Current Trends and Outlook

The fourth quarter retail environment of FY 2009 proved to be the most challenging in our history. Global economic turmoil resulted in a swift and steep decline in consumer spending and a shopping landscape dominated by promotional activity.

We continued to experience this difficult environment throughout FY 2010 and FY 2011. The environment somewhat improved in FY 2012, though we do not believe that the challenges have reversed. As a result, we have and will continue to focus on managing the business in a seasoned, disciplined and controlled manner.

Going forward in FY 2013, we are taking a conservative view of market conditions in the United States. We will continue to focus on our long-term objectives while seeking to maintain flexibility to respond to market conditions, including the pursuit of international growth opportunities to reduce our dependence on the domestic economy.

We are a product-based international franchisor. Our revenues and profitability are derived principally from our franchised system of retail stores that feature chocolate and other confectionery products. We also sell our candy in selected locations outside our system of retail stores to build brand awareness. We operate ten Rocky Mountain Chocolate Factory and nine Aspen Leaf Yogurt retail units as a laboratory to test marketing, design and operational initiatives.

We are subject to seasonal fluctuations in sales because of the location of our franchisees, which have traditionally been located in resort or tourist locations. As we expand our geographical diversity to include regional centers, we have seen some moderation to our seasonal sales mix. Seasonal fluctuation in sales causes fluctuations in quarterly results of operations. Historically, the strongest sales of our products have occurred during key holidays and summer vacation seasons. Additionally, 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 our 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.

The most important factors in continued growth in our earnings are ongoing unit growth, increased same store sales and increased same store pounds purchased from the factory. Historically, unit growth has more than offset decreases in same store sales and same store pounds purchased.

Our ability to successfully achieve expansion of our franchise systems depends on many factors not within our 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, competition, the receptivity of our franchise system to our product introductions and promotional programs. In FY 2012, same store pounds purchased from the factory by franchised stores declined approximately 0.9% in the first quarter, declined approximately 4.6% in the second quarter, declined approximately 4.0% in the third quarter, increased approximately 6.0% in the fourth quarter, and declined approximately 0.6% overall in FY 2012 as compared to the same periods in FY 2011.

In May 2009, we announced the expansion of the co-branding test relationship with Cold Stone Creamery. The Company and Cold Stone Creamery, Inc. have agreed to expand the co-branding relationship to several hundred potential locations, based upon the performance of several test locations, operating under the test agreement announced in October 2008. We believe that if this co-branding strategy proves financially viable it could represent a significant future growth opportunity. As of February 29, 2012, licensees operated 50 co-branded locations.

In September 2010, we incorporated Aspen Leaf Yogurt, LLC ("ALY"), a wholly-owned subsidiary of the Company, and reorganized it as a limited liability company in October 2010 with the Company as the sole founding member. ALY is a franchisor and retail operator of self serve frozen yogurt retail locations. Since its inception, ALY has been developing franchise sales and support, opening Company-owned locations, developing vendor relationships and other organizational activities. As of February 29, 2012, we had nine ALY Company-owned and four domestic franchise stores operating in nine states.

On April 30, 2012 we announced the execution of a Master Licensing Agreement covering the country of Japan. Under the terms of the Agreement, the Licensee will pay the Company a Master License Fee for the right to open Rocky Mountain Chocolate Factory stores for its own account and for the account of franchisees throughout the country of Japan. The Agreement requires at least 10 new stores to open each year for 10 years, for a total minimum of 100 stores in the Licensed Territory by the expiration of the initial term of the Agreement. As of March 31, 2012, one test unit was operating under a letter of intent, preceding the Agreement.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosures. Estimates and assumptions include, but are not limited to, the carrying value of accounts and notes receivable from franchisees, inventories, the useful lives of fixed assets, goodwill, and other intangible assets, income taxes, contingencies and litigation. We base our estimates on analyses, of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We believe that the following represent our more critical estimates and assumptions used in the preparation of our financial statements, although not all inclusive.

Accounts and Notes Receivable - In the normal course of business, we extend credit to customers, primarily franchisees, that satisfy pre-defined credit criteria. We believe that we have a limited concentration of credit risk primarily because our receivables are secured by the assets of the franchisees to which we ordinarily extend credit, including, but not limited to, their franchise rights and inventories. An allowance for doubtful accounts is determined through analysis of the aging of accounts receivable, assessments of collectability based on historical trends, and an evaluation of the impact of current and projected economic conditions. The process by which we perform our analysis is conducted on a customer by customer, or franchisee by franchisee, basis and takes into account, among other relevant factors, sales history, outstanding receivables, customer financial strength, as well as customer specific and geographic market factors relevant to projected performance. The Company monitors the collectability of its accounts receivable on an ongoing basis by assessing the credit worthiness of its customers and evaluating the impact of reasonably likely changes in economic conditions that may impact credit risks. Estimates with regard to the collectability of accounts receivable are reasonably likely to change in the future.

We recorded an average expense of approximately $256,000 per year for potential uncollectible accounts over the three-year period ended February 29, 2012. Write-offs of uncollectible accounts net of recoveries averaged approximately $172,000 over the same period. The provision for uncollectible accounts is recognized as general and administrative expense in the Statements of Income. Over the past three years, the allowances for doubtful notes and accounts have ranged from 6.5% to 11.0% of gross receivables.

Revenue Recognition - We recognize revenue on sales of products to franchisees and other customers at the time of delivery. Franchise fee revenue is recognized upon the opening of the store. We also recognize a marketing and promotion fee of one percent (1%) of the Rocky Mountain Chocolate Factory franchised stores' gross retail sales and a royalty fee based on gross retail sales. Beginning with franchise store openings in the third quarter of fiscal year 2004, we modified our royalty structure. Under the current structure, we recognize no royalty on franchised stores' retail sales of products purchased from us and recognize a ten percent (10%) royalty on all other sales of product sold at franchise locations. For franchise stores opened prior to the third quarter of FY 2004 we recognize a royalty fee of five percent (5%) of franchised stores' gross retail sales.

Inventories - Our inventories are stated at the lower of cost or market value and are reduced by an allowance for slow-moving, excess, discontinued and shelf-life expired inventories. Our estimate for such allowance is based on our review of inventories on hand compared to estimated future usage and demand for our products. Such review encompasses not only potentially perishable inventories but also specialty packaging, much of it specific to certain holiday seasons. If actual future usage and demand for our products are less favorable than those projected by our review, inventory reserve adjustments may be required. We closely monitor our inventory, both perishable and non-perishable, and related shelf and product lives. Historically we have experienced low levels of obsolete inventory or returns of products that have exceeded their shelf life. Over the three-year period ended February 29, 2012, the Company recorded expense averaging $60,000 per year for potential inventory losses, or approximately 0.4% of total cost of sales for that period.

Goodwill - Goodwill consists of the excess of purchase price over the fair market value of acquired assets and liabilities. Effective March 1, 2002, under ASC Topic 350, all goodwill with indefinite lives is no longer subject to amortization. ASC Topic 350 requires that an impairment test be conducted annually or in the event of an impairment indicator. Our test conducted in FY 2012 showed no impairment of our goodwill.

Other accounting estimates inherent in the preparation of the Company's financial statements include estimates associated with its evaluation of the recoverability of deferred tax assets, as well as those used in the determination of liabilities related to litigation and taxation. Various assumptions and other factors underlie the determination of these significant estimates. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, current and expected economic conditions, and product mix. The Company constantly re-evaluates these significant factors and makes adjustments where facts and circumstances dictate. Historically, actual results have not significantly deviated from those determined using the estimates described above.

Results of Operations

Fiscal 2012 Compared To Fiscal 2011

Results Summary

Basic earnings per share decreased 3.1% from $.65 in FY 2011 to $.63 in FY 2012.
Revenues increased 11.2% from $31.1 million for FY 2011 to $34.6 million for FY
2012. Operating income decreased 1.6% from $6.0 million in FY 2011 to $5.9
million in FY 2012. Net income was approximately unchanged at $3.9 million in FY
2011 and FY 2012. The slight decrease in operating income and net income for FY
2012 compared to FY 2011 was due primarily to an increase in operating expenses
that more than offset an increase in revenues.

Revenues
($'s in thousands)              2012           2011         Change        % Change
Factory sales                $ 23,597.1     $ 21,627.6     $ 1,969.5            9.1 %
Retail sales                    5,278.5        3,716.5       1,562.0           42.0 %
Royalty and marketing fees      5,495.6        5,456.6          39.0            0.7 %
Franchise fees                    255.7          327.3         (71.6 )        (21.9 %)
Total                        $ 34,626.9     $ 31,128.0     $ 3,498.9           11.2 %

Factory Sales

The increase in factory sales in FY 2012 compared to FY 2011 was primarily due to a 25.7% increase in shipments of product to customers outside our network of franchised retail stores and a 4.6% increase in purchases by our network of franchised and licensed retail stores during FY 2012 compared with FY 2011.

Retail Sales

The increase in retail sales in FY 2012 compared to FY 2011 was primarily due to an increase in the average sales volume and the average number of Company-owned stores in operation as a result of the opening of eight Company-owned Aspen Leaf Yogurt locations and one Company-owned Rocky Mountain Chocolate Factory location, partially offset by the sale of three Company-owned Rocky Mountain Chocolate Factory locations during the year. Same-store sales at Company-owned stores increased 6.8% in FY 2012 compared to FY 2011.

Royalties, Marketing Fees and Franchise Fees

Royalties and marketing fees were approximately unchanged during FY 2012 compared to FY 2011 as a result of an increase in franchise same store sales and an increase in the number of Cold Stone Creamery co-branded locations in operation, offset by a decline in the average number of domestic franchise units in operation. The average number of domestic franchise units in operation decreased 3.9% from 255 in FY 2011 to 245 in FY 2012. Same store sales at franchise locations increased 1.1% in FY 2012 compared to FY 2011. Franchise fee revenues during FY 2012 decreased 21.9% as a result of a decrease in the average franchise fee per unit, associated with a lower franchise fee for ALY locations and a decrease in licensed, co-branded, location openings from 22 in FY 2011 to 10 openings in FY 2012.

Costs and Expenses ($'s in
thousands)                            2012            2011           Change           % Change

Cost of sales - factory adjusted   $  16,150.9     $  14,784.7     $   1,366.2               9.2 %
Cost of sales - retail                 2,158.3         1,443.5           714.8              49.5 %
Franchise costs                        1,796.5         1,575.8           220.7              14.0 %
Sales and marketing                    1,683.7         1,594.8            88.9               5.6 %
General and administrative             3,044.6         2,691.7           352.9              13.1 %
Retail operating                       3,189.2         2,416.8           772.4              32.0 %
Total                              $  28,023.2     $  24,507.3     $   3,515.9              14.3 %

Adjusted Gross margin ($'s in
thousands)
Factory adjusted gross margin      $   7,446.2     $   6,842.9     $     603.3               8.8 %
Retail                                 3,120.2         2,273.0           847.2              37.3 %
Total                              $  10,566.4     $   9,115.9     $   1,450.5              15.9 %

(Percent)
Factory adjusted gross margin             31.6 %          31.6 %           0.0 %             0.0 %
Retail                                    59.1 %          61.2 %          (2.1 %)           (3.4 %)
Total                                     36.6 %          36.0 %           0.6 %             1.7 %

Factory adjusted gross margin is equal to factory gross margin minus depreciation and amortization expense. We believe factory adjusted gross margin is helpful in understanding our past performance as a supplement to factory gross margin and other performance measures calculated in conformity with accounting principles generally accepted in the United States ("GAAP"). We believe that factory adjusted gross margin is useful to investors because it provides a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use factory adjusted gross margin rather than factory gross margin to make incremental pricing decisions. Factory adjusted gross margin has limitations as an analytical tool because it excludes the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use factory adjusted gross margin as a measure of performance only in conjunction with GAAP measures of performance such as factory gross margin. The following table provides a reconciliation of factory adjusted gross margin to factory gross margin, the most comparable performance measure under GAAP:

($'s in thousands)                     2012          2011
Factory adjusted gross margin        $ 7,446.2     $ 6,842.9
Less: Depreciated and Amortization       278.3         321.2
Factory GAAP gross margin            $ 7,167.9     $ 6,521.7

Cost of Sales

Factory margins were unchanged in FY 2012 compared with FY 2011. The decrease in Company-owned store margin is due primarily to costs associated with Aspen Leaf Yogurt grand openings, a change in the number of Company-owned stores in operation, and the associated change in product mix.

Franchise Costs

The increase in franchise costs for FY 2012 compared to FY 2011 is due primarily to an increase in compensation related costs associated with additional franchise personnel and costs associated with site selection and development of Aspen Leaf Yogurt. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs increased to 31.2% in the FY 2012 from 27.2% in FY 2011. This increase as a percentage of royalty, marketing and franchise fees is primarily a result of higher franchise costs relative to revenues.

Sales and Marketing

The increase in sales and marketing costs for FY 2012 compared to FY 2011 is primarily due to increased marketing related compensation costs and increased ALY advertising.

General and Administrative

The increase in general and administrative expense in FY 2012 compared to FY 2011 is due to an increase in the allowance for doubtful accounts and notes receivable, costs associated with site selection and development of Aspen Leaf Yogurt, and stock-based compensation expense. As a percentage of total revenues, general and administrative expenses increased to 8.8% in FY 2012 compared to 8.6% in FY 2011.

Retail Operating Expenses

The increase in retail operating expenses was due to an increase in the average number of Company-owned stores in operation as a result of the opening of eight Company-owned Aspen Leaf Yogurt locations and one Company-owned Rocky Mountain Chocolate Factory location, partially offset by the sale of three Company-owned Rocky Mountain Chocolate Factory stores. For FY 2012, an operating loss of approximately $586,000 was incurred related to the opening and operation of Aspen Leaf Yogurt locations. Retail operating expenses, as a percentage of retail sales, decreased from 65.0% in FY 2011 to 60.4% in FY 2012.

Depreciation and Amortization

Depreciation and amortization of $751,000 in FY 2012 increased 12.0% from the $670,000 incurred in FY 2011 due to an increase in the number of Company-owned stores in operation partially offset by certain assets becoming fully depreciated.

Interest Income

Interest income was approximately unchanged during FY 2012, compared to FY 2011. Interest income of $58,900 and $58,700 related to notes receivable was realized in FY 2012 and FY 2011, respectively.

Income Tax Expense

Our effective income tax rate in FY 2012 was 34.4% which is a decrease of 0.5% compared to an effective rate of 34.9% during FY 2011. The decrease in the effective tax rate is primarily due to a decrease in expected tax payments in states where we derive a significant portion of our income.

Fiscal 2011 Compared To Fiscal 2010

Results Summary

Basic earnings per share increased 8.3% from $.60 in FY 2010 to $.65 in FY 2011. Revenues increased 9.5% from FY 2010 to FY 2011. Operating income increased 5.4% from $5.6 million in FY 2010 to $6.0 million in FY 2011. Net income increased 9.2% from $3.6 million in FY 2010 to $3.9 million in FY 2011. The increase in revenue, earnings per share, operating income, and net income in FY 2011 compared to FY 2010 was due primarily to an increase in revenues from our system of domestic franchise and licensed locations and an increase in sales to specialty market customers outside our system of franchise and licensed retail locations.

Revenues
($'s in thousands)              2011           2010         Change        % Change
Factory sales                $ 21,627.6     $ 20,118.2     $ 1,509.4            7.5 %
Retail sales                    3,716.5        2,825.8         890.7           31.5 %
Royalty and marketing fees      5,456.6        5,288.0         168.6            3.2 %
Franchise fees                    327.3          204.5         122.8           60.0 %
Total                        $ 31,128.0     $ 28,436.5     $ 2,691.5            9.5 %

Factory Sales

Factory sales increased in FY 2011 compared to FY 2010 due to an increase in revenues from product sales to our system of domestic franchise and licensed locations and a 13.7% increase in product shipments to specialty markets customers. Same store pounds purchased in FY 2011 were down approximately 0.6% from FY 2010. The Company believes the decrease in same store pounds purchased is due primarily to a product mix shift from factory products to products made in the stores and is primarily a result of the United States recession and the resulting financial pressure the recession has created for our system of franchised stores.

Retail Sales

The increase in total retail sales was due to an increase in the average number of Company-owned stores in operation from eight during FY 2010 to 12 Company-owned stores in FY 2011. Same store retail sales at Company-owned store stores declined 2.0%in FY 2011 compared to FY 2010 due to decreased customer traffic counts at certain Company-owned locations.

Royalties, Marketing Fees and Franchise Fees

The increase in royalties and marketing fees resulted from an increase in same
store sales of 0.6% and an increase in royalties from licensed co-branded
locations, partially offset by a decrease in the average number of domestic
units in operation from 266 in FY 2010 to 255 in FY 2011. Franchise fee revenues
increased due to an increase in license fees related to the Company's Cold Stone
Creamery co-branding initiative and renewal of the Franchise Development
Agreement covering the Gulf Cooperation Council States of United Arab Emirates.

Costs and Expenses ($'s in
thousands)                            2011            2010           Change           % Change

Cost of sales - factory adjusted   $  14,784.7     $  13,830.4     $     954.3               6.9 %
Cost of sales - retail                 1,443.5         1,080.2           363.3              33.6 %
Franchise costs                        1,575.8         1,499.5            76.3               5.1 %
Sales and marketing                    1,594.8         1,505.4            89.4               5.9 %
General and administrative             2,691.7         2,422.1           269.6              11.1 %
Retail operating                       2,416.8         1,757.0           659.8              37.6 %
Total                              $  24,507.3     $  22,094.6     $   2,412.7              10.9 %

Adjusted Gross margin ($'s in
thousands)
Factory adjusted gross margin      $   6,842.9     $   6,287.8     $     555.1               8.8 %
Retail                                 2,273.0         1,745.6           527.4              30.2 %
Total                              $   9,115.9     $   8,033.4     $   1,082.5              13.5 %

(Percent)
Factory adjusted gross margin             31.6 %          31.3 %           0.3 %             1.0 %
Retail                                    61.2 %          61.8 %          (0.6 %)           (1.0 %)
Total                                     36.0 %          35.0 %           1.0 %             2.9 %

Factory adjusted gross margin is equal to factory gross margin minus depreciation and amortization expense. We believe factory adjusted gross margin is helpful in understanding our past performance as a supplement to factory gross margin and other performance measures calculated in conformity with accounting principles generally accepted in the United States ("GAAP"). We believe that factory adjusted gross margin is useful to investors because it provides a measure of operating performance and our ability to generate cash that is unaffected by non-cash accounting measures. Additionally, we use factory adjusted gross margin rather than factory gross margin to make incremental pricing decisions. Factory adjusted gross margin has limitations as an analytical tool because it excludes the impact of depreciation and amortization expense and you should not consider it in isolation or as a substitute for any measure reported under GAAP. Our use of capital assets makes depreciation and amortization expense a necessary element of our costs and our ability to generate income. Due to these limitations, we use factory adjusted gross margin as a measure of performance only in conjunction with GAAP measures of performance such as factory gross margin. The following table provides a reconciliation of factory adjusted gross margin to factory gross margin, the most comparable performance measure under GAAP:

($'s in thousands)                     2011          2010
Factory adjusted gross margin        $ 6,842.9     $ 6,287.8
Less: Depreciated and Amortization       321.2         336.0
Factory GAAP gross margin            $ 6,521.7     $ 5,951.8

Cost of Sales

Factory margins increased 30 basis points from FY 2010 compared to FY 2011 due primarily to an increase in manufacturing efficiencies related to increased production volume partially offset by an increase in transportation related costs resulting from an increase in fuel costs during FY 2011 versus FY 2010.

Franchise Costs

The increase in franchise costs is due to costs associated with development of Aspen Leaf Yogurt, LLC in FY 2011 compared with FY 2010. As a percentage of total royalty and marketing fees and franchise fee revenue, franchise costs were approximately unchanged at 27.2% in FY 2011 from 27.3% in FY 2010.

Sales and Marketing

Sales and marketing costs increased 5.9% in FY 2011 compared with FY 2010 due primarily to an increase in advertising related costs. This increase was primarily the result of a planned increase in expenses associated with our marketing efforts.

General and Administrative

The increase in general and administrative costs is due primarily to an increase . . .