UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended January 2, 2011

o		TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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		(I.R.S. Employer
incorporation or organization)		Identification No.)

255 Washington Street, Suite 100

Newton, Massachusetts 02458
(Address of principal executive offices) (Zip Code)

(617) 787-6000
Registrant’s telephone number

Securities registered under Section 12(b) of the Exchange Act:

Title of each class		Name of each exchange on which registered
None		None

Securities registered pursuant to Section 12(g) of the Act:

Common stock, $.001 par value per share
(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes þ No o

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. þ

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site if any, every interactive data 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). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

Large accelerated filer o		Accelerated filer o		Non-accelerated filer o		Smaller reporting company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $10,176,259 based on the last sale price of the common stock as of June 27, 2010. Shares held by each officer and director and by each person who owns 10% or more of the outstanding common stock have been excluded in that such person may be deemed to be affiliates. The determination of affiliate status is not necessarily a conclusive determination for other purposes.

There were 40,532,747 shares of our Common Stock issued and outstanding as March 2, 2011.

Part III of this Annual Report incorporates by reference certain information from the registrant’s definitive proxy statement for the 2011 annual meeting of shareholders, which the registrant will file pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of the registrant’s fiscal year ended January 2, 2011.

 

 

TABLE OF CONTENTS

		Page
PART I
Item 1. Business			3
Item 1A. Risk Factors			9
Item 2. Properties			23
Item 3. Legal Proceedings			23
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters And Issuer Purchases of Equity Securities			24
Item 6. Selected Financial Data			25
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			25
Item 7A. Quantitive and Qualitive Disclosures about Market Risk			37
Item 8. Financial Statements and Supplementary Data			38
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure			65
Item 9A. Controls and Procedures			65
Item 9B Other Information			66
PART III
Item 10. Directors, Executive Officers and Corporate Governance			67
Item 11. Executive Compensation			67
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			67
Item 13. Certain Relationships and Related Transactions, and Director Independence			67
Item 14. Principal Accounting Fees and Services			67
PART IV
Item 15 Exhibits			68
Signatures			69
Exhibit 21
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Forward-Looking Statements

Matters discussed in this report and in our public disclosures, whether written or oral, relating to future events or our future performance, including any discussion express or implied, of our anticipated growth, operating results, future earnings per share, plans and objectives, contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, or Exchange Act. These statements are often identified by the words “believe”, “positioned”, “estimate”, “project”, “target”, “continue”, “intend”, “expect”, “future”, “anticipate”, and similar expressions that are not statements of historical fact. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Our actual results and timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under “Risk Factors” and elsewhere in this report and in our other public filings with the Securities and Exchange Commission, or SEC. It is routine for internal projections and expectations to change as the year or each quarter in the year progresses, and therefore it should be clearly understood that all forward-looking statements and the internal projections and beliefs upon which we base our expectations included in this report or other periodic reports are made only as of the date made and may change. While we may elect to update forward-looking statements at some point in the future, we do not undertake any obligation to update any forward-looking statements whether as a result of new information, future events or otherwise.

PART I

Item 1.		Business

We are a franchisor and operator of fast-casual food service restaurants that capitalize on what we believe are the developing trends toward healthier living and eating and the increasing consumer demands for restaurant fare that offers appetizing food with healthy attributes. We believe our menu items are made with higher quality ingredients and healthier cooking techniques than ordinary quick serve food. Delivering great taste and an overall pleasing dining experience for an individual customer is the focus of UFood’s mission and concept.

We were incorporated in the State of Nevada on February 8, 2006, as Axxent Media Corporation. Prior to December 18, 2007, we were a development stage company. On August 8, 2007, we changed our name to UFood Franchise Company, and on September 25, 2007, we changed our name to UFood Restaurant Group, Inc.

On December 18, 2007, a wholly-owned subsidiary of our Company merged with and into KnowFat Franchise Company, Inc., with KnowFat surviving the merger as our wholly-owned subsidiary. Following the merger, we continued KnowFat’s business operations. KnowFat was founded in 2004 to capitalize on the popularity of a chain of fast-casual concept restaurants operating under the trade name “Lo Fat Know Fat” in the greater Boston area, as well as the trend we believe is developing in the United States towards healthier living and eating. After operating for three years as KnowFat! Lifestyle Grille, while continuously modifying and improving the concept, management decided that future locations will operate under the name UFood Grill. During the third quarter of 2008, the four remaining KnowFat! Lifestyle Grille locations were converted to UFood Grill outlets. All of our Company-owned restaurants and franchise-owned locations now operate, and all future locations will operate, under the name UFood Grill.

Three of our four Company-owned restaurants that were originally KnowFat! Lifestyle Grilles included an integrated convenience-style retail store that carried a variety of health-oriented nutritional products, such as supplements, vitamins, nutrition bars, energy drinks and healthy snacks. As part of the process of conversion to UFood Grill outlets, floor space formerly devoted to the sale of nutritional products in two of these stores was reconfigured to accommodate the sale of smoothie drinks and frozen yogurt, because we believe that these products will generate higher revenues in these locations. None of our franchise locations currently carries nutrition products, and only our Watertown, Massachusetts Company-owned location carries nutritional products. We will continue to evaluate the placement of nutrition products in our existing and future locations based on our assessment of demand in the particular location and, in the case of franchise locations, the franchisee’s preferences.

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 57 franchise units in the following states: Texas, Ohio, Massachusetts, Florida and the Washington, DC area. Furthermore, two of the area development agreements are for non-traditional locations such as airports, colleges, travel plazas, and hospitals across the United States. The 57 units include four franchise locations currently open and operating, and requiring an additional 53 future UFood Grill outlets to be developed by franchisees. The Naples, FL location was closed on July 24, 2010. On July 17, 2010 the Cleveland Hopkins International Airport location was open.

We believe the sale of franchises allows us to expand the UFood Grill brand faster than the construction and operation of Company-owned outlets due to the Company’s limited human and financial resources, while allowing us to collect franchise fees and royalties. Under our area development and franchise agreements, we receive royalties on gross franchise sales as described above, and we do not pay any of the construction, opening (other than the training and advice described above), operating or marketing costs. We do not provide or arrange financing to franchisees or area developers.

All of our Company-owned restaurants and franchise-owned locations now operate, and all future locations will operate, under the name UFood Grill.

We operate in 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 that licenses qualified operators to conduct business under the UFood Grill tradename and monitors the operations of these business units. Certain financial information for each segment is set forth in Note 14, Segment Data, of Notes to Consolidated Financial Statements.

Our headquarters are located at 255 Washington Street, Suite 150, Newton, Massachusetts 02458. Our telephone number is (617) 787-6000.

Concept and Strategy

We are a franchisor and operator of fast-casual food service restaurants that capitalize on what we believe are the developing trend toward healthier living and eating and the increased consumer demands for restaurant fare that offers appetizing food with healthy attributes. We believe our menu items are made using higher quality ingredients and healthier cooking techniques than ordinary quick serve food. Consequently, we believe our menu provides customers with a delicious and healthy alternative to typical fast food options. Guests order at a counter and wait three to five minutes for their meals to be prepared. At UFood Grill, we bake, grill or steam our menu offerings; we never fry our food. Our sauces, cheeses and salad dressings are reduced-fat. We serve whole-grain breads and side dishes and, where we can do so while still charging our customers a reasonable price, organic meats and vegetables (meeting U.S. Food and Drug Administration standards for “organic”). The food is served on ceramic plates with metal utensils and is taken to the table by each guest. Delivering great taste and an overall pleasing dining experience for an individual customer is the focus of UFood’s mission and concept.

The UFood Grill concept attempts to provide each customer segment with the features it seeks in a quick service restaurant. Understanding the market segmentation model allows us to focus on those market segments that afford the greatest sales opportunities. The UFood Grill brand has four pillars on which it rests:

U Love Great Food
U Are Always on the Go
U Want It Your Way
U Want to Look and Feel Great

Approximately half of all our sales are prepared for take-out, with the guest either calling ahead or ordering in the restaurant. Nearly 60% of customers frequent our restaurants for lunch, with the remaining 40% enjoying our fare at dinner time. Most of our restaurants are not open for breakfast service. We are required to offer breakfast service at our UFood Grill outlet at Logan International Airport in Boston.

We believe the UFood concept has significant growth potential, which we hope to realize through a combination of company and franchisee efforts. Franchising will be a key component of our success. There are currently a total of eight UFood Grill restaurant locations open. Four of the locations are in the greater Boston area, with one location in Cleveland, Ohio, and two locations in the area of the Dallas/Ft. Worth Texas.

Industry Background

The United States restaurant industry is benefitting from a long-term trend of consumers eating out more frequently. According to the National Restaurant Association, the restaurant industry’s share of consumer food expenditures has increased from 25% in 1955 to 49% in 2009, and restaurant sales are expected to reach $604 billion in 2011, an increase of 2.5% over 2010 sales. The leading factors contributing to the recent growth have been the growing population, the trend toward busier lifestyles, greater spending on dining and entertainment activities and the increased availability of high-quality dining options.

The recent emergence of the fast-casual dining sector has capitalized significantly on the industry’s expansion. This group, led by companies such as Chipotle Mexican Grill and Panera Bread Company, caters to customers who desire the convenience of fast food, and who are willing to pay a premium for higher quality, differentiated menu items. According to the National Restaurant Association, these consumer preferences have made fast-casual one of the fastest growing sub-sectors within the restaurant industry.

However, the increase in eating out has also contributed to a general deterioration in the health of Americans. Today, obesity has reached epidemic proportions in the United States. According to the Centers for Disease Control and Prevention (CDC), approximately 34% of American adults aged 20 and over, or 72 million people, met the criterion for obesity in 2007-2008. In 2009, only Colorado and the District of Columbia had a prevalence of obesity less than 20%. In addition, a CDC study indicates that in the past 30 years, the occurrence of obesity in children has doubled, and it is now estimated that one in five children in the United States is overweight. According to published studies, obese children are more likely to be obese as adults, which leads to an increased risk for a number of diseases including stroke, cardiovascular disease, hypertension, diabetes and some cancers. Obesity also contributes to additional negative health consequences, including Type 2 Diabetes, high total and LDL (bad) cholesterol and triglyceride levels in the blood, low HDL (good) cholesterol levels in the blood, sleep apnea and inflammation of the liver. Poor food choices, such as diets high in calories (including fats and simple sugars) and lower in fruits and vegetables are linked with being overweight.

Menu

We believe our menu items are made with higher quality ingredients and healthier cooking techniques than ordinary quick serve food. Consequently, we believe our menu provides customers with a delicious and healthy alternative to typical fast food options. Guests order at a counter and wait three to five minutes for their meals to be prepared. At UFood Grill, we bake, grill or steam our menu offerings; we never fry our food. Our sauces, cheeses and salad dressings are reduced-fat. We serve whole-grain breads and side dishes and, where we can do so while still charging our customers a reasonable price, organic meats and vegetables (meeting U.S. Food and Drug Administration standards for “organic”). The food is served on ceramic plates with metal utensils and is taken to the table by each guest. Delivering great taste and an overall pleasing dining experience for an individual customer is the focus of UFood’s mission and concept.

With our innovative menu, we are targeting mainstream customers as well as health conscious customers. We believe the taste and quality of our food offerings will have wide market appeal.

Our menu contains a wide variety of food types, including hot entrees, burgers, salads, sandwiches, wraps, smoothies, and desserts, each of which is united in the theme that the food is “better for you” than many other dining-out options. Each item is prepared with healthier alternatives in mind, whether an ingredient or a method of preparation, and has better nutritional qualities than the equivalent item a consumer might find at a typical quick serve establishment.

Growth Strategy

We plan to further expand our franchising network as well as open other Company-owned stores. We have increased our focus on nontraditional locations such as airports, hospitals, colleges and travel plazas. We anticipate announcing several new nontraditional locations in the coming months.

Franchise sales are led by our chairman and chief executive officer, George Naddaff. In addition, we have entered into a services agreement with George Foreman, the well-known world heavyweight boxing champion, businessman and celebrity, to be a spokesperson for the brand as well as to assist in generating interest in franchising the UFood concept. Under the terms of an agreement, Mr. Foreman has agreed to lend his name and likeness and assist in marketing and branding efforts of UFood restaurants. Mr. Foreman is expected initially to be involved in helping to sell franchises. The agreement expires in June 2011.

Outside of the Boston area, we plan to award only multi-unit territories to sophisticated, experienced owner-operators. These operators will sign area development agreements wherein they will obtain an exclusive territory in which to build UFood outlets. Upon signing these agreements, the operators will pay an upfront fee for the rights to their territory, and they will then be bound to a timeline over which they must open the units. Currently we have four area developers who have committed to building and operating 57 franchise locations (including 4 locations currently open and operating) in four areas:

•

Dallas-Fort Worth International Airport and Parkland Hospital in Dallas, Texas.

•

Florida

•

Cleveland, Ohio

•

Washington, D.C.

We seek to sell franchises to sophisticated, experienced restaurant operators who already know their markets, having operated other restaurants in their territories. We believe these sophisticated operators will enable our concept to grow rapidly and help establish the UFood brand across the country. We do not allow sub-franchising. All franchise agreements are directly with us.

We also intend to grow our store base through the building of Company-owned stores. Our current plan calls for approximately 10% of our stores to be Company-owned. The primary purpose of this effort is to ensure that management understands how the stores evolve and operate and has its own “kitchen” to test new initiatives (menu items, loyalty programs etc.) in front of real customers. We have transitioned our loyalty program to an email club to communicate with our guests and send out special offers. To leverage the current geographical concentration of UFood stores in the Boston area, we plan to locate the new Company-owned stores in the New England area, close to our headquarters.

We have developed two prototype stores that we believe are suitable to differing site and demographic conditions: 1) 1,200 — 2,200 sq. feet units (currently four stores); and 2) 800 — 1,000 sq. feet units that are kiosks in airports, bus and train stations, hospitals and other high-traffic locations (currently three store). We cannot currently estimate the proportion of our planned future locations that will fall in each of these categories

Franchise Operations

UFood has pursued a broad-based franchising program since 2004. UFood continues to extend its franchise relationships beyond its current franchisees. Pursuant to federal and state regulations, UFood annually updates its Franchise Disclosure Document, which includes a disclosure statement, a Franchise Agreement, and an Area Development Agreement, to facilitate sales of additional franchise and area development licenses. The UFood franchise agreement typically requires the payment of a franchise fee of $35,000 per restaurant, royalties of 5.0% of gross sales and contributions to a system-wide advertising fund of 1.5% of gross sales. The franchisee is also required to spend 1.5% of gross sales on local marketing. In general, 50% of the franchise fee is payable at the time the Franchise Agreement is signed and the balance is due at the time each store opens. Each Franchise Agreement generally provides for a term of 15 years and two, five-year renewal options.

The Area Development Agreement is similar to the Franchise Agreement in its terms. In order for an area developer to acquire the rights to a territory, the developer must pay one-half of the franchise fee up front for each unit that developer agrees to build in the territory. In some agreements, UFood has deferred the payment of the upfront fee, so that the developer pays up-front fees for the first few stores upon the execution of the agreement and fees for the stores opening in phase 2 of the build-out at a later date. UFood estimates that it costs between $400,000 and $650,000 to open one of its outlets.

To ensure that the UFood concept is consistent across all geographic areas, we have fully built out the corporate support system for franchisees. New franchisees get assistance on all levels, including build-out specifications, operational guidance, and menu and recipes. We also provide a three week training program for each of our new franchisees and employees prior to new store openings.

Suppliers

We strive to obtain consistent high-quality ingredients at competitive prices from reliable sources. To obtain operating efficiencies and to provide fresh ingredients for our food products while obtaining the lowest possible ingredient prices for the required quality, we purchase over 70% of our restaurant supplies from a single supplier, Sysco, Inc. The balance of our restaurant supplies come from local vegetable and bread suppliers. Most food, produce and other products are shipped from Sysco’s distribution facility directly to our restaurant locations two to three times per week. We do not maintain a central food product warehouse or commissary. We do not have any long-term contracts with our food suppliers. In the past, we have not experienced delays in receiving our food and beverage inventories, restaurant supplies or equipment.

Competition

The restaurant industry is intensely competitive. There are many different sectors within the restaurant industry that are distinguished by types of service, food types and price/value relationships. We position our restaurants in the highly competitive and fragmented fast-casual sector of the restaurant industry. In addition to competing against other fast-casual restaurants, we compete against other sectors of the restaurant industry, including fast-food restaurants and casual dining restaurants. The number, size and strength of competitors within each sector vary by region. We compete based on a number of factors including taste, product quality, speed of service, value, name recognition, restaurant condition and ambiance, location and customer service. Although we believe we compete favorably with respect to each of these factors, many of our direct and indirect competitors are well-established national, regional or local chains and have substantially greater financial, marketing, personnel and other resources.

Customers seeking a healthier meal at a foodservice establishment, have several choices available to them throughout the country. However, we are not aware of any national chains of health-oriented quick-service restaurants that geographically cover the whole United States or even a number of states.

The following is a list of restaurants that position themselves as healthier and compete in the quick-serve environment, mostly on a local level. The largest chain has thirty three stores.

•

Better Burger (New York City)

•

Energy Kitchen (New York City)

•

The Pump (New York City)

•

The Muscle Maker (New Jersey)

•

Topz (California)

•

Evo’s (California, Florida, Nevada, North Carolina)

•

b. good (Boston)

•

Soma Grill (Arizona)

•

Healthy Bites (Florida)

Of the restaurants listed above, only b. good operates in the Boston area. A number of fast food chains and local eateries operating in the greater Boston area offer similar products and services as UFood Grill but without the emphasis on health. b. good operates five locations in the Boston area. In addition to b. good, there are several vegetarian and raw vegan restaurants in the Boston area as well as several health food stores. These outlets offer healthy food but not in a quick-serve environment.

We also compete with these and many other retail establishments for desirable site locations. See “Risk Factors—There is intensive competition in our industry, and we will be competing with national and regional chains and independent restaurant operators.”

Employees

As of January 2, 2011, we employed approximately 32 full-time associates (defined as associates who average 32 hours or more per week), of whom 11 were employed in general or administrative functions, principally at our headquarters in Newton, Massachusetts, and approximately 21 were employed in our four Company-operated restaurant locations in the Boston area as managers and associates. UFood does not have any collective bargaining agreements with its employees and considers its employee relations to be good. UFood places a priority on staffing its restaurant and store operations with skilled associates and invests in training programs to ensure the quality of its operations.

Trademarks

We have registered the following trademarks with the United States Patents and Trademarks Office: “Unfries”, “UFood Grill”, “Proccino,” “KnowFat! Lifestyle Grille,” “KnowFat,” “Prolatta,” “UBerry,” “Ubowls,” “Smuuthies,” and “LoFat KnowFat”. We believe that our trademarks and other proprietary rights have significant value and are important to the marketing of our restaurant concept.

Seasonality

While our business is not significantly seasonal, revenues in the first two quarters of the calendar year are slightly higher than the last two quarters of the year.

Government Regulation

Our restaurants are subject to licensing and regulation by state and local health, sanitation, safety, fire and other authorities, including licensing and permit requirements for the sale of food. To date we have not experienced an inability to obtain or maintain any necessary licenses, permits or approvals. In addition, the development and construction of additional units are also subject to compliance with applicable zoning, land use and environmental regulations. See “Risk Factors—Our food service business and the restaurant industry are subject to extensive government regulation.”

Environmental Regulation

Our business is subject to federal, state and local environmental laws and regulations concerning the discharge, storage, handling, release and disposal of hazardous or toxic substances. These environmental laws provide for significant fines, penalties and liabilities, sometimes without regard to whether the owner or operator of the property knew of, or was responsible for, the release or presence of the hazardous or toxic substances. Third parties may also make claims against owners or operators of properties for personal injuries and property damage associated with releases of, or actual or alleged exposure to, such substances. To date, our stores have not been the subject of any material environmental matters. See “Risk Factors—We have not conducted a comprehensive review of all the potential environmental liabilities at our properties.”

Item 1A.		Risk Factors

Risks Related to Our Company and Our Business

We have a limited operating history and are subject to all of the risks inherent in the expansion of an early-stage business.

We were formed approximately six years ago, and we have a short operating history upon which an investor can evaluate our performance. Our proposed operations are subject to all of the risks inherent in the expansion of an early-stage business enterprise, including higher-than-expected expenses and uncertain revenues. The likelihood of our success must be considered in light of the problems, expenses, difficulties, complications and delays frequently encountered in connection with the expansion of an early-stage business and the competitive environment in which we operate. We have had no profits to date, and there can be no assurance of future profits. As a result of the expansion-stage nature of our business and the fact that we will incur significant expenses in connection with our activities, we can be expected to sustain operating losses for the foreseeable future.

We have not been profitable to date and expect our operating losses to continue for the foreseeable future; we may never be profitable.

We have incurred annual operating losses and generated negative cash flows since our inception and have financed our operations principally through equity investments and borrowings. At this time, our ability to generate sufficient revenues to fund operations is uncertain. For the fiscal year ended January 2, 2011, we had revenue of $4,942,939 and incurred an operating loss of $8,189,022. For the fiscal year ended December 27, 2009, we had revenue of $5,450,836 and incurred an operating loss of $3,957,351. Our total accumulated deficit through January 2, 2011, was $39,723,837.

As a result of our brief operating history, revenue is difficult to predict with certainty. Current and projected expense levels are based largely on estimates of future revenue. We expect expenses to increase in the future as we expand our sales, marketing and administrative activities and incur the expenses of being a public company. As a result, we expect to incur additional losses for at least the next 18 months. We cannot assure you that we will be profitable in the future or generate future revenues. Accordingly, the extent of our future losses and the time required to achieve profitability, if ever, is uncertain. Failure to achieve profitability could materially and adversely affect the value of our Company and our ability to affect additional financings. The success of the business depends on our ability to increase revenues to offset expenses. If our revenues fall short of projections, our business, financial condition and operating results will be materially adversely affected. If we are unable to generate positive cash flow from our Company-owned restaurants or if the market price of our common stock declines, we may be required to recognize an impairment loss with respect to the assets of our Company-owned restaurants or our goodwill.

There are risks inherent in expansion of operations, including our ability to sell franchises, generate profits from new restaurants, find suitable sites and develop and construct stores in a timely and cost-effective way.

We cannot project with certainty, nor do we make any representations regarding, the number of franchises we will be able to sell or the number of new restaurants we and our franchisees will open in accordance with our present plans and within the timeline or the budgets that we currently project. While our business plan focuses primarily on the sale of franchises rather than building and operating additional Company-owned stores, sales at Company-owned stores represented over 91.4% of our total revenues for the year ended January 2, 2011. Our failure to sell the projected number of franchises would adversely affect our ability to execute our business plan by, among other things, reducing our revenues and profits and preventing us from realizing our strategy of being the first major franchiser of retail outlets offering a combination of food service featuring low-fat, low-carbohydrate and low-calorie food items, selected beverages to the general public. Furthermore, we cannot assure you that our new restaurants will generate revenues or profit margins consistent with those currently operated by us and our franchisees or that our restaurants will be operated profitably.

During the year ended January 2, 2011, our store operations business segment generated revenue of $4,518,308 and an operating profit of $142,762. During the year ended December 27, 2009, our store operations business segment generated revenue of $4,632,651 and an operating loss of $13,056.

We will rely primarily upon area developers to open and operate franchise units. The number of openings and the performance of new stores will depend on various factors, including:

•

the availability of suitable sites for new stores;

•

our and our franchisees’ ability to negotiate acceptable lease or purchase terms for new locations, obtain adequate financing, on favorable terms, requires to construct, build-out and operate new stores and meet construction schedules, and hire and train and retain qualified store managers and personnel;

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managing construction and development costs of new stores at affordable levels;

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the establishment of brand awareness in new markets; and

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the ability of our Company and our area developers to manage this anticipated expansion.

While the impact varies with the location and the qualifications of the franchisee, tight credit markets are generally making financing for construction and operation of restaurants more difficult to obtain on favorable terms.

Competition for suitable store sites in target markets is intense and lease costs are increasing (particularly for urban locations). Not all of these factors are within our control or the control of our franchisees, and there can be no assurance that we will be able to accelerate our growth or that we will be able to manage the anticipated expansion of our operations effectively.

We will depend on contractors and real estate developers to construct our stores. Many factors may adversely affect the cost and time associated with the development and construction of our stores, including:

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labor disputes;

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shortages of materials or skilled labor;

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requirements to use union labor;

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energy prices;

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adverse weather;

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unforeseen engineering problems;

•

environmental problems;

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construction or zoning problems;

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local government regulations;

•

modifications in design; and

•

other unanticipated increases in costs.

Any of these factors could give rise to delays or cost overruns, which may prevent us from developing additional stores within our anticipated budgets or time periods or at all. Any such failure could cause our business, results of operations and financial condition to suffer. The recent volatility in certain commodity markets, such as those for energy, grains and dairy products, which have experienced significant increases in prices, may be generally causing franchisees in our industry to delay construction of new restaurants and/or causing potential new franchisees to reconsider entering into franchise agreements.

Our business plan is dependent on the franchising model; therefore, our success will generally depend on the success of our franchisees and the profitability of their stores.

Because royalties from franchisees’ sales are a principal component of our revenue base, our success is dependent upon our ability to attract highly qualified franchisees and the ability of our franchisees to promote and capitalize upon UFood’s concept. Our franchisees generally depend upon financing from banks and other financial institutions to finance the cost of opening a new restaurant. If franchisees cannot obtain reasonable financing and restaurants do not open, our royalties from those restaurants will not exist. Even if we are successful in selling franchise units, the contemplated expansion may entail difficulty in maintaining quality standards, operating controls and communications, and in attracting qualified restaurant operators. Locations for units will be based on theoretical projections of market demand with no assurance that such locations will prove successful. As a result, franchise units may not attain desired levels of revenues or may attain them more slowly than projected, and this would adversely affect our results of operations. Since we are dependent on franchisee royalties, we are also at risk for the non-performance by our franchisees of their payment and other obligations under our franchise agreements. For example, in May 2008, we terminated a 2005 franchise agreement

with our franchisee operator in Dade and Broward Counties, Florida, covering 24 unopened franchise locations because the franchisee did not meet the opening timeline specified in the agreement, and we have reclaimed the franchise territory. In 2007, two agreements covering two operating and four unopened locations were terminated after the stores ceased operations. Two other agreements covering twelve unopened locations were also terminated when the area developers did not meet the opening timeline set forth in their agreements. In 2009, we terminated three Area Development Agreements that included the following states Colorado, Utah, Montana, Wyoming, Idaho, Illinois, and the Houston, TX area. Also, during 2009 we terminated two franchise agreements for stores in DesMoines, IA and Burlington, MA. During 2010, we terminated two Area Development Agreements for the territories covering San Jose, CA and Naples, FL. Similar defaults or failures by other franchisees could materially adversely affect our growth plans and our business, financial condition and operating results.

Our past and future operating losses may make it more difficult for us to attract new franchisees.

Potential new franchisees may be reluctant to commit to develop new UFood Grill restaurants as long as we are not profitable. As stated above, we have not been profitable to date and expect our operating losses to continue for at least the next 18 months. Until we have demonstrated the ability to be profitable, we may find it difficult to attract new franchisees, who are required to expend substantial sums to develop, construct and operate new restaurants, if they perceive that there is a risk that we will not continue in business or that our lack of profitability will impair their ability to make a profit.

We may be subject to general risk factors affecting the restaurant industry, including current economic climate, costs of labor, food prices, gasoline prices and the unemployment levels.

If we grow as anticipated, our Company and our franchisees may be affected by risks inherent in the restaurant industry, including:

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adverse changes in national, regional or local economic or market conditions;

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increased costs of labor (including increases in the minimum wage);

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increased costs of food products;

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availability of, and ability to obtain, adequate supplies of ingredients that meet our quality standards;

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increased energy costs;

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management problems;

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increases in the number and density of competitors;

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limited alternative uses for properties and equipment;

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changing consumer tastes, habits and spending priorities;

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changing demographics;

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the cost and availability of insurance coverage;

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uninsured losses;

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changes in government regulation;

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changing traffic patterns;

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weather conditions; and

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local, regional or national health and safety matters.

Our Company and our franchisees may be the subject of litigation based on discrimination, personal injury or other claims. We can be adversely affected by publicity resulting from food quality, illness, injury or other health concerns or operating issues resulting from one restaurant or a limited number of restaurants in our system. None of these factors can be predicted with any degree of certainty, and any one or more of these factors could have a material adverse effect on our Company.

There is intensive competition in our industry, and we will be competing with national and regional chains and independent restaurant operators.

The restaurant industry is intensely competitive. There are several healthy-food themed restaurants, most of which have fewer than six units. Moreover, the retail food industry in general, which is highly competitive and includes highly sophisticated national and regional chains, has begun to offer “healthier” alternatives to its typical menu offerings. We operate in the fast-casual sector of the retail food industry. This sector is highly competitive with respect to, among other things, taste, price, food quality and presentation, service, location and the ambiance and condition of each restaurant. Some of the restaurants and franchises have substantial financial resources, name recognition and reputations. While we strive to differentiate ourselves from major restaurants and food-service establishments through the nutritional attributes of the items we offer on our menu (all-natural and hormone-free meat, reduced fat sauces, cheeses and salad dressings, whole grain breads, and whenever possible, organic vegetables), the manner in which those items are prepared (baked, steamed or grilled) and the environment in which they are offered, we will, nonetheless, be required to compete with national and regional chains and with independent operators for market share, access to desirable locations and recruitment of personnel. Many of our competitors have existed longer and have a more established market presence with substantially greater financial, marketing, personnel and other resources than us. No assurances can be given that we will have the financial resources, distribution ability, depth of key personnel or marketing expertise to compete successfully in these markets.

Our business has been adversely affected by declines in discretionary spending and may be affected by changes in consumer preferences.

Our success depends, in part, upon the popularity of our food products and our ability to develop new menu items that appeal to consumers. Shifts in consumer preferences away from our restaurants or cuisine, our inability to develop new menu items that appeal to consumers or changes in our menu that eliminate items popular with some consumers could harm our business. Also, our success depends to a significant extent on discretionary consumer spending, which is influenced by general economic conditions and the availability of discretionary income. Accordingly, we may experience declines in sales during economic downturns or during periods of uncertainty like that which followed the 2001 terrorist attacks on the United States and the possibility of further terrorist attacks. A continuing decline in the amount of discretionary spending could have a material adverse effect on our sales, results of operations, business and financial condition.

For the twelve months ended January 2, 2011, comparable store sales for our Company-owned stores decreased by 2.4%. We believe higher gasoline prices, inflationary pressures on groceries and utilities, increased unemployment, home foreclosures and tightening credit conditions have all reduced consumer discretionary spending which in turn has adversely impacted our revenues and may continue to do so.

Increases in costs, including food, labor and energy prices, will adversely affect our results of operations.

Our profitability is dependent on our ability to anticipate and react to changes in our operating costs, including food, labor, occupancy (including utilities and energy), insurance and supplies costs. Various factors beyond our control, including climatic changes and government regulations, may affect food costs. Specifically, our dependence on frequent, timely deliveries of fresh meat and produce subject us to the risks of possible shortages or interruptions in supply caused by adverse weather or other conditions which could adversely affect the availability and cost of any such items. In the past, we have been able to recover some of our higher operating costs 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. The recent volatility in certain commodity markets, such as those for energy, grains and dairy products, which have experienced significant increases in prices, may have an adverse effect on us in the fiscal 2011 and beyond and may cause franchisees in our industry to delay construction of new restaurants and/or cause potential new franchisees to reconsider entering into franchise agreements. The extent of the impact may depend on our ability to increase our menu prices and the timing thereof.

Our stores are concentrated in a small geographic area.

Four of our stores are located in the greater Boston area. A downturn in the regional economy or other significant adverse events in the greater Boston area could have a material adverse effect on our financial condition and results of operations.

The growth of our Company is dependent on the skills and expertise of management and key personnel.

During the upcoming stages of our Company’s growth, we will be entirely dependent upon the management skills and expertise of our management and key personnel, including George Naddaff, our current Chairman and Chief Executive Officer, and Charles A. Cocotas, our current President and Chief Operating Officer. We would be materially adversely affected in the event that the services of these individuals or other management or key personnel for any reason ceased to be available and adequate replacement personnel were not found.

Our food service business and the restaurant industry are subject to extensive government regulation.

We are subject to extensive and varied federal, state and local government regulation, including regulations relating to public health and safety and zoning codes. We operate each of our stores in accordance with standards and procedures designed to comply with applicable codes and regulations. However, if we could not obtain or retain food or other licenses, it would adversely affect our operations. Although we have not experienced, and do not anticipate, any significant difficulties, delays or failures in obtaining required licenses, permits or approvals, any such problem could delay or prevent the opening of, or adversely impact the viability of, a particular store or group of stores.

Massachusetts, California and most other states and local jurisdictions have enacted laws, rules, regulations and ordinances which may apply to the operation of a UFood store, including those which:

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Establish general standards, specifications and requirements for the construction, design and maintenance of the store premises;

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regulate matters affecting the health, safety and welfare of our customers, such as general health and sanitation requirements for restaurants, employee practices concerning the storage, handling, cooking and preparation of food, special health, food service and licensing requirements, restrictions on smoking, exposure to tobacco smoke or other carcinogens or reproductive toxicants and saccharin and availability of and requirements for public accommodations, including restrooms;

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set standards pertaining to employee health and safety;

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set standards and requirements for fire safety emergency preparedness; regulate the proper use, storage and disposal of waste, insecticides, and other hazardous materials;

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establish general requirements or restrictions on advertising containing false or misleading claims, or health and nutrient claims on menus or otherwise, such as “low calorie” or “fat free”, and

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establish requirements concerning withholdings and employee reporting of taxes on tips.

In addition, some jurisdictions now require menu or other in-store disclosure of calorie and other nutritional information for each menu item.

In order to develop and construct more stores, we need to comply with applicable zoning, land use and environmental regulations. Federal and state environmental regulations have not had a material effect on our operations to date, but more stringent and varied requirements of local governmental bodies with respect to zoning, land use and environmental factors could delay or even prevent construction and increase development costs for new stores. We are also required to comply with the accessibility standards mandated by the U.S. Americans with Disabilities Act, which generally prohibit discrimination in accommodation or employment based on disability. We may, in the future, have to modify stores, for example, by adding access ramps or redesigning certain architectural fixtures, to provide service to or make reasonable accommodations for disabled persons. While these expenses could be material, our current expectation is that any such action will not require us to expend substantial funds.

We are subject to the U.S. Fair Labor Standards Act, the U.S. Immigration Reform and Control Act of 1986 and various federal and state laws governing various matters including minimum wages, overtime and other working conditions. We pay a significant number of our hourly staff at rates consistent with but higher than the applicable federal or state minimum wage. Accordingly, increases in the minimum wage would increase our labor cost. We are also subject to various laws and regulations relating to our current and any future franchise operations.

We are also subject to various federal and state laws that regulate the offer and sale of franchises and aspects of the licensor-licensee relationships. Many state franchise laws impose restrictions on the franchise agreement, including the duration and scope of non-competition provisions, the ability of a franchisor to terminate or refuse to renew and the ability of a franchisor to designate sources of supply. The Federal Trade Commission, or the FTC, and some state laws also require that the franchisor furnish to prospective franchisees a franchise offering circular that contains prescribed information and, in some instances, require the franchisor to register the franchise offering.

We have not conducted a comprehensive review of all the potential environmental liabilities at our properties.

We are subject to federal, state and local environmental laws and regulations concerning the discharge, storage, handling, release and disposal of hazardous or toxic substances. These environmental laws provide for significant fines, penalties and liabilities, sometimes without regard to whether the owner or operator of the property knew of, or was responsible for, the release or presence of the hazardous or toxic substances. Third parties may also make claims against owners or operators of properties for personal injuries and property damage associated with releases of, or actual or alleged exposure to, such substances. We cannot predict what environmental laws will be enacted in the future, how existing or future environmental laws will be administered or interpreted or the amount of future expenditures that we may need to make to comply with, or to satisfy claims relating to, environmental laws. While, during the period of their ownership, lease or operation, our stores have not been subject to any material environmental matters, we have not conducted a comprehensive environmental review of our properties or operations. We have not conducted investigations of our properties to identify contamination caused by third-party operations; in such instances, our landlords would be required to address the contamination. If the relevant landlord does not identify contamination properly or completely, then under certain environmental laws, we could be held liable as an owner and operator to address any remaining contamination. Any such liability could be material.

Our success and competitive position depends on our ability to protect our proprietary intellectual property.

We own certain common law trademark rights and a number of federal trademark and service mark registrations. We believe that our trademarks and other proprietary rights are important to our success and our competitive position. We therefore devote what we believe to be appropriate resources to the protection of our trademarks and proprietary rights. The protective actions that we take, however, may not be enough to prevent unauthorized usage or imitation by others, which may cause us to incur significant litigation costs and could harm our image or our brand or competitive position. To date, we have not been notified that our trademarks or menu offerings infringe upon the proprietary rights of third parties, but we cannot assure you that third parties will not claim infringement by us. Any such claim, whether or not it has merit, could be time-consuming, result in costly litigation, cause product delays or require us to enter into royalty or licensing agreements. As a result, any such claim could have a material adverse effect on our business, results of operations and financial condition. As a franchisor, we will grant our franchisees a limited license to use our trademarks and service marks. The general public could incorrectly identify our franchisees as controlled by us. In the event that a court determines the franchisee is not adequately identified as a franchisee, we could be held liable for the misidentified franchisee’s debts, obligations and liabilities.

Our plan to rapidly increase the number of stores may make future results unpredictable, as our success will depend on acceptance of our products in new markets.

We plan to significantly increase the number of our stores in the next three years. This growth strategy and the substantial investment associated with the development of each new store may cause operating results to fluctuate and be unpredictable or adversely affect profits. Our future results depend on various factors, including successful selection of new markets and store locations, market acceptance of the UFood experience, consumer recognition of the quality of our food and willingness to pay our prices (which in some instances reflect higher ingredient costs), the quality of operations and general economic conditions. In addition, as has happened when other fast-casual restaurant concepts have tried to expand nationally, we may find that the UFood concept has limited or no appeal to customers in new markets or we may experience a decline in the popularity of UFood restaurants. Newly opened stores may not succeed, future markets and stores may not be successful and, even if we are successful, our average store sales may not increase.

New stores, once opened, may not be profitable, and the increases in average store sales and Company store sales that we have experienced in the past may not be indicative of future results.

Our ability to operate new stores profitably and increase sales will depend on many factors, some of which are beyond our control, including:

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sales performance of new stores

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competition, either from competitors in the restaurant industry or our own stores;

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changes in consumer preferences and discretionary spending;

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consumer understanding and acceptance of UFood stores;

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road construction and other factors limiting access to new stores;

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general economic conditions, which can affect store traffic, local labor costs and prices we pay for ingredients and other supplies; and

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changes in government regulation.

If we fail to open stores as quickly as planned or if new stores do not perform as planned, our business and future prospects could be harmed. In addition, a decrease in store sales could cause operating results to vary adversely from expectations.

Expansion into new markets may present increased risks due to our unfamiliarity with those areas.

Some of the new stores are planned for markets where we have little or no operating experience. Those markets may have different competitive conditions, consumer tastes and discretionary spending patterns than our existing markets. As a result, those new stores may be less successful than stores in existing markets. Consumers in a new market may not be familiar with the UFood brand, and we may need to build brand awareness in that market through greater investments in advertising and promotional activity than we originally planned. We may find it more difficult in new markets to hire, motivate and keep qualified employees who can project the UFood vision, passion and culture. Stores opened in new markets may also have lower average store sales than stores opened in existing markets, and may have higher construction, occupancy or operating costs than stores in existing markets. Sales at stores opened in new markets may take longer to ramp up and reach expected sales and profit levels, and may never do so, thereby affecting overall profitability.

We may not persuade customers of the benefits of paying higher prices for higher-quality food.

Due to what we believe are our higher quality standards, our food prices may be substantially higher than those of many of our competitors, particularly those in the fast food sector. Our success depends in large part on our ability to persuade customers that food and beverages made with higher-quality ingredients are worth the higher prices they will pay at our stores relative to prices offered by these competitors. That could require us to change our pricing, advertising or promotional strategies, which could materially and adversely affect its results or the brand identity we have tried to create.

Additional instances of avian flu or “mad cow” disease or other food-borne illnesses could adversely affect the price and availability of chicken, beef or other meat, cause the temporary closure of some stores and result in negative publicity, thereby resulting in a decline in sales.

In 2004 and 2005, Asian and European countries experienced outbreaks of avian flu. Incidents of “mad cow” disease have occurred in Canadian and U.S. cattle herds. These problems, other food-borne illnesses (such as E. coli, hepatitis A, trichinosis or salmonella) and illnesses and injuries caused by food tampering have in the past, and could in the future, adversely affect the price and availability of affected ingredients and cause customers to shift their preferences, particularly if we choose to pass any higher ingredient costs along to consumers. As a result, our sales may decline. Instances of food-borne illnesses, real or perceived, whether at our restaurants or those of our competitors, could also result in negative publicity about us or the restaurant industry, which could adversely affect sales. If we react to negative publicity by changing our menu or other key aspects of our restaurants, we may lose customers who do not accept those changes, and may not be able to attract enough new customers to produce the revenue needed to make our stores profitable. If customers become ill from food-borne illnesses, we could face substantial liability and be forced to temporarily close restaurants.

Our franchisees could take actions that harm our reputation and reduce our royalty revenues.

We do not exercise control over the day-to-day operations of our franchised stores. While we try to ensure that franchised stores meet the same operating standards demanded of our Company-operated stores, one or more franchised stores may not do so. Any operational shortcomings of our franchised stores are likely to be attributed by the public and/or regulators to our system-wide operations and could adversely affect our reputation and have a direct negative impact on the royalty revenues received from those stores.

We could be party to litigation that could adversely affect us by distracting management, increasing expenses or subjecting us to material money damages and other remedies.

Customers may occasionally file complaints or lawsuits against us alleging that we are responsible for some illness or injury they suffered at or after a visit to a restaurant, or that we have problems with food quality or operations. We could also become subject to a variety of other claims arising in the ordinary course of business, including personal injury claims, contract claims and claims alleging violations of federal and state law regarding workplace and employment matters, discrimination and similar matters, and could become subject to class action or other lawsuits related to these or different matters in the future. In addition, the restaurant industry has been subject to a growing number of claims based on the nutritional content of food products they sell and disclosure and advertising practices. We may also be subject to this type of proceeding in the future and, even if not, publicity about these matters (particularly directed at the fast food and fast-casual sectors of the industry) may harm our reputation or prospects and adversely affect our results.

Unfavorable publicity or consumer perception of our nutritional products and any similar products distributed by other companies could cause fluctuations in our operating results and could have a material adverse effect on our reputation, the demand for our products and our ability to generate revenues.

Consumer perception of products can be significantly influenced by scientific research or findings, national media attention and other publicity about product use. A product may be received favorably, resulting in high sales associated with that product that may not be sustainable as consumer preferences change. Future scientific research or publicity could be unfavorable to the nutritional products market or any of our particular products and may not be consistent with earlier favorable research or publicity. A future research report or publicity that is perceived by our consumers as less favorable or that question such earlier research or publicity could have a material adverse effect on our ability to generate revenues from nutritional products. For example, our sales were adversely affected when the Food and Drug Administration’s rule banning the sale of dietary supplements containing ephedra went into effect in 2004. As a result of the above factors, our revenues from nutritional products may fluctuate significantly from quarter to quarter, which may impair our overall revenues and profitability. Adverse publicity in the form of published scientific research or otherwise, whether or not accurate, that associates consumption of our nutritional products or any other similar products with illness or other adverse effects, that questions the benefits of our or similar products or that claims that any such products are ineffective could have a material adverse effect on our reputation, the demand for our nutritional products and our ability to generate revenues.

We may incur material product liability claims, which could increase our costs and adversely affect our reputation, revenues and operating income.

As a retailer of nutritional products designed for human consumption, we are subject to product liability claims if the use of our products is alleged to have resulted in injury. Our products include vitamins, minerals, herbs and other ingredients that are classified as foods or dietary supplements and are not subject to pre-market regulatory approval in the United States. Our products could contain contaminated substances, and some of our products contain innovative ingredients that do not have long histories of human consumption. Previously unknown adverse reactions resulting from human consumption of these ingredients could occur. All of the nutritional products we sell are produced by third-party manufacturers. Even though we are only a retailer of nutritional products manufactured by third parties, we may nevertheless be liable for various product liability claims. We may be subject to various product liability claims, including, among others, that our products include inadequate instructions for use or inadequate warnings concerning possible side effects and interactions with other substances. A product liability claim against us could result in increased costs and could adversely affect our reputation with our customers, which in turn could adversely affect our revenues and operating income. Any claims would be tendered to the third-party manufacturer or to our insurer; however, there can be no assurance that the manufacturer would have sufficient financial resources to satisfy any claim or that a claim would be covered by or would not exceed the limits of our insurance.

We will need to raise additional capital to meet our business requirements in the future, and such capital raising may be costly or difficult to obtain and could dilute current stockholders’ ownership interests.

As of January 2, 2011, we expect we will need to raise additional capital to fund our operating plan. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity, Funding and Capital Resources” below. Additional capital may not be available on reasonable terms or at all. Our income from operations is unlikely to be sufficient to fund our business plan. We may need to raise additional funds through borrowings or public or private debt or equity financings to meet various objectives including, but not limited to:

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pursuing growth opportunities, including more rapid expansion;

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opening additional Company-owned stores beyond the four we currently operate

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acquiring complementary businesses

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making capital improvements to improve our infrastructure;

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hiring qualified management and key employees;

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research and development of new products;

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increased advertising and marketing expenses;

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responding to competitive pressures;

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complying with regulatory requirements such as licensing and registration; and

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maintaining compliance with applicable laws.

Any future issuance of our equity or equity-backed securities may dilute then-current stockholders’ ownership percentages. See “You may experience dilution of your ownership interests because of other future issuance of additional shares of common stock” below.

Furthermore, any additional debt or equity financing that we may need may not be available on terms favorable to us, or at all. If we are unable to obtain required additional capital, we may have to curtail our growth plans or cut back on existing business and, further, we may not be able to continue operating if we do not generate sufficient revenues from operations needed to stay in business.

We may incur substantial costs in pursuing future capital financing, including investment banking fees, legal fees, accounting fees, securities law compliance fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities we may issue, such as convertible notes, restricted stock, stock options and warrants, which may adversely impact our financial condition.

Compliance with the reporting requirements of federal securities laws can be expensive.

We are a public reporting company in the United States, and accordingly, are subject to the information and reporting requirements of the Securities Exchange Act of 1934 (the Exchange Act) and other federal securities laws, and the compliance obligations of the Sarbanes-Oxley Act. The costs of preparing and filing annual and quarterly reports and other information with the SEC and furnishing audited reports to stockholders will cause our expenses to be higher than they would be if we had remained privately-held.

Applicable regulatory requirements, including those contained in and issued under the Sarbanes-Oxley Act, may make it difficult for us to retain or attract qualified officers and directors, which could adversely affect the management of our business and our ability to obtain or retain listing of our common stock.

We may be unable to attract and retain those qualified officers, directors and members of board committees required to provide for effective management because of the rules and regulations that govern publicly held companies, including, but not limited to, certifications by principal executive and financial officers. The enactment of the Sarbanes-Oxley Act has resulted in the issuance of a series of rules and regulations and the strengthening of existing rules and regulations by the SEC, as well as the adoption of new and more stringent rules by the stock exchanges. The perceived increased personal risk associated with these changes may deter qualified individuals from accepting roles as directors and executive officers.

Further, some of these changes heighten the requirements for board or committee membership, particularly with respect to an individual’s independence from the corporation and level of experience in finance and accounting matters. We may have difficulty attracting and retaining directors with the requisite qualifications. If we are unable to attract and retain qualified officers and directors, the management of our business and our ability to obtain or retain listing of our common stock on any stock exchange (assuming we elect to seek and are successful in obtaining such listing) could be adversely affected.

We are a holding company that depends on cash flow from our subsidiaries to meet our obligations and pay dividends; our subsidiary is restricted from making distributions to us.

We are a holding company with no material assets other than the stock of our wholly-owned subsidiaries. Accordingly, all of our operations will be conducted by KnowFat, our wholly-owned subsidiary (and the wholly-owned subsidiaries of KnowFat). We currently expect that the earnings and cash flow of our subsidiaries will primarily be retained and used by them in their operations, including servicing any debt obligations they may have now or in the future. Therefore, our subsidiaries may not be able to generate sufficient cash flow to distribute funds to us in order to allow us to pay the obligations of UFood Restaurant Group, Inc., as they become due or, although we do not anticipate paying any dividends in the foreseeable future, pay future dividends on, or make any distributions with respect to, our common or other stock. Additionally, our ability to participate as an equity holder in any distribution of assets of any subsidiary upon liquidation is generally subordinate to the claims of creditors of the subsidiary.

We have reported a material weakness in our internal control over financial reporting as of January 2, 2011. If we fail to maintain an effective system of internal controls, including internal controls over financial reporting, we may not be able to accurately report our financial results or detect fraud. Consequently, investors could lose confidence in our financial reporting and this may decrease the trading price of our stock.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to furnish a report by management on our internal controls over financial reporting. Such report contains, among other matters, an assessment of the effectiveness of our internal control over financial reporting. Our management’s assessment of the effectiveness of our internal control over financial reporting as of January 2, 2011, resulted in a determination that we had a material weakness related to our inability to perform sufficient testing of internal controls over financial reporting.

We must maintain effective internal controls to provide reliable financial reports on a timely basis and detect fraud. We have been assessing our internal controls to identify areas that need improvement. During 2011, we plan to implement changes to internal controls to improve segregation of duties, but have not yet completed implementing these changes. Failure to implement these changes to our internal controls or any others that we identify as necessary to maintain an effective system of internal controls could harm our operating results and cause investors to lose confidence in our reported financial information. Any such loss of confidence would have a negative effect on the trading price of our stock.

Risks Related to Our Securities

There is not now, and there may not ever be, an active market for our common stock.

There currently is a limited public market for our common stock. Further, although the common stock is currently quoted on the OTC Bulletin Board, trading of our common stock may be extremely sporadic. For example, several days may pass before any shares may be traded. As a result, an investor may find it difficult to dispose of, or to obtain accurate quotations of the price of, the common stock. There can be no assurance that a more active market for the common stock will develop, or if one should develop, there is no assurance that it will be sustained. This severely limits the liquidity of the common stock, and would likely have a material adverse effect on the market price of the common stock and on our ability to raise additional capital.

We cannot assure you that our common stock will become liquid or that it will be listed on a securities exchange.

Until our common stock is listed on an exchange, we expect the common stock to remain eligible for quotation on the OTC Bulletin Board, or on another over-the-counter quotation system, or in the “pink sheets.” In those venues, however, an investor may find it difficult to obtain accurate quotations as to the market value of the common stock. In addition, if we fail to meet the criteria set forth in SEC regulations, various requirements would be imposed by law on broker-dealers who sell our securities to persons other than established customers and accredited investors. Consequently, such regulations may deter broker-dealers from recommending or selling the common stock, which may further affect the liquidity of the common stock. This would also make it more difficult for us to raise additional capital in the future.

Applicable SEC rules governing the trading of “penny stocks” limits the trading and liquidity of our common stock, which may affect the trading price of the common stock.

Our common stock is currently quoted on the OTC Bulletin Board, and trades below $5.00 per share; therefore, the common stock is considered a “penny stock” and subject to SEC rules and regulations which impose limitations upon the manner in which such shares may be publicly traded. These regulations require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the associated risks. Under these regulations, certain brokers who recommend such securities to persons other than established customers or certain accredited investors must make a special written suitability determination regarding such a purchaser and receive such purchaser’s written agreement to a transaction prior to sale. These regulations have the effect of limiting the trading activity of the common stock and reducing the liquidity of an investment in the common stock.

The price of our common stock may become volatile due to our operating results, products offered by our competitors and stock market conditions, which could lead to losses by investors and costly securities litigation.

The trading price of our common stock is likely to be highly volatile and could fluctuate in response to factors such as:

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actual or anticipated variations in our operating results;

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announcements of developments by us or our competitors;

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announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;

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adoption of new accounting standards affecting our industry;

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additions or departures of key personnel;

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introduction of new products by us or our competitors;

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sales of our common stock or other securities in the open market; and

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other events or factors, many of which are beyond our control.

The stock market in general, and in particular the penny stock market, is subject to significant price and volume fluctuations. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been initiated against the Company. Litigation initiated against us, whether or not successful, could result in substantial costs and diversion of our management’s attention and resources, which could harm our business and financial condition.

We do not anticipate dividends to be paid on the common stock, and investors may lose the entire amount of their investment.

Cash dividends have never been declared or paid on our common stock, and we do not anticipate such a declaration or payment for the foreseeable future. We expect to use future earnings, if any, to fund business growth. Therefore, stockholders will not receive any funds absent a sale of their shares. We cannot assure stockholders of a positive return on their investment when they sell their shares, nor can we assure that stockholders will not lose the entire amount of their investment.

Securities analysts may not initiate coverage or continue to cover our common stock, and this may have a negative impact on its market price.

The trading market for our common stock will depend on the research and reports that securities analysts publish about our business and our Company. We do not have any control over these analysts. There is no guarantee that securities analysts will cover our common stock. If securities analysts do not cover our common stock, the lack of research coverage may adversely affect its market price. If we are covered by securities analysts, and our stock is the subject of an unfavorable report, our stock price would likely decline. If one or more of these analysts ceases to cover our Company or fails to publish regular reports on us, we could lose visibility in the financial markets, which could cause our stock price or trading volume to decline. In addition, because KnowFat became public through a “reverse triangular merger,” we may have further difficulty attracting the coverage of securities analysts.

You may experience dilution of your ownership interests because of the future issuance of additional shares of common stock.

Any future issuance of our equity or equity-backed securities may dilute then-current stockholders’ ownership percentages and could also result in a decrease in the fair market value of our equity securities, because our assets would be owned by a larger pool of outstanding equity. As stated above, we may need to raise additional capital through public or private offerings of our common or preferred stock or other securities that are convertible into or exercisable for our common or preferred stock. We may also issue such securities in connection with hiring or retaining employees and consultants (including stock options issued under our equity incentive plans), as payment to providers of goods and services, in connection with future acquisitions or for other business purposes. Our Board of Directors may at any time authorize the issuance of additional common or preferred stock without common stockholder approval, subject only to the total number of authorized common and preferred shares set forth in our articles of incorporation. We are currently authorized to issue an aggregate of 310,000,000 shares of capital stock, consisting of 300,000,000 shares of common stock and 10,000,000 shares of preferred stock with preferences and rights to be determined by our Board of Directors. As of January 2, 2011, there were 40,487,293 shares of common stock outstanding, 65,597,193 shares of common stock subject to outstanding options and warrants and 96,325 shares of preferred stock. The terms of equity securities issued by us in future transactions may be more favorable to new investors, and may include dividend and/or liquidation preferences, superior voting rights and the issuance of warrants or other derivative securities, which may have a further dilutive effect. Also, the future issuance of any such additional shares of common or preferred stock or other securities may create downward pressure on the trading price of the common stock. There can be no assurance that any such future issuances will not be at a price (or exercise prices) below the price at which shares of the common stock are then traded on the OTC Bulletin Board or other then-applicable over-the-counter quotation system or exchange.

Item 2.		Properties

Our corporate headquarters, consisting of approximately 3,800 square feet, are located in Newton, Massachusetts. We occupy our headquarters under a lease that expires in 2014, with an option to extend the lease for an additional seven years. We lease each of our restaurant facilities. Our leases expire on various dates through December 2016. The leases require us to pay our share of the operating expenses of the leased properties, including taxes, utilities and insurance.

At January 2, 2011, future minimum payments under non-cancelable leases are as follows:

2011		$	466,000
2012			470,000
2013			473,000
2014			440,000
2015			157,000
Thereafter			36,000
		$	2,042,000

Item 3.		Legal Proceedings

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, including the matters described below, 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, including the matters described below, 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.

PART II

Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is quoted on the OTC Bulletin Board under the symbol “UFFC.OB.” As of March 15, 2011, there were 40,532,747 shares of our common stock issued and outstanding and 65,597,193 shares issuable upon exercise of outstanding stock options and warrants. On that date, there were approximately 387 holders of record of shares of our common stock.

Prior to the merger on December 18, 2007, there was a limited sales history for our common stock, because it had never been actively traded. As of March 15, 2011, the last reported sale price of our shares on the OTC Bulletin Board was $0.19. For the periods indicated, the following table sets forth the range of high and low bid quotations for our common stock, as reported by Nasdaq in the Info Quotes section of its web site located at www.nasdaq.com. The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.

The fiscal year ended

		January 2, 2011								December 27, 2009
		High				Low				High				Low
First Quarter		$	0.21			$	0.06			$	0.36			$	0.10
Second Quarter		$	0.50			$	0.16			$	0.28			$	0.17
Third Quarter		$	0.39			$	0.18			$	0.20			$	0.09
Fourth Quarter		$	0.35			$	0.18			$	0.14			$	0.07

Dividends

We do not intend to pay cash dividends on our common stock for the foreseeable future, but currently intend to retain any future earnings to fund the development and growth of our business. The payment of dividends, if any, on the common stock will rest solely within the discretion of our Board of Directors and will depend, among other things, upon our earnings, capital requirements, financial condition, and other relevant factors. We are a holding company with no material assets and therefore are dependent on our operating subsidiaries to make distributions to us in order to have cash with which to pay dividends. We currently expect that the earnings and cash flow of our subsidiaries will primarily be retained and used by them in their operations, including servicing any debt obligations they may have now or in the future. We are a holding company that depends on cash flow from our subsidiaries to meet our obligations and pay dividends.

Securities Authorized for Issuance under Equity Compensation Plans

The Company has two share-based, shareholder-approved equity compensation plans, the 2004 Stock Option Plan (2004 Plan) and the 2007 Equity Incentive Plan (2007 Plan). Descriptions of these plans, and certain information regarding options issued thereunder, are presented in Note 8, Stock-Based Compensation, of Notes to Consolidated Financial Statements ended January 2, 2011 and December 27, 2009

As of the end of fiscal year 2010, we had the following securities authorized for issuance under our equity compensation plans:

Number of securities

Number of

remaining available for

securities to be

future issuance under

issued upon

Weighted-average

equity compensation

exercise of

exercise price of

plans (excluding

outstanding

outstanding options,

securities reflected in

Plan Category

options

warrants and rights

column (a))

(a)

(b)

(c)

Equity compensation plans approved by security holders

5,917,747

(2)

$

0.19

3,115,010

(3)

Equity compensation plans not approved by security holders

8,728,673

(1)

$

0.19

0

Total

14,646,420

$

0.19

3,115,010

Item 6.		Selected Financial Data

N/A

Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

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” and elsewhere in this report.

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 57 franchise units in the following states: Texas, Ohio, Massachusetts, Florida and the Washington, DC area. Furthermore, two of the area development agreements are for non-traditional locations such as airports, colleges, travel plazas, and hospitals across the United States. The 57 units include four franchise locations currently open and operating, and requiring an additional 53 future UFood Grill outlets to be developed by franchisees. The Naples, FL location was closed on July 24, 2010. On July 17, 2010 the Cleveland Hopkins International Airport location was open.

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 locations) 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 those 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 it is 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 & Estimates

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements for the fiscal years ended January 2, 2011 and December 27, 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 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.

Goodwill and Other Intangible Assets

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. 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. 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 January 2, 2011 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.

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 were $750,155 and $266,176 for the years ended January 2, 2011 and December 27, 2009, respectively, and is included in interest expense.

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. Long-lived assets may be impaired in the future if our actual operating results and cash flows fall short of our expectations.

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.

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 fiscal year ended January 2, 2011 totaled approximately $1,055,569 for stock options. Stock-based compensation expense recognized during the fiscal year ended December 27, 2009 totaled approximately $483,625 for stock options. 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:

		Year Ended
		January 2,				December 27,
		2011				2009
Revenues:
Store sales			91.4	%			85.0	%
Franchise royalties and fees			6.3				7.9
Other revenue			2.3				7.1
			100.0	%			100.0	%
Costs and expenses:
Store operating expenses (1):
Food and paper cost			33.3	%			32.6	%
Cost of goods sold			7.3				7.4
Labor			28.4				29.2
Occupancy			8.8				12.0
Other store operating expenses			18.0				16.8

		Year Ended
		January 2,				December 27,
		2011				2009
General and administrative expenses			83.5				67.8
Advertising, marketing and promotion expenses			4.7				4.0
Depreciation and amortization			6.6				7.5
Loss on disposal of assets, Impairment of Goodwill and Long-lived assets			0.5				4.1
Total costs and expenses			179.5				163.6
Operating loss			(79.5	)			(63.6	)
Other income (expense):
Interest income			0.1				0.4
Interest expense			(78.8	)			(17.5	)
Other expense, net			(7.5	)			8.1
Other income (expense), net			(86.2	)			(9.0	)
Loss before income taxes			(165.7	)			(72.6	)
Income taxes			—				—
Net loss			(165.7	%)			(72.6	%)

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

		Year Ended
		January 2,				December 27,
		2011				2009
Company-owned locations:
Locations at the beginning of the year			4				4
Locations opened			—				—
Locations closed			—				—
Locations sold			—				—
Locations transferred			—				—
Locations at the end of the year			4				4
Franchise-operated locations:
Locations at the beginning of the year			4				6
Locations opened			2				4
Locations closed			(2	)			(6	)
Locations sold			—				—
Locations transferred			—				—
Locations at the end of the year			4				4
System-wide locations
Locations at the beginning of the year			8				10
Locations opened			2				4
Locations closed			(2	)			(6	)
Locations sold			—				—
Locations transferred			—				—
Locations at the end of the year			8				8

Fiscal year 2010 compared to 2009

Our fiscal year ends on the Sunday nearest to December 31 of each year. As a result, every five or six years our fiscal year contains 53 calendar weeks. The fiscal year 2010 contained 53 weeks, whereas the fiscal year 2009 contained 52 weeks. While certain expenses increased in direct relationship to additional revenue from the 53rd week, other costs (for example, depreciation and other fixed costs) are recorded on a calendar month basis. Therefore, the impact of the additional week is not necessarily indicative of a typical relationship of expenses to revenues measured over a longer period of comparison, such as a fiscal month or a fiscal quarter. We estimate that the extra week of operations generated incremental revenue of approximately $67,117 and incremental expenses of approximately $47,907 in fiscal year 2010.

General

For the twelve months ended January 2, 2011, our comparable store sales for Company-owned stores decreased by 2.4%. All of the comparable store locations are located in the greater Boston area. Comparable store sales are based on sales for stores that have been in operation for the entire period of comparison. Franchisee-owned stores which we acquire are included in comparable store sales once they have been open for the entire period of comparison. Comparable store sales exclude closed locations.

Results of Operations

Revenues

Our total revenues for the year ended January 2, 2011 decreased by $507,897, or 9.3%, to $4,942,939 from $5,450,836 for the year ended December 27, 2009. The decrease in total revenues for the year ended January 2, 2011, as compared to the prior year was primarily due to the recognition during the year ended December 27, 2009 of franchise deposits as revenue for the cancellation of several franchise agreements with no material obligations to be satisfied by the Company; and the decrease of Company-owned stores revenue as well as a reduction of royalty revenue due to fewer franchised stores operating.

Total store sales at Company-owned stores for the year ended January 2, 2011 decreased by $114,343, or 2.5%, to $4,518,308 from $4,632,651, for the year ended December 27, 2009. As a percentage of total revenues, sales at Company-owned stores increased to 91.4% of total revenues for the year ended January 2, 2011 from 85.0% of total revenues for the year ended December 27, 2009. The decrease in sales at Company-owned stores for the year ended January 2, 2011 was primarily due the decrease in same store sales and the closing of a company-operated store during 2009.

During the year ended January 2, 2011, franchise royalties and fees decreased by $116,948, or 27.2% to $312,589 from $429,537 for the year ended December 27, 2009 primarily due to a decrease in franchise fees and royalties as a result of less franchised stores in the system. The Company recognized $70,000 of revenue from initial franchise fees during the year ended January 2, 2011 compared with $157,500 for the year ended December 27, 2009.

The other revenue for the year ended January 2, 2011 decrease by $276,606, or 71.2% to $112,042 from $388,648 for the year ended December 27, 2009 primarily attributable to the cancellation of several franchise agreements during 2009, resulting in the recognition of revenues for the franchise deposits since the Company didn’t have any material obligations going forward.

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 57 franchise units in the following states: Texas, Ohio, Massachusetts, Florida and the Washington, DC area. Furthermore, two of the area development agreements are for non-traditional locations such as airports, colleges, travel plazas, and hospitals across the United States. The 57 units include four franchise locations currently open and operating, and requiring an additional 53 future UFood Grill outlets to be developed by franchisees. The Naples, FL location was closed on July 24, 2010. On July 17, 2010 the Cleveland Hopkins International Airport location was open.

During the year ended January 2, 2011, we terminated the area development agreements for San Jose, California and Naples, Florida. Our standard franchise and area development agreements require franchisees and area developers to develop a specified number of stores on or before specific dates. If a franchisee or area developer fails to develop stores on schedule, we have the right to terminate the agreement, retain up-front franchise fees and develop Company-owned locations or develop locations through new area developers in that market. We may exercise one or more alternative remedies to address defaults by area developers and franchisees of the terms of their franchise agreements including the failure to open locations on time and non-compliance with our operating and brand requirements and other covenants under the franchise agreement.

Costs and Expenses

Cost of food and paper products for the year ended January 2, 2011, decreased by $3,937, or 0.3%, to $1,332,303 from $1,336,240 for the year ended December 27, 2009. The decrease in food and paper cost was primarily due to the decrease in Company-owned stores revenue. As a percentage of store sales, food and paper cost increased to 33.3% of store sales for the year ended January 2, 2011, from 32.6% of store sales for the year ended December 27, 2009. The increase in food and paper cost as a percentage of store sales was primarily due to the introduction of bundle items with promotional pricing in order to attract new customers and to increase the frequency of store visits. The cost of goods sold for the year ended January 2, 2011, decreased by $15,669, or 4.6% to $328,550 from $344,219 for the year ended December 27, 2009. The decrease in cost of goods sold was primarily due to the decrease of same store sales of nutritional products. As a percentage of the retail-nutritional products sales, the cost of goods sold decreased to 64.2% of store retail sales for the year ended January 2, 2011, from 65.1% of store retail sales for the year ended December 27, 2009.

Labor expense for the year ended January 2, 2011, decreased by $69,350, or 5.1%, to $1,284,751 from $1,354,101, for the year ended December 27, 2009. The decrease in labor expense was primarily attributable to decrease of man hours and new store managers at entry salary levels. As a percentage of store sales, labor expense decreased to 28.4% of store sales for the year ended January 2, 2011, from 29.2% of store sales for the year ended December 27, 2009. The decrease in labor expense as a percentage of store sales for the year ended January 2, 2011, was primarily due to the reduction of man hours at the stores and new store managers with a an salary at an entry level.

Occupancy costs for the year ended January 2, 2011, decreased by $156,979, or 28.3%, to $397,944 from $554,923 for the year ended December 27, 2009. The decrease in occupancy costs was primarily attributable to the lease amendment of one of our locations adjusting the rent charge to 50% of the current rate with no increments for the remaining term of the lease; as a result of this amendment the Company booked an adjustment to the straight line rent of $39,000. Also, some rents are based on a percentage of sales and lower sales result in lower rent. In addition, our Common Area Maintenance charges were lower than the year ended December 27, 2009. As a percentage of store sales, occupancy costs decreased to 8.8% of store sales for the year ended January 2, 2011, from 12.0% of store sales for the year ended December 27, 2009.

Other store operating expenses for the year ended January 2, 2011, increased by $36,178, or 4.6%, to $814,333 from $778,155 for the year ended December 27, 2009. The increase in other store operating expenses was primarily due to maintenance and repairs expenses as well as credit card fees. As a percentage of store sales, other store operating expenses increased to 18.0% of store sales during the year ended January 2, 2011, from 16.8% of store sales during the year ended December 27, 2009.

General and administrative expenses for the year ended January 2, 2011, increased by $432,857, or 11.7%, to $4,129,282 from $3,696,425 for the year ended December 27, 2009. The increase in general and administrative expenses for the year ended January 2, 2011, compared to the same period in the prior year is primarily due to higher non-cash stock based compensation for officers, directors, employees and vendors related to the investor relations and marketing, partially offset by, reduction in personnel cash costs, consulting expenses, insurance, legal, and rent expenses. The variance for each major category is as follows:

•

The personnel related costs increase was $399,894 and it is comprised of $172,050 reduction of payroll expenses due to the decline of corporate staff headcount, and offset by $571,944 higher stock base compensation than the prior year primarily due to the amendment of the employment agreements of the Company’s Chief Executive Officer and Chief Operating Officer, awarding 3,250,000 and 1,205,673 non-qualified stock options respectively, for which half of their non-qualified stock options grants vested at the execution of the agreement and half over a three year period. The fair value of the stock options granted during 2010 was calculated with the Black-Scholes model. A key aspect of the Black-Scholes model is volatility. The Company changed the expected volatility estimate to an index of the Company’s history combined with volatility of peer companies. The usage of the Company’s history of volatility had a significant impact.

•

General and administrative expenses for the year ended January 2, 2011 include $572,434 of investor and public relations expenses compared to $82,819 for the year ended December 27, 2009. The increase of $489,615 was primarily due to the grant of 10,000 Series “B” preferred shares pursuant to a service agreement for investor and public relations executed on June 29th, 2010 with a term of 12 months from the date of the execution. Pursuant to Section 3 of the Agreement, the Company terminated the agreement on December 8, 2010 which such cancelation reduced the number of preferred shares to be issued by one-half to 5,000 shares.

•

The year-over-year decrease of legal expenses of $163,833 was primarily due to the legal cost associated with the mechanic’s liens in connection with the build-out of premises, which the original contractor failed to pay the subcontractors during the year ended December 27, 2009.

•

The decrease in insurance expenses of $82,678 was primarily due to the cancelation of the key man insurance on our Chief Executive Officer, George Naddaff during the first quarter of 2010.

•

The rent expense reduction of $164,939 during the year ended January 2, 2011 was as a result of moving the Corporate Offices to a smaller suite in the same building for about the one-third of the cost of the previous lease. An adjustment of $110,912 to the straight line rent accrual was booked.

The general and administrative expenses as a percentage of total revenues, increased to 83.5% of total revenues for the year ended January 2, 2011, from 67.8% of total revenues for the year ended December 27, 2009.

Advertising, marketing and promotion expenses for the year ended January 2, 2011, increased by $14,097 or 6.4%, to $233,457 from $219,360 for the year ended December 27, 2009. The increase in advertising, marketing and promotion expenses was primarily due to the increase of the stock grant market value to George Foreman Ventures partially offset by a reduction of media expenses for a TV campaign conducted in 2009. As a percentage of total revenues, advertising, marketing and promotion expenses increased to 4.7% of total revenues in 2010 from 4% of total revenues in 2009.

Depreciation and amortization expense for the year ended January 2, 2011, decreased by $81,641, or 20.0%, to $325,952 from $407,593 for the year ended December 27, 2009 due to the utilization of some fully depreciated equipment in our company-owned stores. As a percentage of total revenues, depreciation and amortization expense decreased to 6.6% of total revenues for the year ended January 2, 2011, from 7.5% of total revenues for the year ended December 27, 2009.

Net interest expense/income for the year ended January 2, 2011, increased by $2,953,480, to $3,887,787, from $934,307 for the year ended December 27, 2009. The increase in net interest expense was primarily due to the conversion of the outstanding Debentures into Series“A” preferred stock. As a result of the conversion, the outstanding balances for deferred financing costs and the debt discount associated with the beneficial conversion feature of the debentures had to be booked as interest expense. The beneficial conversion feature was being accreted using the effective interest method over the term of the debenture.

The detail of the interest expense is as follows:

		Year Ended
		January 2,				December 27,
		2011				2009
Beneficial conversion feature (98.2% of the remaining balance)		$	2,774,619			$	310,201
Deferred Financing			750,154				266,176
Interest expense (net)			370,102				378,639
Net interest expense		$	3,894,875			$	955,016

Other expense/income for the year ended January 2, 2011 changed by $813,952 to an expense of $371,820, from $442,133 of income for the year ended December 27, 2009. The variance of other expenses was primarily due to the change of the fair value of the warrants in connection with the debentures exchange. The warrants were modified to a lower exercise price and extended the term for one additional year. The loss in change in fair value of the warrants was $4,616,401 taking into consideration the fair value of the warrants already booked the prior year and the change in value of the 2008 Warrants considered to be a derivative and included in our Balance Sheet as Warrant Liability. These expenses were partially offset by the extinguishment of debt in connection with the conversion of the debenture into preferred stock. The intrinsic value of the beneficial conversion feature at the date of extinguishment was calculated to be $5,692,500 as such, we recorded a gain on extinguishment of debt for that amount.

Our net loss for the year ended January 2, 2011, increased by 4,231,671, or 106.7%, to $8,189,022 from $3,957,351 for the year ended December 27, 2009. Our net loss increased primarily due to the non-cash transactions in connection with the Debentures conversion into Preferred stock including the full amortization of the beneficial conversion feature and the deferred financing costs, as well as the change in the fair value of the warrants offset by the gain on the extinguishment of debt. As a percentage of total revenues, our net loss increased to 165.7% of total revenues for the year ended January 2, 2011, from 72.6% of total revenues for the year ended December 27, 2009.

Liquidity and Capital Resources

Historically we have funded our operations, working capital requirements, acquisitions and capital expenditures with proceeds from the issuance of debt and equity securities. 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, as well as access to the debt and/or equity capital markets. We have incurred significant operating losses since our inception and we expect to incur operating losses for the foreseeable future.

Our current business plan assumes no Company-owned stores will be constructed during 2011. As set forth in the following table, we will need to secure approximately $2.5 million of additional capital through the sale of debt securities or equity securities or both to fund our current business plan through the next 24 months. The amounts shown below may change as we execute our business plan.

The estimated capital required to fund our current plan is expected to come from the sale of debt securities, equity securities or both. Currently, we do not have a bank line of credit or other source of additional debt financing. There can be no assurance that we will be able to secure the additional capital that our business plan requires. See “Risk Factors—it is highly likely that we will need to raise additional capital to meet our business requirements in the future, and such capital raising may be costly or difficult to obtain and could dilute current stockholders’ ownership interests.”

At and for the Fiscal Year Ended January 2, 2011

Cash and cash equivalents and restricted cash at January 2, 2011 were $2,837,493 compared to $2,338,852 at December 27, 2009. Cash is primarily used to fund our (i) capital expenditures for Company-owned stores, (ii) working capital requirements and (iii) net operating losses. At January 2, 2011, restricted cash included $40,041 in a letter of credit as guarantee of the deposit for the lease of our corporate offices.

We used $2,045,702 of cash to fund our operating activities in the year ended January 2, 2011 compared with $3,189,391 of cash used to fund our operating activities in twelve months ended December 27, 2009. The decrease in cash used to fund our operating activities was primarily due to the reduction in working capital requirements as well as less cash used to fund operating losses compared to the same period last year.

During the twelve months ended January 2, 2011, we spent $95,311 primarily for the acquisition of additional equipment in our stores, compared with $116,910 spent during the twelve months ended December 27, 2009.

Financing Activities

During the year ended January 2, 2011, financing activities provided $2,660,038 of cash including the issuance of 34,400 Series “B” 8% Preferred Shares to accredited investors in the principal amount of $3,440,000, at $100 per share with a par value $0.001. Effective January 1, 2011, each holder of the Series “B” Preferred Stock may convert his, her or its shares of Series “B” Preferred Stock into shares of Common Stock at a conversion price equal to $0.23. Each investor who participated in the Offering also received a warrant to purchase 100 shares of common stock of the Company, par value $0.001 per share, per share of Preferred Stock purchased. The number of shares of Common Stock into which the Series “B” Preferred Stock is convertible is 14,956,522. However, the number of shares is subject to adjustment to prevent dilution in the event of a stock split or stock dividend. The Series B Conversion Price is also subject to a weighted average price protection. The Company paid the placement agent retained in connection with the Offering a commission of $344,000 and granted warrants to purchase 2,243,478 shares of Common Stock in connection with the Offering. The Offering provided $2,953,737 of net cash. In addition, we used $407,882 of cash to repay outstanding indebtedness. Restricted cash decreased by $20,384 during the twelve months ended January 2, 2011.

We evaluated the Series “B” Preferred Stock issued and have recorded the intrinsic value of the embedded beneficial conversion feature of $100,667 as additional paid in capital. The embedded beneficial conversion feature was treated as a deemed dividend and, as such, has been expensed to retained earnings.

Furthermore, we have calculated the relative fair value of the warrants in connection with the Offering on their date of grant, which was determined to be $563,166 and was recorded as additional paid-in capital. The fair value of the warrants was computed using the Black-Scholes option pricing model. The fair value of the warrants was calculated on the dates of issuance, using the following assumptions

Debentures and Debentures Exchange

On March 19 and April 20, 2009, the Company sold 8% Senior Secured Convertible Debentures (the Debentures) to accredited investors in the principal amount of $5,874,000. Those Debentures are convertible into 45,184,615 shares of common stock of the Company at the rate of $0.13 per share. The Debentures bear interest at a rate of 8% per annum, payable quarterly and are due three years from the date they are issued. 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. The potential common shares from the assumed conversion of the debentures and exercise of warrants related to this transaction were exclude from the calculation of diluted net loss per share for the year ended January 2, 2011 because their inclusion would have been anti-dilutive.

The Company paid Garden State Securities, Inc., the placement agent retained in connection with the 2009 Offering (the 2009 Placement Agent) a commission of $587,400 plus a non-accountable expense allowance of $176,220 and received warrants to purchase 9,036,923 shares of Common Stock. 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 a 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. Of the $3,130,200 in debt discount, $571,200 has an effective interest rate of 15.18%, and $2,559,000 has an effective interest rate of 82.97%.

On October 1, 2010, the Company consummated the extinguishment of approximately ninety-eight percent (98%) “the Debentures” in exchange for shares of the Company’s Series A 8% Convertible Preferred Stock (the “Series A Preferred Stock”). An aggregate principal amount of $5,692,500 of outstanding Debentures was extinguished in exchange for 56,925 shares of Series A Preferred Stock. The holders of Series A Preferred Stock will be entitled to receive, before any cash is paid out or set aside for any shares of the Company’s Common Stock (but on an equal basis with the Company’s Series B 8% Redeemable Convertible Preferred Stock) dividends at the annual rate of 8% of the Stated Value of the Preferred Shares, subject to adjustment for stock splits, etc. The dividends will be accruing and cumulative and will be paid upon the occurrence of a liquidation, deemed liquidation, dissolution or redemption if not previously declared and paid.

Effective immediately with respect to one-half of the shares of Series A Preferred Stock issued in connection with the Debenture Exchange, and effective January 1, 2011 with respect to the remaining shares of Series A Preferred Stock issued in connection with the Debenture Exchange, each holder of Series A Preferred Stock may convert his, her or its shares of Series A Preferred Stock into shares of Common Stock at a conversion price equal to $0.13. The number of shares of Common Stock into which the Series A Preferred Stock is convertible is subject to adjustment to prevent dilution in the event of a stock split or stock dividend. The Series A Conversion Price is also subject to a weighted average price protection. Effective January 1, 2011, the Company may, at its election, require the conversion of the Series A Preferred Stock to shares of Common Stock at the Series A Conversion Price if the closing price of the Common Stock for 10 consecutive trading days equals or exceeds 300% of the Series A Conversion Price and the average daily volume of the shares of Common Stock for the same period exceeds 250,000 shares.

Approximately $2,200,869 of the debt discount relating to the beneficial conversion option and the 2009 Warrants issued to the Debenture holders will be recorded to interest expense as a result of the extinguishment of the Debentures. Furthermore, the intrinsic value of the beneficial conversion feature at the date of extinguishment was calculated to be approximately $5,692,500 and, as such, we recorded a gain on extinguishment of debt for that amount.

We have evaluated the Series A Preferred Stock issued and have recorded the intrinsic value of the embedded beneficial conversion feature of $5,692,443 as additional paid in capital. The embedded beneficial conversion feature was treated as a deemed dividend and, as such, has been recorded to retained earnings.

In conjunction with the extinguishment of debt, the Company modified the exercise price of the 2009 Warrants. The exercise price was reduced from $0.14 to $0.09 per share of Common Stock. As such, we have calculated the fair value of the warrants on the date of the modification to be approximately $6,181,501 and recorded the increase in fair value of $4,616,401 as an addition to additional paid-in capital. The fair value of the warrants was computed using the Black-Scholes option pricing model. The Company assumed a risk-free interest rate of 1.17%, no dividends, expected volatility of approximately 118.45%, which was calculated based on a combination of historical volatility and the history of comparable peer companies, and an expected warrant life of approximately 5 years.

Commitments, Contractual Obligations and Off Balance Sheet Arrangements

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 January 2, 2011, 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		$	512,120			$	512,120	(1)		$	—			$	—			$	—
Capital leases			45,340				27,496				17,844				—				—
Operating leases			2,041,000				466,000				943,000				596,000				36,000
Scheduled interest payments(2)			17,300				15,100				2,200				—				—

Impact of Inflation

Our profitability depends in part on our ability to anticipate and react to increases in our operating costs, including food, labor, occupancy (including utilities and energy), insurance and supplies costs. In the past, we have been able to recover some of our higher operating costs 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 net income have not been materially adverse. However, the recent volatility in certain commodity markets, such as those for energy, grains and dairy products, which have experienced significant increases in prices, may have an adverse effect on us and may be generally causing franchisees in our industry to delay construction of new restaurants and/or causing potential new franchisees to reconsider entering into franchise agreements. The extent of the impact may depend on our ability to increase our menu prices and the timing thereof.

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 7A.		Quantitive and Qualitive Disclosures About Market Risk

N/A

Item 8.		Financial Statements and Supplementary Data

Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm			39
Consolidated Balance Sheets as of January 2, 2011 and December 27, 2009			40 - 41
Consolidated Statements of Operations for the Fiscal Years Ended January 2, 2011 and December 27, 2009			42
Consolidated Statements of Stockholders’ Equity (Deficit) for the Fiscal Years Ended January 2, 2011 and December 27, 2009			43
Consolidated Statements of Cash Flows for the Fiscal Years Ended January 2, 2011 and December 27, 2009			44
Notes to Consolidated Financial Statements			45 - 64

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of UFood Restaurant Group, Inc:

We have audited the accompanying consolidated balance sheets of UFood Restaurant Group, Inc and Subsidiary (the Company) as of January 2, 2011 and December 27, 2009, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for the fiscal years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States of America). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion of the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of UFood Restaurant Group, Inc and Subsidiary as of January 2, 2011 and December 27, 2009, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

/s/CCR LLP

Westborough, Massachusetts
March 18, 2011

UFOOD RESTAURANT GROUP, INC. AND SUBSIDIARY

Consolidated Balance Sheets

January 2, 2011 and December 27, 2009

Assets

		2010				2009
ASSETS
Current assets:
Cash and cash equivalents		$	2,797,452			$	2,278,427
Restricted cash			40,041				60,425
Accounts receivable, net			8,334				180,134
Inventories			118,324				123,648
Prepaid expenses and other current assets			78,310				68,605
			3,042,461				2,711,239
Property and equipment:
Equipment			1,006,238				937,857
Furniture and fixtures			210,251				202,205
Leasehold improvements			1,722,654				1,744,594
Website development costs			27,050				37,050
			2,966,193				2,921,706
Accumulated depreciation and amortization			1,863,148				1,560,402
			1,103,045				1,361,304
Other assets:
Deferred financing costs, net			7,717				757,873
Goodwill			75,363				75,363
Other			84,382				86,560
			167,462				919,796
Total assets		$	4,312,968			$	4,992,339

See accompanying notes.

UFOOD RESTAURANT GROUP, INC. AND SUBSIDIARY

Consolidated Balance Sheets
January 2, 2011 and December 27, 2009

Liabilities and Stockholders’ Equity

		2010				2009
LIABILITIES
Current liabilities:
Current portion of long-term debt		$	450,000			$	857,882
Current portion of capital lease obligations			27,496				58,820
Accounts payable			279,102				285,150
Franchisee deposits			80,000				157,500
Accrued dividends			225,779				—
Accrued expenses and other current liabilities			165,632				157,870
			1,228,009				1,517,222
Long-term liabilities:
Long-term debt			62,120				3,044,001
Warrant liability			1,451,669				3,750
Capital lease obligations			17,844				39,071
Other noncurrent liabilities			83,716				276,920
			1,615,349				3,363,742
Total liabilities			2,843,358				4,880,964
EQUITY
Stockholders’ equity:
Preferred stock, $0.001 par value, 10,000,000 shares authorized,
Series “A” 56,925 shares issued and outstanding			57				—
Series “B” 39,400 shares issued and outstanding			39				—
Common stock, $0.001 par value, 300,000,000 shares authorized,
40,487,294 shares issued and outstanding			40,487				37,935
Additional paid-in capital			41,152,864				25,589,311
Accumulated deficit			(39,723,837	)			(25,515,871	)
Total stockholders’ equity			1,469,610				111,375
Total liabilities and stockholders’ equity		$	4,312,968			$	4,992,339

See accompanying notes.

UFOOD RESTAURANT GROUP, INC. AND SUBSIDIARY

Consolidated Statements of Operations

For the Fiscal Years Ended January 2, 2011 and December 27, 2009

		2010				2009
Revenues:
Store sales		$	4,518,308			$	4,632,651
Franchise royalties and fees			312,589				429,537
Other revenue			112,042				388,648
			4,942,939				5,450,836
Costs and expenses:
Store operating expenses:
Food and paper costs			1,332,303				1,336,240
Cost of Goods sold			328,550				344,219
Labor			1,284,751				1,354,101
Occupancy			397,944				554,923
Other store operating expenses			814,333				778,155
General and administrative expenses			4,129,282				3,696,425
Advertising, marketing and promotion expenses			233,457				219,360
Depreciation and amortization			325,952				407,593
Impairment of goodwill			-0-				136,000
Loss on disposal of assets			25,782				88,997
Total costs and expenses			8,872,354				8,916,013
Operating loss			(3,929,415	)			(3,465,177	)
Other income (expense):
Interest income			7,088				20,709
Interest expense			(3,894,875	)			(955,016	)
Other (expense) income			(371,820	)			442,133
Other income (expense), net			(4,259,607	)			(492,174	)
Loss before income taxes			(8,189,022	)			(3,957,351	)
Income taxes			—				—
Net loss		$	(8,189,022	)		$	(3,957,351	)
Dividends on preferred stock			(225,779	)			—
Net loss attributable to common stockholders		$	(8,414,801	)		$	(3,957,351	)
Basic and diluted earnings (loss) per share		$	(0.21	)		$	(0.11	)
Weighted average number of shares outstanding - basic and diluted			39,184,919				35,320,547

See accompanying notes.

UFOOD RESTAURANT GROUP, INC.
and SUBSIDIARY

Consolidated Statements of Changes in Stockholders’ Equity

For the Twelve Months ended January 2, 2011 and December 27, 2009

		Preferred Stock								Common Stock								Additional Paid-in				Accumulated
		Shares				Value				Shares				Value				Capital				Deficit				Total
Balances, December 28, 2008 as filed			—				—				34,818,490				34,818				24,998,924				(24,717,544	)			316,198
Cumulative effect of reclassification of warrants to warrants liabilities			—				—				—				—				(3,512,272	)			3,159,024				(353,248	)
Common stock issued for marketing and promotional services			—				—				—				—				150,920				—				150,920
Common stock issued for interest payment			—				—				2,982,671				2,983				312,995				—				315,978
Exercise of stock options into common stock			—				—				7,618				8				45				—				53
Common stock issued for franchise sales commission			—				—				82,895				83				14,917				—				15,000
Stock-based compensation			—				—				—				—				483,625				—				483,625
Issuance of warrants and beneficial conversion feature in connection			—				—				—				—				3,130,200				—				3,130,200
Forfeitures of common stock			—				—				(33,690	)			(34	)			34				—				—
Exercised debentures into common stock			—				—				76,923				77				9,923				—				10,000
Net loss for year ended December 27, 2009			—				—				—				—				—				(3,957,351	)			(3,957,351	)
Balances, December 27, 2009			—				—				37,934,907			$	37,935			$	25,589,311			$	(25,515,871	)		$	111,375
Preferred stock series “A” issued			56,925				57				—				—				5,591,776				—				5,591,833
Preferred stock series “B” issued			34,400				34				—				—				3,054,370				—				3,054,404
Preferred stock series “B” issued for promotional services			5,000				5				—				—				499,995				—				500,000
Common stock issued for consulting, marketing, & promotional services			—				—				380,000				380				216,218				—				216,598
Common stock issued for interest payment			—				—				1,297,236				1,297				311,587				—				312,884
Stock-based compensation			—				—				—				—				1,055,569				—				1,055,569
Forfeitures of common stock			—				—				(1,773	)			(2	)			2				—				—
Exercised debentures & warrants into common stock			—				—				876,924				877				116,969				—				117,846
Change in the warrants’ fair value			—				—				—				—				4,616,401				—				4,616,401
Beneficial conversion feature- deemed dividend			—				—				—				—				100,667				(100,667	)			—
Dividends on preferred stock			—				—				—				—				—				(225,779	)			(225,779	)
Extinguishment of Debt			—				—				—				—				—				(5,692,500	)			(5,692,500	)
Net loss for the year ended January 2, 2011			—				—				—				—				—				(8,189,022	)			(8,189,022	)
Balances, January 2, 2011			96,325			$	96				40,487,294			$	40,487			$	41,152,864			$	(39,723,837	)		$	1,469,610

UFOOD RESTAURANT GROUP, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

For the Fiscal Years Ended January 2, 2011 and December 27, 2009

		2010				2009
Cash flows from operating activities:
Net loss		$	(8,189,022	)		$	(3,957,351	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			325,952				407,593
Adjustment to straight-line rent			(149,912	)			—
Amortization of beneficial conversion feature			2,673,952				310,201
Amortization of deferred financing costs			750,155				266,176
Provision for doubtful accounts			(10,254	)			161,424
Impairment of goodwill			—				136,000
Loss on disposal of assets			25,782				88,997
Change in value of warrant liability			1,447,919				(349,498	)
Stock-based compensation			1,055,569				483,625
Non-cash promotion expenses			716,598				158,302
Non-cash interest payments			312,884				315,976
Gain on extinguishment of debt			(5,692,500	)			(74,967	)
Change in fair value of warrants (debenture exchange)			4,616,401				—
Increase (decrease) in cash from changes in assets and liabilities:
Accounts receivable			182,054				(189,185	)
Inventories			5,323				18,159
Prepaid expenses and other current assets			295				11,052
Other assets and noncurrent liabilities			2,179				2,640
Accounts payable			(6,048	)			(248,269	)
Franchisee deposits			(77,500	)			(542,500	)
Accrued expenses and other current liabilities			(35,530	)			(187,766	)
Net cash used in operating activities			(2,045,702	)			(3,189,391	)
Cash flows from investing activities:
Proceeds from sale of assets			—				5,600
Acquisition of property and equipment			(95,311	)			(116,910	)
Net cash used in investing activities			(95,311	)			(111,310	)
Cash flows from financing activities:
Proceeds from exercise of options			—				53
Proceeds from issuance of common stock			53,846				—
Proceeds from issuance of preferred stock, net issuance costs			3,054,405				—
Proceeds from issuance of convertible debt			—				5,874,000
Payments for financing costs			—				(1,001,220	)
Payments on long-term debt			(407,882	)			(375,511	)
Payments on capital lease obligations			(60,715	)			(62,810	)
Decrease in restricted cash			20,384				357,065
Net cash provided by financing activities			2,660,038				4,791,577
Increase in cash and cash equivalents			519,025				1,490,876
Cash and cash equivalents — beginning of year			2,278,427				787,551
Cash and cash equivalents — end of year		$	2,797,452			$	2,278,427

See accompanying notes.

UFOOD RESTAURANT GROUP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

1. Nature of Operations and Basis of Presentation

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, and on September 25, 2007, changed its name to UFood Restaurant Group, Inc. (UFood or the Company).

On December 18, 2007, (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 January 2, 2011, the Company’s operations consisted of four Company-owned restaurants and four franchise-owned locations. One of the franchise-owned locations was operated by the Company pursuant to a management series agreement. 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.

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 January 2, 2011, the Company had approximately $2,797,000 of unrestricted cash. 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.

2. Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The accompanying consolidated financial statements of UFood Restaurant Group, Inc. and its subsidiary consist of the accounts of UFood Restaurant Group, Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Fiscal Year

Our fiscal year ends on the Sunday nearest to December 31 of each year. As a result, every five or six years our fiscal year contains 53 calendar weeks. Fiscal 2010 contained 53 weeks, whereas fiscal 2009 contained 52 weeks. While certain expenses increased in direct relationship to additional revenue from the 53rd week, other costs (for example, depreciation and other fixed costs) are recorded on a calendar month basis. Therefore, the impact of the additional week is not necessarily indicative of a typical relationship of expenses to revenues measured over a longer period of comparison, such as a fiscal month or a fiscal quarter. The Company’s fiscal year ended on January 2, 2011 and December 27, 2009, with 53 and 52 weeks respectively.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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.

Cash Equivalents

Cash equivalents represent highly liquid instruments with original maturities of three months or less when purchased. Cash equivalents consist of money market accounts at January 2, 2011 and December 27, 2009. At January 2, 2011 restricted cash was comprised of $40,041 used to collateralize a standby letter of credit.

Inventories

Inventories, which primarily consist of food products, paper goods and supplies and vitamins and supplements for resale, are stated at the lower of cost or market, with cost determined by the average cost method.

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 were $750,154 and $266,176 for the years ended January 2, 2011 and December 27, 2009, respectively, and is included in interest expense. The significant increase in the deferred financing costs amortization was due to the extinguishment of debt related to the conversion of the Debentures into Series “A” preferred stock.

Property and Equipment

Property, equipment and leaseholds are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the shorter of their estimated useful lives or the related reasonably assured lease term. The estimated useful lives used for financial statement purposes are:

Leasehold improvements		5 years, or over life of lease, whichever is shorter
Equipment		5 years
Furniture and fixtures		5 years
Website development costs		3 years

Upon retirement or sale, the cost of assets disposed and their related accumulated depreciation are removed from the accounts. Any resulting gain or loss is credited or charged to operations. Maintenance and repairs are charged to expense when incurred, while betterments are capitalized. The total amounts expensed for maintenance and repairs were $90,700 and $71,038 for the fiscal years ended January 2, 2011 and December 27, 2009, respectively.

Goodwill and Other Intangible Assets

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. 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. 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 January 2, 2011 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

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. Long-lived assets may be impaired in the future if our actual operating results and cash flows fall short of our expectations.

Income Taxes

The Company completes the provision for income taxes in accordance with the accounting standard for income taxes in the Company’s consolidated financial statements and accompanying notes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Any effect on deferred tax assets and liabilities from a change in tax rates is recognized in income in the period that includes the enactment date.

In accordance with the authoritative guidance on income taxes issued by the FASB, the Company establishes additional provisions for income taxes when, despite the belief that tax positions are fully supportable, there remain certain positions that do not meet the minimum probability threshold, which is a tax position that is more likely than not to be sustained upon examination by the applicable taxing authority. In the normal course of business, the Company and its subsidiaries are examined by various Federal, State and foreign tax authorities. The Company regularly assesses the potential outcomes of these examinations and any future examinations for the current or prior years in determining the adequacy of its provision for income taxes. The Company continually assesses the likelihood and amount of potential adjustments and adjusts the income tax provision, the current tax liability and deferred taxes in the period in which the facts that give rise to a revision become known. The Company classifies estimated interest and penalties related to the underpayment of income taxes as a component of income taxes in the consolidated statements of operations.

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.

Advertising Costs

The Company expenses advertising costs as incurred. Advertising expense amounted to $60,644 in 2010 and $76,998 in 2009.

Pre-Opening Costs

All pre-opening costs directly associated with the opening of new Company-owned restaurant locations, which consist primarily of labor and food costs incurred during in-store training and preparation for opening, but exclude manager training costs which are included in other operating expenses, are expensed when incurred.

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 accounts receivable, accounts payable and other accrued expenses 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 fiscal year ended January 2, 2011 totaled approximately $1,055,569 for stock options. Stock-based compensation expense recognized during the fiscal year ended December 27, 2009 totaled approximately $483,625 for stock options. Stock-based compensation expense was included in general and administrative expenses in the accompanying consolidated statements of operations.

Reclassifications

Certain accounts previously reported in the 2009 financial statements have been reclassified to facilitate comparability with the current year presentation. The reclassifications had no effect on the 2009 net loss previously reported.

3. Disposal of Assets

During 2011, the Company recorded a loss on disposal of assets of $25,782 due to the write off of leasehold improvements and equipment as a result of the move of our corporate Offices to another suite within same building.

During 2009, the Company recorded a loss on disposal of assets of $88,997 due to the write off of obsolete equipment and furniture and fixtures as a result of the closure of the Bedford, MA location.

4. Goodwill

During the year ended December 27, 2009, 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.

As of the first day of the fourth quarter of the year ended January 2, 2011 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.

						Franchise
		Store Operations				Operations
		Segment				Segment				Total
Balance as of December 28, 2008			75,363				136,000				211,363
Goodwill written off in connection with impairment test			—				(136,000	)			(136,000	)
Balance as of December 27, 2009			75,363				—				75,363
Goodwill written off in connection with impairment test			—				—				—
Balance as of January 2, 2011			75,363				—				75,363

5. Long-Term Debt

2008 Investor Warrants

On December 18 and 21, 2007, January 22, 2008, February 6, 2008, and 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 consists 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. As a result of the Company’s recent private placement, the exercise price of the 2008 Investor Warrants was reduced to $0.54 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 in the event of a stock dividend, or our 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 $0.49 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 January 2, 2011, the aggregate fair value of the derivative was $1,451,669. The increase in the fair value of the derivative was in the aggregate amount of $1,447,919 during the year ended January 2, 2011. The increase in the fair value of the derivative was recorded in the consolidated statement of operations as other expense.

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 January 2, 2011
		Liability Derivatives
		Balance Sheet
		Location		Fair Value
Derivatives designated as hedging instruments under ASC No. 815:
None
Derivatives not designated as hedging instruments under ASC No. 815:
Derivative warrant liability		Long-term liabilities		$	1,451,669
Total derivatives				$	1,451,669

The effect of the derivative instrument on the consolidated statements of operations for the year ended January 2, 2011 follows:

						Amount of Gain (Loss)
						Recognized in Income on
						Derivative
		Location of Gain (Loss)
		Recognized in Income on				Twelve Months Ended
		Derivative				January 2, 2011
Derivatives not designated as hedging instruments under ASC No. 815:
Derivative warrant liability		Other Income (Expense)				$	1,447,919
Total						$	1,447,919

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 27, 2009, and as of January 2, 2011, using the following assumptions:

		At Issuance				December 27, 2009				January 2, 2011
Expected term (years)		5 – 7 Years				5 – 7 Years				2 – 4 Years
Expected volatility			32.34	%			37.20	%			156.3	%
Risk-free interest rate			2.46	%			1.56	%			0.61	%
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, through for the twelve months ended January 2, 2011:

Balance as of December 29, 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 during the twelve months ended December 27, 2009			(349,498	)
Increase in fair value during the twelve months ended January 2, 2011			1,447,919
Balance as of January 2, 2011		$	1,451,669

2009 Warrants

On March 19 and April 20, 2009, the Company sold 8% Senior Secured Convertible Debentures (the Debentures) to accredited investors in the principal amount of $5,874,000. Those Debentures are convertible into 45,184,615 shares of common stock of the Company at the rate of $0.13 per share. The Debentures bear interest at a rate of 8% per annum, payable quarterly and are due three years from the date they are issued. 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. The potential common shares from the assumed conversion of the debentures and exercise of warrants related to this transaction were exclude from the calculation of diluted net loss per share for the year ended January 2, 2011 because their inclusion would have been anti-dilutive.

The Company paid Garden State Securities, Inc., the placement agent retained in connection with the 2009 Offering (the 2009 Placement Agent) a commission of $587,400 plus a non-accountable expense allowance of $176,220 and received warrants to purchase 9,036,923 shares of Common Stock. 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 a 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. Of the $3,130,200 in debt discount, $571,200 has an effective interest rate of 15.18%, and $2,559,000 has an effective interest rate of 82.97%.

On October 1, 2010, the Company consummated the extinguishment of approximately ninety-eight percent (98%) “the Debentures” in exchange for shares of the Company’s Series A 8% Convertible Preferred Stock (the “Series A Preferred Stock”). An aggregate principal amount of $5,692,500 of outstanding Debentures was extinguished in exchange for 56,925 shares of Series A Preferred Stock. The holders of Series A Preferred Stock will be entitled to receive, before any cash is paid out or set aside for any shares of the Company’s Common Stock (but on an equal basis with the Company’s Series B 8% Redeemable Convertible Preferred Stock) dividends at the annual rate of 8% of the Stated Value of the Preferred Shares, subject to adjustment for stock splits, etc. The dividends will be accruing and cumulative and will be paid upon the occurrence of a liquidation, deemed liquidation, dissolution or redemption if not previously declared and paid.

In conjunction with the extinguishment of debt, the Company modified the exercise price of the 2009 Warrants. The exercise price was reduced from $0.14 to $0.09 per share of Common Stock. As such, we have calculated the fair value of the warrants on the date of the modification to be approximately $6,181,501 and recorded the increase in fair value of $4,616,401 as an addition to additional paid-in capital. The fair value of the warrants was computed using the Black-Scholes option pricing model. The Company assumed a risk-free interest rate of 1.17%, no dividends, expected volatility of approximately 118.45%, which was calculated based on a combination of historical volatility and the history of comparable peer companies, and an expected warrant life of approximately 5 years.

Long-term debt consists of the following at January 2, 2011 and December 27, 2009:

		2010				2009
Senior Secured Convertible Debentures $5,874,000 at 8% interest 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 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. On October 1, 2010, an aggregate principal amount of $5,692,500 of outstanding Debentures was extinguished in exchange for 56,925 shares of Series A Preferred Stock.			62,120				3,044,001
Landmark Center acquisition promissory note with no stated interest rate. Due upon the occurrence of a sales event, as defined in the agreement. The note agreement includes a restrictive covenant requiring the Company’s wholly-owned subsidiary, KnowFat of Landmark Center, Inc., to maintain net equity of not less than $450,000.			450,000				450,000
Term note payable to bank in monthly principal installments of $29,167 commencing January 2007 through December 2010. Interest is payable monthly at the bank’s prime rate (3.25% at May 31, 2010). The note has been fully paid.			—				342,072
Unsecured, non-interest bearing note payable. This note payable is due on demand. Interest imputed on the note using a discount rate of 5% totaled $59,597, which is being amortized over the term of the note. The note has been fully paid.			—				56,033
Indebtedness incurred in connection with the acquisition of the two franchisee locations. No stated interest rate; this note payable is due on demand. The note has been fully paid.			—				2,137
Note payable to the Watertown landlord in connection with the acquisition of the training center in 2004. The note is payable in monthly installments of $2,566 including interest at 5% through April 2010. This note has been fully paid.			—				7,640
			512,120				3,901,883
Less current portion			450,000				857,882
Long-term debt		$	62,120			$	3,044,001

Maturities of long-term debt at January 2, 2011 are as follows:

2011			450,000
2012			62,120
		$	512,120

6. Capital Lease Obligations

The Company leases certain equipment under capital leases. The equipment has been recorded at the present value of the total lease payments using discount rates ranging from 13.9% to 17.95%.

Future minimum lease payments under these leases are as follows:

2011		$	31,986
2012			14,014
Thereafter			5,861
			51,861
Less imputed interest			6,521
			45,340
Less current portion			27,496
Long-term portion of capital lease obligations		$	17,844