Form 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


þ		QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 27, 2010


o		TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from to

Commission File Number: 333-136167

UFOOD RESTAURANT GROUP, INC.

(Exact name of registrant as specified in its charter)


Nevada		20-4463582
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

255 Washington Street, Suite 100
Newton, MA 02458
(Address of principal executive offices)

(617) 787-6000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the issuer (1) 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.

þ Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o
(Do not check if a smaller reporting company)

Smaller reporting company þ

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

þ Yes o No

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes þ No

As of August 9, 2010, there were 39,794,474 shares of the Registrant’s common stock, par value $0.001 per share, issued and outstanding.

UFOOD RESTAURANT GROUP, INC. AND SUBSIDIARY

Consolidated Balance Sheets
June 27, 2010 and December 27, 2009

Liabilities and Stockholders’ Equity (Deficit)


	June 27,			December 27,
	2010			2009
	(unaudited)			(audited)

Current liabilities:
Current portion of long-term debt	$	450,000		$	857,882
Current portion of capital lease obligations		49,702			58,820
Accounts payable		306,523			285,150
Franchisee deposits		145,605			157,500
Accrued expenses and other current liabilities		188,700			157,870

Total current liabilities		1,140,530			1,517,222


Long-term liabilities:
Long-term debt		3,369,013			3,044,001
Derivative warrant liability		225,835			3,750
Capital lease obligations		26,306			39,071
Other noncurrent liabilities		256,087			276,920

Total long term liabilities		3,877,241			3,363,742


Total liabilities		5,017,771			4,880,964


Commitments and contingencies

Stockholders’ equity (deficit):
Common stock, $0.001 par value, 300,000,000 shares authorized, 39,794,473 shares issued and outstanding		39,794			37,935
Additional paid-in capital		26,286,990			25,589,311
Accumulated deficit		(28,102,380	)		(25,515,871	)

Total stockholders’ equity (deficit)		(1,775,596	)		111,375


Total liabilities and stockholders’ equity (deficit)	$	3,242,175		$	4,992,339

See accompanying notes.

UFOOD RESTAURANT GROUP, INC. AND SUBSIDIARY

Consolidated Statements of Operations — Unaudited
For the Three and Six Month Periods Ended June 27, 2010 and June 28, 2009


	Three Months Ended						Six Months Ended
	June 27,			June 28,			June 27,			June 28,
	2010			2009			2010			2009
Revenues:
Store sales	$	1,199,274		$	1,227,321		$	2,268,244		$	2,333,996
Franchise royalties and fees		97,159			90,779			149,949			269,518
Other revenue		6,647			—			7,025			2,696

		1,303,080			1,318,100			2,425,218			2,606,210


Costs and expenses:
Store operating expenses:
Food and paper costs		355,095			352,304			659,564			672,585
Cost of nutritional products		100,364			93,010			184,353			184,869
Labor		318,942			336,823			625,385			705,673
Occupancy		110,896			135,977			234,724			292,607
Other store operating expenses		212,297			188,767			420,942			380,098
General and administrative expenses		892,986			1,113,787			1,610,382			1,992,072
Advertising, marketing and promotion expenses		70,683			60,098			110,335			104,755
Depreciation and amortization		81,093			102,931			164,075			208,811
Loss on disposal of assets		—			57,840			—			62,898

Total costs and expenses		2,142,356			2,441,537			4,009,760			4,604,368


Operating loss		(839,276	)		(1,123,437	)		(1,584,542	)		(1,998,158	)


Other income (expense):
Interest income		1,625			7,149			4,157			10,531
Interest expense		(399,826	)		(285,923	)		(784,039	)		(301,233	)
Other income (expense)		(153,184	)		243,558			(222,085	)		329,777

Other income (expense), net		(551,385	)		(35,216	)		(1,001,967	)		39,075


Loss before income taxes		(1,390,661	)		(1,158,653	)		(2,586,509	)		(1,959,083	)
Income taxes		—			—			—			—


Net loss	$	(1,390,661	)	$	(1,158,653	)	$	(2,586,509	)	$	(1,959,083	)


Basic and diluted loss per share	$	(0.04	)	$	(0.03	)	$	(0.07	)	$	(0.06	)

See accompanying notes.

UFOOD RESTAURANT GROUP, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows — Unaudited
For the Six Months Ended June 27, 2010 and June 28, 2009


	Six Months Ended
	June 27, 2010			June 28, 2009

Cash flows from operating activities:
Net loss	$	(2,586,509	)	$	(1,959,083	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		164,075			208,811
Amortization of the beneficial conversion feature		364,012			86,127
Deferred financing costs		173,828			87,701
Provision for doubtful accounts		(66,322	)		68,687
Stock-based compensation		253,719			303,591
Change in fair value of warrant liability		222,085			(254,809	)
Loss on disposal of assets		4,315			62,898
Non-cash promotion expenses		144,638			138,000
Non-cash interest payments		208,335			70,549
Gain on extinguishment of debt		—			(74,969	)
Increase (decrease) in cash from changes in assets and liabilities:
Accounts receivable		202,176			(30,188	)
Inventories		(3,264	)		(20,558	)
Prepaid expenses and other current assets		20,562			(33,442	)
Other assets and noncurrent liabilities		2,079			(73,963	)
Accounts payable		21,373			(137,710	)
Franchisee deposits		(11,895	)		(70,000	)
Accrued expenses and other current liabilities		9,996			(157,993	)

Net cash used in operating activities		(876,797	)		(1,719,467	)

Cash flows from investing activities:
Proceeds from the disposal of assets		—			5,000
Acquisition of property and equipment		(37,057	)		(31,559	)

Net cash used in investing activities		(37,057	)		(26,559	)

Cash flows from financing activities:
Proceeds from issuance of common stock, net		53,846			—
Proceeds from issuance of convertible debt		—			5,874,000
Payments for financing costs		(52,535	)		(957,185	)
Payments on long-term debt		(407,882	)		(185,470	)
Payments on capital lease obligations		(30,046	)		(30,200	)
Decrease in restricted cash, net		20,425			349,761

Net cash provided (used in) by financing activities		(416,192	)		5,050,906

Increase (decrease) in cash and cash equivalents		(1,330,046	)		3,304,880
Cash and cash equivalents — beginning of year		2,278,427			787,551


Cash and cash equivalents — end of period	$	948,381		$	4,092,431

See accompanying notes.

UFOOD RESTAURANT GROUP, INC.
Notes to Consolidated Financial Statements — Unaudited-

Nature of Operations and Basis of Presentation

Nature of Operations

UFood Restaurant Group, Inc. was incorporated in the State of Nevada on February 8, 2006 as Axxent Media Corp. Prior to December 18, 2007, UFood was a development stage company headquartered in Vancouver, Canada. As Axxent Media Corp., the Company’s business was to obtain reproduction and distribution rights to foreign films within North America and also to obtain the foreign rights to North American films for reproduction and distribution to foreign countries. On August 8, 2007, the Company changed its name to UFood Franchise Company, Inc., and on September 25, 2007, changed its name to UFood Restaurant Group, Inc. (UFood or the Company). Following the Merger described below, the Company abandoned its former plans with respect to film reproduction and distribution rights.

On December 18, 2007, (the Merger Date) pursuant to the terms of an Agreement and Plan of Merger and Reorganization, a wholly-owned subsidiary of the Company merged with and into KnowFat Franchise Company, Inc. (KnowFat). Following the merger (the Merger), UFood continued KnowFat’s business operations as a franchisor and operator of fast-casual food service restaurants that capitalize on consumer demands for great tasting food with healthy attributes. As of June 27, 2010, the Company’s operations consisted of four Company-owned restaurants and four franchisee owned restaurants. On the Merger Date, each share of KnowFat common stock issued and outstanding immediately prior to the Merger was exchanged for 1.52350763 shares of UFood Common Stock. All share amounts have been adjusted to reflect the effect of the share exchange.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the rules and regulations of the Securities and Exchange Commission. They include the activity and balances of UFood and its subsidiaries but do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The interim consolidated financial statements are unaudited; however, they include all normal recurring accruals and adjustments that, in the opinion of management, are necessary to present fairly UFood’s financial position at June 27, 2010, and the results of its operations and cash flows for the three and six month periods ended June 27, 2010 and June 28, 2009. The results of operations for the three and six month periods ended June 27, 2010 are not necessarily indicative of the results to be expected for future quarters or the full year. The interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto for the fiscal year ended December 27, 2009 included in the Company’s Annual Report on Form 10-K.

As shown in the accompanying consolidated financial statements, the Company has incurred recurring losses from operations and negative cash flows from operations. Over the past few years, the Company’s operations have been funded through a combination of private equity and debt financing. As of June 27, 2010, the Company had approximately $948,000 of unrestricted cash. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Based on current trends, management believes that additional franchises will be sold within the next twelve months, and that the additional capital raised will be sufficient to support activities though 2011. The Company is subject to a number of risks similar to those of other companies in its industry, including dependence on key individuals, competition from substitute products, the successful attraction of franchisee, and the ability to obtain adequate additional financing necessary to fund continuing operations. The Company is currently in the process of raising additional equity capital. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

Summary of Significant Accounting Policies

Fiscal Quarters

In 2010, our fiscal quarters end on March 28^th, June 27^th, September 26^th and January 2^nd, 2011. In 2009, our fiscal quarters ended on March 28^th, June 28^th, September 27^th and December 27^th.

Principles of Consolidation

The consolidated financial statements include the assets, liabilities and results of operations of UFood Restaurant Group, Inc. and its subsidiary. All significant intercompany balances and transactions have been eliminated.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual amounts could differ from those estimates.

Reclassifications

Certain reclassifications have been made to conform previously reported data to the current presentation.

Deferred Financing Costs

Deferred financing costs represent costs paid to third parties in order to obtain long-term financing and have been included in other assets. Deferred financing costs are amortized over the life of the related debt. Amortization expense related to these costs was $173,828 and $87,701 for the six months ended June 27, 2010 and June 28, 2009, respectively, and is included in interest expense. The amortization expense recorded by the Company for the three months ended June 27, 2010 and June 28, 2009 was $86,425 and $54,705 respectively.

Valuation of Goodwill

We account for goodwill and other intangible assets under ASC No. 805, Business Combinations, and ASC No. 350-20 to 30, Goodwill and Other Intangible Assets. ASC No. 805 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, and that certain intangible assets acquired in a business combination be recognized as assets apart from goodwill. Under ASC No. 350-20 to 30, purchased goodwill and intangible assets with indefinite lives are not amortized, but instead tested for impairment at least annually or whenever events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill attributable to our franchise operations segment is evaluated by comparing the Company’s fair market value, determined based upon quoted market prices of the Company’s equity securities, to the carrying amount of goodwill. Goodwill attributable to our store operations segment is evaluated on a restaurant-by-restaurant basis by comparing the restaurant’s estimated fair value to the carrying value of the restaurant’s underlying net assets inclusive of goodwill. Fair value is determined based upon the restaurant’s estimated future cash flows. Future cash flows are estimated based upon a restaurant’s historical operating performance and management’s estimates of future revenues and expenses over the period of time that the Company expects to operate the restaurant, which generally coincides with the initial term of the restaurant’s lease but which may take into account the restaurant’s first lease renewal period up to 5 years. The estimate of a restaurant’s future cash flows may also include an estimate of the restaurant’s terminal value, determined by applying a capitalization rate to the restaurant’s estimated cash flows during the last year of the forecast period. The capitalization rate used by the Company was determined based upon the restaurant’s location, cash flows and growth prospects. As of the first day of the fourth quarter of the year ended December 27, 2009 according to our policy we have tested the carrying value of the Goodwill attributable to our store operations and no impairment was necessary. The carrying amount of goodwill may be impaired in the future if our actual operating results and cash flows fall short of our expectations.

The goodwill attributable to our franchise operations segment was impaired due to the decision to not renew the lease agreement for a property originally leased as a training facility. The carrying amount of the goodwill attributable to franchise operations exceeded its implied fair value and the Company recognized a non-cash impairment charge of $136,000 during the year ended December 27, 2009.

Impairment of Long-Lived Assets

In accordance with ASC No. 360 Property, Plant and Equipment, when impairment indicators exist, the Company evaluates its long-lived assets for potential impairment. Potential impairment is assessed when there is evidence that events or changes in circumstances have occurred that indicate the carrying amount of an asset may not be recovered. When events or changes in circumstances have occurred that indicate a long-lived asset may be impaired, the Company uses estimates of future cash flows on a restaurant-by-restaurant basis to test the recoverability of its long-lived assets. Future cash flows are estimated based upon the restaurant’s historical operating performance and management’s projections of future revenues and expenses and may take into account the restaurant’s estimated terminal value.

Revenue Recognition

The Company records revenue for Company-owned store sales upon the delivery of the related food and other products to the customer. The Company records a liability in the period in which a gift card is issued and proceeds are received. As gift cards are redeemed, this liability is reduced and revenue is recognized.

The Company follows the accounting guidance of ASC No. 952, Franchisors. Franchisee deposits represent advances on initial franchise fees prior to the opening of the franchisee location. We recognize initial franchise fee revenue when all material services we are required to perform and all material conditions we are required to satisfy have been substantially completed, which is generally the opening of the franchised location. The Company defers direct costs related to franchise sales until the related revenue is recognized; however, the deferred costs shall not exceed anticipated revenue less estimated additional related costs. Such costs include training, facilities design, menu planning and marketing. Franchise royalty revenues are recognized in the same period the relevant franchisee sales occur.

Rent Expense

The Company recognizes rent expense on a straight-line basis over the reasonably assured lease term as defined in ASC No. 840, Leases. The reasonably assured lease term on most of the Company’s leases is the initial non-cancelable lease term, which generally equates to between 5 and 10 years. In addition, certain of the Company’s lease agreements provide for scheduled rent increases during the lease terms or for rental payments commencing at a date other than the date of initial occupancy. The Company includes any rent escalations and other rent holidays in its determination of straight-line rent expense. Therefore, rent expense for new locations is charged to expense upon the commencement date of the lease.

Earnings Per Share Data

Earnings per share are based on the weighted average number of shares outstanding during the period after consideration of the dilutive effect, if any, for common stock equivalents, including stock options, restricted stock, and other stock-based compensation. Earnings per common share are computed in accordance with ASC No. 260, Earnings Per Share, which requires companies to present basic earnings per share and diluted earnings per share. Basic earnings per share are computed by dividing net income allocable to common stockholders by the weighted average number of shares of common stock outstanding during the year. Diluted earnings per common share are computed by dividing net income by the weighted average number of shares of common stock outstanding and dilutive securities outstanding during the year.

Fair Value of Financial Instruments

The carrying amounts of the Company’s financial instruments, which include cash and cash equivalents, accounts receivable, accounts payable and other accrued expenses and debt obligations approximate their fair values due to the short-term maturity of these instruments.

Stock-Based Compensation

The Company maintains two stock-based incentive plans. The Company grants options to purchase common stock at an option price equal to the market value of the stock at the date of grant. Options generally vest over a three year period beginning on the date of grant and have a ten year contractual term.

The Company applies the fair value recognition provisions of ASC No. 718, Compensation-Stock Compensation, which requires all stock-based compensation, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. The Company uses the Black-Scholes option pricing model which requires extensive use of accounting judgment and financial estimates, including estimates of the expected term participants will retain their vested stock options before exercising them and the estimated volatility of the Company’s common stock price over the expected term.

Stock-based compensation expense recognized during the three months ended June 27, 2010 totaled approximately $197,270 for stock options. Stock-based compensation expense recognized during the six months ended June 27, 2010 totaled approximately $253,719 for stock options. Stock-based compensation expense was included in general and administrative expenses in the accompanying Consolidated Statements of Operations.

Long Term Debt and Warrants

2008 Investor Warrants

On December 18 and 21, 2007, January 22, 2008, February 6, 2008, March 30, 2008, the “ Company” sold 5,720,000, 440,000, 863,000, 1,927,000, and 1,991,000 units (“Units”), respectively, of its securities at a price of $1.00 per Unit, in connection with five separate closings (the “Closings”) of its private placement of securities (the “Offering”). Each Unit consisted of one share of common stock of the Company, par value $.001 per share (“Common Stock”), and a warrant to purchase one-half of one share of Common Stock (the “2008 Investor Warrants”). A total of 5,470,500 2008 Investor Warrants were issued in conjunction with the closings.

The 2008 Investor Warrants provide for the purchase of shares of Common Stock for five years at an original exercise price of $1.25 per share. The 2008 Investor Warrants, at the option of the holder, may be exercised by cash payment of the exercise price or by “cashless exercise” to the extent that a registration statement covering the shares of Common Stock underlying the 2008 Investor Warrants is not in effect following the one year anniversary of issuance. A “cashless exercise” means that in lieu of paying the aggregate purchase price for the shares being purchased upon exercise of the 2008 Investor Warrants in cash, the holder will forfeit a number of shares underlying the 2008 Investor Warrants with a “fair market value” equal to such aggregate exercise price. The Company will not receive additional proceeds to the extent that 2008 Investor Warrants are exercised by cashless exercise. As a result of the Company’s recent private placement, the exercise price of the 2008 Investor Warrants was reduced to $.059 pursuant to the terms of such warrants.

The exercise price and number of shares of Common Stock issuable on exercise of the 2008 Investor Warrants may be adjusted in certain circumstances including a stock dividend, or a recapitalization, reorganization, merger or consolidation. The 2008 Investor Warrants are also subject to a weighted average price protection for the term of the Investor Warrants.

Through March of 2008, the Company paid the placement agent retained in connection with the Offering (the “2008 Placement Agent”) a commission of 10% of the funds raised from the investors in connection with the Closings. In addition, the 2008 Placement Agent received warrants (the “2008 Placement Agent Warrants”) to purchase a number of shares of Common Stock equal to 20% of the shares of Common Stock included in the Units sold to investors. As a result of the foregoing, the 2008 Placement Agent was paid commissions of $1,294,100 and received warrants to purchase 2,988,200 shares of Common Stock. The terms of these warrants were similar to those of the 2008 Investor Warrants, except that they had a seven-year term and $1.00 original exercise price. As a result of the Company’s recent private placement, the exercise price of the 2008 Placement Agent Warrants was reduced to $.049 pursuant to the terms of such warrants.

The Company is subject to a derivative warrant liability instrument due to the fact that the related contract is not indexed to its own stock, as specified by ASC No. 815-40, Derivatives and Hedging-Contracts in entity’s Own Equity. The derivative is accounted for and classified as a “Derivative warrant liability” within the liabilities section of the consolidated balance sheet. The change in the fair value of the derivative is included within “Other income (Loss)” in the consolidated statements of operations. The change in the fair value of the derivative instrument affects the “Change in fair value of derivative warrant liability” line in the “Cash flows from operating activities” section of the consolidated statements of cash flows.

At the date of issuance of the 2008 Investor Warrants and 2008 Placement Agent Warrants, based upon evaluation under applicable ASC No. 815 Derivatives and Hedging guidance, the Company initially determined that the financial instrument did not constitute a derivative, and, accordingly, reflected the balance within additional paid-in capital as of December 28, 2008 in the Company’s Form 10-K. During the quarter ended March 29, 2009, the Company re-assessed this categorization based upon the clarified “indexed to an entity’s own stock” criteria specified within ASC No. 815-40, which is effective for fiscal years beginning after December 15, 2008, and concluded that the financial instrument constituted a derivative. The aggregate fair value of the derivative at inception was determined to be $3,512,272, which was recorded as a derivative liability during the quarter ended March 29, 2009. At December 29, 2008, the aggregate fair value of the derivatives was $353,248. The decrease in the fair value of the derivative in the aggregate amount of $3,159,024 upon adoption of ASC No. 815-40 was recorded in the consolidated statements of changes in stockholders’ equity as a cumulative adjustment gain on derivative during the three months ended March 29, 2009.

At June 27, 2010, the aggregate fair value of the derivative was $225,835. The decrease in the fair value of the derivative was in the aggregate amount of $222,085 during the six months ended June 27, 2010. The decrease in the fair value of the derivative for the three months ended June 27, 2010 was $153,184.

The derivative is not intended to hedge any specific risk exposures, such as fluctuating interest rates, exchange rates, commodity prices, etc. Therefore, the derivative constitutes neither a cash flow hedge, nor a fair value hedge. The volume of derivative activity relates solely to the derivative warrant liability instrument itself, and changes in fair value thereon.

Tabular disclosure of the fair value of the derivative instrument in the consolidated balance sheets, and the effect of the derivative instrument on the consolidated balance sheets follows:


	As of June 27, 2010
	Liability Derivatives
	Balance Sheet
	Location	Fair Value
Derivatives designated as hedging instruments under FAS 133:
None

Derivatives not designated as hedging instruments under FAS 133:
Derivative warrant liability	Long-term liabilities	$	225,835


Total derivatives		$	225,835

The effect of the derivative instrument on the consolidated statements of operations for the quarter ended June 27, 2010 follows:


		Amount of Gain (Loss)
	Location of Gain (Loss)	Recognized in Income on
	Recognized in Income on	Derivative
	Derivative	Quarter Ended June 27, 2010
Derivatives not designated as hedging instruments under FAS 133:
Derivative warrant liability	Other Income (Expense)		($222,085	)


Total			($222,085	)

The fair value of the warrant liability was determined using the Black Scholes Option Pricing method. The valuation methodology uses a combination of observable (Level 2) and unobservable (Level 3) inputs in calculating fair value. As required by ASC 820, assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

The fair value of the warrant liability was estimated on the date of issuance, as of December 29, 2008, and as of June 27, 2010, using the following assumptions:


	At Issuance			December 27, 2009			June 27, 2010
Expected term (years)	5 -7 Years			5 -7 Years			5 -7 Years
Expected volatility		32.34	%		34.87	%		37.20	%
Risk-free interest rate		2.46	%		1.55	%		1.07	%
Expected annual dividend		0.00	%		0.00	%		0.00	%

The table below sets forth a summary of changes in the fair value of the Company’s level 3 derivative at December 29, 2008, and for the quarter ended June 27, 2010:


Balance as of December 28, 2008	$	—
Fair value of warrant liability at issuance		3,512,272
Decrease in fair value at December 29, 2008		(3,159,024	)
Decrease in fair value at December 27, 2009		(349,498	)
Increase in fair value during quarter ended March 28, 2010		68,901
Increase in fair value during quarter ended June 27, 2010		153,184
Balance as of June 27, 2010	$	225,835

2009 Warrants

On March 19, 2009, the Company sold 8% Senior Secured Convertible Debentures (the “Debentures”) to investors in the principal amount of $3,315,000 and issued warrants (the “2009 Warrants” and, collectively with the Debentures, the “Securities”) to purchase 12,750,000 shares of our common stock to such investors in connection with first closing of our private placement of securities (the “ 2009 Offering”). On April 20, 2009, the Company sold an additional $2,559,000 of Senior Secured Convertible Debentures (“the Debentures”) in connection with the final closing of its private offering to accredited investors. The addition of both closings is $5,874,000 of convertible debentures. The Debentures bear interest at a rate of 8% and are due three years from the date they were issued. The Debentures are convertible into shares of common stock at $0.13 per share. In addition, each investor will receive 5-year detachable warrants to purchase a number of shares of Common Stock equal to 50% of the shares underlying the Investor’s Debenture. Interest on the Debentures a rate of 8% per annum is payable on a quarterly basis. Subject to certain conditions, the Company has the right to pay interest on the Debentures in either cash or shares of Common Stock, or in a combination of cash and Common Stock. After the one year anniversary of the Closing, the Company has the right to redeem the Debentures at a 20% premium, subject to certain conditions. Subject to certain conditions, the Company has the right to force conversion of the Debentures into shares of Common Stock. The Company has filed a registration statement with the Securities and Exchange Commission covering all shares of Common Stock issuable upon conversion of the Debentures and/or exercise of the 2009 Warrants.

The Company paid Garden State Securities, Inc., the placement agent retained in connection with the 2009 Offering (the “2009 Placement Agent”), (i) a commission of 10% of the aggregate subscription amount of the Securities sold in the 2009 Offering, plus (ii) $50,000 for its legal fees and expenses, plus (iii) a non-accountable expense allowance equal to 3% of the aggregate subscription amount of the Securities sold in the 2009 Offering. In addition, the 2009 Placement Agent (or its assigns) received warrants (the “2009 Placement Agent Warrants”) to purchase a number of shares of common stock equal to twenty percent (20%) of the maximum number of shares of common stock underlying the Debentures and 2009 Warrants sold in the 2009 Offering. As a result of the foregoing, the 2009 Placement Agent was paid a commission of $587,400 plus a non-accountable expense allowance of $176,220 and received warrants to purchase 5,100,000 shares of Common Stock for March 2009 first closing, and 3,936,923 for April 2009 second and final closing in connection with the 2009 Offering. The terms of these warrants were similar to those of the 2009 Warrants.

In conjunction with the Debentures and the 2009 Warrants, the Company recorded debt discount of $3,130,200 associated with a beneficial conversion feature on the debt, which is being accreted using the effective interest method over the three year term of the debentures. For the quarter ended June 27, 2010, the Company recorded interest expense of $190,834 in conjunction with accreting the debt discount on the warrants and the beneficial conversion feature over the debt term. For the six months ended June 27, 2010, the Company recorded interest expense of $364,012 in connection with the debt discount on the warrants and the beneficial conversion feature over the debt term.

Stock-Based Compensation

During the three and six month periods ended June 27, 2010, the Company recognized $197,270 and $253,719, respectively, of stock-based compensation expense for equity awards to employees, consultants and vendors. During the three and six month periods ended June 28, 2009, the Company recognized $98,347 and $303,591 respectively of stock-based compensation expense.

The Company estimates the fair value of stock options using a Black Scholes option pricing model with the assumptions noted in the following table. Key inputs used to estimate the fair value of stock options include the exercise price of the award, the expected option term, the expected volatility of the Company’s stock over the option’s expected term, the risk-free interest rate over the option’s expected term, and the Company’s expected annual dividend yield.

The fair value of each stock option granted during the three month period ended June 27, 2010 was estimated on the date of grant using the following assumptions:


Expected term (years)		5
Expected volatility		45	%
Risk-free interest rate		2.59	%
Expected annual dividend	None

The expected term is based on the remaining vesting term and the contractual term. Expected volatility is based on the historical volatility of published common stock prices over the last six years of comparable publicly held companies. The risk-free interest rate for the expected term of the stock option is based on the U.S. Treasury yield. The Company believes that the valuation technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of stock options granted during the three and six month periods ended June 27, 2010. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards.

The 2004 Plan

Under the terms of the 2004 Plan, the Company was authorized to grant incentive stock options (ISO’s), non-qualified stock options and restricted stock for up to 304,702 shares of common stock in the aggregate, to employees, officers, directors, consultants and agents of the Company. There were no options granted or exercised, however there were 82,347 options forfeited under the 2004 Plan during the six months ended June 27, 2010. On May 13, 2009 the Company’s Board of Directors approved the cancelation of 181,981 stock options of current employees’ and issuance of new stock options under the 2007 Plan for the same individuals, with a vesting schedule identical to the remaining vesting schedule of the canceled options at an exercise price of $0.20 per share. At June 27, 2010, there were 40,374 options outstanding under the 2004 Plan. All of the outstanding options are exercisable as of June 27, 2010. There was no unrecognized compensation expense related to options outstanding under the 2004 Plan at June 27, 2010.

The 2007 Plan

There were no awards under the 2007 Plan prior to December 18, 2007. Awards of ISO’s, non-qualified stock options, stock appreciation rights, restricted stock units, restricted stock or performance units may be made under the 2007 Plan of up to a maximum of 6,000,000 shares of Common Stock to employees, directors, consultants and agents of the Company. During our annual shareholders’ meeting held on July 1^st, 2010, our shareholders approved the increase in the number of shares of common stock reserved for issuance under the 2007 Plan to 9,000,000 shares. The Company believes awards under the 2007 Plan align the interests of its employees with those of its shareholders. On April 1, 2010 the Company’s Board of Directors approved the grant of 2,070,000 stock options to employees and officers of the Company, fully vested at an exercise price of $0.16 per share. The Company recognized a compensation expense of $140,822 in connection with this grant. At June 27, 2010, there were 5,989,990 stock options outstanding under the 2007 Plan. At June 27, 2010, options to purchase 5,709,682 shares of Common Stock were exercisable at a weighted average exercise price of $0.19. An additional 280,308 options will vest over the next 8 months.

Activity under the 2007 Plan from December 27, 2009 through June 27, 2010 is presented below:


					Weighted
			Weighted		Average
			Average		Remaining		Aggregate
	Number of		Exercise		Contractual		Intrinsic
	Options		Price		Term		Value

Outstanding at December 27, 2009		3,919,990	$	0.20		7.7	$	-0-
Granted		2,070,000		0.16		9.8
Forfeited		—		—		—
Canceled		—		—		—

Outstanding at June 27, 2010		5,989,990	$	0.19		8.4	$	502,099

The options outstanding and exercisable at June 27, 2010 were as follows


		Options Outstanding				Options Exercisable
				Weighted
				Average
				Remaining
Number of		Exercise		Contractual		Number of		Exercise
Options		Price		Term		Options		Price

	3,919,990	$	0.20		7.7		3,639,682	$	0.20
	2,070,000	$	0.16		9.8		2,070,000	$	0.16

The aggregate intrinsic value in the table above represents the total intrinsic value, based on the Company’s closing stock price of $0.27 as of June 27, 2010 which would have been received by the options holders had all option holders exercise their options as of that date.

At June 27, 2010 there was $128,393 of total unrecognized compensation cost related to non-vested options granted under the 2007 Plan. This cost will be recognized over approximately 8 months.

Non-Qualified Stock Options

The Company’s Board of Directors approved on June 30, 2010 the grant of 7,703,673 non-qualified stock options to employees, Officers and Directors of the Company at an exercise price of $0.192 with different vesting schedules.

Income Taxes

The Company applies the provisions of ASC No. 740-10-25, Accounting for Uncertainty in Income Taxes which requires that the impact of tax positions taken by the Company be recognized in the financial statements if they are more likely than not of being sustained based upon the technical merits of the position. The Company has a valuation allowance against the full amount of its net deferred taxes. The Company currently provides a valuation allowance against deferred taxes when it is more likely than not that some portion, or all, of its deferred tax assets will not be realized.

No provision for current income taxes has been recorded for the three and six months ended June 27, 2010 and June 29, 2009 due to the Company’s cumulative net losses. Significant components of deferred tax assets are net operating loss carryforwards; start-up costs and organizational costs capitalized for tax purposes, and deferred revenue. Significant component of deferred tax liabilities is depreciation of property and equipment.

Management has evaluated the evidence bearing upon the realization of its deferred tax assets and has determined that it is more likely than not that the Company will not recognize the benefits of its federal and state deferred tax assets. As a result, the Company has recorded a full valuation allowance against its deferred tax assets. If the Company should generate sustained future taxable income against which these tax attributes might be applied, some portion or all of the valuation allowance would be reversed.

The Company’s income tax returns have not been audited by the Internal Revenue Service (IRS) or any state taxing authority. The years 2006 through 2009 remain open to examination by the IRS and state taxing authority. The Company believes it is not subject to any tax exposure beyond the preceding discussion. The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense.

Commitments and Contingencies

We are subject to legal proceedings and claims which arise in the normal course of business. Although there can be no assurance as to the ultimate outcome, we generally have denied, or believe we have a meritorious defense and will deny, liability in all significant cases pending against us, and we intend to defend vigorously each such case. Based on information currently available, we believe the amount, or range, of reasonably possible losses in connection with the actions against us, in excess of established reserves, in the aggregate, not to be material to our consolidated financial condition or cash flows. However, losses may be material to our operating results for any particular future period, depending on the level of our income for such period.

Supplemental Disclosures of Cash Flow Information


	Three Months Ended				Six Months Ended
	June 27, 2010		June 28, 2009		June 27, 2010		June 28, 2009

Cash paid during the period for interest	$	18,639	$	10,072	$	39,225	$	21,706

Property and equipment acquired with capital lease	$	—	$	—	$	8,163	$	—

Loss Per Share

The amounts used for basic and diluted per share calculations are as follows:


	Three Months Ended						Six Months Ended
	June 27, 2010			June 28, 2009			June 27, 2010			June 28, 2009
Net loss	$	(1,390,661	)	$	(1,158,653	)	$	(2,586,509	)	$	(1,959,083	)

Net loss allocable to common stockholders	$	(1,390,661	)	$	(1,158,653	)	$	(2,586,509	)	$	(1,959,083	)


Weighted average number of shares outstanding — basic and diluted		39,002,440			34,822,681			38,551,920			34,820,585

Basic and diluted per common share	$	(0.04	)	$	(0.03	)	$	(0.07	)	$	(0.06	)

Diluted earnings (loss) per share are not presented since the effect of the assumed exercise of options and warrants to purchase common stock would have been anti-dilutive. A total of a 52,065,042 and 49,847,276 potential common shares from the assumed exercise of options and warrants were excluded from the calculation of diluted net loss per share for the three and six month periods ended June 27, 2010 and June 28, 2009, because their inclusion would have been anti-dilutive.

Segment Data

The Company operates two business segments; Store Operations and Franchise Operations. The Store Operations segment comprises the operating activities of restaurants owned or operated by the Company. The Franchise Operations segment is comprised of the operating activities of the franchise business unit which licenses qualified operators to conduct business under the Knowfat and UFood Grill tradenames and also costs to monitor the operations of these business units. Under the terms of the franchise agreements, the licensed operators pay royalties and fees to the Company in return for the use of the Knowfat and UFood Grill tradenames.

The accounting policies of the segments are the same. Interest expense has been allocated based on operating results and total assets employed in each segment. Inter-segment transactions are uncommon and not material. Therefore, they have not been separately reflected in the financial table below. The totals of the reportable segments’ revenues and net loss agree with the comparable amounts contained in the Company’s consolidated financial statements.

Segment information for the Company’s two business segments follows:


	Three Months Ended						Six Months Ended
	June 27,			June 28,			June 27,			June 28,
	2010			2009			2010			2009
Revenues:
Store operations	$	1,199,274		$	1,227,321		$	2,268,244		$	2,333,996
Franchise operations		103,806			90,779			156,974			272,214

Total revenue	$	1,303,080		$	1,318,100		$	2,425,218		$	2,606,210


Segment income (loss):
Store operations	$	42,608		$	17,613		$	32,601		$	(99,117	)
Franchise operations		(218,899	)		(289,713	)		(388,591	)		(373,625	)

Total segment loss	$	(176,291	)	$	(272,100	)	$	(355,990	)	$	(472,742	)


Unallocated general and administrative expenses	$	511,208		$	688,308		$	954,142		$	1,211,850
Advertising, marketing and promotion		70,683			60,098			110,335			104,755
Depreciation and amortization		81,093			102,931			164,075			208,811

Interest expense, net		398,201			278,774			779,882			290,702
Other (income) expense		153,184			(243,558	)		222,085			(329,777	)

Net loss	$	(1,390,661	)	$	(1,158,653	)	$	(2,586,509	)	$	(1,959,083	)


Item 10.		Subsequent events

On July 15, 2010 we terminated the Area Development Agreement for the Sacramento, CA area and surrounding counties. The franchisee owned store located in Naples, Florida was closed on July 31, 2010.


Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operation

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our financial statements and related notes included elsewhere in this report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of certain factors discussed in “Risk Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 26, 2010.

The information contained in this Report on Form 10-Q and in other public statements by the Company and Company Officers include or may contain forward-looking statements. All statements other than statements of historical facts contained in this Report on Form 10-Q, including statements regarding our future financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “will,” “may,” “future,” “plan,” “intend,” and “expect” and similar expressions generally identify forward-looking statements. Although we believe that our plans, intentions and expectations reflected in the forward-looking statements are reasonable, we cannot be sure that they will be achieved. Actual results may differ materially from the forward-looking statements contained herein due to a number of factors.

Overview

Our operations currently consist of eight restaurants in the Boston area and Dallas Forth Worth, TX and Cleveland, OH; comprising four Company-owned restaurants and four franchise-owned locations. We have entered into a total of four area development agreements and three franchise agreements covering 53 franchise units in five states (California, Florida, Texas, Ohio and Massachusetts) and the Washington, DC area; including four franchise locations currently open and operating, and requiring the construction by franchisees of 49 future UFood Grill outlets.

We view ourselves primarily as a franchisor and continually review our restaurant ownership mix (that is our mix among Company-owned, franchised and joint venture) in an endeavor to deliver a pleasant customer experience and drive profitability. In most cases, franchising is the best way to achieve both goals. In our Company-owned stores, and in collaboration with our franchisees, we further develop and refine operating standards, marketing concepts and product and pricing strategies, so that we introduce system-wide only initiatives that we believe are most beneficial.

We include in this discussion information on Company, franchisee, and/or system-wide comparable sales. System-wide sales are a non-GAAP financial measure that includes sales at all Company-owned and franchise-operated stores, as reported by franchisees. Management uses system-wide sales information internally in connection with store development decisions, planning and budgeting analysis. Management believes system-wide sales are useful in assessing customer acceptance of our brand and facilitating an understanding of financial performance as our franchisees pay royalties and contribute to marketing funds based on a percentage of their sales.

We derive revenues from three sources: (i) store sales which include sales of hot and cold prepared food in a fast casual dining environment as well as sales of health and nutrition related products; (ii) franchise royalties and fees represent amounts earned under franchise and area development agreements; and (iii) other revenues derived primarily from the sale of marketing materials to franchisees. Store operating expenses include the cost of goods, food and paper products sold in Company-owned stores as well as labor and other operating costs incurred to operate Company-owned stores. General and administrative expenses, advertising, marketing and promotion expenses and depreciation expense relate to all three revenue sources.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements for the three and six months ended June 27, 2010 and June 28, 2009, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of the consolidated financial statements requires us to make estimates, judgments and assumptions, which we believe to be reasonable, based on the information available. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses. Variances in the estimates or assumptions used could yield materially different accounting results. On an ongoing basis, we evaluate the continued appropriateness of our accounting policies and resulting estimates to make adjustments we consider appropriate under the facts and circumstances.

We have chosen accounting policies we believe are appropriate to report accurately and fairly our operating results and financial position, and we apply those accounting policies in a consistent manner.

Revenue Recognition

The Company records revenue for Company-owned store sales upon the delivery of food and other products to the customer. The Company records a liability in the period in which a gift card is issued and proceeds are received. As gift cards are redeemed, this liability is reduced and revenue is recognized.

Valuation of Goodwill

We account for goodwill and other intangible assets under ASC No. 805, Business Combinations, and ASC No. 350-20 to 30, Goodwill and Other Intangible Assets. ASC No. 805 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, and that certain intangible assets acquired in a business combination be recognized as assets apart from goodwill. Under ASC No. 350-20 to 30, purchased goodwill and intangible assets with indefinite lives are not amortized, but instead tested for impairment at least annually or whenever events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill attributable to our franchise operations segment is evaluated by comparing the Company’s fair market value, determined based upon quoted market prices of the Company’s equity securities, to the carrying amount of goodwill. Goodwill attributable to our store operations segment is evaluated on a restaurant-by-restaurant basis by comparing the restaurant’s estimated fair value to the carrying value of the restaurant’s underlying net assets inclusive of goodwill. Fair value is determined based upon the restaurant’s estimated future cash flows. Future cash flows are estimated based upon a restaurant’s historical operating performance and management’s estimates of future revenues and expenses over the period of time that the Company expects to operate the restaurant, which generally coincides with the initial term of the restaurant’s lease but which may take into account the restaurant’s first lease renewal period up to 5 years. The estimate of a restaurant’s future cash flows may also include an estimate of the restaurant’s terminal value, determined by applying a capitalization rate to the restaurant’s estimated cash flows during the last year of the forecast period. The capitalization rate used by the Company is determined based upon the restaurant’s location, cash flows and growth prospects. As of the first day of the fourth quarter of the year ended December 27, 2009 according to our policy we have tested the carrying value of the goodwill attributable to our store operations and no impairment was necessary. The carrying amount of goodwill may be impaired in the future if our actual operating results and cash flows fall short of our expectations.

Impairment of Long-Lived Assets

Rent Expense

The Company recognizes rent expense on a straight-line basis over the reasonably assured lease term as defined in ASC No. 840, Leases. The reasonably assured lease term on most of the Company’s leases is the initial non-cancelable lease term, which generally equates to between 5 and 10 years. In addition, certain of the Company’s lease agreements provide for scheduled rent increases during the lease terms or for rental payments commencing at a date other than the date of initial occupancy. The Company includes any rent escalations and other rent holidays in its determination of straight-line rent expense. Therefore, rent expense for new locations is charged to expense upon the commencement date of the lease.

Fair Value of Financial Instruments

The carrying amounts of the Company’s financial instruments, which include cash and cash equivalents, accounts receivable, accounts payable and other accrued expenses and debt obligations, approximate their fair values due to the short-term maturity of these instruments.

Stock-Based Compensation

The Company applies the fair value recognition provisions of ASC No. 718, Compensation-Stock Compensation, which requires all stock-based compensation, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. The Company uses the Black-Scholes option pricing model which requires extensive use of accounting judgment and financial estimates, including estimates of the expected term participants will retain their vested stock options before exercising them and the estimated volatility of the Company’s common stock price over the expected term.

Stock-based compensation expense recognized during the three months ended June 27, 2010 totaled approximately $197,271 for stock options. Stock-based compensation expense recognized during the three months ended June 28, 2009 total approximately $98,347 for stock options. Stock based compensation expense recognized during the six months ended June 27, 2010 and June 28, 2009 was $253,719 and $303,591 respectively. Stock-based compensation expense was included in general and administrative expenses in the accompanying Consolidated Statements of Operations.

Executive Summary of Results

The following table sets forth the percentage relationship to total revenues, except where otherwise indicated, of certain items included in our consolidated statements of operations for the periods indicated. Percentages may not add due to rounding:


	Three Months Ended						Six Months Ended
	June 27,			June 28,			June 27,			June 28,
	2010			2009			2010			2009
Revenues:
Store sales		92.0	%		93.1	%		93.5	%		89.6	%
Franchise royalties and fees		7.5			6.9			6.2			10.3
Other revenue		0.5			—			0.3			0.1

		100.0	%		100.0	%		100.0	%		100.0	%


Costs and expenses:
Store operating expenses (1):
Food and paper costs		33.5	%		32.7	%		33.1	%		32.8	%
Cost of nutritional products		8.4			7.6			8.1			7.9
Labor		26.6			27.4			27.6			30.2
Occupancy		9.2			11.1			10.3			12.5
Other store operating expenses		17.7			15.4			18.6			16.3
General and administrative expenses		68.5			84.5			66.4			76.4
Advertising, marketing and promotion expenses		5.4			4.6			4.5			4.0
Depreciation and amortization		6.2			7.8			6.8			8.0
Loss on disposal of assets		—			4.4			—			2.4

Total costs and expenses		164.4			185.2			165.3			176.7


Operating loss		(64.4	)		(85.2	)		(65.3	)		(76.7	)


Other income (expense):
Interest income		0.1			0.5			0.2			0.4
Interest expense		(30.7	)		(21.7	)		(32.3	)		(11.6	)
Other income		(11.7	)		18.5			(9.2	)		12.7

Other income (expense), net		(42.3	)		(2.7	)		(41.3	)		1.5


Loss before income taxes		(106.7	)		(87.9	)		(106.6	)		(75.2	)
Income taxes		—			—			—			—


Net loss		(106.7	)%		(87.9	)%		(106.6	)%		(75.2	)%


(1)		Food and paper costs are shown as a percentage of food sales. Cost of nutritional products, labor, occupancy and other store operating expenses are shown as a percentage of total store sales.

The following table sets forth certain data relating to the number of Company-owned, franchise-operated and system-wide store locations:


	Three Months Ended					Six Months Ended
	June 27,		June 28,			June 27,			June 28,
	2010		2009			2010			2009
Company-owned locations:
Locations at the beginning of the year		4		4			4			5
Locations opened		—		—			—			—
Locations closed (1)		—		—			—			(1	)
Locations sold		—		—			—			—
Locations transferred		—		—			—			—

Locations at the end of the period		4		4			4			4


Franchise-owned locations:
Locations at the beginning of the year		4		8			4			5
Locations opened		—		—			1			3
Locations closed		—		(3	)		(1	)		(3	)
Locations sold		—		—			—			—
Locations transferred		—		—			—			—

Locations at the end of the period		4		5			4			5


System-wide locations
Locations at the beginning of the year		8		12			8			10
Locations opened		—		—			1			3
Locations closed		—		(3	)		(1	)		(4	)
Locations sold		—		—			—			—
Locations transferred		—		—			—			—

Locations at the end of the period		8		9			8			9


(1)		In February 1, 2008, the Company agreed to operate one franchise-owned location pursuant to the terms of a management services agreement. This store was closed on March 27, 2009.

Three Months Ended June 27, 2010 Compared to Three Months Ended June 28, 2009

General

For the three months ended June 27, 2010, our comparable store sales for Company owned stores decreased by 2.3%. System-wide comparable store sales decreased by 8.4%. Comparable store sales of Company-owned and franchisee-owned locations were adversely impacted by the economic downturn and as a result the slowdown in consumer spending. Comparable store sales are based on sales for stores that have been in operation for the entire period of comparison. Comparable store sales exclude closed locations.

Results of Operations

Revenues

Total revenues for the three months ended June 27, 2010 decreased by $15,020, or 1.1% to $1,303,080 from $1,318,100 for the three months ended June 28, 2009. The decrease in total revenues for the three months ended June 27, 2010 as compared to the prior year was primarily due to lower same store sales.

Sales at Company-operated stores for the three months ended June 27, 2010 decreased by $28,047, or 2.3% to $1,199,274 from $1,227,321 for the three months ended June 28, 2009. As a percentage of total sales revenues, sales at Company-operated stores decreased to 92.0% of the total revenues for the three months ended June 27, 2010 down from 93.1% of the total revenues for the three months ended June 28, 2009. The decrease in sales at Company-operated stores for the three months ended June 27, 2010 was primarily due to a lower average ticket in our stores.

During the three months ended June 27, 2010, franchise royalties and fees increased by $6,380, or 7.1% to $97,159 from $90,779 for the three months ended June 28, 2009 due to higher sales of the stores in the system during this period compared to the stores in the system for the same period a year ago.

Costs and Expenses

Food and paper costs for the three months ended June 27, 2010 increased by $2,791, or 0.8%, to $355,095 from $352,304 for the three months ended June 28, 2009. As a percentage of food sales, food and paper costs increased to 33.5% of food sales for the three months ended June 27, 2010 from 32.7% of food sales for the three months ended June 28, 2009. The increase in food and paper costs as a percentage of food sales was primarily attributable to the introduction of new bundle items with higher food cost.

The cost of nutritional products for the three months ended June 27, 2010 increased by $7,354, or 7.9%, to $100,364 from $93,010 for the three months ended June 28, 2009. As a percentage of store sales, the cost of nutritional products increased to 8.4% of store sales for the three months ended June 27, 2010 from 7.6% of store sales for the three months ended June 28, 2009. The increase in the cost of nutritional products as a percentage of store sales was primarily attributable to higher cost of the nutritional products.

Store labor expense for the three months ended June 27, 2010 decreased by $17,881, or 5.3%, to $318,942 from $336,823 for the three months ended June 28, 2009. The decrease in labor expense was primarily attributable to the reduction of the labor cost as a percentage of sales. As a percentage of store sales, labor expense decreased slightly to 26.6% of store sales for the three months ended June 27, 2010 from 27.4% of store sales for the three months ended June 28, 2009.

Store occupancy costs for the three months ended June 27, 2010 decreased by $25,081, or 18.4%, to $110,896 from $135,977 for the three months ended June 28, 2009. The decrease in occupancy costs was primarily attributable to an adjustment to the straight-line basis accrual for the change of one of our store locations. As a percentage of store sales, occupancy costs decreased to 9.2% of store sales for the three months ended June 27, 2010 from 11.1% of store sales for the three months ended June 28, 2009 primarily due to the reduction of the straight line rent accrual.

Other store operating expenses for the three months ended June 27, 2010 increased by $23,530, or 12.5%, to $212,297 from $188,767 for the three months ended June 28, 2009. The decrease was primarily due to fewer stores in operation by the Company, slightly offset by higher cost for utilities. As a percentage of store sales, other store operating expenses increased to 17.7% of store sales for the three months ended June 27, 2010 from 15.4% of store sales during the three months ended June 28, 2009, primarily due to a back charge for utilities for prior years of one of company owned stores.

General and administrative expenses for the three months ended June 27, 2010 decreased by $220,801 or 19.8%, to $892,986 from $1,113,787 for the three months ended June 28, 2009. The decrease in general and administrative expenses was primarily due to a significant reduction on payroll, rent, insurance, and legal expenses, also due to the reverse of the accrual for the reserve of uncollectible accounts. As a result of the foregoing, general and administrative expenses decreased to 68.5% of total revenues during the three months ended June 27, 2010 down from 84.5% of total revenues for the three months ended June 28, 2009.

Advertising, marketing and promotion expenses for the three months ended June 27, 2010 increased by $10,585 or 17.6%, to $70,683 from $60,098 for the three months ended June 28, 2009. The increase in advertising, marketing and promotion expenses was primarily due to an increase in expenses related to the services agreement with George Foreman Ventures, LLC (GFV Services Agreement) that became effective June 12, 2007. Advertising, marketing and promotion expenses for the three months ended June 27, 2010 and June 28, 2009 include $25,138 and $762, respectively, of non-cash, stock-based compensation expense attributable to the GFV Services Agreement. As a percentage of total revenues, advertising, marketing and promotion expenses increased to 5.4% of total revenues in the three months ended June 27, 2010 down from 4.6% of total revenues in the three months ended June 28, 2009.

Depreciation and amortization expense for the three months ended June 27, 2010 decreased by $21,838, or 21.2%, to $81,093 from $102,931 for the three months ended June 28, 2009. As a percentage of total revenues, depreciation and amortization expense decreased to 6.2% of total revenues for the three months ended June 27, 2010 up from 7.8% of total revenues for the three months ended June 28, 2009.

Other income and expense for the three months ended June 27, 2010 increase by $516,169, to an expense of $551,385 from an expense of $35,216 for the three months ended June 28, 2009. The increase was primarily attributable to the fluctuation of the fair value of the warrants issued in connection with our latest private placement offering and the amortization of the deferred financing costs.

The net loss for the three months ended June 27, 2010 increased by $232,008, or 20% to $1,390,661, from $1,158,653 for the three months ended June 28, 2009. Our net loss increased primarily due to the increase in other income and expenses. As a percentage of total revenues, our net loss decreased to 106.7% of total revenues for the three months ended June 27, 2010 down from 87.9% of total revenues for the three months ended June 28, 2009.

Six Months Ended June 27, 2010 Compared to Six Months Ended June 28, 2009

General

For the six months ended June 27, 2010, our comparable store sales for Company owned stores increased by 1.2%. System-wide comparable store sales decreased by 5.5%. The increase in comparable store sales of Company-owned stores was primarily due to higher number of transactions processes in our stores. Comparable store sales are based on sales for stores that have been in operation for the entire period of comparison. Comparable store sales exclude closed locations.

Results of Operations

Revenues

Our total revenues for the six months ended June 27, 2010 decreased by $180,992, or 6.9%%, to $2,425,218 from $2,606,210 for the six months ended June 28, 2009. The decrease in total revenues was primarily due to fewer Company-operated stores and lower franchise royalties partially offset by an increase in comparable sales for Company-operated stores.

Total store sales at Company-owned stores for the six months ended June 27, 2010 decreased by $65,752, or 2.8%, to $2,268,244 from $2,333,996 for the six months ended June 28, 2009. As a percentage of total revenues, sales at Company-owned stores increased to 93.5% of total revenues for the six months ended June 27, 2010 from 89.6% of total revenues for the six months ended June 28, 2009. The decrease in sales at Company-owned stores for the six months ended June 27, 2010 was primarily due to the decrease in the numbers of Company-operated stores partially offset by an increase in comparable sales for Company-operated stores.

During the six months ended June 27, 2010, franchise royalties and fees decreased by $119,569, or 44.4% to $149,949 from $269,518 for the six months ended June 28, 2009 primarily due to a decrease in franchise fees from new store openings and royalties from the franchised stores.

Costs and Expenses

Food and paper costs for the six months ended June 27, 2010 decreased by $13,021, or 1.9%, to $659,564 from $672,585 for the six months ended June 28, 2009. The decrease was primarily attributable to fewer Company-operated stores during this period of time. As a percentage of food sales, food and paper costs slightly increased to 33.1% of food sales during the six months ended June 27, 2010 down from 32.8% of food sales during the six months ended June 28, 2009. The increase in food and paper costs as a percentage of food sales was primarily attributable to the introduction of new menu items with higher food cost.

The cost of nutritional products for the six months ended June 27, 2010 decreased by $516, or 0.3%, to $184,353 from $184,869 for the six months ended June 28, 2009. As a percentage of store sales, the cost of nutritional products increased to 8.1% of store sales for the six months ended June 27, 2010 down from 7.9% of store sales for the six months ended June 28, 2009; the increase was primarily due to lower total revenues.

Store labor expense for the six months ended June 27, 2010 decreased by $80,288, or 11.4%, to $625,385 from $705,673 for the six months ended June 28, 2009. The decrease in labor expense was primarily attributable to a reduction in the number of Company-operated stores. As a percentage of store sales, labor expense decreased to 27.6% of store sales for the six months ended June 27, 2010 up from 30.2% of store sales for the six months ended June 28, 2009. The decrease in the labor percentage of store sales is primarily due improvement of efficiencies and lower amount of man hours.

Store occupancy costs for the six months ended June 27, 2010 decreased by $57,883, or 19.8%, to $234,724 from $292,607 for the six months ended June 28, 2009. The decrease in store occupancy costs was primarily attributable to fewer Company-operated stores operating during this period of time compared to the prior year for the same period and the partial reversal of the accrual for the straight line basis rent.

Other store operating expenses for the six months ended June 27, 2010 increased by $40,844, or 10.7%, to $420,942 from $380,098 for the six months ended June 28, 2009. The increase was primarily due to the charge back from prior years for utilities at one of our locations, and increase in maintenance and other store expenses. As a percentage of store sales, other store operating expenses increased to 18.6% of store sales for the six months ended June 27, 2010 from 16.3% of store sales for the six months ended June 28, 2009, primarily due to higher maintenance expenses and charge backs for utilities.

General and administrative expenses for the six months ended June 27, 2010 decreased by $381,690, or 19.2%, to $1,610,382 from $1,992,072 for the six months ended June 28, 2009. The decrease in general and administrative expenses was primarily due to reduction on investor relations and public relations expenses, stock-based compensation expense resulting from equity awards to employees and payroll, as well as a significant reduction on legal expenses. During the six months ended June 27, 2010, the Company recognized $253,719 of stock-based compensation expenses attributable to equity awards to employees and $303,591 for the six month ended on June 28, 2009. As a result of the foregoing, general and administrative expenses decreased to 66.4% of total revenues during the six months ended June 27, 2010 from 76.4% of total revenues for the six months ended June 28, 2009.

Advertising, marketing and promotion expenses for the six months ended June 27, 2010 increased by $5,580, or 5.3%, to $110,335 from $104,755 for the six months ended June 28, 2009. The increase in advertising, marketing and promotion expenses was primarily due to an increase in expenses related to the services agreement with George Foreman Ventures, LLC (GFV Services Agreement) that became effective June 12, 2007. Advertising, marketing and promotion expenses for the six months ended June 27, 2010 and June 28, 2009 include $39,611 and $16,758, respectively, of non-cash, stock-based compensation expense attributable to the GFV Services Agreement. As a percentage of total revenues, advertising, marketing and promotion expenses increased to 4.5% of total revenues during the six months ended June 27, 2010 from 4.0% of total revenues during the six months ended June 28, 2009.

Depreciation and amortization expense for the six months ended June 27, 2010 decreased by $44,736, or 21.4%, to $164,075 from $208,811 for the six months ended June 28, 2009. As a percentage of total revenues, depreciation and amortization expense decreased to 6.8% of total revenues for the six months ended June 27, 2010 from 8.0% of total revenues for the six months ended June 28, 2009.

Other income and expense increased from $39,075 of other income for the six months ended June 28, 2009 to $1,001,967 of other expense for the six months ended June 27, 2010. The increase of $1,041,042 was primarily due to higher interest expense attributable to the amortization of the deferred financing costs and the beneficial conversion feature of the outstanding debentures, also the variance of the warrants’ fair value that were issued in conjunction with the latest private placement offering. The Company recognized $784,038 of interest expense for the six months ended June 27, 2010 compared to $301,233 for the six months ended June 28, 2009.

Our net loss for the six months ended June 27, 2010 increased by $627,426, or 32.0%, to $2,586,509, from $1,959,083, for the six months ended June 28, 2009. Our net loss increased primarily due to the increase in other expenses most of them related to the latest private placement offering, which about $799,150 were non-cash expenses. As a percentage of total revenues, our net loss increased to 106.7% of total revenues for the six months ended June 27, 2010 from 75.2% of total revenues for the six months ended June 28, 2009.

Liquidity and Capital Resources

Cash and cash equivalents and restricted cash at June 27, 2010 were $988,381 compared to $2,338,852 at December 27, 2009. Cash is primarily used to fund our (i) capital expenditures for new and remodeled Company-owned stores, (ii) acquisitions of franchisee-owned stores, (iii) working capital requirements and (iv) net operating losses. At June 27, 2010, restricted cash included $40,000 of cash secured by a letter of credit for our office lease.

During the six months ended June 28, 2009, the Company sold $5,874,000 of Senior Secured Convertible Debentures (the Debentures) in a private offering to accredited investors. The Company received net cash proceeds of approximately $4,916,815. The Debentures bear interest at a rate of 8% and are due three years from the date they are issued. The Debentures are convertible into shares of common stock at $0.13 per share. In addition, each investor will receive 5-year detachable Warrants to purchase a number of shares of Common Stock equal to 50% of the shares underlying the Investor’s Debenture. Interest on the Debentures bear a rate of 8% per annum and is payable on a quarterly basis. Subject to certain conditions, the Company has the right to pay interest on the Debentures in either cash or shares of Common Stock, or in a combination of cash and Common Stock.

At June 27, 2010, we had working capital of $67,085 compared to working capital of $1,194,017 at December 27, 2009. The decrease in working capital was primarily due to the operating losses and the bank loan facility pay off.

We used $876,797 of cash to fund our operating activities in the six months ended June 27, 2010 compared with $1,719,467 of cash used to fund our operating activities in six months ended June 28, 2009. The decrease in cash used to fund our operating activities was primarily due to reduction in operating losses, collection of account receivables, and increase in account payable, partially offset by a reduction in franchisee deposits.

During the six months ended June 27, 2010, we spent $37,057 for the acquisition of equipment compared with $31,559 spent for the acquisition of equipment during the six months ended June 28, 2009.

During the six months ended June 27, 2010, financing activities used cash in the amount of $416,192, primarily due to the payment of the long term debt partially offset by the release and usage of restricted cash and the exercise of warrants in connection with our latest private placement. During the six months ended June 28, 2009, financing activities provided $5,050,906, of cash. We received $4,916,815 of net cash proceeds from the sale of the debentures described above.

Historically we have funded our operations, working capital requirements, acquisitions and capital expenditures with proceeds from the issuance of debt and equity securities. We believe that cash flow from operations and proceeds from the issuance of debt and equity securities will be sufficient to fund our operations and capital expenditures for the next twelve months.

Contractual Obligations and Other Commitments

In addition to our capital expenditures requirements, we have certain other contractual and committed cash obligations. Our contractual cash obligations primarily consist of non-cancelable operating leases for our stores and administrative offices. Lease terms for our stores and administrative offices are generally for seven to ten years with renewal options at most locations and generally require us to pay a proportionate share of real estate taxes, insurance, common area, and other operating costs. Some store leases provide for contingent rental (i.e. percentage rent) payments based on sales in excess of specified amount. Certain of our lease agreements provide for scheduled rent increases during the lease terms or for rental payments commencing at a date other than the date of initial occupancy.

The following table sets forth information as of June 27, 2010 with respect to our contractual obligations and the effect they are expected to have on our liquidity and cash flows in future periods:


			Less Than			1 Year to		4 Years to		More than
	Total		1 Year			3 Years		5 Years		5 Years

Long-term debt	$	3,819,013	$	450,000	(1)	$	3,369,013	$	—	$	—
Capital leases		76,008		49,702			26,306				—
Operating leases		2.560,719		250,349			1,021,724		1,006,570		282,076


(1)		Long-term debt due in less than 1 year is $450,000 that becomes due upon the sale of the Company’s Landmark Center restaurant and store. The Company currently has no plans to sell its Landmark Center unit.

Our future capital requirements and the adequacy of available funds will depend on many factors, including the pace of expansion, real estate markets, site locations, and the nature of the arrangements negotiated with landlords. We have incurred significant operating losses since inception and expect to incur a significant operating loss in 2010.

Seasonality

Although our business is not highly seasonal, it can be adversely affected by weather conditions.

Impact of Inflation

In the past, we have been able to recover inflationary cost and commodity price increases through increased menu prices. There have been, and there may be in the future, delays in implementing such menu price increases, and competitive pressures may limit our ability to recover such cost increases in their entirety. Historically, the effects of inflation on our operations have not been materially adverse.

Many of our employees are paid hourly rates related to federal and state minimum wage laws. Although we have and will continue to attempt to pass along any increased labor costs through food price increases, there can be no assurance that all such increased labor costs can be reflected in our prices or that increased prices will be absorbed by consumers without diminishing to some degree consumer spending at our stores. However, we have not experienced to date a significant reduction in store profit margins as a result of changes in such laws, and management does not anticipate any related future significant reductions in gross profit margins.


Item 3.		Quantitative and Qualitative Disclosures About Market Risk

Not applicable.


Item 4.		Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

We have established disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries is made known to the officers who certify our financial reports and to other members of management and the Board of Directors. Based on their evaluations as of June 27, 2010, our Chief Executive Officer (CEO) and Acting Chief Financial Officer (CFO) have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective, except for the material weakness in internal control over financial reporting described below, in ensuring that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

There were no significant changes in the Company’s internal controls during the second fiscal quarter ended June 27, 2010 that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

(a)

Management’s annual report on internal control over financial reporting.

Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed under the supervision of our CEO and CFO to provide reasonable assurance regarding the reliability of financial reporting and preparation of our financial statements for external purposes in accordance with generally accepted accounting principles.

Management, with the participation of our principal executive officer and principal financial officer, is required to evaluate the effectiveness of our internal controls over financial reporting as of June 27, 2010 based on the criteria for effective internal control over financial reporting established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that assessment, management has concluded that our internal controls over financial reporting were not effective as of June 27, 2010 and that a material weakness existed and continues to exist due to our inability to perform sufficient testing of internal controls over financial reporting following the reverse merger on December 18, 2007. A contributing factor to our internal control deficiencies is the Company’s small size and the lack of sufficient resources to perform the testing of internal controls within the prescribed time frame. As defined by the Public Company Accounting Oversight Board’s Auditing Standard No. 5, a material weakness is a significant control deficiency or a combination of significant control deficiencies that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management continues to monitor and assess the controls to ensure compliance.

Because of its inherent limitations, our internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

(b)

Changes in internal control over financial reporting.

There were no changes in our internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION


Item 1.		Legal Proceedings


Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds

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.


	Page
PART I — FINANCIAL INFORMATION

Item 1: Financial Statements		3

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations		18

Item 3: Quantitative and Qualitative Disclosures About Market Risk		26

Item 4: Controls and Procedures		26

PART II — OTHER INFORMATION

Item 1: Legal Proceedings		27

Item 2: Unregistered Sales of Equity Securities and Use of Proceeds		27

Item 3: Defaults Upon Senior Securities		27

Item 4: Submission of Matters to a Vote of Security Holders		27

Item 5: Other Information		27

Item 6: Exhibits		28

Signatures		29

Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2


Index to Consolidated Financial Statements

Consolidated Balance Sheets as of June 27, 2010 (unaudited) and December 27, 2009			4 – 5

Consolidated Statements of Operations for the Unaudited Three Month and Six Month Periods Ended June 27, 2010 and June 28, 2009			6

Consolidated Statements of Cash Flows for the Unaudited Six Month Periods Ended June 27, 2010 and June 28,2009			7

Consolidated Statement of Stockholders’ Equity (deficit) for the Unaudited Six Month Periods Ended June 27, 2010 and June 28,2009			8

Notes to Consolidated Financial Statements			9 – 17


	June 27,		December 27,
	2010		2009
	(unaudited)		(audited)

Current assets:
Cash and cash equivalents	$	948,381	$	2,278,427
Restricted cash		40,000		60,425
Accounts receivable		44,279		180,134
Inventories		126,912		123,648
Prepaid expenses and other current assets		48,043		68,605

		1,207,615		2,711,239


Property and equipment:
Equipment		973,192		937,857
Furniture and fixtures		209,120		202,205
Leasehold improvements		1,747,564		1,744,594
Website development costs		32,735		37,050

Total property and equipment		2,962,611		2,921,706
Accumulated depreciation and amortization		1,724,477		1,560,402

Net fixed assets		1,238,134		1,361,304


Other assets:

Deferred financing costs, net		636,581		757,873
Goodwill		75,363		75,363
Other		84,482		86,560

		796,426		919,796


Total assets	$	3,242,175	$	4,992,339


							Additional					Total
	Common			Common			Paid-in		Accumulated			Stockholders’
	Shares			Stock			Capital		Deficit			Equity (Deficit)
Balance, December 27, 2009		37,934,907		$	37,935		$	25,589,311	$	(25,515,871	)	$	111,375

Conversion of debentures and exercised warrants into common stock		684,616			684			92,162		—			92,845

Forfeitures of common stock		(1,773	)		(2	)		2		—			—
Stock issued for consulting, marketing and promotional services		240,000			240			144,398		—			144,638
Stock issued for interest payment		936,723			937			207,398					208,335
Employee stock-based compensation		—			—			253,719		—			253,719

Net loss		—			—			—		(2,586,509	)		(2,586,509	)

Balance, June 27, 2010		39,794,473		$	39,794		$	26,286,990	$	(28,102,380	)	$	(1,775,596	)


Exhibit
No.				Description

31.1				Certification of CEO required by Section 302 of the Sarbanes-Oxley Act of 2002*

31.2				Certification of CFO required by Section 302 of the Sarbanes-Oxley Act of 2002*

32.1				Certification of CEO required by Section 906 of the Sarbanes-Oxley Act of 2002*

32.2				Certification of CFO required by Section 906 of the Sarbanes-Oxley Act of 2002*

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	UFOOD RESTAURANT GROUP, INC.
Date: August 11, 2010	By:	/s/ George Naddaff
		George Naddaff
		Chairman and Chief Executive Officer (principal executive officer)


Date: August 11, 2010	By:	/s/ Irma Norton
		Irma Norton
		Acting Chief Financial Officer (principal financial officer)


Item 1.		Financial Statements.