We have a license to use the following marks registered with the Canadian Intellectual Property Office:

Type	Mark	Registration Number
Word	Bread Garden	TMA385925
Design	Bread Garden Bakery Café	TMA389963
Word	Bread Garden Catering	TMA703333
Word	Wholesale Food for the Timed Shared	TMA589191
Word	The Break you Need…The Food You Love	TMA558692
Design	Bread Garden Catering	TMA727604
Design	Bread Garden Express	TMA703428
Word	Bread Garden Express	TMA703338
Design	Bread Garden Express	TMA703427
Design	Bread Garden Express	TMA703336

Employees

As of March 16, 2009, we have a total of 102 employees in our franchising, restaurant and bakery operations, of which 28 are full time.

Item 1A.  Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below with all of the other information included in this report before making an investment decision. If any of the possible adverse events described below actually occur, our business, results of operations or financial condition would likely suffer. In such an event, the market price of our common stock could decline and you could lose all or part of your investment. The risks and uncertainties described below are not the only ones we face.

RISKS RELATING TO OUR BUSINESS

We have historically incurred losses and may continue to incur losses in the future, which may impact our ability to implement our business strategy and adversely affect our financial condition.

In the future we expect to increase our operating expenses by expanding our marketing activities and increasing our level of capital expenditures in order to grow our business and further develop and maintain our services. Such increases in operating expense levels and capital expenditures may adversely affect our operating results if we are unable to immediately realize benefits from such expenditures. In addition, if we are unable to manage a significant increase in operating expenses, our liquidity will likely decrease and negatively impact our cash flow and ability to sustain operations. In turn, this would have a negative impact on our financial condition and share price.

NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report, including the sections entitled “Business,” “Risk Factors” and “Management's Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements.

These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. These risks and other factors include those listed under “Risk Factors” and elsewhere in this report. In some cases, you can identify forward-looking statements by terminology such as “may,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “potential,” “continue” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We do not intend to update any of the forward-looking statements after the date of this report or to conform these statements to actual results. 

You should rely only on the information contained in this report. We have not authorized any other person to provide you with information that is different from that contained in this report. If anyone provides you with different or inconsistent information, you should not rely on it. The information presented on, or that can be accessed through, our website is not a part of this report. You should assume the information appearing in this report is accurate only as of the date on which this report was filed. Our business, financial condition, results of operations and prospects may have changed since that date.

Item 1B.  Unresolved Staff Comments

Not required for small reporting companies.

Item 2.  Properties

We do not own any real property. We lease all of the real properties we use in our business. The table below sets forth information regarding each of those properties as of March 16, 2009. We believe that each of our leased facilities is suitable for the operations we conduct in it.

Use

Location

Current Monthly Rent

Square Footage

Remaining Term (in years) Including Expected Renewal Period

Comments

Corporate headquarters

90 Madison St. Denver, CO

$

11,963

7,869

4.50

Rent increases each year through 2013.

 

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Use	Location		Current Monthly Rent				Square Footage				Remaining Term (in years) Including Expected Renewal Period			Comments
Restaurant and bakery	1298 S. Broadway Denver, CO		$	4,081				3,481				8.17		Rent increases in 2012.
Restaurant	10320 Federal Heights Blvd. #200 Federal Heights, CO		$	2,609				1,453				10.67		Rent increases each year.  Includes 2 five-year renewals.
Restaurant	8923 E. Union Ave. Greenwood Village, CO		$	1,909				1,516				11.75		Rent increases each year.  Includes 2 five-year renewals.
Restaurant	2043 S. University Blvd. Denver, CO		$	3,740				2,200				9.42		Rent increases each year.  Includes 2 five-year renewals.
Restaurant	123 N. College Ave. Ft. Collins, CO		$	1,952				1,848				17.83		Includes 3 five-year options.
Restaurant	2120 E. Harmony Rd. #101 Ft. Collins, CO		$	4,650				1,800				9.83		Includes 1 five-year option.
Restaurant	2300 Parker Rd. Aurora, CO		$	5,250				1,800				9.00		Rent increases each year.

Item 3.  Legal Proceedings.

We are not involved in any material legal proceedings.  None of our officers, directors or affiliates, nor any owner of record or beneficially of more than five percent of any class of our voting securities, nor any associate of any such director, officer, affiliate of the Company, or security holder is a party adverse to us or any of our subsidiaries or has a material interest adverse to us or any of our subsidiaries.

Item 4.  Submission of Matters to a Vote of Security Holders.

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2008.

 

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PART II

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

Market Information

Our common stock is quoted on the OTCBB under the symbol “SPKL.” Trading of our stock on the OTCBB began on August 20, 2007. The following table sets forth, for the periods indicated, the reported high and low closing bid quotations for our common stock as reported by NASDAQ in the Info Quotes section of its website located at www.nasdaq.com. The bid prices reflect inter-dealer quotations, do not include retail markups, markdowns or commissions and may not represent actual transactions.

Quarter Ended	High Bid	Low Bid
December 31, 2008	$0.46	$0.17
September 30, 2008	$0.84	$0.39
June 30, 2008	$1.01	$0.67
March 31, 2008	$1.40	$0.80
December 31, 2007	$2.02	$0.92
September 30, 2007	$1.24	$0.48

Shareholders

We have approximately 70 record holders of our common stock as of March 16, 2009.

Dividends

Equity Compensation Plan Information

Information relating to compensation plans under which our equity securities are authorized for issuance is set forth in Item 12 of this report under “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

Issuance of Unregistered Shares

During the year ended December 31, 2008 we issued an aggregate of 80,000 shares of our common stock in consideration for services rendered.  The shares were valued at $70,000, the trading value on the date of issuance.  No underwriters were used in the above stock transactions.  We relied upon the exemption from registration contained in Section 4(2) of the Securities Act of 1933, as the investors were either deemed to be sophisticated with respect to the investment in the securities due to their financial condition and involvement in our business or accredited investors.  Restrictive legends were placed on the certificates evidencing the securities issued in these transactions.

Item 6. Selected Financial Data

Not required for small reporting companies.

 

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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 business is the franchise and operation of Spicy Pickle™ and Bread Garden Urban Café restaurants. Spicy Pickle is a fast casual restaurant where made-to-order panini, submarine-style sandwiches, pizzetti (Neapolitan thin crust pizza), and salads created by our founders are served using fresh-baked breads and high-quality ingredients.  Spicy Pickle restaurants are located in 12 states in the United States.  Bread Garden Urban Café restaurants also specialize in fast casual dining offering salads, soups, sandwiches and dessert items.  Bread Garden Urban Cafés are located in metropolitan Vancouver, British Columbia, Canada.

We market our menu primarily through targeted local store marketing efforts, mail drops, media advertising, and print campaigns, as well as through other grass roots efforts. The "Spicy Pickle" brand name has existed for eight years.   The “Bread Garden Urban Café” brand name has existed since 1979.  We are headquartered in Denver, Colorado.

The first Spicy Pickle restaurant was launched in 1999 by founders Kevin Morrison and Anthony Walker under the name Spicy Pickle, LLC. In late 2001, there were three restaurants, two in Denver and one in Lakewood, a Denver suburb. By January 2003, we organized Spicy Pickle Franchising, LLC and launched the Spicy Pickle brand as a national franchise and recruited Marc Geman, former president of the PretzelMaker franchise, as our Chief Executive Officer.

As of December 31, 2008, we had 32 franchised restaurants and seven company-owned restaurant opened.  Co-located with one of the restaurants is a bakery which provides fresh baked breads to the local area Denver restaurants.  This bakery has replaced the previous supplier of our artisan breads and is expected to result in a food cost savings for the franchisees in that market. Spicy Pickle restaurants outside this market are equipped for bread baking at the store location.

Our franchise agreements include build-out schedules for franchisee restaurants. Through December 31, 2008, the Company has signed agreements with franchisees to open 102 restaurants under the Spicy Pickle Brand.  Based on current franchise agreements and construction schedules, we believe there will be approximately 40 Spicy Pickle, franchisee-owned and operated restaurants and at least 7 company-operated restaurants open by the end of 2009.  The Company continues to interview prospective franchisees and relies on the cash deposits from the franchise sales as well as royalty fees from the existing stores to support the expenses of the business.

Our locations and marketing efforts are directed principally to white collar administrative, managerial, professional, and sales personnel, who are generally found in and near downtown districts, technological centers, universities, hospitals and government complexes.

We currently derive our revenue from the sale of franchises, from royalties paid by franchisees and from the sale of food and beverages at the company owned restaurants.  Our business is headquartered in Colorado, and we have a high concentration of restaurants in the Rocky Mountain region. Additionally, we have franchises opened and planned in a number of other regions in the United States. Our restaurant Spicy Pickle locations (including both company-owned and franchisee-owned), including those under construction and lease negotiation as of December 31, 2008, are:

 

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Location	Restaurants Operating	Under Construction	In Lease Negotiation
Denver, Colorado	5
Boulder, Colorado	2
Ft. Collins, Colorado	2
Aurora, Colorado	2
Littleton, Colorado	1
Centennial, Colorado	1
Lone Tree, Colorado	1
Greenwood Village, Colorado	1
Federal Heights, Colorado	1
Johnstown, Colorado	1
Colorado Springs, Colorado (1)	2
Louisville, Colorado	1
Englewood, Colorado	1
Ashburn, Virginia	1
Portland, Oregon	2
Poway, California	1
Henderson, Nevada	1
Reno, Nevada	2
Chicago, Illinois	1
Cincinnati, Ohio	1
Austin, Texas	2
San Diego, California	1
Chandler, Arizona	1
Brooklyn, New York (2)	1
Hattiesburg, Mississippi	1
Edmond, Oklahoma	1
Cedar Park, Texas	1
Portage, Michigan	1
Kalamazoo, Michigan		1
Houston, Texas		1	1
San Antonio, Texas			1
Las Vegas, Nevada			1
	39	2	3

________________

(1)	One restaurant closed subsequent to December 31, 2008.

(2)	Closed subsequent to December 31, 2008.

On October 1, 2008, we acquired all of the operating assets of Bread Garden, a company which franchises fast casual restaurants under the trade name Bread Garden Urban Café.  The assets were acquired in exchange for 5,177,500 restricted shares of our common stock and warrants to purchase 3,038,750 shares of our common stock.

 

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Our Bread Garden locations including those under construction and in lease negotiation as of December 31, 2008 are:

Location	Restaurants Operating	Under Construction	In Lease Negotiation
Vancouver, British Columbia	5	3
North Vancouver, British Columbia (1)	1
Richmond, British Columbia	1	1
Cloverdale, British Columbia	1
Surrey, British Columbia	1
Burnaby, British Columbia	1
Coquitlam, British Columbia	2
Kamloops, British Columbia		1
Brisbane, Australia		1
	12	6

_______________

(1)	Closed subsequent to December 31, 2008 and relocated to the Cloverdale location included above.

We intend to increase our revenues by adding new company-owned stores, selling new franchises and expanding consumption of our food products at all restaurants. General economic and industry conditions may affect our ability to do so and our revenue performance.

Critical Accounting Policies and Estimates

The financial statements included in this filing have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP), which contemplates continuation of the Company as a going concern.  We incurred a net loss of $5,612,749 for the year ended December 31, 2008 and have incurred significant net losses since inception.

We have been developing our franchise network through the sale of franchises and through acquisition.  We have relied on fund raising and the sales of new franchises to augment the cash we receive from continuing royalty payments for our cash flow.  The unanticipated economic conditions of 2008 resulted in a significant reduction in the sales of new franchises which has resulted in a significant decrease in our cash position.  As soon as it became apparent that the economic downturn would not correct itself in 2008, we significantly reduced our corporate overhead mostly in the area of personnel cost.

Our ability to fund our operations will depend on the length of time of the current economic downturn, our future performance and our ability to successfully implement our business and growth strategies.  In the event that we need additional capital and are unable to obtain it, we could be left without sufficient liquidity.  The nature of our business is that a portion of our revenue is a continuing stream from franchisees.  We will continually monitor our expenses and reduce those expenses as best we can to match the revenue flow.  We may elect to raise money during the year ended December 31, 2009 to meet any shortfalls from operations.  However a realization of a significant portion of the assets in the balance sheet is dependent on our continued operations, which in turn is dependent on the increase in sales of new franchises, the number of operating franchise restaurants, or the additional capital raised through a placement of our securities.

The preparation of our financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting periods. Actual results could differ from those estimates. A summary of accounting policies that have been applied to the historical financial statements presented in this report can be found in the footnotes thereto.  We consider certain of these accounting policies to be critical as they are important to the portrayal of our financial condition and results of operations and may require judgments on the part of management about matters that are uncertain. We have identified the following accounting policies that are important to the presentation of financial information in this report.

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Revenue Recognition

Initial Franchise Fees - We enter into franchise agreements, which grant franchisees the exclusive right to develop and operate businesses at certain locations. Initial franchise fees are recognized as revenue when all material services and conditions required to be performed by us have been substantially completed, which is generally when the restaurant opens.  Initial franchise fees were established at $45,000 and $35,000 for the years ended December 31, 2008 and 2007, respectively.  Franchise fees recognized were $252,500 and $497,500 for the years ended December 31, 2008 and 2007 respectively.

Royalty Fees - Pursuant to the franchise agreements of both our Spicy Pickle and Bread Garden Urban Café brands, franchisees are required to pay royalties to us based on 5% of weekly gross sales as reported to us through the franchisees’ point of sales systems. The royalties are recognized as revenue in the period corresponding to the sales reporting period. Royalty fees were $819,489 and $577,334 for the years ended December 31, 2008 and 2007, respectively.

With regard to royalty fees, our franchisees grant us the right to extract data from their point of sale systems in each restaurant they operate. We receive weekly reports on sales at each franchise location and calculate our revenue directly from those reports. This allows for extremely accurate accounting of our revenue stream from royalty fees. We do not anticipate any future change in the method of reporting.

Rebates - We receive rebates from certain purveyors that supply products to our franchisees, these rebates are included in Franchise Fees and Royalties. The rebates are recorded when earned. Rebates that relate to company-owned restaurants are offset against restaurant cost of sales. Rebates related to franchisees were $235,305, and $151,020 for the years ended December 31, 2008 and 2007, respectively.

Product Sales – Prior to the fourth quarter of 2007, we sold logo products to our franchisees. Sales were recognized when products were shipped to the franchisee.  These types of sales are now handled by a third-party supplier who sells directly to our franchisees.

Restaurant and Bakery Sales - We record revenue from company-owned restaurant sales upon delivery of the related food and other products to customers. Our restaurant sales are either cash or credit card (which are pre-approved) sales and, therefore, no estimate for collectibility is necessary.  We record revenue from bakery sales when sold to the bakery customers, which are our franchisees.

Advertising Costs

Franchisees must contribute to an advertising fund established by us at a rate of up to 2% for our Spicy Pickle brand and 1.5% for our Bread Garden Urban Café brand of total franchisee gross sales. In our discretion, we may spend more or less than our actual advertising receipts from the franchisees. Advertising fees collected were $375,477 and $291,881 for the years ended December 31, 2008 and 2007, respectively.  These fees are offset against actual advertising expenses, which are recognized when incurred. We incurred advertising expenses of $828,335 and $443,566 for the years ended December 31, 2008 and 2007, respectively. We paid those expenses from the advertising fund and from our own funds. The net amounts reflected as advertising costs in the financial statements are $452,858 and $151,685 for the years ended December 31, 2008 and 2007, respectively.

Rent Expense

We recognize rent expense on a straight-line basis over the reasonably assured lease term as defined in the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 98, "Accounting for Leases”. ' In addition, certain of our lease agreements provide for scheduled rent increases during the lease term or for rental payments commencing on a date other than the date of initial occupancy. We include any rent escalations and construction period and other rent holidays in our determination of straight-line rent expense. Therefore, rent expense for new locations is charged to expense beginning with the start of the construction period.

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Equity-Based Compensation

On January 1, 2006, we adopted FASB SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options based on estimated fair values. SFAS 123(R) supersedes our previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”.  In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). We have applied the provisions of SAB 107 in our adoption of SFAS 123(R).

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our statement of operations. Prior to the adoption of SFAS 123(R), we had no stock-based compensation awarded to employees and directors.

Recent Pronouncements

We have reviewed all recently issued, but not yet effective, accounting pronouncements and do not believe the future adoption of any such pronouncements may be expected to cause a material impact on our financial condition or the results of our operations.

In December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations” (“SFAS 141R”). SFAS 141R will change the accounting for business combinations. Under SFAS 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS 141R will change the accounting treatment and disclosure for certain specific items in a business combination. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Accordingly, any business combinations we engage in will be recorded and disclosed following existing GAAP until January 1, 2009. We expect that SFAS 141R will have an impact on accounting for business combinations once adopted, but the effect is dependent upon acquisitions at that time. We are still assessing the impact of this pronouncement.

In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements-An Amendment of ARB No. 51" (“SFAS 160"). SFAS 160 establishes new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. We believe that SFAS 160 should not have a material impact on our financial position or results of operations.

In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities" ("SFAS 161"). SFAS 161 requires companies with derivative instruments to disclose information that should enable financial-statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under FASB Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities" and how derivative instruments and related hedged items affect a company's financial position, financial performance and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The adoption of this statement is not expected to have a material effect on the our future financial position or results of operations.

In May 2008, the FASB issued SFAS No. 163, "Accounting for Financial Guarantee Insurance Contracts--an interpretation of FASB Statement No. 60" ("SFAS 163"). SFAS 163 interprets Statement 60 and amends existing accounting pronouncements to clarify their application to the financial guarantee insurance contracts included within the scope of that Statement. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years. As such, we are required to adopt these provisions at the beginning of the fiscal year ended December 31, 2009. We are currently evaluating the impact of SFAS 163 on its financial statements but does not expect it to have an effect on our financial position or results of operations.

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Liquidity and Capital Resources

At December 31, 2008, we had a working capital deficit of $925,635, as compared to working capital of $4,398,216 at December 31, 2007.  Of the working capital deficit, $771,500 was deferred franchise fee revenue and does not represent a cash liability.  The decrease in working capital is primarily due to increased operating activities and losses.  During 2007, we completed two separate financings. The first was the public sale of 4,352,780 shares of our common stock for gross proceeds of $1,741,112 offset by offering expenses of $162,361 for net proceeds of $1,578,751.  The second was a private equity financing of $5,992,500.  The net proceeds from the offering were $5,622,996.  The Company issued 705 shares of its Series A Preferred Stock, par value $0.001 per share and stated value of $8,500 per share. Each share of the Series A Preferred Stock is immediately convertible into 1,000 shares of the Company’s $.001 par value common stock.  No fund raising activities were conducted in 2008.  Instead, we

 

 

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obtained a $550,000 line of credit from two of our directors in 2008.  We borrowed $100,000 against this line of credit in 2008.

During the year ended December 31, 2008, we used cash in operating activities of $3,775,810 as compared to cash used in operations of $2,425,198 for the same period in 2007. We also used cash for the acquisition of assets in the amount of $1,307,681 in 2008 as compared to $584,389 in 2007.  We receive payments from franchisees when they sign a franchise agreement. We do not include those payments in revenue until such time as the franchisee opens the restaurant. The amount recorded as deferred revenue at December 31, 2008 was $771,500, an increase of $1,500 compared to December 31, 2007. Although not recorded as revenue, any payments received will provide working capital.

At December 31, 2008, we had contractual obligations for operating leases of approximately $2,917,742, of which $458,743 was due in less than one year.

2009		$	458,743
2010			435,447
2011			417,091
2012			378,369
2013			351,734
Later years			876,358
		$	2,917,742

We pay to each holder of Series A Preferred Stock cumulative dividends at a rate per share of 5% per annum until December 14, 2010, 7.5% per annum from December 15, 2010 until December 14, 2011, and 14% per annum thereafter, payable semi-annually on January 1 and July 1, beginning on July 1, 2008,   In July 2008 we made the first required payment of $159,596 in cash.  In January 2009 we issued 798,555 shares of our $.001 par value common stock in settlement of $135,035 of the accrued dividend at December 31, 2008 and made a cash payment of $2,853 for the balance.  Whenever possible we will make dividend payments in our common stock in lieu of cash.  There is no guarantee that we will be able to continue to do so.

Summary – December 31, 2008

The unanticipated economic conditions of 2008 resulted in us not selling as many new franchises as we initially predicted.  The extent of the recession was not clear until the third or fourth quarter of 2008.  We reacted to the downturn as soon as it became apparent that it would not correct itself in 2008.  Our need to raise additional equity or debt financing and our ability to generate cash flow from operations will depend on the length of time we are in a recession, our future performance and our ability to successfully implement our stated business and growth strategies.  Many of these factors are beyond our control. If our working capital is insufficient to fund the implementation of our business plan we will be required to seek additional financing sooner than currently anticipated in order to proceed with our business goals.  In the event that we need additional capital and are unable to obtain it, we could be left without sufficient liquidity.  The nature of our business is that a portion of our revenue is a continuing stream from franchisees.  We will continually monitor our expenses and reduce those expenses as best we can to match the revenue flow.  In the past we have issued common stock to our consultants and professional services providers in lieu of cash payments for these services. We may continue this practice to conserve our cash to pay for operations, product development and inventory.

Off-Balance Sheet Arrangements

At December 31, 2008, we had no obligations that would qualify to be disclosed as off-balance sheet arrangements.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Not required

Item 8.  Financial Statements and Supplementary Data

Index to Consolidated Financial Statements			Page
	Reports of Independent Registered Public Accounting Firm		28 -29
	Consolidated Balance Sheets as of December 31, 2008 and 2007		30
	Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2008 and 2007		31
	Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2008 and 2007		32
	Consolidated Statements of Cash Flows for the Years Ended December 31, 2008 and 2007		33
	Notes to Consolidated Financial Statements		34 - 50

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Spicy Pickle Franchising, Inc.

Denver, Colorado

We have audited the accompanying consolidated balance sheet of Spicy Pickle Franchising, Inc. (the “Company”) as of December 31, 2008 and the related consolidated statements of operations, changes in stockholders’ equity and comprehensive income and cash flows for the year 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 audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  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 has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audit included 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 on 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 audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Spicy Pickle Franchising, Inc. as of December 31, 2008 and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ EIDE BAILLY LLP

Greenwood Village, Colorado

March 26, 2009

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Spicy Pickle Franchising, Inc.

Denver, Colorado

We have audited the accompanying consolidated balance sheet of Spicy Pickle Franchising, Inc. as of December 31, 2007 and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for the year 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 audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included 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 on 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 audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Spicy Pickle Franchising, Inc as of December 31, 2007 and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ GORDON, HUGHES & BANKS

Greenwood Village, Colorado

March 21, 2008

 

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Spicy Pickle Franchising, Inc.
Consolidated Balance Sheets
December 31, 2008 and 2007
		2008				2007
Assets
Current assets:
Cash and cash equivalents		$	287,482			$	5,405,069
Current portion of notes receivable			35,000				40,000
Accounts receivable, trade, net			251,173				60,489
Inventory			34,180				11,383
Prepaid expenses and other current assets			63,449				184,498
Total current assets			671,284				5,701,439
Property and equipment, net of accumulated depreciation			1,897,639				685,751
Other assets:
Notes receivable, less current portion			-				40,000
Deposits and other assets			81,806				12,869
Goodwill and other intangible assets			2,914,461				-
Total other assets			2,996,267				52,869
Total assets		$	5,565,190			$	6,440,059
Liabilities and stockholders' equity
Current liabilities:
Accounts payable		$	440,190			$	441,096
Accrued expenses and compensation			247,340				89,827
Accrued dividends			137,889				-
Deferred franchise revenue			771,500				770,000
Other			-				2,300
Total current liabilities			1,596,919				1,303,223
Notes payable to related parties			100,000				-
Long-term debt			500,000				-
Deferred rent expense			93,052				-
Total long-term liabilities			693,052				-
Minority interest			51,955				-
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, 20,000,000 shares authorized,
649 and 705 shares of Series A Variable Rate
Convertible Preferred Stock, stated value $8,500
per share, issued and outstanding in 2008 and 2007, respectively			4,418,941				4,801,124
Common stock, $.001 par value, 200,000,000 shares
authorized, 53,535,247 and 47,634,053 shares issued
and outstanding in 2008 and 2007, respectively			53,535				47,634
Additional paid in capital			9,548,678				5,546,692
Fair value of common stock warrants			873,825				873,825
Accumulated (deficit)			(11,658,300	)			(5,562,772	)
Accumulated comprehensive income (loss)			(13,415	)			-
Deferred compensation			-				(569,667	)
Total stockholders' equity			3,223,264				5,136,836
Total liabilities and stockholders’ equity		$	5,565,190			$	6,440,059

See the accompanying notes to the consolidated financial statements

 

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Spicy Pickle Franchising, Inc.
Consolidated Statements of Operations and Comprehensive Loss
For The Years Ended December 31, 2008 and 2007
		2008				2007
Revenue:
Restaurant and bakery sales		$	3,110,351			$	30,730
Franchise fees and royalties			1,307,295				1,243,263
Total revenues			4,417,646				1,273,993
Operating costs and expenses:
Restaurant and bakery:
Cost of sales			1,090,129				30,383
Labor			1,434,518				33,137
Occupancy			436,889				44,423
Depreciation			256,147				3,876
Other operating costs			490,073				38,675
Total restaurant and bakery operating costs			3,707,756				150,494
Franchise and general:
General and administrative			6,291,136				4,735,854
Depreciation			29,455				22,744
Total franchise and general			6,320,591				4,758,598
Total operating costs and expenses			10,028,347				4,909,092
(Loss) from operations			(5,610,701	)			(3,635,099	)
Other income (expense):
Loss on sale of assets			(32,015	)			-
Interest income			72,472				51,252
Interest (expense)			(42,504	)			(18,037	)
Total other income (expense):			(2,048	)			33,215
Net (loss)			(5,612,749	)			(3,601,884	)
Dividend on preferred stock			(295,185	)			-
Net (loss) attributable to common shareholders			(5,907,934	)			(3,601,884	)
Other comprehensive (loss):
Foreign currency exchange (loss)			(13,415	)			-
Comprehensive (loss)		$	(5,921,349	)		$	(3,601,884	)
Per share information - basic and fully diluted:
Weighted average shares outstanding			49,487,007				44,315,486
Net (loss) per share attributable to common shareholders		$	(0.12	)		$	(0.08	)

See the accompanying notes to the consolidated financial statements

 

 

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Spicy Pickle Franchising, Inc.
Consolidated Statement of Stockholders’ Equity
For The Years Ended December 31, 2008 and 2007
																		Additional				Common												Accumulated
		Preferred Stock								Common Stock								Paid in				Stock				Deferred				Accumulated				Comprehensive
		Shares				Amount				Shares				Amount				Capital				Warrants				Compensation				(Deficit)				(Loss)				Total
Balances at January 1, 2007			-			$	-				40,996,455			$	40,996			$	1,161,516			$	-			$	-			$	(610,667	)		$	-			$	591,845
Common shares issued for cash and services in connection with registered offering			-				-				4,352,780				4,353				1,574,398				-				-				-				-				1,578,751
Common shares issued for services			-				-				2,284,818				2,285				1,109,142				-				(871,292	)			-				-				240,135
Preferred shares issued for cash			705				5,622,996				-				-				-				-				-				-				-				5,622,996
Allocation of fair value common stock       warrants			-				(821,872	)			-				-				-				821,872				-				-				-				-
Fair value of placement consultant warrants			-				-				-				-				(51,953	)			51,953				-				-				-				-
Beneficial conversion dividend on preferred       stocks			-				-				-				-				1,350,221				-				-				(1,350,221	)			-				-
Fair value of stock options granted			-				-				-				-				403,368				-				-				-				-				403,368
Amortization of deferred compensation			-				-				-				-				-				-				301,625				-				-				301,625
Net (loss) for the year			-				-				-				-				-				-				-				(3,601,884	)			-				(3,601,884	)
Balances at December 31, 2007			705				4,801,124				47,634,053				47,634				5,546,692				873,825				(569,667	)			(5,562,772	)			-				5,136,836
Common shares issued for cash			-				-				82,500				83				25,417				-				-				-				-				25,500
Common shares issued for services			-				-				80,000				80				69,920				-				(70,000	)			-				-				-
Common shares issued for asset acquisition			-				-				5,177,500				5,177				2,497,038				-				-				-				-				2,502,215
Conversion of preferred stock			(56	)			(382,183	)			561,194				561				381,622				-				-				-				-				-
Cancellation of service contract			-				-				-				-				-				-				23,467				-				-				23,467
Dividends on preferred stock			-				-				-				-				(295,185	)			-				-				-				-				(295,185	)
Beneficial conversion dividend on preferred     stock			-				-				-				-				482,779				-				-				(482,779	)			-				-
Fair value of stock options granted			-				-				-				-				840,395				-				-				-				-				840,395
Amortization of deferred compensation			-				-				-				-				-				-				616,200				-				-				616,200
Foreign currency translation adjustment			-				-				-				-				-				-				-				-				(13,415	)			(13,415	)
Net (loss) for the year			-				-				-				-				-				-				-				(5,612,749	)			-				(5,612,749	)
Balances at December 31, 2008			649			$	4,418,941				53,535,247			$	53,535			$	9,548,678			$	873,825			$	-			$	(11,658,300	)		$	(13,415	)		$	3,223,264

See the accompanying notes to the consolidated financial statements

 

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Spicy Pickle Franchising, Inc.
Consolidated Statements of Cash Flows
Years Ended December 31, 2008 and 2007
		2008				2007
Cash flows from operating activities:
Net (loss)		$	(5,612,749	)		$	(3,601,884	)
Adjustments to reconcile net (loss) to net cash (used in)
operating activities:
Depreciation			285,602				26,620
Stock based compensation expense			1,480,062				901,201
Loss on sale of assets			32,015				-
Changes in operating assets and liabilities:
Accounts receivable, trade			(191,263	)			3,108
Notes receivable			80,000				(80,000	)
Prepaid expenses and other			93,004				(155,327	)
Inventories			(29,650	)			20,586
Deposits			(70,937	)			17,238
Accounts payable, trade			(907	)			385,656
Accrued expenses and compensation			157,513				26,529
Deferred franchise revenue			1,500				85,000
Other liabilities			-				(53,925	)
Net cash (used in) operating activities			(3,775,810	)			(2,425,198	)
Cash flows from investing activities:
Purchase of property and equipment			(762,400	)			(584,389	)
Proceeds from sale of assets			76,319				-
Investment in purchased subsidiaries			(621,600	)			-
Net cash (used in) investing activities			(1,307,681	)			(584,389	)
Cash flows from financing activities:
Proceeds from exercise of common stock options			25,500				-
Payment of preferred stock dividends			(159,596	)			-
Proceeds from note payable to related parties			100,000				-
Repayment of notes payable to related party			-				(30,000	)
Proceeds from sale of common stock			-				1,622,678
Proceeds from sale of preferred stock and warrants			-				5,622,996
Net cash (used in)  provided by financing activities			(34,096	)			7,215,674
Net (decrease) increase in cash and cash equivalents			(5,117,587	)			4,206,087
Cash and cash equivalents, beginning of period			5,405,069				1,198,982
Cash and cash equivalents, end of period		$	287,482			$	5,405,069
Supplemental cash flow information:
Cash paid for income taxes		$	-			$	-
Cash paid for interest		$	37,500			$	-
Non-cash investing activities:
Notes payable issued for acquisition of assets		$	500,000			$	-
Common stock issued for acquisition of assets		$	2,502,215			$	-
Non-cash financing activities:
Common stock issued for offering expenses			-			$	43,927
Accrued preferred stock dividends		$	137,889			$	-

See the accompanying notes to the consolidated financial statements

 

33

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

 

1. Nature of Business

Spicy Pickle Franchising, Inc. ("Spicy Pickle" or the "Company”) was organized in the State of Colorado on January 14, 2003 as a limited liability company and on September 8, 2006 converted to a corporation. The Company is engaged in the business of marketing and franchising Spicy Pickle restaurants, which specialize in fast casual food featuring fresh, made-to-order, premium submarine-style, deli and Panini sandwiches, salads, soups and soft drinks. Through December 31, 2008, the Company has signed agreements with franchisees to open 102 restaurants. Thirty two of the franchisee-owned restaurants and seven Company-owned restaurants were open as of December 31, 2008.  The restaurants are located in 13 states. The Company continues to interview prospective franchisees and relies on the cash deposits from the franchise sales as well as royalty fees from the existing stores to support the expenses of the business.

The business of each of the Company owned restaurants is operated by a wholly owned subsidiary.

In October 2008 the Company, acquired the operating assets of Bread Garden Franchising, Inc. (“Bread Garden”).  Bread Garden is in the business of marketing and franchising Bread Garden Urban Cafés, restaurants that also specialize in fast casual dining.  At December 31, 2008 there were 11 franchised Bread Garden Urban Cafés located in metropolitan Vancouver in British Columbia, Canada.

2. Summary of Significant Accounting Policies

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplates continuation of the Company as a going concern.  The Company incurred a net loss of $5,612,749 for the year ended December 31, 2008 and has incurred significant net losses since inception.

The Company has been developing its franchise network through the sale of franchises and through acquisition.  The Company has relied on fund raising and the sales of new franchises to augment the cash it receives from continuing royalty payments for its cash flow.  The unanticipated economic conditions of 2008 resulted in a significant reduction in the sales of new franchises which has resulted in a significant decrease in the Company’s cash position.  As soon as it became apparent that the economic downturn would not correct itself in 2008, the Company significantly reduced its corporate overhead mostly in the area of personnel cost.

The Company’s ability to fund its operations will depend on the length of time of the current economic downturn, its future performance and its ability to successfully implement its business and growth strategies.  In the event that the Company needs additional capital and is unable to obtain it, it could be left without sufficient liquidity.  The nature of the Company’s business is that a portion of its revenue is a continuing stream from franchisees.  The Company will continually monitor its expenses and reduce those expenses as best it can to match the revenue flow.  Management may elect to raise money during the year ended December 31, 2009 to meet any shortfalls from operations.  However a realization of a significant portion of the assets in the accompanying balance sheet is dependent on the continued operations of the Company, which in turn is dependent on the increase in sales of new franchises, the number of operating franchise restaurants, or the additional capital raised through a placement of its securities.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and our wholly owned subsidiaries, SP Broadway, LLC, SP Chicago, LLC, Crumb Rustic Bakery, LLC, SP Promenade, LLC, SP DU, LLC, SP Federal Heights, LLC, SP Greenwood, LLC, SP Harmony, LLC, SP College Avenue, LLC, all of which are established as Colorado limited liability companies, and SPBG Franchising, Inc., a Canadian corporation.  All material inter-company transactions and balances have been eliminated in consolidation.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less, at the time of purchase, to be cash equivalents.

 

34

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

 

Accounts Receivable

Accounts receivable consists primarily of amounts billed to franchisees for royalties, advertising fees, expenses advanced on behalf of the franchisees and expected rebates from vendors. The Company makes its best estimate of the amounts of probable credit losses in the Company’s existing accounts receivable and provides for such loss as an allowance for doubtful accounts.  At December 31, 2008 and at December 31, 2007, the Company estimated an allowance for doubtful accounts of $70,595.  Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance-sheet credit exposure related to its customers.

Inventories

Inventories are stated at the lower of cost or market, with cost being determined on the first-in, first-out method. Inventories include food, beverage and supply items at Company-owned or operated locations.

Property and equipment

Property and equipment are stated at cost. Depreciation is computed 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:

Computer software and equipment 3 years

Furniture and fixtures 5 to 7 years

Kitchen equipment 5 years

Office equipment 5 years

Leasehold improvements 5 years

Maintenance and repairs of property and equipment are charged to operations. Major improvements are capitalized. Upon retirement, sale or other disposition of property and equipment, the cost and accumulated depreciation are eliminated from the accounts and any gain or loss is included in operations.

Goodwill and Other Intangibles

Intangible assets include both goodwill and identifiable intangibles arising from the allocation of the purchase prices of assets acquired. Goodwill represents the excess of cost over fair value of net assets acquired in various transactions conducted during 2008.  Other intangibles consist mainly of reacquired franchise rights.

Goodwill and other intangible assets with indefinite lives are not subject to amortization, but are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), requires a two-step approach for testing impairment. For goodwill, the fair value of each reporting unit is compared to its carrying value to determine whether an indication of impairment exists. If impairment is indicated, the fair value of the reporting unit’s goodwill is determined by allocating the unit’s fair value to its assets and liabilities (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. For intangibles with indefinite lives, the fair value is compared to the carrying value. The amount of impairment for goodwill and other intangible assets is measured as the excess of its carrying amount over its fair value.

As of December 31, 2008, the Company performed an impairment analysis of the goodwill and indefinite lived intangibles assets.  For the year ended December 31, 2008 there was no indication of impairment in goodwill and indefinite lived intangible assets.

Long-Lived Assets

In accordance with the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment

 

 

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

 

charge is recognized as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Based on the Company’s analysis, no impairment charges were recognized for the years ended December 31, 2008 and 2007.

Use of Estimates

The preparation of 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, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Concentration of Credit Risks

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of cash and trade accounts receivable. The Company’s receivables are primarily from its franchisees. To the extent our franchisees face difficult economic conditions, the Company is exposed to a concentration of credit risk.

The Company’s cash is primarily in demand deposit accounts placed with federally insured financial institutions. Such deposit accounts at times may exceed federally insured limits. However, the Company believes the risk of loss to be minimal.

Fair Value Measurements

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”), which provides a comprehensive framework for measuring fair value and expands disclosures which are required about fair value measurements.  Specifically, SFAS 157 sets forth a definition of fair value and establishes a hierarchy prioritizing the inputs to valuation techniques, giving the highest priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable value inputs.  The adoption of this statement had no impact on the Company’s financial statements.  SFAS 157 defines the hierarchy as follows:

Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reported date. The types of assets and liabilities included in Level 1 are highly liquid and actively traded instruments with quoted prices, such as equities listed on the New York Stock Exchange.

Level 2 – Pricing inputs are other than quoted prices in active markets, but are either directly or indirectly observable as of the reported date.  The types of assets and liabilities in Level 2 are typically either comparable to actively traded securities or contracts, or priced with models using highly observable inputs.

Level 3 – Significant inputs to pricing that are unobservable as of the reporting date.  The types of assets and liabilities included in Level 3 are those with inputs requiring significant management judgment or estimation, such as complex and subjective models and forecasts used to determine the fair value of financial transmission rights.

Revenue Recognition

Initial Franchise Fees - The Company enters into franchise agreements, which grant franchisees the exclusive right to develop and operate businesses at certain locations. Initial franchise fees are recognized as revenue when all material services and conditions required to be performed by the Company have been substantially completed, which is generally when the business commences operations. Initial franchise fees were established at $45,000 and $35,000 for the years ended December 31, 2008 and 2007, respectively.  Franchise fees recognized were $252,500 and $497,500 for the years ended December 31, 2008 and 2007 respectively.

Royalty Fees - Pursuant to the franchise agreements, franchisees are required to pay royalties to the Company based on 5% of weekly gross sales as reported to the Company through the franchisees’ point of sales systems. The royalties are recognized as revenue in the period corresponding to the sales reporting period. Royalty fees were $819,489 and $577,334 for the years ended December 31, 2008 and 2007, respectively.

Product Sales – During the year ended December 31, 2007 the Company sold logo products to its franchisees. Sales were recognized when products are shipped to the franchisee. Product sales were $17,411 for the year ended December 31, 2007.  As of December 31, 2008 the Company is using a third party to provide logo products to its franchisees.

36

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

 

Rebates - Rebates received from purveyors that supply products to the Company's franchisees are included in Franchise Fees and Royalties. The rebates are recorded when earned. Rebates that relate to company-owned restaurants are offset against restaurant cost of sales. Rebates related to franchisees were $235,305, and $151,020 for the years ended December 31, 2008 and 2007, respectively.

Restaurant and Bakery Sales - The Company records revenue from restaurant and bakery sales upon delivery of the related food and other products to customers, which, in the case of the bakery, are our franchisees.  There were no bakery sales in 2007.

Advertising Costs

Franchisees must contribute to an advertising fund established by the Company at a rate of up to 2% for the Spicy Pickle brand and 1.5% for the Bread Garden Urban Café brand of total franchisee gross sales. The Company, at its discretion, may spend more or less than actual advertising receipts from the franchises. Advertising fees collected were $375,477 and $291,881 for the years ended December 31, 2008 and 2007, respectively. These fees are offset against advertising expenses, which are recognized when incurred. The Company incurred advertising expense of $828,335 and $443,566 in 2008 and 2007, respectively, including those from the advertising fund and the Company’s own advertising expenses. The net amounts reflected in the financial statements are $452,858 and $151,685 in 2008 and 2007, respectively.

Income Taxes

The provision for income taxes is determined in accordance with the provisions of SFAS 109, “Accounting for Income Taxes.” 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 of a change in tax rates is recognized in income in the period that includes the enactment date.

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainties in Income Taxes, an interpretation of SFAS No. 109, Accounting for Income Taxes” (“FIN 48”). FIN 48 prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. Under FIN 48, tax positions must initially be recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions must initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts. FIN 48 is effective for fiscal years beginning after December 15, 2006.

FIN 48 became effective for the Company on January 1, 2007. The cumulative effect of adopting FIN 48 on January 1, 2007 has been recorded net in deferred tax assets, which resulted in no FIN 48 liability on the balance sheet. The total amount of unrecognized tax benefits as of the date of adoption was zero. There are open statutes of limitations for taxing authorities in federal and state jurisdictions to audit the Company’s tax returns from 2006 through the current period. The Company’s policy is to account for income tax related interest and penalties in income tax expense in the statement of operations. There have been no income tax related interest or penalties assessed or recorded. Because the Company has provided a full valuation allowance on all of its deferred tax assets, the adoption of FIN 48 had no impact on the Company’s effective tax rate.

37

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

Rent Expense

The Company recognizes rent expense on a straight-line basis over the reasonably assured lease term as defined in SFAS No. 98, "Accounting for Leases.'' 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. Beginning January 1, 2006, the Company adopted FASB Staff Position (“FSP”) No. FAS 13-1, "Accounting for Rental Costs Incurred During a Construction Period'' ("FSP 13-1''). FSP 13-1 states that rental costs associated with operating leases must be recognized as rental expense allocated on a straight-line basis over the lease term, which includes the construction period.  Deferred rent expense at December 31, 2008 was $93,052 and will be charge to rent expense over the life of the leases to which it relates.

The Company includes any rent escalations and construction period and other rent holidays in its determination of straight-line rent expense. Therefore, rent expense for new locations is charged to expense beginning with the start of the construction period.

Equity-Based Compensation

On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options based on estimated fair values. SFAS 123(R) supersedes our previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in our adoption of SFAS 123(R).

The Company has adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of our fiscal year 2006. Our financial statements as of and for the year ended December 31, 2007 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Company’s financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for the years ended December 31, 2008 and 2007 was $840,395 and $403,368, respectively, which consisted of stock-based compensation expense related to employee stock options.

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our statement of operations. Prior to the adoption of SFAS 123(R), the Company had no stock-based compensation awarded to employees and directors.

Upon adoption of SFAS 123(R), the Company used the Black-Scholes option-pricing model (“Black-Scholes model”) to determine fair value. The determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. Although the fair value of employee stock options is determined in accordance with SFAS 123(R) and SAB 107 using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

The weighted average fair value of options granted during 2008 of $0.168 was estimated on the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions: expected volatility of 43.18%, expected term of 2.5 years, risk-free interest rate of 2.4% and no expected dividend yield.

The weighted average fair value of options granted during 2007 of $0.222 was estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions: expected volatility of 41.66%, expected term of 2.5 years, risk-free interest rate of 5.9%, and expected dividend yield of 0%.

38

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

Foreign Currency Transactions

Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the date of the transaction. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency using the applicable exchange rates at the balance sheet dates. The resulting exchange differences are recorded in the consolidated statement of operations.

The reporting currency of the Company is the United States dollars (“U.S. dollars”) and the accompanying consolidated financial statements have been expressed in U.S. dollars. In addition, one of the Company’s operating subsidiaries in Canada maintains their books and record in their local currency, Canadian dollars, which are the functional currency of the economic environment in which their operations are conducted.

Assets and liabilities of the subsidiary whose functional currency is not the U.S. dollars are translated into US dollars, in accordance with SFAS No 52, “Foreign Currency Translation”, using the exchange rate on the balance sheet date. Revenues and expenses are translated at average rates prevailing during the period. The gains and losses resulting from translation of financial statements of foreign subsidiary is recorded as a separate component of accumulated other comprehensive income within the statement of stockholders’ equity.

Comprehensive Income

SFAS No. 130, “Reporting Comprehensive Income”, establishes standards for reporting and display of comprehensive income, its components and accumulated balances. Comprehensive income as defined includes all changes in equity during a period from non-owner sources. Accumulated comprehensive income, as presented in the accompanying consolidated statement of stockholders’ equity consists of changes in unrealized gains and losses on foreign currency translation. This comprehensive income is not included in the computation of income tax expense or benefit.

Recent Pronouncements

The Company has reviewed all recently issued, but not yet effective, accounting pronouncements and does not believe the future adoption of any such pronouncements may be expected to cause a material impact on its financial condition or the results of its operations.

In December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations” (“SFAS 141R”). SFAS 141R will change the accounting for business combinations. Under SFAS 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS 141R will change the accounting treatment and disclosure for certain specific items in a business combination. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Accordingly, any business combinations the Company engages in will be recorded and disclosed following existing GAAP until January 1, 2009. The Company expects SFAS 141R will have an impact on accounting for business combinations once adopted, but the effect is dependent upon acquisitions at that time.

In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements-An Amendment of ARB No. 51" (“SFAS 160"). SFAS 160 establishes new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. The Company believes that SFAS 160 should not have a material impact on our financial position or results of operations.

In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities" ("SFAS 161"). SFAS 161 requires companies with derivative instruments to disclose information that should enable financial-statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under FASB Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities" and how derivative instruments and related hedged items affect a company's financial position, financial performance and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The adoption of this statement is not expected to have a material effect on the Company's future financial position or results of operations.

39

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

 

In May 2008, the FASB issued SFAS No. 163, "Accounting for Financial Guarantee Insurance Contracts--an interpretation of FASB Statement No. 60" ("SFAS 163"). SFAS 163 interprets Statement 60 and amends existing accounting pronouncements to clarify their application to the financial guarantee insurance contracts included within the scope of that Statement. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended December 31, 2009. The Company is currently evaluating the impact of SFAS 163 on its financial statements but does not expect it to have an effect on the Company's financial position or results of operations.

Also in May 2008, the FASB issued FSP APB 14-1, "Accounting for Convertible Debt Instruments that may be Settled in Cash upon Conversion (Including Partial Cash Settlement)" ("FSP APB 14-1"). FSP APB 14-1 applies to convertible debt securities that, upon conversion, may be settled by the issuer fully or partially in cash. FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity's nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for fiscal years after December 15, 2008, and must be applied on a retrospective basis. Early adoption is not permitted. The Company does not expect it to have an effect on the Company's financial position or results of operations.

In June 2008, the FASB issued FSP EITF 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities" ("FSP EITF 03-6-1"). FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting, and therefore need to be included in the earnings allocation in computing earnings per share under the two-class method as described in SFAS No. 128, Earnings per Share. Under the guidance of FSP EITF 03-6-1, unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings-per-share pursuant to the two-class method. FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and all prior-period earnings per share data presented shall be adjusted retrospectively. Early application is not permitted. The Company does not expect it to have an effect on the Company's financial position or results of operations.

Also in June 2008, the FASB ratified EITF No. 07-5, "Determining Whether an Instrument (or an Embedded Feature) is Indexed to an Entity's Own Stock" ("EITF 07-5"). EITF 07-5 provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument's contingent exercise and settlement provisions. EITF 07-5 is effective for financial statements issued for fiscal years beginning after December 15, 2008. Early application is not permitted. The Company is assessing the potential impact of this EITF 07-5 on the financial condition and results of operations and does not expect it to have an effect on the Company's financial position or results of operations.

In September 2008, the FASB issued FSP 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161” (“FSP FAS 133-1” and “FIN 45-4”). FSP 133-1 and FIN 45-4 amends disclosure requirements for sellers of credit derivatives and financial guarantees and also clarify the disclosure requirements of SFAS 161.  FSP 133-1 and FIN 45-5 are effective for quarterly periods beginning after November 15, 2008, and fiscal years that include those periods. The adoption of FSP 133-1 and FIN 45-4 did not have a material impact on the Company’s current financial position or results of operation.

40

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

 

3. Property and Equipment

Major classes of property and equipment consist of the following:

		2008				2007
Computer software and equipment		$	161,860			$	86,643
Furniture and fixtures			296,056				47,753
Office equipment			26,681				26,344
Leasehold improvements			1,153,294				392,994
Kitchen equipment			533,862				147,548
Vehicles			17,340				17,340
Construction in progress			41,186				35,303
			2,230,279				753,926
Less: accumulated depreciation			(332,640	)			(68,175	)
		$	1,897,639			$	685,751

The Company recorded depreciation expense related to these assets of $285,602 and $26,620 in 2008 and 2007, respectively.

4. Business Combinations

In 2008 the Company made an investment in an existing franchised restaurant, purchased the assets of four existing franchised restaurants and acquired the assets of an existing franchisor in an effort to expand its operations in the Spicy Pickle brand and to franchise another branded concept, Bread Garden Urban Cafés, in the fast casual restaurants industry.

On February 5, 2008, the Company acquired from a franchisee a 60% ownership interest in an existing franchised restaurant operating in Ft. Collins, Colorado.  The Company paid an aggregate of $120,000 for its interest, which included the repayment of a $119,400 note owed by the previous owner to a third party.  The results of the operations have been included in the consolidated financial statements beginning at the acquisition date. The aggregate value ascribed to the assets acquired including minority interest of $80,000 at the purchase date is as follows:

At February 5, 2008:

Current assets	$	14,900
Property and equipment		120,718
Lease deposits		7,200
Goodwill		57,182
Total and net assets acquired	$	200,000

Goodwill consists of the excess of the purchase price over the fair value of the net assets acquired in connection with this acquisition.  Subsequent to the date of purchase an additional $2,572 was added to goodwill for acquisitions costs.

Subsequent to the acquisition of the minority interest in the franchised restaurant an amount of $28,045 which was owed to the Company by the franchisee was converted to additional equity thereby reducing the minority interest.

On February 21, 2008, the Company acquired substantially all of the assets, including lease assignments, of an existing franchise restaurant location in Chicago, Illinois from a franchisee.  No liabilities were assumed in the

 

 

41

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

 

 

transaction. The results of the operations have been included in the consolidated financial statements since November 2007 pursuant to an operating agreement. The aggregate purchase price of $157,300 was paid in cash and allocated in full to property and equipment and lease deposit.  No goodwill was recorded as a result of the transaction.

On March 1, 2008, the Company acquired substantially all of the assets, including lease assignments, of three existing franchise restaurant locations in Colorado from a franchisee.  No liabilities were assumed in the transaction. The results of these operations have been included in the consolidated financial statements since that date.  The acquisition will permit the Company to expand its presence in its home location and is expected to increase sales volume at the acquired locations.  Additionally, the expansion of the company-owned restaurant base will demonstrate to potential franchisees and investors the Company’s commitment to overall Company growth.  The Company also expects to reduce costs through economies of scale.

The aggregate purchase price was $844,310, including $344,310 of cash and three-year notes aggregating $500,000 with interest at 10% per year payable monthly.  Additional consideration may be required if aggregate annual sales for the locations exceed $1,425,000 at a rate of 6% of any such excess through February 28, 2011.  Any additional consideration will be expensed as paid.  The following table summarizes the estimated fair values of the assets acquired at the date of acquisition.

At March 1, 2008:

Current assets		$	21,410
Property, and equipment			498,785
Lease deposits			8,290
Other intangible assets			55,000
Goodwill			260,825
Total and net assets acquired		$	844,310

Other intangible assets consist of reacquired franchise rights assumed in connection with this acquisition and were recorded in accordance with the provisions of EITF No. 04-1.

Goodwill consists of the excess of the purchase price over the fair value of the net assets acquired in connection with this acquisition.

On October 1, 2008, the Company acquired all of the operating assets of Bread Garden, a company which franchises fast casual restaurants under the trade name Bread Garden Urban Café.  Bread Garden currently has 11 franchised locations in the Vancouver, British Columbia, Canada metropolitan area.  The assets were acquired in exchange for 5,177,500 restricted shares of the registrant’s common stock and warrants to purchase 3,038,750 shares of the registrant’s common stock, 2,700,000 are exercisable at $0.63 per share and 338,750 are exercisable at $0.615 per share.  The warrants are exercisable for five years.  Certain of the shares and warrants are subject to a lock-up agreement.  Pursuant to the lock-up agreement, 4,500,000 shares of the common stock and 2,700,000 of the warrants issued pursuant to the Asset Purchase Agreement, cannot be sold, transferred or otherwise disposed of for a period of one year from the effective date of the closing.  The remaining 677,500 common shares and 338,750 warrants are not covered by the lock-up agreement and are only subject to the restriction of the Securities and Exchange Commission rules and regulations for unregistered securities.

The following table summarizes the estimated fair values of the assets acquired at the date of acquisition.

 

 

42

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

At October 1, 2008:

Property, and equipment		$	52,175
Lease deposits			7,702
Goodwill			2,538,882
Total and net assets acquired		$	2,598,759

Goodwill consists of the excess of the purchase price over the fair value of the net assets acquired in connection with this acquisition.

As of December 31, 2008 the purchase price allocation of the acquisition of this restaurant’s operations is preliminary dependent on finalization of the Company’s valuation assessment in accordance with SFAS No. 141, “Business Combinations.”

The proforma unaudited results of operations for the years ended December 31, 2008 and 2007, assuming that the acquisitions had occurred at the beginning of each period presented, would be as follows:

		2008				2007
Revenue		$	4,803,224			$	3,462,268
Net loss attributed to common shareholders		$	(5,810,697	)		$	(3,430,300	)
Loss per share		$	(0.12	)		$	(0.8	)

The $2,859,461 of aggregate goodwill recognized in all of the acquisitions was assigned to the franchise operations segment and the restaurant operations segment in the amounts of $2,538,882 and $320,579, respectively.  The total amount is expected to be deductable over a fifteen year period for tax purposes.

5. Commitments and Contingencies

The aggregate minimum requirements under non-cancelable leases as of December 31, 2008 are as follows:

2009		$	458,743
2010			435,447
2011			417,091
2012			378,369
2013			351,734
Later years			876,358
		$	2,917,742

Rent expense for the years ended December 31, 2008 and 2007 was $529,465 and $146,039, respectively.

43

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

6. Stockholders’ Equity

The Company is authorized to issue two hundred million (200,000,000) shares of common stock, par value $0.001. At December 31, 2008, the Company has reserved 7,417,500 shares of common stock for issuance upon exercise of awards granted under the Company’s 2006 Stock Option Plan (Note 10).

The Company also is authorized to issue twenty million (20,000,000) shares of preferred stock, $0.001 par value. The Board of Directors of the Company is authorized to provide for the issuance of shares of preferred stock in one or more classes or series and to fix the designation, powers, preferences and rights of shares to be included in each such class or series. Each such class or series of preferred stock shall have such voting power as shall be authorized by the Board of Directors.

The Company filed a registration statement with the United States Securities and Exchange Commission (“SEC”) that became effective during January 2007. The registration statement covered 8,240,000 common shares of the Company held by shareholders. The Company has not received and will not receive any proceeds from the sales of these shares by the selling shareholders. In addition, the Company registered 10,000,000 common shares to be sold by the Company, and the Company received the proceeds from such sales.  As of December 31, 2007, the Company had sold 4,352,780 of such shares at a price of $.40 per share for gross proceeds of $1,741,112, less offering expenses of $162,361, for net proceeds of $1,578,751.  The offering was terminated November 15, 2007.

The Company completed a private equity financing of $5,992,500 on December 14, 2007, with 14 accredited investors.  Net proceeds from the offering were approximately $5,623,000.  The Company issued 705 shares of its Series A Variable Rate Convertible Preferred Stock, par value $0.001 per share and stated value of $8,500 per share (the “Series A Preferred Stock”). Each share of the Series A Preferred Stock is immediately convertible into 10,000 shares of the Company’s $.001 par value common stock.  This conversion rate implies a discount to the fair value of the common stock of $.26 per share ($1,833,000), which amount will be recorded by the Company $1,350,221 as a current dividend on the Series A Preferred Stock with an additional dividend of $482,779 recorded ratably over a 45-day period immediately subsequent to December 31, 2007.  During the year ended December 31, 2008 56 shares of the Series A Preferred Stock were converted into 561,194 shares of the Company’s $.001 par value common stock.

Additionally, the Company shall pay each holder of Series A Preferred Stock cumulative dividends at a rate per share of 5% per annum until the second anniversary of the original issue date, 7.5% per annum from the second anniversary of the original issue date until the third anniversary of the original issue date, and 14% per annum thereafter, payable semi-annually on January 1 and July 1, beginning on July 1, 2008, and upon conversion or redemption of the Series A Preferred Stock. Such dividends are payable in cash or, at the Company’s option, in shares of common stock or a combination thereof.  The dividend on the Series A Preferred stock for the year ended December 31, 2008 was $298,485.  Subsequent to December 31, 2008 the Company issued 798,555 shares of its $.001 par value common stock in settlement of $135,035 of the accrued dividend at December 31, 2008 and cash of $2,854.

The terms of the Series A Preferred Stock include certain “Non-Cash Redemption Triggering Events” that may be considered to be outside of the control of the Company that would, if occurring and elected by the investor, require the Company to (a) redeem all of the Series A Preferred Stock then held by the investors for a redemption price, in shares of common stock, equal to a number of shares of common stock equal to the stated redemption amount divided by 75% of the average of the 10 daily volume weighted average price calculations (“VWAPs”) immediately prior to the date of redemption election or (b) increase the dividend rate on all of the outstanding Series A Preferred Stock held by the investor to 18% per annum thereafter.

Additionally, the investors received warrants to purchase an aggregate of 5,287,500 shares of the Company’s $.001 par value common stock at an exercise price of $1.60 per share. Should the warrants be exercised in full, the Company would receive additional proceeds from the offering of $8,460,000.

The warrants that each investor received as a result of the Series A Preferred Stock financing are exercisable immediately at an exercise price of $1.60 per share.  The Company was obligated to register the common shares

 

 

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

 

 

underlying the warrants within 180 days of the closing date in order to avoid cash penalties which could amount to an aggregate of $719,100.  The Company completed the registration of the shares during February 2008.  No warrants were exercised during the year ended December 31, 2008.

The Company has determined the fair value of the warrants as of the issuance date. The Company used the Black-Scholes option-pricing model with the following assumptions: an expected life equal to half of the contractual term of the warrants, no dividends, a risk free rate of 5.5%, and volatility of 39%. Under the assumptions, the Black-Scholes option pricing model yielded an aggregate fair value of approximately $952,500.  A portion of this amount ($821,872) has been allocated to Common Stock Warrants in the accompanying balance sheet based upon the percentage relationship of the warrant fair value to the total fair value of the offering multiplied by the gross proceeds of the offering.

In connection with this financing, the Company paid cash compensation to a placement consultant in the amount of $369,500 and issued it 288,400 placement consultant warrants (fair value $51,953), exercisable at $1.60 per share for a period of five years from the date of issue.  Also, the placement consultant may be entitled to 216,300 additional warrants based on subsequent exercise of warrants by certain investors. The fees were recorded as a cost of capital.

Proceeds were used during 2008 for the acquisition and /or internal development of eight Company owned restaurant locations, the bakery facility and to fund working capital requirements.

In addition, the Company issued 80,000 shares and 2,284,818 shares of common stock to non-employees for services rendered during 2008 and 2007, respectively. The Company recorded the shares at their fair value at the issue dates with fair value determined to be equivalent to the then-current market price.  For the year ended December 31, 2008 the fair value of the shares amounted to an aggregate of $70,000 which was recorded as deferred compensation.  For the year ended December 31, 2007 the fair value of the shares amounted to an aggregate of $1,067,500 of which $196,208 has been recorded as current expenses for consulting services with the remaining balance of $871,292 recorded as deferred compensation costs. All of the deferred compensation was amortized to expense during 2008.

During the year ended December 31, 2008, holders of 82,500 common stock purchase options issued pursuant to Company’s 2006 Stock Option Plan (see Note 10) exercised their options, pursuant to which the Company issued 82,500 shares of common stock resulting in $25,500 of proceeds to the Company.

7. Earnings Per Share Data

 

Earnings per share is 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 SFAS No. 128 "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 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. At December 31, 2008 and 2007, any equivalents would be anti-dilutive as the Company had losses for the years then ended.

8. Income Taxes

 

The Company accounts for income taxes under SFAS 109, which requires the use of the liability method. SFAS 109 provides that deferred tax assets and liabilities are recorded based on the differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as temporary differences. Deferred tax assets and liabilities at the end of each period are determined using the currently enacted tax rates applied to taxable income in the periods in which the deferred tax assets and liabilities are expected to be settled or realized.

45

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

 

 

Income tax provision (benefit) for the year ended December 31, 2008 and 2007 is summarized below:

		2008				2007
Current:
Federal		$	-			$	-
State			-				-
Total current			-				-
Deferred:
Federal			(1,606,000	)			(1,053,000	)
State			(249,000	)			(163,000	)
Total deferred			(1,855,000	)			(1,216,000	)
Increase in valuation allowance			1,855,000				1,216,000
Total provision		$	-			$	-

The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before provision for income taxes. The sources and tax effects of the differences are as follows:

		2008				2007
Income tax provision at the federal statutory rate			34.0	%			34.0	%
State income taxes, net of federal benefit			3.3	%			3.3	%
Effect of net operating loss			(37.3	%)			(37.3	%)
			0.0	%			0.0	%

Components of the net deferred income tax assets at December 31, 2008 and 2007 were as follows:

Deferred tax assets:		2008				2007
Net operating loss carryovers		$	3,051,000			$	1,299,000
Taxable deferred franchise fees			238,000				130,000
Other			9,000				14,000
Valuation allowance			(3,298,000	)			(1,443,000	)
		$	-			$	-

SFAS 109 requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. After consideration of all the evidence, both positive and negative, management has determined that a $3,298,000 allowance at December 31, 2008 is necessary to reduce the deferred tax assets to the amount that will more likely than not be realized. The change in the valuation allowance for the current year is $1,855,000.

As of December 31, 2008, the Company has a net operating loss carry forward of approximately $8,150,000. This loss will be available to offset future taxable income. If not used, this carry forward will expire as follows:

2026		$	619,000
2027		$	2,807,000
2028		$	4,724,000

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

9. Related Party Transactions

Parties, which can be a corporation or individual, are considered to be related if the Company has the ability, directly or indirectly, to control the other party or exercise significant influence over the other party in making financial and operating decisions. Companies are also considered to be related if they are subject to common control or common significant influence.

The Company rents a suite at a local events center from a partnership in which an officer and member of the Company is a partner. The partnership passed through the rent at the same rate it paid to the event center owner. The booth is used primarily for marketing entertainment purposes. The amounts charged to expense were $75,641 and $75,197 for the years ended December 31, 2008 and 2007, respectively.

In December 2008 two members of the Board of Directors granted the Company a line of credit which expires January 31, 2010.  The line of credit is for an aggregate of $550,000 and bears interest at a rate of one percent above the prime rate and is secured by certain assets of the Company.  At December 31, 2008 the interest rate on the borrowings was 4.25% and balance outstanding was $100,000.

10. Stock-Based Compensation

In October 2006, the Company’s Board of Directors adopted the 2006 Stock Option Plan (“2006 Plan”), which was approved by the Company’s stockholders the same month. The 2006 Plan provides for the grant of up to 7,500,000 shares of the Company’s common stock (subject to certain adjustments in the event of stock splits or other similar events) as incentive stock options. The Company’s Board of Directors has delegated authority to grant awards under the 2006 Plan to the Company’s Compensation Committee.

A summary of stock option activity under the Company’s stock-based compensation plan is set forth below:

										Weighted Average
						Weighted				Remaining
						Average				Contractual Term				Aggregate
		Options				Exercise Price				(in years)				Intrinsic Value
Outstanding January 1, 2007			100,000			$	0.25							$	7,590
Granted			3,960,000			$	0.78								893,796
Exercised			-
Cancelled			-
Outstanding December 31, 2007			4,060,000			$	0.76				4.80				901,386
Granted			3,060,000			$	0.65				4.49				515,232
Exercised			82,500			$	0.31								7,997
Cancelled			891,250			$	0.98								260,581
Outstanding December 31, 2008			6,146,250			$	0.67				4.02			$	1,148,040
Exercisable December 31, 2008			5,532,500			$	0.65				4.01			$	1,060,771

The following table summarizes information concerning outstanding and exercisable options at December 31, 2008:

	Options Outstanding			Options Exercisable
Range of Exercise Price	Number Outstanding	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price	Number Exercisable	Weighted Average Exercise Price
$.25 - $1.29	6,146,250	4.02	$0.67	5,532,500	$0.65

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

11. Business Segment information

The Company operates in three business segments. The Company Restaurant Operations segment is comprised of restaurants owned by the Company.  The company-owned restaurants conduct business under the Spicy Pickle name. These restaurants specialize in fast casual dining featuring fresh, made-to-order, premium submarine, deli and panini sandwiches, salads, soups and soft drinks. Information for this segment for the year ended December 31, 2008 includes the operating activities of eight company-owned restaurants.

The Bakery Operations segment is comprised of the operating activities of a bakery located at one of the Company’s Denver restaurants, which supplies breads and other bakery products for Company and franchisee-owned locations in Colorado.

The Franchise Operations segment is comprised of the operating activities of the franchise business unit, which licenses qualified operators to conduct business under the Spicy Pickle name or the Bread Garden name, and also of the costs to monitor the operations of these restaurants. Under the terms of the agreements, the licensed operators pay royalties and fees to the Company in return for the use of the Spicy Pickle or the Bread Garden name as the case may be.

The following table sets forth certain restaurant data relating to company-owned and franchise-operated restaurants:

		2008				2007
Number of restaurants:
Company-owned:
Beginning of period			1				-
Restaurants opened (includes 4 restaurants converted from franchise owned to company owned)			7				1
Restaurants sold			(1	)			-
End of period			7				1
Franchise-operated:
Beginning of period			35				16
Restaurants opened			5				19
Restaurants closed (includes 4 restaurants converted from franchise owned to company owned)			(8	)			-
End of period			32				35
System-wide:
Beginning of period			36				16
Restaurants opened (net of conversions from company owned to franchised)			7				20
Restaurants closed			(4	)			-
End of period			39				36

The accounting policies of the segments are the same as those described in the summary of significant accounting policies (see Note 2). In 2008 the Company’s bakery segment had sales to the restaurant segment in the amount of $112,594.  There were no inter-segment sales in 2007.  Management has determined that the Company’s reportable segments are strategic business units that offer different products and services.

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

Segment information related to the Company's three business segments follows:

		2008				2007
Revenues:
Company restaurant operations		$	2,756,276			$	(119,764	)
Franchise operations			354,075				-
Franchise operations			1,307,295				(3,515,335	)
Total revenues		$	4,417,646			$	(3,635,099	)
Segment profit (loss)
Company restaurant operations		$	(560,713	)		$	102,615
Bakery operations			(64,254	)			-
Franchise operations			(4,985,734	)			1,200,608
Total profit (loss)		$	(5,610,701	)		$	1,303,223

Segment assets:
Company restaurant operations		$	2,014,714			$	625,874
Bakery operations			372,146				-
Franchise operations			3,178,330				5,814,185
Total segment assets		$	5,565,190			$	6,440,059

Segment liabilities:
Company restaurant operations		$	1,484,406			$	102,615
Bakery operations			24,793				-
Franchise operations			832,727				1,200,608
Total segment liabilities		$	2,341,926			$	1,303,223

Depreciation and amortization (included in segment profit (loss):
Company restaurant operations		$	216,495			$	3,876
Bakery operations			39,652				-
Franchise operations			29,455				22,744
Total depreciation and amortization		$	285,602			$	26,620

Capital expenditures:
Company restaurant operations		$	994,025			$	561,761
Bakery operations			261,240				-
Franchise operations			2,591,298				22,628
Total capital expenditures		$	3,846,563			$	584,389

49

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Spicy Pickle Franchising, Inc.

Notes to Consolidated Financial Statements

(Continued)

The Company operates in the United States of America and Canada.  In respect of geographical segment reporting, revenues and total assets are based on the country where the operations are conducted.

Geographic Revenues:
United States of America		$	4,256,612			$	1,273,993
Canada			74,861				-
Total Revenues		$	4,331,473			$	1,273,993
Geographic assets:
United States of America, including goodwill of $320,579		$	2,952,456			$	6,440,059
Canada, including goodwill of $2,538,882			2,612,734				-
Total assets		$	5,565,190			$	6,440,059

Note 12. Sales of Assets

In December 2008 the Company sold all of the operating assets of one of its restaurants to a new franchisee for approximately $116,000, paid with $81,000 in cash and a note in the amount of $35,000.  The note is payable in ten installment of $3,500 plus accrued interest on the unpaid principal at a rate of 8% per annum.  The note will be fully paid during 2009.  The Company recognized a loss on the sale of approximately $32,000.