Nature of business and summary of significant accounting policies

Basis of presentation

The accompanying consolidated financial statements of Crumbs Bake Shop, Inc. (“CBS”), formerly known as 57^th Street General Acquisition Corp., and Crumbs Holdings LLC and its wholly-owned subsidiaries (CBS and Crumbs Holdings LLC and its wholly-owned subsidiaries are collectively referred to herein as “Crumbs”) as of December 31, 2013 and 2012 and for the years ended December 31, 2013 and 2012 have been prepared in conformity with the accounting principles generally accepted in the United States of America (“GAAP”). As used in these notes, the term “Holdings” refers to Crumbs Holdings LLC and, unless the context requires otherwise, its wholly-owned subsidiaries.

Going concern

The accompanying consolidated financial statements have been prepared in conformity with GAAP, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business and the continuation of Crumbs as a going concern. Crumbs’ net loss attributable to stockholders was approximately $15.3 million and $7.7 million during the years ended December 31, 2013 and 2012, respectively, and its operating activities used cash of approximately $7.6 million and $4.1 million during the years ended December 31, 2013 and 2012, respectively.

Management expects that Crumbs’ operating expenses will continue to consume a significant portion of its cash resources and that Crumbs will not be able to generate gross profits in amounts necessary to offset or exceed such expenses in the foreseeable future. Accordingly, management anticipates that Crumbs will continue to record net losses in future periods. Management is evaluating the steps that it may be able to take to reduce Crumbs’ operating expenses and increase gross profits, but management cannot predict if or when Crumbs will be able to generate net income. At December 31, 2013, Crumbs had a working capital deficit of approximately $2.6 million and an accumulated deficit of $25.0 million. Crumbs will require additional funds to meet its working capital needs, execute its business strategy and further develop its business. Crumbs has historically funded its operations, business development and growth through sales of CBS common stock and convertible debt financings. In addition to reducing operating costs and increasing gross profits, management’s plan for funding future operations may include additional equity or debt financings. No assurance can be given, however, that financing will be available at desireable times, amounts or terms.

These factors raise substantial doubt as to Crumbs’ ability to continue as a going concern. In the event that Crumbs’ operations do not generate sufficient cash flows to fund operations and/or Crumbs is unable to obtain additional funds on a timely basis, Crumbs may be forced to curtail or cease its activities, which would likely result in the loss to investors of all or a substantial portion of their investment. The accompanying consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from the outcome of this uncertainty.

Reverse merger

On January 9, 2011, CBS, 57th Street Merger Sub LLC, a wholly-owned subsidiary of CBS (“Merger Sub”), Holdings, the members of Holdings immediately prior to the consummation of the Merger (each, a “Member” and, collectively, the “Members”) and the representatives of the Members and Holdings, entered into a Business Combination Agreement, amended on each of February 18, 2011, March 17, 2011 and April 7, 2011 (the “Business Combination Agreement”), pursuant to which Merger Sub merged with and into Holdings with Holdings surviving the merger as a non-wholly owned subsidiary of CBS (the “Merger”). The entity surviving the Merger kept the Crumbs Holdings LLC name; however, references herein to the Members of Holdings refer only to the members of Crumbs Holdings LLC immediately prior to the consummation of the Merger and Julian R. Geiger and, therefore, exclude the members of Merger Sub. The transactions contemplated by the consummation of the Merger and Business Combination Agreement are referred to herein collectively as the “Transaction.” Management has concluded that Holdings is the accounting acquirer based on its evaluation of the facts and circumstances of the acquisition.

Upon consummation of the Merger, the Members received consideration in the form of newly issued securities and approximately $22,086,000 in cash. The securities consisted of (i) 4,541,394 New Crumbs Class B Exchangeable Units (“Class B Units”) issued by Holdings (the aggregate of which were exchangeable for 4,541,394 shares of CBS common stock, and 2,981,394 which have been exchanged to date for shares of CBS common stock), and (ii) 454,139.4 shares of Series A Voting Preferred Stock (“Series A Preferred Stock”) issued by CBS (each such share entitling its holder the right to cast 10 votes per share in all matters for which the holders of common stock are entitled to vote, and 298,139.4 of which have been surrendered and redeemed by CBS in connection with the above-mentioned exchange of Class B Units). CBS also reserved an additional 4,400,000 shares of its common stock for issuance in exchange for up to 4,400,000 Class B Units which may be earned by the Members if certain financial or stock price targets are met (the “Contingency Consideration”) as follows:

1,466,666.7 Class B Units in the event the common stock of CBS has a trading price at $15.00 or above for 20 trading days out of 30 consecutive trading days during the calendar year 2011 (“First Stock Target”); and/or

1,466,666.7 Class B Units in the event the common stock of CBS has a trading price at $17.50 or above for 20 trading days out of 30 consecutive trading days during either the calendar year 2011 or 2012 (“Second Stock Target”); and/or

1,466,666.6 Class B Units in the event the common stock of CBS has a trading price at $20.00 or above for 20 trading days out of 30 consecutive trading days during any of the calendar years 2011, 2012 or 2013 (“Third Stock Target”); and/or

to the extent that not all of the foregoing Stock Targets have been achieved, 2,200,000 Class B Units in the event CBS achieves $17,500,000 in Adjusted EBITDA (as described in the Business Combination Agreement) for the twelve months ending December 31, 2013; and/or

to the extent that not all of the foregoing Stock Targets have been achieved, 2,200,000 Class B Units in the event CBS achieves $25,000,000 in Adjusted EBITDA for the twelve months ending December 31, 2014; and/or

any remaining Contingency Consideration not otherwise achieved hereunder up to the Maximum Contingency Consideration in the event CBS achieves $30,000,000 in Adjusted EBITDA for the twelve months ending December 31, 2015.

In the event a stock target is not met, Members may still be entitled to the Contingency Consideration from the stock target should subsequent stock targets be achieved.

In addition, Holdings, as the entity surviving the Merger, received, as a capital contribution from CBS, the sum of approximately $13,725,000 (not including refunds receivable after the closing of the Merger) after giving effect to the retention of approximately $53,000 by CBS for future public company expenses and the payment of approximately $149,000 for CBS’ then outstanding franchise taxes.

Nature of business

Holdings, through its subsidiaries, engages in the business of selling a wide variety of cupcakes, cakes, cookies and other baked goods as well as hot and cold beverages. Holdings offers these products through its stores, e-commerce division, catering services and wholesale distribution business.

Principles of consolidation

The accompanying consolidated financial statements include the accounts of CBS and Holdings. Intercompany transactions and balances have been eliminated in consolidation.

Trade receivables

Crumbs carries its trade receivables at cost less an allowance for doubtful accounts. On a periodic basis, Crumbs evaluates its accounts receivable and establishes an allowance for doubtful accounts, based on a history of past write-offs and collections and current credit conditions. The amount of allowance for doubtful accounts at both December 31, 2013 and 2012 was $0.

Restricted certificates of deposit

As of both December 31, 2013 and December 31, 2012, Crumbs had $673,000 of cash restricted from withdrawal and held by banks as certificates of deposit securing letters of credit (see Note 10). The letters of credit are required as security deposits for certain of Crumbs’ non-cancellable store operating leases.

Fair value of financial instruments

Crumbs’ financial instruments consist primarily of cash in banks, certificates of deposit and trade receivables. The carrying amounts for cash and cash equivalents, certificates of deposit and trade receivables approximate fair value due to the short term nature of the instruments.

Property and equipment

Property and equipment is stated at cost less accumulated depreciation. Depreciation is provided for by the straight-line method over the following estimated useful lives:

	Estimated
Asset	Useful Life

Leasehold improvements	Lesser of useful lives or lease term
Furniture and equipment	5-10 years
Computer software and equipment	3-5 years

Expenditures for repairs and maintenance are charged to operations as incurred.

Impairment of long-lived assets

When facts and circumstances indicate that the carrying values of long-lived assets may not be recoverable, Crumbs evaluates long-lived assets for impairment in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360, “Property, Plant and Equipment.” Crumbs first compares the carrying value of the asset to the asset’s estimated future cash flows (undiscounted). If the estimated future cash flows are less than the carrying value of the asset, Crumbs calculates an impairment loss based on the asset’s estimated fair value. The fair value of the assets is estimated using a discounted cash flow model based on future store revenue and operating costs, using internal projections. Cash flows for store assets are identified at the individual store level. Crumbs most recently completed an impairment evaluation in the fourth quarter of 2013, and certain assets were determined to be impaired (see Note 5).

Intangible assets

Intangible assets related to branding costs and website design are amortized over their useful lives, estimated to be five years. Intangible assets related to Crumbs’ trademark costs, including initial registration, are considered to have indefinite useful lives and are evaluated annually for impairment.

Deposits

Deposits consist of security deposits made in connection with operating lease agreements for the rental of stores and office space and utility deposits made for gas and electric services at several stores. According to the terms of certain lease agreements, a few security deposits are kept in separate bank accounts by the respective landlords and earn interest at various rates, while also being subject to administrative fees. Most utility deposits are eligible for refund after three years of consecutive, timely payments.

Tax Receivable Agreement

Holdings has made an election under Section 754 of the Internal Revenue Code (the "Code"), which resulted in and may continue to result in an adjustment to the tax basis of the assets of Holdings at the time of an exchange of Class B Units. As a result of both the initial purchase of Class B Units from the Members in connection with the Merger and subsequent exchanges, CBS will become entitled to a proportionate share of the existing tax basis of the assets of Holdings. In addition, the purchase of Class B Units and subsequent exchanges are expected to result in increases in the tax basis of the assets of Holdings that otherwise would not have been available. Both this proportionate share and these increases in tax basis may reduce the amount of tax that CBS would otherwise be required to pay in the future. These increases in tax basis may also decrease gains (or increase losses) on future dispositions of certain capital assets to the extent tax basis is allocated to those capital assets.

CBS entered into a Tax Receivable Agreement with Holdings (the “Tax Agreement”) that requires CBS to pay to the Members up to 75% of the amount of the tax benefits, if any, that CBS is deemed to realize as a result of (i) the existing tax basis in the assets of Holdings on the date of the Merger, (ii) these increases in tax basis and (iii) certain other tax benefits related to CBS entering into the Tax Agreement, including tax benefits attributable to payments under the Tax Agreement. These payment obligations are obligations of CBS and not of Holdings. On November 14, 2011, Julian Geiger became a party to the Tax Agreement as part of the Geiger Employment Agreement (see Note 15). For purposes of the Tax Agreement, the benefit deemed realized by CBS will be computed by comparing the actual income tax liability of CBS (calculated with certain assumptions) to the amount of such taxes that CBS would have been required to pay had there been no increase to the tax basis of the assets of Holdings as a result of the purchase or exchanges, had there been no tax benefit from the tax basis in the intangible assets of Holdings on the date of the Merger and had CBS not entered into the Tax Agreement. The term of the Tax Agreement will continue until all such tax benefits have been utilized or expired, unless CBS exercises its right to terminate the Tax Agreement for an amount based on the agreed payments remaining to be made under the Tax Agreement or CBS breaches any of its material obligations thereunder, in which case all obligations will generally be accelerated and due as if CBS had exercised its right to terminate the Tax Agreement.

Income taxes

Crumbs complies with FASB ASC 740, “Income Taxes,” which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between financial statement and tax bases of assets and liabilities that will result in future taxable or deductible amounts, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce the deferred tax asset to the amount expected to be realized.

Crumbs is required to determine whether its tax positions are more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit recognized is measured as the largest amount of benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement with the relevant taxing authority. De-recognition of a tax benefit previously recognized results in Crumbs recording a tax liability that reduces stockholders’ equity. Based on its analysis, Crumbs has determined that it has not incurred any liability for unrecognized tax benefits as of December 31, 2013 or 2012. Crumbs’ conclusions may be subject to review and adjustment at a later date based on factors including, but not limited to, on-going analyses of and changes to tax laws, regulations and interpretations thereof.

Crumbs recognizes interest and penalties related to unrecognized tax benefits in interest expense and other expenses, respectively. No interest expense or penalties have been recognized in 2013 or 2012.

Lease obligations

Crumbs leases stores and office space under operating leases. Most lease agreements contain rent escalation clauses, and some contain contingent rent provisions, tenant improvement allowances and rent holidays. For purposes of recognizing incentives and minimum rental expenses on a straight-line basis over the terms of the leases, Crumbs uses the date of initial possession to begin amortization, which is generally when Crumbs enters the space and begins to make improvements in preparation for its intended use. No restrictions are imposed in the lease agreements regarding dividends, additional debt or further leasing.

For tenant improvement allowances and rent holidays, Crumbs records deferred rent in the consolidated balance sheets and amortizes the deferred rent over the terms of the leases as reductions to occupancy expense in the consolidated statements of operations.

For scheduled rent escalation clauses during the lease terms or for rental payments commencing at a date other than the date of initial occupancy, Crumbs records minimum rental expenses on a straight-line basis over the terms of the leases in the consolidated statements of operations.

For contingent rent provisions that require payment of additional rent based on a specified percentage of a store’s net sales in excess of a defined breakpoint, Crumbs records occupancy expense related to the contingency in the consolidated statements of operations provided the achievement of the breakpoint is considered probable.

Sales tax

Crumbs charges sales tax to its customers as and at the rates required by applicable state law and records the liability to remit such taxes on an individual state basis.

Restricted stock

Compensation cost for awards of restricted shares of CBS common stock stock is measured using the market price of CBS’ common stock at the date each award is granted. The compensation cost is recognized over the period between the award grant date and the date that all restrictions lapse.

Warrant liability

Crumbs accounts for CBS’ 5,456,300 outstanding publicly-traded warrants in accordance with the guidance contained in FASB ASC 815-40-15-7D. Pursuant to this guidance, management has determined that the warrants do not meet the criteria for equity treatment and must be recorded as a liability. Accordingly, Crumbs classifies the warrant instruments as a liability at their fair value and adjusts the instruments to fair value at each reporting period. This liability is subject to re-measurement at each balance sheet date until exercised or expired, and any change in fair value is recognized in Crumbs’ consolidated statements of operations. The fair value of warrants issued by CBS has been estimated using the warrants’ quoted market price.

Fair value - definition and hierarchy

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

In determining fair value, Crumbs uses various valuation approaches. A fair value hierarchy for inputs is used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs are to be used when available. Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of Crumbs. Unobservable inputs reflect Crumbs’ assumptions about the inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The fair value hierarchy is categorized into three levels based on the inputs as follows:

Level 1 - Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that Crumbs has the ability to access. Valuation adjustments are not applied to Level 1 investments. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these investments does not entail a significant degree of judgment.

Level 2 - Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

Fair Value - valuation techniques and inputs

Crumbs determined the fair value of the warrant liability using the quoted market prices for the warrants. On reporting dates where there are no active trades, Crumbs uses the last reported closing sales price of the warrants to determine the fair value (Level 2). There were no transfers between Levels 1, 2 or 3 during 2013 and 2012.

Revenue recognition

Crumbs recognizes store revenue when payment is tendered at the point of sale. Revenue from Crumbs’ catering services and wholesale distribution business is recognized once goods are delivered, and revenue from its e-commerce division is recognized once goods are shipped. Revenue is reported net of sales, use or other transaction taxes that are collected from customers and remitted to taxing authorities.

Revenue from Crumbs’ gift cards is recognized when they are tendered for payment or redeemed. Outstanding customer balances are included in gift cards in the consolidated balance sheets. There are no expiration dates on gift cards, and Crumbs does not charge any service fees that cause a decrement to customer balances.

While Crumbs will continue to honor all gift cards presented for payment, management may determine the likelihood of redemption to be remote for certain cards and certificates due to, among other things, long periods of inactivity. In these circumstances, if management also determines there is no requirement for remitting balances to government agencies under state escheatment laws, card balances may then be recognized in the consolidated statements of operations.

Sales incentives, promotions and marketing

Expenses related to buy-one-get-one-free incentives and product costs associated with redemptions from Crumbs’ coffee loyalty card program, through which customers receive free product after a designated number of purchases, are recorded in cost of sales at the time of redemption. Such costs totaled approximately $103,000 and $173,000 in 2013 and 2012, respectively.

Ongoing promotional product giveaway costs, marketing and public relations costs are included in selling expenses. Product giveaway costs and other promotions associated with new store openings are included in new store expenses. All costs are expensed as incurred. Amounts recorded in selling expenses totaled approximately $1,226,000 and $496,000 in 2013 and 2012, respectively, and those included in new store expenses totaled approximately $15,000 and $62,000 in 2013 and 2012, respectively.

New store expenses

New store expenses consisting primarily of manager salaries, employee payroll and related training costs incurred prior to the opening of a store, straight-line rent from the possession date to store opening date, related occupancy costs incurred prior to opening, start-up supplies and promotion of new store openings, are expensed as incurred.

Store closings

During 2013, 10 underperforming stores were closed. Costs associated with store closings included lease termination and professional fees and store repairs totaling approximately $415,000. These costs are included with occupancy expenses on the Statement of Operations. Occupancy expenses also included approximately $718,000 of reduced expenses associated with an adjustment in deferred rent expense associated with these stores. Loss on disposal of property and equipment included approximately $1,013,000 of loss related to these stores.

Shipping and handling costs

Shipping and handling costs related to the e-commerce division are expensed as incurred and included in the cost of sales. Total expenses for 2013 and 2012 were approximately $529,000 and $527,000, respectively.

Use of estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.

Concentrations of credit risk

Financial instruments which potentially expose Crumbs to concentrations of credit risk consist primarily of trade receivables. Management does not believe significant credit risk existed at December 31, 2013 or 2012.

Crumbs maintains cash at two financial institutions. The accounts are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000 per financial institution. In addition, the FDIC enacted temporary unlimited coverage for noninterest-bearing transaction accounts, effective December 31, 2010 through December 31, 2012. Crumbs’ uninsured bank balances, including certificates of deposit, totaled approximately $687,000 and $682,000 at December 31, 2013 and 2012, respectively.

Concentrations

Cupcake sales comprised approximately 78.4% and 77.0% of Crumbs’ net sales for the years ended December 31, 2013 and 2012, respectively. Beverage sales comprised approximately 11.4% and 11.1% of Crumbs’ net sales for the years ended December 31, 2013 and 2012, respectively.

Recently issued accounting standards

Crumbs does not believe that the adoption of any recently issued accounting standards will have a material impact on its current financial position and results of operations.

Reclassifications

Certain reclassifications have been made to amounts previously reported for 2012 to conform with the 2013 presentation. Such reclassifications have no effect on previously reported net loss.