<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 1998
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)
Indicate by checkmark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
--- ---
On September 23, 1998 the registrant had outstanding 2,591,599 shares of its
common stock, $.03 par value.
The exhibit index is located on page 20.
1
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ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements 3-9
Statements of Income 3
Balance Sheets 5
Statements of Cash Flows 6
Notes to Interim Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10-19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 2. Changes in Securities and Use of Proceeds 20
Item 3. Defaults Upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 20
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 20
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended August 31, Six Months Ended August 31,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
REVENUES
Sales $ 5,682,996 $ 5,079,202 $10,491,802 $ 9,391,774
Franchise and royalty fees 934,902 814,000 1,699,644 1,589,111
Total revenues 6,617,898 5,893,202 12,191,446 10,980,885
COSTS AND EXPENSES
Cost of sales 2,783,683 2,544,310 5,342,802 4,773,202
Franchise costs 289,181 277,488 568,170 542,987
Sales and marketing 428,807 278,576 827,571 559,359
General and administrative 463,228 451,453 932,945 910,790
Retail operating 1,661,386 1,427,818 3,107,272 2,917,797
Total costs and expenses 5,626,285 4,979,645 10,778,760 9,704,135
INCOME FROM OPERATIONS 991,613 913,557 1,412,686 1,276,750
OTHER INCOME (EXPENSE)
Interest expense (176,946) (169,815) (355,614) (337,473)
Interest income 16,952 30,065 42,289 45,524
Other, net (159,994) (139,750) (313,325) (291,949)
INCOME FROM CONTINUING OPERATIONS BEFORE
INCOME TAXES 831,619 773,807 1,099,361 984,801
PROVISION FOR INCOME TAXES 321,590 299,075 425,125 380,625
INCOME FROM CONTINUING OPERATIONS 510,029 474,732 674,236 604,176
INCOME (LOSS) FROM DISCONTINUED OPERATIONS -
NET OF INCOME TAXES - 19,074 - (22,249)
NET INCOME $ 510,029 $ 493,806 $ 674,236 $ 581,927
</TABLE>
(CONTINUED)
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
STATEMENTS OF INCOME (CONTINUED)
<TABLE>
<CAPTION>
Three Months Ended August 31, Six Months Ended August 31,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
BASIC EARNINGS (LOSS) PER COMMON SHARE
Continuing operations $ .20 $ .16 $ .25 $ .21
Discontinued operations - .01 - (.01)
Net income $ .20 $ .17 $ .25 $ .20
DILUTED EARNINGS (LOSS) PER COMMON SHARE
Continuing operations $ .20 $ .16 $ .25 $ .21
Discontinued operations - .01 - (.01)
Net income $ .20 $ .17 $ .25 $ .20
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 2,595,981 2,912,353 2,730,459 2,912,326
DILUTIVE EFFECT OF EMPLOYEE STOCK OPTIONS 13,766 12,909 15,599 11,460
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING,
ASSUMING DILUTION 2,609,747 2,925,262 2,746,058 2,923,786
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
August 31, February 28,
1998 1998
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 176,374 $ 1,795,381
Accounts and notes receivable, less allowance for doubtful
accounts of $202,173 and $214,152 1,876,155 2,174,618
Refundable income taxes - 483,448
Inventories 3,247,608 2,567,966
Deferred income taxes 360,849 257,176
Other 229,346 103,195
Net current assets of discontinued operations - 44,351
Total current assets 5,890,332 7,426,135
PROPERTY AND EQUIPMENT, NET 10,280,827 9,672,443
OTHER ASSETS
Net noncurrent assets of discontinued operations - 1,555,681
Accounts and notes receivable 349,028 279,122
Goodwill, less accumulated amortization
of $362,283 and $325,848 1,499,717 596,152
Other 362,030 338,359
Total other assets 2,210,775 2,769,314
Total assets $ 18,381,934 $ 19,867,892
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt $ 1,140,500 $ 1,132,900
Line of credit 750,000 -
Accounts payable 1,336,689 1,296,769
Accrued salaries and wages 675,740 707,737
Other accrued expenses 612,670 339,481
Total current liabilities 4,515,599 3,476,887
LONG-TERM DEBT, LESS CURRENT MATURITIES 5,092,574 5,993,273
DEFERRED INCOME TAXES 20,627 378,272
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, $.03 par value, 7,250,000 shares authorized,
2,599,599 and 2,912,449 issued and outstanding 77,988 87,373
Additional paid-in capital 7,037,172 8,719,604
Retained earnings 1,886,719 1,212,483
Less notes receivable from officers and directors (248,745) -
Total stockholders' equity 8,753,134 10,019,460
Total liabilities and stockholders' equity $ 18,381,934 $ 19,867,892
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended
August 31,
1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 674,236 $ 581,927
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss from discontinued operations - 22,249
Depreciation and amortization 683,641 698,119
Gain on sale of property and equipment (15,696) (53,164)
Decrease in accounts and notes receivable 178,557 131,963
Decrease in refundable income taxes 456,460 159,099
Increase in inventories (679,642) (491,277)
Increase in other assets (99,163) (60,157)
Increase in accounts payable 39,920 249,297
Increase in income taxes payable - 264,282
Decrease in deferred income taxes 2,837 -
Increase (decrease) in accrued liabilities (33,536) 23,707
Decrease in deferred income - (93,000)
Net cash provided by operating activities of continuing operations 1,207,614 1,433,045
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of assets 37,500 -
Purchases of property and equipment (701,952) (623,768)
Loans to officers and shareholders (248,750) -
Decrease (increase) in other assets 10,887 (85,159)
Net cash used in investing activities of continuing operations (902,315) (708,927)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt - 1,132,043
Payments on long-term debt (893,099) (459,550)
Proceeds from line of credit 4,925,000 -
Payments on line of credit (4,175,000) -
Repurchase of stock (1,773,266) -
Proceeds from exercise of stock options 80,751 -
Net cash provided by (used in) financing activities of continuing operations (1,835,614) 672,493
NET CASH PROVIDED BY (USED IN) DISCONTINUED OPERATIONS (88,692) 133,128
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,619,007) 1,529,739
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,795,381 792,606
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 176,374 $ 2,322,345
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS
NOTE 1 - NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Nature of Operations
Rocky Mountain Chocolate Factory, Inc. (the "Company") is a manufacturer,
international franchiser and retail operator. The Company manufactures an
extensive line of gourmet chocolates and other confectionery items. The
Company sells its candies in over 220 Rocky Mountain Chocolate Factory stores
as well as through a variety of third party retail and non-retail programs,
including national and international retail, fundraising, corporate sales and
internet programs.
Basis of Presentation
The accompanying financial statements have been prepared by the Company,
without audit, and reflect all adjustments which are, in the opinion of
management, necessary for a fair statement of the results for the interim
periods. The statements have been prepared in accordance with generally
accepted accounting principles for interim financial reporting and Securities
and Exchange Commission regulations. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. In the opinion of management, the
financial statements reflect all adjustments (of a normal and recurring
nature) which are necessary for a fair presentation of the financial
position, results of operations and cash flows for the interim periods. The
results of operations for the period March 1, 1998 to August 31, 1998 are not
necessarily indicative of the results to be expected for the entire fiscal
year.
These financial statements should be read in conjunction with the financial
statements and notes thereto included in the Company's Annual Report on Form
10-K for the fiscal year ended February 28, 1998.
NOTE 2 - EARNINGS PER SHARE
Basic earnings per share is calculated using the weighted average number of
common shares outstanding. Diluted earnings per share is computed on the
basis of the weighted average number of common shares outstanding plus the
effect of outstanding stock options using the treasury stock method.
7
<PAGE>
NOTE 3 - INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
August 31, 1998 February 28, 1998
<S> <C> <C>
Ingredients and supplies $ 1,228,134 $ 1,153,433
Finished candy 2,019,474 1,414,533
$ 3,247,608 $ 2,567,966
</TABLE>
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
August 31, 1998 February 28, 1998
<S> <C> <C>
Land $ 513,618 $ 513,618
Building 3,665,581 3,665,581
Machinery and equipment 6,555,121 6,023,347
Furniture and fixtures 2,443,547 2,072,208
Leasehold improvements 1,732,637 1,389,608
Transportation equipment 199,639 293,357
15,110,143 13,957,719
Less accumulated depreciation 4,829,316 4,285,276
Property and equipment, net $ 10,280,827 $ 9,672,443
</TABLE>
NOTE 5 - STOCKHOLDERS' EQUITY
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
unrelated to any Company transactions from certain shareholders. The Company
loaned certain officers and directors the funds to pay a portion of the
purchase price for 40,000 of the 104,000 shares purchased by them.
Additionally, on June 1, 1998 the Company loaned an officer approximately
$49,000 to fund the exercise of options. These loans are secured by the
related shares, bear interest payable annually at 7.5% and are due May 15,
2003.
NOTE 6 - DISCONTINUED OPERATIONS
In December 1997, the Company decided its Fuzziwig's Candy Factory Store
("Fuzziwig's") segment did not meet its long-term strategic goals, and
accordingly, adopted a plan to discontinue its operations. On June 5, 1998,
the Company entered into a definitive agreement to sell substantially all the
assets of its Fuzziwig's segment for $1.6 million. The divestiture of
Fuzziwig's was completed as planned as of the close of business on July 31,
1998.
8
<PAGE>
The operating results of Fuzziwig's have been segregated from continuing
operations and reported as separate line items net of applicable income taxes
in the accompanying statements of income. The current assets, net noncurrent
assets and net cash flows of Fuzziwig's have been segregated and reported as
separate line items in the accompanying balance sheets and statements of cash
flows. The financial statements for prior periods have been restated to
conform to this presentation.
Summarized financial information for the discontinued operations follows:
<TABLE>
<CAPTION>
Six Months Ended
August 31,
1998 1997
<S> <C> <C>
Sales $ 1,095,431 $ 1,680,247
Loss before taxes (51,562) (36,264)
Loss from discontinued operations, net of income taxes (31,622) (22,249)
</TABLE>
NOTE 7 - SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
Six Months Ended
August 31,
1998 1997
<S> <C> <C>
Cash paid (received) for:
Interest $ 370,060 $ 324,158
Income taxes (88,029) (94,198)
Supplemental schedule of non-cash investing and financing activities:
Property and equipment acquired in settlement of note receivable 130,000 -
Notes receivable from sale of property and equipment - 589,108
</TABLE>
The statement of cash flows for the six months ending August 31, 1998 excludes
the effects of certain non-cash investing and financing activities relating to
the divestiture of Fuzziwig's (Note 6). The following is a summary of the
non-cash effects of this transaction.
<TABLE>
<S> <C>
Decrease in:
Net current assets of discontinued operations $ 44,351
Net noncurrent assets of discontinued operations 1,555,681
Increase in:
Short-term note receivable (80,000)
Property and equipment (480,000)
Excess purchase price over identifiable tangible assets (Goodwill) (940,000)
Net increase in cash and cash equivalents $ 100,032
</TABLE>
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of the financial condition and results
of operations of the Company should be read in conjunction with the unaudited
financial statements and related notes of the Company included elsewhere in
this report. This Management's Discussion and Analysis of Financial Condition
and Results of Operations and other parts of this Quarterly Report on Form
10-Q contain forward-looking statements that involve risks and uncertainties.
The Company's ability to successfully achieve expansion of its Rocky Mountain
Chocolate Factory franchise system depends on many factors not within the
Company's control including the availability of suitable sites for new store
establishment and the availability of qualified franchisees to support such
expansion.
Efforts to reverse the decline in same store pounds purchased from the
factory by franchised stores and to increase total factory sales depends on
many factors not within the Company's control including the receptivity of
its franchise system and of customers in potential new distribution channels
to its product introductions and promotional programs. Other factors that
could affect the Company's ability to achieve the financial performance
contemplated by the forward-looking statements include changing market
conditions in the overall economy and retail industry, changes in consumer
demand or competitive conditions and the success of the Company's strategy of
expanding into new and previously untested distribution channels.
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 made in this Quarterly Report on Form 10-Q.
Results of Operations
THREE MONTHS ENDED AUGUST 31, 1998 COMPARED TO THE THREE MONTHS ENDED AUGUST 31,
1997
Income from continuing operations for the three months ended August 31, 1998
was $510,029 or $.20 per share versus $474,732 or $.16 per share for the
three months ended August 31, 1997. Income from discontinued operations was
$19,074 or $.01 per share for the three months ended August 31, 1997. Net
income was $510,029 for the three months ended August 31, 1998 or $.20 per
share versus $493,806 or $.17 per share for the three months ended August 31,
1997.
10
<PAGE>
Revenues
<TABLE>
<CAPTION>
Three Months Ended
August 31, %
($'s in thousands) 1998 1997 Change Change
<S> <C> <C> <C> <C>
Factory sales $ 2,434.7 $ 2,281.4 $ 153.3 6.7%
Retail sales 3,248.3 2,797.8 450.5 16.1
Franchise fees 43.8 87.0 (43.2) (49.7)
Royalty and Marketing fees 891.1 727.0 164.1 22.6
Total $ 6,617.9 $ 5,893.2 $ 724.7 12.3%
</TABLE>
Factory Sales
Factory sales increased $153,000 or 6.7% to $2.4 million in the second
quarter of fiscal 1999, compared to $2.3 million in the second quarter of
fiscal 1998. This was due to an increase in the average number of franchised
stores operating during the quarter from 176 for the three months ending
August 31, 1997 to 183 for the three months ending August 31, 1998 and to an
increase in sales of packaged product to new distribution channels. Total
pounds shipped by the factory increased 14% to 503,000 in the second quarter
of fiscal 1999 from 442,000 in the second quarter of fiscal 1998. The
increase in pounds shipped was due primarily to a 17% and 13% increase in
pounds shipped in the second quarter of fiscal 1999 related to packaged and
bulk products, respectively, versus the second quarter of fiscal 1998. Same
store pounds purchased from the factory by franchised stores declined by 2.2%
in the second quarter of fiscal 1999 compared to the second quarter of fiscal
1998, partially offsetting increased factory sales. The decline in same store
pounds purchased from the factory resulted primarily from increased sales at
franchised stores of store-made product and product purchased from authorized
vendors relative to factory-made products.
Retail Sales
Retail sales increased $451,000 or 16.1% to $3.2 million in the second
quarter of fiscal 1999, compared to $2.8 million in the second quarter of
fiscal 1998. This increase resulted from an increase in the average number of
stores in operation in the second quarter of fiscal 1999 (39) versus the same
period last year (37) and an increase in comparable store sales of 3.7%.
Royalties, Marketing Fees and Franchise Fees
Royalties and marketing fees increased $164,000 or 22.6% to $891,000 in the
second quarter of fiscal 1999, compared to $727,000 in the second quarter of
fiscal 1998. This increase resulted from an increase in the average number of
franchised stores operating during the quarter to 183 in the second quarter
of fiscal 1999 compared to 176 in the second quarter of fiscal 1998 and an
increase in same store sales at franchised stores of approximately 8%.
Franchise fee revenues decreased in the second quarter of fiscal 1999
approximately $43,000 due to a reduction in the number of new franchises sold
versus the second quarter of fiscal 1998. The
11
<PAGE>
Company expects its strategy of diversifying into new distribution channels
to continue to reduce the percentage of the Company's revenues derived from
the sale of new franchises to operate Rocky Mountain Chocolate Factory stores.
Costs and Expenses
Cost of Sales
Cost of sales as a percentage of sales decreased to 49.0% in the second
quarter of fiscal 1999 versus 50.1% in the second quarter of fiscal 1998.
This decrease resulted from increased retail sales (due to a greater number
of Company-owned stores), which generate higher margins than factory sales,
and from increased margins on factory sales. Company-owned store margins for
the second quarter of 1999 were 64.3% versus 64.6% in the second quarter of
fiscal 1998. Factory margins improved to 33.4% in the second quarter of
fiscal 1999 from 31.9% in the second quarter of fiscal 1998 as a result of
improved manufacturing efficiencies realized from increased volume.
Franchise Costs
Franchise costs increased 4.2% from $277,000 in the second quarter of fiscal
1998 to $289,000 in the second quarter of fiscal 1999. As a percentage of
total royalty and marketing fees and franchise fee revenue, franchise costs
decreased to 30.9% in the second quarter of fiscal 1999 from 34.1% in the
second quarter of fiscal 1998. This decrease as a percentage of royalty,
marketing and franchise fees is primarily a result of an increase in royalty
and marketing fees of 22.6% offset by a 49.7% decrease in income from
franchise fees and to a lesser extent increased franchise support costs.
Sales and Marketing
Sales and Marketing costs increased 53.9% to $429,000 in the second quarter
of fiscal 1999 from $279,000 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 made available to franchised and Company-owned
stores; (3) establishment of a sales force focused on new distribution
opportunities and related new distribution channel start-up costs; and (4)
enhanced customer service and new product marketing programs.
General and Administrative
General and administrative expenses increased 2.6% from $451,000 in the
second quarter of fiscal 1998 to $463,000 in the second quarter of fiscal
1999. As a percentage of total revenues, general and administrative expenses
declined from 7.7% in fiscal 1998 to 7.0% in fiscal 1999. The Company expects
the trend of decreasing general and administrative expenses as a percentage
of sales to continue due to its policy of controlling its current cost
structure.
12
<PAGE>
Retail Operating Expenses
Retail operating expenses increased from $1.4 million in the second quarter
of fiscal 1998 to $1.7 million in the second quarter of fiscal 1999; an
increase of 16.4%. This increase is due to an increase in the average number
of stores open during the second quarter of fiscal 1999 versus the second
quarter of fiscal 1998. Retail operating expenses, as a percentage of retail
sales, increased slightly from 51.0% in the second quarter of fiscal 1998 to
51.1% in the second quarter of fiscal 1999.
Other Expense
Other expense of $160,000 incurred in the second quarter of fiscal 1999
increased 14.5% from the $140,000 incurred in the second quarter of fiscal
1998. This resulted from interest expense related to borrowings in support of
the Company's fiscal 1996 and 1997 Company-owned store expansion and
increased borrowing on the Company's line of credit facility.
Income Tax Expense
The Company's effective income tax rate in the second quarter of fiscal 1998
was 38.7%, which is approximately the same rate as the second quarter of
fiscal 1999.
Discontinued Operations
In December 1997, the Company decided its Fuzziwig's Candy Factory Store
segment did not meet its long-term strategic goals, and accordingly, made the
decision to dispose of these operations. See "NOTE 6 - DISCONTINUED
OPERATIONS" of notes to interim financial statements.
SIX MONTHS ENDED AUGUST 31, 1998 COMPARED TO THE SIX MONTHS ENDED AUGUST 31,
1997
Income from continuing operations for the six months ended August 31, 1998
was $674,236 or $.25 per share versus $604,176 or $.21 per share for the six
months ended August 31, 1997. Loss from discontinued operations was $22,249
or $.01 per share for the six months ended August 31, 1997. Net income was
$674,236 for the six months ended August 31, 1998 or $.25 per share versus
$581,927 or $.20 per share for the six months ended August 31, 1997.
Revenues
<TABLE>
<CAPTION>
Six Months Ended
August 31, %
($'s in thousands) 1998 1997 Change Change
<S> <C> <C> <C> <C>
Factory sales 4,899.7 4,115.5 784.2 19.1%
Retail sales 5,592.1 5,276.3 315.8 6.0
Franchise fees 109.7 290.5 (180.8) (62.2)
Royalty and Marketing fees 1,589.9 1,298.6 291.3 22.4
Total 12,191.4 10,980.9 1,210.5 11.0%
</TABLE>
13
<PAGE>
Factory Sales
Factory sales increased $784,000 or 19.1% to $4.9 million in the first six
months of fiscal 1999, compared to $4.1 million in the first six months of
fiscal 1998. This was due to a shift in product mix from lower price point
bulk products to higher price point packaged products driven by sales to new
distribution channels, and to an increase in the average number of franchised
stores operating from 174 for the six months ended August 31, 1997 to 184 for
the six months ended August 31, 1998. Total pounds shipped by the factory
increased 15% to 931,000 in the first six months of fiscal 1999 from 811,000
in the first six months of fiscal 1998. The increase in pounds shipped was
due to a 45% and 7% increase in pounds shipped in the first six months of
fiscal 1999 related to packaged and bulk products, respectively, versus the
first six months of fiscal 1998. Same store pounds purchased from the factory
by franchised stores declined by 1.9% in the first six months of fiscal 1999
compared to the first six months of fiscal 1998, partially offsetting
increased factory sales. The decline in same store pounds purchased from the
factory resulted primarily from increased sales at franchised stores of
store-made product and product purchased from authorized vendors relative to
factory-made products.
Retail Sales
Retail sales increased $316,000 or 6.0% to $5.6 million in the first six
months of fiscal 1999, compared to $5.3 million in the first six months of
fiscal 1998. This increase resulted from the increased revenue associated
with the Rocky Mountain Chocolate Factory stores acquired on July 1, 1998 in
connection with the divestiture of Fuzziwig's and an increase in comparable
store sales of 4.2% offset by two fewer stores (on average) in the first six
months of fiscal 1999 compared to fiscal 1998.
Royalties, Marketing Fees and Franchise Fees
Royalties and marketing fees increased $291,000 or 22.4% to $1.6 million in
the first six months of fiscal 1999, compared to $1.3 million in the first
six months of fiscal 1998. This increase resulted from an increase in the
average number of franchised stores operating to 184 in the first six months
of fiscal 1999 compared to 174 in the first six months of fiscal 1998 and an
increase in same store sales at franchised stores of approximately 8.8%.
Franchise fee revenues decreased in the first six months of fiscal 1999 due
to a reduction in the number of new franchises sold versus the first six
months of fiscal 1998. While franchise interest remains strong, continued
lack of premium locations in proven environments has constrained sales of new
franchises to interested parties. The Company expects its strategy of
diversifying into new distribution channels to continue to reduce the
percentage of the Company's revenues derived from the sale of new franchises
to operate Rocky Mountain Chocolate Factory stores.
14
<PAGE>
Costs and Expenses
Cost of Sales
Cost of sales as a percentage of sales in the first six months of fiscal 1999
was 50.9%, which is approximately the same percentage as the first six months
of fiscal 1998. Company-owned store margins for the first six months of 1999
were 63.3% which is approximately the same percentage as the first six months
of fiscal 1998. Factory margins improved to 32.9% in the first six months of
fiscal 1999 from 31.3% in the first six months of fiscal 1998 as a result of
improved manufacturing efficiencies realized from increased volume.
Franchise Costs
Franchise costs increased 4.6% from $543,000 in the first six months of
fiscal 1998 to $568,000 in the first six months of fiscal 1999. As a
percentage of total royalty and marketing fees and franchise fee revenue,
franchise costs decreased to 33.4% in the first six months of fiscal 1999
from 34.2% in the first six months of fiscal 1998. This decrease as a
percentage of royalty, marketing and franchise fees is primarily a result of
an increase in royalty and marketing fees of 22.4% offset by a 62.2% decrease
in income from franchise fees and to a lesser extent increased franchise
support costs.
Sales and Marketing
Sales and Marketing costs increased 48% to $828,000 in the first six months
of fiscal 1999 from $559,000 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 made available to franchised and Company-owned
stores; (3) establishment of a sales force focused on new distribution
opportunities and related new distribution channel start-up costs; and (4)
enhanced customer service and new product marketing programs.
General and Administrative
General and administrative expenses increased 2.4% from $911,000 in the first
six months of fiscal 1998 to $933,000 in the first six months of fiscal 1999.
As a percentage of total revenues, general and administrative expenses
declined from 8.3% in fiscal 1998 to 7.7% in fiscal 1999. The Company expects
the trend of decreasing general and administrative expenses as a percentage
of sales to continue due to its policy of controlling its current cost
structure.
Retail Operating Expenses
Retail operating expenses increased from $2.9 million in the first six months
of fiscal 1998 to $3.1 million in the first six months of fiscal 1999; an
increase of 6.5%. This increase is slightly higher than the attendant
increase in retail sales as a result of start-up costs associated with
several of the Company's new stores.
15
<PAGE>
Retail operating expenses, as a percentage of retail sales, increased
slightly from 55.3% in the first six months of fiscal 1998 to 55.6% in the
first six months of fiscal 1999.
Other Expense
Other expense of $313,000 incurred in the first six months of fiscal 1999
increased 7.2% from the $292,000 incurred in the first six months of fiscal
1998. This resulted from interest expense related to borrowings in support of
the Company's fiscal 1996 and 1997 Company-owned store expansion and
increased borrowings on the Company's line of credit facility.
Income Tax Expense
The Company's effective income tax rate in the first six months of fiscal
1998 was 38.7%, which is approximately the same rate as the first six months
of fiscal 1999.
Discontinued Operations
In December 1997, the Company decided its Fuzziwig's Candy Factory Store
segment did not meet its long-term strategic goals, and accordingly, made the
decision to dispose of these operations. See "NOTE 6 - DISCONTINUED
OPERATIONS" of notes to interim financial statements.
LIQUIDITY AND CAPITAL RESOURCES
As of August 31, 1998 working capital was $1,375,000, compared with
$3,949,000 as of February 28, 1998, a $2,574,000 decrease. This decrease is
primarily the result of the use of $1,773,000 of working capital to
repurchase 336,000 shares of the Company's common stock at $5.15 per share
and related transaction expenses, loans to officers and directors of $249,000
to acquire an additional 55,000 shares of the Company's common stock and cash
flows used by investing and other financing activities in excess of cash
flows generated by operating activities.
Cash and cash equivalent balances decreased from $1,795,000 as of February
28, 1998 to $176,000 as of August 31, 1998 as a result of cash flows used by
investing and financing activities in excess of cash flows generated by
operating activities. The Company's current ratio was 1.3 to 1 at August 31,
1998 in comparison with 2.1 to 1 at February 28, 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 August 31, 1998 $1.9 million), and chattel mortgage notes (unpaid balance
as of August 31, 1998 $4.3 million) used to fund the fiscal 1996 and 1997
Company-owned store expansion.
The Company has a $3.0 million ($2,250,000 available as of August 31, 1998)
working capital line of credit collateralized by certain of the Company's
inventories and accounts receivable. The line is subject to renewal in July,
1999.
16
<PAGE>
The Company is currently in the process of securing certain fixed asset based
financings, the proceeds of which will be used to reduce amounts outstanding
on its working capital line of credit.
The Company believes cash flows generated by operating activities and
available financing will be sufficient to fund the Company's operations at
least through the end of fiscal 1999.
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.
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 their
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; (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 will commence in the third quarter of fiscal 1999 and is scheduled to be
tested and installed by March 1999. Non-critical system conversions have been
identified and scheduled for completion by July 1999. This remediation
process will commence in May of 1999 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
17
<PAGE>
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 most relevant third parties and will commence
its efforts to contact additional relevant third parties in the third quarter
of fiscal 1999. 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 $29,000 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 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
18
<PAGE>
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. 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 costs for new facilities may include potentially
escalating costs of real estate and construction. There is no assurance that
the Company will be able to pass on increased costs to its customers.
Depreciation expense is based on the historical cost to the Company of its
fixed assets, and is therefore potentially less than it would be if it were
based on current replacement cost. While property and equipment acquired in
prior years 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. The Company anticipates that sales to new
distribution channels will also be subject to seasonal fluctuation with
stronger sales during the Christmas holiday season. Because of the
seasonality of the Company's business results for any quarter are not
necessarily indicative of results that may be achieved in other quarters or
for a full fiscal year.
19
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits
4.1 Amendment dated July 31, 1998 to Term Loan and Credit
Agreement dated April 5, 1996 in the amount of $3,000,000
between Norwest Bank and the registrant.
27.1 Financial Data Schedule for the six months ended August
31, 1998.
27.2 Restated Financial Data Schedule for the six months ended
August 31, 1997.
B. Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
(Registrant)
Date: October 14, 1998 /s/ Bryan J. Merryman
---------------------------------------------
Bryan J. Merryman, Vice President - Finance
Chief Financial Officer and authorized officer
20
<PAGE>
July 31, 1998
Mr. Bryan Merryman
Rocky Mountain Chocolate Factory
265 Turner Dr.
Durango, CO 81301
VIA FAX 970-385-5919 AND FIRST CLASS MAIL
Subject: SEVENTH AMENDMENT TO TERM LOAN AND CREDIT AGREEMENT
Dear Bryan:
Rocky Mountain Chocolate Factory, Inc. ("RMCF") and Norwest Bank Colorado,
N.A. (the "Bank") are parties to a certain Loan Agreement dated April 5, 1996
as amended six previous times (collectively, the "Agreement"). The purpose
of this amendment (the "Seventh Amendment") is to make further changes to the
Agreement as follows:
The Revolving Line of Credit shall be increased from $2,000,000 to $3,000,000.
Acceptable Accounts Receivable shall include receivables from Sam's Club less
than 120 days old.
Borrowing Base shall include 50% of Acceptable Inventory. The limit of
$500,000 shall be deleted.
Maintain quarterly a ratio of Indebtedness to Tangible Net Worth of not more
than 1.6 to 1.
Maintain quarterly a ratio of Current Assets to Current Liabilities of not
less than 1.3 to 1.
Maintain quarterly a minimum Cash Flow Coverage Ratio of more than 1.25 to 1.
Cash Flow Coverage Ratio shall mean the ratio of earnings before interest,
taxes, depreciation and amortization ("EBITDA") divided by the sum of all
principal and interest payments.
Maintain quarterly a Tangible Net Worth of more than $6,000,000.
Maintain quarterly Working Capital of more than $1,500,000.
Capitalized terms not further defined herein are defined in the Agreement. All
other terms conditions shall remain the same.
ACCEPTED AND AGREED
BANK
/s/ Bill Maurer
- -------------------------------
Bill Maurer, V.P.
RMCF
/s/ Bryan Merryman
- -------------------------------
Bryan Merryman, CFO
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