7% absolute in the second half from factory margin results experienced in the prior year full year and second half periods. The Company has made major improvement in manufacturing performance as a result of its concerted effort to correct for the increased material usage, reduced labor efficiencies and increased overhead spending resulting in this decline in factory margins. As a result of its efforts, factory margins have improved significantly from depressed levels existing in the second half of fiscal 1996, before the impact of obsolete inventory and factory sales and production volume shortfalls on factory margins, as discussed above. Before the effect of such impacts, factory margins are approximately 1% absolute below recent year historical averages. The Company continues to seek improvement in factory margins through further automation to reduce cost and by its program to improve factory sales and production volumes through its programs to improve same store pounds purchased, as discussed above. In April 1997 the Company increased the factory price of its products by 2.8% to compensate for material and factory wage increases, with the goal of improving factory margin. FRANCHISE COSTS. FRANCHISE costs increased 10.9% from $1.8 million in fiscal 1996 to $2.0 million in fiscal 1997. As a percentage of the total of royalty and marketing fees and franchise fee revenue, franchise costs increased to 77.0% of such fees in fiscal 1997 from 68.1% in fiscal 1996. The addition of an expanded marketing group to support corporate public relations and promotional programs and marketing materials in support of the Company's larger 23 base of stores is the primary cause of this increase. Decreased franchise fee revenues relative to last year is also a partial cause of this increase in relative percentage. GENERAL AND ADMINISTRATIVE EXPENSES. General and Administrative expenses increased 38.5% from $1.4 million in fiscal 1996 to $2.0 million in fiscal 1997, primarily as a result of increased bad debt provisions (a $260,000 increase from the prior year) coupled with increased expense for administrative support personnel, and increased depreciation expense for additional investment in computer hardware and software. Increased bad debt provisions resulted from providing for potential loss on lease settlements and notes receivable for 2 franchised stores expected to close, together with increased provision for loss on accounts receivable on several other troubled stores and accounts. As a percentage of total revenues, general and administrative expense increased from 7.7% in fiscal 1996 to 8.2% in fiscal 1997, primarily due to the increase in expenses noted above. RETAIL OPERATING EXPENSES. Retail operating expenses increased from $4.7 million in fiscal 1996 to $8.1 million in fiscal 1997; an increase of 70.4%. 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 59.8% in fiscal 1996 to 64.8% in fiscal 1997 as a result of insufficient sales volume leveraging resulting from the decline in same store retail sales at Company-owned Rocky Mountain Chocolate Factory stores as discussed above, and partially as a result of this "start-up" effect and partially as a result of sales volumes at many Company-owned stores, (particularly those established within the last 12 months) significantly below Company expectations. As discussed above, the Company in fiscal 1998 will close an estimated 8 underperforming Company-owned stores not meeting minimum economic criteria. The Company also has continued its program to sell certain other Company-owned stores to potential franchisees. In fiscal 1997, a restructuring charge, NOT included, in retail operating expenses but reflected as individual profit and loss statement line items, was provided to income of $2.2 million representing estimated loss expected to result from these closures and from writedown of certain other store assets considered impaired under provisions of Financial Accounting Standard (FAS) 121 "Accounting for the Impairment of Long-Lived Assets." Note that such sale, closure and slowdown of establishment of new Rocky Mountain Chocolate Factory stores is currently not anticipated to affect its expansion program for its new store concept Fuzziwig's and conversion of existing Company-owned Fuzziwig's locations to franchised locations or closure of such locations is not currently planned. The Company does not expect sale of stores to have appreciable positive or negative impact on Company earnings performance because store profits sacrificed in such cases are expected to be approximately compensated for by royalties generated and cost of capital saved, Any gains or losses realized on store disposition are also not expected to be material to Company results of operations. The Company believes that, through its store closures and its continued program to sell certain other Company-owned stores to potential franchisees, it will improve the on-going profitability of its Company-owned store program. OTHER EXPENSE Other expense of $445,000 incurred in fiscal 1997 increased 83.7% from the $242,200 incurred in fiscal 1996. Other expense increased as a result increased interest expense resulting from borrowings in support of the Company's Company- owned store expansion. 24 INCOME TAX EXPENSE The Company's effective income tax rate in fiscal 1997 of 37.9% approximated the 37.0% in fiscal 1996. RESULTS OF OPERATIONS 1996 COMPARED TO 1995 RESULTS SUMMARY The Company reported net income of $1,207,745 for fiscal 1996 in comparison with $1,350,432 for fiscal 1995; a decrease of $142,687 and 10.6%. Below is a detailed analysis of financial results by revenue, cost of revenue and expense line item: REVENUES Revenue results by revenue component for fiscal 1996 in comparison with fiscal 1995 are as follows ($000): Revenue Component 1996 1995 Change Change% - - - ----------------- ---- ---- ------ ------- Factory Sales $ 8,156.5 $ 6,399.3 $1,757.2 27.5% Royalty and Marketing Fees 2,034.0 1,606.6 427.4 26.6% Franchise Fees 614.3 581.9 32.4 5.6% Retail Sales 7,938.5 5,028.3 2,910.2 57.9% --------- --------- -------- ------ Total $18,743.3 $13,616.1 $5,127.2 37.7% --------- --------- -------- ------ --------- --------- -------- ------ FACTORY SALES Factory sales represent candy sales to the Company's franchised Rocky Mountain Chocolate Factory store locations. Significantly increased factory sales resulted primarily from the larger number of franchised stores in existence throughout the year (151 franchised stores at February 29, 1996 in comparison with 131 at February 28, 1995) as augmented by the impact of an approximate 2% price increase effected in April 1995. Same store pounds purchased declined by 1% in fiscal 1996. When computing same store pounds purchased from the factory, purchases by franchised stores open for 12 months in each period are compared. ROYALTIES AND MARKETING FEES AND FRANCHISE FEES Increased royalties and marketing fees resulted from the combined impact of a larger number of franchised stores in existence throughout the year together with an increase in same store sales at franchised stores of approximately 2.8%. The Company sold 41 new franchises in fiscal 1996 in comparison with 39 in fiscal 1995 resulting in the increased franchise fee revenue shown, in combination with the effect of higher balance - due revenue recognition on franchises previously sold: $5,000 is earned upon franchise agreement signing with the balance of $14,500 earned upon signing of the lease of the facility representing the franchised location. 25 RETAIL SALES Retail sales of Company-owned stores increased as a result of a larger number of Company-owned stores in existence throughout the year (42 stores existed at February 29, 1996, in comparison with 22 in existence at February 28, 1995) in fiscal 1996 in comparison with the prior fiscal year coupled with a same store retail sales increase of 4%. COSTS AND EXPENSES COST OF CHOCOLATE SALES. Cost of chocolate sales, which includes costs incurred by the Company to manufacture candy sold by its Company-owned stores and to its franchised stores, increased 43.6% to $8.6 million in fiscal 1996 from $6.0 million in fiscal 1995. Cost of chocolate sales as a percentage of total chocolate sales (defined as the total of factory sales and retail sales) increased to 53.4% in fiscal 1996 from 52.4% in 1995. Cost of chocolate sales as a percentage of total chocolate sales had been expected to improve as a result of an increase in higher margin retail sales as a percentage of total chocolate sales brought about by the rapid and large increase in the number of Company-owned stores, together with the effect of an approximate 2% retail and factory price increase effected in April, 1995. This has not occurred due to an absolute 4% decline in factory margins resulting from increased material usage and lesser labor efficiencies in the manufacture of the Company's products, the effect of increased manufacturing overhead cost relative to pounds produced, together with certain price reductions in selected categories of Company product sales. FRANCHISE COSTS. Franchise costs increased 31.0% to $1.8 million in 1996 from $1.4 million in fiscal 1995. As a percentage of the total of royalties and marketing fees and franchise fees, franchise costs increased to 68.1% of such fees in 1996 from 62.9% in 1995. The hiring of additional field support and associated administrative personnel to support the Company's accelerated pace of new franchise signing and store opening activities and the larger base of stores is the partial cause of this increase. Additionally, the Company incurred increased expenses for promotional programs and marketing materials to support the larger base of stores. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased 16.4% to $1.4 million in fiscal 1996 from $1.2 million in fiscal 1995, as a result of increased expense for administrative support personnel and increased depreciation expense for additional investment in computer hardware and software to serve as the platform for additional manufacturing and administrative control capability for the Company. As a percentage of total revenues, general and administrative expense declined to 7.7% in fiscal 1996 from 9.1% in fiscal 1995, due to a focus by the Company on minimizing increases in administrative personnel and other administrative cost by a concerted effort to effect automated data entry and control processes as a basis for minimizing such increases. RETAIL OPERATING EXPENSES. Retail operating expenses increased 72.6% to $4.7 million in fiscal 1996 from $2.7 million in fiscal 1995. This increase resulted from the effect of the larger number of Company-owned stores in existence as discussed above. As a percentage of retail sales, retail operating expenses increased to 59.8% in fiscal 1996 from 54.7% in fiscal 1995. The Company experienced delays in store openings in fiscal 1996. This delay in store openings resulted in total revenue growth not in proportion to the increase in operating expenses. Additionally, the Company for the first time in fiscal 1996, began a program of allocating directly-related administrative expense to support the Company-owned store programs to retail operating expense. 26 OTHER EXPENSE Other expense of $242,000 incurred in fiscal 1996 increased 86.3% from the $130,000 incurred in fiscal 1995. This increase resulted from increased interest expense caused by borrowings in support of the Company's factory expansion and Company-owned store expansion as partially offset by increased interest income resulting from cash surpluses generated by the Company's stock offering completed in September, 1995. INCOME TAX EXPENSE The Company's effective income tax rate in fiscal 1996 of 37.0% approximated the 36.9% in fiscal 1995. LIQUIDITY AND CAPITAL RESOURCES Operating cash flows in fiscal 1997 increased $495,000 and 52.1% from the $949,900 in fiscal 1996 to $1,444,700 in fiscal 1997. This increase resulted from operating cash flows generated by increased number of Company-owned stores (reflected in increased depreciation and amortization charges shown in the Company's statements of cash flows). At February 28, 1997, working capital was $2,663,775 in comparison with $2,043,143 at February 28, 1996, a $620,632 increase. This increase resulted from fixed asset financing achieved recovering cash from investments in Company store operating assets previously funded from operating cash flows, together with the impact of improved operating cash flows, as discussed above. Cash and cash equivalent balances increased from $528,787 at February 29, 1996 to $792,606 at February 28, 1997. The Company's current ratio was 1.9/1 at February 28, 1997 in comparison with 1.7/1 at February 29, 1996. The Company's long-term debt is comprised primarily of real estate mortgage financing provided by a local banking facility used to finance the Company's factory expansion (unpaid balance as of February 28, 1997, $1,614,033), and chattel mortgage financing (unpaid balance as of February 28, 1997, $4,971,160) provided both by local banking facilities and national financing facilities and used to fund the Company's Company-owned store expansion. The Company also possessed a $2,000,000 working capital line of credit at February 28, 1997, secured by accounts receivable and inventories, which line had a $0 balance at that date. The line was renewed for an additional 12 month period at May 22, 1997 and expires July, 1998. The Company possessed $750,000 in fixed asset availability lines of credit at February 28, 1997. For fiscal 1998, the Company anticipates making $1.1 million in capital expenditures. Of this sum, approximately $600,000 is anticipated to be used for the opening of new Company-owned stores where lease commitments have already been made, (as discussed above, the Company has reduced its expansion program in the establishment of Company-owned stores), with the balance anticipated to be used for the purchase of additional factory equipment and computer equipment for the Company's administrative functions. The Company believes that cash flow from operating activities and available bank lines of fixed asset and working capital credit will be sufficient to service debt, fund anticipated capital expenditures and provide necessary working capital at least through the end of fiscal 1998. There can be no guarantee, however, that unforeseen events will not require the Company to secure additional sources of financing. Such events could include the need to repay loans secured by any Company-owned stores which may be closed. The Company may also seek additional 27 financing from time to time, through borrowings or public or private offerings of equity or debt securities, to fund its future expansion plans. 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 reflect potentially escalating cost of real estate and construction. There is no assurance that the Company will be able to pass on its increased costs to its customers. Depreciation expense is based on the historical cost to the Company of its fixed assets, and therefore is 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. EFFECT OF NEW ACCOUNTING STANDARD The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 128, EARNINGS PER SHARE, which is effective for financial statements issued after December 15, 1997. Early adoption of the new standard is not permitted. The new standard eliminates primary and fully diluted earnings per share and requires presentation of basic and diluted earnings per share together with disclosure of how the per share amounts were computed. The adoption of this new standard is not expected to have a material impact on the disclosure of earnings per share in the financial statements of the Company. FORWARD-LOOKING STATEMENTS Certain statements contained in this report are forward-looking statements that reflect assumptions made by management based on information currently available to it, and the Company can give no assurance that the expectations or potential occurrences reflected in such statements will be realized. Should one or more of the uncertainties underlying such expectations materialize or underlying assumptions prove incorrect, actual results may vary materially from those expected. Whether factory margins improve depends on many factors that are not within the Company's control. Such factors include the ability of the Company to reduce manufacturing overhead cost per pound through correction of negative trends in same store pounds purchased and associated factory sales and production volumes. The Company's ability to successfully achieve expansion of its Rocky Mountain Chocolate Factory and Fuzziwig's franchise systems depends on many factors also not within the Company's control including the availability of suitable sites for new store establishment, the availability of qualified franchisees to support such expansion and acceptance by the public of the Fuzziwig's concept. 28 Efforts to sell, close or improve operating results of under-performing Company-owned stores depends on many factors not within the Company's control including availability of qualified buyers and its ability to negotiate out of existing leases under favorable terms, as well as on consumer traffic and spending patterns. Efforts to improve the decline in same store pounds purchased 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 to its product introductions and promotional programs, which receptivity is by no means assured. 29 ITEM 8. FINANCIAL STATEMENTS INDEX TO FINANCIAL STATEMENTS Page ---- REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS . . . . . . . . . . . . . . . . . . . . . 31 BALANCE SHEETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 STATEMENTS OF OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . 34 STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY. . . . . . . . . . . . . 35 STATEMENTS OF CASH FLOWS . . . . . . . . . . . . . . . . . . . . . . . 37 30 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors and Stockholders Rocky Mountain Chocolate Factory, Inc. We have audited the accompanying consolidated balance sheets of Rocky Mountain Chocolate Factory, Inc. as of February 28, 1997 and February 29, 1996, and the related statements of income, stockholders' equity, and cash flows for each of the three years in the period ended February 28, 1997. 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 consolidated financial position of Rocky Mountain Chocolate Factory, Inc. as of February 28, 1997 and February 29, 1996, and the results of their operations and their cash flows for each of the three years in the period ended February 28, 1997, in conformity with generally accepted accounting principles. GRANT THORNTON LLP Dallas, Texas April 23, 1997 31 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. BALANCE SHEETS
ASSETS February 28, February 29, 1997 1996 ----------- ----------- CURRENT ASSETS Cash and cash equivalents $ 792,606 $ 528,787 Accounts and notes receivable-trade,less allowance for doubtful accounts of $202,029 in 1997 and $28,196 in 1996 1,729,971 1,463,901 Inventories 2,311,321 2,504,908 Deferred income taxes 722,595 59,219 Other 181,133 224,001 ----------- ----------- Total current assets 5,737,626 4,780,816 PROPERTY AND EQUIPMENT - AT COST Land 122,558 122,558 Building 3,644,357 3,596,905 Leasehold improvements 2,213,116 1,753,165 Machinery and equipment 6,446,612 4,898,174 Furniture and fixtures 2,667,420 2,330,057 Transportation equipment 246,499 228,816 ----------- ----------- 15,340,562 12,929,675 Less accumulated depreciation and amortization 3,565,194 2,468,084 ----------- ----------- 11,775,368 10,461,591 ----------- ----------- OTHER ASSETS Accounts and notes receivable - trade, due after one year 82,774 111,588 Goodwill, net of accumulated amortization of $277,344 in 1997 and $253,740 in 1996 312,656 336,260 Deferred income taxes 43,044 - Other 638,637 624,185 ----------- ----------- 1,077,111 1,072,033 ----------- ----------- $18,590,105 $16,314,440 ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these statements. 32 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. BALANCE SHEETS - CONTINUED
LIABILITIES and STOCKHOLDERS' EQUITY February 28, February 29, 1997 1996 ----------- ----------- CURRENT LIABILITIES Short-term debt $ - $ 1,000,000 Current maturities of long-term debt 847,881 134,538 Accounts payable - trade 799,671 998,520 Accrued compensation 465,338 335,926 Accrued liabilities 867,961 214,460 Income taxes payable - 54,229 Deferred income 93,000 - ----------- ----------- Total current liabilities 3,073,851 2,737,673 LONG-TERM DEBT, less current maturities 5,737,312 2,183,877 DEFERRED INCOME TAXES - 275,508 COMMITMENTS AND CONTINGENCIES - - STOCKHOLDERS' EQUITY Common stock - authorized, 7,250,000 shares,$.03 par value; issued, 3,041,302 shares in 1997 and 3,034,302 in 1996 91,239 91,029 Additional paid-in capital 9,730,872 9,703,985 Retained earnings 972,565 2,338,267 ----------- ----------- 10,794,676 12,133,281 Less common stock held in treasury, at cost - 129,003 shares in 1997 and 129,153 shares in 1996 1,015,734 1,015,899 ----------- ----------- 9,778,942 11,117,382 ----------- ----------- $18,590,105 $16,314,440 ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these statements. 33 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. STATEMENTS OF OPERATIONS
For the years ended ------------------------------------------- February 28, February 29, February 28, 1997 1996 1995 ----------- ----------- ----------- REVENUES Sales $21,674,485 $16,094,995 $11,427,700 Franchise and royalty fees 2,597,985 2,648,303 2,188,434 ----------- ----------- ----------- 24,272,470 18,743,298 13,616,134 COSTS AND EXPENSES Cost of sales 11,508,384 8,598,798 5,985,970 Franchise costs 1,999,964 1,803,506 1,376,820 General and administrative 1,989,958 1,436,551 1,234,002 Retail operating expenses 8,087,052 4,746,026 2,749,511 Provision for store closures 1,358,398 - - Impairment loss - retail operations 597,062 - - Loss on writedown of assets 330,587 - - ----------- ----------- ----------- 25,871,405 16,584,881 11,346,303 ----------- ----------- ----------- Operating (loss) profit (1,598,935) 2,158,417 2,269,831 OTHER INCOME (EXPENSE) Interest expense (473,618) (299,792) (152,592) Interest income 28,637 57,620 22,580 ----------- ----------- ----------- (444,981) (242,172) (130,012) Litigation settlements (154,300) - - Income (loss) before income tax expense (2,198,216) 1,916,245 2,139,819 ----------- ----------- ----------- INCOME TAX EXPENSE (BENEFIT) Current 149,414 583,488 749,516 Deferred (981,928) 125,012 39,871 ----------- ----------- ----------- (832,514) 708,500 789,387 ----------- ----------- ----------- NET INCOME (LOSS) (1,365,702) 1,207,745 1,350,432 Dividend requirements on preferred stock - - 14,610 ----------- ----------- ----------- INCOME (LOSS) ALLOCABLE TO COMMON STOCKHOLDERS $(1,365,702) $ 1,207,745 $ 1,335,822 ----------- ----------- ----------- ----------- ----------- ----------- PRIMARY INCOME (LOSS) PER COMMON AND EQUIVALENT SHARE $ (.46) $ .42 $ .51 ----------- ----------- ----------- ----------- ----------- ----------- Weighted average and equivalent shares 2,950,265 2,887,063 2,612,730 ----------- ----------- ----------- ----------- ----------- ----------- FULLY-DILUTED INCOME (LOSS) PER COMMON AND EQUIVALENT SHARE $ (.46) $ .42 $ .49 ----------- ----------- ----------- ----------- ----------- ----------- Weighted average and equivalent shares 2,951,722 2,889,538 2,725,690 ----------- ----------- ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these statements. 34 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the years ended --------------------------------------------------- February 28, February 29, February 28, 1997 1996 1995 ----------- ----------- ----------- COMMON STOCK Balance at beginning of year $ 91,029 $ 79,029 $ 65,590 Conversion of 7% convertible notes to common - - 12,972 Sale of common stock - 10,125 - Conversion of preferred stock to common - 435 17 Exercise of stock options 210 1,440 450 ----------- ----------- ----------- Balance at end of year 91,239 91,029 79,029 ----------- ----------- ----------- PREFERRED STOCK Balance at beginning of year - 1,462 1,496 Conversion of preferred stock to common - (1,309) (34) Redemption of preferred stock - (153) - ----------- ----------- ----------- Balance at end of year - - 1,462 ----------- ----------- ----------- ADDITIONAL PAID-IN CAPITAL Balance at beginning of year 9,703,985 4,700,527 4,197,838 Conversion of 7% convertible notes to common - - 387,029 Sale of common stock - 4,846,010 - Conversion of preferred stock to common - 874 17 Exercise of stock options 26,040 180,435 114,280 Distribution of treasury stock 847 2,010 1,363 Redemption of preferred stock - (25,871) - ----------- ----------- ----------- Balance at end of year 9,730,872 9,703,985 4,700,527 ----------- ----------- ----------- RETAINED EARNINGS Balance at beginning of year 2,338,267 1,130,522 (117,341) Net income (loss) for the year (1,365,702) 1,207,745 1,350,432 Preferred stock dividends - - (102,569) ----------- ----------- ----------- Balance at end of year 972,565 2,338,267 1,130,522 ----------- ----------- ----------- TREASURY STOCK, AT COST Balance at beginning of year (1,015,899) (4,733) (4,870) Purchase of stock for treasury - (1,011,331) - Distribution of treasury stock 165 165 137 ----------- ----------- ----------- Balance at end of year (1,015,734) (1,015,899) (4,733) ----------- ----------- ----------- $ 9,778,942 $11,117,382 $ 5,906,807 ----------- ----------- ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these statements. 35 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY - CONTINUED
For the years ended ----------------------------------------- February 28, February 29, February 28, 1997 1996 1995 ----------- ----------- ----------- COMMON SHARES Balance at beginning of year 3,034,302 2,634,289 2,186,335 Conversion of 7% convertible notes to common - - 432,376 Sale of common stock - 337,500 - Conversion of preferred stock to common - 14,513 578 Exercise of stock options 7,000 48,000 15,000 ----------- ----------- ----------- Balance at end of year 3,041,302 3,034,302 2,634,289 ----------- ----------- ----------- ----------- ----------- ----------- PREFERRED SHARES Balance at beginning of year - 14,610 14,954 Redemption of preferred stock `- (1,532) - Conversion of preferred stock to common - (13,078) (344) ----------- ----------- ----------- Balance at end of year - - 14,610 ----------- ----------- ----------- ----------- ----------- ----------- TREASURY SHARES Balance at beginning of year 129,153 4,303 4,428 Purchase of stock for treasury - 125,000 - Distribution of treasury stock (150) (150) (125) ----------- ----------- ----------- Balance at end of year 129,003 129,153 4,303 ----------- ----------- ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these statements. 36 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. STATEMENTS OF CASH FLOWS
For the years ended ---------------------------------------------------- February 28, February 29, February 28, 1997 1996 1995 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $(1,365,702) $1,207,745 $1,350,432 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,682,158 823,890 487,737 Asset impairment and store closure losses 2,230,047 - - Gain on sale of assets (72,707) - - Changes in operating assets and liabilities: Accounts and notes receivable - trade (110,556) (260,338) (117,236) Inventories 193,587 (817,892) (602,672) Other assets 42,868 (113,896) (47,474) Accounts payable-trade (198,849) 159,403 332,011 Income taxes payable (287,518) (229,101) 121,134 Deferred income taxes (981,928) 125,012 39,871 Accrued liabilities and compensation 220,270 55,080 153,954 Deferred income 93,000 - - ----------- ----------- ----------- Net cash provided by operating activities 1,444,670 949,903 1,717,757 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of assets 420,690 - - Purchase of other assets (622,631) (164,353) (50,064) Purchase of property and equipment (4,272,950) (5,464,166) (4,399,958) ----------- ----------- ----------- Net cash used in investing activities $(4,474,891) $(5,628,519) $(4,450,022) ----------- ----------- ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these statements. 37 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. STATEMENTS OF CASH FLOWS - CONTINUED
For the years ended ----------------------------------------- February 28, February 29, February 28, 1997 1996 1995 ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Net change in line of credit $(1,000,000) $1,000,000 $ - Proceeds from issuance of long-term debt 7,071,852 1,500,000 2,437,500 Principal payments on long-term debt (2,805,074) (1,678,332) (270,882) Proceeds from sale of common stock - 4,856,135 - Proceeds from exercise of stock options 26,250 181,875 52,876 Redemption of preferred stock - (26,024) - Dividends paid - - (102,570) Proceeds from distribution of treasury stock 1,012 2,175 1,500 Purchase of stock for treasury - (1,011,331) - ----------- ----------- ----------- Net cash provided by financing activities 3,294,040 4,824,498 2,118,424 ----------- ----------- ----------- Net increase (decrease)in cash and cash equivalents 263,819 145,882 (613,841) Cash and cash equivalents at beginning of year 528,787 382,905 996,746 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 792,606 $ 528,787 $ 382,905 ----------- ----------- ----------- ----------- ----------- ----------- SUPPLEMENTARY DISCLOSURES: Interest paid $ 469,237 $ 301,481 $ 155,015 Income taxes paid 436,932 812,589 628,382 Non-cash financing activities: Issuance of 432,376 shares of common stock upon conversion of 7% convertible notes in 1995 - - 400,000 Owner financed equipment purchase - - 30,000 Conversion of preferred stock into - 1,309 34 common stock
The accompanying notes are an integral part of these statements. 38 ROCKY MOUNTAIN CHOCLATE FACTORY, INC. NOTES TO FINANCIAL STATEMENTS NOTE A - DESCRIPTION OF BUSINESS AND SUMMARY OF ACCOUNTING POLICIES Description of the nature of Company operations, together with a summary of the significant accounting policies applied in the preparation of the accompanying financial statements and of the estimates used in their preparation follows: NATURE OF OPERATIONS The Company is a manufacturer of an extensive line of premium chocolate candy for sale to its franchised and at its Company-owned Rocky Mountain Chocolate Factory stores located throughout the United States and in Canada. The Company is also the operator and franchiser of a new concept store called Fuzziwig's Candy Factory. This new concept store sells hard conventional and nostalgic/unusual candies (which are not manufactured by the Company, but procured from wholesale candy suppliers) in a themed, self-serve environment featuring animation, movement, music, color and entertainment. The majority of the Company's revenues are generated from 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 by 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 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. The Company receives a royalty fee of seven percent (7%) of the gross sales from franchised Fuzziwig's Candy Factory stores. 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. 39 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. NOTES TO FINANCIAL STATEMENTS NOTE A - DESCRIPTION OF BUSINESS AND SUMMARY OF ACCOUNTING POLICIES - CONTINUED USE OF ESTIMATES - CONTINUED 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. VULNERABILITY DUE TO CERTAIN CONCENTRATIONS The Company's stores are concentrated in the factory outlet mall environment. At February 28, 1997, 53 Company-owned stores and 69 franchise stores of 228 total stores (53.5%) 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. INCOME (LOSS) PER COMMON SHARE Primary income (loss) per common and common equivalent share is computed by dividing net income (loss), adjusted for dividends on preferred stock, by the weighted average number of common and common equivalent shares outstanding during the year. Common equivalent shares result from the assumed issuance of shares under the Company's stock option plans when dilutive. Fully-diluted income per common share is computed as above but assumes conversion of convertible notes payable and cumulative convertible preferred stock, when dilutive. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments consist of cash and cash equivalents, short- term investments in money market fund and other liquid assets, trade receivable and payable, notes receivable and debt, which has variable rates. The fair value of all instruments approximates the carrying value. NOTE B - NEW ACCOUNTING PRONOUNCEMENT The FASB has issued Statement of Financial Accounting Standards No. 128, EARNINGS PER SHARE, which is effective for financial statements issued after December 15, 1997. Early adoption of the new standard is not permitted. The new standard eliminates primary and fully diluted earnings per share and requires presentation of basic and diluted earnings per share together with disclosure of how the per share amounts were computed. The adoption of this new standard is not expected to have a material impact on the disclosure of earnings per share in the financial statements. 40 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. NOTES TO FINANCIAL STATEMENTS NOTE C - INVENTORIES Inventories consist of the following: February 28, February 29, 1997 1996 ------------ ------------ Ingredients and supplies $1,168,216 $1,117,517 Finished candy 1,143,105 1,387,391 ---------- ---------- $2,311,321 $2,504,908 ---------- ---------- ---------- ---------- NOTE D - LINE OF CREDIT AND LONG-TERM DEBT LINE OF CREDIT At February 28, 1997 the Company possessed a $2,000,000 line of credit from a bank, collateralized by accounts receivable and inventory. 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 (8.25% at February 28, 1997 and at February 29, 1996). 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 a bank provide for the maintenance of certain financial covenants. Because of the net loss reported by the Company for the year ended February 28, 1997, the Company would not have been in compliance with one such covenant had the bank not granted waiver of such technical default. On May 22, 1997, the Company and the bank entered into an amendment to the Term Loan and Credit Agreement effective as of March 1, 1997 which provides, among other things, a decrease in the Tangible Net Worth requirement from $10,000,000 to $9,000,000 and extension of the line of credit to July 1998. LONG-TERM DEBT February 28, February 29, 1997 1996 ------------ ------------ 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. 415,557 - Real estate mortgage note payable in monthly installments of $14,250 through April, 2011; interest rate of 8.25%; collateralized by factory building. Interest adjusted to prime in May, 2001 and every five years thereafter until maturity in April 2016. 1,614,033 - 41 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. NOTES TO FINANCIAL STATEMENTS LONG-TERM DEBT - CONTINUED February 28, February 29, 1997 1996 ------------ ------------ Chattel mortgage note payable in monthly installments of $12,359 through April, 2002 including interest at 8.25% per annum, collateralized by equipment 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. 1,434,090 - 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. 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 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. 450,432 - Eight Chattel mortgage notes payable in monthly installments of $32,277 through February 2002 including interest at between 8.75% and 9.44% per annum, collateralized by equipment, furniture and fixtures. 1,431,291 - Chattel mortgage note payable in monthly installments of $9,247 through August, 2004 including interest at 8.25% per annum, collateralized by machinery, equipment, furniture and fixtures. - 658,479 Real estate mortgage note payable in monthly installments of $14,506 through August, 2014; interest rate of 8.25%; collateralized by factory building. - 1,625,798 Other - 34,138 ---------- ---------- 6,585,193 2,318,415 Less current maturities 847,881 134,538 ---------- ---------- $5,737,312 $2,183,877 ---------- ---------- ---------- ---------- 42 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. NOTES TO FINANCIAL STATEMENTS LONG-TERM DEBT - CONTINUED Maturities of long-term debt are as follows: Year-Ending February 28 (29), ----------------------------- 1998 $ 847,881 1999 928,150 2000 1,016,064 2001 1,096,584 2002 845,164 Thereafter 1,851,350 ---------- $6,585,193 ---------- ---------- NOTE E - 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: Year-Ending February 28 (29), ----------------------------- 1998 $ 1,252,288 1999 1,215,706 2000 1,121,401 2001 975,165 2002 482,141 Thereafter 681,841 ----------- $ 5,728,542 ----------- ----------- 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: Year-Ending February 28 (29), ----------------------------- 1998 $1,294,202 1999 1,166,474 2000 989,149 2001 726,482 2002 384,003 Thereafter 666,095 ---------- $5,226,405 ---------- ---------- 43 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. NOTES TO FINANCIAL STATEMENTS NOTE E - OPERATING LEASES - CONTINUED The following is a schedule of lease expense for all operating leases for the three years ended February 28, 1997: 1997 1996 1995 ---------- ---------- ---------- Minimum rentals $2,278,591 $1,547,817 $1,042,235 Less sublease rentals (1,184,301) (982,780) (663,457) Contingent rentals 47,116 56,037 33,040 ---------- ---------- ---------- $1,141,406 $ 621,074 $ 411,818 ---------- ---------- ---------- ---------- ---------- ---------- NOTE F - RELATED PARTY LEASE Until June, 1994 the Company leased land and its factory building under a ten year operating lease with the President of the Company for a monthly rental of $7,750. On June 2, 1994 the Company acquired the land and building from the President at a price of $700,332. NOTE G - INCOME TAXES Income tax expense is comprised of the following: Years Ended February 28 - 29, 1997 1996 1995 --------- --------- --------- Current Federal $146,743 $527,211 $658,061 State 2,671 56,277 91,455 --------- --------- --------- Total Current 149,414 583,488 749,516 --------- --------- --------- Deferred Federal (879,936) 116,527 34,759 State (101,992) 8,485 5,112 --------- --------- --------- Total Deferred (981,928) 125,012 39,871 --------- --------- --------- Total $(832,514) $708,500 $789,387 --------- --------- --------- --------- --------- --------- A reconciliation of the statutory federal income tax rate and the effective rate as a percentage of pretax income is as follows: Years Ended February 28 - 29, 1997 1996 1995 -------- -------- -------- Statutory rate 34.0% 34.0% 34.0% Goodwill amortization .4% .4% .4% State income taxes, net of federal benefit 3.0% 2.2% 3.0% Other .5% .4% (.5%) -------- -------- -------- Effective Rate 37.9% 37.0% 36.9% -------- -------- -------- -------- -------- -------- 44 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. NOTES TO FINANCIAL STATEMENTS NOTE G - INCOME TAXES - CONTINUED The components of deferred income taxes at February 28, 1997 and February 29, 1996 are as follows: Deferred Tax Asset 1997 1996 ------------------ --------- --------- Allowance for doubtful accounts $ 99,728 $ 10,573 Accrued compensation 63,666 48,646 Deferred income 35,944 - Contribution carryover 9,610 - Loss provisions 940,972 - Alternative minimum tax carryforward 85,689 - Deferred lease rentals 33,914 18,729 --------- --------- 1,269,523 77,948 Deferred Tax Liabilities ------------------------ Depreciation (503,884) (294,237) --------- --------- Net deferred tax asset (liability) $ 765,639 $(216,289) --------- --------- --------- --------- NOTE H - PREFERRED STOCK On February 15, 1995, the Company called for redemption of all outstanding shares of its 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 I - 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. Grants of options representing 111,000 shares of the Company's common stock remained outstanding under the 1985 Plan at February 28, 1997. Under the 1995 Stock Option Plan (the "1995 Plan") and the Nonqualified Stock Option Plan for Nonemployee Directors (the "Directors' Plan"), options to purchase up to 100,000 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. Grants of options representing 121,000 and 40,000 shares of the Company's common stock remained outstanding under the 1995 Plan and Directors' Plan, respectively at February 28, 1997. 45 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. NOTES TO FINANCIAL STATEMENTS NOTE I - STOCK OPTION PLANS - CONTINUED 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 161,000 shares were exercisable at February 28, 1997. 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 income (loss) per share would have been reduced to the pro-forma amounts indicated in the table below (in 000's except per share amounts): Years Ended February 28 (29): ----------------------------- 1997 1996 ------- ------- Net Income (Loss)-as reported $(1,366) $ 1,208 Net Income (Loss)-pro forma $(1,530) $ 876 Income per Share-as reported $ (.46) $ .42 Income (Loss) per Share-pro forma $ (.52) $ .30 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: Expected dividend yield 0% Expected stock price volatility 50% Risk-free interest rate 6.5% Expected life of options 7 years Additional information with respect to options outstanding under the Plans at February 28, 1997, and changes for the two years then ended was as follows: 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 Cancelled (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 $4.04 46 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. NOTES TO FINANCIAL STATEMENTS NOTE I - STOCK OPTION PLANS - CONT.
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 29, 1996 200,000 $ 11.19 Information about stock options outstanding at February 28, 1997 is summarized as follows:
Options Outstanding ------------------------------- Weighted average Number remaining Weighted average Range of exercise prices outstanding contractual life exercise price - - - ------------------------ ----------- ---------------- ---------------- $3.125 to 5.875 91,000 5.42 years $ 4.32 $6.25 to 7.75 90,000 9.21 years 7.70 $11.50 to 18.25 91,000 7.45 years 14.99 -------- 272,000 -------- -------- Options Exercisable ------------------------------------ Weighted Number average Range of exercise prices exercisable exercise price - - - ------------------------ ----------- -------------- $3.125 to 5.875 71,000 $3.88 $6.25 to 7.75 - - $11.50 to 18.25 90,000 $15.03 ------- 161,000 ------- ------- NOTE J - SEGMENT INFORMATION The Company operates in only one industry segment. All significant revenues relate to sales of its products through Company operated and franchised retail stores. 47 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. NOTES TO FINANCIAL STATEMENTS NOTE K - 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 anticipated closure date of these stores varies between May 1997 and February 1998. 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 E). 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. 48 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 The executive officers and directors of the Company are as follows: NAME AGE POSITION ---- --- -------- Franklin E. Crail.............. 55 Chairman of the Board, President, Treasurer and Director Edward L. Dudley............... 33 Vice President - Product Sales Development Clifton W. Folsom.............. 43 Vice President - Franchise Support Gary S. Hauer.................. 52 Vice President - Manufacturing and Director Jay B. Haws.................... 46 Vice President - Marketing Lawrence C. Rezentes........... 49 Vice President - Finance Virginia M. Perez.............. 59 Corporate Secretary Gerald A. Kien................. 66 Director Lee N. Mortenson............... 61 Director Everett A. Sisson.............. 76 Director Fred M. Trainor................ 58 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 - Product Sales Development, with the goal of increasing Company factory and retail sales. Mr. Dudley served in a number of senior marketing and sales management capacities, including most recently that of Director, Distribution Services, during his 10 year career with Baxter Healthcare Corporation. Mr. Dudley holds B.S. degrees in Finance and Accounting from the University of Colorado. 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 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. 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 confectionery and food 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. JAY B. HAWS. Mr. Haws joined the Company in August 1991 as Vice President of Marketing. Since 1981, Jay 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 49 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. LAWRENCE C. REZENTES. Mr. Rezentes joined the Company in July 1990 as Vice President of Finance. From 1989 to April 1990, he served as Vice President of Finance for Fanamation, Inc., a designer and manufacturer of robotic inspection systems. From 1985 through 1988, he was a principal in Venture Consulting Resource, a financial and business planning consulting organization to technology-based businesses and to the venture capital community. From 1980 through 1984, Mr. Rezentes was co-founder and Vice President of Finance of Infomed Corporation, a venture capital financed pioneer in the field of computer and telecommunications-based medical diagnosis. Mr. Rezentes holds a B.S. in accounting from Fairleigh Dickinson University and an M.B.A. in finance from the University of Chicago Graduate School of Business. He is a certified public accountant. 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. Mr. Kien was first elected as a Director of the Company in August 1995. From 1993 to 1995 Mr. 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 Mr. 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 Mr. Kien remained as President of the Sun Electric division of Snap-On Tools until his retirement in 1994. Mr. 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. Mr. Kien received his Ph.D. from the University of Illinois Graduate College of Medicine, in 1959. LEE N. MORTENSON. Mr. Mortenson has served on the Board of Directors of the Company since 1987. Since December 1993, Mr. Mortenson has been President and a Director of Coronet Insurance Company. Mr. Mortenson has served, since May 1988, as President and a Director and, since December 1990, as Chief Operating Officer of Sunstates Corporation (formerly known as Acton Corporation). He also served as Chief Executive Officer of Sunstates Corporation, the parent corporation of Coronet, from May 1988 to December 1990. Sunstates Corporation is engaged in non-standard automative casualty insurance, manufacturing and real estate development. Since 1984, Mr. Mortenson has served as President, Chief Operating Officer and a Director of Telco Capital Corporation, a diversified financial services and manufacturing company and an indirect parent of Coronet. Mr. Mortenson also served as a Director of Hickory Furniture Company from 1980 to 1993 and of Sun Electric Corporation, a manufacturer of automotive test equipment, from 1988 to 1992 and has served as a Director of Alba-Waldensian, Inc., since 1984, of NRG Inc., a leasing company, since 1987, and of Wellco Enterprises, Inc., a boot manufacturer, since 1994. On December 10, 1996, the Director of Insurance of the State of Illinois, as Conservator, took possession and control of the assets and properties of Coronet Insurance 50 Company and certain of its affiliated companies and issued a Cease and Desist Order prohibiting issuance of new or renewal policies of insurance, following the reduction of such companies' statutory surplus to less that the minimum amounts required under insurance regulations. On December 24, 1996, the Director of Insurance, as Conservator, ordered the complete liquidation of Coronet and such affiliates for the benefit of its creditors and policyholders. Mr. Mortenson also serves as director or officer of certain of these affiliates of Coronet. 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 has been a Director of Coronet since 1992. 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 thirteen years in a number of management capacities. 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) COMPLIANCE The Company has no knowledge that any director, executive officer or 10% stockholder was required to file a Form 5 for fiscal 1996 and failed to do so, and the Company has received a written representation that a Form 5 was not required from each such person other than Clyde Wm. Engle who, together with certain affiliated companies is a 10% stockholder of the Company. 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 Chief Executive Officer (the "named officer"). No other executive officer of the Company met the minimum compensation threshold of $100,000 for inclusion in the table. SUMMARY COMPENSATION TABLE
ANNUAL ALL OTHER COMPENSATION COMPENSATION(2) ------------ --------------- NAME AND PRINCIPAL POSITION YEAR SALARY(1) BONUS --------------------------- ---- --------- ----- Franklin E. Crail, 1997 $150,000 -0- $2,250 Chairman of the Board and President 1996 $146,538 $10,000 $1,833 1995 $129,618 $31,050 $2,162
51 (1) Includes amounts deferred at the Named Officer's election pursuant to the Company's 401(k) Plan. (2) Represents Company contributions on behalf of the Named Officer under the Company's 401(k) Plan. 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 Officer. COMPENSATION OF DIRECTORS Directors of the Company do not receive any compensation for serving on the Board or on committees. Directors are entitled to receive stock option awards under the Company's 1990 Nonqualified Stock Option Plan for Nonemployee Directors ("the Directors' Plan"). The Directors' 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 Directors' 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. In 1987, the Company granted to Coronet Insurance Company the right to require the Company, at the Company's expense, to register for public sale the shares of Common Stock of the Company acquired by Coronet pursuant to the conversion of the Company's 7% Convertible Secured Notes, all of which have previously been converted by Coronet. Such registration rights, which apply to 724,562 of the shares of Common Stock currently held by Coronet, are exercisable by Coronet at any time. However, Coronet may not exercise the registration rights more than once in any consecutive 12-month period nor more than three times in the aggregate, unless Coronet agrees to pay all the Company's costs and expenses in connection therewith. Coronet has exercised such registration rights one time, in connection with the public offering of Common Stock completed in September and October, 1995. The Company also granted "piggyback" rights to Coronet entitling Coronet to participate in registered offerings of Common Stock by the Company in certain circumstances. Coronet's assets are currently under the control of the Director of Insurance of the State of Illinois. See Item 12, below. Mr. Mortenson is President and a director of Coronet and a director and officer of certain affiliated corporations of Coronet. Mr. Sisson has been a director of Coronet since 1992 and, during various periods over the past 20 years, has served as a director of certain affiliated corporations of Coronet. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information, at May 12, 1997, with respect to (i) each person known to the Company to be the beneficial owner of more than 5% of the Company's Common 52 Stock, (ii) the shares of the Company's Common Stock beneficially owned by each Director and nominee (which includes the Named Officer) 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 or conversion privileges is deemed to be outstanding for the purpose of computing the percentage of Common Stock beneficially owned by the person holding such options or conversion privileges, but is not deemed to be outstanding for the purpose of computing the percentage of Common Stock beneficially owned by any other person. Rocky Mountain Holdings Company ("Holdings") has pledged to LaSalle National Bank of Chicago, Illinois, 799,357 of the shares of Common Stock indicated in the table below as being beneficially owned by Clyde Wm. Engle, representing 27.5% of the total outstanding shares as of May 12, 1997, to secure certain indebtedness to such bank. Holdings, a subsidiary of Coronet Insurance Company ("Coronet"), is the direct owner of the pledge shares. See footnote (2) to the table below. Holdings has retained voting rights with respect to the pledged shares. An event resulting in foreclosure on the indebtedness could result in a change in control of the Company at a subsequent date. The Director of Insurance of the State of Illinois, as Conservator, took possession and control of the assets and properties of Coronet and certain of its affiliates, including Casualty Insurance Company of Florida and Crown Casualty Company, on December 10, 1996, and, on December 24, 1996, ordered the complete liquidation of Coronet and such affiliates for the benefit of their creditors and policyholders. It is the Company's understanding that the details of such liquidation, and of any related dispositions of the 868,757 shares of the Company's Common Stock held by Coronet's subsidiaries, as described in footnote (2) to the table below, have not been finalized. Any such dispositions could result in a change in control of the Company at a subsequent date. Such shares represent 29.8% of the total outstanding shares of Common Stock as of May 12, 1997. The Director of Insurance has advised the Company that sales of the shares on the market, if any, would be made in an orderly fashion over a period of time to minimize any impact on the market for the Company's stock. Common Stock - - - ------------ Amount and Name of Nature of Percent Beneficial Beneficial of Owner (1) Ownership class - - - ---------- ---------- ------- Clyde Wm. Engle et al. 893,757 (2) 30.7% Franklin E. Crail 293,099 10.1% Gary S. Hauer 35,991 (3) 1.2% Everett A. Sisson 10,000 (4) .3% Gerald A. Kien 10,000 (4) .3% Lee N. Mortenson 12,500 (4) .4% Fred M. Trainor 20,000 (4) .7% All executive officers and directors as a group (10 persons) 537,522 (5) 18.5% - - - --------------------- (1) Mr. Engle's address is 3500 West Peterson Avenue, Chicago, Illinois 60659. Mr. Crail's address is the same as the Company's address 53 (2) 868,757 of the shares indicated as being beneficially owned by Mr. Engle are held of record by the following subsidiaries of Coronet: Holdings (799,357 shares), Casualty Insurance Company of Florida (58,670 shares) and Crown Casualty Company (10,730 shares). Such shares may also be deemed to be beneficially owned by the following affiliates of Coronet: Normandy Insurance Agency, Inc., Sunstates Corporation, Hickory Furniture Company, Telco Capital Corporation and RDIS Corporation. Mr. Engle is the beneficial owner of a majority equity interest in RDIS Corporation, the ultimate parent of the foregoing corporations. This information is based on Forms 4 dated June 6, 1996, filed by Mr. Engle, Coronet and such affiliates and a Form 4 dated March 8, 1997, filed by Mr. Engle with the Securities and Exchange Commission and on information provided to the Company by Coronet. The Form 4 filed by Mr. Engle indicates that he beneficially owns an additional 25,000 shares, of which 15,000 shares are owned by 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. Eagle disclaims beneficial ownership of the shares owned by his family members. (3) Mr. Hauer has the right to acquire these shares within 60 days through the exercise of employee stock options previously granted to him. (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 pursuant to the Directors Plan. (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 The information set forth under the heading "Compensation Committee Interlocks and Insider Participation" in Item 11, Executive Compensation, above, is incorporated by reference in this Item 13. 54 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. . . . . . . . . . . . . . . . . . . 31 BALANCE SHEETS. . . . . . . . . . . . . . . . . . . . . . . . . . 32 STATEMENTS OF OPERATIONS. . . . . . . . . . . . . . . . . . . . . 34 STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY . . . . . . . . . . 35 STATEMENTS OF CASH FLOWS. . . . . . . . . . . . . . . . . . . . . 37 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. 3. EXHIBITS Exhibit Incorporated by Number Description Reference to ------ ----------- --------------- 3.1 Articles of Incorporation of Exhibit 3.1 to Current Report on the Registrant, as amended Form 8-K of the Registrant filed on August 1, 1988. 3.2 By-laws of the Registrant, as Exhibit 3.2 to the Annual Report on amended on June 10, 1987 Form 10-K of the Registrant for the fiscal year ended February 28, 1987. 4.1 Specimen Common Stock Exhibit 4.1 to Current Report on Certificate Form 8-K of the Registrant filed on August 1, 1988. 4.2 Working capital loan Exhibit 4.8 to the Annual Report on agreement dated October 17, Form 10-K of the Registrant for the 1991 between the Company and Fiscal year ended February 29, 1992 Burns National Bank of Durango (Amended by change in terms agreements provided as Exhibits 4.12 and 4.16 below) 4.3 Lease agreement dated July Exhibit 4.10 to the Annual Report 19, 1991 between the Company on Form 10-K of the Registrant for and Ford Equipment Leasing the Fiscal year ended February 29, Company 1992 4.4 Installment note dated August Exhibit 4.11 to the Annual Report 23, 1991 between the Company on Form 10-K of the Registrant for and Textron Financial the Fiscal year ended February 29, Corporation 1992 55 Exhibit Incorporated by Number Description Reference to ------ ----------- --------------- 4.5 Change in terms agreement (to Exhibit 4.12 to the Annual Report working capital loan on Form 10-KSB of registrant for agreement dated October 17, the fiscal year ended February 28, 1991 filed as Exhibit 4.8) 1994 dated October 17, 1994 4.6 Letters of commitment from Exhibit 4.13 to the Form 10-K of financial institutions registrant for the fiscal year supporting commitment of ended February 29, 1996 $3,500,000 in financing 4.7 Chattel mortgage loan Exhibit 4.14 to the Form 10-K of agreement dated June 2, 1994 registrant for the fiscal year in the amount of $750,000 ended February 29, 1996 between the registrant and First National Bank of Farmington 4.8 Real estate mortgage loan Exhibit 4.15 to the Form 10-K of agreement dated June 2, 1994 registrant for the fiscal year in the amount of $1,687,500 ended February 29, 1996 between the registrant and First National Bank of Farmington 4.9 Change in terms agreement (to Exhibit 4.16 to the Form 10-K of working capital loan registrant for the fiscal year agreement dated October 17, ended February 29, 1996 1991 filed as Exhibit 4.8) dated April 12, 1995 4.10 Chattel mortgage loan Exhibit 4.17 to the Form 10-K of agreement dated April 12, registrant for the fiscal year 1995 in the amount of ended February 29, 1996 $1,500,000 between the registrant and First National Bank of Farmington 4.11 Working Capital availability Exhibit 4.18 to the Form 10-K of loan agreement dated April 5, registrant for the fiscal year 1996 in the amount of ended February 29, 1996 $2,000,000 between Norwest Banks and the Registrant 4.12 Working Capital availability Filed Herewith loan agreement dated May 22, 1997 in the amount of $2,000,000 between Norwest Banks and the Registrant 10.1 Form of Stock Option Exhibit 10.3 to the Annual Report Agreement for Incentive Stock on Form 10-K of the Registrant for Option Plan of the Registrant* the fiscal year ended February 28, 1986. 56 Exhibit Incorporated by Number Description Reference to ------ ----------- --------------- 10.2 Incentive Stock Option Plan Exhibit 10.2 to the Annual Report of the Registrant as amended on Form 10-K of the Registrant for July 27, 1990 * the fiscal year ended February 28, 1991 10.4 Current form of franchise Filed herewith. agreement used by the Registrant 10.5 Form of Real Estate Lease Exhibit 10.7 to Registration 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 Report Option Agreement for on Form 10-K of the Registrant for Nonemployee Directors for the the fiscal year ended February 28, Registrant * 1991. 10.8 Nonqualified Stock Option Exhibit 10.9 to the Annual Report Plan for Nonemployee on Form 10-K of the Registrant for Directors dated March 20, the fiscal year ended February 28, 1990 * 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 (Registration Stock Option Plan* 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 (Registration Stock Option Plan* No. 33-62149) filed on August 25, 1995 11.1 Statement re-computation of Filed herewith. per share earnings 23.1 Consent of independent public Filed herewith accountants 27.1 Financial Data Schedule Filed herewith * 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, 1997. 57
Exhibit Incorporated by Sequentially Number Description Reference to Numbered Page ------- ----------- --------------- ------------- 3.1 Articles of Incorporation of Exhibit 3.1 to Current Report on the Registrant, as amended Form 8-K of the Registrant filed on August 1, 1988. 3.2 By-laws of the Registrant, Exhibit 3.2 to the Annual Report as amended on June 10, 1987 on Form 10-K of the Registrant for the fiscal year ended February 28, 1987. 4.1 Specimen Common Stock Exhibit 4.1 to Current Report on Certificate Form 8-K of the Registrant filed on August 1, 1988. 4.2 Working capital loan Exhibit 4.8 to the Annual Report agreement dated October 17, on Form 10-K of the Registrant 1991 between the Company and for the Fiscal year ended Burns National Bank of February 29, 1992 Durango (Amended by change in terms agreements provided as Exhibits 4.12 and 4.16 below) 4.3 Lease agreement dated July Exhibit 4.10 to the Annual Report 19, 1991 between the Company on Form 10-K of the Registrant and Ford Equipment Leasing for the Fiscal year ended Company February 29, 1992 4.4 Installment note dated Exhibit 4.11 to the Annual Report August 23, 1991 between the on Form 10-K of the Registrant Company and Textron for the Fiscal year ended Financial Corporation February 29, 1992 4.5 Change in terms agreement Exhibit 4.12 to the Annual Report (to working capital loan on Form 10-KSB of registrant for agreement dated October 17, the fiscal year ended February 1991 filed as Exhibit 4.8) 28, 1994 dated October 17, 1994 4.6 Letters of commitment from Exhibit 4.13 to the Form 10-K of financial institutions registrant for the fiscal year supporting commitment of ended February 29, 1996 $3,500,000 in financing 4.7 Chattel mortgage loan Exhibit 4.14 to the Form 10-K of agreement dated June 2, 1994 registrant for the fiscal year in the amount of $750,000 ended February 29, 1996 between the registrant and First National Bank of Farmington 58 Exhibit Incorporated by Sequentially Number Description Reference to Numbered Page ------- ----------- --------------- ------------- 4.8 Real estate mortgage loan Exhibit 4.15 to the Form 10-K of agreement dated June 2, 1994 registrant for the fiscal year in the amount of $1,687,500 ended February 29, 1996 between the registrant and First National Bank of Farmington 4.9 Change in terms agreement Exhibit 4.16 to the Form 10-K of (to working capital loan registrant for the fiscal year agreement dated October 17, ended February 29, 1996 1991 filed as Exhibit 4.8) dated April 12, 1995 4.10 Chattel mortgage loan Exhibit 4.17 to the Form 10-K of agreement dated April 12, registrant for the fiscal year 1995 in the amount of ended February 29, 1996 $1,500,000 between the registrant and First National Bank of Farmington 4.11 Working Capital availability Exhibit 4.18 to the Form 10-K of loan agreement dated April registrant for the fiscal year 5, 1996 in the amount of ended February 29, 1996 $2,000,000 between Norwest Banks and the Registrant 4.12 Working Capital availability Filed Herewith loan agreement dated May 22, 1997 in the amount of $2,000,000 between Norwest Banks and the Registrant 10.1 Form of Stock Option Exhibit 10.3 to the Annual Report Agreement for Incentive on Form 10-K of the Registrant Stock Option Plan of the for the fiscal year ended Registrant * February 28, 1986. 10.2 Incentive Stock Option Plan Exhibit 10.2 to the Annual Report of the Registrant as amended on Form 10-K of the Registrant July 27, 1990 * for the fiscal year ended February 28, 1991 10.4 Current form of franchise Filed herewith. agreement used by the Registrant 59 Exhibit Incorporated by Sequentially Number Description Reference to Numbered Page ------- ----------- --------------- ------------- 10.5 Form of Real Estate Lease Exhibit 10.7 to Registration 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 Report Option Agreement for on Form 10-K of the Registrant Nonemployee Directors for for the fiscal year ended the Registrant * February 28, 1991. 10.8 Nonqualified Stock Option Exhibit 10.9 to the Annual Report Plan for Nonemployee on Form 10-K of the Registrant Directors dated March 20, for the fiscal year ended 1990 * February 28, 1991 10.9 1995 Stock Option Plan of Exhibit 10.9 to Registration the 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 11.1 Statement re-computation of Filed herewith. per share earnings 23.1 Consent of independent Filed herewith public accountants 27.1 Financial Data Schedule Filed herewith
* 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, 1997. 60 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. By /S/ FRANKLIN E. CRAIL ---------------------------- FRANKLIN E. CRAIL President Date: May 26, 1997 In accordance with the Exchange Act, 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: May 26, 1997 /S/ FRANKLIN E. CRAIL ----------------------------- FRANKLIN E. CRAIL Chairman of the Board of Directors, President, Treasurer and Director (principal executive officer) Date: May 26, 1997 /S/ LAWRENCE C. REZENTES ----------------------------- LAWRENCE C. REZENTES Vice President - Finance (principal financial and accounting officer) Date: May 26, 1997 /S/ GARY S. HAUER ----------------------------- GARY S. HAUER Vice President - Manufacturing, Director Date: May 26, 1997 /S/ GERALD A KIEN ----------------------------- GERALD A. KIEN, Director Date: May 26, 1997 /S/ LEE N. MORTENSON ----------------------------- LEE N. MORTENSON, Director Date: May 26, 1997 /S/ EVERETT A. SISSON ----------------------------- EVERETT A. SISSON, Director Date: May 26, 1997 /S/ FRED M. TRAINOR ----------------------------- FRED M. TRAINOR, Director 61 EX-4.12 2 EXHIBIT 4.12 Exhibit 4.12 THIRD AMENDMENT TO TERM LOAN AND CREDIT AGREEMENT THIS THIRD AMENDMENT OF TERM LOAN AND CREDIT AGREEMENT (the "Third Amendment") is entered into this 22nd day of May, 1997, by and between Norwest Bank Colorado, National Association (the "Bank") and the Rocky Mountain Chocolate Factory, Inc. (the "Borrower"). RECITALS I. On April 5, 1996, the Borrower and the Bank entered into a Term Loan and Credit Agreement (the "Agreement") setting forth the terms and conditions of a revolving line of credit facility and three term loan credit facilities extended by the Bank to the Borrower. II. On February 5, 1997, and May 2, 1997, the Bank and the Borrower entered into agreements amending certain terms of the Agreement (the "First Amendment" and the "Second Amendment," respectively). III. The Bank and the Borrower now wish to modify certain other terms of the Agreement concerning renewal of the Credit and changes of certain covenants. NOW, THEREFORE, in consideration of the premises contained herein, the parties agree as follows: 1 INCORPORATION OF RECITALS. The recitals are incorporated herein. 2 CAPITALIZED TERMS. Unless the context requires otherwise, all capitalized terms in the Second Amendment shall have the same meaning as ascribed to them in the Agreement, the First Amendment and the Second Amendment. 3 AMENDMENTS. The Agreement is amended as follows: 3.1. Section 1.10 of the Agreement is deleted and replaced with the following new section 1.10: "1.10. Borrowing Base Certificate" shall mean a schedule of Borrower's Accounts Receivable, Acceptable Accounts Receivable, Inventory, Acceptable Inventory, and Account Receivable agings, executed by an authorized officer of the Borrower and in form acceptable to the Bank." 3.2. Section 1.14 of the Agreement is deleted and replaced with the following new section 1.14: "1.14. "Credit Maturity Date' shall mean July 31, 1998." 3.3 Section 2.1.2 of the Agreement is deleted and replaced with the following new section 2.1.2: "2.1.2. The purpose of the Credit is to finance Accounts Receivable from the franchise stores and the purchase of raw materials." 3.4. Section 2.4 of the Agreement is deleted in its entirety. 3.5. Section 6 of the Agreement is deleted in its entirety and replaced with the following new section 6, which new section 6 shall be effective March 1, 1997: "6. Affirmative Covenants The Borrower covenants and agrees that so long as any Indebtedness remains outstanding hereunder, unless the Bank shall otherwise consent in writing, it will: 6.1 Pay, when due, all taxes assessed against it or its property except to the extent and so long as contested in good faith. 6.2 Maintain its corporate existence, comply with all laws and regulations applicable thereto, and comply with all laws applicable to the Borrower and the Borrower's business, including but not limited to all laws governing the Borrower's franchise operations. 6.3 Furnish to the Bank: 6.3.1. Within 90 days after the end of each fiscal year of the Borrower (i) a detailed report of audit of the Borrower for such fiscal year including the balance sheet of the Borrower as of the end of such fiscal year and the statements of profit and loss and surplus of the Borrower for the fiscal year then ended, prepared by independent certified public accountants satisfactory to the Bank, and (ii) a certificate of such accountants stating whether, in making their audit, they have become aware of any Event of Default set forth in Section 8 hereof, or of any event which might become such an Event of Default after the lapse of time or the giving of notice Third Amendment 2 of 6 and the lapse of time, which has occurred and is then continuing and, if any such event has occurred and is continuing, specifying the nature and period of existence thereof. 6.3.2. Within 30 days after the end of each month, the balance sheet of the Borrower as of the end of such period and the statement of profit and loss and surplus of the Borrower from the beginning of such fiscal year to the end of such period, unaudited, but certified as correct (subject to year end adjustments) by an appropriate officer of the Borrower. 6.3.3. Annually, within 90 days after the Borrower's fiscal year end, a properly completed United States Securities and Exchange Commission Form 10K. 6.3.4. Quarterly, within 45 days after the end of each quarter, a properly completed United States Securities and Exchange Commission Form 10Q. 6.3.5. Monthly, within 45 days after the end of each calendar month, Borrowing Base Certificates. 6.3.6. Monthly, a list of all franchisees currently in default, if any, together with a description of the nature of each default. 6.3.7. Annually, within 90 days after the end of the Borrower's fiscal year, a list of monthly projections of the Borrower's business for the coming year and a list of annual projections for the coming 3 years. 6.3.8. Annually, a copy of a policy of insurance, showing the Bank as Loss Payee, Mortgagee, or Additional Insured, covering all personal and real property of the Borrower, and its subsidiaries and affiliates, if any. 6.3.9. Promptly upon knowledge thereof, notice of the Bank in writing of the occurrence of any event which has or might, after the lapse of time or the giving of notice and the lapse of time, become an event of default under Section 8 of this Agreement; and, 6.3.10 Promptly, such other information as the Bank may reasonably request. Third Amendment 3 of 6 6.4. Maintain present management of the Borrower, present ownership interest of the Borrower's management, and the Borrower's present principal place of business. 6.5. Use proceeds from sales of Borrower's assets to repay borrowings hereunder. 6.6. Maintain at all times its Inventory, Equipment, real estate and other properties in good condition and repair (normal wear and tear excepted), and pay and discharge or cause to be paid and discharged when due, the cost of repairs to or maintenance of the same, and pay or cause to be paid all rental or mortgage payments due on such real estate. 6.7. Maintain at all times a ratio of debt to Tangible Net Worth of not more than 1.00 to 1.00. 6.8. Maintain at all times a ratio of Current Assets to Current Liabilities of not less than 1.50 to 1.00. 6.9. Maintain at all times a Tangible Net Worth of more than $9,000,000.00. 6.10. Maintain at all times a minimum Cash Flow Coverage Ratio of more than 1.25 to 1:00. 6.11. Maintain at all times a loan-to-value ratio of no more than 75%. If the Bank reasonably believes that (i) the market value of the Borrower's real property has declined or (ii) Debt Service Coverage has fallen below 1:25 to 1:00 or (iii) regulatory requirements of the Bank have changed, the Bank may require that the property be reappraised at the Borrower's expense, and in the event of a decline in the value of the property, that the Borrower reduce amounts outstanding under Credit or the Term Loans or take such other measures as the Bank may require at that time. 6.12. Maintain at all times a Working Capital of at least 2,250,000.00. 6.13. When requested so to do, make available for inspection by duly authorized representatives of the Bank any of its books and records, and furnish the Bank any information regarding its Third Amendment 4 of 6 business affairs and financial condition within a reasonable time after written request therefor. 6.14. Promptly notify the Bank of any defaults occurring with any franchisee of the Borrower, of any litigation initiated against the Borrower, and of the Borrower's intent to acquire additional factory facilities or other business operations." 3.6 Section 7.3 of the Agreement is deleted and replaced with the following new section 7.3, which new section 7.3 shall be effective as of March 1, 1997: "7.3. Permit the aggregate amount of the Borrower's capital expenditures for fixed assets, including but not limited to fixed asset leases and lease purchases, to exceed $1,750,000.00 annually." 4 NEW LOANS. The Borrower agrees to inform the Bank of the Borrower's intentions, if any, to incur new debt in order to perm the Bank to offer financing of such new debt to the Borrower. 5 REPRESENTATION AND WARRANTIES. The Borrower restates and reaffirms all warranties made in the Agreement, and represents and warrants that no Event of Default or event that, with the passing of time may become an Event of Default has occurred or is occurring, except for those Events of Default or events previously disclosed to the Bank or acknowledged by the Bank in writing. 6. INTEGRATION OF AGREEMENTS. The Agreement, the First Amendment, the Second Amendment, and the Third Amendment shall be read together so as to give effect to the terms of all. All terms and provisions set forth in the Agreement, the First Amendment, and the Second Amendment that are not specifically amended herein shall remain in full force and effect. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the day and year first above written. BANK: Norwest Bank Colorado, National Association By: /s/ Michael Noesen ------------------------------ Michael Noesen, Vice President Third Amendment 5 of 6 BORROWER: Rocky Mountain Chocolate Factory, Inc. By: /s/ Lawrence C. Rezentes ------------------------------ Name: Lawrence C. Rezentes ----------------------------- Title: Chief Financial Officer ---------------------------- Third Amendment 6 of 6 EX-10.4 3 EXHIBIT 10.4 Exhibit 10.4 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. FRANCHISE AGREEMENT TABLE OF CONTENTS 1. PURPOSE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2. GRANT OF FRANCHISE . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2.1. Grant of Franchise . . . . . . . . . . . . . . . . . . . . . . 1 2.2. Scope of Franchise Operations. . . . . . . . . . . . . . . . . 1 3. FRANCHISED LOCATION AND DESIGNATED AREA. . . . . . . . . . . . . . . . 2 3.1. Franchised Location. . . . . . . . . . . . . . . . . . . . . . 2 3.2. Protected Territory. . . . . . . . . . . . . . . . . . . . . . 2 3.3. Limitation on Franchise Rights . . . . . . . . . . . . . . . . 2 3.4. Franchisor's Reservation of Rights . . . . . . . . . . . . . . 3 4. INITIAL FRANCHISE FEE. . . . . . . . . . . . . . . . . . . . . . . . . 3 4.1. Initial Franchise Fee. . . . . . . . . . . . . . . . . . . . . 3 5. DEVELOPMENT OF FRANCHISED LOCATION . . . . . . . . . . . . . . . . . . 3 5.1. Approval of Lease. . . . . . . . . . . . . . . . . . . . . . . 3 5.2. Conversion and Design. . . . . . . . . . . . . . . . . . . . . 4 5.3. Signs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 5.4. Equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . 4 5.5. Permits and Licenses . . . . . . . . . . . . . . . . . . . . . 5 5.6. Commencement of Operations . . . . . . . . . . . . . . . . . . 5 6. TRAINING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 6.1. Initial Training Program . . . . . . . . . . . . . . . . . . . 5 6.2. Length of Training . . . . . . . . . . . . . . . . . . . . . . 6 6.3. Additional Training. . . . . . . . . . . . . . . . . . . . . . 6 7. DEVELOPMENT ASSISTANCE . . . . . . . . . . . . . . . . . . . . . . . . 6 7.1. Franchisor's Development Assistance. . . . . . . . . . . . . . 6 8. OPERATIONS MANUAL. . . . . . . . . . . . . . . . . . . . . . . . . . . 7 8.1. Operations Manual. . . . . . . . . . . . . . . . . . . . . . . 7 8.2. Confidentiality of Operations Manual Contents. . . . . . . . . 7 8.3. Changes to Operations Manual . . . . . . . . . . . . . . . . . 8 9. OPERATING ASSISTANCE . . . . . . . . . . . . . . . . . . . . . . . . . 8 9.1. Franchisor's Services. . . . . . . . . . . . . . . . . . . . . 8 9.2. Additional Franchisor Services . . . . . . . . . . . . . . . . 9 10. FRANCHISEE'S OPERATIONAL COVENANTS . . . . . . . . . . . . . . . . . . 9 10.1. Business Operations. . . . . . . . . . . . . . . . . . . . . . 9 11. ROYALTIES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 11.1. Monthly Royalty. . . . . . . . . . . . . . . . . . . . . . . . 12 11.2. Gross Retail Sales . . . . . . . . . . . . . . . . . . . . . . 12 11.3. Royalty Payments . . . . . . . . . . . . . . . . . . . . . . . 12 12. ADVERTISING. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 12.1. Approval of Advertising. . . . . . . . . . . . . . . . . . . . 13 12.2. Local Advertising. . . . . . . . . . . . . . . . . . . . . . . 13 12.3. Marketing and Promotion Fee. . . . . . . . . . . . . . . . . . 13 12.4. Regional Advertising Programs. . . . . . . . . . . . . . . . . 14 12.5. Marketing Services . . . . . . . . . . . . . . . . . . . . . . 15 13. QUALITY CONTROL. . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 13.1. Compliance with Operations Manual. . . . . . . . . . . . . . . 15 13.2. Standards and Specifications . . . . . . . . . . . . . . . . . 15 13.3. Inspections. . . . . . . . . . . . . . . . . . . . . . . . . . 15 13.4. Restrictions on Services and Products. . . . . . . . . . . . . 15 13.5. Approved Suppliers . . . . . . . . . . . . . . . . . . . . . . 16 13.6. Request to Change Supplier . . . . . . . . . . . . . . . . . . 16 13.7. Approval of Intended Supplier. . . . . . . . . . . . . . . . . 16 14. TRADEMARKS, TRADE NAMES AND PROPRIETARY INTERESTS. . . . . . . . . . . 17 14.1. Marks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 14.2. No Use of Other Marks. . . . . . . . . . . . . . . . . . . . . 17 14.3. Licensed Methods . . . . . . . . . . . . . . . . . . . . . . . 17 14.4. Effect of Termination. . . . . . . . . . . . . . . . . . . . . 17 14.5. Mark Infringement. . . . . . . . . . . . . . . . . . . . . . . 17 14.6. Franchisee's Business Name . . . . . . . . . . . . . . . . . . 18 14.7. Change of Marks. . . . . . . . . . . . . . . . . . . . . . . . 18 15. REPORTS, RECORDS AND FINANCIAL STATEMENTS. . . . . . . . . . . . . . . 18 15.1. Franchisee Reports . . . . . . . . . . . . . . . . . . . . . . 18 15.2. Annual Financial Statements. . . . . . . . . . . . . . . . . . 19 15.3. Verification . . . . . . . . . . . . . . . . . . . . . . . . . 19 15.4. Books and Records. . . . . . . . . . . . . . . . . . . . . . . 19 15.5. Audit of Books and Records . . . . . . . . . . . . . . . . . . 19 15.6. Failure to Comply with Reporting Requirements. . . . . . . . . 20 15.7. Shopping Service . . . . . . . . . . . . . . . . . . . . . . . 20 16. ASSIGNMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 16.1. Assignment by Franchisee . . . . . . . . . . . . . . . . . . . 20 16.2. Pre-Conditions to Franchisee's Assignment. . . . . . . . . . . 20 16.3. Franchisor's Approval of Transfer. . . . . . . . . . . . . . . 21 16.4. Right of First Refusal . . . . . . . . . . . . . . . . . . . . 21 16.5. Types of Transfers . . . . . . . . . . . . . . . . . . . . . . 22 16.6. Assignment by the Franchisor . . . . . . . . . . . . . . . . . 23 16.7. Franchisee's Death or Disability . . . . . . . . . . . . . . . 23 17. TERM AND EXPIRATION. . . . . . . . . . . . . . . . . . . . . . . . . . 23 17.1. Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 17.2. Rights Upon Expiration . . . . . . . . . . . . . . . . . . . . 23 17.3. Exercise of Option for Successor Franchise . . . . . . . . . . 24 17.4. Conditions of Refusal. . . . . . . . . . . . . . . . . . . . . 24 18. DEFAULT AND TERMINATION. . . . . . . . . . . . . . . . . . . . . . . . 24 18.1. Termination by Franchisor - Effective Upon Notice. . . . . . . 24 18.2. Termination by Franchisor - Thirty Days Notice . . . . . . . . 26 18.3. Franchisor's Remedies. . . . . . . . . . . . . . . . . . . . . 27 18.4. Right to Purchase. . . . . . . . . . . . . . . . . . . . . . . 27 18.5. Obligations of Franchisee Upon Termination or Expiration . . . 28 18.6. State and Federal Law. . . . . . . . . . . . . . . . . . . . . 29 19. BUSINESS RELATIONSHIP. . . . . . . . . . . . . . . . . . . . . . . . . 29 19.1. Independent Businesspersons. . . . . . . . . . . . . . . . . . 29 19.2. Payment of Third Party Obligations . . . . . . . . . . . . . . 30 19.3. Indemnification. . . . . . . . . . . . . . . . . . . . . . . . 30 20. RESTRICTIVE COVENANTS. . . . . . . . . . . . . . . . . . . . . . . . . 30 20.1. Non-Competition During Term. . . . . . . . . . . . . . . . . . 30 20.2. Post-Termination Covenant Not to Compete . . . . . . . . . . . 31 20.3. Confidentiality of Proprietary Information . . . . . . . . . . 32 20.4. Confidentiality Agreement. . . . . . . . . . . . . . . . . . . 32 21. INSURANCE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 21.1. Insurance Coverage . . . . . . . . . . . . . . . . . . . . . . 32 21.2. Proof of Insurance Coverage. . . . . . . . . . . . . . . . . . 32 22. MISCELLANEOUS PROVISIONS . . . . . . . . . . . . . . . . . . . . . . . 33 22.1. Governing Law/Consent to Venue and Jurisdiction. . . . . . . . 33 22.2. Modification . . . . . . . . . . . . . . . . . . . . . . . . . 33 22.3. Entire Agreement . . . . . . . . . . . . . . . . . . . . . . . 33 22.4. Delegation by the Franchisor . . . . . . . . . . . . . . . . . 33 22.5. Effective Date . . . . . . . . . . . . . . . . . . . . . . . . 34 22.6. Review of Agreement. . . . . . . . . . . . . . . . . . . . . . 34 22.7. Attorneys' Fees. . . . . . . . . . . . . . . . . . . . . . . . 34 22.8. Injunctive Relief. . . . . . . . . . . . . . . . . . . . . . . 34 22.9. No Waiver. . . . . . . . . . . . . . . . . . . . . . . . . . . 34 22.10. No Right to Set Off. . . . . . . . . . . . . . . . . . . . . . 34 22.11. Invalidity . . . . . . . . . . . . . . . . . . . . . . . . . . 34 22.12. Notices. . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 22.13. Acknowledgment . . . . . . . . . . . . . . . . . . . . . . . . 35 EXHIBITS I. Addendum to Franchise Agreement - Location Approval II. Personal Guaranty III. Statement of Ownership 2.2. SCOPE OF FRANCHISE OPERATIONS. The Franchisee agrees at all times to faithfully, honestly and diligently perform the Franchisee's obligations hereunder, and to continuously exert best efforts to promote the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. The Franchisee agrees to utilize the Marks and Licensed Methods to operate all aspects of the business franchised hereunder in accordance with the methods and systems developed and prescribed from time to time by the Franchisor, all of which are a part of the Licensed Methods. The Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Business shall offer all products and services as the Franchisor shall designate and shall be restricted from manufacturing, offering or selling any products and services not previously approved by the Franchisor in writing. The Franchisee is required to devote a minimum of 50% of all retail floor space to ROCKY MOUNTAIN CHOCOLATE FACTORY brand bulk chocolates and packaged candies. The Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Business must feature ROCKY MOUNTAIN CHOCOLATE FACTORY brand candy, cookies made from ROCKY MOUNTAIN CHOCOLATE FACTORY brand cookie dough and other confectionery products ("Candy") and related nonconfectionary items ("Items") approved by the Franchisor in writing. The products which Franchisee shall be permitted to serve, make and/or sell are store-made candies prepared from recipes and specifications authorized in the Franchisor's Operations Manual, described in Article 8 below, through the process of dipping, molding and cooking ("Store-Made Candies"), Australian glazed fruit, chocolate sandwich cookies, graham crackers, pretzels, fresh and dried fruit items, dog bones and plain chocolate ("Candy-Related Items"), and such other Items which the Franchisor has approved in writing, in its sole discretion. 3. FRANCHISED LOCATION AND DESIGNATED AREA 3.1. FRANCHISED LOCATION. The Franchisee is granted the right and franchise to own and operate a ROCKY MOUNTAIN CHOCOLATE FACTORY Business at the address and location which shall be set forth in EXHIBIT I attached hereto ("Franchised Location"). If, at the time of execution of this Agreement, the Franchised Location cannot be designated as a specific address because a location has not been selected and approved, then the Franchisee shall promptly take steps to choose and acquire a location for its ROCKY MOUNTAIN CHOCOLATE FACTORY Business within the Designated Area, set forth in EXHIBIT I. In such circumstances, the Franchisee shall select and propose to the Franchisor for the Franchisor's prior approval a specific location for the Franchised Location which, once approved by the Franchisor, shall hereinafter be set forth in the rider to EXHIBIT I. 3.2. PROTECTED TERRITORY. So long as the Franchisee is in compliance with this Agreement, the Franchisor shall not establish or license another person or entity to establish a 2 ROCKY MOUNTAIN CHOCOLATE FACTORY Business within a certain geographic area as set forth in EXHIBIT I ("Protected Territory"). 3.3. LIMITATION ON FRANCHISE RIGHTS. The rights that are hereby granted to the Franchisee are for the specific Franchised Location and Protected Territory and cannot be transferred to an alternative Franchised Location or Protected Territory, or any other location, without the prior written approval of the Franchisor, which approval shall not be unreasonably withheld. The Marks and Licensed Methods are licensed to the Franchisee for the operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business only at the Franchised Location; therefore, the Franchisee may not operate food carts or kiosks, participate in food festivals or offer any other type of off-site food services using the Marks and Licensed Methods without the prior written consent of the Franchisor. 3.4. FRANCHISOR'S RESERVATION OF RIGHTS. The Franchisee acknowledges that the franchise granted hereunder is non-exclusive and that the Franchisor retains the rights, among others: (1) to use, and to license others to use, the Marks and Licensed Methods for the operation of ROCKY MOUNTAIN CHOCOLATE FACTORY Businesses at any location other than in the Protected Territory; (2) to use the Marks and Licensed Methods in connection with other services and products, promotional and marketing efforts or related items, materials or services or in alternative channels of distribution, without regard to the location of the use, including, but not limited to, the wholesale sale of its products to unrelated retail outlets or to candy distributors; and (3) to use and license the use of other proprietary marks or methods in connection with the operation of retail stores selling gourmet chocolates and other premium confectionery products business at any location, which businesses are the same as, or similar to, or different from a ROCKY MOUNTAIN CHOCOLATE FACTORY Business, on any terms and conditions as the Franchisor deems advisable, and without granting the Franchisee any rights therein. 4. INITIAL FRANCHISE FEE 4.1. INITIAL FRANCHISE FEE. In consideration for the right to develop and operate one ROCKY MOUNTAIN CHOCOLATE FACTORY Business, the Franchisee agrees to pay to the Franchisor an initial franchise fee of $19,500, $5,000 of which is due and payable as of the date of execution of this Agreement, with the balance of $14,500 due and payable at the earlier of 120 days from the date this Agreement is executed or the date that a lease is executed for a Franchised Location that has been approved by the Franchisor. The Franchisee acknowledges and agrees that the initial franchise fee represents payment for the initial grant of the rights to use the Marks and Licensed Methods, that the Franchisor has earned the initial franchise fee upon receipt thereof and that the fee is under no circumstances refundable to the Franchisee after it is paid, unless otherwise specifically set forth in this Agreement. 3 5. DEVELOPMENT OF FRANCHISED LOCATION 5.1. APPROVAL OF LEASE. The Franchisee shall obtain the Franchisor's prior written approval before executing any lease or purchase agreement for the Franchised Location. Any lease for the Franchised Location shall, at the option of the Franchisor, contain a provision: (1) allowing for assignment of the lease to the Franchisor in the event that this Agreement is terminated or not renewed for any reason; (2) giving the Franchisor the right to cure any default by the Franchisee under such lease; and (3) providing the Franchisor with the right, exercisable upon and as a condition of the approval of the Franchised Location, to execute the lease agreement or other document providing entitlement to the use of the Franchised Location in its own name or jointly with the Franchisee as lessee and, upon the exercise of such option, the Franchisor shall provide the Franchisee with the right to use the premises as its sublessee, assignee, or other similar capacity upon the same terms and conditions as obtained by the Franchisor. The Franchisee shall deliver a copy of the signed lease for the Franchised Location to the Franchisor within 15 days of its execution. The Franchisee acknowledges that approval of a lease for the Franchised Location by the Franchisor does not constitute a recommendation, endorsement or guarantee by the Franchisor of the suitability of the location or the lease and the Franchisee should take all steps necessary to ascertain whether such location and lease are acceptable to the Franchisee. 5.2. CONVERSION AND DESIGN. The Franchisee acknowledges that the layout, design, decoration and color scheme of ROCKY MOUNTAIN CHOCOLATE FACTORY Businesses are an integral part of the Franchisor's proprietary Licensed Methods and accordingly, the Franchisee shall convert, design and decorate the Franchised Location in accordance with the Franchisor's plans and specifications. The Franchisee shall also obtain the Franchisor's written consent to any conversion, design or decoration of the premises before remodeling or decorating begins, recognizing that such remodeling, decoration and any related costs are the Franchisee's sole responsibility. 5.3. SIGNS. The Franchisee shall purchase or otherwise obtain for use at the Franchised Location and in connection with the ROCKY MOUNTAIN CHOCOLATE FACTORY Business signs which comply with the standards and specifications of the Franchisor as set forth in the Operations Manual, as that term is defined in Section 8.1. It is the Franchisee's sole responsibility to insure that any signs comply with applicable local ordinances, building codes and zoning regulations. Any modifications to the Franchisor's standards and specifications for signs which must be made due to local ordinances, codes or regulations shall be submitted to the Franchisor for prior written approval. The Franchisee acknowledges the Marks, or any other name, symbol or identifying marks on any signs shall only be used in accordance with the Franchisor's standards and specifications and only with the prior written approval of the Franchisor. 4 5.4. EQUIPMENT. The Franchisee shall purchase or otherwise obtain for use at the Franchised Location and in connection with the ROCKY MOUNTAIN CHOCOLATE FACTORY Business equipment of a type and in an amount which complies with the standards and specifications of the Franchisor. The Franchisee acknowledges that the type, quality, configuration, capability and/or performance of the equipment are all standards and specifications which are a part of the Licensed Methods and therefore such equipment must be purchased, leased, or otherwise obtained in accordance with the Franchisor's standards and specifications and only from suppliers or other sources approved by the Franchisor. The Franchisee must purchase a facsimile machine and connect it to a phone line which is separate from the main phone number for the Business. The Franchisor reserves the right to require the Franchisee to purchase or lease computer hardware and software for use in the operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. The Franchisor also reserves the right to require that it be given reasonable access to information and data regarding the Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Business by computer modem. 5.5. PERMITS AND LICENSES. The Franchisee agrees to obtain all such permits and certifications as may be required for the lawful construction and operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business together with all certifications from government authorities having jurisdiction over the site that all requirements for construction and operation have been met, including without limitation, zoning, access, sign, health, safety requirements, building and other required construction permits, licenses to do business and fictitious name registrations, sales tax permits, health and sanitation permits and ratings and fire clearances. Franchisee agrees to obtain all customary contractors' sworn statements and partial and final lien waivers for construction, remodeling, decorating and installation of equipment at the Franchised Location. Copies of all subsequent inspection reports, warnings, certificates and ratings issued by any governmental entity during the term of this Agreement in connection with the conduct of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business which indicates the Franchisee's failure to meet or maintain the highest governmental standards, or less than full compliance by the Franchisee with any applicable law, rule or regulation, shall be forwarded to the Franchisor within five days of the Franchisee's receipt thereof. 5.6. COMMENCEMENT OF OPERATIONS. Unless otherwise agreed in writing by the Franchisor and the Franchisee, the Franchisee has 180 days from the date of this Agreement within which to complete the initial training program, described in Section 6.1 of this Agreement, select and develop the Franchised Location and commence operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. The Franchisor will extend the time in which the Franchisee has to commence operations for a reasonable period of time in the event factors beyond the Franchisee's reasonable control prevent the Franchisee from 5 meeting this development schedule, so long as the Franchisee has made reasonable and continuing efforts to comply with such development obligations and the Franchisee requests, in writing, an extension of time in which to have its ROCKY MOUNTAIN CHOCOLATE FACTORY Business established before such development period lapses. 6. TRAINING 6.1. INITIAL TRAINING PROGRAM. The Franchisee or, if the Franchisee is not an individual, the person designated by the Franchisee to assume primary responsibility for the management of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, ("General Manager") is required to attend and successfully complete the initial training program which is offered by the Franchisor at one of the Franchisor's designated training facilities. Up to three individuals are eligible to participate in the Franchisor's initial training program without charge of a tuition or fee. The Franchisee shall be responsible for any and all traveling and living expenses incurred in connection with attendance at the training program. At least one individual must successfully complete the initial training program prior to the Franchisee's commencement of operation of its ROCKY MOUNTAIN CHOCOLATE FACTORY Business. 6.2. LENGTH OF TRAINING. The initial training program shall consist of 10 days of instruction at a location designated by the Franchisor; provided, however, that the Franchisor reserves the right to waive a portion of the training program or alter the training schedule, if in the Franchisor's sole discretion, the Franchisee or General Manager has sufficient prior experience or training. 6.3. ADDITIONAL TRAINING. From time to time, the Franchisor may present seminars, conventions or continuing development programs or conduct meetings for the benefit of the Franchisee. The Franchisee or its General Manager shall be required to attend any ongoing mandatory seminars, conventions, programs or meetings as may be offered by the Franchisor. The Franchisor shall give the Franchisee at least 30 days prior written notice of any ongoing seminar, convention or program which is deemed mandatory. The Franchisor shall not require that the Franchisee attend any ongoing training more often than once a year. All mandatory training will be offered without charge of a tuition or fee; provided, however, the Franchisee will be responsible for all traveling and living expenses which are associated with attendance at the same. 7. DEVELOPMENT ASSISTANCE 6 7.1. FRANCHISOR'S DEVELOPMENT ASSISTANCE. The Franchisor shall provide the Franchisee with assistance in the initial establishment of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business as follows: (a) Provision of the initial training program to be conducted at the Franchisor's designated training facilities or at another location designated by the Franchisor, as described in Article 6 above. (b) Provision of written specifications for a Franchised Location which shall include, without limitation, specifications for space requirements, build out and the demographics and character of surrounding area. The Franchisee acknowledges that the Franchisor shall have no other obligation to provide assistance in the selection and approval of a Franchised Location other than the provision of such written specifications and approval or disapproval of a proposed Franchised Location, which approval or disapproval shall be based on information submitted to the Franchisor in a form sufficient to assess the proposed location as may be reasonably required by the Franchisor. (c) Direction regarding the required conversion, design and decoration of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business premises, plus specifications concerning signs, decor and equipment. (d) Direction regarding the selection of suppliers of equipment, items and materials used and inventory offered for sale in connection with the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. After execution of this Agreement, the Franchisor will provide the Franchisee with a list of approved suppliers, if any, of such equipment, items, materials and inventory and, if available, a description of any national or central purchase and supply agreements offered by such approved suppliers for the benefit of ROCKY MOUNTAIN CHOCOLATE FACTORY franchisees. (e) Provision of an operations manual in accordance with Section 8 below. (f) As the Franchisor may reasonably schedule, and depending on availability of personnel, the Franchisor will make available to the Franchisee at or close to the commencement of the Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Business a representative ("Site Representative") to be present during the opening of the Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Business. There will be no charge to the Franchisee for this service provided by the Franchisor. The Site Representative will assist the Franchisee's employees in opening the Business, unless in the Franchisor's determination, the Franchisee or the General Manager have had sufficient prior training or experience. 7 8. OPERATIONS MANUAL 8.1. OPERATIONS MANUAL. The Franchisor agrees to provide to the Franchisee one or more manuals, technical bulletins, cookbooks and recipes or other written materials (collectively referred to as "Operations Manual") covering Candy ordering, manufacturing, processing and stocking and other operating and in-store marketing techniques for the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. The Franchisee agrees that it shall comply with the Operations Manual as an essential aspect of its obligations under this Agreement and failure by the Franchisee to substantially comply with the Operations Manual may be considered by the Franchisor to be a breach of this Agreement. 8.2. CONFIDENTIALITY OF OPERATIONS MANUAL CONTENTS. The Franchisee agrees to use the Marks and Licensed Methods only as specified in the Operations Manual. The Operations Manual is the sole property of the Franchisor and shall be used by the Franchisee only during the term of this Agreement and in strict accordance with the terms and conditions hereof. The Franchisee shall not duplicate the Operations Manual nor disclose its contents to persons other than its employees or officers who have signed a confidentiality and noncompetition agreement in a form approved by the Franchisor. The Franchisee shall return the Operations Manual to the Franchisor upon the expiration, termination or assignment of this Agreement. 8.3. CHANGES TO OPERATIONS MANUAL. The Franchisor reserves the right to revise the Operations Manual from time to time as it deems necessary to update or change operating and marketing techniques or standards and specifications. The Franchisee, within 30 days of receiving any updated information, shall in turn update its copy of the Operations Manual as instructed by the Franchisor and shall conform its operations with the updated provisions within a reasonable time thereafter. The Franchisee acknowledges that a master copy of the Operations Manual maintained by the Franchisor at its principal office shall be controlling in the event of a dispute relative to the content of any Operations Manual. 9. OPERATING ASSISTANCE 9.1. FRANCHISOR'S SERVICES. The Franchisor agrees that, during the Franchisee's operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, the Franchisor shall make available to the Franchisee the following services: (a) Upon the reasonable request of the Franchisee, consultation by telephone regarding the continued operation and management of a ROCKY MOUNTAIN 8 CHOCOLATE FACTORY Business and advice regarding the retail services, product quality control, inventory issues, customer relations issues and similar advice. (b) Access to advertising and promotional materials as may be developed by the Franchisor, the cost of which may be passed on to the Franchisee at the Franchisor's option. (c) On-going updates of information and programs regarding the candy industry, the ROCKY MOUNTAIN CHOCOLATE FACTORY concept and related Licensed Methods, including, without limitation, information about special or new products which may be developed and made available to ROCKY MOUNTAIN CHOCOLATE FACTORY Franchisees. (d) The Franchisor shall make the initial training program available to replacement or additional General Managers during the term of this Agreement. The Franchisor reserves the right to charge a tuition or fee in an amount payable in advance, commensurate with the then current published prices of the Franchisor for such training. The Franchisee shall be responsible for all travel and living expenses incurred by its personnel during the training program. Further, the availability of the training programs shall be subject to space considerations and prior commitments to new ROCKY MOUNTAIN CHOCOLATE FACTORY franchisees. 9.2. ADDITIONAL FRANCHISOR SERVICES. Although not obligated to do so, upon the reasonable request of the Franchisee, the Franchisor may make its employees or designated agents available to the Franchisee for on-site advice and assistance in connection with the ongoing operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business governed by this Agreement. In the event that the Franchisee requests such additional assistance and the Franchisor agrees to provide the same, the Franchisor reserves the right to charge the Franchisee for all travel, lodging, living expenses, telephone charges and other identifiable expenses associated with such assistance, plus a fee based on the time spent by each employee on behalf of the Franchisee, which fee will be charged in accordance with the then current daily or hourly rates being charged by Franchisor for assistance. 10. FRANCHISEE'S OPERATIONAL COVENANTS 10.1. BUSINESS OPERATIONS. The Franchisee acknowledges that it is solely responsible for the successful operation of its ROCKY MOUNTAIN CHOCOLATE FACTORY Business and that the continued successful operation thereof is, in part, dependent upon the Franchisee's compliance with this Agreement and the Operations Manual. In addition to all 9 other obligations contained in this Agreement and in the Operations Manual, the Franchisee covenants that: (a) The Franchisee shall maintain clean, efficient and high quality ROCKY MOUNTAIN CHOCOLATE FACTORY Business operations and shall operate the business in accordance with the Operations Manual and in such a manner as not to detract from or adversely reflect upon the name and reputation of the Franchisor and the goodwill associated with the ROCKY MOUNTAIN CHOCOLATE FACTORY name and Marks. (b) The Franchisee will conduct itself and operate its ROCKY MOUNTAIN CHOCOLATE FACTORY Business in compliance with all applicable laws, health department regulations and other ordinances and in such a manner so as to promote a good public image in the business community. In connection therewith, the Franchisee will be solely and fully responsible for obtaining any and all licenses to carry on the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. The Franchisee shall promptly forward to the Franchisor copies of all health department, fire department, building department and other similar reports of inspections as and when they become available. (c) The Franchisee acknowledges that proper management of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business is important and shall insure that the Franchisee or a designated General Manager who has completed the Franchisor's initial training program be responsible for the management of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business after commencement of Business operations and be present at the Franchised Location during operation of the Business. (d) The Franchisee shall offer only authorized products and services as are more fully described in the Operations Manual, which may include, without limitation, Candy, Store-Made Candy, Candy-Related Items, Items and other authorized confectionery food and beverage products. The Franchisee shall offer all types of products and services as from time to time may be prescribed by the Franchisor and shall refrain from offering any other types of products or services, or operating or engaging in any other type of business or profession, from or through the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, including, without limitation, filling "Wholesale Orders", defined below, any catering or off-premises sales, without the prior written consent of the Franchisor. "Wholesale Orders" are defined as those orders or sales where the principal purpose of the purchase is for resale, not consumption, or any sale other than those sold over the counter at a price other than that price charged to the general public; provided, however, that volume discounted sales made on the premises at the Franchised Location to a single purchaser, not for resale, and discounted sales made on the premises at the Franchised Location to charitable organizations for fund-raising purposes shall be permitted. Candy, 10 Store-Made Candies, Candy-Related Items and Items shall never be sold in containers or bags other than those supplied by the Franchisor or other supplier approved by the Franchisor. (e) The Franchisee shall promptly pay when due all taxes and other obligations owed to third parties in the operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, including without limitation, unemployment and sales taxes, and any and all accounts or other indebtedness of every kind incurred by the Franchisee in the conduct of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. In the event of a bona fide dispute as to the liability for taxes assessed or other indebtedness, the Franchisee may contest the validity or the amount of the tax or indebtedness in accordance with procedures of the taxing authority or applicable law; however, in no event shall the Franchisee permit a tax sale or seizure by levy or execution or similar writ or warrant, or attachment by a creditor to occur against the premises of the Franchised Location, or any improvement thereon. (f) The Franchisee shall subscribe for and maintain not fewer than two separate telephone numbers for its ROCKY MOUNTAIN CHOCOLATE FACTORY Business at the Franchised Location, both of which shall be listed and identified exclusively with the ROCKY MOUNTAIN CHOCOLATE FACTORY Business in all official telephone directories and in all advertising in which such numbers appear and shall be separate and distinct from all other telephone numbers subscribed for by the Franchisee. One number shall be used exclusively for voice communication and the other shall be used exclusively for a facsimile machine. (g) The Franchisee shall comply with all agreements with third parties related to the ROCKY MOUNTAIN CHOCOLATE FACTORY Business including, in particular, all provisions of any premises lease. (h) The Franchisee and all employees of the Franchisee shall adhere to strict grooming and dress code guidelines while on duty at the Franchised Location. The Franchisee is required, at the Franchisee's expense, to purchase specified wearing apparel from suppliers approved by the Franchisor. All General Managers, employees of the Franchisee, the Franchisee and its owners shall wear the specified uniform at all times while working at the Franchised Location. The Franchisor has the right, in its sole and absolute discretion, to change or modify such dress code guidelines. (i) The Franchisee agrees to renovate, refurbish, remodel or replace, at its own expense, the real and personal property and equipment used in the operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, when reasonably required by the Franchisor in order to comply with the image, standards of operation and 11 performance capability established by the Franchisor from time to time. If the Franchisor changes its image or standards of operation, it shall give the Franchisee a reasonable period of time within which to comply with such changes. (j) The Franchisee shall be responsible for training all of its employees who work in any capacity in the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. The Franchisee must conduct its employee training in the manner and according to the standards as prescribed in the Operations Manual. Any employee who does not satisfactorily complete the training shall not work in any capacity in the Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Business. (k) The Franchisee shall at all times during the term of this Agreement own and control the ROCKY MOUNTAIN CHOCOLATE FACTORY Business authorized hereunder. Upon request of the Franchisor, the Franchisee shall promptly provide satisfactory proof of such ownership to the Franchisor. The Franchisee represents that the Statement of Ownership, attached hereto as EXHIBIT III and by this reference incorporated herein, is true, complete, accurate and not misleading, and, in accordance with the information contained in the Statement of Ownership, the controlling ownership of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business is held by the Franchisee. The Franchisee shall promptly provide the Franchisor with a written notification if the information contained in the Statement of Ownership changes at any time during the term of this Agreement and shall comply with the applicable transfer provisions contained in Article 16 herein. In addition, if the Franchisee is an entity, all of the owners of the Franchisee shall sign the Personal Guaranty attached hereto as EXHIBIT II. (l) The Franchisee shall at all times during the term of this Agreement keep its ROCKY MOUNTAIN CHOCOLATE FACTORY Business open during the business hours as may be designated by the Franchisor from time to time in the Operations Manual. (m) Unless notified in writing otherwise by the Franchisor, all Candy and related products shall be sold and shipped to the Franchisee on a net 30-day basis, or according to the then current payment terms set by the Franchisor or its designated suppliers. The Franchisor reserves the right to charge interest at the rate of 1.5% per month if the Franchisee fails to pay for its orders on time and the Franchisor reserves the right to discontinue shipment of products to the Franchisee if the Franchisee is repeatedly delinquent in paying for its products, in the Franchisor's sole discretion. The Franchisee may be required to "prepay" factory orders, notwithstanding the payment policy set forth above, in the event of poor payment performance. The Franchisor reserves the right to change payment terms and policies at any time. The Franchisor also reserves the right to 12 change the price for Candy and Items from time to time as may be set forth in the most recent price bulletin sent to all franchisees or the then current Operations Manual. 11. ROYALTIES 11.1. MONTHLY ROYALTY. The Franchisee agrees to pay to the Franchisor a monthly royalty ("Royalty") equal to 5% of the total amount of its Gross Retail Sales, defined in Section 11.2 below, generated from or through its ROCKY MOUNTAIN CHOCOLATE FACTORY Business. 11.2. GROSS RETAIL SALES. "Gross Retail Sales" shall be defined as receipts and income of any kind from all products or services sold from or through the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, including any such sale of products or services made for cash or upon credit, or partly for cash and partly for credit, regardless of collection of charges for which credit is given, less returns for which refunds are made, provided that the refund shall not exceed the sales price and exclusive of discounts, sales taxes and other taxes, amounts received in settlement of a loss of merchandise, shipping expenses paid by the customer and discount sales to corporations or to charities for fund-raising purposes. "Gross Retail Sales" shall also include the fair market value of any services or products received by the Franchisee in barter or exchange for its services and products. 11.3. ROYALTY PAYMENTS. The Franchisee agrees that Royalty payments shall be paid monthly and sent to the Franchisor, post-marked no later than the 15th of each month based on Gross Retail Sales for the immediately preceding month. Royalty payments shall be accompanied by monthly reports, as more fully described in Article 15 hereof, and standard transmittal forms containing information regarding the Franchisee's Gross Retail Sales and such additional information as may be requested by the Franchisor. The Franchisor reserves the right to require Royalty payments be made on a weekly or bi-weekly basis if the Franchisee does not timely or fully submit the required payments or reports. The Franchisor shall have the right to verify such Royalty payments from time to time as it deems necessary, in any reasonable manner. In the event that the Franchisee fails to pay any Royalties within 14 days after they are due, the Franchisee shall, in addition to such Royalties, pay a late charge equivalent to 18% of the late Royalty payment; provided, however, in no event shall the Franchisee be required to pay a late payment at a rate greater than the maximum interest rate permitted by applicable law. If the Franchisee pays Royalties with a check returned for non-sufficient funds more than one time in any calendar year, in addition to all other remedies which may be available, the Franchisor shall have the right to require that Royalty payments be made by certified or cashier's checks. 13 12. ADVERTISING 12.1. APPROVAL OF ADVERTISING. The Franchisee shall obtain the Franchisor's prior written approval of all written advertising or other marketing or promotional programs regarding the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, including, without limitation, "Yellow Pages" advertising, newspaper ads, flyers, brochures, coupons, direct mail pieces, specialty and novelty items and radio and television advertising. The Franchisee shall also obtain the Franchisor's prior written approval of all promotional materials provided by vendors. The proposed written advertising or a description of the marketing or promotional program shall be submitted to the Franchisor at least 10 days prior to publication, broadcast or use. The Franchisee acknowledges that advertising and promoting the ROCKY MOUNTAIN CHOCOLATE FACTORY Business in accordance with the Franchisor's standards and specifications is an essential aspect of the Licensed Methods, and the Franchisee agrees to comply with all advertising standards and specifications. The Franchisee shall display all required promotional materials, signs, point of purchase displays and other marketing materials in its ROCKY MOUNTAIN CHOCOLATE FACTORY Business in the manner prescribed by the Franchisor. The Franchisee shall not, under any circumstances, use handwritten signs in the operation of its Business. 12.2. LOCAL ADVERTISING. The Franchisor reserves the right to require the Franchisee to spend up to 1% of monthly Gross Retail Sales on local advertising to create public awareness of the Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Business. The Franchisee will submit to the Franchisor an accounting of the amounts spent on advertising within 30 days following the end of each calendar quarter. If the Franchisor requires its franchisees to advertise locally as described above, all Franchisor-owned Businesses will be required to spend money for local advertising on an equal percentage basis with all franchised Businesses. If the Franchisee's lease requires it to advertise locally, the Franchisor may, in its sole discretion, count such expenditures toward the Franchisee's local advertising expenditure required by this Section 12.2. The Franchisee shall obtain the Franchisor's prior written approval of all written advertising and promotional materials before publication. 12.3. MARKETING AND PROMOTION FEE. The Franchisee shall pay to the Franchisor, in addition to Royalties, a fee of 1% of the total amount of the Franchisee's Gross Retail Sales ("Marketing and Promotion Fee"). The Marketing and Promotion Fee shall be in addition to and not in lieu of the Franchisee's expenditures for local advertising, as described in Section 12.2 above. The following terms and conditions will apply: (a) The Marketing and Promotion Fee shall be payable concurrently with the payment of the Royalties, mailed to the Franchisor, postmarked no later than the 15th day 14 of each month, for all Marketing and Promotion Fees based on Gross Retail Sales for the immediately preceding month. (b) The Marketing and Promotion Fees will be subject to the same late charges as the Royalties, in an amount and manner set forth in Section 12.3 above. (c) Upon written request by the Franchisee, the Franchisor will make available to the Franchisee, no later than 120 days after the end of each fiscal year, an annual financial statement which indicates how the Marketing and Promotion Fees have been spent. (d) The Marketing and Promotion Fees, will be administered by the Franchisor, in its sole discretion, and may be used for production and placement of point of purchase advertising, in-store signage, in-store promotions, media advertising, direct mailings, brochures, collateral material advertising, surveys of advertising effectiveness, or other advertising or public relations expenditures relating to advertising the Franchisee's services and products. (e) The Franchisor may reimburse itself for independent audits, reasonable accounting, bookkeeping, reporting and legal expenses, taxes and other reasonable direct and indirect expenses as may be incurred by the Franchisor or its authorized representatives in connection with the programs funded by the Marketing and Promotion Fees. The Franchisor will not be liable for any act or omission with respect to such Marketing and Promotion Fees which is consistent with this Agreement and is done in good faith. 12.4. REGIONAL ADVERTISING PROGRAMS. Although not obligated to do so, the Franchisor reserves the right to allocate all or a portion of the Marketing and Promotion Fees as may be collected in accordance with Section 12.3 above toward a regional advertising program for the benefit of ROCKY MOUNTAIN CHOCOLATE FACTORY franchisees located within a particular region. The Franchisor has the right, in its sole discretion, to determine the composition of all geographic territories and market areas for the implementation of such regional advertising and promotion campaigns and to require that the Franchisee participate in such regional advertising programs as and when they may be established by the Franchisor. If a regional advertising program is implemented on behalf of a particular region by the Franchisor, the Franchisor, to the extent reasonably calculable, will only use contributions from ROCKY MOUNTAIN CHOCOLATE FACTORY franchisees within such region for the particular regional advertising program. The Franchisor also reserves the right to establish an advertising cooperative for a particular region to enable the cooperative to self-administer the regional advertising program. If a regional advertising cooperative is established by the Franchisor, the Franchisee agrees that it will participate in the same. 15 12.5. MARKETING SERVICES. The Franchisor may, in its sole discretion, offer marketing and merchandising services to the Franchisee at rates that are competitive with those charged by third parties offering similar services. The Franchisee may utilize such services, if they are offered, at the Franchisee's option. Services offered by the Franchisor may include marketing consulting, graphic design, copywriting, advertising, public relations and merchandising consulting in the Franchisor's sole discretion. 13. QUALITY CONTROL 13.1. COMPLIANCE WITH OPERATIONS MANUAL. The Franchisee agrees to maintain and operate the ROCKY MOUNTAIN CHOCOLATE FACTORY Business in compliance with this Agreement and the standards and specifications contained in the Operations Manual, as the same may be modified from time to time by the Franchisor. 13.2. STANDARDS AND SPECIFICATIONS. The Franchisor will make available to the Franchisee standards and specifications for products and services offered at or through the ROCKY MOUNTAIN CHOCOLATE FACTORY Business and specifically, for the candy processing recipes, uniforms, materials, forms, menu boards, items and supplies used in connection with the Business. The Franchisor reserves the right to change standards and specifications for services and products offered at or through the ROCKY MOUNTAIN CHOCOLATE FACTORY Business and for the candy processing recipes, uniforms, materials, forms, items and supplies used in connection with the Business upon 30 days prior written notice to the Franchisee. The Franchisee shall strictly adhere to all of the Franchisor's current standards and specifications for the ROCKY MOUNTAIN CHOCOLATE FACTORY Business as prescribed from time to time. 13.3. INSPECTIONS. The Franchisor shall have the right to examine the Franchised Location, including the inventory, products, equipment, materials or supplies, to ensure compliance with all standards and specifications set by the Franchisor. The Franchisor shall conduct such inspections during regular business hours and the Franchisee may be present at such inspections. The Franchisor, however, reserves the right to conduct the inspections without prior notice to the Franchisee. 13.4. RESTRICTIONS ON SERVICES AND PRODUCTS. The Franchisee will be required to purchase any and all of its Candy, including cookie dough, for its ROCKY MOUNTAIN CHOCOLATE FACTORY Business from the Franchisor or its designee. Candy shall consist of any and all varieties from time to time made available to the Franchisor's franchisees by the Franchisor and its designated suppliers. The parties hereby acknowledge the uniqueness and importance of Candy being prepared by the Franchisor or its designee in order to maintain the uniformity, quality and uniqueness of Candy, and therefore the Franchisor and its designees 16 are hereby appointed the Franchisee's exclusive source of Candy. The Franchisee is prohibited from offering or selling any products or services not authorized by Franchisor, including, without limitation, operating a catering or wholesale business as part of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. However, if the Franchisee proposes to offer, conduct or utilize any products, services, materials, forms, items and supplies for use in connection with or sale through the ROCKY MOUNTAIN CHOCOLATE FACTORY Business which are not previously approved by the Franchisor as meeting its specifications, the Franchisee shall first notify the Franchisor in writing requesting approval. The Franchisor may, in its sole discretion, for any reason whatsoever, elect to withhold such approval; however, in order to make such determination, the Franchisor may require submission of specifications, information, or samples of such products, services, materials, forms, items or supplies. The Franchisor will advise the Franchisee within a reasonable time whether such products, services, materials, forms, items or supplies meet its specifications. 13.5. APPROVED SUPPLIERS. The Franchisee shall purchase all products, services, supplies and materials required for the operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business licensed herein, from manufacturers, suppliers or distributors designated by the Franchisor or, if there is no designated supplier for a particular product, service, supply or material, from such other suppliers who meet all of the Franchisor's specifications and standards as to quality, composition, finish, appearance and service, and who shall adequately demonstrate their capacity and facilities to supply the Franchisee's needs in the quantities, at the times, and with the reliability requisite to an efficient operation. 13.6. REQUEST TO CHANGE SUPPLIER. In the event the Franchisee desires to purchase products, services, supplies or materials from manufacturers, suppliers or distributors other than those previously approved by the Franchisor, the Franchisee shall, prior to purchasing any such products, services, supplies or materials, give the Franchisor a written request by certified mail, return receipt requested, to change supplier. In the event the Franchisor rejects the Franchisee's requested new manufacturer, supplier or distributor, the Franchisor must, within 60 days of the receipt of the Franchisee's request to change supplier notify the Franchisee in writing of its rejection. Failure to notify the Franchisee within such time period shall constitute a waiver of any and all objections by the Franchisor to the new manufacturer, supplier or distributor submitted by the Franchisee. The Franchisor may continue from time to time to inspect any manufacturer's, suppliers, or distributor's facilities and products to assure proper production, processing, storing and transportation of products, services, supplies or materials to be purchased from the manufacturer, supplier or distributor by the Franchisee. Permission for such inspection shall be a condition of the continued approval of such manufacturer, supplier or distributor. 13.7. APPROVAL OF INTENDED SUPPLIER. The Franchisor may at its sole discretion, for any reason whatsoever, elect to withhold approval of the manufacturer, supplier or distributor; however, in order to make such determination, the Franchisor may require that 17 samples from a proposed new supplier be delivered to the Franchisor for testing prior to approval and use. A charge not to exceed the actual cost of the test may be made by the Franchisor and shall be paid by the Franchisee. 14. TRADEMARKS, TRADE NAMES AND PROPRIETARY INTERESTS 14.1. MARKS. The Franchisee hereby acknowledges that the Franchisor has the sole right to license and control the Franchisee's use of the ROCKY MOUNTAIN CHOCOLATE FACTORY service mark and other of the Marks, and that such Marks shall remain under the sole and exclusive ownership and control of the Franchisor. The Franchisee acknowledges that it has not acquired any right, title or interest in such Marks except for the right to use such Marks in the operation of its ROCKY MOUNTAIN CHOCOLATE FACTORY Business as it is governed by this Agreement. 14.2. NO USE OF OTHER MARKS. The Franchisee further agrees that no service mark other than "ROCKY MOUNTAIN CHOCOLATE FACTORY" or such other Marks as may be specified by the Franchisor shall be used in the marketing, promotion or operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. 14.3. LICENSED METHODS. The Franchisee hereby acknowledges that the Franchisor owns and controls the distinctive plan for the establishment, operation and promotion of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business and all related licensed methods of doing business, previously defined as the "Licensed Methods", which include, but are not limited to, gourmet chocolate specialty recipes and cooking methods, confectionery ordering, processing, manufacturing, stocking and inventory control, technical equipment standards, order fulfillment methods and customer relations, marketing techniques, written promotional materials, advertising, and accounting systems, all of which constitute trade secrets of the Franchisor, and the Franchisee acknowledges that the Franchisor has valuable rights in and to such trade secrets. The Franchisee further acknowledges that it has not acquired any right, title or interest in the Licensed Methods except for the right to use the Licensed Methods in the operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business as it is governed by this Agreement. 14.4. EFFECT OF TERMINATION. In the event this Agreement is terminated for any reason, the Franchisee shall immediately cease using any of the Licensed Methods and Marks, trade names, trade dress, trade secrets, copyrights or any other symbols used to identify the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, and all rights the Franchisee had to the same shall automatically terminate. The Franchisee agrees to execute any documents of assignment as may be necessary to transfer any rights the Franchisee may possess in and to the Marks. 18 14.5. MARK INFRINGEMENT. The Franchisee agrees to notify the Franchisor in writing of any possible infringement or illegal use by others of a trademark the same as or confusingly similar to the Marks which may come to its attention. The Franchisee acknowledges that the Franchisor shall have the right, in its sole discretion, to determine whether any action will be taken on account of any possible infringement or illegal use. The Franchisor may commence or prosecute such action in the Franchisor's own name and may join the Franchisee as a party thereto if the Franchisor determines it to be reasonably necessary for the continued protection and quality control of the Marks and Licensed Methods. The Franchisor shall bear the reasonable cost of any such action, including attorneys' fees. The Franchisee agrees to fully cooperate with the Franchisor in any such litigation. 14.6. FRANCHISEE'S BUSINESS NAME. The Franchisee acknowledges that the Franchisor has a prior and superior claim to the ROCKY MOUNTAIN CHOCOLATE FACTORY trade name. The Franchisee shall not use the words "ROCKY MOUNTAIN CHOCOLATE FACTORY" in the legal name of its corporation, partnership or any other business entity used in conducting the business provided for in this Agreement. The Franchisee also agrees not to register or attempt to register a trade name using the word "ROCKY MOUNTAIN CHOCOLATE FACTORY" in the Franchisee's name or that of any other person or business entity, without prior written consent of the Franchisor. When this Agreement is terminated, the Franchisee shall execute any assignment or other document the Franchisor requires to transfer to itself any rights the Franchisee may possess in a trade name utilizing the word ROCKY MOUNTAIN CHOCOLATE FACTORY or any other Mark owned by the Franchisor. The Franchisee further agrees that it will not identify itself as being "Rocky Mountain Chocolate Factory, Inc." or as being associated with the Franchisor in any manner other than as a franchisee or licensee. The Franchisee further agrees that in all advertising and promotion and promotional materials it will display its business name only in obvious conjunction with the phrase "ROCKY MOUNTAIN CHOCOLATE FACTORY Licensee" or "ROCKY MOUNTAIN CHOCOLATE FACTORY Franchisee" or with such other words and in such other phrases as may from time to time be prescribed in the Operations Manual, in the Franchisor's sole discretion. 14.7. CHANGE OF MARKS. In the event that the Franchisor, in its sole discretion, shall determine it necessary to modify or discontinue use of any proprietary Marks, or to develop additional or substitute marks, the Franchisee shall, within a reasonable time after receipt of written notice of such a modification or discontinuation from the Franchisor, take such action, at the Franchisee's sole expense, as may be necessary to comply with such modification, discontinuation, addition or substitution. 19 15. REPORTS, RECORDS AND FINANCIAL STATEMENTS 15.1. FRANCHISEE REPORTS. The Franchisee shall establish and maintain at its own expense a bookkeeping and accounting system which conforms to the specifications which the Franchisor may prescribe from time to time, including the Franchisor's current "Standard Code of Accounts" as described in the Operations Manual. The Franchisee shall supply to the Franchisor such reports in a manner and form as the Franchisor may from time to time reasonably require, including: (a) Monthly summary reports, in a form as may be prescribed by the Franchisor, mailed to the Franchisor postmarked no later than the 15th day of the month and containing information relative to the previous month's operations; and (b) Quarterly financial statements, prepared in accordance with Generally Accepted Accounting Principles ("GAAP"), and consisting of a profit and loss statement and balance sheet for the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, mailed to the Franchisor postmarked no later than the 15th day following the end of the calendar quarter, based on operating results of the prior quarter, which shall be submitted in a form approved by the Franchisor and shall be certified by the Franchisee to be correct. The Franchisor reserves the right to disclose data derived from such reports, without identifying the Franchisee, except to the extent identification of the Franchisee is required by law. 15.2. ANNUAL FINANCIAL STATEMENTS. The Franchisee shall, within 90 days after the end of its fiscal year, provide to the Franchisor annual unaudited financial statements, compiled or reviewed by an independent certified public accountant acceptable to and approved by the Franchisor and prepared in accordance with GAAP, and state and federal income tax returns prepared by a certified public accountant. If these financial statements or tax returns show an underpayment of any amounts owed to the Franchisor, these amounts shall be paid to the Franchisor concurrently with the submission of the statements or returns. 15.3. VERIFICATION. Each report and financial statement to be submitted to the Franchisor hereunder shall be signed and verified by the Franchisee. 15.4. BOOKS AND RECORDS. The Franchisee shall maintain all books and records for its ROCKY MOUNTAIN CHOCOLATE FACTORY Business in accordance with generally accepted accounting principles, consistently applied, and preserve these records for at least five years after the fiscal year to which they relate. 20 15.5. AUDIT OF BOOKS AND RECORDS. The Franchisee shall permit the Franchisor to inspect and audit the books and records of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business at any reasonable time, at the Franchisor's expense. If any audit discloses a deficiency in amounts for payments owed to the Franchisor pursuant to this Agreement, then such amounts shall become immediately payable to the Franchisor by the Franchisee, with interest from the date such payments were due at the lesser of 1 1/2% per month or the maximum rate allowed by law. In addition, if it is found by such audit that the Gross Retail Sales of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business have been understated by five percent (5%) or more during the period audited, the Franchisee shall pay all reasonable costs and expenses the Franchisor incurred in connection with such audit. 15.6. FAILURE TO COMPLY WITH REPORTING REQUIREMENTS. If the Franchisee fails to prepare and submit any statement or report as required under this Article 15, then the Franchisor shall have the right to treat the Franchisee's failure as good cause for termination of this Agreement. In addition to all other remedies available to the Franchisor, in the event that the Franchisee fails to prepare and submit any statement or report required under this Article 15 for two consecutive reporting periods, the Franchisor shall be entitled to make an audit, at the expense of the Franchisee, of the Franchisee's books, records and accounts, including the Franchisee's bank accounts, which in any way pertain to the Gross Retail Sales of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. The statements or reports not previously submitted shall be prepared by or under the direction and supervision of an independent certified public accountant selected by the Franchisor. 15.7. SHOPPING SERVICE. The Franchisor reserves the right to use third party shopping services from time to time to evaluate the conduct of the Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Business, including such things as customer service, cleanliness, merchandising and proper use of registers. The Franchisor may use such shopping services to inspect the Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Business at any time at the Franchisor's expense, without prior notification to the Franchisee. The Franchisor may make the results of any such service evaluation available to the Franchisee, in the Franchisor's sole discretion. 16. ASSIGNMENT 16.1. ASSIGNMENT BY FRANCHISEE. The franchise granted herein is personal to the Franchisee and, except as stated below, the Franchisor shall not allow or permit any transfer, assignment, subfranchise or conveyance of this Agreement or any interest hereunder. 16.2. PRE-CONDITIONS TO FRANCHISEE'S ASSIGNMENT. The Franchisee shall not sell, transfer or assign its rights under this Agreement or any interest in it, or any part or portion of 21 any business entity that owns it or all or a substantial portion of the assets of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, unless the Franchisee obtains the Franchisor's written consent and complies with the following requirements: (a) Payment of all amounts due and owing pursuant to this Agreement by the Franchisee to the Franchisor or its affiliates or to third parties whose debts or obligations the Franchisor has guaranteed on behalf of the Franchisee, if any; (b) Agreement by the proposed transferee to satisfactorily complete the initial training program described in this Agreement, which training may be completed by the transferee either prior to or immediately after assignment of this Agreement; (c) Execution of a Franchise Agreement in a form then currently offered by the Franchisor, which shall supersede this Agreement in all respects. If a new Franchise Agreement is signed, the terms thereof may differ from the terms of this Agreement; provided, however, the transferee will not be required to pay any additional initial franchise fee; (d) Provision by the Franchisee of written notice to the Franchisor 30 days' prior to the proposed effective date of the transfer, such notice to contain information reasonably detailed to enable the Franchisor to evaluate the terms and conditions of the proposed transfer; (e) The proposed transferee shall have provided information to the Franchisor sufficient for the Franchisor to assess the proposed transferee's business experience, aptitude and financial qualification, and the Franchisor shall have ascertained that the proposed transferee meets such qualifications; (f) Execution by Franchisee of a general release, in a form satisfactory to the Franchisor, of any and all claims against the Franchisor, its affiliates and their respective officers, directors, employees and agents; (g) Payment by the Franchisee or the proposed transferee of $2,500; and (h) Agreement by the Franchisee to abide by the post-termination covenant not to compete set forth in Section 19.2 below. 16.3. FRANCHISOR'S APPROVAL OF TRANSFER. The Franchisor has 30 days from the date of the written notice to approve or disapprove in writing, of the Franchisee's proposed assignment. The Franchisee acknowledges that the proposed transferee shall be evaluated for approval by the Franchisor based on the same criteria as is currently being used to assess new 22 franchisees of the Franchisor and that such proposed transferee shall be provided, if appropriate, with such disclosures as may be required by state or federal law. If the Franchisee and its proposed transferee comply with all conditions for assignment set forth herein and the Franchisor has not given the Franchisee notice of its approval or disapproval within such period, approval is deemed granted. 16.4. RIGHT OF FIRST REFUSAL. In the event the Franchisee wishes to sell, transfer or assign its rights under this Agreement or any interest in it, or any part or portion of any business entity that owns it, or all or a substantial portion of the assets of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, the Franchisee agrees to grant to the Franchisor a 30 day right of first refusal to purchase such rights, interest or assets on the same terms and conditions as are contained in the written offer to purchase submitted to the Franchisee by the proposed purchaser; provided, however, the following additional terms and conditions shall apply: (a) The Franchisee shall notify the Franchisor of such offer by sending a written notice to the Franchisor (which notice may be the same notice as required by Section 16.2(d) above), enclosing a copy of the written offer from the proposed purchaser; (b) The 30 day right of first refusal period will run concurrently with the period in which the Franchisor has to approve or disapprove the proposed transferee; (c) Such right of first refusal is effective for each proposed transfer and any material change in the terms or conditions of the proposed transfer shall be deemed a separate offer on which a new 30 day right of first refusal shall be given to the Franchisor; (d) If the consideration or manner of payment offered by a third party is such that the Franchisor may not reasonably be required to furnish the same, then the Franchisor may purchase the interest which is proposed to be sold for the reasonable cash equivalent. If the parties cannot agree within a reasonable time on the cash consideration, an independent appraiser shall be designated by the Franchisor, whose determination will be binding upon the parties. All expenses of the appraiser shall be paid for equally between the Franchisor and the Franchisee; and (e) If the Franchisor chooses not to exercise its right of first refusal, the Franchisee shall be free to complete the sale, transfer or assignment, subject to compliance with Sections 16.2 and 16.3 above. Absence of a reply to the Franchisee's notice of a proposed sale within the 30 day period is deemed a waiver of such right of first refusal. 23 16.5. TYPES OF TRANSFERS. The Franchisee acknowledges that the Franchisor's right to approve or disapprove of a proposed sale or transfer, and all other requirements and rights related to such proposed sale or transfer, as provided for above, shall apply (1) if the Franchisee is a partnership or other business association, to the addition or deletion of a partner or members of the association or the transfer of any partnership or membership among existing partners or members; (2) if the Franchisee is a corporation, to any proposed transfer or assignment of 25% or more of the stock of the corporate Franchisee, whether such transfer occurs in a single transaction or several transactions; and (3) if the Franchisee is an individual, to the transfer from such individual or individuals to a corporation controlled by them, in which case the Franchisor's approval will be conditioned upon: (i) the continuing personal guarantee of the individual (or individuals) for the performance of obligations under this Agreement; (ii) the issuance and/or transfer of shares which would affect a change in ownership of 25% or more of the stock in the corporation being conditioned on the Franchisor's prior written approval; (iii) a limitation on the corporation's business activity to that of operating the ROCKY MOUNTAIN CHOCOLATE FACTORY Business and related activities; and (iv) other reasonable conditions. With respect to a proposed transfer as described in subsection (1) and (3) of this Section, the Franchisor's right of first refusal to purchase, as set forth above, shall not apply and the Franchisor will waive any transfer fee chargeable to the Franchisee for a transfer under these circumstances. 16.6. ASSIGNMENT BY THE FRANCHISOR. This Agreement is fully assignable by the Franchisor and shall inure to the benefit of any assignee or other legal successor in interest, and the Franchisor shall in such event be fully released from the same. 16.7. FRANCHISEE'S DEATH OR DISABILITY. Upon the death or permanent disability of the Franchisee (or the Franchisee's individual controlling the Franchisee entity), the executor, administrator, conservator, guardian or other personal representative of such person shall transfer the Franchisee's interest in this Agreement or such interest in the Franchisee entity to an approved third party. Such disposition of this Agreement or such interest (including, without limitation, transfer by bequest or inheritance) shall be completed within a reasonable time, not to exceed 120 days from the date of death or permanent disability, and shall be subject to all terms and conditions applicable to transfers contained in this Article 16. Provided, however, that for purposes of this Section 16.7, there shall be no fee charged by the Franchisor for the initial training program offered to the transferee. Failure to transfer the interest in this Agreement or such interest in the Franchisee entity within said period of time shall constitute a breach of this Agreement. For the purposes hereof, the term "permanent disability" shall mean a mental or physical disability, impairment or condition that is reasonably expected to prevent or actually does prevent the Franchisee or the owner of a controlling interest in the Franchisee entity from supervising the management and operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business for a period of 120 days from the onset of such disability, impairment or condition. 24 17. TERM AND EXPIRATION 17.1. TERM. The term of this Agreement is for a period of five years from the date of this Agreement, unless sooner terminated as provided herein. 17.2. RIGHTS UPON EXPIRATION. At the end of the initial term hereof the Franchisee shall have the option to renew its franchise rights for two additional five year terms, by acquiring successor franchise rights, if the Franchisor does not exercise its right not to offer a successor franchise in accordance with Section 17.4 below and if the Franchisee: (a) At least 30 days prior to expiration of the term, executes the form of Franchise Agreement then in use by the Franchisor; (b) Has complied with all provisions of this Agreement during the current term, including the payment on a timely basis of all Royalties and other fees due hereunder. "Compliance" shall mean, at a minimum, that the Franchisee has not received any written notification from the Franchisor of breach hereunder more than four times during the term hereof; (c) Upgrades and/or remodels the ROCKY MOUNTAIN CHOCOLATE FACTORY Business and its operations at the Franchisee's sole expense (the necessity of which shall be in the sole discretion of the Franchisor) to conform with the then current Operations Manual; (d) Executes a general release, in a form satisfactory to the Franchisor, of any and all claims against the Franchisor and its affiliates, and their respective officers, directors, employees and agents arising out of or relating to this Agreement; and (e) Pays a success or franchise fee of $100. 17.3. EXERCISE OF OPTION FOR SUCCESSOR FRANCHISE. The Franchisee may exercise its option for a successor franchise by giving written notice of such exercise to the Franchisor not less than 210 days prior to the scheduled expiration of this Agreement. The Franchisee's successor franchise rights shall become effective by signing the Franchise Agreement then currently being offered to new franchisees of the Franchisor. 17.4. CONDITIONS OF REFUSAL. The Franchisor shall not be obligated to offer the Franchisee a successor franchise upon the expiration of this Agreement if the Franchisee fails to comply with any of the above conditions of renewal. In such event, except for failure to 25 execute the then current Franchise Agreement or pay the successor franchise fee, the Franchisor shall give notice of expiration at least 180 days prior to the expiration of the term, and such notice shall set forth the reasons for such refusal to offer successor franchise rights. Upon the expiration of this Agreement, the Franchisee shall comply with the provisions of Section 18.2 below. 18. DEFAULT AND TERMINATION 18.1. TERMINATION BY FRANCHISOR - EFFECTIVE UPON NOTICE. The Franchisor shall have the right, at its option, to terminate this Agreement and all rights granted the Franchisee hereunder, without affording the Franchisee any opportunity to cure any default (subject to any state laws to the contrary, where state law shall prevail), effective upon receipt of notice by the Franchisee, addressed as provided in Section 22.12, upon the occurrence of any of the following events: (a) ABANDONMENT. If the Franchisee ceases to operate the ROCKY MOUNTAIN CHOCOLATE FACTORY Business or otherwise abandons the ROCKY MOUNTAIN CHOCOLATE FACTORY Business for a period of five consecutive days, or any shorter period that indicates an intent by the Franchisee to discontinue operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, unless and only to the extent that full operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business is suspended or terminated due to fire, flood, earthquake or other similar causes beyond the Franchisee's control and not related to the availability of funds to the Franchisee; (b) INSOLVENCY; ASSIGNMENTS. If the Franchisee becomes insolvent or is adjudicated a bankrupt; or any action is taken by the Franchisee, or by others against the Franchisee under any insolvency, bankruptcy or reorganization act, (this provision may not be enforceable under federal bankruptcy law, 11 U.S.C. Sections 101 ET SEQ.), or if the Franchisee makes an assignment for the benefit of creditors, or a receiver is appointed by the Franchisee; (c) UNSATISFIED JUDGMENTS; LEVY; FORECLOSURE. If any material judgment (or several judgments which in the aggregate are material) is obtained against the Franchisee and remains unsatisfied or of record for 30 days or longer (unless a supersedeas or other appeal bond has been filed); or if execution is levied against the Franchisee's business or any of the property used in the operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business and is not discharged within five days; or if the real or personal property of the Franchisee's business shall be sold after levy thereupon by any sheriff, marshall or constable; 26 (d) CRIMINAL CONVICTION. If the Franchisee is convicted of a felony, a crime involving moral turpitude, or any crime or offense that is reasonably likely, in the sole opinion of the Franchisor, to materially and unfavorably affect the Licensed Methods, Marks, goodwill or reputation thereof, (e) FAILURE TO MAKE PAYMENTS. If the Franchisee fails to pay any amounts due the Franchisor or affiliates, including any amounts which may be due as a result of any subleases or lease assignments between the Franchisee and the Franchisor, within 10 days after receiving notice that such fees or amounts are overdue; (f) MISUSE OF MARKS. If the Franchisee misuses or fails to follow the Franchisor's directions and guidelines concerning use of the Franchisor's Marks and fails to correct the misuse or failure within ten days after notification from the Franchisor; (g) UNAUTHORIZED DISCLOSURE. If the Franchisee intentionally or negligently discloses to any unauthorized person the contents of or any part of the Franchisor's Operations Manual or any other trade secrets or confidential information of the Franchisor; (h) REPEATED NONCOMPLIANCE. If the Franchisee has received two previous notices of default from the Franchisor and is again in default of this Agreement within a 12 month period, regardless of whether the previous defaults were cured by the Franchisee; or (i) UNAUTHORIZED TRANSFER. If the Franchisee sells, transfers or otherwise assigns the Franchise, an interest in the Franchise or the Franchisee entity, this Agreement, the ROCKY MOUNTAIN CHOCOLATE FACTORY Business or a substantial portion of the assets of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business owned by the Franchisee without complying with the provisions of Article 16 above. 18.2. TERMINATION BY FRANCHISOR - THIRTY DAYS NOTICE. The Franchisor shall have the right to terminate this Agreement (subject to any state laws to the contrary, where state law shall prevail), effective upon 30 days written notice to the Franchisee, if the Franchisee breaches any other provision of this Agreement and fails to cure the default during such 30 day period. In that event, this Agreement will terminate without further notice to the Franchisee, effective upon expiration of the 30 day period. Defaults shall include, but not be limited to, the following: 27 (a) FAILURE TO MAINTAIN STANDARDS. The Franchisee fails to maintain the then current operating procedures and adhere to the specifications and standards established by the Franchisor as set forth herein or in the Operations Manual or otherwise communicated to the Franchisee; (b) DECEPTIVE PRACTICES. The Franchisee engages in any unauthorized business or practice or sells any unauthorized product or service under the Franchisor's Marks or under a name or mark which is confusingly similar to the Franchisor's Marks; (c) FAILURE TO OBTAIN CONSENT. The Franchisee fails, refuses or neglects to obtain the Franchisor's prior written approval or consent as required by this Agreement; (d) FAILURE TO COMPLY WITH MANUAL. The Franchisee fails or refuses to comply with the then-current requirements of the Operations Manual; or (e) BREACH OF RELATED AGREEMENT. The Franchisee defaults under any term of the sublease or lease assignment for the Franchised Location, any other agreement material to the ROCKY MOUNTAIN CHOCOLATE FACTORY Business or any other Franchise Agreement between the Franchisor and the Franchisee and such default is not cured within the time specified in such sublease, other agreement or other Franchise Agreement. Notwithstanding the foregoing, if the breach is curable, but is of a nature which cannot be reasonably cured within such 30 day period and the Franchisee has commenced and is continuing to make good faith efforts to cure the breach during such 30 day period, the Franchisee shall be given an additional reasonable period of time to cure the same, and this Agreement shall not automatically terminate without written notice from the Franchisor. 18.3. FRANCHISOR'S REMEDIES. (a) FAILURE TO PAY. In addition to all other remedies that may be exercised by the Franchisor upon a default by the Franchisee under the terms of this Agreement, the Franchisor reserves the right to collect amounts due from the Franchisee to any third party and to pay the third party directly. If the Franchisor collects any such amounts, the Franchisor may, in its sole discretion, charge the Franchisee an administrative fee to reimburse the Franchisor for its costs of collecting and paying such amounts. Any administrative fee charged would not exceed 15% of the total amount of money collected. (b) FAILURE TO MAINTAIN STANDARDS. In addition to all other remedies that may be exercised by the Franchisor upon a default by the Franchisee under the terms of this Agreement, the Franchisor may collect a fee of $500 per day for every day following the 28 30 day cure period in which the Franchisee continues to breach this Agreement by failing to maintain and adhere to the Franchisor's standards and specifications for the operation of the Franchisee's Business. 18.4. RIGHT TO PURCHASE. Upon termination or expiration of this Agreement for any reason, the Franchisor shall have the option to purchase the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, which may include, at the Franchisor's option, all of the Franchisee's interest, if any, in and to the real estate upon which the ROCKY MOUNTAIN CHOCOLATE FACTORY Business is located, and all buildings and other improvements thereon, including leasehold interests, at fair market value, less any amount apportioned to the goodwill of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business which is attributable to the Franchisor's Marks and Licensed Methods, and less any amounts owed to the Franchisor by the Franchisee. The following additional terms shall apply to the Franchisor's exercise of this option: (a) The Franchisor's option hereunder shall be exercisable by providing the Franchisee with written notice of its intention to exercise the option given to the Franchisee no later than the effective date of termination, in the case of termination, or at least 90 days prior to the expiration of the term of the franchise, in the case of non-renewal. (b) In the event that the Franchisor and the Franchisee cannot agree to a fair market value of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, then the fair market value shall be determined by an independent third party appraisal. The Franchisor and the Franchisee shall each select one independent, qualified appraiser, and the two so selected shall select a third appraiser, all three to determine the fair market value of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. The purchase price shall be the median of the fair market values as determined by the three appraisers. (c) The Franchisor and the Franchisee agree that the terms and conditions of this right and option to purchase may be recorded, if deemed appropriate by the Franchisor, in the real property records and the Franchisor and the Franchisee further agree to execute such additional documentation as may be necessary and appropriate to effectuate such recording. (d) The closing for the purchase of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business will take place no later than 60 days after the termination or nonrenewal date. The Franchisor will pay the purchase price in full at the closing, or, at its option, in five equal consecutive monthly installments with interest at a rate of ten percent per annum. The Franchisee must sign all documents of assignment and transfer as are 29 reasonably necessary for purchase of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business by the Franchisor. In the event that the Franchisor does not exercise the Franchisor's right to repurchase the Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Business as set forth above, the Franchisee will be free to keep or to sell, after such termination or expiration, to any third party, all of the physical assets of its ROCKY MOUNTAIN CHOCOLATE FACTORY Business; provided, however, that all appearances of the Marks are first removed in a manner approved in writing by the Franchisor. The Franchisor will only be obligated to purchase any assets of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business in the event and to the extent it is required by applicable state or federal law. 18.5. OBLIGATIONS OF FRANCHISEE UPON TERMINATION OR EXPIRATION. The Franchisee is obligated upon termination or expiration of this Agreement to immediately: (a) Pay to the Franchisor all Royalties, other fees, and any and all amounts or accounts payable then owed the Franchisor or its affiliates pursuant to this Agreement, or pursuant to any other agreement, whether written or oral, including subleases and lease assignments, between the parties; (b) Cease to identify itself as a ROCKY MOUNTAIN CHOCOLATE FACTORY Franchisee or publicly identify itself as a former Franchisee or use any of the Franchisor's trade secrets, signs, symbols, devices, trade names, trademarks, or other materials. (c) Immediately cease to identify the Franchised Location as being, or having been, associated with the Franchisor, and immediately cease using any proprietary mark of the Franchisor or any mark in any way associated with the ROCKY MOUNTAIN CHOCOLATE FACTORY Marks and Licensed Methods; (d) Deliver to the Franchisor all Candy inventory which bears the ROCKY MOUNTAIN CHOCOLATE FACTORY logo, signs, sign-faces, advertising materials, forms and other materials bearing any of the Marks or otherwise identified with the Franchisor and obtained by and in connection with this Agreement; (e) Immediately deliver to the Franchisor the Operations Manual and all other information, documents and copies thereof which are proprietary to the Franchisor; (f) Promptly take such action as may be required to cancel all fictitious or assumed names or equivalent registrations relating to its use of any Marks which are 30 under the exclusive control of the Franchisor or, at the option of the Franchisor, assign the same to the Franchisor; (g) Notify the telephone company and all telephone directory publishers of the termination or expiration of the Franchisee's right to use any telephone number and any regular, classified or other telephone directory listings associated with any Mark and to authorize transfer thereof to the Franchisor or its designee. The Franchisee acknowledges that, as between the Franchisee and the Franchisor, the Franchisor has the sole rights to and interest in all telephone, telecopy or facsimile machine numbers and directory listings associated with any Mark. The Franchisee authorizes the Franchisor, and hereby appoints the Franchisor and any of its officers as the Franchisee's attorney-in-fact, to direct the telephone company and all telephone directory publishers to transfer any telephone, telecopy or facsimile machine numbers and directory listings relating to the ROCKY MOUNTAIN CHOCOLATE FACTORY Business to the Franchisor or its designee, should the Franchisee fail or refuse to do so, and the telephone company and all telephone directory publishers may accept such direction or this Agreement as conclusive of the Franchisor's exclusive rights in such telephone numbers and directory listings and the Franchisor's authority to direct their transfer; and (h) Abide by all restrictive covenants set forth in Article 20 of this Agreement. 18.6. STATE AND FEDERAL LAW. THE PARTIES ACKNOWLEDGE THAT IN THE EVENT THAT THE TERMS OF THIS AGREEMENT REGARDING TERMINATION OR EXPIRATION ARE INCONSISTENT WITH APPLICABLE STATE OR FEDERAL LAW, SUCH LAW SHALL GOVERN THE FRANCHISEE'S RIGHTS REGARDING TERMINATION OR EXPIRATION OF THIS AGREEMENT. 19. BUSINESS RELATIONSHIP 19.1. INDEPENDENT BUSINESSPERSONS. The parties agree that each of them are independent businesspersons, their only relationship is by virtue of this Agreement and that no fiduciary relationship is created hereunder. Neither party is liable or responsible for the other's debts or obligations, nor shall either party be obligated for any damages to any person or property directly or indirectly arising out of the operation of the other party's business authorized by or conducted pursuant to this Agreement. The Franchisor and the Franchisee agree that neither of them will hold themselves out to be the agent, employer or partner of the other and that neither of them has the authority to bind or incur liability on behalf of the other. 19.2. PAYMENT OF THIRD PARTY OBLIGATIONS. The Franchisor shall have no liability for the Franchisee's obligations to pay any third parties, including without limitation, any 31 product vendors, or any sales, use, service, occupation, excise, gross receipts, income, property or other tax levied upon the Franchisee, the Franchisee's property, the ROCKY MOUNTAIN CHOCOLATE FACTORY Business or upon the Franchisor in connection with the sales made or business conducted by the Franchisee (except any taxes the Franchisor is required by law to collect from the Franchisee with respect to purchases from the Franchisor). 19.3. INDEMNIFICATION. The Franchisee agrees to indemnify, defend and hold harmless the Franchisor, its subsidiaries and affiliates, and their respective shareholders, directors, officers, employees, agents, successors and assignees, (the "Indemnified Parties") against, and to reimburse them for all claims, obligations and damages described in this Section 19.3, any and all third party obligations described in Section 19.2 and any and all claims and liabilities directly or indirectly arising out of the operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business or arising out of the use of the Marks and Licensed Methods in any manner not in accordance with this Agreement. For purposes of this indemnification, claims shall mean and include all obligations, actual and consequential damages and costs reasonably incurred in the defense of any claim against the Indemnified Parties, including, without limitation, reasonable accountants', attorneys' and expert witness fees, costs of investigation and proof of facts, court costs, other litigation expenses and travel and living expenses. The Franchisor shall have the right to defend any such claim against it. This indemnity shall continue in full force and effect subsequent to and notwithstanding the expiration or termination of this Agreement. 20. RESTRICTIVE COVENANTS 20.1. NON-COMPETITION DURING TERM. The Franchisee acknowledges that, in addition to the license of the Marks hereunder, the Franchisor has also licensed commercially valuable information which comprises and is a part of the Licensed Methods, including without limitation, recipes, operations, marketing, advertising and related information and materials and that the value of this information derives not only from the time, effort and money which went into its compilation, but from the usage of the same by all the franchisees of the Franchisor using the Marks and Licensed Methods. The Franchisee therefore agrees that other than the ROCKY MOUNTAIN CHOCOLATE FACTORY Business licensed herein, neither the Franchisee nor any of the Franchisee's officers, directors, shareholders or partners, nor any member of his or their immediate families, shall during the term of this Agreement: (a) have any direct or indirect controlling interest as a disclosed or beneficial owner in a "Competitive Business" as defined below; 32 (b) perform services as a director, officer, manager, employee, consultant, representative, agent or otherwise for a Competitive Business; or (c) divert or attempt to divert any business related to, or any customer or account of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business, the Franchisor's business or any other ROCKY MOUNTAIN CHOCOLATE FACTORY franchisee's business, by direct inducement or otherwise, or divert or attempt to divert the employment of any employee of the Franchisor or another franchisee licensed by the Franchisor to use the Marks and Licensed Methods, to any Competitive Business by any direct inducement or otherwise. The term "Competitive Business" as used in this Agreement shall mean any business operating, or granting franchises or licenses to others to operate, a retail, wholesale, distribution or manufacturing business deriving more than 5% of its gross receipts from the sale, processing or manufacturing of Candy, Items or other products which are offered in ROCKY MOUNTAIN CHOCOLATE FACTORY Businesses and which constitutes 5% or more of the Gross Retail Sales of any ROCKY MOUNTAIN CHOCOLATE FACTORY Business; provided, however, the Franchisee shall not be prohibited from owning securities in a Competitive Business if such securities are listed on a stock exchange or traded on the over-the-counter market and represent 5% or less of that class of securities issued and outstanding. 20.2. POST-TERMINATION COVENANT NOT TO COMPETE. Upon termination or expiration of this Agreement for any reason, the Franchisee and its officers, directors, shareholders, and/or partners agree that, for a period of two years commencing on the effective date of termination or expiration, or the date on which the Franchisee ceases to conduct business, whichever is later, neither Franchisee nor its officers, directors, shareholders, and/or partners shall have any direct or indirect interest (through a member of any immediate family of the Franchisee or its Owners or otherwise) as a disclosed or beneficial owner, investor, partner, director, officer, employee, consultant, representative or agent or in any other capacity in any Competitive Business, defined in Section 20.1 above, located or operating within a 10 mile radius of the Franchised Location or within ten miles of any other franchised or company-owned ROCKY MOUNTAIN CHOCOLATE FACTORY Business. The restrictions of this Section shall not be applicable to the ownership of shares of a class of securities listed on a stock exchange or traded on the over-the-counter market that represent 5% or less of the number of shares of that class of securities issued and outstanding. The Franchisee and its officers, directors, shareholders, and/or partners expressly acknowledge that they possess skills and abilities of a general nature and have other opportunities for exploiting such skills. Consequently, enforcement of the covenants made in this Section will not deprive them of their personal goodwill or ability to earn a living. 33 20.3. CONFIDENTIALITY OF PROPRIETARY INFORMATION. The Franchisee shall treat all information it receives which comprises or is a part of the Licensed Methods licensed hereunder as proprietary and confidential and will not use such information in an unauthorized manner or disclose the same to any unauthorized person without first obtaining the Franchisor's written consent. The Franchisee acknowledges that the Marks and the Licensed Methods have valuable goodwill attached to them, that the protection and maintenance thereof is essential to the Franchisor and that any unauthorized use or disclosure of the Marks and Licensed Methods will result in irreparable harm to the Franchisor. 20.4. CONFIDENTIALITY AGREEMENT. The Franchisor reserves the right to require that the Franchisee cause each of its officers, directors, partners, shareholders, and General Manager, and, if the Franchisee is an individual, immediate family members, to execute a Nondisclosure and Noncompetition Agreement containing the above restrictions, in a form approved by the Franchisor. 21. INSURANCE 21.1. INSURANCE COVERAGE. The Franchisee shall procure, maintain and provide evidence of (i) comprehensive general liability insurance for the Franchised Location and its operations with a limit of not less than $1,000,000 combined single limit, or such greater limit as may be required as part of any lease agreement for the Franchised Location; (ii) automobile liability insurance covering all employees of the ROCKY MOUNTAIN CHOCOLATE FACTORY Business with authority to operate a motor vehicle in an amount not less than $1,000,000 or, with the prior written consent of the Franchisor, such lesser amount as may be available at a commercially reasonable rate, but in no event less than any statutorily imposed minimum coverage; (iii) unemployment and worker's compensation insurance with a broad form all-states endorsement coverage sufficient to meet the requirements of the law; and (iv) all-risk personal property insurance in an amount equal to at least 100% of the replacement costs of the contents and tenant improvements located at the ROCKY MOUNTAIN CHOCOLATE FACTORY Business. All of the required policies of insurance shall name the Franchisor as an additional named insured and shall provide for a 30 day advance written notice to the Franchisor of cancellation. 21.1. PROOF OF INSURANCE COVERAGE. The Franchisee will provide proof of insurance to the Franchisor prior to commencement of operations at its ROCKY MOUNTAIN CHOCOLATE FACTORY Business. This proof will show that the insurer has been authorized to inform the Franchisor in the event any policies lapse or are cancelled. The Franchisor has the right to change the minimum amount of insurance the Franchisee is required to maintain by giving the Franchisee prior reasonable notice, giving due consideration to what is reasonable and customary in the similar business. Noncompliance 34 with the insurance provisions set forth herein shall be deemed a material breach of this Agreement; in the event of any lapse in insurance coverage, in addition to all other remedies, the Franchisor shall have the right to demand that the Franchisee cease operations of the ROCKY MOUNTAIN CHOCOLATE FACTORY Businesses until coverage is reinstated, or, in the alternative, pay any delinquencies in premium payments and charge the same back to the Franchisee. 22. MISCELLANEOUS PROVISIONS 22.1. GOVERNING LAW/CONSENT TO VENUE AND JURISDICTION. Except to the extent governed by the United States Trademark Act of 1946 (Lanham Act, 15 U.S.C. Sections 1051 ET SEQ.) or other federal law, this Agreement, the franchise and the relationship between the Franchisor and the Franchisee shall be governed by the laws of the state of Colorado. The Franchisee agrees that the Franchisor may institute any action against the Franchisee in any state or federal court of general jurisdiction in the state of Colorado and the Franchisee irrevocably submits to the jurisdiction of such courts and waives any objection he may have to either the jurisdiction of or venue in such courts. The Franchisee agrees that the only proper venue for any action shall be in the County of La Plata, State of Colorado. 22.2. MODIFICATION. The Franchisor and/or the Franchisee may modify this Agreement only upon execution of a written agreement between the two parties. The Franchisee acknowledges that the Franchisor may modify its standards and specifications and operating and marketing techniques set forth in the Operations Manual unilaterally under any conditions and to the extent in which the Franchisor, in its sole discretion, deems necessary to protect, promote, or improve the Marks and the quality of the Licensed Methods, but under no circumstances will such modifications be made arbitrarily without such determination. 22.3. ENTIRE AGREEMENT. This Agreement contains the entire agreement between the parties and supersedes any and all prior agreements concerning the subject matter hereof. The Franchisee agrees and understands that the Franchisor shall not be liable or obligated for any oral representations or commitments made prior to the execution hereof and that no modifications of this Agreement shall be effective except those in writing and signed by both parties. The Franchisor does not authorize and will not be bound by any representation of any nature other than those expressed in this Agreement. The Franchisee further acknowledges and agrees that no representations have been made to it by the Franchisor regarding projected sales volumes, market potential, revenues, profits of the Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Business, or operational assistance other than as stated in this Agreement or in any disclosure document provided by the Franchisor or its representatives. 35 22.4. DELEGATION BY THE FRANCHISOR. From time to time, the Franchisor shall have the right to delegate the performance of any portion or all of its obligations and duties hereunder to third parties, whether the same are agents of the Franchisor or independent contractors which the Franchisor has contracted with to provide such services. The Franchisee agrees in advance to any such delegation by the Franchisor of any portion or all of its obligations and duties hereunder. 22.5. EFFECTIVE DATE. This Agreement shall not be effective until accepted by the Franchisor as evidenced by dating and signing by an officer of the Franchisor. 22.6. REVIEW OF AGREEMENT. The Franchisee acknowledges that it had a copy of this Agreement in its possession for a period of time not fewer than 10 full business days, during which time the Franchisee has had the opportunity to submit same for professional review and advice of the Franchisee's choosing prior to freely executing this Agreement. 22.7. ATTORNEYS' FEES. In the event of any default on the part of either party to this Agreement, in addition to all other remedies, the party in default will pay the aggrieved party all amounts due and all damages, costs and expenses, including reasonable attorneys' fees, incurred by the aggrieved party in any legal action, arbitration or other proceeding as a result of such default, plus interest at the highest rate allowable by law, accruing from the date of such default. 22.8. INJUNCTIVE RELIEF. Nothing herein shall prevent the Franchisor or the Franchisee from seeking injunctive relief to prevent irreparable harm, in addition to all other remedies. 22.9. NO WAIVER. No waiver of any condition or covenant contained in this Agreement or failure to exercise a right or remedy by the Franchisor or the Franchisee shall be considered to imply or constitute a further waiver by the Franchisor or the Franchisee of the same or any other condition, covenant, right, or remedy. 22.10. NO RIGHT TO SET OFF. The Franchisee shall not be allowed to set off amounts owed to the Franchisor for Royalties, fees or other amounts due hereunder, against any monies owed to Franchisee, nor shall the Franchisee in any event withhold such amounts due to any alleged nonperformance by the Franchisor hereunder, which right of set off is hereby expressly waived by the Franchisee. 22.11. INVALIDITY. If any provision of this Agreement is held invalid by any tribunal in a final decision from which no appeal is or can be taken, such provision shall be deemed modified to eliminate the invalid element and, as so modified, such provision shall be deemed 36 a part of this Agreement as though originally included. The remaining provisions of this Agreement shall not be affected by such modification. 22.12. NOTICES. All notices required to be given under this Agreement shall be given in writing, by certified mail, return receipt requested, or by an overnight delivery service providing documentation of receipt, at the address set forth in the first Section of this Agreement or at such other addresses as the Franchisor or the Franchisee may designate from time to time, and shall be effectively given when deposited in the United States mails, postage prepaid, or when received via overnight delivery, as may be applicable. 22.13. ACKNOWLEDGEMENT. BEFORE SIGNING THIS AGREEMENT, THE FRANCHISEE SHOULD READ IT CAREFULLY WITH THE ASSISTANCE OF LEGAL COUNSEL. THE FRANCHISEE ACKNOWLEDGES THAT: (A) THE SUCCESS OF THE BUSINESS VENTURE CONTEMPLATED HEREIN INVOLVES SUBSTANTIAL RISKS AND DEPENDS UPON THE FRANCHISEE'S ABILITY AS AN INDEPENDENT BUSINESS PERSON AND ITS ACTIVE PARTICIPATION IN THE DAILY AFFAIRS OF THE BUSINESS, AND (B) NO ASSURANCE OR WARRANTY, EXPRESS OR IMPLIED, HAS BEEN GIVEN AS TO THE POTENTIAL SUCCESS OF SUCH BUSINESS VENTURE OR THE EARNINGS LIKELY TO BE ACHIEVED, AND (C) NO STATEMENT, REPRESENTATION OR OTHER ACT, EVENT OR COMMUNICATION, EXCEPT AS SET FORTH IN THIS DOCUMENT, AND IN ANY OFFERING CIRCULAR SUPPLIED TO THE FRANCHISEE IS BINDING ON THE FRANCHISOR IN CONNECTION WITH THE SUBJECT MATTER OF THIS AGREEMENT. 37 FUZZIWIG'S-TM- CANDY FACTORY FRANCHISE AGREEMENT TABLE OF CONTENTS 1. PURPOSE............................................................ 1 2. GRANT OF FRANCHISE................................................. 1 2.1. Grant of Franchise........................................ 1 2.2. Scope of Franchise Operations............................. 1 3. FRANCHISED LOCATION AND DESIGNATED AREA............................ 2 3.1. Franchised Location....................................... 2 3.2. Protected Territory....................................... 2 3.3. Limitation on Franchise Rights........................... 2 3.4. Franchisor's Reservation of Rights........................ 2 4. INITIAL FRANCHISE FEE.............................................. 3 4.1. Initial Franchise Fee..................................... 3 5. DEVELOPMENT OF FRANCHISED LOCATION................................. 3 5.1. Approval of Lease......................................... 3 5.2. Conversion and Design..................................... 4 5.3. Signs..................................................... 4 5.4. Equipment................................................. 4 5.5. Permits and Licenses...................................... 4 5.6. Commencement of Operations................................ 5 6. TRAINING........................................................... 5 6.1. Initial Training Program.................................. 5 6.2. Length of Training........................................ 5 6.3. Additional Training....................................... 6 7. DEVELOPMENT ASSISTANCE............................................. 6 7.1. Franchisor's Development Assistance....................... 6 8. OPERATIONS MANUAL.................................................. 7 8.1. Operations Manual......................................... 7 8.2. Confidentiality of Operations Manual Contents............. 7 8.3. Changes to Operations Manual.............................. 7 9. OPERATING ASSISTANCE............................................... 8 9.1. Franchisor's Services..................................... 8 9.2. Additional Franchisor Services............................ 8 10. FRANCHISEE'S OPERATIONAL COVENANTS................................. 9 10.1. Business Operations....................................... 9 11. ROYALTIES.......................................................... 12 11.1. Monthly Royalty........................................... 12 11.2. Gross Retail Sales........................................ 12 11.3. Royalty Payments.......................................... 12 12. ADVERTISING........................................................ 13 12.1. Approval of Advertising................................... 13 12.2. Local Advertising......................................... 13 12.3. Marketing and Promotion Fee............................... 13 12.4. Regional Advertising Programs............................. 14 12.5. Marketing Services........................................ 15 13. QUALITY CONTROL.................................................... 15 13.1. Compliance with Operations Manual......................... 15 13.2. Standards and Specifications.............................. 15 13.3. Inspections............................................... 15 13.4. Restrictions on Services and Products..................... 15 14. MARKS, TRADE NAMES AND PROPRIETARY INTERESTS....................... 17 14.1. Marks..................................................... 17 14.2. No Use of Other Marks..................................... 17 14.3. Licensed Methods.......................................... 17 14.4. Effect of Termination..................................... 17 14.5. Mark Infringement......................................... 17 14.6. Franchisee's Business Name................................ 18 14.7. Change of Marks........................................... 18 15. REPORTS, RECORDS AND FINANCIAL STATEMENTS.......................... 18 15.1. Franchisee Reports....................................... 18 15.2. Annual Financial Statements............................... 19 15.3. Verification.............................................. 19 15.4. Books and Records......................................... 19 15.5. Audit of Books and Records................................ 19 15.6. Failure to Comply with Reporting Requirements............. 20 15.7. Shopping Service.......................................... 20 16. ASSIGNMENT......................................................... 20 16.1. Assignment by Franchisee.................................. 20 16.2. Pre-Conditions to Franchisee's Assignment................. 20 16.3. Franchisor's Approval of Transfer......................... 21 16.4. Right of First Refusal.................................... 21 16.5. Types of Transfers........................................ 22 16.6. Assignment by the Franchisor.............................. 23 16.7. Franchisee's Death or Disability.......................... 23 17. TERM AND EXPIRATION................................................ 23 17.1. Term...................................................... 23 17.2. Rights Upon Expiration.................................... 23 17.3. Exercise of Option for Successor Franchise................ 24 17.4. Conditions of Refusal..................................... 24 18. DEFAULT AND TERMINATION............................................ 24 18.1. Termination by Franchisor - Effective Upon Notice......... 24 18.2. Termination by Franchisor - Thirty Days Notice............ 26 18.3. Franchisor's Remedies..................................... 27 18.4. Right to Purchase......................................... 27 18.5. Obligations of Franchisee Upon Termination or Expiration.. 28 18.6. State and Federal Law..................................... 29 19. BUSINESS RELATIONSHIP.............................................. 30 19.1. Independent Businesspersons............................... 30 19.2. Payment of Third Party Obligations........................ 30 19.3. Indemnification........................................... 30 20. RESTRICTIVE COVENANTS.............................................. 30 20.1. Non-Competition During Term............................... 30 20.2. Post-Termination Covenant Not to Compete.................. 31 20.3. Confidentiality of Proprietary Information................ 32 20.4. Confidentiality Agreement................................. 32 21. INSURANCE.......................................................... 32 21.1. Insurance Coverage....................................... 32 21.2. Proof of Insurance Coverage.............................. 32 22. MISCELLANEOUS PROVISIONS........................................... 33 22.1. Governing Law/Consent to Venue and Jurisdiction........... 33 22.2. Modification.............................................. 33 22.3. Entire Agreement.......................................... 33 22.4. Delegation by the Franchisor.............................. 33 22.5. Effective Date............................................ 34 22.6. Review of Agreement....................................... 34 22.7. Attorneys' Fees........................................... 34 22.8. Injunctive Relief......................................... 34 22.9. No Waiver.......................................................... 34 22.10. No Right to Set Off................................................ 34 22.11. Invalidity......................................................... 34 22.12. Notices............................................................ 34 22.13. Acknowledgment..................................................... 35 EXHIBITS I. Addendum to Franchise Agreement - Location Approval II. Personal Guaranty III. Statement of Ownership EXIHBIT II TO FRANCHISE AGREEMEENT GUARANTY AND ASSUMPTION OF FRANCHISEE'S OBLIGATIONS --------------------------------------------------- In consideration of, and as an inducement to, the execution of the above Franchise Agreement (the "Agreement") by Rocky Mountain Chocolate Factory, Inc. ("the Franchisor"), each of the undersigned hereby personally and unconditionally: Guarantees to the Franchisor and its successors and assigns, for the term of this Agreement, including renewals thereof, that the franchisee as that term is defmed in the Agreement ("Franchisee") shall punctually pay and perform each and every undertaking, agreement and covenant set forth in the Agreement; and Agrees to be personally bound by, and personally liable for the breach of, each and every provision in the Agreement. Each of the undersigned waives the following: 1. Acceptance and notice of acceptance by the Franchisor of the foregoing undertaking; 2. Notice of demand for payment of any indebtedness or nonperformance of any obligations hereby guaranteed; 3. Protest and notice of default to any party with respect to the indebtedness or nonperformance of any obligations hereby guaranteed; 4. Any right he or she may have to require that any action be brought against Franchisee or any other person as a condition of liability; and 5. Any and all other notices and legal or equitable defenses to which he or she may be entitled. Each of the undersigned consents and agrees that: 1. His or her direct and immediate liability under this guaranty shall be joint and several; 2. He or she shall render any payment or performance required under the Agreement upon demand if Franchisee fails or refuses punctually to do so; 1 prescribed from time to time by the Franchisor, all of which are a part of the Licensed Methods. The Franchisee's FUZZIWIG'S-TM- CANDY FACTORY Business shall offer all products and services as the Franchisor shall designate and shall be restricted from manufacturing, offering or selling any products and services not previously approved by the Franchisor in writing. The Franchisee is required to devote a minimum of 80% of its retail floor space to specified brands and types of bulk candies and confections and the remainder of its retail floor space to non-confectionery items, such as gifts and toys. The Franchisee's FUZZIWIG'S-TM- CANDY FACTORY Business must feature bulk candy and other confectionery products ("Candy") purchased from specified suppliers and related nonconfectionery items ("Items") approved by the Franchisor in writing. 3. FRANCHISED LOCATION AND DESIGNATED AREA 3.1. FRANCHISED LOCATION. The Franchisee is granted the right and franchise to own and operate a FUZZIWIG'S-TM- CANDY FACTORY Business at the address and location which shall be set forth in EXHIBIT 1, attached hereto ("Franchised Location"). If, at the time of execution of this Agreement, the Franchised Location cannot be designated as a specific address because a location has not been selected and approved, then the Franchisee shall promptly take steps to choose and acquire a location for its FUZZIWIG'S-TM- CANDY FACTORY Business within the Designated Area, set forth in EXHIBIT I. In such circumstances, the Franchisee shall select and propose to the Franchisor for the Franchisor's prior approval a specific location for the Franchised Location which, once approved by the Franchisor, shall hereinafter be set forth in the rider to EXHIBIT 1. 3.2. PROTECTED TERRITORY. So long as the Franchisee is in compliance with this Agreement, the Franchisor shall not establish or license another person or entity to establish a FUZZIWIG'S-TM- CANDY FACTORY Business within a certain geographic area as set forth in EXHIBIT I ("Protected Territory"). 3.3. LIMITATION ON FRANCHISE RIGHTS. The rights that are hereby granted to the Franchisee are for the specific Franchised Location and Protected Territory and cannot be transferred to an alternative Franchised Location or Protected Territory, or any other location, without the prior written approval of the Franchisor, which approval shall not be unreasonably withheld. The Marks and Licensed Methods are licensed to the Franchisee for the operation of the FUZZIWIG'S-TM- CANDY FACTORY Business only at the Franchised Location; therefore, the Franchisee may not operate food carts or kiosks, participate in food festivals or offer any other type of off-site food services using the Marks and Licensed Methods without the prior written consent of the Franchisor. 2 3.4. FRANCHISOR'S RESERVATION OF RIGHTS. The Franchisee acknowledges that the franchise granted hereunder is non-exclusive and that the Franchisor retains the rights, among others: (1) to use, and to license others to use, the Marks and Licensed Methods for the operation of FUZZIWIG'S-TM- CANDY FACTORY Businesses at any location other than in the Protected Territory; (2) to use the Marks and Licensed Methods in connection with other services and products, promotional and marketing efforts or related items, materials or services or in alternative channels of distribution, without regard to the location of the use, including, but not limited to, the wholesale sale of its products to unrelated retail outlets or to candy distributors; and (3) to use and license the use of other proprietary marks or methods in connection with the operation of retail stores selling candy and other confectionery products business at any location, which businesses are the same as, or similar to, or different from a FUZZIWIG'S-TM- CANDY FACTORY Business, on any terms and conditions as the Franchisor deems advisable, and without granting the Franchisee any rights therein. 4. INITIAL FRANCHISE FEE 4.1. INITIAL FRANCHISE FEE. In consideration for the right to develop and operate one FUZZIWIG'S-TM- CANDY FACTORY Business, the Franchisee agrees to pay to the Franchisor an initial franchise fee of $25,000, $15,000 of which is due and payable as of the date of execution of this Agreement, with the balance of $10,000 due and payable at the earlier of 180 days from the date this Agreement is executed or the date that a lease is executed for a Franchised Location that has been approved by the Franchisor. The Franchisee acknowledges and agrees that the initial franchise fee represents payment for the initial grant of the rights to use the Marks and Licensed Methods, that the Franchisor has earned the initial franchise fee upon receipt thereof and that the fee is under no circumstances refundable to the Franchisee after it is paid, unless otherwise specifically set forth in this Agreement. 5. DEVELOPMENT OF FRANCHISED LOCATION 5.1. APPROVAL OF LEASE. The Franchisee shall obtain the Franchisor's prior written approval before executing any lease or purchase agreement for the Franchised Location. Any lease for the Franchised Location shall, at the option of the Franchisor, contain a provision: (1) allowing for assignment of the lease to the Franchisor in the event that this Agreement is terminated or not renewed for any reason; (2) giving the Franchisor the right to cure any default by the Franchisee under such lease; and (3) providing the Franchisor with the right, exercisable upon and as a condition of the approval of the Franchised Location, to execute the lease agreement or other document providing entitlement to the use of the Franchised Location in its own name or jointly with the Franchisee as lessee and, upon the exercise of such option, the Franchisor shall provide the Franchisee with the right to use the premises as 3 its sublessee, assignee, or other similar capacity upon the same terms and conditions as obtained by the Franchisor. The Franchisee shall deliver a copy of the signed lease for the Franchised Location to the Franchisor within 15 days of its execution. The Franchisee acknowledges that approval of a lease for the Franchised Location by the Franchisor does not constitute a recommendation, endorsement or guarantee by the Franchisor of the suitability of the location or the lease and the Franchisee should take all steps necessary to ascertain whether such location and lease are acceptable to the Franchisee. 5.2. CONVERSION AND DESIGN. The Franchisee acknowledges that the layout, design, decoration and color scheme of FUZZIWIG'S-TM- CANDY FACTORY Businesses are an integral part of the Franchisor's proprietary Licensed Methods and accordingly, the Franchisee shall convert, design and decorate the Franchised Location in accordance with the Franchisor's plans and specifications and with the assistance of contractors and suppliers designated by the Franchisor. The Franchisee shall also obtain the Franchisor's written consent to any conversion, design or decoration of the premises before remodeling or decorating begins, recognizing that such remodeling, decoration and any related costs are the Franchisee's sole responsibility. 5.3. SIGN. The Franchisee shall purchase or otherwise obtain for use at the Franchised Location and in connection with the FUZZIWIG'S-TM- CANDY FACTORY Business signs which comply with the standards and specifications of the Franchisor as set forth in the Operations Manual, as that term is defined in Section 8. 1. It is the Franchisee's sole responsibility to insure that any signs comply with applicable local ordinances, mall regulations, building codes and zoning regulations. Any modifications to the Franchisor's standards and specifications for signs which must be made due to local ordinances, codes or regulations shall be submitted to the Franchisor for prior written approval. The Franchisee acknowledges the Marks, or any other name, symbol or identifying marks on any signs shall only be used in accordance with the Franchisor's standards and specifications and only with the prior written approval of the Franchisor. 5.4. EQUIPMENT. The Franchisee shall purchase or otherwise obtain for use at the Franchised Location and in connection with the FUZZIWIG'S-TM- CANDY FACTORY Business equipment of a type and in an amount which complies with the standards and specifications of the Franchisor. The Franchisee acknowledges that the type, quality, configuration, capability and/or performance of the equipment are all standards and specifications which are a part of the Licensed Methods and therefore such equipment must be purchased, leased, or otherwise obtained in accordance with the Franchisor's standards and specifications and only from suppliers or other sources approved by the Franchisor. The Franchisee must purchase a facsimile machine and connect it to a phone line which is separate from the main phone number for the Business. The Franchisor reserves the right to require the Franchisee to purchase or lease computer hardware and software for use in the operation 4 of the FUZZIWIG'S-TM- CANDY FACTORY Business. The Franchisor also reserves the right to require that it be given reasonable access to information and data regarding the Franchisee's FUZZIWIG'S-TM- CANDY FACTORY Business by computer modem. 5.5. PERMITS AND LICENSES. The Franchisee agrees to obtain all such pen-nits and certifications as may be required for the lawful construction and operation of the FUZZIWIG'S-TM- CANDY FACTORY Business together with all certifications from goverrunent authorities having jurisdiction over the site that all requirements for construction and operation have been met, including without limitation, zoning, access, sign, health, safety requirements, building and other required construction permits, licenses to do business and fictitious name registrations, sales tax permits, health and sanitation permits and ratings and fire clearances. Franchisee agrees to obtain all customary contractors' sworn statements and partial and final lien waivers for construction, remodeling, decorating and installation of equipment at the Franchised Location. Copies of all subsequent inspection reports, warnings, certificates and ratings issued by any govenunental entity during the term of this Agreement in connection with the conduct of the FUZZIWIG'S-TM- CANDY FACTORY Business which indicates the Franchisee's failure to meet or maintain the highest governmental standards, or less than full compliance by the Franchisee with any applicable law, rule or regulation, shall be forwarded to the Franchisor within five days of the Franchisee's receipt thereof 5.6. COMMENCEMENT OF OPERATIONS. Unless otherwise agreed in writing by the Franchisor and the Franchisee, the Franchisee has 270 days from the date of this Agreement within which to complete the initial training program, described in Section 6.1 of this Agreement, select and develop the Franchised Location and commence operation of the FUZZIWIG'S-TM- CANDY FACTORY Business. The Franchisor will extend the time in which the Franchisee has to commence operations for a reasonable period of time in the event factors beyond the Franchisee's reasonable control prevent the Franchisee from meeting this development schedule, so long as the Franchisee has made reasonable and continuing efforts to comply with such development obligations and the Franchisee requests, in writing, an extension of time in which to have its FUZZIWIG'S-TM- CANDY FACTORY Business established before such development period lapses. 6. TRAINING 6.1. INITIAL TRAINING PROGRAM. The Franchisee or, if the Franchisee is not an individual, the person designated by the Franchisee to assume primary responsibility for the management of the FUZZIWIG'S-TM- CANDY FACTORY Business, ("General Manager") is required to attend and successfully complete the initial training program which is offered by the Franchisor at one of the Franchisor's designated training facilities. Up to four individuals are eligible to participate in the Franchisor's initial training program without charge of a 5 tuition or fee. The Franchisee shall be responsible for any and all traveling and living expenses incurred in connection with attendance at the training program. At least one individual must successfully complete the initial training program prior to the Franchisee's commencement of operation of its FUZZIWIG'S-TM- CANDY FACTORY Business. 6.2. LENGTH OF TRAINING. The initial training program shall consist of a total of 11 days, five of which shall be classroom instruction at a location designated by the Franchisor and six of which shall be on-site at the Franchised Location during the grand opening period. The Franchisee, the General Manager and the Franchisee's principals must attend the on-site training during the grand opening period. The Franchisor reserves the right to waive a portion of the training program or alter the training schedule, if in the Franchisor's sole discretion, the Franchisee or General Manager has sufficient prior experience or training. 6.3. ADDITIONAL TRAINING. From time to time, the Franchisor may present seminars, conventions or continuing development programs or conduct meetings for the benefit of the Franchisee. The Franchisee or its General Manager shall be required to attend any ongoing mandatory seminars, conventions, programs or meetings as may be offered by the Franchisor. The Franchisor shall give the Franchisee at least 30 days prior written notice of any ongoing seminar, convention or program which is deemed mandatory. The Franchisor shall not require that the Franchisee attend any ongoing training more often than once a year. All mandatory training will be offered without charge of a tuition or fee; provided, however, the Franchisee will be responsible for all traveling and living expenses which are associated with attendance at the same. 7. DEVELOPMENT ASSISTANCE 7.1. FRANCHISOR'S DEVELOPMENT ASSISTANCE. The Franchisor shall provide the Franchisee with assistance in the initial establishment of the FUZZIWIG'S-TM- CANDY FACTORY Business as follows: (a) Provision of the initial training program to be conducted at the Franchisor's designated training facilities or at another location designated by the Franchisor, as described in Article 6 above. (b) Provision of written specifications for a Franchised Location which shall include, without limitation, specifications for space requirements, build out and the demographics and character of the mall, if applicable, and the surrounding area. The Franchisee acknowledges that the Franchisor shall have no other obligation to provide assistance in the selection and approval of a Franchised Location other than the provision of such written specifications and approval or disapproval of a proposed Franchised 6 Location, which approval or disapproval shall be based on information submitted to the Franchisor in a form sufficient to assess the proposed location as may be reasonably required by the Franchisor. (c) Direction regarding the required conversion, design and decoration of the FUZZIWIG'S-TM- CANDY FACTORY Business premises, plus specifications concerning signs, decor, animation and equipment. (d) Direction regarding the selection of suppliers of equipment, animated characters, items and materials used and inventory offered for sale in connection with the FUZZIWIG'S-TM- CANDY FACTORY Business. After execution of this Agreement, the Franchisor will provide the Franchisee with a list of approved suppliers, if any, of such equipment, animated characters, items, materials and inventory and, if available, a description of any national or central purchase and supply agreements offered by such approved suppliers for the benefit of FUZZIWIG'S-TM- CANDY FACTORY franchisees. (e) Provision of an operations manual in accordance with Section 8 below. (f) As the Franchisor may reasonably schedule, and depending on availability of personnel, the Franchisor will make available to the Franchisee at or close to the commencement of the Franchisee's FUZZIWIG'S-TM- CANDY FACTORY Business a representative ("Site Representative") to be present for up to six days during the opening of the Franchisee's FUZZIWIG'S-TM- CANDY FACTORY Business. There will be no charge to the Franchisee for this service provided by the Franchisor. The Site Representative will assist the Franchisee's employees in opening the Business, unless in the Franchisor's determination, the Franchisee or the General Manager have had sufficient prior training or experience. 8. OPERATIONS MANUAL 8.1. OPERATIONS MANUAL. The Franchisor agrees to provide to the Franchisee one or more manuals, technical bulletins, or other written materials (collectively referred to as "Operations Manual") covering Candy ordering, stocking and other operating and in-store marketing techniques for the FUZZIWIG'S-TM- CANDY FACTORY Business. The Franchisee agrees that it shall comply with the Operations Manual as an essential aspect of its obligations under this Agreement and failure by the Franchisee to substantially comply with the Operations Manual may be considered by the Franchisor to be a breach of this Agreement. 8.2. CONFIDENTIALITY OF OPERATIONS MANUAL CONTENTS. The Franchisee agrees to use the Marks and Licensed Methods only as specified in the Operations Manual. The 7 Operations Manual is the sole property of the Franchisor and shall be used by the Franchisee only during the term of this Agreement and in strict accordance with the terms and conditions hereof. The Franchisee shall not duplicate the Operations Manual nor disclose its contents to persons other than its employees or officers who have signed a confidentiality and noncompetition agreement in a form approved by the Franchisor. The Franchisee shall return the Operations Manual to the Franchisor upon the expiration, termination or assignment of this Agreement. 8.3. CHANGES TO OPERATIONS MANUAL. The Franchisor reserves the right to revise the Operations Manual from time to time as it deems necessary to update or change operating and marketing techniques or standards and specifications. The Franchisee, within 30 days of receiving any updated information, shall in turn update its copy of the Operations Manual as instructed by the Franchisor and shall conform its operations with the updated provisions within a reasonable time thereafter. The Franchisee acknowledges that a master copy of the Operations Manual maintained by the Franchisor at its principal office shall be controlling in the event of a dispute relative to the content of any Operations Manual. 9. OPERATING ASSISTANCE 9.1. FRANCHISOR'S SERVICES. The Franchisor agrees that, during the Franchisee's operation of the FUZZIWIG'S CANDY FACTORY Business, the Franchisor shall make available to the Franchisee the following services: (a) Upon the reasonable request of the Franchisee, consultation by telephone regarding the continued operation and management of a FUZZIWIG'S-TM- CANDY FACTORY Business and advice regarding the retail services, product quality control, inventory issues, customer relations issues and similar advice. (b) Access to advertising and promotional materials as may be developed by the Franchisor, the cost of which may be passed on to the Franchisee at the Franchisor's option. (c) On-going updates of information and programs regarding the candy industry, the FUZZIWIG'S-TM- CANDY FACTORY concept and related Licensed Methods, including, without limitation, information about special or new products which may be developed and made available to FUZZIWIG'S-TM- CANDY FACTORY Franchisees. (d) The Franchisor shall make the initial training program available to replacement or additional General Managers during the term of this Agreement. The 8 Franchisor reserves the right to charge a tuition or fee in an amount payable in advance, commensurate with the then current published prices of the Franchisor for such training. The Franchisee shall be responsible for all travel and living expenses incurred by its personnel during the training program. Further, the availability of the training programs shall be subject to space considerations and prior commitments to new FUZZIWIG'S-TM- CANDY FACTORY franchisees. 9.2. ADDITIONAL FRANCHISOR SERVICES. Although not obligated to do so, upon the reasonable request of the Franchisee, the Franchisor may make its employees or designated agents available to the Franchisee for on-site advice and assistance in connection with the ongoing operation of the FUZZIWIG'S-TM- CANDY FACTORY Business governed by this Agreement. In the event that the Franchisee requests such additional assistance and the Franchisor agrees to provide the same, the Franchisor reserves the right to charge the Franchisee for all travel, lodging, living expenses, telephone charges and other identifiable expenses associated with such assistance, plus a fee based on the time spent by each employee on behalf of the Franchisee, which fee will be charged in accordance with the then current daily or hourly rates being charged by Franchisor for assistance. 10. FRANCHISEE'S OPERATIONAL COVENANTS 10.1. BUSINESS OPERATIONS. The Franchisee acknowledges that it is solely responsible for the successful operation of its FUZZIWIG'S-TM- CANDY FACTORY Business and that the continued successful operation thereof is, in part, dependent upon the Franchisee's compliance with this Agreement and the Operations Manual. In addition to all other obligations contained in this Agreement and in the Operations Manual, the Franchisee covenants that: (a) The Franchisee shall maintain clean, efficient and high quality FUZZIWIG'S-TM- CANDY FACTORY Business operations and shall operate the business in accordance with the Operations Manual and in such a manner as not to detract from or adversely reflect upon the name and reputation of the Franchisor and the goodwill associated with the FUZZIWIG'S-TM- CANDY FACTORY name and Marks. (b) The Franchisee will conduct itself and operate its FUZZIWIG'S-TM- CANDY FACTORY Business in compliance with all applicable laws, health department regulations and other ordinances and in such a manner so as to promote a good public image in the business community. In connection therewith, the Franchisee will be solely and fully responsible for obtaining any and all licenses to carry on the FUZZIWIG'S-TM- CANDY FACTORY Business. The Franchisee shall 9 promptly forward to the Franchisor copies of all health department, fire department, building department and other similar reports of inspections as and when they become available. (c) The Franchisee acknowledges that proper management of the FUZZIWIG'S-TM- CANDY FACTORY Business is important and shall insure that the Franchisee or a designated General Manager who has completed the Franchisor's initial training program be responsible for the management of the FUZZIWIG'S-TM- CANDY FACTORY Business after commencement of Business operations and be present at the Franchised Location during operation of the Business. (d) The Franchisee shall offer only authorized products and services as are more fully described in the Operations Manual, which may include, without limitation, Candy, Items and other authorized confectionery products. The Franchisee shall offer all types of products and services as from time to time may be prescribed by the Franchisor and shall refrain from offering any other types of products or services, or operating or engaging in any other type of business or profession, from or through the FUZZIWIG'S-TM- CANDY FACTORY Business, including, without limitation, filling "Wholesale Orders", defined below, any catering or off-premises sales, without the prior written consent of the Franchisor. "Wholesale Orders" are defined as those orders or sales where the principal purpose of the purchase is for resale, not consumption, or any sale other than those sold over the counter at a price other than that price charged to the general public; provided, however, that volume discounted sales made on the premises at the Franchised Location to a single purchaser, not for resale, and discounted sales made on the premises at the Franchised Location to charitable organizations for fund-raising purposes shall be permitted. Candy and other Items shall never be sold in containers or bags other than those supplied by the Franchisor or other supplier approved by the Franchisor. (e) The Franchisee shall promptly pay when due all taxes and other obligations owed to third parties in the operation of the FUZZIWIG'S-TM- CANDY FACTORY Business, including without limitation, unemployment and sales taxes, and any and all accounts or other indebtedness of every kind incurred by the Franchisee in the conduct of the FUZZIWIG'S-TM- CANDY FACTORY Business. In the event of a bona fide dispute as to the liability for taxes assessed or other indebtedness, the Franchisee may contest the validity or the amount of the tax or indebtedness in accordance with procedures of the taxing authority or applicable law; however, in no event shall the Franchisee permit a tax sale or seizure by levy or execution or similar writ or warrant, or attachment by a creditor to occur against the premises of the Franchised Location, or any improvement thereon. 10 (f) The Franchisee acknowledges that the unique design, decor, music and animation found in the FUZZIWIG'S-TM- CANDY FACTORY Business are important and the Franchisee shall insure that the theme, animation, decoration, product display, uniforms and background music are all strictly adhered to without exception in the operation of the FUZZIWIG'S-TM- CANDY FACTORY Business. (g) The Franchisee shall subscribe for and maintain not fewer than two separate telephone numbers for its FUZZIWIG'S-TM- CANDY FACTORY Business at the Franchised Location, both of which shall be listed and identified exclusively with the FUZZIWIG'S-TM- CANDY FACTORY Business in all official telephone directories and in all advertising in which such numbers appear and shall be separate and distinct from all other telephone numbers subscribed for by the Franchisee. One number shall be used exclusively for voice communication and the other shall be used exclusively for a facsimile machine. (h) The Franchisee shall comply with all agreements with third parties related to the FUZZIWIG'S-TM- CANDY FACTORY Business including, in particular, all provisions of any premises lease. (i) The Franchisee and all employees of the Franchisee shall adhere to strict grooming and dress code guidelines while on duty at the Franchised Location. The Franchisee is required, at the Franchisee's expense, to purchase specified wearing apparel from suppliers approved by the Franchisor. All General Managers, employees of the Franchisee, the Franchisee and its owners, shall wear the specified uniform at all times while working at the Franchised Location. The Franchisor has the right, in its sole and absolute discretion, to change or modify such dress code guidelines. (j) The Franchisee agrees to renovate, refurbish, remodel or replace, at its own expense, the real and personal property and equipment used in the operation of the FUZZIWIG'S-TM- CANDY FACTORY Business, when reasonably required by the Franchisor in order to comply with the image, standards of operation and performance capability established by the Franchisor from time to time. If the Franchisor changes its image or standards of operation, it shall give the Franchisee a reasonable period of time within which to comply with such changes. (k) The Franchisee shall be responsible for training all of its employees who work in any capacity in the FUZZIWIG'S-TM- CANDY FACTORY Business. The Franchisee must conduct its employee training in the manner and according to the standards as prescribed in the Operations Manual. Any employee who does not satisfactorily complete the training shall not work in any capacity in the Franchisee's FUZZIWIG'S-TM- CANDY FACTORY Business. 11 (l) The Franchisee shall at all times during the term of this Agreement own and control the FUZZIWIG'S' CANDY FACTORY Business authorized hereunder. Upon request of the Franchisor, the Franchisee shall promptly provide satisfactory proof of such ownership to the Franchisor. The Franchisee represents that the Statement of Ownership, attached hereto as EXHIBIT III and by this reference incorporated herein, is true, complete, accurate and not misleading, and, in accordance with the information contained in the Statement of Ownership, the controlling ownership of the FUZZIWIG'S-TM- CANDY FACTORY Business is held by the Franchisee. The Franchisee shall promptly provide the Franchisor with a written notification if the information contained in the Statement of Ownership changes at any time during the term of this Agreement and shall comply with the applicable transfer provisions contained in Article 16 herein. In addition, if the Franchisee is an entity, all of the owners of the Franchisee shall sign the Personal Guaranty attached hereto as EXHIBIT 11. (m) The Franchisee shall at all times during the term of this Agreement keep its FUZZIWIG'S-TM- CANDY FACTORY Business open during the business hours as may be designated by the Franchisor from time to time in the Operations Manual. (n) Unless notified in writing otherwise by the Franchisor, all Candy and related products shall be sold and shipped to the Franchisee on a net 30-day basis, or according to the then current payment terms set by the Franchisor or its designated suppliers. The Franchisor reserves the right to charge interest at the rate of 1.5% per month if the Franchisee fails to pay for its orders on time and the Franchisor reserves the right to discontinue shipment of products to the Franchisee if the Franchisee is repeatedly delinquent in paying for its products, in the Franchisor's sole discretion. The Franchisee may be required to "prepay" factory orders, notwithstanding the payment policy set forth above, in the event of poor payment performance. The Franchisor reserves the right to change payment terms and policies at any time. The Franchisor also reserves the right to change the price for Candy and Items from time to time as may be set forth in the most recent price bulletin sent to all franchisees or the then current Operations Manual. (o) The Franchisee acknowledges that the Franchisor has no responsibility or liability whatsoever for the maintenance, repair or replacement at any time of any equipment used in the operation of the Franchisee's FUZZIWIG'S-TM- CANDY FACTORY Business, including but not limited to, animated characters, audio components, and other items. Any warranties or guaranties of any item must be purchased directly from the dealer or manufacturer. 12 11. ROYALTIES 11.1. MONTHLY ROYALTY. The Franchisee agrees to pay to the Franchisor a monthly royalty ("Royalty") equal to seven percent of the total amount of its Gross Retail Sales, defined in Section 11.2 below, generated from or through its FUZZIWIG'S-TM- CANDY FACTORY Business. 11.2. GROSS RETAIL SALES. "Gross Retail Sales" shall be defined as receipts and income of any kind from all products or services sold from or through the FUZZIWIG'S-TM- CANDY FACTORY Business, including any such sale of products or services made for cash or upon credit, or partly for cash and partly for credit, regardless of collection of charges for which credit is given, less returns for which refunds are made, provided that the refund shall not exceed the sales price and exclusive of discounts, sales taxes and other taxes, amounts received in settlement of a loss of merchandise and shipping expenses paid by the customer. "Gross Retail Sales" shall also include the fair market value of any services or products received by the Franchisee in barter or exchange for its services and products. 11.3. ROYALTY PAYMENTS. The Franchisee agrees that Royalty payments shall be paid monthly and sent to the Franchisor, post-marked no later than the 15th of each month based on Gross Retail Sales for the immediately preceding month. Royalty payments shall be accompanied by monthly reports, as more fully described in Article 15 hereof, and standard transmittal forms containing information regarding the Franchisee's Gross Retail Sales and such additional information as may be requested by the Franchisor. The Franchisor reserves the right to require Royalty payments be made on a weekly or bi-weekly basis if the Franchisee does not timely or fully submit the required payments or reports. The Franchisor shall have the right to verify such Royalty payments from time to time as it deems necessary, in any reasonable manner. In the event that the Franchisee fails to pay any Royalties within 14 days after they are due, the Franchisee shall, in addition to such Royalties, pay a late charge equivalent to 18% of the late Royalty payment; provided, however, in no event shall the Franchisee be required to pay a late payment at a rate greater than the maximum interest rate permitted by applicable law. If the Franchisee pays Royalties with a check returned for non-sufficient funds more than one time in any calendar year, in addition to all other remedies which may be available, the Franchisor shall have the right to require that Royalty payments be made by certified or cashier's checks. 12. ADVERTISING 12.1. APPROVAL OF ADVERTISING. The Franchisee shall obtain the Franchisor's prior written approval of all written advertising or other marketing or promotional programs 13 regarding the FUZZIWIG'S-TM- CANDY FACTORY Business, including, without limitation, "Yellow Pages" advertising, newspaper ads, flyers, brochures, coupons, direct mail pieces, specialty and novelty items and radio and television advertising. The Franchisee shall also obtain the Franchisor's prior written approval of all promotional materials provided by vendors. The proposed written advertising or a description of the marketing or promotional program shall be submitted to the Franchisor at least IO days prior to publication, broadcast or use. The Franchisee acknowledges that advertising and promoting the FUZZIWIG'S-TM- CANDY FACTORY Business in accordance with the Franchisor's standards and specifications is an essential aspect of the Licensed Methods, and the Franchisee agrees to comply with all advertising standards and specifications. The Franchisee shall display all required promotional materials, signs, point of purchase displays and other marketing materials in its FUZZIWIG'S-TM- CANDY FACTORY Business and in the manner prescribed by the Franchisor. The Franchisee shall not, under any circumstances use handwritten signs in the operation of its Business. 12.2. LOCAL ADVERTI5ING. The Franchisor reserves the right to require the Franchisee to spend up to one percent of monthly Gross Retail Sales on local advertising to create public awareness of the Franchisee's FUZZIWIG'S-TM- CANDY FACTORY Business. The Franchisee will submit to the Franchisor an accounting of the amounts spent on advertising within 30 days following the end of each calendar quarter. If the Franchisor requires its franchisees to advertise locally as described above, all Franchisor-owned Businesses will be required to spend money for local advertising on an equal percentage basis with all franchised Businesses. If the Franchisee's lease requires it to advertise locally, the Franchisor may, in its sole discretion, count such expenditures toward the Franchisee's local advertising expenditure required by this Section 12.2. The Franchisee shall obtain the Franchisor's prior written approval of all written advertising and promotional materials before publication. 12.3. MARKETING AND PROMOTION FEE. The Franchisor reserves the right to require the Franchisee to pay to the Franchisor, in addition to Royalties, a fee of up to one percent of the total amount of the Franchisee's Gross Retail Sales. ("Marketing and Promotion Fee"). If required, the Marketing and Promotion Fee shall be in addition to and not in lieu of the Franchisee's expenditures for local advertising, as described in Section 12.2 above. The following terms and conditions will apply: (a) The Marketing and Promotion Fee shall be payable concurrently with the payment of the Royalties, mailed to the Franchisor, postmarked no later than the 15th day of each month, for all Marketing and Promotion Fees based on Gross Retail Sales for the immediately preceding month. (b) The Marketing and Promotion Fees will be subject to the same late charges as the Royalties, in an amount and manner set forth in Section 12.3 above. 14 (c) Upon written request by the Franchisee, the Franchisor will make available to the Franchisee, no later than 120 days after the end of each fiscal year, an annual financial statement which indicates how the Marketing and Promotion Fees have been spent. (d) The Marketing and Promotion Fees, will be administered by the Franchisor, in its sole discretion, and may be used for production and placement of point of purchase advertising, in-store signage, in-store promotions, media advertising, direct mailings, brochures, collateral material advertising, surveys of advertising effectiveness, or other advertising or public relations expenditures relating to advertising the Franchisee's services and products. (e) The Franchisor may reimburse itself for independent audits, reasonable accounting, bookkeeping, reporting and legal expenses, taxes and other reasonable direct and indirect expenses as may be incurred by the Franchisor or its authorized representatives in connection with the programs funded by the Marketing and Promotion Fees. The Franchisor will not be liable for any act or omission with respect to such Marketing and Promotion Fees which is consistent with this Agreement and is done in good faith. 12.4. REGIONAL ADVERTISING PROGRAMS. Although not obligated to do so, the Franchisor reserves the right to allocate all or a portion of the Marketing and Promotion Fees as may be collected in accordance with Section 12.3 above toward a regional advertising program for the benefit of FUZZIWIG'S-TM- CANDY FACTORY franchisees located within a particular region. The Franchisor has the right, in its sole discretion, to determine the composition of all geographic territories and market areas for the implementation of such regional advertising and promotion campaigns and to require that the Franchisee participate in such regional advertising programs as and when they may be established by the Franchisor. If a regional advertising program is implemented on behalf of a particular region by the Franchisor, the Franchisor, to the extent reasonably calculable, will only use contributions from FUZZIWIG'S-TM- CANDY FACTORY franchisees within such region for the particular regional advertising program. The Franchisor also reserves the right to establish an advertising cooperative for a particular region to enable the cooperative to self-administer the regional advertising program. If a regional advertising cooperative is established by the Franchisor, the Franchisee agrees that it will participate in the same. 12.5. MARKETING SERVICES. The Franchisor may, in its sole discretion, offer marketing and merchandising services to the Franchisee at rates that are competitive with those charged by third parties offering similar services. The Franchisee may utilize such services, if they are offered, at the Franchisee's option. Services offered by the Franchisor 15 may include marketing consulting, graphic design, copywriting, advertising, public relations and merchandising consulting, in the Franchisor's sole discretion. 13. QUALITY CONTROL 13.1. COMPLIANCE WITH OPERATIONS MANUAL. The Franchisee agrees to maintain and operate the FUZZIWIG'S-TM- CANDY FACTORY Business in compliance with this Agreement and the standards and specifications contained in the Operations Manual, as the same may be modified from time to time by the Franchisor. 13.2. STANDARDS AND SPECIFICATIONS. The Franchisor will make available to the Franchisee standards and specifications for products and services offered at or through the FUZZIWIG'S-TM- CANDY FACTORY Business and specifically for the animated characters, decor, product displays, music, theme, uniforms, materials, forms, menu boards, items and supplies used in connection with the Business. The Franchisor reserves the right to change standards and specifications for services and products offered at or through the FUZZIWIG'S-TM- CANDY FACTORY Business and for the animated characters, decor, product displays, music, theme, uniforms, materials, forms, menu boards, items and supplies used in connection with the Business upon 30 days prior written notice to the Franchisee. The Franchisee shall strictly adhere to all of the Franchisor's current standards and specifications for the FUZZIWIG'S-TM- CANDY FACTORY Business as prescribed from time to time. 13.3. INSPECTIONS. The Franchisor shall have the right to examine the Franchised Location, including the inventory, products, equipment, materials or supplies, to ensure compliance with all standards and specifications set by the Franchisor. The Franchisor shall conduct such inspections during regular business hours and the Franchisee may be present at such inspections. The Franchisor, however, reserves the right to conduct the inspections without prior notice to the Franchisee. 13.4. RESTRICTIONS ON SERVICES AND PRODUCTS. The Franchisee will be required to purchase any and all of its Candy, for its FUZZIWIG'S-TM- CANDY FACTORY Business from the Franchisor or its designee. Candy shall consist of any and all varieties from time to time made available to the Franchisor's franchisees by the Franchisor and its designated suppliers. The parties hereby acknowledge the uniqueness and importance of Candy being prepared by the Franchisor or its designee in order to maintain the uniformity, quality and uniqueness of Candy, and therefore the Franchisor and its designees are hereby appointed the Franchisee's exclusive source of Candy. The Franchisee is prohibited from offering or selling any products or services not authorized by Franchisor, including, without limitation, operating a catering or wholesale business as part of the FUZZIWIG'S-TM- CANDY FACTORY Business. However, if the Franchisee proposes to offer, conduct or utilize any products, services, materials, forms, 16 items and supplies for use in connection with or sale through the FUZZIWIG'S-TM- CANDY FACTORY Business which are not previously approved by the Franchisor as meeting its specifications, the Franchisee shall first notify the Franchisor in writing requesting approval. The Franchisor may, in its sole discretion, for any reason whatsoever, elect to withhold such approval; however, in order to make such determination, the Franchisor may require submission of specifications, information, or samples of such products, services, materials, forms, items or supplies. The Franchisor will advise the Franchisee within a reasonable time whether such products, services, materials, forms, items or supplies meet its specifications. 13.5. APPROVED SUPPLIERS. The Franchisee shall purchase all products, services, supplies and materials required for the operation of the FUZZIWIG'S-TM- CANDY FACTORY Business licensed herein, from manufacturers, suppliers or distributors designated by the Franchisor or, if there is no designated supplier for a particular product, service, supply or material, from such other suppliers who meet all of the Franchisor's specifications and standards as to quality, composition, finish, appearance and service, and who shall adequately demonstrate their capacity and facilities to supply the Franchisee's needs in the quantities, at the times, and with the reliability requisite to an efficient operation. 13.6. REQUEST TO CHANGE SUPPLIER. In the event the Franchisee desires to purchase products, services, supplies or materials from manufacturers, suppliers or distributors other than those previously approved by the Franchisor, the Franchisee shall, prior to purchasing any such products, services, supplies or materials, give the Franchisor a written request by certified mail, return receipt requested, to change supplier. In the event the Franchisor rejects the Franchisee's requested new manufacturer, supplier or distributor, the Franchisor must, within 60 days of the receipt of the Franchisee's request to change supplier notify the Franchisee in writing of its rejection. Failure to notify the Franchisee within such time period shall constitute a waiver of any and all objections by the Franchisor to the new manufacturer, supplier or distributor submitted by the Franchisee. The Franchisor may continue from time to time to inspect any manufacturer's, suppliers, or distributor's facilities and products to assure proper production, processing, storing and transportation of products, services, supplies or materials to be purchased from the manufacturer, supplier or distributor by the Franchisee. Permission for such inspection shall be a condition of the continued approval of such manufacturer, supplier or distributor. 13.7. APPROVAL OF INTENDED SUPPLIER. The Franchisor may at its sole discretion, for any reason whatsoever, elect to withhold approval of the manufacturer, supplier or distributor; however, in order to make such determination, the Franchisor may require that samples from a proposed new supplier be delivered to the Franchisor for testing prior to approval and use. A charge not to exceed the actual cost of the test may be made by the Franchisor and shall be paid by the Franchisee. 17 14. MARKS, TRADE NAMES AND PROPRIETARY INTERESTS 14.1. MARKS. The Franchisee hereby acknowledges that the Franchisor has the sole right to license and control the Franchisee's use of the FUZZIWIG'S-TM- CANDY FACTORY service mark and other of the Marks, and that such Marks shall remain under the sole and exclusive ownership and control of the Franchisor. The Franchisee acknowledges that it has not acquired any right, title or interest in such Marks except for the right to use such marks in the operation of its FUZZIWIG'S-TM- CANDY FACTORY Business as it is governed by this Agreement. 14.2. N0 USE OF OTHER MARKS. The Franchisee further agrees that no service mark other than "FUZZIWIG'S-TM- CANDY FACTORY" or such other Marks as may be specified by the Franchisor shall be used in the marketing, promotion or operation of the FUZZIWIG'S-TM- CANDY FACTORY Business. 14.3. LICENSED METHODS. The Franchisee hereby acknowledges that the Franchisor owns and controls the distinctive plan for the establishment, operation and promotion of the FUZZIWIG'S-TM- CANDY FACTORY Business and all related licensed methods of doing business, previously defined as the "Licensed Methods", which include, but are not limited to, bulk candy sources, product mix and display, confectionery ordering, processing, stocking and inventory control, technical equipment standards, order fulfillment methods and customer relations, marketing techniques, written promotional materials, advertising, and accounting systems, all of which constitute trade secrets of the Franchisor, and the Franchisee acknowledges that the Franchisor has valuable rights in and to such trade secrets. The Franchisee further acknowledges that it has not acquired any right, title or interest in the Licensed Methods except for the right to use the Licensed Methods in the operation of the FUZZIWIG'S-TM- CANDY FACTORY Business as it is governed by this Agreement. 14.4. EFFECT OF TERMINATION. In the event this Agreement is terminated for any reason, the Franchisee shall immediately cease using any of the Licensed Methods and Marks, trade names, trade dress, trade secrets, copyrights or any other symbols used to identify the FUZZIWIG'S-TM- CANDY FACTORY Business, and all rights the Franchisee had to the same shall automatically terminate. The Franchisee agrees to execute any documents of assignment as may be necessary to transfer any rights the Franchisee may possess in and to the Marks. 14.5. MARK INFRINGEMENT. The Franchisee agrees to notify the Franchisor in writing of any possible infringement or illegal use by others of a trademark the same as or confusingly similar to the Marks which may come to its attention. The Franchisee acknowledges that the Franchisor shall have the right, in its sole discretion, to determine whether any action will be taken on account of any possible infringement or illegal use. The 18 Franchisor may commence or prosecute such action in the Franchisor's own name and may join the Franchisee as a party thereto if the Franchisor determines it to be reasonably necessary for the continued protection and quality control of the Marks and Licensed Methods. The Franchisor shall bear the reasonable cost of any such action, including attorneys' fees. The Franchisee agrees to fully cooperate with the Franchisor in any such litigation. 14.6. FRANCHISEE'S BUSINESS NAME. The Franchisee acknowledges that the Franchisor has a prior and superior claim to the FUZZIWIG'S-TM- CANDY FACTORY trade name. The Franchisee shall not use the words "FUZZIWIG'S-TM- CANDY FACTORY" in the legal name of its corporation, partnership or any other business entity used in conducting the business provided for in this Agreement. The Franchisee also agrees not to register or attempt to register a trade name using the word "FUZZIWIG'S-TM- CANDY FACTORY" in the Franchisee's name or that of any other person or business entity, without prior written consent of the Franchisor. When this Agreement is terminated, the Franchisee shall execute any assignment or other document the Franchisor requires to transfer to itself any rights the Franchisee may possess in a trade name utilizing the word FUZZIWIG'S-TM- CANDY FACTORY or any other Mark owned by the Franchisor. The Franchisee further agrees that it will not identify itself as being "Fuzziwig's Candy Factory, Inc." or as being associated with the Franchisor in any manner other than as a franchisee or licensee. The Franchisee further agrees that in all advertising and promotion and promotional materials it will display its business name only in obvious conjunction with the phrase "FUZZIWIG'S-TM- CANDY FACTORY Licensee" or "FUZZIWIG'S-TM- CANDY FACTORY Franchisee" or with such other words and in such other phrases as may from time to time be prescribed in the Operations Manual, in the Franchisor's sole discretion. 14.7. CHANGE OF MARKS. In the event that the Franchisor, in its sole discretion, shall determine it necessary to modify or discontinue use of any proprietary Marks, or to develop additional or substitute marks, the Franchisee shall, within a reasonable time after receipt of written notice of such a modification or discontinuation from the Franchisor, take such action, at the Franchisee's sole expense, as may be necessary to comply with such modification, discontinuation, addition or substitution. 15. REPORTS, RECORDS AND FINANCIAL STATEMENTS 15.1. FRANCHISEE REPORTS. The Franchisee shall establish and maintain at its own expense a bookkeeping and accounting system which conforms to the specifications which the Franchisor may prescribe from time to time, including the Franchisor's current "Standard Code of Accounts" as described in the Operations Manual. The Franchisee shall supply to the 19 Franchisor such reports in a manner and form as the Franchisor may from time to time reasonably require, including: (a) Monthly summary reports, in a form as may be prescribed by the Franchisor, mailed to the Franchisor postmarked no later than the 15th day of the month and containing information relative to the previous month's operations; and (b) Quarterly financial statements, prepared in accordance with Generally Accepted Accounting Principles ("GAAP"), and consisting of a profit and loss statement and balance sheet for the FUZZIWIG'S-TM- CANDY FACTORY Business, mailed to the Franchisor postmarked no later than the 15th day following the end of the calendar quarter, based on operating results of the prior quarter, which shall be submitted in a form approved by the Franchisor and shall be certified by the Franchisee to be correct. The Franchisor reserves the right to disclose data derived from such reports, without identifying the Franchisee, except to the extent identification of the Franchisee is required by law. 15.2. ANNUAL FINANCIAL STATEMENTS. The Franchisee shall, within 90 days after the end of its fiscal year, provide to the Franchisor annual unaudited financial statements, compiled or reviewed by an independent certified public accountant acceptable to and approved by the Franchisor and prepared in accordance with GAAP, and state and federal income tax returns prepared by a certified public accountant. If these financial statements or tax returns show an underpayment of any amounts owed to the Franchisor, these amounts shall be paid to the Franchisor concurrently with the submission of the statements or returns. 15.3. VERIFICATION. Each report and financial statement to be submitted to the Franchisor hereunder shall be signed and verified by the Franchisee. 15.4. BOOKS AND RECORDS. The Franchisee shall maintain all books and records for its FUZZIWIG'S-TM- CANDY FACTORY Business in accordance with generally accepted accounting principles, consistently applied, and preserve these records for at least five years after the fiscal year to which they relate. 15.5. AUDIT OF BOOKS AND RECORDS. The Franchisee shall permit the Franchisor to inspect and audit the books and records of the FUZZIWIG'S-TM- CANDY FACTORY Business at any reasonable time, at the Franchisor's expense. If any audit discloses a deficiency in amounts for payments owed to the Franchisor pursuant to this Agreement, then such amounts shall become immediately payable to the Franchisor by the Franchisee, with interest from the date such payments were due at the lesser of one and one-half percent per month or the 20 maximum rate allowed by law. In addition, if it is found by such audit that the Gross Retail Sales of the FUZZIWIG'S-TM- CANDY FACTORY Business have been understated by five percent or more during the period audited, the Franchisee shall pay all reasonable costs and expenses the Franchisor incurred in connection with such audit. 15.6. FAILURE TO COMPLY WITH REPORTING REQUIREMENTS. If the Franchisee fails to prepare and submit any statement or report as required under this Article 15, then the Franchisor shall have the right to treat the Franchisee's failure as good cause for termination of this Agreement. In addition to all other remedies available to the Franchisor, in the event that the Franchisee fails to prepare and submit any statement or report required under this Article 15 for two consecutive reporting periods, the Franchisor shall be entitled to make an audit, at the expense of the Franchisee, of the Franchisee's books, records and accounts, including the Franchisee's bank accounts, which in any way pertain to the Gross Retail Sales of the FUZZIWIG'S-TM- CANDY FACTORY Business. The statements or reports not previously submitted shall be prepared by or under the direction and supervision of an independent certified public accountant selected by the Franchisor. 15.7. SHOPPING SERVICE. The Franchisor reserves the right to use third party shopping services from time to time to evaluate the conduct of the Franchisee's FUZZIWIG'S-TM- CANDY FACTORY Business, including such things as customer service, cleanliness, merchandising and proper use of registers. Franchisor may use such shopping services to inspect the Franchisee's FUZZIWIG'S-TM- CANDY FACTORY Business at any time at the Franchisor's expense, without prior notification to the Franchisee. The Franchisor may make the results of any such service evaluation available to the Franchisee, in the Franchisor's sole discretion. 16. ASSIGNMENT 16.1. ASSIGNMENT BY FRANCHISEE. The franchise granted herein is personal to the Franchisee and, except as stated below, the Franchisor shall not allow or permit any transfer, assignment, subfranchise or conveyance of this Agreement or any interest hereunder. 16.2. PRE-CONDITIONS TO FRANCHISEE'S ASSIGNMENT. The Franchisee shall not sell, transfer or assign its rights under this Agreement or any interest in it, or any part or portion of any business entity that owns it or all or a substantial portion of the assets of the FUZZIWIG'S-TM- CANDY FACTORY Business, unless the Franchisee obtains the Franchisor's written consent and complies with the following requirements: 21 (a) Payment of all amounts due and owing pursuant to this Agreement by the Franchisee to the Franchisor or its affiliates or to third parties whose debts or obligations the Franchisor has guaranteed on behalf of the Franchisee, if any; (b) Agreement by the proposed transferee to satisfactorily complete the initial training program described in this Agreement, which training may be completed by the transferee either prior to or immediately after assignment of this Agreement; (c) Execution of a Franchise Agreement in a form then currently offered by the Franchisor, which shall supersede this Agreement in all respects. If a new Franchise Agreement is signed, the terms thereof may differ from the terms of this Agreement; provided, however, the transferee will not be required to pay any additional initial franchise fee; (d) Provision by the Franchisee of written notice to the Franchisor 30 days' prior to the proposed effective date of the transfer, such notice to contain information reasonably detailed to enable the Franchisor to evaluate the terms and conditions of the proposed transfer; (e) The proposed transferee shall have provided information to the Franchisor sufficient for the Franchisor to assess the proposed transferee's business experience, aptitude and financial qualification, and the Franchisor shall have ascertained that the proposed transferee meets such qualifications; (f) Execution by Franchisee of a general release, in a form satisfactory to the Franchisor, of any and all claims against the Franchisor, its affiliates and their respective officers, directors, employees and agents; (g) Payment by the Franchisee or the proposed transferee of $2,500; and (h) Agreement by the Franchisee to abide by the post-termination covenant not to compete set forth in Section 19.2 below. 16.3. FRANCHISOR'S APPROVAL OF TRANSFER. The Franchisor has 30 days from the date of the written notice to approve or disapprove in writing, of the Franchisee's proposed assignment. The Franchisee acknowledges that the proposed transferee shall be evaluated for approval by the Franchisor based on the same criteria as is currently being used to assess new franchisees of the Franchisor and that such proposed transferee shall be provided, if appropriate, with such disclosures as may be required by state or federal law. If the Franchisee and its proposed transferee comply with all conditions for assignment set forth 22 herein and the Franchisor has not given the Franchisee notice of its approval or disapproval within such period, approval is deemed granted. 16.4. RIGHT OF FIRST REFUSAL. In the event the Franchisee wishes to sell, transfer or assign its rights under this Agreement or any interest in it, or any part or portion of any business entity that owns it, or all or a substantial portion of the assets of the FUZZIWIG'S-TM- CANDY FACTORY Business, the Franchisee agrees to grant to the Franchisor a 30 day right of first refusal to purchase such rights, interest or assets on the same terms and conditions as are contained in the written offer to purchase submitted to the Franchisee by the proposed purchaser; provided, however, the following additional terms and conditions shall apply: (a) The Franchisee shall notify the Franchisor of such offer by sending a written notice to the Franchisor (which notice may be the same notice as required by Section 16.2(d) above), enclosing a copy of the written offer from the proposed purchaser; (b) The 30 day right of first refusal period will run concurrently with the period in which the Franchisor has to approve or disapprove the proposed transferee; (c) Such right of first refusal is effective for each proposed transfer and any material change in the terms or conditions of the proposed transfer shall be deemed a separate offer on which a new 30 day right of first refusal shall be given to the Franchisor; (d) If the consideration or manner of payment offered by a third party is such that the Franchisor may not reasonably be required to furnish the same, then the Franchisor may purchase the interest which is proposed to be sold for the reasonable cash equivalent. If the parties cannot agree within a reasonable time on the cash consideration, an independent appraiser shall be designated by the Franchisor, whose determination will be binding upon the parties. All expenses of the appraiser shall be paid for equally between the Franchisor and the Franchisee; and (e) If the Franchisor chooses not to exercise its right of first refusal, the Franchisee shall be free to complete the sale, transfer or assignment, subject to compliance with Sections 16.2 and 16.3 above. Absence of a reply to the Franchisee's notice of a proposed sale within the 30 day period is deemed a waiver of such right of first refusal. 16.5. TYPES OF TRANSFERS. The Franchisee acknowledges that the Franchisor's right to approve or disapprove of a proposed sale or transfer, and all other requirements and rights related to such proposed sale or transfer, as provided for above, shall apply (1) if the 23 Franchisee is a partnership or other business association, to the addition or deletion of a partner or members of the association or the transfer of any partnership or membership among existing partners or members; (2) if the Franchisee is a corporation, to any proposed transfer or assignment of 25% or more of the stock of the corporate Franchisee, whether such transfer occurs in a single transaction or several transactions; and (3) if the Franchisee is an individual, to the transfer from such individual or individuals to a corporation controlled by them, in which case the Franchisor's approval will be conditioned upon: (i) the continuing personal guarantee of the individual (or individuals) for the performance of obligations under this Agreement; (ii) the issuance and/or transfer of shares which would affect a change in ownership of 25% or more of the stock in the corporation being conditioned on the Franchisor's prior written approval; (iii) a limitation on the corporation's business activity to that of operating the FUZZIWIG'S-TM- CANDY FACTORY Business and related activities; and (iv) other reasonable conditions. With respect to a proposed transfer as described in subsection (1) and (3) of this Section, the Franchisor's right of first refusal to purchase, as set forth above, shall not apply and the Franchisor will waive any transfer fee chargeable to the Franchisee for a transfer under these circumstances. 16.6. ASSIGNMENT BY THE FRANCBISOR. This Agreement is fully assignable by the Franchisor and shall inure to the benefit of any assignee or other legal successor in interest, and the Franchisor shall in such event be fully released from the same. 16.7. FRANCHISEE'S DEATH OR DISABILITY. Upon the death or permanent disability of the Franchisee (or the Franchisee's individual controlling the Franchisee entity), the executor, administrator, conservator, guardian or other personal representative of such person shall transfer the Franchisee's interest in this Agreement or such interest in the Franchisee entity to an approved third party. Such disposition of this Agreement or such interest (including, without limitation, transfer by bequest or inheritance) shall be completed within a reasonable time, not to exceed 120 days from the date of death or permanent disability, and shall be subject to all terms and conditions applicable to transfers contained in this Article 16. Provided, however, that for purposes of this Section 16.7, there shall be no fee charged by the Franchisor for the initial training program offered to the transferee. Failure to transfer the interest in this Agreement or such interest in the Franchisee entity within said period of time shall constitute a breach of this Agreement. For the purposes hereof, the term "permanent disability" shall mean a mental or physical disability, impairment or condition that is reasonably expected to prevent or actually does prevent the Franchisee or the owner of a controlling interest in the Franchisee entity from supervising the management and operation of the FUZZIWIG'S-TM- CANDY FACTORY Business for a period of 120 days from the onset of such disability, impairment or condition. 17. TERM AND EXPIRATION 24 17.1. TERM. The term of this Agreement is for a period of 10 years from the date of this Agreement, unless sooner terminated as provided herein. 17.2. RIGHTS UPON EXPIRATION. At the end of the initial term hereof the Franchisee shall have the option to renew its franchise rights for two additional terms of FIVE years each, by acquiring successor franchise rights, if the Franchisor does not exercise its right not to offer a successor franchise in accordance with Section 17.4 below and if the Franchisee: (a) At least 30 days prior to expiration of the term, executes the form of Franchise Agreement then in use by the Franchisor; (b) Has complied with all provisions of this Agreement during the current term, including the payment on a timely basis of all Royalties and other fees due hereunder. "Compliance" shall mean, at a minimum, that the Franchisee has not received any written notification from the Franchisor of breach hereunder more than four times during the term hereof; (c) Upgrades and/or remodels the FUZZIWIG'S-TM- CANDY FACTORY Business and its operations at the Franchisee's sole expense (the necessity of which shall be in the sole discretion of the Franchisor) to conform with the then current Operations Manual; (d) Executes a general release, in a form satisfactory to the Franchisor, of any and all claims against the Franchisor and its affiliates, and their respective officers, directors, employees and agents arising out of or relating to this Agreement; and (e) Pays a successor franchise fee of $2,500. 17.3. EXERCISE OF OPTION FOR SUCCESSOR FRANCHISE. The Franchisee may exercise its option for a successor franchise by giving written notice of such exercise to the Franchisor not less than 210 days prior to the scheduled expiration of this Agreement. The Franchisee's successor franchise rights shall become effective by signing the Franchise Agreement then currently being offered to new franchisees of the Franchisor. 17.4. CONDITIONS OF REFUSAL. The Franchisor shall not be obligated to offer the Franchisee a successor franchise upon the expiration of this Agreement if the Franchisee fails to comply with any of the above conditions of renewal. In such event, except for failure to execute the then current Franchise Agreement or pay the successor franchise fee, the Franchisor shall give notice of expiration at least 180 days prior to the expiration of the term, and such notice shall set forth the reasons for such refusal to offer successor franchise rights. 25 Upon the expiration of this Agreement, the Franchisee shall comply with the provisions of Section 18.2 below. 18. DEFAULT AND TERMINATION 18.1. TERMINATION BY FRANCHISOR - EFFECTIVE UPON NOTICE. The Franchisor shall have the right, at its option, to terminate this Agreement and all rights granted the Franchisee hereunder, without affording the Franchisee any opportunity to cure any default (subject to any state laws to the contrary, where state law shall prevail), effective upon receipt of notice by the Franchisee, addressed as provided in Section 22.12, upon the occurrence of any of the following events: (a) ABANDONMENT. If the Franchisee ceases to operate the FUZZIWIG'S-TM- CANDY FACTORY Business or otherwise abandons the FUZZIWIG'S-TM- CANDY FACTORY Business for a period of five consecutive days, or any shorter period that indicates an intent by the Franchisee to discontinue operation of the FUZZIWIG'S-TM- CANDY FACTORY Business, unless and only to the extent that full operation of the FUZZIWIG'S-TM- CANDY FACTORY Business is suspended or terminated due to fire, flood, earthquake or other similar causes beyond the Franchisee's control and not related to the availability of funds to the Franchisee; (b) INSOLVENCY, ASSIGNMENTS. If the Franchisee becomes insolvent or is adjudicated a bankrupt; or any action is taken by the Franchisee, or by others against the Franchisee under any insolvency, bankruptcy or reorganization act, (this provision may not be enforceable under federal bankruptcy law, 11 U.S.C. Sections 101 ET SEQ.), or if the Franchisee makes an assignment for the benefit of creditors, or a receiver is appointed by the Franchisee; (c) UNSATISFIED JUDGMENTS; LEVY; FORECLOSURE. If any material judgment (or several judgments which in the aggregate are material) is obtained against the Franchisee and remains unsatisfied or of record for 30 days or longer (unless a supersedeas or other appeal bond has been filed); or if execution is levied against the Franchisee's business or any of the property used in the operation of the FUZZIWIG'S-TM- CANDY FACTORY Business and is not discharged within five days; or if the real or personal property of the Franchisee's business shall be sold after levy thereupon by any sheriff, marshall or constable; (d) CRIMINAL CONVICTION. If the Franchisee is convicted of a felony, a crime involving moral turpitude, or any crime or offense that is reasonably likely, in 26 the sole opinion of the Franchisor, to materially and unfavorably affect the Licensed Methods, Marks, goodwill or reputation thereof; (e) FAILURE TO MAKE PAYMENTS. If the Franchisee fails to pay any amounts due the Franchisor or affiliates, including any amounts which may be due as a result of any subleases or lease assignments between the Franchisee and the Franchisor, within 10 days after receiving notice that such fees or amounts are overdue; (f) MISUSE OF MARKS. If the Franchisee misuses or fails to follow the Franchisor's directions and guidelines concerning use of the Franchisor's Marks and fails to correct the misuse or failure within ten days after notification from the Franchisor; (g) UNAUTHORIZED DISCLOSURE. If the Franchisee intentionally or negligently discloses to any unauthorized person the contents of or any part of the Franchisor's Operations Manual or any other trade secrets or confidential information of the Franchisor; (h) REPEATED NONCOMPLIANCE. If the Franchisee has received two previous notices of default from the Franchisor and is again in default of this Agreement within a 12 month period, regardless of whether the previous defaults were cured by the Franchisee; or (i) UNAUTHORIZED TRANSFER. If the Franchisee sells, transfers or otherwise assigns the Franchise, an interest in the Franchise or the Franchisee entity, this Agreement, the FUZZIWIG'S-TM- CANDY FACTORY Business or a substantial portion of the assets of the FUZZIWIG'S-TM- CANDY FACTORY Business owned by the Franchisee without complying with the provisions of Article 16 above. 18.2. TERMINATION BY FRANCHISOR - THIRTY DAYS NOTICE. The Franchisor shall have the right to terminate this Agreement (subject to any state laws to the contrary, where state law shall prevail), effective upon 30 days written notice to the Franchisee, if the Franchisee breaches any other provision of this Agreement and fails to cure the default during such 30 day period. In that event, this Agreement will terminate without further notice to the Franchisee, effective upon expiration of the 30 day period. Defaults shall include, but not be limited to, the following: (a) FAILURE TO MAINTAIN STANDARDS. The Franchisee fails to maintain the then-current operating procedures and adhere to the specifications and standards established by the Franchisor as set forth herein or in the Operations Manual or otherwise communicated to the Franchisee; 27 (b) DECEPTIVE PRACTICES. The Franchisee engages in any unauthorized business or practice or sells any unauthorized product or service under the Franchisor's Marks or under a name or mark which is confusingly similar to the Franchisor's Marks; (c) FAILURE TO OBTAIN CONSENT. The Franchisee fails, refuses or neglects to obtain the Franchisor's prior written approval or consent as required by this Agreement; (d) FAILURE TO COMPLY WITH MANUAL. The Franchisee fails or refuses to comply with the then-current requirements of the Operations Manual; or (e) BREACH OF RELATED AGREEMENT. The Franchisee defaults under any term of the sublease or lease assignment for the Franchised Location, any other agreement material to the FUZZIWIG'S-TM- CANDY FACTORY Business or any other Franchise Agreement between the Franchisor and the Franchisee and such default is not cured within the time specified in such sublease, other agreement or other Franchise Agreement. Notwithstanding the foregoing, if the breach is curable, but is of a nature which cannot be reasonably cured within such 30 day period and the Franchisee has commenced and is continuing to make good faith efforts to cure the breach during such 30 day period, the Franchisee shall be given an additional reasonable period of time to cure the same, and this Agreement shall not automatically terminate without written notice from the Franchisor. 18.3. FRANCHISOR'S REMEDIES. (a) FAILURE TO PAY. In addition to all other remedies that may be exercised by the Franchisor upon a default by the Franchisee under the terms of this Agreement, the Franchisor reserves the right to collect amounts due from the Franchisee to any third party and to pay the third party directly. If the Franchisor collects any such amounts, the Franchisor may, in its sole discretion, charge the Franchisee an administrative fee to reimburse the Franchisor for its costs of collecting and paying such amounts. Any administrative fee charged would not exceed 15% of the total amount of money collected. (b) FAILURE TO MAINTAIN STANDARDS. In addition to all other remedies that may be exercised by the Franchisor upon a default by the Franchisee under the terms of this Agreement, the Franchisor may collect a fee of $500 per day for every day following the 30 day cure period in which the Franchisee continues to breach this 28 Agreement by failing to maintain and adhere to the Franchisor's standards and specifications for the operation of the Franchisee's Business. 18.4. RIGHT TO PURCHASE. Upon termination or expiration of this Agreement for any reason, the Franchisor shall have the option to purchase the FUZZIWIG'S-TM- CANDY FACTORY Business, which may include, at the Franchisor's option, all of the Franchisee's interest, if any, in and to the real estate upon which the FUZZIWIG'S-TM- CANDY FACTORY Business is located, and all buildings and other improvements thereon, including leasehold interests, at fair market value, less any amount apportioned to the goodwill of the FUZZIWIG'S-TM- CANDY FACTORY Business which is attributable to the Franchisor's Marks and Licensed Methods, and less any amounts owed to the Franchisor by the Franchisee. The following additional terms shall apply to the Franchisor's exercise of this option: (a) The Franchisor's option hereunder shall be exercisable by providing the Franchisee with written notice of its intention to exercise the option given to the Franchisee no later than the effective date of termination, in the case of termination, or at least 90 days prior to the expiration of the term of the franchise, in the case of non-renewal. (b) In the event that the Franchisor and the Franchisee cannot agree to a fair market value of the FUZZIWIG'S-TM- CANDY FACTORY Business, then the fair market value shall be determined by an independent third party appraisal. The Franchisor and the Franchisee shall each select one independent, qualified appraiser, and the two so selected shall select a third appraiser, all three to determine the fair market value of the FUZZIWIG'S-TM- CANDY FACTORY Business. The purchase price shall be the median of the fair market values as determined by the three appraisers. (c) The Franchisor and the Franchisee agree that the terms and conditions of this right and option to purchase may be recorded, if deemed appropriate by the Franchisor, in the real property records and the Franchisor and the Franchisee further agree to execute such additional documentation as may be necessary and appropriate to effectuate such recording. (d) The closing for the purchase of the FUZZIWIG'S-TM- CANDY FACTORY Business will take place no later than 60 days after the termination or nonrenewal date. The Franchisor will pay the purchase price in full at the closing, or, at its option, in five equal consecutive monthly installments with interest at a rate of ten percent per annum. The Franchisee must sign all documents of assignment and transfer as are reasonably necessary for purchase of the FUZZIWIG'S-TM- CANDY FACTORY Business by the Franchisor. 29 In the event that the Franchisor does not exercise the Franchisor's right to purchase the Franchisee's FUZZIWIG'S-TM- CANDY FACTORY Business as set forth above, the Franchisee will be free to keep or to sell, after such termination or expiration, to any third party, all of the physical assets of its FUZZIWIG'S-TM-CANDY FACTORY Business; provided, however, that all appearances of the Marks are first removed in a manner approved in writing by the Franchisor. Notwithstanding the foregoing sentence, the Franchisee acknowledges that it is impossible to remove the appearance of trademark from certain items used in the Business, such as the animated characters, and therefore, if the Franchisor does not exercise its right to purchase the Franchisee's Business, the Franchisee agrees to sell all of its animated characters and all other proprietary items, as determined by the Franchisor in its sole discretion, to the Franchisor for a price equal to the lesser of: (1) depreciated book value or (2) actual market value. The Franchisor will only be obligated to purchase any assets of the FUZZIWIG'S-TM- CANDY FACTORY Business in the event and to the extent it is required by applicable state or federal law. 18.5. OBLIGATIONS OF FRANCHISEE UPON TERMINATION OR EXPIRATION. The Franchisee is obligated upon termination or expiration of this Agreement to immediately: (a) Pay to the Franchisor all Royalties, other fees, and any and all amounts or accounts payable then owed the Franchisor or its affiliates pursuant to this Agreement, or pursuant to any other agreement, whether written or oral, including subleases and lease assignments, between the parties; (b) Cease to identify itself as a FUZZIWIG'S-TM- CANDY FACTORY Franchisee or publicly identify itself as a former Franchisee or use any of the Franchisor's trade secrets, signs, symbols, devices, trade names, trademarks, or other materials. (c) Immediately cease to identify the Franchised Location as being, or having been, associated with the Franchisor, and immediately cease using any proprietary mark of the Franchisor or any mark in any way associated with the FUZZIWIG'S-TM- CANDY FACTORY Marks and Licensed Methods; (d) Deliver to the Franchisor all Candy inventory which bears the FUZZIWIG'S-TM- CANDY FACTORY logo, signs, sign-faces, advertising materials, forms and other materials bearing any of the Marks or otherwise identified with the Franchisor and obtained by and in connection with this Agreement; (e) Immediately deliver to the Franchisor the Operations Manual and all other information, documents and copies thereof which are proprietary to the Franchisor; 30 (f) Promptly take such action as may be required to cancel all fictitious or assumed names or equivalent registrations relating to its use of any Marks which are under the exclusive control of the Franchisor or, at the option of the Franchisor, assign the same to the Franchisor; (g) Notify the telephone company and all telephone directory publishers of the termination or expiration of the Franchisee's right to use any telephone number and any regular, classified or other telephone directory listings associated with any Mark and to authorize transfer thereof to the Franchisor or its designee. The Franchisee acknowledges that, as between the Franchisee and the Franchisor, the Franchisor has the sole rights to and interest in all telephone, telecopy or facsimile machine numbers and directory listings associated with any Mark. The Franchisee authorizes the Franchisor, and hereby appoints the Franchisor and any of its officers as the Franchisee's attorney-in-fact, to direct the telephone company and all telephone directory publishers to transfer any telephone, telecopy or facsimile machine numbers and directory listings relating to the FUZZIWIG'S-TM- CANDY FACTORY Business to the Franchisor or its designee, should the Franchisee fail or refuse to do so, and the telephone company and all telephone directory publishers may accept such direction or this Agreement as conclusive of the Franchisor's exclusive rights in such telephone numbers and directory listings and the Franchisor's authority to direct their transfer; and (h) Abide by all restrictive covenants set forth in Article 20 of this Agreement. 18.6. STATE AND FEDERAL LAW. THE PARTIES ACKNOWLEDGE THAT IN THE EVENT THAT THE TERMS OF THIS AGREEMENT REGARDING TERMINATION OR EXPIRATION ARE INCONSISTENT WITH APPLICABLE STATE OR FEDERAL LAW, SUCH LAW SHALL GOVERN THE FRANCHISEE'S RIGHTS REGARDING TERMINATION OR EXPIRATION OF THIS AGREEMENT. 19. BUSINESS RELATIONSHIP 19.1. INDEPENDENT BUSINESSPERSONS. The parties agree that each of them are independent businesspersons, their only relationship is by virtue of this Agreement and that no fiduciary relationship is created hereunder. Neither party is liable or responsible for the other's debts or obligations, nor shall either party be obligated for any damages to any person or property directly or indirectly arising out of the operation of the other party's business authorized by or conducted pursuant to this Agreement. The Franchisor and the Franchisee 31 agree that neither of them will hold themselves out to be the agent, employer or partner of the other and that neither of them has the authority to bind or incur liability on behalf of the other. 19.2. PAYMENT OF THIRD PARTY OBLIGATIONS. The Franchisor shall have no liability for the Franchisee's obligations to pay any third parties, including without limitation, any product vendors, or any sales, use, service, occupation, excise, gross receipts, income, property or other tax levied upon the Franchisee, the Franchisee's property, the FUZZIWIG'S-TM- CANDY FACTORY Business or upon the Franchisor in connection with the sales made or business conducted by the Franchisee (except any taxes the Franchisor is required by law to collect from the Franchisee with respect to purchases from the Franchisor). 19.3. INDEMNIFICATION. The Franchisee agrees to indemnify, defend and hold harmless the Franchisor, its subsidiaries and affiliates, and their respective shareholders, directors, officers, employees, agents, successors and assignees, (the "Indemnified Parties") against, and to reimburse them for all claims, obligations and damages described in this Section 19.3, any and all third party obligations described in Section 19.2 and any and all claims and liabilities directly or indirectly arising out of the operation of the FUZZIWIG'S-TM- CANDY FACTORY Business or arising out of the use of the Marks and Licensed Methods in any manner not in accordance with this Agreement. For purposes of this indemnification, claims shall mean and include all obligations, actual and consequential damages and costs reasonably incurred in the defense of any claim against the Indemnified Parties, including, without limitation, reasonable accountants', attorneys' and expert witness fees, costs of investigation and proof of facts, court costs, other litigation expenses and travel and living expenses. The Franchisor shall have the right to defend any such claim against it. This indemnity shall continue in full force and effect subsequent to and notwithstanding the expiration or termination of this Agreement. 20. RESTRICTIVE COVENANTS 20.1. NON-COMPETITION DURING TERM. The Franchisee acknowledges that, in addition to the license of the Marks hereunder, the Franchisor has also licensed commercially valuable information which comprises and is a part of the Licensed Methods, including without limitation, recipes, operations, marketing, advertising and related information and materials and that the value of this information derives not only from the time, effort and money which went into its compilation, but from the usage of the same by all the franchisees of the Franchisor using the Marks and Licensed Methods. The Franchisee therefore agrees that other than the FUZZIWIG'S-TM- CANDY FACTORY Business licensed herein, neither the Franchisee nor any of the Franchisee's officers, directors, shareholders or partners, nor any member of his or their immediate families, shall during the term of this Agreement: 32 (a) have any direct or indirect controlling interest as a disclosed or beneficial owner in a "Competitive Business" as defined below; (b) perform services as a director, officer, manager, employee, consultant, representative, agent or otherwise for a Competitive Business; or (c) divert or attempt to divert any business related to, or any customer or account of the FUZZIWIG'S CANDY FACTORY Business, the Franchisor's business or any other FUZZIWIG'S-TM- CANDY FACTORY franchisee's business, by direct inducement or otherwise, or divert or attempt to divert the employment of any employee of the Franchisor or another franchisee licensed by the Franchisor to use the Marks and Licensed Methods, to any Competitive Business by any direct inducement or otherwise. The term "Competitive Business" as used in this Agreement shall mean any business operating, or granting franchises or licenses to others to operate, a retail, wholesale, distribution or manufacturing business deriving more than 5% of its gross receipts from the sale, processing or manufacturing of Candy, Items or other products which are offered in FUZZIWIG'S-TM- CANDY FACTORY Businesses and which constitutes 5% or more of the Gross Retail Sales of any FUZZIWIG'S-TM- CANDY FACTORY Business; provided, however, the Franchisee shall not be prohibited from owning securities in a Competitive Business if such securities are listed on a stock exchange or traded on the over-the-counter market and represent 5% or less of that class of securities issued and outstanding. 20.2. POST-TERMINATION COVENANT NOT TO COMPETE. Upon termination or expiration of this Agreement for any reason, the Franchisee and its officers, directors, shareholders, and/or partners agree that, for a period of two years commencing on the effective date of termination or expiration, or the date on which the Franchisee ceases to conduct business, whichever is later, neither Franchisee nor its officers, directors, shareholders, and/or partners shall have any direct or indirect interest (through a member of any immediate family of the Franchisee or its Owners or otherwise) as a disclosed or beneficial owner, investor, partner, director, officer, employee, consultant, representative or agent or in any other capacity in any Competitive Business, defined in Section 20.1 above, located or operating within a 1O mile radius of the Franchised Location or within 1O miles of any other franchised or company-owned FUZZIWIG'S-TM-CANDY FACTORY Business. The restrictions of this Section shall not be applicable to the ownership of shares of a class of securities listed on a stock exchange or traded on the over-the-counter market that represent 5% or less of the number of shares of that class of securities issued and outstanding. The Franchisee and its officers, directors, shareholders, and/or partners expressly acknowledge that they possess skills and abilities of a general nature and have other opportunities for 33 exploiting such skills. Consequently, enforcement of the covenants made in this Section will not deprive them of their personal goodwill or ability to earn a living. 20.3. CONFIDENTIALITY OF PROPRIETARY INFORMATION. The Franchisee shall treat all information it receives which comprises or is a part of the Licensed Methods licensed hereunder as proprietary and confidential and will not use such information in an unauthorized manner or disclose the same to any unauthorized person without first obtaining the Franchisor's written consent. The Franchisee acknowledges that the Marks and the Licensed Methods have valuable goodwill attached to them, that the protection and maintenance thereof is essential to the Franchisor and that any unauthorized use or disclosure of the Marks and Licensed Methods will result in irreparable harm to the Franchisor. 20.4. CONFIDENTIALITY AGREEMENT. The Franchisor reserves the right to require that the Franchisee cause each of its officers, directors, partners, shareholders, and General Manager, and, if the Franchisee is an individual, immediate family members, to execute a Nondisclosure and Noncompetition Agreement containing the above restrictions, in a form approved by the Franchisor. 21. INSURANCE 21.1. INSURANCE COVERAGE. The Franchisee shall procure, maintain and provide evidence of (i) comprehensive general liability insurance for the Franchised Location and its operations with a limit of not less than $1,000,000 combined single limit, or such greater limit as may be required as part of any lease agreement for the Franchised Location; (ii) automobile liability insurance covering all employees of the FUZZIWIG'S-TM- CANDY FACTORY Business with authority to operate a motor vehicle in an amount not less than $1,000,000 or, with the prior written consent of the Franchisor, such lesser amount as may be available at a commercially reasonable rate, but in no event less than any statutorily imposed minimum coverage; (iii) unemployment and worker's compensation insurance with a broad form all-states endorsement coverage sufficient to meet the requirements of the law; and (iv) all-risk personal property insurance in an amount equal to at least 100% of the replacement costs of the contents and tenant improvements located at the FUZZIWIG'S-TM- CANDY FACTORY Business. All of the required policies of insurance shall name the Franchisor as an additional named insured and shall provide for a 30 day advance written notice to the Franchisor of cancellation. 21.2. PROOF OF INSURANCE COVERAGE. The Franchisee will provide proof of insurance to the Franchisor prior to commencement of operations at its FUZZIWIG'S-TM- CANDY FACTORY Business. This proof will show that the insurer has been authorized to inform the Franchisor in the event any policies lapse or are canceled. The Franchisor has the 34 right to change the minimum amount of insurance the Franchisee is required to maintain by giving the Franchisee prior reasonable notice, giving due consideration to what is reasonable and customary in the similar business. Noncompliance with the insurance provisions set forth herein shall be deemed a material breach of this Agreement; in the event of any lapse in insurance coverage, in addition to all other remedies, the Franchisor shall have the right to demand that the Franchisee cease operations of the FUZZIWIG'S-TM- CANDY FACTORY Businesses until coverage is reinstated, or, in the alternative, pay any delinquencies in premium payments and charge the same back to the Franchisee. 22. MISCELLANEOUS PROVISIONS 22.1. GOVERNING LAW/CONSENT TO VENUE AND JURISDICTION. Except to the extent governed by the United States Trademark Act of 1946 (Lanham Act, 15 U.S.C. Sections 1051 ET SEQ.) or other federal law, this Agreement, the franchise and the relationship between the Franchisor and the Franchisee shall be governed by the laws of the state of Colorado. The Franchisee agrees that the Franchisor may institute any action against the Franchisee in any state or federal court of general jurisdiction in the state of Colorado and the Franchisee irrevocably submits to the jurisdiction of such courts and waives any objection he may have to either the jurisdiction of or venue in such courts. The Franchisee agrees that the only proper venue for any action shall be in the County of La Plata, State of Colorado. 22.2. MODIFICATION. The Franchisor and/or the Franchisee may modify this Agreement only upon execution of a written agreement between the two parties. The Franchisee acknowledges that the Franchisor may modify its standards and specifications and operating and marketing techniques set forth in the Operations Manual unilaterally under any conditions and to the extent in which the Franchisor, in its sole discretion, deems necessary to protect, promote, or improve the Marks and the quality of the Licensed Methods, but under no circumstances will such modifications be made arbitrarily without such determination. 22.3. ENTIRE AGREEMENT. This Agreement contains the entire agreement between the parties and supersedes any and all prior agreements concerning the subject matter hereof. The Franchisee agrees and understands that the Franchisor shall not be liable or obligated for any oral representations or commitments made prior to the execution hereof and that no modifications of this Agreement shall be effective except those in writing and signed by both parties. The Franchisor does not authorize and will not be bound by any representation of any nature other than those expressed in this Agreement. The Franchisee further acknowledges and agrees that no representations have been made to it by the Franchisor regarding projected sales volumes, market potential, revenues, profits of the Franchisee's FUZZIWIG'S-TM- CANDY FACTORY Business, or operational assistance other than as stated in this Agreement or in any disclosure document provided by the Franchisor or its representatives. 35 22.4. DELEGATION BY THE FRANCHISOR. From time to time, the Franchisor shall have the right to delegate the performance of any portion or all of its obligations and duties hereunder to third parties, whether the same are agents of the Franchisor or independent contractors which the Franchisor has contracted with to provide such services. The Franchisee agrees in advance to any such delegation by the Franchisor of any portion or all of its obligations and duties hereunder. 22.5. EFFECTIVE DATE. This Agreement shall not be effective until accepted by the Franchisor as evidenced by dating and signing by an officer of the Franchisor. 22.6. REVIEW OF AGREEMENT. The Franchisee acknowledges that it had a copy of this Agreement in its possession for a period of time not less than ten full business days, during which time the Franchisee has had the opportunity to submit same for professional review and advice of the Franchisee's choosing prior to freely executing this Agreement. 22.7. ATTORNEYS' FEES. In the event of any default on the part of either party to this Agreement, in addition to all other remedies, the party in default will pay the aggrieved party all amounts due and all damages, costs and expenses, including reasonable attorneys' fees, incurred by the aggrieved party in any legal action, arbitration or other proceeding as a result of such default, plus interest at the highest rate allowable by law, accruing from the date of such default. 22.8. INJUNCTIVE RELIEF. Nothing herein shall prevent the Franchisor or the Franchisee from seeking injunctive relief to prevent irreparable harm, in addition to all other remedies. 22.9. NO WAIVER. No waiver of any condition or covenant contained in this Agreement or failure to exercise a right or remedy by the Franchisor or the Franchisee shall be considered to imply or constitute a further waiver by the Franchisor or the Franchisee of the same or any other condition, covenant, right, or remedy. 22.10. NO RIGHT TO SET OFF. The Franchisee shall not be allowed to set off amounts owed to the Franchisor for Royalties, fees or other amounts due hereunder, against any monies owed to Franchisee, nor shall the Franchisee in any event withhold such amounts due to any alleged nonperformance by the Franchisor hereunder, which right of set off is hereby expressly waived by the Franchisee. 22.11. INVALIDITY. If any provision of this Agreement is held invalid by any tribunal in a final decision from which no appeal is or can be taken, such provision shall be deemed modified to eliminate the invalid element and, as so modified, such provision shall be deemed 36 EX-11.1 4 EXHIBIT 11.1 Exhibit 11.1 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. and SUBSIDIARIES COMPUTATION OF INCOME (LOSS) PER COMMON SHARE
February 28, February 29, February 28, 1997 1996 1995 ------------- ------------- ------------ PRIMARY INCOME (LOSS) PER SHARE Net income (loss) ($1,365,702) $1,207,745 $1,350,432 Dividend requirements on preferred stock - - (14,610) ----------- ----------- ---------- Net income allocable to common and common equivalent shares ($1,365,702) $1,207,745 $1,335,822 ----------- ----------- ---------- ----------- ----------- ---------- Weighted average number of common shares outstanding 2,908,512 2,797,201 2,517,449 Net effect of dilutive stock options based on the treasury stock method using average market price 41,753 89,862 95,281 ----------- ----------- ---------- Weighted average number of common and common equivalent shares outstanding 2,950,265 2,887,063 2,612,730 ----------- ----------- ---------- ----------- ----------- ---------- PRIMARY INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE $(.46) $ .42 $ .51 ----------- ----------- ---------- ----------- ----------- ----------
Exhibit 11.1 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. And SUBSIDARIES COMPUTATION OF INCOME (LOSS) PER COMMON SHARE - CONTINUED
February 28, February 29, February 28, 1997 1996 1995 ------------- ------------- -------------- PRIMARY INCOME (LOSS) PER SHARE Net income (loss) ($1,365,702) $1,207,745 $1,350,432 Dividend requirements on preferred stock - - (14,610) ------------ ----------- ---------- Net income allocable to common and common equivalent shares ($1,365,702) $1,207,745 $1,335,822 ------------ ----------- ---------- ------------ ----------- ---------- Weighted average number of common shares outstanding 2,908,512 2,797,201 2,517,449 Assuming conversion of convertible debt - - 107,798 Assuming conversion of preferred stock - - - Net effect of dilutive stock options based on the treasury stock method using average market price 43,210 92,337 100,443 ------------ ----------- ---------- Weighted average number of common and common equivalent shares outstanding 2,951,722 2,887,063 2,612,730 ------------ ----------- ---------- ------------ ----------- ---------- INCOME (LOSS) PER COMMON EQUIVALENT SHARE ASSUMING FULL DILUTION $ (.46) $ .42 $ .49 ------------ ----------- ---------- ------------ ----------- ----------
For 1995, if conversion of the preferred stock were assumed, the related income per share would be $.51. EX-23.1 5 EXHIBIT 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our report dated April 23, 1997, accompanying the financial statements incorporated by reference or included in the Annual Report of Rocky Mountain Chocolate Factory, Inc. on Form 10-K for the year ended February 28, 1997. We hereby consent to the incorporation by reference of said report in the Registration Statements of Rocky Mountain Chocolate Factory, Inc. on Forms S-8 (File No. 33-79342, effective May 25, 1994 and File No. 33-64653, effective November 30, 1995). GRANT THORNTON LLP Dallas, Texas May 22, 1997 EX-27.1 6 EX 27.1
5 YEAR FEB-28-1997 MAR-01-1996 FEB-28-1997 792,606 0 1,729,971 0 2,322,321 5,737,626 15,340,562 3,565,194 18,590,105 3,073,851 5,737,312 0 0 91,239 10,703,437 18,590,105 21,674,485 24,272,470 11,508,384 25,871,405 0 0 444,981 (2,198,216) (832,514) (1,365,702) 0 0 0 (1,365,702) (.46) (.46)
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