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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

(Mark One)

For the quarterly period ended November 30, 2003

For the transition period from ________to________

Commission file number 0-14749

Rocky Mountain Chocolate Factory, Inc.

Colorado
(State of incorporation)
84-0910696
(I.R.S. Employer Identification No.)

265 Turner Drive, Durango, CO 81303
(Address of principal executive offices)

(970) 259-0554
(Registrant’s telephone number, including area code)

Indicate by 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange act). Yes [   ] No [X].

On December 31, 2003 the registrant had outstanding 2,525,954 shares of its common stock, $.03 par value.

The exhibit index is located on page 18.

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ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.

FORM 10-Q

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these financial statements.

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ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
BALANCE SHEETS

The accompanying notes are an integral part of these financial statements.

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ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these financial statements.

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ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS

NOTE 1 – NATURE OF OPERATIONS AND BASIS OF PRESENTATION

Nature of Operations

Rocky Mountain Chocolate Factory, Inc. is an international franchiser, confectionery manufacturer and retail operator in the United States, Guam, Canada and the United Arab Emirates. The Company manufactures an extensive line of premium chocolate candies and other confectionery products. The Company’s revenues are currently derived from three principal sources: sales to franchisees and others of chocolates and other confectionery products manufactured by the Company; the collection of initial franchise fees and royalties from franchisees’ sales; and sales at Company-owned stores of chocolates and other confectionery products.

Basis of Presentation

The accompanying financial statements have been prepared by the Company, without audit, and reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods. The statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and Securities and Exchange Commission regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the financial statements reflect all adjustments (of a normal and recurring nature) which are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The results of operations for the nine months ended November 30, 2003 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, 2003.

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 and SFAS 148.

The Company has adopted the disclosure-only provisions of SFAS 123. In accordance with those provisions, the Company applies APB 25 and related interpretations in accounting for its stock option plans and, accordingly, does not recognize compensation cost if the exercise price is not less than market at date of grant. No compensation expense was recognized during the quarters ended November 30, 2003 or 2002. If the Company had elected to recognize compensation cost based on the fair value of the options granted at grant dates as prescribed by SFAS 123, net income and earnings per share would have been reduced to the pro-forma amounts indicated in the table below for the nine months ending November 30, (in 000’s except per share amounts):

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NOTE 1 – NATURE OF OPERATIONS AND BASIS OF PRESENTATION – CONTINUED

Stock-Based Compensation – Continued

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model utilizing the following weighted average assumptions:

NOTE 2 – EARNINGS PER SHARE

Basic earnings per share is calculated using the weighted average number of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through stock options. For the three months ended November 30, 2003 and 2002, 13,333 and 456,356 stock options were excluded from the computation of earnings per share because their effect would have been anti-dilutive. For the nine months ended November 30, 2003 and 2002, 81,021 and 43,967 stock options were excluded from the computation of earnings per share because their effect would have been anti-dilutive.

NOTE 3 – INVENTORIES

Inventories consist of the following:

NOTE 4 – PROPERTY AND EQUIPMENT, NET

Property and equipment consists of the following:

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NOTE 5 – STOCKHOLDERS’ EQUITY

Stock Split

On December 17, 2003 the Board of Directors approved a three-for-two stock split payable February 2, 2004 to shareholders of record at the close of business on January 20, 2004. Shareholders will receive one additional share of Common Stock for every two shares owned prior to the record date. Subsequent to the split there will be approximately 3.8 million shares outstanding.

Stock Repurchases

Between October 3, 2003 and November 21, 2003 the Company repurchased 30,300 Company shares at an average price of $11.41 per share. In December 2003 the Company repurchased 13,000 Company shares at an average price of $11.91 per share.

Cash Dividend

The Company paid an initial quarterly cash dividend of $0.075 per common share on September 16, 2003 to shareholders of record on September 2, 2003. The Company paid a quarterly cash dividend of $0.08125 per common share on December 16, 2003 to shareholders of record on December 2, 2003. The Board of Directors also announced, on September 26, 2003, their intent to declare dividends per common share of $0.0875 in February and ensuing quarters.

Future declaration of dividends will depend on, among other things, the Company’s results of operations, capital requirements, financial condition and on such other factors as the Company’s Board of Directors may in its discretion consider relevant and in the best long term interest of the shareholders.

NOTE 6 – SUPPLEMENTAL CASH FLOW INFORMATION

NOTE 7 – OPERATING SEGMENTS

The Company classifies its business interests into two reportable segments: Franchising and Manufacturing. The Company’s retail stores provide an environment for testing consumer behavior, various pricing strategies, new products and promotions, operating and training methods and merchandising techniques. Three operational stores previously classified as held for sale were reclassified as assets held and used when management’s intentions changed. All Company-owned retail stores are evaluated by management in relation to their contribution to franchising efforts and are included in the Franchising segment. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1 to the Company’s financial statements included in the Company’s annual report on Form 10-K for the year ended February 28, 2003. 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 inter-segment sales prices are market based. Each segment is managed separately because of the differences in required infrastructure and the difference in products and services:

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NOTE 7 – OPERATING SEGMENTS – CONTINUED

NOTE 8 – ASSET SALES AND FORECLOSURES

At November 30, 2003, the Company had approximately $1,037,000 of notes receivable outstanding. The notes require monthly payments and bear interest at rates ranging from 7.5% to 12.5%. The notes mature through October 2006 and are secured by the assets financed.

During fiscal 2002 the Company adjusted the repayment schedule of the notes from a single franchisee to correspond to the franchisee’s store operating cycles. The Company also financed an additional $300,000 of inventory and wrote-off $243,750 of the notes receivable. During fiscal 2003 the Company financed $230,000 for an additional store for the franchisee. During the third quarter of fiscal 2003 the Company recorded an additional $1,667,000 provision for potential loss on accounts and notes receivable and foreclosure costs related to the insolvency of this franchisee. In December 2002, the Company foreclosed on four of the stores previously operated by the franchisee and plans to operate these retail outlets as Company-owned stores. At November 30, 2003 the Company has no balance recorded for notes receivable from this franchisee.

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NOTE 9 – GOODWILL AND INTANGIBLE ASSETS

Effective March 1, 2002 the Company adopted Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Intangible Assets. SFAS 142 revised the accounting for purchased goodwill and intangible assets. Under SFAS 142, goodwill and intangible assets with indefinite lives will no longer be amortized, will be tested for impairment annually and also in the event of an impairment indicator, and must be assigned to reporting units for purposes of impairment testing and segment reporting.

The Company has historically amortized goodwill on the straight-line method over ten to twenty-five years. Beginning March 1, 2002, quarterly and annual goodwill amortization is no longer recognized.

Intangible assets consist of the following:

Amortization expense related to intangible assets totaled $56,116 and $64,880 during the nine months ended November 30, 2003 and 2002, respectively. The aggregate estimated amortization expense for intangible assets remaining as of November 30, 2003 is as follows:

NOTE 10 – ASSETS HELD FOR SALE

Assets held for sale consist of individual items of equipment, furniture and fixtures that were acquired in partial satisfaction of certain notes receivable from a franchisee. The notes were originally extended as part of store sales and construction financing of additional stores for the franchisee (Note 8). Management expects to dispose of the acquired assets to either existing franchisees who plan to upgrade or expand their operations or to prospective franchisees. These assets are included in “Other” for segment reporting. Three operational stores in the amount of $255,000 previously classified as held for sale were reclassified to property and equipment, net when management’s intentions changed in the second quarter of Fiscal 2004.

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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. The nature of the Company’s operations and the environment in which it operates subject it to changing economic, competitive, regulatory and technological conditions, risks and uncertainties. The Company notes the following factors that, among others, could cause future results to differ materially from the forward-looking statements, expectations and assumptions expressed or implied in this Quarterly Report on Form 10-Q. Many of the forward-looking statements contained in this document may be identified by the use of forward-looking words such as “will,” “intend,” “believe,” “expect,” “anticipate,” “should,” “plan,” “estimate” and “potential,” or similar expressions. Factors which could cause results to differ include, but are not limited to: changes in the confectionery business environment, seasonality, consumer interest in the Company’s products, general economic conditions, consumer trends, costs and availability of raw materials, competition and the effect of government regulation. Government regulation which the Company and its franchisees either are or may be subject to and which could cause results to differ from forward-looking statements include, but are not limited to: local, state and federal laws regarding health, sanitation, safety, building and fire codes, franchising, employment, manufacturing, packaging and distribution of food products and motor carriers.

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 depend on many factors, including new store openings and the receptivity of the Company’s franchise system to its product introductions and promotional programs.

Results of Operations

Three Months Ended November 30, 2003 Compared to the Three Months Ended November 30, 2002

Net income was $630,000 for the three months ended November 30 2003, or $.25 per basic share, versus net loss of $473,000, or $.19 per basic share, for the three months ended November 30, 2002.

Revenues

Factory Sales

The decrease in factory sales was due primarily to a decrease of 56.3% in factory sales to customers outside the Company’s system of franchised retail stores. This decrease was partially offset by an increase of 4.3% in same store pounds purchased by the franchise system and by purchases made by new franchise stores.

Retail Sales

The increase in retail sales resulted primarily from an increase in the number of stores in operation in the third quarter of fiscal 2004 (8) versus the same period last year (4) and an increase in same store sales at Company-owned stores of 7.9%.

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Royalties, Marketing Fees and Franchise Fees

The increase in royalty and marketing fees resulted from sales related to new franchise stores partially offset by a decline in the average number of franchised stores in operation in the third quarter of fiscal 2004 versus the same period last year. Same store sales at franchised stores declined 2.5% versus the prior year. Franchise fee revenues increased in the third quarter of fiscal 2004 due to an increase in the number of franchises sold versus the third quarter of fiscal 2003.

Costs and Expenses

Gross margin

The increase in factory margin is due primarily to production efficiencies. Improvement of Company-owned store margin is due to changes in mix of product sold.

Franchise Costs

The decrease in franchise costs is due primarily to a planned reduction in expenditures. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs decreased to 29.0% in the third quarter of fiscal 2004 from 34.6% in the third quarter of fiscal 2003. This decrease as a percentage of royalty, marketing and franchise fees is the combined result of decreased franchise costs and increased revenue.

Sales and Marketing

The decrease in sales and marketing expenses is due primarily to more focused and efficient marketing programs.

General and Administrative

General and administrative expenses increased primarily due to accrual of incentive-based compensation in the third quarter of fiscal 2004 versus none in the third quarter of fiscal 2003. Additionally, the relocation and remodel of the Company’s Aspen, CO store and the related disposal of certain of the old location’s assets, primarily leasehold improvements, also contributed to the increase in the third quarter of fiscal 2004 versus the same period last year. Excluding the costs associated with incentive-based compensation and the relocation and remodel of the Aspen store, general and administrative expenses would have been $436,000 in the third quarter of fiscal 2004, an increase of 2.3% compared to the third quarter of fiscal 2003. As a percentage of total revenues, general and administrative expenses increased to 11.8% in fiscal 2004 compared to 7.6% in fiscal 2003.

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Retail Operating Expenses

The increase in retail operating expenses was due primarily to an increase in the number of stores in operation during the third quarter of fiscal 2004 versus the third quarter of fiscal 2003. Retail operating expenses, as a percentage of retail sales, decreased from 85.5% in the third quarter of fiscal 2003 to 63.3% in the third quarter of fiscal 2004 due to a change in mix of stores in operation and related seasonality.

Depreciation and Amortization

Depreciation and amortization of $178,000 in the third quarter of fiscal 2004 decreased 11.9% from $201,000 incurred in the third quarter of fiscal 2003 due to cessation of depreciation of certain assets related to the relocation and remodel of the Company’s Aspen, Colorado store and the increase in the estimated expected asset life of certain Company-owned retail stores in operation.

Provision for Loss on Accounts and Notes Receivable and Related Foreclosure Costs

The provision for loss on accounts and notes receivable and related foreclosure costs in the third quarter of fiscal 2003 resulted from the insolvency of a single franchisee. There was no such provision in the third quarter of fiscal 2004.

Other Expense, Net

Other expense, net of $12,000 incurred in the third quarter of fiscal 2004 represents a 81.7% decrease from the $64,000 incurred in the third quarter of fiscal 2003, due primarily to lower interest expense on lower average outstanding balances of long-term debt plus increased interest income on notes receivable and invested cash.

Income Tax Expense

The Company’s effective income tax rate in the third quarter of fiscal 2004 was 37.8%, which is approximately the same rate as the third quarter of fiscal 2003.

Nine Months Ended November 30, 2003 Compared to the Nine Months Ended November 30, 2002

Net income was $1,691,000 for the nine months ended November 30, 2003, or $.67 per basic share, versus $603,000 or $.24 per basic share, for the nine months ended November 30, 2002.

Revenues

Factory Sales

The decrease in factory sales was due primarily to a decrease of 29.4% in factory sales to customers outside the Company’s system of franchised retail stores. A decrease of 3.8% in same store pounds purchased by the franchise system was approximately offset by sales to new franchise stores.

Efforts to reverse the decline in same store pounds purchased from the factory by franchised stores and to increase total factory sales depend on many factors, including new store openings and the receptivity of the Company’s franchise system to its product introductions and promotional programs.

Retail Sales

The increase in retail sales resulted primarily from an increase in the average number of stores in operation in the first nine months of fiscal 2004 versus the same period last year.

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Royalties, Marketing Fees and Franchise Fees

The decrease in royalty and marketing fees resulted from a decline in same store sales at franchised stores of approximately 3.6%. Franchise fee revenues increased in the first nine months of fiscal 2004 due to an increase in the number of franchises sold versus the first nine months of fiscal 2003.

Costs and Expenses