-----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, TWjiMXCK9cp8SocyhuyjWbS5E2QxDQTwHfQvossXmOi2vVtYXbcB3P+MADum5Vkd mhfjSukIPX+6c7C5wIB0TQ== 0001047469-99-022766.txt : 19990625 0001047469-99-022766.hdr.sgml : 19990625 ACCESSION NUMBER: 0001047469-99-022766 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990228 FILED AS OF DATE: 19990601 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ROCKY MOUNTAIN CHOCOLATE FACTORY INC CENTRAL INDEX KEY: 0000785815 STANDARD INDUSTRIAL CLASSIFICATION: SUGAR & CONFECTIONERY PRODUCTS [2060] IRS NUMBER: 840910696 STATE OF INCORPORATION: CO FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-14749 FILM NUMBER: 99638687 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-K405 1 FORM 10-K405 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, 1999 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES - ---- EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number 0-14749 Rocky Mountain Chocolate Factory, Inc. (Exact name of registrant as specified in its charter) Colorado 84-0910696 (State of Incorporation) (I.R.S. Employer Identification No.) 265 Turner Drive, Durango, CO 81301 (Address of principal executive offices) (970) 259-0554 (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT Common Stock, $.03 par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] On May 24, 1999, there were 2,599,599 shares of Common Stock outstanding. The aggregate market value of the Common Stock (based on the average of the closing bid and ask prices as quoted on the NASDAQ National Market System on May 24, 1999) held by non-affiliates was $13,128,341. Documents incorporated by reference: None The Exhibit Index is located on page 51. ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. FORM 10-K TABLE OF CONTENTS
Page No. PART I. Item 1 Business 3 Item 2 Properties 13 Item 3 Legal Proceedings 14 Item 4 Submission of Matters to a Vote of Security Holders 14 PART II. Item 5 Market for Registrant's Common Equity and Related Stockholder Matters 14 Item 6 Selected Financial Data 15 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 7A Quantitative and Qualitative Disclosures About Market Risk 23 Item 8 Financial Statements 25 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 44 PART III. Item 10 Directors and Executive Officers of the Registrant 44 Item 11 Executive Compensation 47 Item 12 Security Ownership of Certain Beneficial Owners and Management 48 Item 13 Certain Relationships and Related Transactions 51 PART IV. Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 51 SIGNATURES 55
PART I. ITEM 1. BUSINESS GENERAL Founded in 1981 and incorporated in Colorado in 1982, Rocky Mountain Chocolate Factory, Inc. (the "Company") is a manufacturer, international franchiser and retail operator. The Company is headquartered in Durango, Colorado and manufactures an extensive line of premium chocolate candies and other confectionery products. As of April 30, 1999 there were 40 Company-owned and 187 franchised Rocky Mountain Chocolate Factory stores operating in 41 states, Canada and Guam. Approximately 40% of the products sold at the Company-owned and franchised Rocky Mountain Chocolate Factory stores are prepared on the premises. The Company believes this in-store preparation creates a special store ambiance and the aroma and sight of products being made attracts foot traffic and assures customers that products are indeed fresh. The Company believes that its principal competitive strengths lie in its name recognition, its reputation for the quality, variety and the taste of its products; the special ambiance of its stores; its knowledge and experience in applying criteria for selection of new store locations; its expertise in the manufacture of chocolate candy products and the merchandising and marketing of chocolate and other candy products; and the control and training infrastructures it has implemented to assure consistent customer service and execution of successful practices and techniques at its franchised and Company-owned stores. The Company believes its manufacturing expertise and reputation for quality has facilitated the sale of selected product through new distribution channels. The Company is currently testing and evaluating a number of new distribution channel programs including wholesaling, fundraising, corporate sales, mail order and internet sales. The Company's revenues are currently derived from three principal sources: (i) sales to franchisees and others of chocolates and other confectionery products manufactured by the Company (43-43-41%); (ii) sales at Company-owned stores of chocolates and other confectionery products (including product manufactured by the Company) (45-44-47%) and (iii) the collection of initial franchise fees and royalties from franchisees (12-13-12%). The figures in parentheses show the percentage of total revenues attributable to each source for fiscal years ended February 28, 1999, 1998 and 1997, respectively. According to the National Confectionery Association the total U.S. candy market exceeded $22.7 billion of sales in 1997. Candy sales have risen 29% since 1988, with an average annual growth rate of between 4% and 6%, according to United States Department of Commerce figures. According to the Department of Commerce, per capita consumption of chocolate exceeds 11 pounds per year nationally, generating annual sales of approximately $12.5 billion. In 1997, consumption of chocolate products increased 1.0% versus a 2.3% increase in non-chocolate candies. In December 1997, the Company decided its Fuzziwig's Candy Factory store segment did not meet its strategic long-term goals, and accordingly, adopted a plan to divest itself of these operations. The Company completed the divestiture on July 31, 1998. Fuzziwig's Candy Factory stores sold hard conventional and nostalgic candies purchased from third party suppliers. BUSINESS STRATEGY The Company's objective is to build on its position as a leading international franchiser, manufacturer of high quality chocolate and other confectionery products, and operator of retail chocolate stores. The Company continually seeks opportunities to profitably expand its business. To accomplish this objective, the Company employs a business strategy that includes the following elements: 3 Product Quality and Variety The Company maintains the unsurpassed taste and quality of its chocolate candies by using only the finest chocolate and other wholesome ingredients. The Company uses its own proprietary recipes, primarily developed by its master candy maker. A typical Rocky Mountain Chocolate Factory store offers up to 100 of the Company's chocolate candies throughout the year and as many as 200, including many packaged candies, during the holiday seasons. Individual stores also offer several varieties of premium fudge and gourmet caramel apples, as well as other products prepared in the store from Company recipes. The Company, in fiscal 1998, implemented a major program to improve factory sales through development and sale of an expanded line of new products, including its own sugar-free line and themed, branded and novelty chocolate candies. Store Atmosphere and Ambiance The Company seeks to establish an enjoyable and inviting atmosphere in each Rocky Mountain Chocolate Factory store. Each store prepares certain products, including fudge, brittles and caramel apples, in the store. In-store preparation is designed both to be fun and entertaining for customers and to convey an image of freshness and homemade quality. The special ambiance of Rocky Mountain Chocolate Factory stores is also achieved through the use of distinctive decor designed to give the store an attractive country Victorian look. The Company's design staff has developed easily replicable designs and specifications to ensure that the Rocky Mountain Chocolate Factory concept is consistently implemented throughout the system. Site Selection Careful selection of a site is critical to the success of a Rocky Mountain Chocolate Factory store. Many factors are considered by the Company in identifying suitable sites, including tenant mix, visibility, attractiveness, accessibility, level of foot traffic and occupancy costs. Final site selection, for both franchised and Company-owned stores, occurs only after the Company's senior management has approved the site. The Company believes that the experience of its management team in evaluating a potential site is one of the Company's competitive strengths. Customer Service Commitment The Company emphasizes excellence in customer service and seeks to employ and to sell franchises to motivated and energetic people. The Company has implemented sales incentive programs for the employees of Company-owned stores so that the store personnel having direct contact with customers share in the success of their stores. The Company also fosters enthusiasm for its customer service philosophy and the Rocky Mountain Chocolate Factory concept through its annual franchisee convention, annual regional meetings and other frequent contacts with its franchisees and store managers. Increase Same Store Retail Sales at Existing Locations The Company seeks to increase profitability of its store system through increasing sales at existing store locations. System wide same store retail sales have grown each year for the last 5 fiscal years, except for fiscal 1997: 1995 3.4% 1996 2.9% 1997 (0.5%) 1998 7.4% 1999 6.7%
The Company feels that same store retail sales growth can be accelerated though store redesign to provide a more attractive and effective retail sales environment embodying more shelf space and accessibility/visibility of products while retaining the Rocky Mountain Chocolate Factory store ambiance and theme. The Company believes that development and sale of superior new products, such as its new line of sugar-free products, will also prove to be conducive to the goal of enhanced same store retail sales growth. 4 Increase Same Store Pounds Purchased by Existing Locations In fiscal 1999, the Company experienced a same store pounds purchased decline of 2.7%. 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 is in the process of designing new packaging, adding new products and focusing its existing product lines in an effort to reverse this trend. Enhanced Operating Efficiencies The Company seeks to improve its profitability by controlling costs and increasing the efficiency of its operations. Efforts in the last several years include the purchase of additional automated factory equipment, implementation of a comprehensive MRP II forecasting, planning, scheduling and reporting system and the closure or sale of underperforming Company-owned stores. In the spring of calendar year 1995, the Company completed a factory expansion and expanded its operation of a small fleet of trucks for the shipment of its products. These measures have significantly improved the Company's ability to deliver its products to franchised and Company-owned stores safely, quickly and cost-effectively. EXPANSION STRATEGY Key elements of the Company's expansion strategy include: New Distribution Channels In fiscal 1998, the Company began aggressively pursuing distribution of its products outside its franchised and Company-owned store system. With limited viable real estate available domestically for the establishment of new franchise and Company-owned store locations the Company believes a significant portion of its revenue growth and profitability goals will be achieved through distribution of products outside the existing system of retail stores. The Company believes that its strategy to distribute selected Rocky Mountain Chocolate Factory products through new distribution channels will build its brand awareness and customer base and ultimately increase the Company's and its franchisees' market share. Unit Growth for Rocky Mountain Chocolate Factory The Company is experiencing constraints in the growth in the number of its Rocky Mountain Chocolate Factory locations posed by a slowdown in the pace of establishment of new factory outlet centers and availability of existing premium locations in existing factory outlet and other environments where its concept has proven successful. Despite such constraints, the Company is continuing to seek locations in its traditional operating environments such as prime tourist areas, regional malls, and mixed use and factory outlet centers. 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. 5 Name Recognition and New Market Penetration The Company believes the visibility of its stores and the high foot traffic at its factory outlet mall and tourist locations has generated strong name recognition of Rocky Mountain Chocolate Factory and demand for its franchises. The Rocky Mountain Chocolate Factory system has historically been concentrated in the western United States and the Rocky Mountains, but recent growth has generated a gradual easterly momentum as new Company-owned and franchised stores have been opened in the eastern half of the country. This growth has further increased the Company's name recognition and demand for its franchises. Distribution of Rocky Mountain Chocolate Factory products through new channels, such as major national retail chains, also increases name recognition and brand awareness in areas of the country in which the Company has not previously had a significant presence. The Company believes that by distributing selected Rocky Mountain Chocolate Factory products through new distribution channels its name recognition will improve and benefit its entire franchised and Company-owned store systems. STORE CONCEPT The Company seeks to establish a fun and inviting atmosphere in its Rocky Mountain Chocolate Factory store locations. Unlike most other confectionery stores, each Rocky Mountain Chocolate Factory store prepares certain products, including fudge and caramel apples, in the store. Customers can observe store personnel make fudge from start to finish, including the mixing of ingredients in old-fashioned copper kettles and the cooling of the fudge on large marble tables, and are often invited to sample the store's products. The Company believes that an average of approximately 40% of the revenues of Company-owned and franchised stores are generated by sales of products prepared on the premises. The Company believes the in-store preparation and aroma of its products enhance the ambiance at Rocky Mountain Chocolate Factory stores, are fun and entertaining for its customers and convey an image of freshness and homemade quality. Rocky Mountain Chocolate Factory stores have a distinctive country Victorian decor, which further enhances their friendly and enjoyable atmosphere. Each store includes finely-crafted wood cabinetry, copper and brass accents, etched mirrors and large marble tables on which fudge and other products are made. To ensure that all stores conform to the Rocky Mountain Chocolate Factory image, the Company's design staff provides working drawings and specifications and approves the construction plans for each new franchised or Company-owned store. The Company also controls the signage and building materials that may be used in the stores. The average store size is approximately 1,000 square feet, approximately 650 square feet of which is selling space. Most stores are open seven days a week. Typical hours are 10 a.m. to 9 p.m., Monday through Saturday, and 12 noon to 6 p.m. on Sundays. Store hours in tourist areas may vary depending upon the tourist season. PRODUCTS AND PACKAGING The Company typically produces approximately 300 chocolate candies and other confectionery products, using proprietary recipes developed primarily by the Company's master candy maker. These products include many varieties of clusters, caramels, creams, mints and truffles. The Company continues to engage in a major effort to expand its product line by developing additional exciting and attractive new products. During the Christmas, Easter and Valentine's Day holiday seasons, the Company may make as many as 200 additional items, including many candies offered in packages specially designed for the holidays. A typical Rocky Mountain Chocolate Factory store offers up to 100 of these candies throughout the year and up to 200 during holiday seasons. Individual stores also offer more than 15 premium fudges and other products prepared in the store. The Company believes that approximately 50% of the revenues of Rocky Mountain Chocolate Factory stores are generated by products manufactured at the Company's factory, 40% by products made in the store using Company recipes and ingredients purchased from the Company or approved suppliers and the remaining 10% by 6 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 packaging for its Rocky Mountain Mints in 1995 received the AWARD OF EXCELLENCE from the National Paperbox Association. OPERATING ENVIRONMENT The Company currently establishes franchised and Company-owned Rocky Mountain Chocolate Factory stores in three primary environments: factory outlet malls, tourist areas and regional malls. Each of these environments has a number of attractive features, including high levels of foot traffic. Factory Outlet Malls There are approximately 340 factory outlet malls in the United States, and as of February 28, 1999, there were Rocky Mountain Chocolate Factory stores in approximately 100 of these malls in over 35 states. The Company has established business relationships with the major outlet mall developers in the United States. Although not all factory outlet malls provide desirable locations for the Company's stores, management believes the Company's relationships with these developers will provide it with the opportunity to take advantage of attractive sites in new and existing outlet malls. Tourist Areas As of February 28, 1999, there were approximately 50 Rocky Mountain Chocolate Factory stores in franchised locations considered to be tourist areas, including Fisherman's Wharf in San Francisco, California and the Riverwalk in San Antonio, Texas. Tourist areas are very attractive locations because they offer high levels of foot traffic and favorable customer spending characteristics, and greatly increase the Company's visibility and name recognition. The Company believes there are significant opportunities to expand into additional tourist areas with high levels of foot traffic. Regional Malls There are approximately 2,500 regional malls in the United States, and as of February 28, 1999, there were Rocky Mountain Chocolate Factory stores in approximately 20 of these, including the franchised locations in the Mall of America in Bloomington, Minnesota; Escondido, California; Fort Collins, Colorado; and West Palm Beach, Florida. Although often providing favorable levels of foot traffic, regional malls typically involve more expensive rent structures and more competing food and beverage concepts. The Company believes there are a number of other environments that have the characteristics necessary for the successful operation of Rocky Mountain Chocolate Factory stores such as airports and sports arenas. Three franchised Rocky Mountain 7 Chocolate Factory stores exist at airport locations: two at Denver International Airport and one at Vancouver International Airport in Canada. As described above, the Company has also recently begun aggressively pursuing the distribution of its products through new distribution channels such as major national retail, fundraising and corporate sales organizations. FRANCHISING PROGRAM General The Company's franchising philosophy is one of service and commitment to its franchise system, and it continuously seeks to improve its franchise support services. The Company's concept has consistently been rated as an outstanding franchise opportunity by publications and organizations rating such opportunities. In February 1995, Rocky Mountain Chocolate Factory was rated seventh in SUCCESS MAGAZINE's "Franchise Gold 100" most desirable franchises. As of April 30, 1999, there were 187 franchised stores in the Rocky Mountain Chocolate Factory system. Franchisee Sourcing and Selection The majority of new franchises are awarded to persons referred by existing franchisees, to interested consumers who have visited Rocky Mountain Chocolate Factory stores and to existing franchisees. The Company also advertises for new franchisees in national and regional newspapers as suitable potential store locations come to the Company's attention. Franchisees are approved by the Company on the basis of the applicant's net worth and liquidity, together with an assessment of work ethic and personality compatibility with the Company's operating philosophy. In fiscal 1992, the Company entered into a franchise development agreement covering Canada with Immaculate Confections, Ltd. of Vancouver, British Columbia. Pursuant to this agreement, Immaculate Confections purchased the exclusive right to franchise and operate Rocky Mountain Chocolate Factory stores in Canada. Immaculate Confections, as of April 30, 1999, operated 27 stores under the agreement. Training and Support Each domestic franchisee owner/operator and each store manager for a domestic franchisee is required to complete a 7-day comprehensive training program in store operations and management. The Company has established a training center at its Durango headquarters in the form of a full-sized replica of a properly configured and merchandised Rocky Mountain Chocolate Factory store. Topics covered in the training course include the Company's philosophy of store operation and management, customer service, merchandising, pricing, cooking, inventory and cost control, quality standards, record keeping, labor scheduling and personnel management. Training is based on standard operating policies and procedures contained in an operations manual provided to all franchisees, which the franchisee is required to follow by terms of the franchise agreement. Additionally, and importantly, trainees are provided with a complete orientation to Company operations by working in key factory operational areas and by meeting with each member of the senior management of the Company. Training continues through the opening of the store, where Company field consultants assist and guide the franchisee in all areas of operation. The Company's operating objectives include providing Company knowledge and expertise in merchandising, marketing and customer service to all front-line store level employees to maximize their skills and ensure that they are fully versed in the Company's proven techniques. The Company provides ongoing support to franchisees through its field consultants, who maintain regular and frequent communication with the stores by phone and by site visits. The field consultants also review and discuss with the franchisee store operating results and provide advice and guidance in improving store profitability and in developing and executing store marketing and merchandising programs. The Company has developed a handbook containing a "pre-packaged" local store marketing plan, which 8 allows franchisees to implement cost-effective promotional programs that have proven successful in other Rocky Mountain Chocolate Factory stores. Regional conferences are held each fall with a focus on holiday merchandising techniques in preparation for the fall and Christmas holidays. "Town Meetings" are held each March with the goal of furthering communication and obtaining franchisee feedback in anticipation of the Company's annual Franchisee Convention. The Company holds its annual convention each May, at which seminars and workshops are presented on subjects considered vital to continuing improvement in operating results of Rocky Mountain Chocolate Factory stores. Quality Standards and Control The franchise agreement for Rocky Mountain Chocolate Factory franchisees requires compliance with the Company's procedures of operation and food quality specifications and permits audits and inspections by the Company. Operating standards for Rocky Mountain Chocolate Factory stores are set forth in operating manuals. These manuals cover general operations, factory ordering, merchandising, advertising and accounting procedures. Through their regular visits to franchised stores, Company field consultants audit performance and adherence to Company standards. The Company has the right to terminate any franchise agreement for non-compliance with the Company's operating standards. Products sold at the stores and ingredients used in the preparation of products approved for on-site preparation must be purchased from the Company or from approved suppliers. The Franchise Agreement: Terms and Conditions The domestic offer and sale of Rocky Mountain Chocolate Factory franchises is made pursuant to the Uniform Franchise Offering Circular prepared in accordance with federal and state laws and regulations. States that regulate the sale and operation of franchises require a franchiser to register or file certain notices with the state authorities prior to offering and selling franchises in those states. Under the current form of domestic Rocky Mountain Chocolate Factory franchise agreement, franchisees pay the Company (i) an initial franchise fee of $19,500 for each store, (ii) royalties equal to 5% of monthly gross sales, and (iii) a marketing fee equal to 1% of monthly gross sales. Franchisees are generally granted exclusive territory with respect to the operation of Rocky Mountain Chocolate Factory stores only in the immediate vicinity of their stores. Chocolate products not made on the premises by franchisees must be purchased from the Company or approved suppliers. The franchise agreements require franchisees to comply with the Company's procedures of operation and food quality specifications, to permit inspections and audits by the Company and to remodel stores to conform with standards in effect. The Company may terminate the franchise agreement upon the failure of the franchisee to comply with the conditions of the agreement and upon the occurrence of certain events, such as insolvency or bankruptcy of the franchisee or the commission by the franchisee of any unlawful or deceptive practice, which in the judgment of the Company is likely to adversely affect the Rocky Mountain Chocolate Factory system. The Company's ability to terminate franchise agreements pursuant to such provisions is subject to applicable bankruptcy and state laws and regulations. See "Business-Regulation." The agreements prohibit the transfer or assignment of any interest in a franchise without the prior written consent of the Company. The agreements also give the Company a right of first refusal to purchase any interest in a franchise if a proposed transfer would result in a change of control of that franchise. The refusal right, if exercised, would allow the Company to purchase the interest proposed to be transferred under the same terms and conditions and for the same price as offered by the proposed transferee. The term of each Rocky Mountain Chocolate Factory franchise agreement is five years, and franchisees have the right to renew for two successive five-year terms. 9 Franchise Financing The Company does not provide prospective franchisees with financing for their stores, but has developed relationships with two national sources of franchisee financing to whom it will refer franchisees. Typically, franchisees have obtained their own sources of such financing and have not required the Company's assistance. COMPANY STORE PROGRAM As of April 30, 1999, there were 40 Company-owned Rocky Mountain Chocolate Factory stores. Company-owned stores provide a training ground for Company-owned store personnel and district managers and a controllable testing ground for new products and promotions, operating and training methods and merchandising techniques. In many cases, the Company has been able to take advantage of a promising new location by establishing a Company-owned store when a delay in finding a qualified franchisee might have jeopardized the Company's ability to secure the site. Managers of Company-owned stores are required to comply with all Company operating standards and undergo training and receive support from the Company similar to the training and support provided to franchisees. See "Franchising Program-Training and Support" and "Franchising Program-Quality Standards and Control." MANUFACTURING OPERATIONS General The Company manufactures its chocolate candies at its factory in Durango, Colorado. All products are produced consistent with the Company's philosophy of using only the finest, highest quality ingredients with no artificial preservatives to achieve its marketing motto of "THE PEAK OF PERFECTION IN HANDMADE CHOCOLATES-TM-." It has always been the belief of management that the Company should control the manufacturing of its own chocolate products. By controlling manufacturing, the Company can better maintain its high product quality standards, offer unique, proprietary products, manage costs, control production and shipment schedules and potentially pursue new or under-utilized distribution channels. Manufacturing Processes The manufacturing process primarily involves cooking or preparing candy centers, including nuts, caramel, peanut butter, creams and jellies, and then coating them with chocolate or other toppings. All of these processes are conducted in carefully controlled temperature ranges, and the Company employs strict quality control procedures at every stage of the manufacturing process. The Company uses a combination of manual and automated processes at its factory. Although the Company believes that it is currently preferable to perform certain manufacturing processes, such as dipping of some large pieces, by hand, automation increases the speed and efficiency of the manufacturing process. The Company has from time to time automated processes formerly performed by hand where it has become cost-effective for the Company to do so without compromising product quality or appearance. The Company seeks to ensure the freshness of products sold in Rocky Mountain Chocolate Factory stores with frequent shipments and production schedules that are closely coordinated with projected and actual orders. Most Rocky Mountain Chocolate Factory stores do not have significant space for the storage of inventory, and the Company encourages franchisees and store managers to order only the quantities that they can reasonably expect to sell within approximately two to four weeks. For these reasons, the Company generally does not have a significant backlog of orders. Ingredients The principal ingredients used by the Company are chocolate, nuts, sugar, corn syrup, peanut butter, cream and butter. The factory receives shipments of ingredients daily. 10 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. Trucking Operations The Company operates eight trucks and ships a substantial portion of its products from the factory on its own fleet. The Company's trucking operations enable it 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. COMPETITION The retailing of confectionery products is highly competitive. The Company and its franchisees compete with numerous businesses that offer confectionery products. Many of these competitors have greater name recognition and financial, marketing and other resources than the Company. In addition, there is intense competition among retailers for real estate sites, store personnel and qualified franchisees. Competitive market conditions could adversely affect the Company and its results of operations and its ability to expand successfully. The Company believes that its principal competitive strengths lie in its name recognition and its reputation for the quality, value, variety and taste of its products and the special ambiance of its stores; its knowledge and experience in applying criteria for selection of new store locations; its expertise in merchandising and marketing of chocolate and other candy products; and the control and training infrastructures it has implemented to assure execution of successful practices and techniques at its franchised and Company-owned store locations. In addition, by controlling the manufacturing of its own chocolate products, the Company can better maintain its high product quality standards for those products, offer proprietary products, manage costs, control production and shipment schedules and pursue new or under-utilized distribution channels. 11 TRADE NAME AND TRADEMARKS The trade name "ROCKY MOUNTAIN CHOCOLATE FACTORY,-Registered Trademark" the phrases "THE PEAK OF PERFECTION IN HANDMADE CHOCOLATES-TM-" and "AMERICA'S CHOCOLATIER-TM-", 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. Applications have been filed to register the Rocky Mountain Chocolate Factory trademark in certain foreign countries. The Company has not attempted to obtain patent protection for the proprietary recipes developed by the Company's master candy-maker and is relying upon its ability to maintain the confidentiality of those recipes. EMPLOYEES At February 28, 1999, the Company employed approximately 390 people. Most employees, with the exception of store, factory and corporate management, are paid on an hourly basis. The Company also employs some people on a temporary basis during peak periods of store and factory operations. The Company seeks to assure that participatory management processes, mutual respect and professionalism and high performance expectations for the employee exist throughout the organization. The Company believes that it provides working conditions, wages and benefits that compare favorably with those of its competitors. The Company's employees are not covered by a collective bargaining agreement. The Company considers its employee relations to be good. SEASONAL FACTORS The Company's sales and earnings are seasonal, with significantly higher sales and earnings occurring during the Christmas holiday and summer vacation seasons than at other times of the year, which causes fluctuations in the Company's quarterly results of operations. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and the sale of franchises. Because of the seasonality of the Company's business and the impact of new store openings and sales of franchises, results for any quarter are not necessarily indicative of the results that may be achieved in other quarters or for a full fiscal year. REGULATION Each of the Company-owned and franchised stores is subject to licensing and regulation by the health, sanitation, safety, building and fire agencies in the state or municipality where located. Difficulties or failures in obtaining the required licensing or approvals could delay or prevent the opening of new stores. New stores must also comply with landlord and developer criteria. Many states have laws regulating franchise operations, including registration and disclosure requirements in the offer and sale of franchises. The Company is also subject to the Federal Trade Commission regulations relating to disclosure requirements in the sale of franchises and ongoing disclosure obligations. Additionally, certain states have enacted and others may enact laws and regulations governing the termination or non-renewal of franchises and other aspects of the franchise relationship that are intended to protect franchisees. Although these laws and regulations, and related court decisions may limit the Company's ability to terminate franchises and alter franchise agreements, the Company does not believe that such laws or decisions will have a material adverse effect on its franchise operations. However, the laws applicable to franchise operations and relationships continue to develop, and the Company is unable to predict the effect on its intended operations of additional requirements or restrictions that may be enacted or of court 12 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 Company's product labeling is subject to and complies with the Nutrition Labeling and Education Act of 1990. 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 58,000 square foot manufacturing facility, which it owns, in Durango, Colorado. During fiscal 1999, the Company's factory produced approximately 2.2 million pounds of chocolate candies, up from 2.0 million pounds in fiscal 1998. The factory has the capacity to produce approximately 3.5 million pounds per year. In January 1998, the Company acquired a two acre parcel adjacent to its factory to ensure the availability of adequate space to expand the factory as volume demands. In January 1998, the Company acquired a two acre parcel adjacent to its factory to ensure the availability of adequate space to expand the factory as volume demands. As of April 30, 1999, 36 of the 40 Company-owned stores were occupied pursuant to non-cancelable leases of five to ten years having varying expiration dates, most of which contain optional five-year renewal rights. The Company does not deem any individual store lease to be significant in relation to its overall operations. The Company acts as primary lessee of some franchised store premises, which it then subleases to franchisees, but the majority of existing locations are leased by the franchisee directly. Current Company policy is not to act as primary lessee on any further franchised locations. At April 30, 1999, the Company was the primary lessee at 43 of its 187 franchised stores. The subleases for such stores are on the same terms as the Company's leases of the premises. For information as to the amount of the Company's rental obligations under leases on both Company-owned and franchised stores, see Note 6 of Notes to financial statements. 13 ITEM 3. LEGAL PROCEEDINGS The Company is not currently involved in any legal proceedings that are material to the Company's business or financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the fourth quarter of fiscal 1999. PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (a) MARKET INFORMATION The Company's Common Stock trades on the National Market System of The Nasdaq Stock Market under the trading symbol "RMCF". On May 18, 1998 the Company purchased 336,000 shares of its common stock at $5.15 per share in a private transaction. The Company made this purchases because the Company felt that its Common Stock was undervalued and that such purchase would therefore be in the best interest of the Company and its stockholders. The table below sets forth high and low bid information for the Common Stock as quoted on Nasdaq for each quarter of fiscal years 1999 and 1998. The quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission and may not necessarily represent actual transactions.
FISCAL YEAR ENDED FEBRUARY 28, 1999 HIGH LOW First Quarter $7.75 $4.750 Second Quarter 7.125 4.250 Third Quarter 6.500 4.000 Fourth Quarter 5.625 3.938
FISCAL YEAR ENDED FEBRUARY 28, 1998 HIGH LOW First Quarter $5.125 $2.750 Second Quarter 5.250 4.000 Third Quarter 7.125 4.250 Fourth Quarter 6.594 4.500
On May 24, 1999 the closing bid price for the Common Stock as reported on the NASDAQ Stock Market was $6.00. (b) HOLDERS On May 24, 1999 there were approximately 420 record holders of the Company's Common Stock. The Company believes that there are more than 2000 beneficial owners of its Common Stock. (c) DIVIDENDS The Company has not paid cash dividends on its Common Stock since its inception and does not intend to pay cash dividends for the foreseeable future. Any future earnings will be retained for use in the Company's business. 14 ITEM 6. SELECTED FINANCIAL DATA The selected financial data presented below for the fiscal years ended February 28 or 29, 1995 through 1999, are derived from the Financial Statements of the Company, which have been audited by Grant Thornton LLP, independent auditors. The selected financial data should be read in conjunction with the Financial Statements and related Notes thereto included elsewhere in this Report and "Management's Discussion and Analysis of Financial Condition and Results of Operations." (Amounts in thousands, except per share data)
YEARS ENDED FEBRUARY 28 or 29, SELECTED STATEMENT OF OPERATIONS DATA 1995 1996 1997 1998 1999 Total revenues $13,616 $18,552 $22,281 $23,764 $26,233 Operating income (loss) 2,270 2,157 (1,026) 2,599 1,319 Income (loss) from continuing operations 1,350 1,207 (1,010) 1,260 687 Income (loss) from discontinued operations (net of income taxes) -- 1 (356) (1,020) -- Net income (loss) $1,350 $1,208 $(1,366) $240 $421 BASIC EARNINGS (LOSS) PER COMMON SHARE Continuing Operations $.53 $.43 $(.35) $.43 $.16 Discontinued Operations -- -- (.12) (.35) -- Net Income (loss) $.53 $.43 $(.47) $.08 $.16 DILUTED EARNINGS (LOSS) PER COMMON SHARE Continuing Operations $.50 $.42 $(.35) $.43 $.16 Discontinued Operations -- -- (.12) (.35) -- Net Income (loss) $.50 $.42 $(.47) $.08 $.16 Weighted average common shares outstanding 2,515 2,797 2,908 2,913 2,665 Weighted average common shares outstanding, assuming dilution 2,718 2,887 2,908 2,930 2,677 SELECTED BALANCE SHEET DATA Working capital $1,627 $2,043 $2,664 $3,949 $1,558 Total assets 10,181 16,308 18,666 19,868 18,652 Long-term debt 2,314 2,184 5,737 5,993 5,250 Stockholders' equity 5,907 11,117 9,779 10,019 8,509
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of the financial condition and results of operations of the Company should be read in conjunction with the audited financial statements and related Notes of the Company included elsewhere in this report. This Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this Annual Report on Form 10-K contain forward-looking statements that involve risks and uncertainties. The Company's ability to successfully achieve expansion of its Rocky Mountain Chocolate Factory franchise system depends on many factors not within the Company's control including the availability of suitable sites for new store establishment and the availability of qualified franchisees to support such expansion. 15 Efforts to reverse the decline in same store pounds purchased from the factory by franchised stores and to increase total factory sales depends on many factors not within the Company's control including the receptivity of its franchise system and of customers in potential new distribution channels of its product introductions and promotional programs. As a result, the actual results realized by the Company could differ materially from the results discussed in or contemplated by the forward-looking statements made herein. Words or phrases such as "will," "anticipate," "expect," "believe," "intend," "estimate," "project," "plan" or similar expressions are intended to identify forward-looking statements. Readers are cautioned not to place undue reliance on the forward-looking statements in this Annual Report on Form 10-K. RESULTS OF OPERATIONS FISCAL 1999 COMPARED TO FISCAL 1998 Continuing Operations Results Summary The Company posted record revenues in fiscal 1999. Revenues rose 10.4% from 1998 to 1999, operating income decreased $1.3 million from $2.6 million in 1998 to $1.3 million in 1999 and income from continuing operations decreased $0.9 million from $1.3 million in 1998 to $0.4 million in 1999. Diluted earnings per share from continuing operations decreased from $.43 per share in 1998 to $.16 per share in 1999. Revenues
($'s in thousands) 1999 1998 Change % Change Factory Sales $11,433.3 $10,198.6 $1,234.7 12.1% Retail Sales 11,759.7 10,460.5 1,299.2 12.4% Royalty and Marketing Fees 2,919.6 2,747.6 172.0 6.3% Franchise Fees 119.9 357.3 (237.4) (66.4%) Total $26,232.5 $23,764.0 $2,468.5 10.4%
Factory Sales Factory sales increased $1.2 million or 12.1% to $11.4 million in fiscal 1999, compared to $10.2 million in 1998. This increase was due primarily to wholesale sales of product to distribution channels outside of the Company's retail store system. Same store pounds purchased from the factory by franchised stores declined 2.9% in fiscal 1999 versus fiscal 1998 partially offsetting the increase in wholesale sales. The Company believes the decline in same store pounds purchased from the factory resulted primarily from increased retail sales of store-made product and product purchased from authorized vendors relative to factory-made products. Same store pounds purchased is a comparison of pounds purchased from the factory by franchised stores open for 12 months in each fiscal year. In response to the trend of decreasing same store pounds purchased from the factory and the limited number of suitable locations available for new Company-owned and franchised stores, the Company is focusing on developing new distribution channels, and new product introductions that replace products from authorized outside vendors, to improve factory sales trends. Retail Sales Retail sales increased $1.3 million or 12.4% to $11.8 million in fiscal 1999, compared to $10.5 million in fiscal 1998. This increase resulted primarily from an increase in the number of Company-owned stores from 37 as of February 28, 1998 to 42 as of February 28, 1999 and a 2.4% increase in same store sales. 16 During fiscal 1999 the Company bought 5 stores from franchisees. During fiscal 2000 the Company plans to begin a program of selective divestiture of lower volume Company-owned stores. Royalties, Marketing Fees and Franchise Fees Royalties and marketing fees increased $172,000 or 6.3% to $2.9 million in fiscal 1999, compared to $2.7 million in fiscal 1998. This increase resulted from an increase in same store sales at franchised stores of 7.7%. Franchise fee revenues decreased $237,000 in fiscal 1999 compared to fiscal 1998 due to a decrease in the number of new franchises sold. The Company is currently experiencing a constraint in the number of viable new locations available for establishment of its Rocky Mountain Chocolate Factory stores due to a lack of quality locations in environments where the concept has proven successful. The Company is currently examining alternatives to stand-alone Rocky Mountain Chocolate Factory stores to further penetrate established operating environments and venues that have yet to be exploited. Costs and Expenses Cost of Sales Cost of sales as a percentage of sales increased to 56.7% in fiscal 1999 versus 53.1% in fiscal 1998. This deterioration resulted from decreased factory and Company-owned store margins. Factory margins decreased to 26.8% in fiscal 1999 from 32.5% in fiscal 1998. Company-owned store margins for fiscal 1999 decreased to 59.3% from 61.0% in fiscal 1998. Factors contributing to the decrease in factory margins include: (1) incremental costs associated with the start-up (due to labor shortages and facility space constraints) and ultimate closure (due to less than anticipated demand) of a remote packaging facility; (2) production inefficiencies caused by facility space constraints and the lack of a sufficient seasonal workforce; (3) higher than expected third party shipping costs; (4) provisions for returns and allowances relating to products sold to outside distribution channels and (5) a non-recurring charge to factory cost of sales of approximately $398,000 representing write-down provisions for spoiled, excess and obsolete inventory resulting primarily from product over-production. The reduction in Company-owned store margins was due primarily to a product mix shift from store made product to product produced by the factory. The Company has implemented certain changes to its manufacturing processes and cost structure in order to improve factory gross margin and address facility space constraints and seasonal labor shortages. The Company believes these efforts will ultimately restore manufacturing profitability to levels achieved in fiscal 1998. Franchise Costs Franchise costs increased $42,000 or 3.8% in fiscal 1999 compared to fiscal 1998 due to increased support costs. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increased to 37.8% in fiscal 1999 from 35.6% in fiscal 1998 due to increased support costs and a 66.4% decrease in franchise fee revenue. Sales & Marketing Sales and Marketing costs increased 40% to $1.8 million in fiscal 1999 from $1.3 million in fiscal 1998. This increase is due to: (1) expansion of the Company's sales and marketing group to support a larger base of franchised and Company-owned stores; (2) expansion of promotional programs and marketing materials available to franchised and Company-owned stores; (3) establishment of a sales force focused on new distribution opportunities; (4) enhanced customer service and new product marketing programs and (5) costs associated with certain new distribution channel customers. 17 General and Administrative General and administrative expenses increased 6.8% from $1.9 million in fiscal 1998 to $2.0 million in fiscal 1999, primarily as a result of increased bad debt expense related to new distribution channel customers. As a percentage of total revenues, general and administrative expense declined from 7.9% in fiscal 1998 to 7.6% in fiscal 1999. Retail Operating Expenses Retail operating expenses increased from $5.9 million in fiscal 1998 to $6.7 million in fiscal 1999; an increase of 12.6%. This increase resulted primarily from an increase in the number of Company-owned stores from 37 at February 28, 1998 to 42 at February 28, 1999. Retail operating expenses, as a percentage of retail sales, remained relatively constant at 56.7% in fiscal 1998 compared to 56.8% in fiscal 1999. Provision for Store Closures, Impairment Loss and Loss on Write-down of Assets In the fourth quarter of fiscal 1999, a non-recurring charge of approximately $124,000 was recorded representing the loss expected to result from the closure of two Company-owned stores. Other Expense Other expense of $631,000 incurred in fiscal 1999 increased 14.8% from the $550,000 incurred in fiscal 1998. This increase resulted from decreased interest income on excess cash balances in fiscal 1999 and increased interest expense related to borrowings on the Company's line of credit facility. Income Tax Expense The Company's effective income tax rate in fiscal 1999 was 38.7% in comparison with the 38.5% in 1998. Discontinued Operations In December 1997, the Company decided its Fuzziwig's Candy Factory Store ("Fuzziwig's") segment did not meet its long-term strategic goals, and accordingly, adopted a plan to discontinue its operations. On June 5, 1998, the Company entered into a definitive agreement to sell substantially all the assets of its Fuzziwig's segment for $1.6 million. This transaction closed on July 31, 1998. The estimated loss on disposition of Fuzziwig's of $929,000 (inclusive of estimated losses during the phase out period of $250,000), net of applicable income tax benefit of $587,000, has been recorded in the accompanying statement of operations for the year ending February 28, 1998. The operating results of Fuzziwig's, including disposition costs, and operating losses during the phase-out period totaling $1.5 million have been segregated from continuing operations and reported as separate line items net of applicable income taxes in the statements of operations for all applicable periods reported. Loss from discontinued operations was $.35 per diluted share in fiscal 1998 versus nil in fiscal 1999. Net Income Net Income including discontinued operations was $.08 per diluted share in fiscal 1998 versus $.16 per diluted share in fiscal 1999. 18 FISCAL 1998 COMPARED TO FISCAL 1997 Continuing Operations Results Summary The Company posted record revenues and operating income in fiscal 1998. Revenues rose 6.7% from 1997 to 1998, operating income increased $3.6 million from a loss of $1.0 million in 1997 to $2.6 million in 1998 and income from continuing operations increased $2.3 million from a loss of $1.0 million in 1997 to income of $1.3 million in 1998. Diluted earnings per share from continuing operations increased from a loss of $.35 per share in 1997 to income of $.43 per share in 1998. Revenues
($'s in thousands) 1998 1997 Change % Change Factory Sales $10,198.6 $9,188.2 $1,010.4 11.0% Retail Sales 10,460.5 10,494.4 (33.9) (.3%) Royalty and Marketing Fees 2,747.6 2,342.4 405.2 17.3% Franchise Fees 357.3 255.6 101.7 39.8% Total $23,764.0 $22,280.6 $1,483.4 6.7%
Factory Sales Factory sales increased $1.0 million or 11% to $10.2 million in fiscal 1998, compared to $9.2 million in 1997. This increase was due to: (1) an increase in the number of franchised stores from 170 as of February 28, 1997 to 183 as of February 28, 1998; (2) the commencement in fiscal 1998 of wholesale sales of product to alternative distribution channels and (3) a 2.6% price increase in April of 1997. Same store pounds purchased from the factory by franchised stores declined 2.2% in fiscal 1998 versus fiscal 1997 partially offsetting the above increases. The Company believes the decline in same store pounds purchased from the factory resulted primarily from increased retail sales of store-made product and product purchased from authorized vendors relative to factory-made products. Same store pounds purchased is a comparison of pounds purchased from the factory by franchised stores open for 12 months in each fiscal year. Retail Sales Retail sales decreased $34,000 or 0.3% to $10.46 million in fiscal 1998, compared to $10.49 million in fiscal 1997. This decrease resulted primarily from the closure and sale of certain under-performing stores in fiscal 1998 and was substantially offset by an increase of 7.1% in comparable store retail sales in 1998 versus fiscal 1997. During fiscal 1998 the Company sold 7 and closed 6 Company-owned stores. Royalties, Marketing Fees and Franchise Fees Royalties and marketing fees increased $405,000 or 17.3% to $2.7 million in fiscal 1998, compared to $2.3 million in fiscal 1997. This increase resulted from an increase in the number of franchised stores operating to 183 in fiscal 1998 compared to 170 in fiscal 1997 and an increase in same store sales at franchised stores of 7.4%. Franchise fee revenues increased $102,000 in fiscal 1998 compared to fiscal 1997 due to an increase in the number of new franchises sold. Costs and Expenses Cost of Sales Cost of sales as a percentage of sales decreased to 53.1% in fiscal 1998 versus 56.0% in fiscal 1997. This improvement resulted from increased margins on both factory and retail sales. Company-owned store margins for fiscal 1998 improved to 61.0% in fiscal 1998 from 57.8% in fiscal 1997 as a result of an increase in retail prices, a focus on 19 higher margin products and reduced inventory shrinkage. Factory margins improved to 32.5% in fiscal 1998 from 28.3% in fiscal 1997 as a result of improved manufacturing efficiencies and a 2.6% price increase in April of 1997. Franchise Costs Franchise costs decreased $152,000 or 12.1% in fiscal 1998 compared to fiscal 1997. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 35.6% in fiscal 1998 from 48.4% in fiscal 1997. This decrease is due primarily to reductions in design and construction staffing. Sales & Marketing Sales and Marketing increased 74% to $1.3 million in fiscal 1998 from $742,000 in fiscal 1997. This increase is due to: (1) expansion of the Company's sales and marketing group to support a larger base of franchised and Company-owned stores; (2) expansion of promotional programs and marketing materials available to franchised and Company-owned stores; (3) establishment of a sales force focused on alternative distribution opportunities; and (4) enhanced customer service and new product marketing programs. General and Administrative General and administrative expenses decreased 6.0% from $2.0 million in fiscal 1997 to $1.9 million in fiscal 1998, primarily as a result of reduced bad debt expense. As a percentage of total revenues, general and administrative expense declined from 9% in fiscal 1997 to 7.9% in fiscal 1998. Retail Operating Expenses Retail operating expenses decreased from $6.4 million in fiscal 1997 to $5.9 million in fiscal 1998; a decrease of 7.0%. This decrease resulted from closing and selling certain under-performing Company-owned stores. As a result of this decrease and the improvement in same store retail sales, retail operating expenses, as a percentage of retail sales, decreased from 60.7% in fiscal 1997 to 56.7% in fiscal 1998. Provision for Store Closures, Impairment Loss and Loss on Write-down of Assets In fiscal 1997, a non-recurring restructuring charge of $1.8 million was recorded representing the loss expected to result from the sale or closure of certain Company-owned stores and from write-down of certain other store assets considered impaired under provisions of Financial Accounting Standard (FAS) 121 "Accounting for the Impairment of Long-Lived Assets." Other Expense Other expense of $550,000 incurred in fiscal 1998 decreased 8.2% from the $599,000 incurred in fiscal 1997. This decrease resulted from a non-recurring litigation settlement charge of $154,000 in fiscal 1997 for early lease terminations on certain Company-owned stores, and increased interest income on excess cash balances in fiscal 1998, offset by increased interest expense related to borrowings in support of the Company's fiscal 1996 and 1997 Company-owned store expansion. Income Tax Expense The Company's effective income tax rate in fiscal 1997 was 37.9% in comparison with the 38.5% in 1998. The increase resulted from utilization of remaining available state net operating loss carryforwards in fiscal 1997. Discontinued Operations In December 1997, the Company decided its Fuzziwig's Candy Factory Store ("Fuzziwig's") segment did not meet its long-term strategic goals, and accordingly, 20 adopted a plan to discontinue its operations. On June 5, 1998, the Company entered into a definitive agreement to sell substantially all the assets of its Fuzziwig's segment for $1.6 million. This transaction closed on July 31, 1998. The estimated loss on disposition of Fuzziwig's of $929,000 (inclusive of estimated losses during the phase out period of $250,000), net of applicable income tax benefit of $587,000, has been recorded in the accompanying statement of operations for the year ending February 28, 1998. The operating results of Fuzziwig's, including disposition costs and operating losses during the phase-out period totaling $1.5 million have been segregated from continuing operations and reported as separate line items net of applicable income taxes in the statements of operations for all periods reported. Loss from discontinued operations was $.35 per diluted share in fiscal 1998 versus $.12 in fiscal 1997. Net Income Net Income including discontinued operations was $.08 per diluted share in fiscal 1998 versus a loss of $.47 per diluted share in fiscal 1997. LIQUIDITY AND CAPITAL RESOURCES As of February 28, 1999, working capital was $1.5 million compared with $3.9 million as of February 28, 1998, a $2.4 million decrease. This decrease is primarily the result of the use of $1.8 million of working capital to repurchase 336,000 shares of the Company's common stock at $5.15 per share, related transaction expenses and loans to certain officers and directors of $249,000 to acquire an additional 54,000 shares. Cash and cash equivalent balances decreased from $1.8 million as of February 28, 1998 to $.3 million as of February 28, 1999 as a result of cash flows used in investing activities in excess of cash flows generated by operating and financing activities. The Company's current ratio was 1.3 to 1 at February 28, 1999 in comparison with 2.1 to 1 at February 29, 1998. The Company's long-term debt is comprised primarily of a real estate mortgage facility used to finance the Company's factory expansion (unpaid balance as of February 28, 1999, $1.9 million), and chattel mortgage notes (unpaid balance as of February 28, 1999, $5.2 million) used to fund the fiscal 1996 and 1997 Company-owned store expansion. The Company has a $3.0 million credit line, of which $2.1 million was available, secured by substantially all of the Company's assets except retail store assets and is subject to renewal in July, 1999. For fiscal 2000, the Company anticipates making capital expenditures of approximately $700,000, which will be used to maintain and improve existing factory and administrative infrastructure and for store remodels. The Company believes that cash flow from operations and available bank lines of credit will be sufficient to fund capital expenditures and working capital requirements for fiscal 2000. YEAR 2000 MATTERS The Company recognizes that the arrival of the year 2000 poses a unique worldwide challenge to the ability of systems to recognize the date change from December 31, 1999 to January 1, 2000. The year 2000 issue could result, at the Company and elsewhere, in system failures or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions or to engage in other normal business activities. The Company has assessed its computer and business processes and is reprogramming and upgrading its computer applications to provide for their continued functionality. An assessment of the readiness of the external entities with which it interfaces is ongoing. 21 The Company has developed a detailed year 2000 Conversion Project Plan ("Plan") to address the methods to correct possible disruptions of operations due to the year 2000 issue. The Plan takes into consideration the following items: (i) identification and inventorying of hardware, application software, and equipment utilizing programmable logic chips to control aspects of the Company's operation, with potential year 2000 problems; (ii) assessment of scope of year 2000 issues for, and assigning priorities to, each item based on its importance to the Company's operations; (iii) remediation of year 2000 issues in accordance with assigned priorities, by correction, upgrade, replacement or retirement; (iv) testing for and validation of year 2000 compliance; and (v) determination of key vendor and customers and their year 2000 compliance. Because the Company uses a variety of information technology systems, internally-developed and third-party provided software and embedded chip equipment, depending upon business function and location, various aspects of the Company's year 2000 efforts are in different phases and are proceeding in parallel. The task of identifying and inventorying hardware and application software with year 2000 issues and developing specific strategies for compliance has been completed. The Company is in the process of upgrading its main systems and hardware for year 2000 compliance. This critical remediation work is approximately 70% complete and is scheduled to be tested and installed by June 1999. Non-critical system conversions have been identified and are scheduled for completion by October 1999. This remediation process has commenced and encompasses all areas of operations of the Company, from verification of the year 2000 compliance of email systems to telephone systems. The Company's operations are also dependent on the year 2000 readiness of third parties who do business with the Company. In particular, the Company's information technology systems interact with commercial electronic transaction processing systems to handle customer credit card purchases and other point of sale transactions, and the Company is also dependent on third-party suppliers of such infrastructure elements as telephone services, electric power, water, and banking facilities. The Plan includes identifying and initiating formal communications with key third parties and suppliers and with significant vendors to determine the extent to which the Company will be vulnerable to such parties' failure to resolve their own year 2000 issues. The Company has contacted its relevant third parties. Although the Company has not been put on notice that any known third party problem will not be resolved, the Company has limited information and no assurance of additional information concerning the year 2000 readiness of third parties. The resulting risks to the Company's business are very difficult to assess. The estimated cost for implementing the plan including all required remediation and testing activities is between $100,000 and $150,000 and is being funded through operating cash flows. The Company anticipates that approximately 15% of these costs will relate to identification and assessment efforts, approximately 55% to the replacement of noncompliant software and equipment, approximately 5% to the correction of existing systems and approximately 25% to the testing of corrections implemented under the Plan. Costs incurred in connection with the Plan are not expected to result in significant delays or revisions to any of the Company's other pending or proposed information technology programs. Operating costs related to year 2000 compliance projects will be incurred over several quarters and will be expensed as incurred. To date, the Company has incurred approximately $47,000 of expenses in connection with the Plan. Based upon the planning completed to date, the Company believes that, with modifications to existing software, conversions to new software, and appropriate remediation of embedded chip equipment, the year 2000 issue is not reasonably likely to pose significant operational problems for the Company's information technology systems and embedded chip equipment as so modified and converted. The Company is presently unable to assess the likelihood that the Company will experience operational problems due to unresolved year 2000 problems of third parties who do business with the Company. There can be no assurance that other entities will achieve timely year 2000 compliance; if they do not, year 2000 problems could have a material impact on the Company's operations. Where 22 commercially reasonable to do so, the Company intends to assess its risks with respect to failure by third parties to be year 2000 compliant and to seek to mitigate those risks. If such mitigation is not achievable, year 2000 problems could have a material impact on the Company's operations. The Company's estimates of the costs of achieving year 2000 compliance and the date by which year 2000 compliance will be achieved are based on management's best estimates, which were derived using numerous assumptions about future events including the continued availability of certain resources, third party modification plans and other factors. However, there can be no assurance that these estimates will be achieved, and actual results could differ materially from these estimates. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in year 2000 remediation work, the ability to locate and correct all computer codes, the success achieved by the Company's suppliers in reaching year 2000 readiness, the timely availability of necessary replacement items and similar uncertainties. The Company presently believes that the most reasonably likely worst-case scenarios that the Company might confront with respect to year 2000 issues have to do with third parties not being year 2000 compliant. The Company is presently evaluating vendor and customer compliance and will develop contingency plans, such as alternate vendor opportunities, after obtaining compliance evaluations, if necessary, from the balance of vendors who have yet to respond (83%). However, alternative vendors may not be available for certain services, such as electrical power, water and local telephone services. The Company's timeline is to finalize these contingency plans by October 1999. IMPACT OF INFLATION Inflationary factors such as increases in the costs of ingredients and labor directly affect the Company's operations. Most of the Company's leases provide for cost-of-living adjustments and require it to pay taxes, insurance and maintenance expenses, all of which are subject to inflation. Additionally the Company's future lease cost for new facilities may include potentially escalating costs of real estate and construction. There is no assurance that the Company will be able to pass on increased costs to its customers. Depreciation expense is based on the historical cost to the Company of its fixed assets, and is therefore potentially less than it would be if it were based on current replacement cost. While property and equipment acquired in prior years will ultimately have to be replaced at higher prices, it is expected that replacement will be a gradual process over many years. SEASONALITY The Company is subject to seasonal fluctuations in sales, which cause fluctuations in quarterly results of operations. Historically, the strongest sales of the Company's products have occurred during the Christmas holiday and summer vacation seasons. In addition, quarterly results have been, and in the future are likely to be, affected by the timing of new store openings and sales of franchises. Because of the seasonality of the Company's business and the impact of new store openings and sales of franchises, results for any quarter are not necessarily indicative of results that may be achieved in other quarters or for a full fiscal year. ITEM 7A. 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. 23 The Company frequently enters into purchase contracts for chocolate and, to a lesser extent, certain nuts having durations ranging from six to 18 months. 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 February 28, 1999, $1.2 million of the Company's long-term debt was subject to a variable interest rate. Assuming that this principal amount did not change during fiscal 2000, other than as a result of scheduled principal reductions, and assuming that the average effective interest rate on this debt for 2000 increased by one percent as compared to the average effective interest rate in effect during 1999, the Company would incur an additional $10,000 in interest expense in 2000, as compared to 1999, and would experience a corresponding reduction in cash flow. A decrease in the average interest rate in effect on this debt during 2000 would result in a corresponding decrease in interest expense and an increase in cash flow. The Company also has a $3.0 million bank line of credit that bears interest at a variable rate. As of February 28, 1999, $900,000 was outstanding under the line of credit. However, this line of credit is used primarily for working capital purposes, and the Company expects the outstanding principal balance to be significantly lower during most of fiscal 2000. As of May 28, 1999, the outstanding principal balance under the line of credit was $100,000. The outstanding principal balance as of February 28, 1999 was impacted by, among other things, the expenditure during fiscal 1999 of more than $1.7 million for the repurchase of Common Stock. The Company does not believe that it is exposed to any material interest rate risk related to 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 has primary responsibility for determining the timing and duration of commodity purchase contracts and negotiating the terms and conditions of those contracts. 24 ITEM 8. FINANCIAL STATEMENTS INDEX TO FINANCIAL STATEMENTS
Page Report of Independent Certified Public Accountants 26 Statements of Operations 27 Balance Sheets 29 Statements of Changes in Stockholders Equity 30 Statements of Cash Flows 31 Notes to Financial Statements 32
25 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors and Stockholders Rocky Mountain Chocolate Factory, Inc. We have audited the accompanying balance sheets of Rocky Mountain Chocolate Factory, Inc. as of February 28, 1999 and 1998, and the related statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended February 28, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Rocky Mountain Chocolate Factory, Inc. as of February 28, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended February 28, 1998, in conformity with generally accepted accounting principles. GRANT THORNTON LLP Dallas, Texas May 12, 1999 26 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED FEBRUARY 28, 1999 1998 1997 REVENUES Sales $23,193,011 $20,659,076 $19,682,622 Franchise and royalty fees 3,039,517 3,104,906 2,597,985 Total revenues 26,232,528 23,763,982 22,280,607 COSTS AND EXPENSES Cost of sales 13,153,614 10,960,966 11,017,119 Franchise costs 1,147,862 1,106,172 1,258,361 Sales & marketing 1,809,077 1,290,516 741,603 General and administrative 2,004,970 1,877,528 2,076,196 Retail operating expenses 6,674,472 5,930,039 6,375,279 Provision for store closures 123,903 -- 1,358,398 Impairment loss -- -- 149,000 Loss on write-down of assets -- -- 330,587 Total costs and expenses 24,913,898 21,165,221 23,306,543 OPERATING INCOME (LOSS) 1,318,630 2,598,761 (1,025,936) OTHER INCOME (EXPENSE) Interest expense (698,557) (664,852) (473,618) Litigation settlements -- -- (154,300) Interest income 67,080 114,732 28,637 Other, net (631,477) (550,120) (599,281) INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 687,153 2,048,641 (1,625,217) INCOME TAX EXPENSE (BENEFIT) 265,725 788,640 (615,506) INCOME (LOSS) FROM CONTINUING OPERATIONS 421,428 1,260,001 (1,009,711) DISCONTINUED OPERATIONS Income (loss) from discontinued operations (net of income taxes) -- (90,849) (355,991) Provision for estimated loss on disposition, including provision for operating losses during phase out period of $153,250 (net of income taxes) -- (929,234) -- Total -- (1,020,083) (355,991) NET INCOME (LOSS) $421,428 $239,918 $(1,365,702)
(CONTINUED) The accompanying notes are an integral part of these statements. 27 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. STATEMENTS OF OPERATIONS (CONTINUED)
FOR THE YEARS ENDED FEBRUARY 28, 1999 1998 1997 BASIC EARNINGS (LOSS) PER COMMON SHARE Continuing Operations $.16 $.43 $(.35) Discontinued Operations -- (.35) (.12) Net Income (Loss) $.16 $.08 $(.47) DILUTED EARNINGS (LOSS) PER COMMON SHARE Continuing Operations $.16 $.43 $(.35) Discontinued Operations -- (.35) (.12) Net Income (Loss) $.16 $.08 $(.47) WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 2,665,567 2,912,387 2,908,492 DILUTIVE EFFECT OF EMPLOYEE STOCK OPTIONS 11,776 17,158 -- WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, ASSUMING DILUTION 2,677,343 2,929,545 2,908,492
The accompanying notes are an integral part of these statements. 28 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. BALANCE SHEETS
AS OF FEBRUARY 28, 1999 1998 ASSETS CURRENT ASSETS Cash and cash equivalents $317,155 $1,795,381 Accounts and notes receivable, less allowance for doubtful accounts of $259,408 and $214,152 1,874,286 2,174,618 Refundable income taxes 383,511 483,448 Inventories 3,276,550 2,567,966 Deferred income taxes 433,229 257,176 Other 73,827 103,195 Net current assets of discontinued operations -- 44,351 Total current assets 6,358,558 7,426,135 PROPERTY AND EQUIPMENT, NET 10,238,671 9,672,443 OTHER ASSETS Net non-current assets of discontinued operations -- 1,555,681 Accounts and notes receivable 291,648 279,122 Goodwill, less accumulated amortization of $441,246 and 325,848 1,420,754 596,152 Other 342,469 338,359 Total other assets 2,054,871 2,769,314 Total assets $18,652,100 $19,867,892 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Current maturities of long-term debt $1,831,000 $1,132,900 Line of credit 900,000 -- Accounts payable 1,066,986 1,296,769 Accrued salaries and wages 548,745 707,737 Other accrued expenses 453,407 339,481 Total current liabilities 4,800,138 3,476,887 LONG-TERM DEBT, LESS CURRENT MATURITIES 5,249,769 5,993,273 DEFERRED INCOME TAXES 93,007 378,272 COMMITMENTS AND CONTINGENCIES -- -- STOCKHOLDERS' EQUITY Common stock, $.03 par value; 7,250,000 shares authorized; 2,599,599 and 2,912,449 shares issued and outstanding 77,988 87,373 Additional paid-in capital 7,046,032 8,719,604 Retained earnings 1,633,911 1,212,483 Less notes receivable from officers and directors (248,745) -- Total stockholders' equity 8,509,186 10,019,460 Total liabilities and stockholders' equity $18,652,100 $19,867,892
The accompanying notes are an integral part of these statements. 29 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED FEBRUARY 28, 1999 1998 1997 COMMON STOCK Balance at beginning of year $87,373 $87,369 $87,155 Repurchase and retirement of common stock (10,080) -- -- Issuance of common stock 5 4 4 Exercise of stock options 690 -- 210 Balance at end of year 77,988 87,373 87,369 NOTES RECEIVABLE-OFFICERS AND DIRECTORS Balance at beginning of year -- -- -- Issuance of notes (248,745) -- -- Balance at end of year (248,745) -- -- ADDITIONAL PAID-IN CAPITAL Balance at beginning of year 8,719,604 8,719,008 8,691,960 Repurchase and retirement of common stock (1,754,331) -- -- Issuance of common stock 699 596 1,008 Exercise of stock options 80,060 -- 26,040 Balance at end of year 7,046,032 8,719,604 8,719,008 RETAINED EARNINGS Balance at beginning of year 1,212,483 972,565 2,338,267 Net income (loss) for the year 421,428 239,918 (1,365,702) Balance at end of year 1,633,911 1,212,483 972,565 TOTAL STOCKHOLDERS' EQUITY $8,509,186 $10,019,460 $9,778,942 COMMON SHARES Balance at beginning of year 2,912,449 2,912,299 2,905,149 Repurchase and retirement of common stock (336,000) -- -- Issuance of common stock 150 150 150 Exercise of stock options 23,000 -- 7,000 Balance at end of year 2,599,599 2,912,449 2,912,299
The accompanying notes are an integral part of these statements 30 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED FEBRUARY 28, 1999 1998 1997 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $421,428 $239,918 $(1,365,702) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Loss from discontinued operations -- 90,849 355,991 Provision for estimated loss on disposition of business -- 929,234 -- Depreciation and amortization 1,508,111 1,335,715 1,383,212 Asset impairment and store closure losses 123,903 -- 1,781,985 Gain on sale of assets (11,420) (76,474) (72,707) Changes in operating assets and liabilities: Accounts and notes receivable 237,806 (158,353) 232,733 Refundable income taxes 99,937 (250,159) (233,289) Inventories (708,584) (485,400) 378,020 Other assets 29,368 74,872 45,934 Accounts payable (229,783) 497,098 (198,849) Income taxes payable -- -- (287,518) Deferred income taxes (461,318) 767,666 (856,020) Accrued liabilities (223,533) (286,081) 220,270 Deferred income -- (93,000) 93,000 Net cash provided by operating activities of continuing operations 785,915 2,585,885 1,477,060 CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of assets 39,300 8,602 310,690 Sale (purchase) of other assets 58,054 (233,380) (328,940) Loans to officers and directors (248,745) -- -- Purchase of property and equipment (1,383,718) (1,984,940) (2,251,598) Net cash used in investing activities (1,535,109) (2,209,718) (2,269,848) CASH FLOWS FROM FINANCING ACTIVITIES: Net change in line of credit 900,000 -- (1,000,000) Proceeds from long-term debt 2,022,456 1,522,043 7,071,852 Payments on long-term debt (2,067,860) (981,063) (2,805,074) Proceeds from issuance of common stock -- 600 1,012 Proceeds from exercise of stock options 80,750 -- 26,250 Repurchase and redemption of common stock (1,764,410) -- -- Net cash provided by (used in) financing activities (829,064) 541,580 3,294,040 NET CASH PROVIDED BY (USED IN) DISCONTINUED OPERATIONS 100,032 85,028 (2,237,433) NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,478,226) 1,002,775 263,819 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 1,795,381 792,606 528,787 CASH AND CASH EQUIVALENTS AT END OF YEAR $317,155 $1,795,381 $792,606
The accompanying notes are an integral part of these statements. 31 NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations The Company is a manufacturer of an extensive line of premium chocolate candy for sale to its franchised and Company-owned Rocky Mountain Chocolate Factory stores located throughout the United States and in Guam and Canada. The Company is also a retail operator and international franchiser. The majority of the Company's revenues are generated from wholesale and retail sales of candy. The balance of the Company's revenues are generated from royalties and marketing fees, based on a franchisee's monthly gross sales, and from franchise fees, which consist of fees earned from the sale of franchises. Inventories Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method. Property and Equipment Property and equipment are recorded at cost. Depreciation and amortization are computed using the straight-line method based upon the estimated useful life of the asset. Leasehold improvements are amortized on the straight-line method over the lives of the respective leases or the service lives of the improvements, whichever is shorter. The Company reviews its long-lived assets, including identifiable intangible assets, whenever events or changes indicate the carrying amount of such assets may not be recoverable. The Company's policy is to review the recoverability of all assets, at a minimum, on an annual basis. See Note 10. Amortization of Goodwill Goodwill is amortized on the straight-line method over ten to twenty-five years. Franchise and Royalty Fees Franchise fee revenue is recognized upon completion of all significant initial services provided to the franchisee and upon satisfaction of all material conditions of the franchise agreement. In addition to the initial franchise fee, the Company receives a royalty fee of five percent (5%) and a marketing and promotion fee of one percent (1%) of the Rocky Mountain Chocolate Factory franchised stores' gross sales. Use of Estimates In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, the disclosure of contingent assets and liabilities, at the date of the financial statements, and revenues and expenses during the reporting period. Actual results could differ from those estimates. Additionally, estimates of losses anticipated to result from store closure and impairment are based on the best information currently available to management. Such estimates may differ materially from results actually produced by store closure as a result of uncertainties in the amount of finally negotiated lease settlements, the amount of operating losses sustained by the stores to their dates of closure and in the amount recoverable by sale or redeployment of assets of stores to be closed. Vulnerability Due to Certain Concentrations The Company's stores are concentrated (47%) in the factory outlet mall environment. At April 30, 1999, 32 Company-owned stores and 74 franchise stores of 227 total stores are located in this environment. The Company is, therefore, vulnerable to changes in consumer traffic in this market environment and to changes in the level of 32 construction of additional, new factory outlet mall locations. Cash Equivalents Cash equivalents include cash in excess of daily requirements which is invested in various financial instruments having an original maturity of three months or less. Stock-Based Compensation Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation" encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees" and provides the required pro forma disclosures prescribed by SFAS 123. Earnings (Loss) Per Share Basic earnings (loss) per share is computed as net earnings (loss) divided by the weighted average number of common shares outstanding during each year of 2,665,567, 2,912,387 and 2,908,492, for the fiscal years ended February 28, 1999, 1998 and 1997. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through stock options. Incremental shares assumed issued on the exercise of common stock options during the fiscal years ended February 28, 1999 and 1998 were 11,776 and 17,158. The effect of stock options in 1997 would be antidilutive. Fair Value of Financial Instruments The Company's financial instruments consist of cash and cash equivalents, short-term investments in money market funds, other liquid assets, trade receivables, payables, notes receivable, and debt. The fair value of all instruments approximates the carrying value. Reclassifications Certain reclassifications have been made to prior years' financial statements in order to conform with the presentation of the February 28, 1999 financial statements. NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure these instruments at fair value. This statement is effective for years beginning after June 15, 1999 and is not applied retroactively to financial statements for prior periods. The Company believes that this statement will not have a material effect on its financial statements. NOTE 3 - INVENTORIES Inventories consist of the following at February 28:
1999 1998 Ingredients and supplies $1,594,579 $1,153,433 Finished candy 1,681,971 1,414,533 $3,276,550 $2,567,966
33 NOTE 4 - PROPERTY AND EQUIPMENT, NET Property and equipment consists of the following at February 28:
1999 1998 Land $ 513,618 $ 513,618 Building 3,672,870 3,665,581 Machinery and equipment 7,147,833 6,023,347 Furniture and fixtures 2,408,807 2,072,208 Leasehold improvements 1,876,223 1,389,608 Transportation equipment 199,639 293,357 15,818,990 13,957,719 Less accumulated depreciation 5,580,319 4,285,276 Property and equipment, net $10,238,671 $ 9,672,443
NOTE 5 - LINE OF CREDIT AND LONG-TERM DEBT Line of Credit At February 28, 1999 the Company had a $3,000,000 line of credit from a bank, collateralized by substantially all of the Company's assets with the exception of the Company's retail store assets. Draws may be made under the line at 75% of eligible accounts receivable plus 50% of eligible inventory. Interest on borrowings is at prime (7.75% at February 28, 1999). Terms of the line require that the line be rested (that is, that there be no outstanding balance) for a period of 30 consecutive days during the term of the loan. The credit line is subject to renewal in July, 1999. On May 15, 1998, the Company used its line of credit to fund the purchase of 336,000 shares and to lend certain officers and directors funds to acquire 40,000 shares of its issued and outstanding common stock. See Note 8. Long-Term Debt Long-term debt consists of the following at February 28:
1999 1998 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. $ 210,731 $ 320,793 Real estate mortgage note payable in monthly installments of $17,490 through April, 2011 including interest at 8.25% per annum, collateralized by land and factory building. Interest adjusted to prime in May, 2001 and every five years thereafter until maturity in April 2016. 1,925,405 1,969,930 Chattel mortgage note payable in monthly installments of $12,359 through April, 2002 including interest at 8.25% per annum, collateralized by equipment. 412,064 521,427 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. 1,052,241 1,251,663
34 NOTE 5 - LINE OF CREDIT AND LONG-TERM DEBT - CONTINUED Long-Term Debt - Continued
1999 1998 Chattel mortgage note payable in monthly installments of $5,472 through January, 2002 including interest at 10.36% per annum, collateralized by machinery, equipment, furniture and fixtures. 164,686 210,669 Chattel mortgage note payable in monthly installments of $27,632 through April, 2001 including interest at 7.9% per annum, collateralized by machinery, equipment, furniture and fixtures. 658,322 -- 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. 283,500 371,265 Chattel mortgage notes payable in monthly principal installments of $37,881 through April, 2002 plus interest at LIBOR plus 2.85% (7.79% at February 28, 1999), collateralized by equipment, furniture and fixtures. 1,215,375 -- Chattel mortgage note payable in monthly installments of $7,828 through November, 2001 including interest at 7.95% per annum, collateralized by equipment, furniture and fixtures. 231,361 -- Chattel mortgage note payable in monthly installments of $454 through October, 2003 including interest at 7.91% per annum, collateralized by equipment. 21,219 -- Chattel mortgage note payable in quarterly installments of $105,000 through October, 1999, $90,000 through October, 2000, $57,150 through January, 2002, and a final installment of $38,100 in April, 2002, including interest at 6.73% per annum collateralized by equipment, furniture and fixtures. 905,865 -- Chattel mortgage notes payable (retired in fiscal 1999), interest rates ranging from 8.75 to 10.5%. -- 2,480,426 $7,080,769 $7,126,173 Less current maturities 1,831,000 1,132,900 $5,249,769 $5,993,273
Maturities of long-term debt are as follows for the years ending February 28 or 29: 2000 $1,831,000 2001 1,842,580 2002 1,239,879 2003 428,892 2004 128,393 Thereafter 1,610,025 $7,080,769
35 NOTE 6 - OPERATING LEASES The Company conducts its retail operations in facilities leased under five to ten year noncancelable operating leases. Certain leases contain renewal options for between two and ten additional years at increased monthly rentals. The majority of the leases provide for contingent rentals based on sales in excess of predetermined base levels. The following is a schedule by year of future minimum rental payments required under such leases for the year ending February 28 or 29: 2000 $ 900,741 2001 775,630 2002 508,195 2003 340,564 2004 176,627 Thereafter 157,683 $2,859,440
In some instances, in order to retain the right to site selection or because of requirements imposed by the lessor, the Company has leased space for its proposed franchise outlets. When a franchise was sold, the store was subleased to the franchisee who is responsible for the monthly rent and other obligations under the lease. The Company's liability as primary lessee on sublet franchise outlets, all of which is offset by sublease rentals, is as follows for the years ending February 28 or 29: 2000 $1,336,496 2001 1,127,867 2002 780,781 2003 505,057 2004 316,818 Thereafter 499,358 $4,566,377
The following is a schedule of lease expense for all operating leases for the three years ended February 28:
1999 1998 1997 Minimum rentals $ 2,316,508 $ 2,454,744 $ 2,278,591 Less sublease rentals (1,239,663) (1,294,202) (1,184,301) Contingent rentals 35,150 100,771 47,116 $ 1,111,995 $ 1,261,313 $ 1,141,406
NOTE 7 - INCOME TAXES Income tax expense (benefit) relating to continuing operations is comprised of the following for the years ending February 28:
1999 1998 1997 Current Federal $ 240,834 $ 18,520 $ 230,618 State 25,183 2,454 9,896 Total Current 266,017 20,974 240,514 Deferred Federal (264) 677,849 (768,992) State (28) 89,817 (87,028) Total Deferred (292) 767,666 (856,020) Total $ 265,725 $ 788,640 $(615,506)
36 NOTE 7 - INCOME TAXES - CONTINUED A reconciliation of the statutory federal income tax rate and the effective rate as a percentage of pretax income is as follows for the years ending February 28:
1999 1998 1997 Statutory rate 34.0% 34.0% 34.0% Goodwill amortization 1.2% .4% .4% State income taxes, net of federal benefit 2.4% 3.1% 3.0% Other 1.1% 1.0% .5% Effective Rate 38.7% 38.5% 37.9%
The components of deferred income taxes at February 28, 1999 and 1998 are as follows:
Deferred Tax Assets 1999 1998 Allowance for doubtful accounts $ 100,313 $ 82,877 Inventories 28,742 -- Accrued compensation 67,279 70,774 Contribution carryover 37,249 26,511 Loss provisions 597,422 206,902 Alternative minimum tax carryforward 150,402 85,689 Deferred lease rentals 18,333 26,167 Other 7,781 -- 1,007,521 498,920 Deferred Tax Liabilities - Depreciation (667,299) (620,016) Net deferred tax asset (liability) $ 340,222 $ (121,096)
NOTE 8 - STOCK REPURCHASE On May 15, 1998, the Company purchased 336,000 shares and certain of its directors and executive officers purchased 104,000 shares of the Company's issued and outstanding common stock at $5.15 per share from La Salle National Bank of Chicago, Illinois, which obtained these shares through foreclosure from certain shareholders 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 9 - STOCK OPTION PLANS Under the Company's 1985 Incentive Stock Option Plan (the "1985 Plan") options to purchase 215,000 shares of the Company's common stock were granted at prices not less than market value at the date of grant. The 1985 Plan expired in October 1995. Options granted under the 1985 Plan could not have a term exceeding ten years. Options representing the right to purchase 54,000 shares of the Company's common stock remained outstanding under the 1985 Plan at February 28, 1999. Under the 1995 Stock Option Plan (the "1995 Plan") and the Nonqualified Stock Option Plan for Non-employee Directors (the "Director's Plan"), options to purchase up to 250,000 and 90,000 shares, respectively, of the Company's common stock may be granted at prices not less than market value at the date of grant. Options granted may not have a term exceeding ten years. Options representing the right to purchase 147,000 and 40,000 shares of the Company's common stock were outstanding under the 1995 Plan and Director's Plan, respectively, at February 28, 1999. 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 May 2000 through January 2008. 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 37 NOTE 9 - STOCK OPTION PLANS - CONTINUED compensation cost if the exercise price is not less than market. If the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by Financial Accounting Standard 123, net income (loss) and diluted income (loss) per share would have been reduced to the pro-forma amounts indicated in the table below for the years ending February 28 (in 000's except per share amounts):
1999 1998 1997 Net Income (Loss)-as reported $ 421 $ 240 $ (1,366) Net Income (Loss)-pro forma $ 362 $ 177 $ (1,530) Basic Income (Loss) per Share-as reported $ .16 $ .08 $ (.47) Diluted Income (Loss) per Share-as reported $ .16 $ .08 $ (.47) Basic Income (Loss) per Share-pro forma $ .14 $ .06 $ (.53) Diluted Income (Loss) per Share-pro forma $ .14 $ .06 $ (.53)
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:
1999 1998 1997 Expected dividend yield 0% 0% 0% Expected stock price volatility 65% 65% 50% Risk-free interest rate 6.0% 6.0% 6.5% Expected life of options 7 years 7 years 7 years
Additional information with respect to options outstanding under the Plans at February 28, 1999, and changes for the three years then ended was as follows:
1999 Weighted Average Shares Exercise Price Outstanding at beginning of year 290,000 $ 7.81 Exercised (23,000) 3.51 Forfeited (26,000) 10.63 Outstanding at end of year 241,000 7.91 Options exercisable at February 28, 1999 141,800 9.18
1998 Weighted Average Shares Exercise Price Outstanding at beginning of year 272,000 $ 9.01 Granted 55,000 4.55 Forfeited (37,000) 11.80 Outstanding at end of year 290,000 7.81 Options exercisable at February 28, 1998 151,000 9.22 Weighted average fair value per share of options granted during 1998 was $3.44.
38 NOTE 9 - STOCK OPTION PLANS - CONTINUED
1997 Weighted Average Shares Exercise Price Outstanding at beginning of year 224,000 $11.95 Granted 111,000 7.05 Exercised (7,000) 3.75 Canceled (56,000) 18.25 Outstanding at end of year 272,000 9.01 Options exercisable at February 28, 1997 161,000 10.11 Weighted average fair value per share of options granted during 1997 was $4.04.
Information about stock options outstanding at February 28, 1999 is summarized as follows:
Options Outstanding Weighted average Number remaining Weighted average Range of exercise prices outstanding contractual life exercise price $3.125 to 4.50 82,000 6.49 years $ 4.21 $5.125 to 7.75 104,000 7.04 years 7.03 $11.50 to 18.00 55,000 5.52 years 15.10 241,000
Options Exercisable Weighted Number average Range of exercise prices exercisable exercise price $3.125 to 4.50 40,400 $ 3.91 $5.125 to 7.75 47,000 6.80 $11.50 to 18.00 54,400 15.14 141,800
NOTE 10 - LOSS PROVISIONS Loss provisions were provided as follows: Store Closures In February 1999, the Company adopted a plan to close two underperforming Company-owned stores. The Company made a loss provision in February 1999 for closure of these stores in the total amount of approximately $123,000 including $86,000 for estimated operating losses to date of closure and $37,000 for writedown of store assets to their estimated recoverable values. In February 1997, the Company adopted a plan to close eight underperforming Company-owned stores. The Company made a loss provision in February, 1997 for closure of these stores in the total amount of $1,302,000 including $138,000 for estimated operating losses to date of closure, $473,000 for estimated cost of settlement of leases, and $691,000 for writedown of store assets to their estimated recoverable values. A loss provision of $56,000 was made in February, 1997 for estimated cost of settlement of leases relating to the Company's liability as primary lessee on sublet franchise outlets. 39 NOTE 10 - LOSS PROVISIONS - CONTINUED Long-Lived Asset Impairments In February 1997, 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 In February 1999, a loss provision was made in the amount of $398,000 to reduce certain inventories to the lower of cost or market. This charge is included in cost of sales in the accompanying statement of operations. In fiscal 1997, a loss provision was made in the amount of $331,000 for estimated loss on future disposition of certain obsolete factory assets and to reduce to net realizable value certain surplus fixtures and equipment utilized in Company-owned stores. Litigation Settlements In fiscal 1997, the Company settled in the amount of $154,000, litigation brought against it for premature lease termination resulting from closure in fiscal 1996 of one Company-owned store and of one franchised store where the Company was the primary lessee on the franchisee-sublet location. NOTE 11 - OPERATING SEGMENTS Effective May 31, 1998 the Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information which changes the way the Company reports information about its operating segments. The Company classifies its business interests into three reportable segments: Franchising, Retail stores and Manufacturing. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (Note 1). 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:
Franchising Manufacturing Retail Other Total FY 1999 Total revenues 3,039,517 14,737,115 11,759,655 -- 29,536,287 Intersegment revenues -- (3,303,759) -- -- (3,303,759) Revenue from external customers 3,039,517 11,433,356 11,759,655 -- 26,232,528 Segment profit (loss) 806,106 2,990,147 48,936 (3,158,036) 687,153 Total assets 889,713 8,947,006 6,507,865 2,307,516 18,652,100 Capital expenditures 38,666 720,670 529,172 95,210 1,383,718 Total depreciation & amortization 178,575 447,140 666,056 216,340 1,508,111
40 NOTE 11 - OPERATING SEGMENTS - CONTINUED Franchising Manufacturing Retail Other Total FY 1998 Total revenues 3,104,906 13,276,949 10,460,518 -- 26,842,373 Intersegment revenues -- (3,078,391) -- -- (3,078,391) Revenue from external customers 3,104,906 10,198,558 10,460,518 -- 23,763,982 Segment profit (loss) 1,148,989 3,074,658 252,642 (2,427,648) 2,048,641 Total assets 1,217,689 8,388,569 4,864,567 5,397,067 19,867,892 Capital expenditures 38,749 565,711 857,974 522,506 1,984,940 Total depreciation & amortization 83,100 426,770 631,121 194,724 1,335,715 FY 1997 Total Revenues 2,597,985 12,273,039 10,494,396 -- 25,365,420 Intersegment revenues -- (3,084,813) -- -- (3,084,813) Revenue from external customers 2,597,985 9,188,226 10,494,396 -- 22,280,607 Segment profit (loss) 784,734 2,649,432 (396,537) (4,662,846) (1,625,217) Total assets 713,444 7,342,938 5,529,304 5,080,444 18,666,130 Capital expenditures 140,117 589,471 1,600,410 (78,400) 2,251,598 Total depreciation & amortization 68,909 365,884 777,754 170,665 1,383,212
NOTE 12 - DISCONTINUED OPERATION In December 1997, the Company decided its Fuzziwig's Candy Factory Store ("Fuzziwig's") segment did not meet its long-term strategic goals, and accordingly, adopted a plan to discontinue its operations. On June 5, 1998, the Company entered into a definitive agreement to sell substantially all the assets of its Fuzziwig's segment for $1.6 million. This transaction closed on July 31, 1998 (the "Closing Date"). The purchase price included $180,000 cash, $100,000 of which was paid at the Closing Date and the remaining $80,000 paid six months from the Closing Date. Pursuant to the agreement, the Company also received four Rocky Mountain Chocolate Factory stores previously operated as franchised stores by one of the purchasers and valued at approximately $1.42 million. The estimated loss on disposition of Fuzziwig's of $929,000 (inclusive of estimated losses during the phase out period of $250,000), net of applicable income tax benefit of $587,000, has been recorded in the accompanying statement of operations for the year ending February 28, 1998. Operating results of the discontinued operation have been reclassified from amounts previously reported and have been reported separately in the statements of operations. Summarized financial information for the discontinued operation for the years ended February 28 follow:
1999 1998 1997 Revenues $ 1,095,431 $ 2,928,403 $ 1,991,863 Loss from the discontinued operation, net of income tax benefit of $57,235 and $217,008 -- (90,849) (355,991) Provision for loss on disposal, net of income tax benefit of $586,766 -- (929,234) --
41 NOTE 12 - DISCONTINUED OPERATION - CONTINUED The net assets of the discontinued operation have been segregated in the February 28, 1998 balance sheet as follows: 1998 Net current assets: Inventories $ 178,765 Other current assets 29,803 Deferred income taxes 103,673 Current liabilities (267,890) $ 44,351 Net non-current assets: Net property, plant and equipment $ 1,159,969 Other assets 38,067 Deferred income taxes 357,645 $ 1,555,681 NOTE 13 - SUPPLEMENTAL CASH FLOW INFORMATION For the three years ended February 28:
1999 1998 1997 Interest paid $ 703,953 $ 658,700 $ 469,237 Income taxes paid (received) 165,788 (30,619) 436,932 Non-Cash Financing Activities: Company financed sales of retail store assets -- 715,931 110,000
NOTE 14 - EMPLOYEE BENEFIT PLAN The Company has a 401(k) plan called the Rocky Mountain Chocolate Factory, Inc. 401(k) Plan. Eligible participants are permitted to make contributions up to 15% of compensation. The Company makes a matching contribution, which vests ratably over a 5 year period, and is 50% of the employee's contribution up to a maximum of 1.5% of the employee's compensation. During the years ended February 28, 1999, 1998, and 1997, the Company contribution was approximately $36,000, $33,000 and $27,000, respectively, to the plan. NOTE 15 - SUBSEQUENT EVENT (UNAUDITED) On May 10, 1999, Whitman's Candies, Inc. commenced an unsolicited tender offer for all of the outstanding shares of common stock of the Company at a price of $5.75 per share in cash. The Board of Directors of the Company, in a May 21, 1999 letter to shareholders, indicated that the tender offer is inadequate and not in the best interests of either the Company or its shareholders and recommended that the shareholders reject the tender offer. Unless extended or earlier withdrawn by the offeror, the tender offer will expire on June 16, 1999. Additionally, the Company adopted a Rights Plan (the "Plan") on May 18, 1999. In connection with the adoption of the Plan, the Board authorized and declared a dividend of one right (a "Right") for each outstanding share of Common Stock, par value $0.03 per share ("Common Stock"), of the Company. The dividend is payable on May 28, 1999 (the "Record Date") to the holders of record of the Common Stock at the close of business on that date. When exercisable each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value $0.10 per share ("Preferred Stock"), of the Company at a price of $30 per one one-hundredth of a share of Preferred Stock, subject to adjustment. The Rights will become exercisable upon the earlier to occur of ten (10) days after the first public announcement that a person or group has acquired beneficial ownership of 15% or more, or ten (10) business days after a person or group announces a tender offer that would result in beneficial ownership of 15% or more, of 42 NOTE 15 - SUBSEQUENT EVENT (UNAUDITED) - CONTINUED the Company's outstanding Common Stock. The holder of each one one-hundredth of a share of Preferred Stock would have voting, dividend and certain other rights substantially equivalent to the rights of a holder of one share of Common Stock. The Board resolved to delay the exercisability of the Rights under the Plan with respect to the unsolicited tender offer by Whitman's Candies, Inc. until June 15, 1999 or such later date as may be determined by the Board. If the Company is acquired in a business combination transaction while the Rights are outstanding, each Right will entitle its holder to purchase, for $30, in lieu of Preferred Stock, common shares of the acquiring company having a market value of $60. In addition, if a person or group acquires beneficial ownership of 15% or more of the Company's outstanding Common Stock, each Right will entitle its holder (other than such person or members of such group) to purchase, for $30, a number of shares of the Company's Common Stock having a market value of $60. Furthermore, at any time after a person or group acquires beneficial ownership of !5% or more (but less than 50%) of the Company's outstanding Common Stock, the Board of Directors may, at its option, exchange part or all of the Rights (other than Rights held by the acquiring person or group) for shares of the Company's Common Stock on a one-for-one basis. At any time prior to the acquisition of 15% of the Company's outstanding Common Stock, the Company can redeem the Rights for $0.01 per Right. Unless earlier redeemed or extended, the Rights will expire on May 28, 2009. 43 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT EXECUTIVE OFFICERS AND DIRECTORS
NAME AGE POSITION Franklin E. Crail............. 57 Chairman of the Board, President, Treasurer and Director Bryan J. Merryman............. 38 Chief Operating Officer, Chief Financial Officer and Director Edward L. Dudley.............. 35 Vice President - Sales and Marketing Gary S. Hauer................. 54 Vice President - Manufacturing Clifton W. Folsom............. 45 Vice President - Franchise Support Jay B. Haws................... 48 Vice President - Creative Services Virginia M. Perez............. 61 Corporate Secretary Lee N. Mortenson.............. 63 Director Fred M. Trainor............... 60 Director Gerald A. Kien................ 68 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. Bryan J. Merryman Mr. Merryman joined the Company in December 1997 as Vice President - Finance and Chief Financial Officer. Since April 1999 Mr. Merryman has also served the Company as the Chief Operating Officer and as a Director. Prior to joining the Company, Mr. Merryman was a principal in Knightsbridge Holdings, Inc. (a leveraged buyout firm) from January 1997 to December 1997. Mr. Merryman also served as Chief Financial Officer of Super Shops, Inc., a retailer and manufacturer of aftermarket auto parts from July 1996 to November 1997 and was employed for more than eleven years by Deloitte and Touche LLP, most recently as a senior manager. Edward L. Dudley Mr. Dudley joined the Company in January 1997 to spearhead the Company's newly-formed Product Sales Development function as Vice President - Sales and Marketing, with the goal of increasing the Company's factory and retail sales. During his 10 year career with Baxter Healthcare Corporation, Mr. Dudley served in a number of senior marketing and sales management capacities, including most recently that of Director, Distribution Services from March 1996 to January 1997. Mr. Dudley holds B.S. degrees in Finance and Accounting from the University of Colorado. Gary S. Hauer Mr. Hauer joined the Company in May 1996 as Vice President of Manufacturing. Mr. Hauer has served in a number of manufacturing management capacities over a 28 year career in the chocolate candy and confectionery industries, including 18 years with See'S Candies, the last 10 years of which he served as plant manager. Mr. Hauer possesses a B.S. in business administration from San Jose State University. 44 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. Jay B. Haws Mr. Haws joined the Company in August 1991 as Vice President of Creative Services. Since 1981, Mr. Haws had been closely associated with the Company both as a franchisee and marketing/graphic design consultant. From 1986 to 1991 he operated two Rocky Mountain Chocolate Factory franchises located in San Francisco, California. From 1983 to 1989 he served as Vice President of Marketing for Image Group, Inc., a marketing communications firm based in Northern California. Concurrently, Mr. Haws was co-owner of two other Rocky Mountain Chocolate Factory franchises located in Sacramento and Walnut Creek, California. From 1973 to 1983 he was principal of Jay Haws and Associates, an advertising and graphic design agency. Mr. Haws holds a B.A. in graphics design and communication from California State University. Virginia M. Perez Ms. Perez joined the Company in June 1996 and has served as the Company's corporate secretary since February, 1997. From 1992 until joining the Company, she was employed by Huettig & Schromm, Inc., a property management and development firm in Palo Alto, California as executive assistant to the president and owner. Huettig & Schromm developed, owned and managed over 1,000,000 square feet of office space in business parks and office buildings on the San Francisco peninsula. Ms. Perez is a paralegal and has held various administrative positions during her career including executive assistant to the Chairman and owner of Sunset Magazine & Books, Inc. Gerald A. Kien Dr. Kien was first elected as a Director of the Company in August 1995. From 1993 to 1995 Dr. Kien served as President and Chief Executive Officer of Remote Sensing Technologies, Inc., a subsidiary of Envirotest Systems, Inc., a company engaged in the development of instrumentation for vehicle emissions testing. From 1989 to 1993 Dr. Kien served as Chairman, President and Chief Executive Officer of Sun Electric Corporation, a manufacturer of automotive test equipment, and has served as a Director and as Chairman of the Executive Committee of that Company since 1980. Sun Electric merged with Snap-On Tools in 1993, and Dr. Kien remained as President of the Sun Electric division of Snap-On Tools until his retirement in 1994. Dr. Kien was a co-founder of the First National Bank of Hoffman Estates and remained as a Director from 1979 to 1990, and was a Director of the Charter Bank and Trust of Illinois from 1984 to 1990. He served as a Director of Systems Control, Inc. and Vehicle Test Technologies, Inc., from 1989 to 1993, both of which are engaged in emissions testing of motor vehicles. Dr. Kien received his Ph.D. from the University of Illinois Graduate College of Medicine, in 1959. Lee N. Mortenson Mr. Mortenson has served on the Board of Directors of the Company since 1987. Mr. Mortenson has served as President, Chief Operating Officer and a Director of Telco Capital Corporation of Chicago, Illinois since January 1984. Telco Capital Corporation is principally engaged in the manufacturing and real estate businesses. He was President, Chief Executive Officer and a Director of Sunstates Corporation (formerly Acton Corporation) from May 1988 to December 1990 and he has been President, Chief Operating Officer and a Director of Sunstates Corporation since December 1990. Sunstates Corporation is a publicly traded company primarily engaged in real estate development and manufacturing. Mr. Mortenson has been a Director of Alba-Waldensian, Inc., which is principally engaged in the manufacturing of apparel and medical products, since 1984 and has served as its President and Chief Executive Officer since 45 February 1997. Mr. Mortenson has also served as a Director of NRG Inc., a leasing company, since 1987. On December 24, 1996, an Agreed Order of Liquidation with a finding of insolvency was entered under the Illinois Insurance Code against the principal subsidiary of Sunstates Corporation, Coronet Insurance Company ("Coronet"), and Coronet's subsidiaries, National Assurance Indemnity Company ("National Assurance") and Crown Casualty Company ("Crown"), pursuant to which, among other things, all of the assets of Coronet, National Assurance and Crown were transferred to the Office of the Special Deputy for the purposes of winding up the affairs of such companies. On February 27, 1997, a consent order appointing the Florida Department of Insurance as Receiver for purposes of liquidation was entered under the Florida Insurance Code against Casualty Insurance Company of Florida ("Casualty"), a subsidiary of Coronet. Mr. Mortenson, prior to March 14, 1997, was a Director and President of each of Coronet, National Assurance, Crown and Casualty. On January 24, 1997, Hickory White Company, a furniture manufacturing subsidiary of Sunstates Corporation, filed a voluntary petition under Chapter 11 of the Federal Bankruptcy Code. All of the assets of Hickory White Company were sold to an unrelated party on March 11, 1997. Mr. Mortenson is Vice President and a Director of Hickory White Company. Fred M. Trainor Mr. Trainor has served as a Director since August 1992. Mr. Trainor is the founder, and since 1984 has served as Chief Executive Officer and President of AVCOR Health Care Products, Inc., Fort Worth, Texas, a manufacturer and marketer of specialty dressings products. Prior to founding AVCOR Health Care Products, Inc., in 1984, Mr. Trainor was a founder, Chief Executive Officer and President of Tecnol, Inc. of Fort Worth, Texas, also a company involved with the health care industry. Before founding Tecnol, Inc., Mr. Trainor was with American Hospital Supply Corporation (AHSC) for 13 years in a number of management capacities. The Board of Directors has a standing Audit Committee and Compensation Committee, each consisting of Messrs. Mortenson, Trainor and Kien. Currently, all Directors of the Company are elected annually by the stockholders and hold office until their respective successors are elected and qualified. SECTION 16 (a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE The Company has no knowledge that any Director, executive officer or 10% stockholder was required to file a Form 5 for fiscal 1998 and failed to do so, and the Company has received a written representation that a Form 5 was not required from each such person. In making these disclosures, the Company has relied solely on written representations of its directors, executive officers and 10% stockholders and copies of the reports filed by them with the Securities and Exchange Commission. 46 ITEM 11. EXECUTIVE COMPENSATION The following table sets forth certain information with respect to annual compensation paid for the years indicated to the Company's "Named Officers". No other executive officers of the Company met the minimum compensation threshold of $100,000 for inclusion in the table. SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION AWARDS- ANNUAL COMPENSATION SECURITIES UNDERLYING NAME AND PRINCIPAL OPTIONS ALL OTHER POSITION YEAR SALARY(1) BONUS (#)(2) COMPENSATION(3) Franklin E. Crail, Chairman of the Board and President 1999 $161,250 $67,500 -- $2,500 1998 $150,000 -- -- $2,250 1997 $150,000 -- -- $2,250 Bryan J. Merryman Chief Operating Officer, Chief Financial Officer and Director 1999 $107,500 $20,000 -- -- 1998 (4) $25,000 -- 30,000 -- 1997 -- -- -- -- Gary S. Hauer, Vice President- Manufacturing (5) 1999 $107,000 $20,000 -- $1,500 1998 $100,000 $12,500 -- $ 750 1997 (4) $ 75,071 -- 30,000 -- Jay B. Haws, Vice President-- Creative Services 1999 $98,500 $23,500 -- $1,830 1998 $94,000 -- -- $1,410 1997 $94,000 -- 10,000 $1,410 Clifton W. Folsom, Vice President-- Franchise Support 1999 $97,500 $22,500 -- -- 1998 $90,000 -- -- $104 1997 $90,000 -- 10,000 $1,350
(1) Includes amounts deferred at the Named Officers' election pursuant to the Company's 401(k) Plan. (2) Options to acquire shares of Common Stock under the 1995 Stock Option Plan. All options have ten-year terms. The options granted vest with respect to one-fifth of the shares covered thereby annually beginning on the date of grant. (3) Represents Company contributions on behalf of the Named Officers under the Company's 401(k) Plan. (4) Mr. Hauer joined the Company as an officer in May 1996. Mr. Merryman joined the Company as an officer in December 1997. (5) Mr. Hauer resigned as an officer of the Company on May 21, 1999. Additional columns required by Securities and Exchange Commission rules to be included in the foregoing table, and certain additional tables required by such rules, have been omitted because no compensation required to be disclosed therein was paid or awarded to the Named Officers. 47 OPTION GRANTS DURING FISCAL 1999 None of the Named Officers received grants in fiscal 1999. AGGREGATED OPTION EXERCISES DURING FISCAL 1999 AND FISCAL YEAR END OPTION VALUES The following table provides information regarding the number and value of options held by the Named Officers at fiscal year end. The Company does not have any outstanding stock appreciation rights.
Number of Securities Shares Underlying Unexercised Value of Unexercised Acquired on Value Options at Fiscal In-the-Money Options at Fiscal Exercise Realized Year End (#) Year End ($) (1) Name (#) ($) Exercisable Unexercisable Exercisable Unexercisable Franklin E. Crail -- -- -- -- -- -- Bryan J. Merryman -- -- 6,000 24,000 -- -- Gary S. Hauer -- -- 12,000 18,000 -- -- Jay B. Haws 15,000 $48,750 27,000 4,000 $4,000 -- Clifton W. Folsom -- -- 29,000 4,000 $4,000 --
(1) The closing bid price of the Common Stock on the Nasdaq Stock Market on February 26, 1999, was $4.50 per share. Value of unexercised in the money options at fiscal year end was determined by the difference between the closing bid price and option strike price multiplied by the number of option shares. COMPENSATION OF DIRECTORS Directors of the Company do not receive any compensation for serving on the Board or on committees. Directors who are not officers or employees are entitled to receive stock option awards under the Company's 1990 Nonqualified Stock Option Plan for Nonemployee Directors (the "Director's Plan"). The Director's Plan, as amended, provides for automatic grants of nonqualified stock options covering a maximum of 90,000 shares of Common Stock of the Company to Directors of the Company who are not also employees or officers of the Company and who have not made an irrevocable, one-time election to decline to participate in the plan. The Director's Plan provides that during the term of the plan options will be granted automatically to new nonemployee Directors upon their election. Each such option permits the nonemployee Director to purchase 10,000 shares of Common Stock at an exercise price equal to the fair market value of the Common Stock on the date of grant of the option. Each nonemployee Director's option may be exercised in full during the period beginning one year after the grant date of such option and ending ten years after such grant date, unless the option expires sooner due to termination of service or death. No options were granted under the Director's Plan during fiscal 1999. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Compensation Committee of the Company's Board of Directors consists of Lee N. Mortenson, Fred M. Trainor and Gerald A. Kien. None of the foregoing persons is or has been an officer of the Company. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information, at May 24, 1999, with respect to the shares of the Company's common stock beneficially owned by (i) each person known to the Company to be the beneficial owner of more than 5% of the Company's Common Stock, (ii) each Director and nominee, (iii) each Named Officer and (iv) 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 48 beneficial ownership of that security within sixty (60) days through the exercise of an option or through the conversion of another security. Except as noted, each beneficial owner has sole investment and voting power with respect to the Common Stock. Common Stock not outstanding that is subject to options is deemed to be outstanding for the purpose of computing the percentage of Common Stock beneficially owned by the person holding such options, but is not deemed to be outstanding for the purpose of computing the percentage of Common Stock beneficially owned by any other person. Common Stock
Amount and Name of Nature of Percent Beneficial Beneficial of Owner Ownership Class Franklin E. Crail (1) 298,924 11.5% Clyde Wm. Engle et al. (1) 219,357 (2) 8.4% Fred M. Trainor 70,000 (3) 2.7% Jay B. Haws 57,216 (4) 2.2% Clifton W. Folsom 54,716 (5) 2.1% Gary S. Hauer 37,991 (6) 1.5% Lee N. Mortenson 27,000 (3) 1.0% Bryan J. Merryman 20,000 (7) .8% Gerald A. Kien 10,000 (3) .4% All executive officers and directors as a group (9 persons) 597,847 (8) 23.0%
(1) Mr. Engle's address is 4433 West Touhy Avenue, Lincolnwood, Illinois 60646. Mr. Crail's address is the same as the Company's address. (2) The following information was provided to the Company by Mr. Engle. Of the 219,357 shares indicated as being beneficially owned by Mr. Engle, 115,000 shares are owned by GSC Enterprises, Inc., a corporation in which Mr. Engle owns a majority interest, and 10,000 shares are owned beneficially by members of Mr. Engle's immediate family. Mr. Engle disclaims beneficial ownership of the shares owned by his family members. (3) Includes 10,000 shares that Messrs. Mortenson, Trainor and Kien each has the right to acquire within 60 days through the exercise of options granted pursuant to the Director's Plan. Mr. Mortenson has pledged 8,000 shares owned by him to the Company to secure payment of certain indebtedness to the Company incurred by Mr. Mortenson in connection with his purchase of such shares. (4) Includes 27,000 shares Mr. Haws has the right to acquire within 60 days through the exercise of employee stock options previously granted to him. Mr. Haws has pledged 15,000 shares owned by him to the Company to secure payment of certain indebtedness to the Company incurred by Mr. Haws in connection with his purchase of such shares. (5) Includes 29,000 shares Mr. Folson has the right to acquire within 60 days through the exercise of employee stock options previously granted to him. Mr. Folsom has pledged 8,000 shares owned by him to the Company to secure payment of certain indebtedness to the Company incurred by Mr. Folsom in connection with his purchase of such shares. (6) Includes 18,000 shares Mr. Hauer has the right to acquire within 60 days through the exercise of employee stock options previously granted to him and 5,991 shares beneficially owned by his wife. Mr. Hauer disclaims beneficial ownership of the shares owned by his wife. Mr. Hauer has pledged 8,000 shares owned by him to the Company to secure payment of certain indebtedness to the Company incurred by Mr. Hauer in connection with his purchase of such shares. 49 (7) Includes 6,000 shares Mr. Merryman has the right to acquire within 60 days through the exercise of employee stock options previously granted to him. Mr. Merryman has pledged 8,000 shares owned by him to the Company to secure payment of certain indebtedness to the Company incurred by Mr. Merryman in connection with his purchase of such shares. (8) 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. POTENTIAL CHANGE IN CONTROL On May 10, 1999, Whitman's Candies, Inc. commenced an unsolicited tender offer for all of the outstanding shares of Common Stock of the Company at a price of $5.75 per share in cash. The Board of Directors of the Company, in a May 21, 1999 letter to shareholders, indicated that the tender offer is inadequate and not in the best interests of either the Company or its shareholders and recommended that the shareholders reject the tender offer. Unless extended or earlier withdrawn by the offeror, the tender offer will expire on June 16, 1999. See Note 15 to the Financial Statements included elsewhere in this Report. If such tender offer is successful, it will result in a change in control of the Company. 50 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS NONE PART IV. ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: 1. Financial Statements
Page Report of Independent Certified Public Accountants 26 Statements of Operations 27 Balance Sheets 29 Statements of Changes in Stockholders' Equity 30 Statements of Cash Flows 31 Notes to Financial Statements 32
2. Financial Statement Schedules
Page Report of Independent Certified Public Accountants on Schedules 51 SCHEDULE II - Valuation and Qualifying Accounts 51
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULES Board of Directors and Stockholders Rocky Mountain Chocolate Factory, Inc. In connection with our audit of the financial statements of Rocky Mountain Chocolate Factory, Inc. referred to in our report dated May 12, 1999, which is included in Part II of this form, we have also audited Schedule II for each of the three years in the period ended February 28, 1999. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein. GRANT THORNTON LLP Dallas, Texas May 12, 1999 SCHEDULE II - Valuation and Qualifying Accounts
Balance at Additions Charged Balance at End of Beginning of Period to Costs & Exp. Deductions Period Year Ended February 28, 1999 Accounts Receivable Allowance 214,152 120,000 74,744 259,408 Year Ended February 28, 1998 Accounts Receivable Allowance 202,029 49,525 37,402 214,152 Year Ended February 28, 1997 Accounts Receivable Allowance 28,196 295,000 121,167 202,029
51 3. Exhibits
Exhibit Incorporated by Number Description Reference to 3.1 Articles of Incorporation of the Registrant, Exhibit 3.1 to Current Report on Form 8-K as amended of the Registrant filed on August 1, 1988. 3.2 By-laws of the Registrant, as amended on Exhibit 3.2 to the Annual Report on Form November 25, 1997 10-K of the Registrant for the fiscal year ended February 28, 1998. 4.1 Specimen Common Stock Certificate Exhibit 4.1 to Current Report on Form 8-K of the Registrant filed on August 1, 1988. 4.2 Term Loan and Credit Agreement dated April Exhibit 4.18 to the Annual Report on Form 5, 1996 in the amount of $2,000,000 between 10-K of the Registrant for the fiscal year Norwest Banks and the Registrant ended February 29, 1996. 4.3 Amendments dated February 5, 1997, May 2, Exhibit 4.12 to the Annual Report on Form 1997, and May 22, 1997 to Term Loan and 10-K of the Registrant for the fiscal year Credit Agreement dated April 5, 1996 in the ended February 28, 1997. amount of $2,000,000 between Norwest Banks and the Registrant 4.4 Amendments dated December 23, 1997, March 9, Exhibit 4.4 to the Annual Report on Form 1998 & May 6, 1998 to Term Loan and Credit 10-K of the Registrant for the fiscal year Agreement dated April 5, 1996 in the amount ended February 28, 1998. of $2,000,000 between Norwest Banks and the Registrant 4.5 Instruments with respect to long-term debt not exceeding 10% of the total assets of the Company have not been filed. The Company agrees to furnish a copy of such instruments to the Securities and Exchange Commission upon request. 10.1 Form of Stock Option Agreement for Incentive Exhibit 10.3 to the Annual Report on Form Stock Option Plan of the Registrant * 10-K of the Registrant for the fiscal year ended February 28, 1986. 10.2 Incentive Stock Option Plan of the Exhibit 10.2 to the Annual Report on Form Registrant as amended July 27, 1990 * 10-K of the Registrant for the fiscal year ended February 28, 1991.
52
Exhibit Incorporated by Number Description Reference to 10.3 Form of Employment Agreement between the Exhibit 99.2 to Schedule on Form 14D9 Registrant and its officers * of the Registrant filed on May 21, 1999. 10.4 Current form of franchise agreement used by Filed herewith. the Registrant 10.5 Form of Real Estate Lease between the Exhibit 10.7 to Registration Statement on Registrant as Lessee and franchisee as Form S-18 (Registration No. 33-2016-D). Sublessee 10.6 Form of Nonqualified Stock Option Agreement Exhibit 10.8 to the Annual Report on Form for Nonemployee Directors of the Registrant * 10-K of the Registrant for the fiscal year ended February 28, 1991. 10.7 Nonqualified Stock Option Plan for Exhibit 10.9 to the Annual Report on Form Nonemployee Directors dated March 20, 1990 * 10-K of the Registrant for the fiscal year ended February 28, 1991. 10.8 1995 Stock Option Plan of the Registrant* Exhibit 10.9 to Registration Statement on Form S-1 (Registration No. 33-62149) filed August 25, 1995. 10.9 Forms of Incentive Stock Option Agreement Exhibit 10.10 to Registration Statement on for 1995 Stock Option Plan* Form S-1 (Registration No. 33-62149) filed on August 25, 1995. 10.10 Forms of Nonqualified Stock Option Agreement Exhibit 10.11 to Registration Statement on for 1995 Stock Option Plan* Form S-1 (Registration No. 33-62149) filed on August 25, 1995. 10.11 Form of Indemnification Agreement between Exhibit 10.12 to the Annual Report on Form the Registrant and its directors 10-K of the Registrant for the fiscal year ended February 28, 1998. 10.12 Form of Indemnification Agreement between Exhibit 10.13 to the Annual Report on Form the Registrant and its officers 10-K of the Registrant for the fiscal year ended February 28, 1998. 10.13 Form of Promissory Note and Stock Pledge Exhibit 10.14 to the Annual Report on Form Agreement between the Registrant and certain 10-K of the Registrant for the fiscal year of its officers and directors ended February 28, 1998. 10.14 Asset Purchase Agreement dated June 5, 1998 Exhibit 10.15 to the Annual Report on Form between the Registrant as seller and Resort 10-K of the Registrant for the fiscal year Confections, Inc. et al., as purchasers ended February 28, 1998.
53
Exhibit Incorporated by Number Description Reference to 11.1 Statement re: computation of per share Filed herewith. earnings 23.1 Consent of Independent Public Accountants Filed herewith. 27.1 Fiscal 1999 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, 1999. 54 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. By/S/ Bryan J. Merryman -------------------------------- BRYAN J. MERRYMAN Vice-President - Finance, Chief Operating Officer, Chief Financial Officer and Director Date: May 28, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date: May 28, 1999 /S/ Franklin E. Crail -------------------------------- FRANKLIN E. CRAIL Chairman of the Board of Directors, President, Treasurer and Director (principal executive officer) Date: May 28, 1999 /S/ Bryan J. Merryman -------------------------------- BRYAN J. MERRYMAN Vice President - Finance Chief Financial Officer (principal financial and accounting officer) Date: May 28, 1999 /S/ Gerald A Kien -------------------------------- GERALD A. KIEN, Director Date: May 28, 1999 /S/ Lee N. Mortenson -------------------------------- LEE N. MORTENSON, Director Date: May 28, 1999 /S/ Fred M. Trainor -------------------------------- FRED M. TRAINOR, Director 55 EXHIBIT INDEX
Exhibit Incorporated by Number Description Reference to 3.1 Articles of Incorporation of the Exhibit 3.1 to Current Report on Form 8-K of the Registrant, as amended Registrant filed on August 1, 1988. 3.2 By-laws of the Registrant, as amended Exhibit 3.2 to the Annual Report on Form 10-K of on November 25, 1997 the Registrant for the fiscal year ended February 28, 1998. 4.1 Specimen Common Stock Certificate Exhibit 4.1 to Current Report on Form 8-K of the Registrant filed on August 1, 1988. 4.2 Term Loan and Credit Agreement dated Exhibit 4.18 to the Annual Report on Form 10-K of April 5, 1996 in the amount of the Registrant for the fiscal year ended February $2,000,000 between Norwest Banks and 29, 1996. the Registrant 4.3 Amendments dated February 5, 1997, May Exhibit 4.12 to the Annual Report on Form 10-K of 2, 1997, and May 22, 1997 to Term Loan the Registrant for the fiscal year ended February and Credit Agreement dated April 5, 28, 1997. 1996 in the amount of $2,000,000 between Norwest Banks and the Registrant 4.4 Amendments dated December 23, 1997, Exhibit 4.4 to the Annual Report on Form 10-K of March 9, 1998 & May 6, 1998 to Term the Registrant for the fiscal year ended February Loan and Credit Agreement dated April 28, 1998. 5, 1996 in the amount of $2,000,000 between Norwest Banks and the Registrant 4.5 Instruments with respect to long-term debt not exceeding 10% of the total assets of the Company have not been filed. The Company agrees to furnish a copy of such instruments to the Securities and Exchange Commission upon request. 10.1 Form of Stock Option Agreement for the Exhibit 10.3 to The Annual Report on Form 10-K of Registrant * the Registrant for the fiscal year ended February 28, 1986. 10.2 Incentive Stock Option Plan of the Exhibit 10.2 to the Annual Report on Form 10-K of Registrant as amended July 27, 1990 * the Registrant for the fiscal year ended February 28, 1991.
56
Incorporated by Description Reference to 10.3 Form of Employment Agreement between the Exhibit 99.2 to Schedule on Form 14D9 of Registrant and its officers * the Registrant filed on May 21, 1999. 10.4 Current form of franchise agreement Filed herewith. used by the Registrant 10.5 Form of Real Estate Lease between the Exhibit 10.7 to Registration Statement on Form S-18 Registrant as Lessee and franchisee as (Registration No. 33-2016-D). Sublessee 10.6 Form of Nonqualified Stock Option Exhibit 10.8 to the Annual Report on Form 10-K of Agreement for Nonemployee Directors for the Registrant for the fiscal year ended February the Registrant * 28, 1991. 10.7 Nonqualified Stock Option Plan for Exhibit 10.9 to the Annual Report on Form 10-K of Nonemployee Directors dated March 20, the Registrant for the fiscal year ended February 1990 * 28, 1991. 10.8 1995 Stock Option Plan of the Exhibit 10.9 to Registration Statement on Form S-1 Registrant* (Registration No. 33-62149) filed August 25, 1995. 10.9 Forms of Incentive Stock Option Exhibit 10.10 to Registration Statement on Form S-1 Agreement for 1995 Stock Option Plan* (Registration No. 33-62149) filed on August 25, 1995. 10.10 Forms of Nonqualified Stock Option Exhibit 10.11 to Registration Statement on Form S-1 Agreement for 1995 Stock Option Plan* (Registration No. 33-62149) filed on August 25, 1995. 10.11 Form of Indemnification Agreement Exhibit 10.12 to the Annual Report on Form 10-K of between the Registrant and its directors the Registrant for the fiscal year ended February 28, 1998. 10.12 Form of Indemnification Agreement Exhibit 10.13 to the Annual Report on Form 10-K of between the Registrant and its officers the Registrant for the fiscal year ended February 28, 1998. 10.13 Form of Promissory Note and Stock Exhibit 10.14 to the Annual Report on Form 10-K of Pledge Agreement between the Registrant the Registrant for the fiscal year ended February and certain of its officers and 28, 1998. directors
57
Incorporated by Description Reference to 10.14 Asset Purchase Agreement dated June 5, Exhibit 10.15 to the Annual Report on Form 10-K of 1998 between the Registrant as seller the Registrant for the fiscal year ended February and Resort Confections, Inc. et al., as 28, 1998. purchasers 11.1 Statement re: computation of per share Filed herewith. earnings 23.1 Consent of Independent Public Filed herewith. Accountants 27.1 Fiscal 1999 Financial Data Schedule Filed herewith.
58 EX-10.4 2 EXHIBIT 10.4 Exhibit 10.4 ROCKY MOUNTAIN CHOCOLATE FACTORY FRANCHISE AGREEMENT Franchisee:_________________________ Date:_______________________________ Franchised Location:________________ (7/1/98) 10. FRANCHISEE'S OPERATIONAL COVENANTS.......................................................................9 10.1. Store 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 Store 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
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.................................................................................35 22.12. Notices....................................................................................35 22.13. Acknowledgement............................................................................35
EXHIBITS I. Addendum to Franchise Agreement - Location Approval II. Personal Guaranty III. Statement of Ownership ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. FRANCHISE AGREEMENT THIS AGREEMENT (the "Agreement") is made this ____ day of ________, 199__, by and between ROCKY MOUNTAIN CHOCOLATE FACTORY, INC., a Colorado corporation, located at 265 Turner Drive, Durango, Colorado 81301 (the "Franchisor") and _______________, located at __________________ (the "Franchisee"), who, on the basis of the following understandings and agreements, agree as follows: 1. PURPOSE 1.1. The Franchisor has developed methods for establishing, operating and promoting retail stores selling gourmet chocolates and other premium confectionery products ("ROCKY MOUNTAIN CHOCOLATE FACTORY Stores" or "Stores") using the service mark "ROCKY MOUNTAIN CHOCOLATE FACTORY" and related trade names and trademarks ("Marks") and the Franchisor's proprietary methods of doing business (the "Licensed Methods"). 1.2. The Franchisor grants the right to others to develop and operate a ROCKY MOUNTAIN CHOCOLATE FACTORY Store, under the Marks and pursuant to the Licensed Methods. 1.3. The Franchisee desires to establish a ROCKY MOUNTAIN CHOCOLATE FACTORY Store at a location identified herein or to be later identified, and the Franchisor desires to grant the Franchisee the right to operate a ROCKY MOUNTAIN CHOCOLATE FACTORY Store at such location under the terms and conditions which are contained in this Agreement. 2. GRANT OF FRANCHISE 2.1. GRANT OF FRANCHISE. The Franchisor grants to the Franchisee, and the Franchisee accepts from the Franchisor, the right to use the Marks and Licensed Methods in connection with the establishment and operation of a ROCKY MOUNTAIN CHOCOLATE FACTORY Store, at the location described in Article 3 of this Agreement. The Franchisee agrees to use the Marks and Licensed Methods, as they may be changed, improved, and further developed by the Franchisor from time to time, only in accordance with the terms and conditions of this Agreement. 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 Store. 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 Store 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 assorted bulk chocolates and boxed and packaged candies. The Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 Store 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 Store 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 ROCKY MOUNTAIN CHOCOLATE FACTORY Store within a certain geographic area as set forth in EXHIBIT I ("Protected Territory"). 2 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 Store 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, in which case the Franchisor and the Franchisee shall execute EXHIBIT IV or EXHIBIT V to this Agreement, whichever is applicable, relating to the operation of "Satellite Stores" (if this Agreement governs the operation of a traditional Store, any Satellite Store(s) shall be governed by separate Franchise Agreements) or "Temporary Stores." 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 Stores, Satellite Stores and Temporary Stores, at any location other than in the Protected Territory; (2) to use the Marks and Licensed Methods to identify services and products, promotional and marketing efforts or related items, and to identify products and services similar to those which the Franchisee will sell, but made available through alternative channels of distribution other than through traditional ROCKY MOUNTAIN CHOCOLATE FACTORY Stores, at any location, including, but not limited to, through Satellite Stores, Temporary Stores, by way of mail order, (including electronic mail order), catalog, television, retail store kiosk or display or through the wholesale sale of its products to unrelated retail outlets or to candy distributors or outlets located in stadiums, arenas, airports, turnpike rest stops or supermarkets in the Franchisee's Protected Territory; and (3) to use and license the use of other proprietary marks or methods in connection with the sale of products and services similar to those which the Franchisee will sell or in connection with the operation of retail stores selling gourmet chocolates or other premium confectionery products, at any location, which stores are the same as, or similar to, or different from a traditional ROCKY MOUNTAIN CHOCOLATE FACTORY Store or a Satellite Store or a Temporary Store, 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 Store, 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 3 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. 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 Stores 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 Store signs which comply with the standards and specifications of the Franchisor as 4 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. 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 Store 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 Store. 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 Store. 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 Store 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 Store 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 Store 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 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 Store. 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 ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 Store, ("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 Store. 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. 6 7. DEVELOPMENT ASSISTANCE 7.1. FRANCHISOR'S DEVELOPMENT ASSISTANCE. The Franchisor shall provide the Franchisee with assistance in the initial establishment of the ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 Store 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 Store. 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 Store a representative ("Site Representative") to be present during the opening of the Franchisee's ROCKY MOUNTAIN CHOCOLATE FACTORY Store. There will be no charge to the Franchisee for this service provided by the Franchisor. 7 The Site Representative will assist the Franchisee's employees in opening the Store, 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, 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 Store. 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 Store, the Franchisor shall make available to the Franchisee the following services: 8 a. Upon the reasonable request of the Franchisee, consultation by telephone regarding the continued operation and management of a ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 on-going operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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. 9 10. FRANCHISEE'S OPERATIONAL COVENANTS 10.1. STORE OPERATIONS. The Franchisee acknowledges that it is solely responsible for the successful operation of its ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 Store 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 Store. 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 Store 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 Store after commencement of Store operations and be present at the Franchised Location during operation of the Store. 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 Store, including, without limitation, filling "Wholesale Orders", defined below, any catering or off-premises sales, without the prior written consent of 10 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, 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 Store, 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 Store. 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 Store at the Franchised Location, both of which shall be listed and identified exclusively with the ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 Store 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 11 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 Store, 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. j. The Franchisee shall be responsible for training all of its employees who work in any capacity in the ROCKY MOUNTAIN CHOCOLATE FACTORY Store. 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 Store. k. The Franchisee shall at all times during the term of this Agreement own and control the ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 Store 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 Store 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 12 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. 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 Store. 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 Store, 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 13 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 advertising or other marketing or promotional programs published by any method, including print, broadcast or electronic media, regarding the ROCKY MOUNTAIN CHOCOLATE FACTORY Store, including, without limitation, "Yellow Pages" advertising, newspaper ads, flyers, brochures, coupons, direct mail pieces, specialty and novelty items, radio, television, Internet and World Wide Web 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 Store 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 Store in the manner prescribed by the Franchisor. The Franchisee shall not, under any circumstances, use handwritten signs in the operation of its Store. 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 Store. 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 Stores will be required to spend money for local advertising on an equal percentage basis with all franchised Stores. 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 14 ("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 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 up to 50% 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 15 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. 1.1. 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 Store 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 Store and specifically, for the candy processing recipes, uniforms, materials, forms, menu boards, items and supplies used in connection with the Store. The Franchisor reserves the right to change standards and specifications for services and products offered at or through the ROCKY MOUNTAIN CHOCOLATE FACTORY Store and for the candy processing recipes, uniforms, materials, forms, items and supplies used in connection with the Store 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 Store 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. 16 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 Store 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 ROCKY MOUNTAIN CHOCOLATE FACTORY Store. 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 Store 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. 1.1. 13.39. APPROVED SUPPLIERS. The Franchisee shall purchase all products, services, supplies and materials required for the operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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. 13.5. 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 17 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. 13.6. 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. 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 Store as it is governed by this Agreement. Except as permitted in the Operations Manual, the Franchisee agrees not to use any of the Marks as part of an electronic mail address, or on any sites on the Internet or World Wide Web and the Franchisee agrees not to use or register any of the Marks as a domain name on the Internet. 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 Store. 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 Store 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 18 or interest in the Licensed Methods except for the right to use the Licensed Methods in the operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 Store, 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 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 STORE 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 19 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 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 Store, 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 20 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 Store 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 ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 Store 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 Store. 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 Store, 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 Store at any time at the Franchisor's expense, without prior notification to the Franchisee. The Franchisor may make 21 the results of any such service evaluation available to the Franchisee, in the Franchisor's sole discretion. 16. TRANSFER 16.1. TRANSFER 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. As used in this Agreement, the term "transfer" includes the Franchisee's voluntary, involuntary, direct or indirect assignment, sale, gift or other disposition of any interest in: (1) this Agreement; (2) the Franchisee entity; (3) the Store governed by this Agreement; or (4) all or a substantial portion of the assets of the Store. 16.2. PRE-CONDITIONS TO FRANCHISEE'S TRANSFER. The Franchisee shall not engage in a transfer unless the Franchisee obtains the Franchisor's written consent and the Franchisee and the proposed transferee comply with the following requirements: a. 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, are paid in full; b. The proposed transferee agrees to operate the Store as a ROCKY MOUNTAIN CHOCOLATE FACTORY Store and agrees 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 the transfer is effective; c. The proposed transferee agrees to execute the then current form of Franchise Agreement 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 initial franchise fee; d. The Franchisee provides written notice to the Franchisor 30 days' prior to the proposed effective date of the transfer, and includes information reasonably detailed to enable the Franchisor to evaluate the terms and conditions of the proposed transfer and which at a minimum includes a written offer from the proposed transferee; e. The proposed transferee provides information to the Franchisor sufficient for the Franchisor to assess the proposed transferee's business experience, aptitude and financial qualification, and the Franchisor approves the proposed transferee as a franchisee; 22 f. The Franchisee executes 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. The Franchisee or the proposed transferee pay a transfer fee of $2,500; provided, however, that no transfer fee will be charged for a transfer by the Franchisee to a corporation wholly-owned by the Franchisee, between partners of a partnership Franchisee or to a spouse of a Franchisee upon the death or disability of the Franchisee; and h. The Franchisee agrees to abide by all post-termination covenants set forth herein, including, without limitation, the covenant not to compete 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 transfer. 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 transfer 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 engage in a transfer, 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 notice set forth in Section 16.2(d); provided, however, the following additional terms and conditions shall apply: a. 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; b. The right of first refusal will be 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 the Franchisor shall have a new 30 day right of first refusal; c. If the consideration or manner of payment offered by a proposed transferee 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 23 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 d. If the Franchisor chooses not to exercise its right of first refusal, the Franchisee shall be free to complete the transfer subject to compliance with Sections 16.2 and 16.3 above. Absence of a reply to the Franchisee's notice of a proposed transfer within the 30 day period may be 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 transfer as provided for above, shall apply (1) if the Franchisee is a partnership, corporation or other business association, (i) to the addition or deletion of a partner, shareholder or members of the association or the transfer of any ownership interest among existing partners, shareholders or members; (ii) to any proposed transfer of 25% or more of the interest (whether stock, partnership interest or membership interest) to a third party, whether such transfer occurs in a single transaction or several transactions; and (2) if the Franchisee is an individual, to the transfer from such individual or individuals to a corporation or other entity 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; and (ii) a limitation on the corporation's or other entity's business activity to that of operating the ROCKY MOUNTAIN CHOCOLATE FACTORY Store and related activities provided that with respect to such transfer, the Franchisor's right of first refusal to purchase shall not apply and the Franchisor will not charge any transfer fee. 16.6. TRANSFER 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 individual owning 25% or more of, or controlling the Franchisee entity), the 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 (unless extended by probate proceedings), 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 transfer fee charged by the Franchisor. Failure to transfer the interest 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 25% or more of, or controlling, the Franchisee entity) from 24 supervising the management and operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Store for a period of 120 days from the onset of such disability, impairment or condition. 25 TERM AND EXPIRATION 17.1. TERM. The term of this Agreement begins on the date this Agreement is fully executed and ends five years from the date the Store opens, as set forth in EXHIBIT I-2, 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 Store 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 $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 execute the then current Franchise Agreement or pay the successor franchise fee, the Franchisor shall 26 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 Store or otherwise abandons the ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 Store, unless and only to the extent that full operation of the ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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. ss.ss. 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 Store 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; 27 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 Store or a substantial portion of the assets of the ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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; 28 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 Store 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. Additionally, in the event this Agreement is terminated by the Franchisor prior to its expiration as set forth in Sections 18.1 or 18.2 above, the Franchisee acknowledges and agrees that in addition to all other available remedies, the Franchisor shall have the right to recover lost future Royalties during any period in which the Franchisee fails to pay such Royalties through and including the remainder of the then current term of this Agreement. 29 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 Agreement by failing to maintain and adhere to the Franchisor's standards and specifications for the operation of the Franchisee's Store. 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 Store, 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 Store 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 Store 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 Store, 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 Store. 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 Store 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 30 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 ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 Store 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 Store; 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 Store 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; 31 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 ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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. 32 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 ROCKY MOUNTAIN CHOCOLATE FACTORY Store 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 Store 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 Store 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; 33 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 Store, 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 Stores and which constitutes 5% or more of the Gross Retail Sales of any ROCKY MOUNTAIN CHOCOLATE FACTORY Store; 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 a 10 mile radius of any other franchised or company-owned ROCKY MOUNTAIN CHOCOLATE FACTORY Store. 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. 34 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 Store 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 Store. 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 ROCKY MOUNTAIN CHOCOLATE FACTORY Store. 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 with the insurance provisions set forth herein 35 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 Stores 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 shall be interpreted under the laws of the state of Colorado and any disputes between the parties shall be governed by and determined in accordance with the substantive laws of the state of Colorado, which laws shall prevail in the event of any conflict of law. The Franchisee and the Franchisor have negotiated regarding a forum in which to resolve any disputes which may arise between them and have agreed to select a forum in order to promote stability in their relationship. Therefore, if a claim is asserted in a legal proceeding involving the Franchisee, its officers, directors, partners or managers (collectively, "Franchisee Affiliates") and the Franchisor, its officers, directors or sales employees (collectively, "Franchisor Affiliates") all parties agree that the exclusive venue for disputes between them shall be in the state and federal courts of Colorado and each waive any objections they may have to the personal jurisdiction of or venue in the state and federal courts of Colorado. The Franchisor, the Franchisor Affiliates, the Franchisee and the Franchisee Affiliates each waive their rights to a trial by jury. 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, including all exhibits and addenda hereto, 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 or for claims of negligent or fraudulent misrepresentation based on any such oral representations or commitments 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 36 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 Store, or operational assistance other than as stated in this Agreement or in any disclosure document provided by the Franchisor or its representatives. 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. If the Franchisor seeks an injunction, the Franchisor will not be required to post a bond in excess of $500. 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 37 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 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. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above set forth. 38 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. Date: By: ----------------------------- --------------------------------- Title: ------------------------------ FRANCHISEE: Date: ----------------------------- ------------------------------------ ------------------------------------ Individually AND: (if a corporation or partnership) ------------------------------------ Company Name Date: By: ----------------------------- --------------------------------- Title: ------------------------------ (7/1/98) 39 EXHIBIT I TO FRANCHISE AGREEMENT ADDENDUM TO ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. FRANCHISE AGREEMENT 1. FRANCHISED LOCATION AND PROTECTED TERRITORY. The Franchised Location, set forth in Section 3.1 of the Agreement shall be: , and the Protected Territory described in Section 3.2 of the Agreement, shall be: . 2. DESIGNATED AREA. The Franchisor and the Franchisee acknowledge that the Franchised Location cannot be designated in Section 1 above as a specific address because the location has not been selected and approved; therefore, within 120 days following the date of the Agreement, the Franchisee shall take steps to choose and acquire a location for its ROCKY MOUNTAIN CHOCOLATE FACTORY Store within the following geographic area ("Designated Area"): - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------. 3. OPENING DATE. The parties agree that the Opening Date of the Store which is the subject of the Agreement cannot be designated because the Store has not yet opened for business, but within 30 days after the Store opens for business, the parties shall sign the Rider to this Addendum specifying the Opening Date of the Store. Fully executed this day of , 19 . ------ ----------------- ---- ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. By: ------------------------------------- Title: ------------------------------------- FRANCHISEE By: ------------------------------------- Title: ------------------------------------- EXHIBIT II TO FRANCHISE AGREEMENT 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 defined 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; 3. Such liability shall not be contingent or conditioned upon pursuit by the Franchisor of any remedies against Franchisee or any other person; and 4. Such liability shall not be diminished, relieved or otherwise affected by any extension of time, credit or other indulgence which the Franchisor may from time to time grant to Franchisee or to any other person, including without limitation the acceptance of any partial payment or performance, or the compromise or release of any claims, none of which shall in any way modify or amend this guaranty, which shall be continuing and irrevocable during the term of the Agreement, including renewals thereof. IN WITNESS WHEREOF, each of the undersigned has affixed his or her signature effective on the same day and year as the Agreement was executed. WITNESS GUARANTOR(S) - ---------------------------------- ---------------------------------------- - ---------------------------------- ---------------------------------------- - ---------------------------------- ---------------------------------------- - ---------------------------------- ---------------------------------------- 2 EXHIBIT III TO FRANCHISE AGREEMENT STATEMENT OF OWNERSHIP FRANCHISEE: TRADE NAME (if different from above): Form of Ownership (Check One) Limited ______ Individual ______ Partnership ______ Corporatio ______ Liability Company If a Partnership, provide name and address of each partner showing percentage owned, whether active in management, and indicate the state in which the partnership was formed. If a Limited Liability Company, provide name and address of each member and each manager showing percentage owned and indicate the state in which the Limited Liability Company was formed. If a Corporation, give the state and date of incorporation, THE NAMES AND ADDRESSES OF EACH OFFICER AND DIRECTOR, and list the names and addresses of every shareholder showing what percentage of stock is owned by each. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Franchisee acknowledges that this Statement of Ownership applies to the ROCKY MOUNTAIN CHOCOLATE FACTORY Store authorized under the Franchise Agreement. Use additional sheets if necessary. Any and all changes to the above information must be reported to the Franchisor in writing. - -------------------------------- ----------------------------------- Date Name EX-11.1 3 EXHIBIT 11.1 Exhibit 11.1 ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. and SUBSIDIARIES COMPUTATION OF EARNINGS (LOSS) PER COMMON SHARE
For Years Ended February 28, 1999 1998 1997 BASIC EARNINGS (LOSS) PER SHARE INCOME (LOSS) FROM CONTINUING OPERATIONS 421,428 1,260,001 ($ 1,009,711) INCOME (LOSS) FROM DISCONTINUED OPERATIONS -- (1,020,083) (355,991) NET INCOME (LOSS) 421,428 239,918 (1,365,702) WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 2,665,567 2,912,387 2,908,492 DILUTIVE EFFECT OF EMPLOYEE STOCK OPTIONS 11,776 17,158 -- WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, ASSUMING DILUTION 2,677,343 2,929,545 2,908,492 BASIC EARNINGS (LOSS) PER COMMON SHARE CONTINUING OPERATIONS $ .16 $ .43 $ (.35) DISCONTINUED OPERATIONS -- (.35) (.12) NET INCOME (LOSS) $ .16 $ .08 $ (.47) DILUTED EARNINGS (LOSS) PER COMMON SHARE CONTINUING OPERATIONS $ .16 $ .43 $ (.35) DISCONTINUED OPERATIONS -- (.35) (.12) NET INCOME (LOSS) $ .16 $ .08 $ (.47)
EX-23.1 4 EXHIBIT 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our report dated May 12, 1999, accompanying the financial statements included in the Annual Report of Rocky Mountain Chocolate Factory, Inc. on Form 10-K for the year ended February 28, 1999. 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, File No. 33-62689, effective September 15, 1995, File No. 33-63177, effective October 3, 1995, File No. 33-64651, effective November 30, 1995, File No. 33-64653, effective November 30, 1995, and File No. 333-8739, effective July 24, 1996). GRANT THORNTON LLP Dallas, Texas May 12, 1999 EX-27 5 EXHIBIT 27
5 YEAR FEB-28-1999 MAR-01-1998 FEB-28-1999 317,155 0 2,133,694 259,408 3,276,550 6,358,558 15,818,990 5,580,319 18,652,100 4,800,138 5,249,769 0 0 77,988 8,431,198 18,652,100 23,193,011 26,232,528 13,153,614 24,913,898 0 0 631,477 687,153 265,725 421,428 0 0 0 421,428 .16 .16
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