10-Q 1 d93160e10-q.txt FORM 10-Q FOR QUARTER ENDED NOVEMBER 30, 2001 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES --- EXCHANGE ACT OF 1934 For the quarterly period ended November 30, 2001 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES --- EXCHANGE ACT OF 1934 For the transition period from ________to________ Commission file number 0-14749 Rocky Mountain Chocolate Factory, Inc. (Exact name of registrant as specified in its charter) Colorado 84-0910696 (State of incorporation) (I.R.S. Employer Identification No.) 265 Turner Drive, Durango, CO 81303 (Address of principal executive offices) (970) 259-0554 (Registrant's telephone number, including area code) Indicate by checkmark 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 . --- --- On December 28, 2001 the registrant had outstanding 1,855,768 shares of its common stock, $.03 par value. The exhibit index is located on page 16. 1 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. FORM 10-Q TABLE OF CONTENTS
Page No. -------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements 3 Statements of Income 3 Balance Sheets 4 Statements of Cash Flows 5 Notes to Interim Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk 15 PART II. OTHER INFORMATION Item 1. Legal Proceedings 16 Item 2. Changes in Securities 16 Item 3. Defaults Upon Senior Securities 16 Item 4. Submission of Matters to a Vote of Security Holders 16 Item 5. Other Information 16 Item 6. Exhibits and Reports on Form 8-K 16 SIGNATURE 16
2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. STATEMENTS OF INCOME
Three Months Ended Nine Months Ended November 30, November 30, ---------------------------- ---------------------------- 2001 2000 2001 2000 ------------ ------------ ------------ ------------ REVENUES Sales $ 4,579,714 $ 5,490,053 $ 11,391,108 $ 14,576,507 Franchise and royalty fees 1,028,537 849,749 3,139,608 2,586,054 Total revenues 5,608,251 6,339,802 14,530,716 17,162,561 COSTS AND EXPENSES Cost of sales 3,222,064 3,128,222 7,232,831 7,650,966 Franchise costs 293,370 320,872 977,499 848,847 Sales and marketing 301,658 286,022 912,419 855,234 General and administrative 378,952 395,742 1,303,687 1,256,555 Retail operating 177,137 861,773 754,712 3,063,472 Depreciation and amortization 220,182 302,060 673,865 941,619 Total costs and expenses 4,593,363 5,294,691 11,855,013 14,616,693 INCOME FROM OPERATIONS 1,014,888 1,045,111 2,675,703 2,545,868 OTHER INCOME (EXPENSE) Interest expense (101,698) (177,845) (345,725) (522,063) Interest income 71,657 36,682 196,362 61,028 Other, net (30,041) (141,163) (149,363) (461,035) INCOME BEFORE INCOME TAXES 984,847 903,948 2,526,340 2,084,833 PROVISION FOR INCOME TAXES 372,270 349,825 954,955 806,830 NET INCOME $ 612,577 $ 554,123 $ 1,571,385 $ 1,278,003 BASIC EARNINGS PER COMMON SHARE $ .33 $ .28 $ .85 $ .62 DILUTED EARNINGS PER COMMON SHARE $ .31 $ .28 $ .80 $ .62 WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 1,837,449 1,956,833 1,854,628 2,052,858 DILUTIVE EFFECT OF EMPLOYEE STOCK OPTIONS 141,005 -- 102,636 6,493 WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, ASSUMING DILUTION 1,978,454 1,956,833 1,957,264 2,059,351
The accompanying notes are an integral part of these financial statements. 3 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. BALANCE SHEETS
November 30, February 28, 2001 2001 ------------ ------------ ASSETS CURRENT ASSETS Cash and cash equivalents $ 61,475 $ 87,301 Accounts receivable, less allowance for doubtful accounts of $49,415 and $59,342 4,006,828 2,161,457 Notes receivable 953,233 135,768 Refundable income taxes -- 37,574 Inventories 2,563,234 2,800,128 Deferred income taxes 113,906 113,906 Other 401,879 270,714 Total current assets 8,100,555 5,606,848 PROPERTY AND EQUIPMENT, NET 6,238,651 6,820,377 OTHER ASSETS Notes receivable, less allowance for doubtful notes of $205,248 and $143,202 2,011,143 1,212,572 Goodwill, less accumulated amortization of $702,809 and $614,603 827,191 915,397 Other 622,145 486,869 Total other assets 3,460,479 2,614,838 Total assets $ 17,799,685 $ 15,042,063 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Current maturities of long-term debt $ 1,263,700 $ 1,556,800 Line of credit 900,000 550,000 Accounts payable 922,638 1,065,210 Accrued salaries and wages 529,093 1,006,630 Other accrued expenses 568,305 179,425 Total current liabilities 4,183,736 4,358,065 LONG-TERM DEBT, LESS CURRENT MATURITIES 4,619,950 3,297,340 DEFERRED GAIN ON SALE OF ASSETS 578,493 192,246 DEFERRED INCOME TAXES 131,985 131,985 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Common stock, $.03 par value, 7,250,000 shares authorized, 1,854,768 and 2,386,879 issued and outstanding 55,643 57,698 Additional paid-in capital 2,531,626 2,926,612 Retained earnings 5,818,249 4,246,864 Less notes receivable from officers and directors (119,997) (168,747) Total stockholders' equity 8,285,521 7,062,427 Total liabilities and stockholders' equity $ 17,799,685 $ 15,042,063
The accompanying notes are an integral part of these financial statements. 4 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. STATEMENTS OF CASH FLOWS
Nine Months Ended November 30, -------------------------- 2001 2000 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 1,571,385 $ 1,278,003 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 673,865 941,619 Provision for doubtful accounts 62,046 62,000 Provision for inventory loss 62,000 231,500 (Gain) loss on sale of property and equipment (124,646) 1,797 Changes in operating assets and liabilities: Accounts receivable (1,844,868) (768,811) Notes receivable (638,582) (357,594) Refundable income taxes 37,574 76,689 Inventories 149,894 46,244 Other assets (131,165) (205,505) Accounts payable (142,572) (139,154) Deferred tax assets -- (250,000) Accrued liabilities (98,037) 896 Net cash provided by (used in) operating activities (423,106) 917,684 CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale of assets 181,800 787,370 Purchases of property and equipment (673,132) (387,330) Increase in other assets (142,607) (167,060) Net cash provided by (used in) investing activities (633,939) 232,980 CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from long-term debt 6,027,429 1,093,240 Payments on long-term debt (4,997,919) (1,608,805) Proceeds from line of credit 6,455,000 6,435,000 Payments on line of credit (6,105,000) (4,310,000) Repurchase of stock (625,541) (2,847,424) Reduction of loan from officer 48,750 -- Proceeds from exercise of stock options 228,500 31,250 Net cash provided by (used in) financing activities 1,031,219 (1,206,739) NET DECREASE IN CASH AND CASH EQUIVALENTS (25,826) (56,075) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 87,301 128,192 CASH AND CASH EQUIVALENTS, END OF PERIOD $ 61,475 $ 72,117
The accompanying notes are an integral part of these financial statements. 5 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. NOTES TO INTERIM FINANCIAL STATEMENTS NOTE 1 - NATURE OF OPERATIONS AND BASIS OF PRESENTATION Nature of Operations Rocky Mountain Chocolate Factory, Inc. is an international franchiser, confectionery manufacturer and retail operator in the United States, Guam, Canada and the United Arab Emirates. The Company manufactures an extensive line of premium chocolate candies and other confectionery products. The Company's revenues are currently derived from three principal sources: sales to franchisees and others of chocolates and other confectionery products manufactured by the Company; the collection of initial franchise fees and royalties from franchisees' sales; and sales at Company-owned stores of chocolates and other confectionery products. Basis of Presentation The accompanying financial statements have been prepared by the Company, without audit, and reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods. The statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and Securities and Exchange Commission regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the financial statements reflect all adjustments (of a normal and recurring nature) which are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The results of operations for the nine months ended November 30, 2001 are not necessarily indicative of the results to be expected for the entire fiscal year. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended February 28, 2001. NOTE 2 - EARNINGS PER SHARE Basic earnings per share is calculated using the weighted average number of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through stock options. For the three months ended November 30, 2001 and 2000, 30,000 and 296,000 stock options were excluded from the computation of earnings per share because their effect would have been anti-dilutive. For the nine months ended November 30, 2001 and 2000, 58,938 and 245,818 stock options were excluded from the computation of earnings per share because their effect would have been anti-dilutive. NOTE 3 - INVENTORIES Inventories consist of the following:
November 30, 2001 February 28, 2001 ----------------- ----------------- Ingredients and supplies $ 1,379,386 $ 1,312,014 Finished candy 1,183,848 1,488,114 $ 2,563,234 $ 2,800,128
6 NOTE 4 - PROPERTY AND EQUIPMENT Property and equipment consists of the following:
November 30, 2001 February 28, 2001 ----------------- ----------------- Land $ 513,618 $ 513,618 Building 3,773,986 3,723,086 Machinery and equipment 6,598,923 6,493,850 Furniture and fixtures 591,396 1,127,023 Leasehold improvements 418,403 832,148 Transportation equipment 323,252 205,539 12,219,578 12,895,264 Less accumulated depreciation 5,980,927 6,074,887 Property and equipment, net $ 6,238,651 $ 6,820,377
NOTE 5 - STOCKHOLDERS' EQUITY Between March 6, 2001 and September 28, 2001, the Company repurchased 92,516 Company shares at an average price of $6.76 per share. Of the shares repurchased during this period, 19,000 were repurchased from employees. In January 2001 the Company repurchased 46,000 Company shares at an average price of $5.06 per share. On March 21, 2000, the Company commenced a tender offer to acquire shares of its common stock. Pursuant to the tender offer, which was completed on May 1, 2000, the Company acquired 447,595 shares of its issued and outstanding common stock at a purchase price of $6.25 per share. Between December 22, 1999 and February 7, 2000, the Company repurchased 213,470 shares of its issued and outstanding common stock on the open market at an average price of $5.48 per share. On May 15, 1998, certain of the Company's directors and executive officers purchased 104,000 shares of the Company's issued and outstanding common stock at $5.15 per share from La Salle National Bank of Chicago, Illinois, which obtained these shares through foreclosure from certain shareholders unrelated to any transactions of the Company. The Company loaned certain officers and directors the funds to acquire 40,000 of the 104,000 shares purchased by them. The loans are secured by the related shares, bear interest payable annually at 7.5% and are due May 15, 2003. NOTE 6 - SUPPLEMENTAL CASH FLOW INFORMATION
Nine Months Ended November 30, ----------------------- 2001 2000 ---------- ---------- Cash paid for: Interest $ 356,049 $ 526,260 Income taxes 674,019 575,499 Supplemental schedule of non-cash investing and financing activities: Notes receivable in partial payment of asset sales $1,039,500 $ 774,493
7 NOTE 7 - OPERATING SEGMENTS The Company classifies its business interests into three reportable segments: Franchising, Manufacturing and Retail stores. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1 to the Company's financial statements included in the Company's annual report on Form 10-K for the year ended February 28, 2001. The Company evaluates performance and allocates resources based on operating contribution, which excludes unallocated corporate general and administrative costs and income tax expense or benefit. The Company's reportable segments are strategic businesses that utilize common merchandising, distribution, and marketing functions, as well as common information systems and corporate administration. All intersegment sales prices are market based. Each segment is managed separately because of the differences in required infrastructure and the difference in products and services. Certain reclassifications have been made to prior periods' amounts in order to conform with the current periods' presentation.
Three Months Ended November 30, 2001 Franchising Manufacturing Retail Other Total ------------ ------------- ------------ ------------ ------------ Total revenues $ 1,028,537 $ 4,609,510 $ 202,482 $ -- $ 5,840,529 Intersegment revenues -- (232,278) -- -- (232,278) Revenue from external customers 1,028,537 4,377,232 202,482 -- 5,608,251 Segment profit (loss) 497,104 1,056,464 (112,527) (456,194) 984,847 Total assets 550,883 10,171,319 1,462,649 5,614,834 17,799,685 Capital expenditures 13,042 89,063 45,461 75,075 222,641 Total depreciation & amortization 16,376 109,365 47,240 47,201 220,182 Three Months Ended November 30, 2000 Total revenues $ 849,749 $ 4,631,711 $ 1,546,398 $ -- $ 7,027,858 Intersegment revenues -- (688,056) -- -- (688,056) Revenue from external customers 849,749 3,943,655 1,546,398 -- 6,339,802 Segment profit (loss) 307,176 1,273,703 (84,860) (592,071) 903,948 Total assets 552,696 9,351,333 3,266,703 3,557,130 16,727,862 Capital expenditures 3,206 1,792 10,277 1,845 17,120 Total depreciation & amortization 30,439 121,335 96,385 53,901 302,060
Nine Months Ended November 30, 2001 Franchising Manufacturing Retail Other Total ------------ ------------- ------------ ------------ ------------ Total revenues $ 3,139,608 $ 11,046,741 $ 1,163,967 $ -- $ 15,350,316 Intersegment revenues -- (819,600) -- -- (819,600) Revenue from external customers 3,139,608 10,227,141 1,163,967 -- 14,530,716 Segment profit (loss) 1,443,469 2,916,846 (229,372) (1,604,603) 2,526,340 Total assets 550,883 10,171,319 1,462,649 5,614,834 17,799,685 Capital expenditures 33,513 208,669 78,926 352,024 673,132 Total depreciation & amortization 54,867 329,310 142,185 147,503 673,865 Nine Months Ended November 30, 2000 Total revenues $ 2,586,054 $ 10,925,333 $ 5,621,713 $ -- $ 19,133,100 Intersegment revenues -- (1,970,539) -- -- (1,970,539) Revenue from external customers 2,586,054 8,954,794 5,621,713 -- 17,162,561 Segment profit (loss) 1,089,180 3,077,199 (210,749) (1,870,797) 2,084,833 Total assets 552,696 9,351,333 3,266,703 3,557,130 16,727,862 Capital expenditures 31,651 118,749 162,211 74,719 387,330 Total depreciation & amortization 80,038 357,618 350,260 153,703 941,619
8 NOTE 8 - STORE SALES In connection with the conversion of its Company-owned stores to franchised-owned stores, the Company sold ten Company owned stores resulting in sales proceeds consisting of cash and notes receivable of approximately $1.2 million and recognized and deferred gains of $124,000 and $386,000, respectively. At November 30, 2001, the Company has approximately $2.8 million in notes receivable outstanding related to store sales. The notes require monthly payments and bear interest at rates ranging from 9.0% to 12.5%. The notes mature from December 2001 to March 2003 and are secured by the assets of the sold stores. Of these notes, approximately $2.3 million are due from a single franchisee, bear interest at 10% and mature in March 2003. NOTE 9 - LINE OF CREDIT AND LONG-TERM DEBT On August 31, 2001 the Company refinanced approximately $3.72 million of its term debt and approximately $2.31 million of its line of credit into $6.03 million of term debt. The new term debt is comprised of four individual notes that have a fixed interest rate of 6% and maturities of between eighteen months and fifteen years. At August 31, 2001 the Company also had approximately $293,000 of additional term debt that was not included in the refinancing. This debt currently bears interest at between 5.1% and 10.4% and matures between one and twenty-three months. The Company also negotiated a new $2.0 million line of credit, subject to renewal in July 2002, with interest floating at prime less fifty basis points. On November 30, 2001 the balance on the line of credit was $900,000 bearing interest at 4.5% The new term debt and line of credit are subject to various financial ratio and leverage covenants, all of which were complied with at November 30, 2001. NOTE 10 - RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board approved for issuance Statement of Financial Accounting Standards No. 141 (SFAS 141), Business Combinations. This standard eliminates the pooling method of accounting for business combinations initiated after June 30, 2001. In addition, SFAS 141 addresses the accounting for intangible assets and goodwill acquired in a business combination. This portion of SFAS 141 is effective for business combinations completed after June 30, 2001. The Company does not expect SFAS 141 to have a material effect on the Company's financial position or results of operations. In June 2001, the Financial Accounting Standards Board approved for issuance Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Intangible Assets, which revises the accounting for purchased goodwill and intangible assets. Under SFAS 142, goodwill and intangible assets with indefinite lives will no longer be amortized, but will be tested for impairment annually, and also in the event of an impairment indicator. SFAS 142 is effective for fiscal years beginning after December 15, 2001. The Company expects that adoption of SFAS 142 will increase annual operating income by approximately $118,000. The Company will adopt SFAS 142 in fiscal 2003. In August 2001, the Financial Accounting Standards Board Issued Statement of Financial Accounting Standards No. 144 (SFAS 144), Accounting for Impairment or Disposal of Long-Lived Assets. SFAS 144 is effective for fiscal years beginning after December 15, 2001. The company does not believe that the implementation of this standard will have any material effect on its financial position, results of operations or cash flows. 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of the financial condition and results of operations of the Company should be read in conjunction with the unaudited financial statements and related notes of the Company included elsewhere in this report. This Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this Quarterly Report on Form 10-Q contain forward-looking statements that involve risks and uncertainties. The Company's ability to successfully expand its Rocky Mountain Chocolate Factory franchise system depends on many factors not within the Company's control, including the availability of suitable sites for new store establishment and the availability of qualified franchisees to support such expansion. Efforts to reverse the decline in same store pounds purchased from the factory by franchised stores and to increase total factory sales depend on many factors not within the Company's control, including the receptivity of its franchise system to its product introductions and promotional programs. Other factors potentially having an effect on the Company include seasonality, consumer interest in the Company's products, general economic conditions, consumer trends, costs and availability of raw materials, competition and the effect of government regulation. Therefore, actual results realized by the Company could differ materially from results discussed in or contemplated by the forward-looking statements made herein. Words or phrases such as "will," "anticipate," "expect," "believe," "intend," "estimate," "project," "plan" or similar expressions are intended to identify forward-looking statements. Readers are cautioned not to place undue reliance on the forward-looking statements made in this Quarterly Report on Form 10-Q. Results of Operations THREE MONTHS ENDED NOVEMBER 30, 2001 COMPARED TO THE THREE MONTHS ENDED NOVEMBER 30, 2000 Net income was $612,577 for the three months ended November 30, 2001, or $.33 per basic share, versus $554,123, or $.28 per basic share, for the three months ended November 30, 2000. Revenues
Three Months End November 30, ----------------------- % ($'s in thousands) 2001 2000 Change Change ---------- ---------- ---------- ------- Factory sales $ 4,377.2 $ 3,943.6 $ 433.6 11.0% Retail Sales 202.5 1,546.4 (1,343.9) (86.9%) Franchise fees 203.7 92.7 111.0 119.7% Royalty and Marketing fees 824.8 757.1 67.7 8.9% Total $ 5,608.2 $ 6,339.8 $ (731.6) (11.5%)
Factory Sales Factory sales increased $433,600, or 11.0%, to $4.4 million in the third quarter of fiscal 2002, compared to $3.9 million in the third quarter of fiscal 2001. This increase in factory sales was due primarily to an increase in the number of franchised stores in operation in the third quarter of fiscal 2002 versus the third quarter of fiscal 2001. Same store pounds purchased from the factory by franchised stores in the third quarter of fiscal 2002 were approximately the same as in the third quarter of fiscal 2001. 10 Retail Sales Retail sales decreased $1.3 million, or 86.9%, to $202,500 in the third quarter of fiscal 2002, from $1.5 million in the third quarter of fiscal 2001. This decrease resulted from a reduction in the average number of stores in operation in the third quarter of fiscal 2002 (4) versus the same period last year (22). The decrease in average number of stores in operation is due to completion of the Company's plan to convert its Company-owned stores to franchise-owned stores. Royalties, Marketing Fees and Franchise Fees Royalties and marketing fees increased $67,700, or 8.9%, to $824,800 in the third quarter of fiscal 2002, compared to $757,100 in the third quarter of fiscal 2001. This increase resulted from growth in the average number of franchised stores in operation in the third quarter of fiscal 2002 versus the same period last year. Same store sales were down at franchised stores 2.2%. Franchise fee revenues increased in the third quarter of fiscal 2002 primarily due to an increase in the number of franchises sold versus the comparable period in fiscal 2001. Costs and Expenses Cost of Sales Cost of sales as a percentage of sales increased to 70.4% in the third quarter of fiscal 2002 versus 57.0% in the third quarter of fiscal 2001. This increase resulted from decreased retail sales, which generate higher margins than factory sales, and a decrease in factory margins to 28.4% in fiscal 2002 from 37.1% in the third quarter of fiscal 2001. The decrease in factory margins is due primarily to decreased production efficiencies due to planned packaging changes. Company-owned store margins for the third quarter decreased to 56.8% compared to 58.2% in the third quarter of fiscal 2001 due to changes in mix of products sold. Franchise Costs Franchise costs decreased 8.6% to $293,400 in the third quarter of fiscal 2002 compared to $320,900 in the third quarter of fiscal 2001. The decrease is primarily due to lower personnel costs related to reduced staffing and salary levels. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 28.5% in the third quarter of fiscal 2002 from 37.8% in the third quarter of fiscal 2001. This decrease as a percentage of royalty, marketing and franchise fees is a result of decreased franchise support expenditures and increased royalty, marketing and franchise fees. Sales and Marketing Sales and Marketing expenses increased 5.5% to $301,700 in the third quarter of fiscal 2002 from $286,000 in fiscal 2001 due to a higher level of promotional and commission expenses incurred to increase sales and visibility of the Company's products. General and Administrative General and administrative expenses decreased 4.2% from $395,700 in the third quarter of fiscal 2001 to $379,000 in the third quarter of fiscal 2002. As a percentage of total revenue, general and administrative expenses increased to 6.8% in fiscal 2002 compared to 6.2% in fiscal 2001. This increase as a percentage of total revenues primarily resulted from a 11.5% decrease in total revenues. 11 Retail Operating Expenses Retail operating expenses decreased 79.4% from $861,800 in the third quarter of fiscal 2001 to $177,100 in the third quarter of fiscal 2002. This decrease was due to a decline in the average number of stores in operation during the third quarter of fiscal 2002 (4) versus the third quarter of fiscal 2001 (22). Retail operating expenses, as a percentage of retail sales, increased from 55.7% in the third quarter of fiscal 2001 to 87.5% in the third quarter of fiscal 2002 due to a change in mix of stores in operation and related seasonality. Depreciation and Amortization Depreciation and amortization decreased 27.1% to $220,200 in the third quarter of fiscal 2002 from $302,100 in the third quarter of fiscal 2001. The decrease in depreciation and amortization is due primarily to lower depreciation expense as a result of fewer Company-owned stores. Other Expense Other expense of $30,000 incurred in the third quarter of fiscal 2002 decreased 78.7% from the $141,000 incurred in the third quarter of fiscal 2001 due primarily to lower interest expense on lower average outstanding amounts of and rates on long-term debt. The Company also earned increased interest income on higher average outstanding balances of notes receivable. Income Tax Expense The Company's effective income tax rate in the third quarter of fiscal 2002 was 37.8%, which is approximately the same as the effective rate in the third quarter of fiscal 2001. NINE MONTHS ENDED NOVEMBER 30, 2001 COMPARED TO THE NINE MONTHS ENDED NOVEMBER 30, 2000 Net income was $1.6 million for the nine months ended November 30, 2001 or $.85 per basic share versus $1.3 million or $.62 per basic share for the nine months ended November 30, 2000. Revenues Nine Months Ended November 30, ------------------------- % ($'s in thousands) 2001 2000 Change Change ----------- ----------- ---------- ------- Factory sales $ 10,227.1 $ 8,954.8 $ 1,272.3 14.2% Retail sales 1,164.0 5,621.7 (4,457.7) (79.3%) Franchise fees 606.9 290.6 316.3 108.8% Royalty and Marketing fees 2,532.7 2,295.5 237.2 10.3% Total $ 14,530.7 $ 17,162.6 $ (2,631.9) (15.3%)
Factory Sales Factory sales increased $1.3 million, or 14.2%, to $10.2 million in the first nine months of fiscal 2002, compared to $8.9 million in the first nine months of fiscal 2001. The increase in factory sales was due primarily to an increase in the number of franchised stores in operation in the first nine months of fiscal 2002 versus the comparable period last year. This increase was partially offset by a decrease in same store pounds purchased from the factory by franchised stores of 7.6% in the first nine months of fiscal 2002 compared to the first nine months of fiscal 2001. 12 Retail Sales Retail sales decreased $4.4 million, or 79.3%, to $1.2 million in the first nine months of fiscal 2002, compared to $5.6 million in the first nine months of fiscal 2001. This decrease resulted from a decrease in the average number of stores in operation in the first nine months of fiscal 2002 (5) versus the same period last year (28). The decrease in average number of stores in operation is due to completion of the Company's plan to convert its Company-owned stores to franchise-owned stores. Royalties, Marketing Fees and Franchise Fees Royalties and marketing fees increased $237,200, or 10.3%, to $2.5 million in the first nine months of fiscal 2002, compared to $2.3 million in the first nine months of fiscal 2001. This increase resulted from growth in the average number of franchised stores in operation in the first nine months of fiscal 2002 versus the same period last year. Same store sales decreased minimally at franchised stores by 0.2%. Franchise fee revenues increased in the first nine months of fiscal 2002 due to an increase in the number of franchises sold versus the first nine months of fiscal 2001. Costs and Expenses Cost of Sales Cost of sales as a percentage of sales increased to 63.5% in the first nine months of fiscal 2002 from 52.5% in the first nine months of fiscal 2001. This increase resulted from decreased retail sales, which generate higher margins than factory sales, and a decrease in factory margins to 34.0% in fiscal 2002 from 40.5% in fiscal 2001. This decrease in factory margins is due primarily to decreased production efficiencies due to lower than planned production levels and increased inventory reserves due to planned packaging changes. Company-owned store margins for the first nine months of fiscal 2002 improved to 58.8% compared to 58.6% in the comparable period of fiscal 2001 due to changes in mix of products sold. Franchise Costs Franchise costs increased 15.2% from $848,800 in the first nine months of fiscal 2001 to $977,500 in the first nine months of fiscal 2002. The increase is due primarily to an advertising campaign completed in September 2001 and costs associated with the Company's bi-annual franchise convention. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 31.1% in the first nine months of fiscal 2002 from 32.8% in the first nine months of fiscal 2001. This decrease as a percentage of royalty, marketing and franchise fees is a result of increased franchise support costs offset by a 21.4% increase in income from franchise fees and royalty and marketing fees. Sales and Marketing Sales and Marketing costs increased 6.7% to $912,000 in the first nine months of fiscal 2002 from $855,000 in the first nine months of fiscal 2001 due to a higher level of promotional and commission expenses incurred to increase sales and visibility of the Company's products. General and Administrative General and administrative expenses increased 3.8% to $1.3 million in the first nine months of fiscal 2002 from $1.26 million in the first nine months of fiscal 2001. The increase is due to increased professional fees incurred for investor relations to enhance the Company's visibility in the marketplace, and for information technology support of franchisees. As a percentage of total revenues, general and administrative expenses increased to 9.0% in fiscal 2002 compared to 7.3% in fiscal 2001. This increase, as a percentage of total revenues, primarily resulted from a 15.3% decease in total revenues. 13 Retail Operating Expenses Retail operating expenses decreased 75.4% from $3.1 million in the first nine months of fiscal 2001 to $754,700 in the first nine months of fiscal 2002. This decrease was due primarily to a decrease in the average number of stores open during the first nine months of fiscal 2002 (5) versus the first nine months of fiscal 2001 (28). Retail operating expenses, as a percentage of retail sales, increased from 54.5% in the first nine months of fiscal 2001 to 64.8% in the first nine months of fiscal 2002 due to a decrease in same store sales of 6.0% and a change in mix of stores and related seasonality. Depreciation and Amortization Depreciation and amortization decreased 28.4% to $674,000 for the first nine months of fiscal 2002 from $941,600 for the first nine months of fiscal 2001. The decrease in depreciation and amortization is due primarily to lower depreciation expense as a result of fewer Company-owned stores. Other Expense Other expense of $149,400 incurred in the first nine months of fiscal 2002 decreased 67.6% from the $461,000 incurred in the first nine months of fiscal 2001 due primarily to lower interest expense on lower average outstanding amounts of and rates on long-term debt. The Company also earned increased interest income on higher average outstanding balances of notes receivable. Income Tax Expense The Company's effective income tax rate in the first nine months of fiscal 2002 was 37.8%, which is approximately the same as the effective rate in the first nine months of fiscal 2001. LIQUIDITY AND CAPITAL RESOURCES As of November 30, 2001 working capital was $3.9 million, compared with $1.2 million as of February 28, 2001, an increase of $2.7 million. The increase in working capital was primarily due to increased receivables generated by sales to customers for the upcoming holiday season. Cash and cash equivalent balances decreased from $87,000 as of February 28, 2001 to $61,500 as of November 30, 2001 as a result of cash used by operating and investing activities in excess of cash flows provided by financing activities. The Company's current ratio was 1.93 to 1 at November 30, 2001 in comparison with 1.29 to 1 at February 28, 2001. The Company's long-term debt is comprised primarily of a real estate mortgage facility used to finance the Company's factory expansion (unpaid balance as of November 30, 2001 $2.1 million), and chattel mortgage notes (unpaid balance as of November 30, 2001 $3.8 million) used to fund the fiscal 1996 and 1997 Company-owned store expansion and improve and automate the Company's factory infrastructure. The Company has a $2.0 million ($1.1 million available as of November 30, 2001) working capital line of credit collateralized by substantially all of the Company's assets with the exception of the Company's retail store assets. The line is subject to renewal in July, 2002. The Company believes cash flows generated by operating activities and available financing will be sufficient to fund the Company's operations at least through the end of fiscal 2002. 14 IMPACT OF INFLATION Inflationary factors such as increases in the costs of ingredients, insurance and labor directly affect the Company's operations. Most of the Company's leases provide for cost-of-living adjustments and require the Company to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally the Company's future lease costs for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that the Company will be able to pass on increased costs to its customers. Depreciation expense is based on the historical cost to the Company of its fixed assets, and is therefore potentially less than it would be if it were based on current replacement cost. While property and equipment acquired in prior years may 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. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company does not engage in commodity futures trading or hedging activities and does not enter into derivative financial instrument transactions for trading or other speculative purposes. The Company also does not engage in transactions in foreign currencies or in interest rate swap transactions that could expose the Company to market risk. However, the Company is exposed to some commodity price and interest rate risks. The Company frequently enters into purchase contracts of between six to eighteen months for chocolate and certain nuts. These contracts permit the Company to purchase the specified commodity at a fixed price on an as-needed basis during the term of the contract. 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 and it is unable to renegotiate the terms of the contract. As of November 30, 2001, approximately $40,000 of the Company's long-term debt was subject to a variable interest rate. The Company also has a $2.0 million bank line of credit under which borrowings bear interest at a variable rate. As of November 30, 2001, there was $900,000 outstanding under the line of credit. The Company does not believe that it is exposed to any material interest rate risk related to its long-term debt or the line of credit. The Chief Financial Officer and Chief Operating Officer of the Company has primary responsibility over the Company's long-term and short-term debt and for determining the timing and duration of commodity purchase contracts and negotiating the terms and conditions of those contracts. 15 PART II. OTHER INFORMATION Item 1. Legal Proceedings The Company is not currently involved in any legal proceedings that are material to the Company's business or financial condition. Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K A. Exhibits None B. Reports on Form 8-K None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. (Registrant) Date: January 4, 2002 /s/ Bryan J. Merryman ------------------------------------------------- Bryan J. Merryman, Chief Operating Officer, Chief Financial Officer, Treasurer and Director 16