SECURITIES AND EXCHANGE COMMISION
                             Washington, D.C. 20549

                                  FORM 10-KSB/A
                                 Amendment No. 1
(Mark one)

      [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                      EXCHANGE ACT OF 1934 [Fee Required]
                   For the fiscal year ended December 31, 1996

                                       OR

        [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
                     EXCHANGE ACT OF 1934 [No Fee Required]
              For the transition period from ________ to _________

                         Commission File Number 0-24388


                          MANHATTAN BAGEL COMPANY, INC.

                 (Name of small business issuer in its charter)

         NEW JERSEY                                          22-2981539
(State or other jurisdiction of                              (I.R.S. Employer
incorporation or organization)                               Identification No.)

    246 Industrial Way West                                    07724
     Eatontown, New Jersey                                   (Zip Code)    

Issuer's telephone number  (908) 544-0155

Securities registered under Section 12(b) of the Exchange Act:  NONE

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

                           Common Stock, no par value
                                (Title of class)

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days. Yes |X|
No |_|

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]

The issuer's revenues for the fiscal year ended December 31, 1996 were
$36,944,549. The aggregate market value of the voting stock held by
non-affiliates as of April 11, 1997 was $33,077,532.

As of April 11, 1997, there were 7,454,822 shares of the registrant's common
stock outstanding.

                       Documents Incorporated by Reference

                                      None
<PAGE>

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     Certain statements in this Annual Report on Form 10-KSB, particularly under
Items 1-8, constitute "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Such
forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance, or achievements
of the Company to be materially different from any future results, performance
or achievements, expressed or implied by such forward-looking statements.

     Specifically, the Company is dependent upon the success of existing and new
franchised and Company owned stores and alternative distribution outlets; the
success of the Company, its master franchisees and area developers in getting
new stores or other retail locations opened; the ability of the Company and its
master franchisees to attract new qualified franchisees; and such other factors
as competition, commodity pricing and economic conditions.

     The opening and success of Manhattan Bagel Company stores will depend on
various factors, including the availability of suitable store sites and the
negotiation of acceptable lease terms for new locations, the ability of the
Company or its franchisees to obtain construction and other necessary permits in
a timely manner the ability to meet constructions schedules, the financial and
other capabilities of the Company's franchisees and master franchisees, and
general economic and business conditions.

     The Company's success is partially dependent on its ability to attract,
retain and contract with suitable franchisees and the ability of these
franchisees to open and operate their stores successfully.

     The Company's business may also be subject to changes in consumer taste,
national, regional and local economic conditions, demographic trends and the
type, number and location of competing businesses. Competition in the bagel
industry is increasing significantly with an increasing number of national,
regional and local stores competing for franchisees and store locations as well
as customers.

     The Company's future results may also be negatively impacted by future
pricing of the key ingredients for its frozen bagel dough.

     The success of Manhattan Bagel Company units in alternative distribution
locations, including convenience stores, supermarkets, military bases and other
non-traditional locations, will depend, in addition to the factors affecting
traditional franchisee and Company owned stores, on the success of the locations
in which they are located.

     The openings and remodelings of Manhattan Bagel stores, as well as openings
of units within alternative locations, may be subject to potential delays caused
by, among other things, permitting, weather, the delivery of equipment and
materials, and the availability of labor.

                                       2
<PAGE>

                                     PART 1

Item 1.   Description of Business

     Manhattan Bagel Company Inc. ("the Company") manufactures bagel dough and
blends a wide variety of cheese spreads that are distributed to its franchised,
licensed and Company-owned stores. The bagels sold by the stores are first
boiled and then baked in the traditional "New York" style. Since the opening of
the first store in 1987, the Company's retail system has grown to 293 stores as
of December 31, 1996, consisting of 258 franchised and licensed stores and 35
Company-owned and joint-ventured stores in 18 states and Canada.

Market Opportunity

     The consumer food products industry is being shaped by several factors,
including increased consumer demand for healthier food products. Management
believes many American consumers are actively seeking to reduce the fat content
and improve the nutritional content of their diet. A survey has reported that
the single most important factor influencing a buying decision among consumers
who read nutritional labels is fat content. Bagels have a significantly lower
fat content than food alternatives typically purchased for breakfast take-out
such as donuts and pastries, and it is management's belief that consumers
generally consider bagels to be a healthier alternative.

     When Kraft General Foods Inc. purchased Lender's Bagels in 1984 and began
distributing frozen bagels through supermarket chains throughout the United
States, the popularity of bagels began to increase significantly throughout the
country. Bagels are believed to be the fastest growing breakfast food in the
United States and national bagel sales were estimated to be in excess of $2
billion in 1995.

     The bagel industry is primarily comprised of small operators that operate
one or a few stores and larger bagel chains that generally have their bagel
dough produced at each retail location or at independently-operated regional
facilities. See "Competition." As a result, bagel quality can vary from location
to location within these chains. Management of the Company believes that there
is a significant market opportunity for companies able to produce large volumes
of consistent, superior quality bagels and distribute such product nationally
and internationally.

Strategy

     The Company's objective is to become one of the leading producers of fresh
bagels and bagel dough nationally, utilizing the strength of its franchise
stores and brand name to create demand for the Company's products. Key elements
of the Company's strategy include the following:

     Control of Manufacturing and Distribution. The Company places great
emphasis on product quality in both bagels and cheese spreads, which it
believes, together with competitive pricing, is the primary factor in a
consumer's decision to patronize Manhattan Bagel Company stores. The Company
believes that controlling the manufacture and distribution of bagels and cheese
spreads is key to ensuring its product quality and thereby maximizing
profitability. To support this business philosophy and rapid growth, the Company
has continued to expand its 

                                       3
<PAGE>

manufacturing capacity and to make significant improvements in processing
technology and formulations.

     During 1996, the Company opened a new highly automated state-of-the-art
manufacturing facility in its corporate headquarters building in Eatontown, NJ
and a modest manufacturing operation in Calgary, Alberta. In 1997 the Company
expects to significantly increase overall Company manufacturing capability with
the addition of a second production line in Eatontown. The Company is
constructing a new 25,000 sq. ft. distribution facility adjacent to the existing
factory, which is expected to quadruple raw material and finished goods storage.
As a result, the Company's Eatontown production capacity is expected to double.
(See "Bagel Manufacturing and Distribution"). Also, the Company is planning to
construct a new bagel dough manufacturing facility in or around Los Angeles, CA
to service the Company's West Coast stores. This facility is expected to be in
operation in the fourth quarter of 1997. All these changes combined are expected
to provide the Company with the capability of supporting up to 625 stores.

     Increase Sales. The Company intends to increase sales of its products by
expanding its number of stores. To achieve new store growth, the Company will
seek to license experienced area developers to open multiple units within an
exclusive territory; to increase the number of single unit franchisees sold both
directly and through master franchisees; and to accelerate the development of
stores within supermarket chains and other alternate distribution channels. The
total number of stores has increased from four on December 31, 1990 to 293 on
December 31, 1996. The Company had an additional 100 stores in various stages of
development as of December 31, 1996. The Company will continue to seek to
attract experienced retail operators for single unit and multiple unit
franchised development, and to ensure that each franchisee strictly adheres to
the Company's high standards. The Company sold six area development territories
in 1996 for a commitment to develop and open over 100 stores within a three to
four year period. Territories sold include Dallas/Ft. Worth, TX; Lansing, MI;
Morris County, NJ; Center City Philadelphia, PA; Tucson, AZ and Clark County,
NV.

     The Company also implemented a multi-faceted re-imaging program in 1996.
This program included an advertising campaign promoting Manhattan Bagel
Company's bagels as, "America's Most Wanted", employed in radio and print ads.
In addition, the Company created a new corporate logo and new store design
highlighted by a colorful, full length wall mural specially commissioned for the
Company, which will be utilized in all newly constructed stores and elements of
which are being installed in many of the Company's existing franchised and
Company owned stores.

     Alternative Distribution Strategies. The Company believes that marketing
and selling its products in association with national or regional chain stores
or food service providers (co-branding, offers an excellent way to expand the
distribution of its products. Co-branding arrangements may range from
over-the-counter sales of the Company's products by the chain store, in-store
kiosks to display and sell the Company's products or opening a Manhattan Bagel
Company store either, owned or franchised, in association with a chain. The
Company is continuing to develop new types of carts, kiosks and other branded
display formats. The Company believes that its method of manufacturing and
shipping frozen raw bagel dough to retail stores provides the necessary
flexibility and simplicity of operation to expand distribution with a broad
range of retailing environments.

     The Company is pursuing alternative distribution opportunities with strong
regional supermarket chains, major food service contractors that service
non-traditional retail environments, and established food retailers.


                                       4
<PAGE>

     Distribution within supermarkets may include a traditional branded retail
unit which boils and bakes bagels at the store, a reduced sized unit which
produces bagels or non-producing full service kiosks or self-service branded
product cases. The Company currently has agreements with Von's Supermarkets in
California in which four units are open, Kroger's in Georgia and North Carolina
in which three units are open, Clemens Market in Pennsylvania in which two units
are open, Foodtown in New Jersey in which one unit is open and through its
regional master franchisee, HEB in Texas in which eighteen branded cases have
been installed.

     The Company also seeks to expand its distribution through major food
service contractors in non-traditional retail environments, such as college
campuses, military bases, hospitals, airports and convenience stores and food
courts on toll roads. An agreement has been signed with ARAMARK Corp. providing
the Company's franchisees the right to place Manhattan Bagel cases on college
campuses, serviced by ARAMARK. Under this agreement, Manhattan Bagel branded
product cases are currently found at the University of Delaware and at
Westchester State College in Pennsylvania. A license agreement has also been
signed with AAFFES, to operate traditional Manhattan Bagel Company stores and
Kiosks within military bases in the United States and certain other countries.

     Co-branded distribution with other established food retailers is also being
expanded. Co-branded units will consist of a Manhattan Bagel Company store
combined with at least one other compatible brand, sharing one facility with
common seating and preferably common supervision. A Co-branding agreement has
been signed with Ranch 1 Group to develop and operate or franchise others to
operate Manhattan Bagel Company units in Manhattan. This agreement calls for the
development of at least 20 co-branded stores within 4 years. Manhattan Bagel
recently signed a co-branding agreement with Jreck Subs, Inc. to open Manhattan
Bagel units within Jreck Sub shops in central and northeastern New York State.
Eight Jreck shops already have co-branded bagel shops which are being replaced
with Manhattan Bagel Company units. Jreck expects to open an additional 20 units
during the next twelve months.

     The Company is pursuing alternative distribution opportunities with
regional supermarket chains, major food service contractors which service
non-traditional retail environments, and established food retailers as discussed
above. The Manhattan Bagel Company units operated in these alternative
distribution locations are typically operated by the Company's franchisees and
in some cases are secured by the Company's master franchisees. In the case of
established food retailers, the co-venturer may act as a franchisee or its
franchisees may in turn offer a Manhattan Bagel franchise to its franchisees.
The Company typically works out a different franchise fee arrangement in these
types of co-branding situations.

Products

     The Company seeks to provide the consumer with superior quality products,
primarily bagels and cheese spreads, combined with excellent service in a clean
pleasant environment. The Company's bagels are prepared in each store with the
Company's frozen raw bagel dough using a technique which requires the bagel to
be boiled first, then baked, under the Company's quality control guidelines, a
procedure which is believed to be the traditional "New York" style.
Non-producing locations such as branded cases or kiosks are typically provided
with bagels prepared at a local store or commissary.

     In addition, the Company blends and supplies a wide variety of cheese
spreads, including low fat and no fat cheese spreads to substantially all of the
Company-owned and franchised 


                                       5
<PAGE>

stores. The Company purchases plain cream cheese from independent suppliers and
mixes in ingredients at its manufacturing facilities. The Company produces
cheese spreads in seven ounce and one ounce containers.

     The Company manufactures and distributes to its franchisees and
Company-owned stores frozen raw bagel dough from its central manufacturing
facilities. By supplying the franchisees and Company-owned stores with frozen
raw bagel dough and cheese spreads, the Company is able to control the quality
of product sold in the stores. All but three stores purchase frozen raw bagel
dough from the Company. Other benefits realized include an easier and more
efficient operation at the stores; a reduction in the cost of establishing a
franchise outlet; and a reduction in utility costs and labor costs. The bagel
dough is delivered to each store generally by the Company's and or distributors
delivery vehicles.

     In addition to bagels and cheese spreads, Manhattan Bagel Company stores
generally offer coffee, soft drinks, deli meats, salads, muffins and soups.

Bagel Manufacturing and Distribution

     The Company believes that it has developed significant know-how and
technical expertise for manufacturing and freezing mass quantities of raw bagel
dough in variable conditions to produce a high-quality product more commonly
associated with smaller bakeries. The Company believes this system enables
stores to provide all Company customers with consistent, superior products,
thereby helping to build brand name awareness and customer loyalty. The Company
currently operates bagel manufacturing and distribution facilities located in
Eatontown, NJ and Greenville, SC which provide bagel dough to Company-owned and
franchised stores.

     The Company's primary bagel dough manufacturing facility is located at the
Company's headquarters in Eatontown, New Jersey. The facility, which became
operational in April 1996, is currently capable of supplying 150 stores at
current store sale levels. This highly automated, state-of-the-art facility was
originally built with the ability to expand its capacity by adding a new
production line. In 1996, the new line was added which has become operational,
pending the completion of a new 25,000 square foot distribution facility being
constructed adjacent to the manufacturing facility. The new distribution
facility is expected to quadruple raw material and finished good storage
capacity which is necessary to support the product to be produced when the new
line is operational. When fully operational, the manufacturing facility will be
capable of supplying 300 stores at current store sales levels.

     The Company also continues to operate its original Eatontown facility which
was expanded in 1994 and 1995 and is currently capable of supplying 100 stores
at current store sales levels. The Company's lease for this facility extends
through December 1997 and the Company does not have an option to renew it.

     The Company's bagel manufacturing facility located in Greenville, South
Carolina, became operational in July 1995 and has the capacity to supply 100
stores at current store sales levels. It supplies the Company's franchised
stores in the Southeastern territory of the United States, including stores in
Florida, Georgia, North Carolina, South Carolina, Virginia and Arkansas.

     During the third quarter of 1996, the Company opened a modest bagel and
cheese manufacturing facility in Alberta, Calgary. Distribution in Canada has
been handled by an outside distribution company.


                                       6
<PAGE>

     The Company had previously announced that it intends to construct a new
bagel and cheese spread manufacturing facility in the metropolitan Los Angeles,
CA area which will also provide offices for the Company's West Coast operations.

     The Company's products are typically delivered by truck directly from the
manufacturing facility to the store. The Company has determined that in certain
regions, because of the distance of stores from the manufacturing facility, it
is more efficient to deliver bagel dough and cheese spreads to a local
distribution facility having adequate freezer facilities, from which products
are delivered to the stores. The Company has established manufacturing and
distribution facilities in Greenville, SC and Calgary, Alberta, CN; and
additional distribution facilities in Richmond, VA; Los Angeles, CA; Longwood,
FL; West Hartford, CT and Houston, TX.

     The Company generally seeks to operate a bagel manufacturing facility to
serve stores within a distance considered to be manageable for the Company's
trucks to make regular deliveries to stores or distribution facilities. As the
Company expands its distribution network by adding franchised and Company-owned
stores, it continually evaluates the relative cost effectiveness of delivering
products to stores within a particular region from existing manufacturing plants
versus delivering to distribution facilities or establishing new manufacturing
facilities. As store density, sales volume and the geographic scope of
distribution expands, the Company expects to open additional regional bagel
manufacturing plants.

Franchising

     The Company offers both single unit and multi-unit franchises throughout
the United States. The Company is currently legally permitted to offer
franchises in over 40 states. The Company offers franchises both directly by the
Company and through master franchisees. The Company has sold master franchise
rights for six territories in the United States and the master rights to
Canada.

     The Company attempts to attract single and multiple unit franchisees that
are committed to the Company's high standards of product quality and customer
service. All franchisees are required to operate their stores in accordance with
the guidelines and standards detailed in the Company's operations manual. The
Company conducts regular inspections of franchise stores to determine whether
the stores meet applicable standards, and works with franchisees to improve
substandard performance. The Company is also attempting to attract area
developers with multi-unit retail experience and the organizational and
financial resources to develop and operate multiple units within an exclusive
territory on a reasonably aggressive time schedule. Five area development
territories were sold in 1996 for a commitment to open over 100 units over the
next three to four years.

     Current franchise agreements provide for payment of an initial franchise
for traditional producing stores of $30,000 with lesser fees for additional
traditional or alternative units. Current franchise agreements also provide for
a weekly 5% royalty of gross sales (exclusive of sales tax) and a monthly
contribution to a national advertising fund ranging from .5% to 4.0% of gross
sales (the current contribution) depending when the franchise was sold.
Franchise agreements provide each franchisee with an area of exclusivity, which
allows only that franchisee to open additional units in that area of
exclusivity. Although an area of exclusivity is generally irregularly shaped, it
may range from 1 to 2 blocks in a dense city to approximately 2 to 3 miles in
suburban locations, and is determined by the primary population base and
activity generator sites, which support the location. Exceptions to the area of
exclusivity may include non-traditional distribution opportunities and
supermarkets. The franchise agreement term runs concurrent with the lease term.
In the 


                                       7
<PAGE>

past, the Company has signed the majority of the leases as lessee and subleased
the store to the franchisee. Each franchise agreement provides the right to
renew the franchise, at no additional cost, if the lease term is renewed. While
costs including initial franchise fee, cost of construction, equipment and other
start-up expenses vary by location and type of store, such costs usually range
from $175,000 to $250,000. It typically takes six to eight months from the
signing of a franchise agreement to the opening of the store.

     In certain instances the Company has become a joint venture partner in a
franchise in return for providing funds for the start-up costs of the Manhattan
Bagel store. The Company is currently a joint venture partner in three
franchises. The Company may also operate stores opened in a new location and
stores repurchased from franchise owners (where the Company believes a change of
ownership is beneficial). At December 31, 1996 the Company was operating 32
stores and intends to sell the majority of these stores to franchise owners in
1997.

     The Company has the right to terminate a franchise agreement for a variety
of reasons, including a franchisee's failure to make payments when due or
failure to adhere to the Company's policies and standards. Many state franchise
laws limit the ability of a franchisor to terminate or refuse to renew a
franchise. See "Government Regulation."

Field Support/Marketing

     The Company provides field support services to its franchisees to help
franchisees maximize business and financial management, acquire local market
area penetration, maintain quality control and customer service excellence, stay
abreast of new product developments and to allow the franchisees the opportunity
to share new business ideas with the Company and provide advertising services.
See "Advertising."

     Prior to opening a new store, all franchisees go through Bagel University,
a two-week training program run each month by the Company which includes one
week of classroom training in marketing, administrative record keeping, and
inventory control, and one week of training in baking and food preparation. This
program is also available to employees of franchisees. The Company has an 1,100
square foot fully equiped store located inside Company headquarters which serves
as an operational training center. The Company also provides on-site personnel
for each store's grand opening. After a store opens, the Company's regional
franchise consultants monitor operational results, visit stores for on-site
consultation and provide advice based on the experience of other franchisees.
Management of the Company reviews franchise store sales weekly and attempts to
provide operational assistance as necessary.

Master Franchises

     The Company has pursued a strategy of developing new territories through
the sale of master franchises. The Company has sold master franchises in the
following areas: a territory consisting of the states of North Carolina, South
Carolina and Georgia; a territory consisting of the states of Maryland, Virginia
and the District of Columbia; a territory consisting of the state of Florida; a
territory consisting of western New York, Erie, Pennsylvania, and southern Ohio;
a territory in Texas consisting of Austin, San Antonio and El Paso; a territory
in northern California consisting of Sacramento, San Francisco and San Jose; and
a territory consisting of Canada.


                                       8
<PAGE>

     A master franchisee is responsible for selling franchises, finding
locations, negotiating leases, supervising the design and building of new
stores, training franchisees and supervising them after the locations are
opened, all in accordance with Company's quality control guidelines. The Company
retains the right to supply the bagel dough and cheese spreads to franchisees of
the master franchisee.

     Current master franchise agreements provide for a payment by the master
franchisee which is based on the population of the territory covered by such
master franchise. Master franchise fees are generally calculated based on a
negotiated rate per person in that territory. The master franchisee is
responsible for collecting the initial franchise fee and royalties from each
franchisee in its territory. As part of the master franchise agreement, the
master franchisee retains two-thirds of the initial franchise fee and royalties
payable by the individual franchisees in the master franchisee's territory, and
remits to the Company one-third of such amounts.

     The master franchise agreement requires the master franchisee to secure the
lease for the individual franchisees in the name of the master franchisee. If
required by a landlord, the Company has signed the leases as an accommodation to
a master franchisee, in which event the Company has received the guarantee of
its master franchisee.

     Master franchisees have minimum franchise sales requirements to maintain
their exclusive rights in their respective territories. Those master franchisees
with territories that are part of a state, are required to sell a minimum of
three franchises a year for ten years in order to maintain their exclusive
rights. Those master franchisees with territories equal to a state or multiple
states, must sell six franchises per year for ten years to maintain their
exclusive rights.

     In March 1996, two master franchises were sold. The first master was sold
the rights in Texas for Austin, San Antonio and El Paso, while the second master
was sold the rights in northern California.

Area Developers

     The Company also seeks to franchise exclusive territories to experienced
multi-unit retail operators, preferably with food service experience. Area
developers have the financial and organizational resources to rapidly develop
and operate Manhattan Bagel stores in a given geographic area. Area development
agreements have been sold in Dallas/Ft. Worth, TX; Lansing, MI; Morris County,
NJ; Tucson, AZ; Center City, Philadelphia, PA and Clark County, NV.

     Area developers are granted limited exclusivity to develop and operate
stores within a predetermined geographic area. Limits to exclusivity include
supermarket distribution and non-traditional retail opportunities. To maintain
development rights developers must open units in accordance with a predetermined
schedule, meet all financial obligations to the Company and operate stores
within established operating standards.

Leasing/Construction of Stores

     The Company has historically leased free standing space, as well as, space
in convenience centers, neighborhood shopping centers, community shopping
centers, and dense urban areas and subsequently sub-leased the space to its
franchisees at the same terms and conditions of the prime lease. The subleases
may be terminated in the event that the franchisee defaults under the prime
lease, the prime lease is canceled or terminated, or the franchise agreement is
terminated.


                                       9
<PAGE>

     Locations leased by the Company are typically leased "triple net," and
require the Company to pay its proportionate share of real estate taxes,
maintenance and insurance costs and, in some cases, additional rent as a
percentage of sales in excess of negotiated amounts. All of the above charges
are due from the franchisees under the sub-lease agreement. Generally, the
Company leases space for initial terms of ten years and attempts to negotiate
for options to renew. The rent for the existing Manhattan Bagel Company stores
range from $1,200 to $7,000 per month.

     The Company designs the store and submits the plans to the franchisee and
landlord for approval, and then to required officials, for construction permits.
The franchisee may then utilize the Company to complete the construction of the
store at an additional cost, or may engage other contractors.

     The Company has on occasion helped to finance the construction of a new
Manhattan Bagel Company store either through loans to a franchisee or by
becoming a joint venture partner in a franchise in return for providing such
financing. The Company anticipates, that in limited circumstances, it will
continue to provide such financing in the form of loans to franchisees. At times
the Company may construct stores where there is an available site and then
franchise the location.

     In April 1997, the Company announced that Global Alliance Finance Company,
LLC (GAFCO), a wholly owned subsidiary of Deutsche Bank North America, has
agreed to provide, on a case-by-case basis, the lending of up to $50 million per
year, chainwide, in franchise financing to qualified applicants. The GAFCO
program is targeted at multi-unit operators from other franchise systems who
plan to open new Manhattan Bagel stores or acquire existing locations. The
Company believes that the new financing program will assist it in attracting new
area developers.


                                       10
<PAGE>

Store Locations

     The following table sets forth by location the number of Company-owned,
franchised and licensed stores as of December 31, 1996.

                                 STORE LOCATIONS

<TABLE>
<CAPTION>
                                        1996 STORES OPEN                                       1997 STORES IN 
                                                                                               DEVELOPMENT
<S>                                  <C>            <C>             <C>              <C>             <C>            <C>
STATE                             Company       Franchised          Total           Company      Franchised      Total
New Jersey                            2              49              51               5              14              19
Pennsylvania                          3              45              48               1              14              15
California                           25              14              39               3               8              11
New York                              2              24              26               2               9              11
Florida                               0              22              22               0               7               7
Virginia                              0              18              18               0               3               3
Ohio                                  2              15              17               7               3              10
Georgia                               0              15              15               0               4               4
Connecticut                           0              14              14               0               0               0
North Carolina                        0              13              13               0               0               0
Canada                                0               8               8               0               0               0
Texas                                 0               7               7               0               8               8
Delaware                              0               5               5               0               0               0
Arizona                               0               3               3               0               2               2
Massachusetts                         1               2               3               0               1               1
Maryland/DC                           0               2               2               0               1               1
Rhode Island                          0               1               1               0               0               0
South Carolina                        0               1               1               0               1               1
Arkansas                              0               0               0               0               3               3
Nevada                                0               0               0               0               1               1
Michigan                              0               0               0               0               3               3
                                      -               -               -               -               -               -

TOTAL                                35             258             293              18              82             100
                                     ==             ===             ===              ==              ==             ===
</TABLE>

     The number of franchised and licensed stores in development represent
locations for which the Company has executed franchise agreements or signed
leases. While historically few franchisees that have reached this stage of
development fail to commence operations, no assurance can be given that all such
stores will ultimately open.

Acquisitions

     On June 29, 1995, the Company acquired I&J Bagels Inc. I&J was a private
company which owned and licensed a total of 17 bagel bakery stores in the Los
Angeles area operating under the name of I & Joy Bagels. The Company completed
the acquisition through the merging of a newly created, wholly-owned subsidiary
of the Company with DAB, whose sole asset is all of the 


                                       11
<PAGE>

stock of I&J, in exchange for 1,500,000 shares of Common Stock of the Company.
Accordingly, the audited consolidated financial statements for periods prior to
June 29, 1995 have been restated to include the accounts and results of
operations of I&J for all the periods presented. The costs associated with this
acquisition, primarily legal, accounting and consulting services were charged
against earnings in the second quarter of 1995.

     On January 9, 1996, the Company completed the acquisition of Bay Area
Bagels, Inc., a private company which owned eight bagel bakery stores in the San
Francisco Area. The purchase price was 65,500 shares of Common stock of the
Company and $85,000. The transaction was treated as a purchase for accounting
purposes.

     On January 17, 1996, the Company completed the acquisition of three stores
in the Los Angeles market, which were licensed locations of I&J Bagels, Inc.
Such stores are being operated as company owned locations. The purchase price
was $1,500,000 and was treated as a purchase for accounting purchases.

     On May 22, 1996, the Company completed the acquisition of Specialty
Bakeries, Inc. ("SBI") a private company which owned and franchised a total of
23 bagel bakery stores in the Southern New Jersey and Philadelphia areas
operating under the name Bagel Builders. The Company completed the acquisition
through the merging of a newly created, wholly owned subsidiary of the Company
with and into SBI and 132,500 shares of common stock of the Company were issued
to the shareholders of SBI. This transaction is being accounted for as a pooling
of interests.

     On June 28, 1996, the Company completed a transaction under which it added
23 Bagel Brothers stores (including two under development) to its franchise
network. Under terms of the agreement, the Company purchased the Bagel Brothers
bagel dough factories in Cleveland and Buffalo for $2,000,000 and 50,000 shares
of the Company's common stock. This transaction was treated as a purchase for
accounting purposes. Additionally, the Company provided Bagel Brothers with
$6,000,000 in financing, which, among other things, provided funds to retire
existing loans, to pay franchise fees, and to remodel the 21 operating stores.
The Company has the right to convert the loan to equity should certain profit
targets be met.

Trademarks and Service Marks

     The Company's Manhattan Bagel (TM) is registered with the United States
Patent and Trademark Office, the mark is licensed to franchisees pursuant to the
franchise agreements.

     The Company's "Manhattan Bagel" name and Service Mark suggest an
association with New York City, which is the place the Company believes is most
often associated with quality bagels. Similarly, the Company's depiction of a
skyline is intended to invoke a similar association and maintain a recognizable
image in the customer's eyes.

     The Company is aware of a number of companies which use various
combinations of the words "Manhattan" and "Bagel" in their names, some of which
may have senior rights to the Company for such use, but none of which, either
individually or in the aggregate, are considered to materially impair the use by
the Company of its Service Mark. The Company considers its intellectual property
rights to be material to its business and intends to actively defend and enforce
them.


                                       12
<PAGE>

Competition

     The Company competes against well established food service companies with
greater product and name recognition and with larger financial, marketing and
distribution capabilities than the Company's, as well as with innumerable local
food establishments that offer similar products. The food service industry in
general, and the take-out sector in particular, are intensely competitive with
respect to food quality, concept, location, service and price.

     The bagel industry is highly fragmented and has traditionally been
dominated by "mom and pop" operators, which creates a unique growth opportunity
for the Company's expansion. In addition, there are a growing number of
national, regional and local chains, operating both owned and franchised bagel
stores. The Company believes that its most direct competitors are Einstein
Brothers Bagel, Inc. ("Einstein Brothers"), Bruegger's Corporation
("Bruegger's"), Chesapeake Bagels ("Chesapeake") and Big Apple Bagels ("Big
Apple"). Einstein Brothers' retail system consists of over 300 owned and
franchised stores. Bruegger's owns and operates 100 retail bagel bakeries with
over 300 bakeries franchised. Chesapeake has approximately 150 units in
operation. Big Apple has approximately 144 units in operation.

     Recently, the bagel industry has witnessed both rapid expansion and entry
from large companies not traditionally in the bagel industry. Boston Chicken,
Inc. provided a convertible loan to Einstein Brothers, which under certain
conditions can be converted into a majority equity interest in Einstein
Brothers. Further, Einstein Brothers recently acquired Noah's New York Bagels, a
West Coast chain consisting of approximately 40 stores. Quality Dining Inc.
acquired Bruegger's. Dunkin Donuts now offers freshly baked bagels in their
system.

     There are several other regional bagel chains with under 100 units, all of
which may be expected to compete with the Company, including Bon Jour Bagel Cafe
and All American Food Group Inc. In addition, the Company believes that the
start-up costs associated with opening a retail food establishment offering
similar products on a stand-alone basis are competitive with the start-up costs
associated with commencing a Manhattan Bagel Company store and accordingly, such
start-up costs are not an impediment to entry into the retail bagel business.

Advertising

     The Company presently advertises and plans to continue advertising its
franchises in current stores, franchise trade shows, newspapers and business
opportunity magazines.

     The Company and its franchisees also advertise products in newspapers,
through direct mailing and on radio and television. Advertising is primarily
funded out of the required contribution to the Company's regional advertising
co-operative by franchisees. The Company's "Co-operative Advertising" program
provides advertising support in the form of recommended advertisements,
advertising mats, community cash back programs, gift certificates, "Dozen Club",
direct mail and focused local store marketing programs. In 1996, the Company
used co-operative advertising funds to air a television commercial in selected
New York, Pennsylvania and Connecticut area markets on network television
channels.

     The Company implemented a multi-faceted re-imaging program in 1996. This
program included an advertising campaign promoting Manhattan Bagel Company's
bagels as, "America's Most Wanted", employed in radio and print ads. In
addition, the Company created a new corporate logo and new store design
highlighted by a colorful, full length wall mural specially commissioned for
Manhattan Bagel, which will be utilized in all newly constructed stores and


                                       13
<PAGE>

elements of which are being installed in many of the Company's existing
franchised and Company owned stores.

Government Regulation

     The Company and its franchisees are required to comply with federal, state,
and local government regulations applicable to consumer food service businesses
generally, including those relating to the preparation and sale of food, minimum
wage requirements, overtime, working and safety conditions, and citizenship
requirements, as well as regulations relating to zoning, construction, health,
business licensing and employment. The Company believes that it and its master
franchisees and franchisees are in material compliance with these provisions.
Continued compliance with this broad federal, state and local regulatory network
is essential and costly and the failure to comply with such regulations may have
an adverse effect on the Company and its franchisees.

     The Company's operations are subject to regulation by the Federal Trade
Commission ("FTC") in compliance with the FTC's rule entitled Disclosure
Requirements and Prohibitions Concerning Franchising and Business Opportunity
Ventures, which requires, among other things, that the Company prepare and
update periodically a comprehensive disclosure document, known as the Uniform
Franchise Offering Circular ("UFOC"), in connection with the sale and operation
of its franchises. In addition, some states require a franchisor to register its
franchise with the state before it may offer the franchise. The Company believes
that its UFOC, together with any applicable state versions or supplements,
complies with both the FTC guidelines and all applicable state laws regulating
franchising in those states in which it has offered franchises.

     In addition to the rules governing the offer and sale of franchises, the
Company is also subject to a number of state laws, as well as foreign laws (to
the extent it offers franchises outside of the United States), that regulate
substantive aspects of the franchisor-franchisee relationship, including, but
not limited to, those concerning termination and non-renewal. Currently, 18
states, the District of Columbia, Puerto Rico and the Virgin Islands, have
Franchise Termination and Non-Renewal Laws. These laws govern the termination
and/or non-renewal of the franchise agreement and, by and large, require the
franchisor to have good cause, reasonable cause or just cause in order to
terminate the franchise agreement or not to renew the franchise agreement. In
addition, some of these laws provide for longer cure periods than which
currently exist in the Company's franchise agreement.

     Each store will be subject to regulation by federal agencies and to
licensing and regulation by state and local health, sanitation, safety, fire and
other departments. Difficulties or failures in obtaining the required licenses
or approvals could delay or prevent the opening of a new store. The Company
believes that it is in substantial compliance with the applicable laws and
regulations governing its operations.

     While the Company intends to comply with all federal, state and foreign
laws and regulations, there can be no assurance that it will continue to meet
the requirements of such laws and regulations, which, in turn, could result in a
withdrawal of approval to franchise in one or more jurisdictions. Any such loss
of approval would have a material adverse effect upon the Company's ability to
successfully market its franchises. Violations of franchising laws and/or state
laws and regulations regulating substantive aspects of doing business in a
particular state could subject the Company and its affiliates to rescission
offers, monetary damages, penalties, imprisonment and/or injunctive proceedings.
The state laws and regulations concerning termination and non-renewal of
franchisees are not expected to have a material impact on the Company's
operations. In addition,


                                       14
<PAGE>

under court decisions in certain states absolute vicarious liability may be
imposed upon franchisors based upon claims made against franchisees. Even if the
Company is able to obtain coverage for such claims, there can be no assurance
that such insurance will be sufficient to cover potential claims against the
Company. Further, there can be no assurance that existing or future franchise
regulations will not have an adverse effect on the Company's ability to expand
its franchise program.

Employees

     At December 31, 1996, the Company had 572 employees. The Company has never
experienced a work stoppage and no employees are represented by any labor union.
The Company believes that its employee relations are good.

Item 2.   Description of Property.

     The Company's headquarters are located at 246 Industrial Way West,
Eatontown, New Jersey 07724. The premises originally included 37,358 square feet
of which approximately 13,158 feet are for offices and 24,200 square feet are
for a manufacturing facility. Bagel University is also housed at the facility,
which includes a fully operational Manhattan Bagel Company store. During 1996
and early 1997, the Company entered into additional leases bringing the total to
68,194 square feet. The new space will be split approximately one-third office
and administrative space and two-thirds manufacturing space. The lease was
further modified to add an additional 32,493 sq. ft. of manufacturing space to
be constructed by the landlord. All of the leases have been rewritten to provide
for a similar term, which ends on January 31, 2005 and on January 31, 2015 if
two five year options to extend the term are exercised.

     The Company's original bagel manufacturing facility was located at 15
Meridian Road, Eatontown, New Jersey. The Company has a five-year lease for the
11,350 square foot facility, which previously combined the executive offices
with the factory operations. The lease began on November 15, 1992, and expires
on December 31, 1997. The Company does not have an option to renew the lease,
and the Company is utilizing this facility until the expiration of the lease.

     The Company owns and operates a 12,500 square foot manufacturing facility
to serve the southeast region on a 1.45 acre parcel of land in Greenville, South
Carolina, became operational in July 1995.

     The Company's third facility is located in Los Angeles, California and was
acquired as part of the acquisition of I&Joy Bagels, in June 1995. It has been
converted to a distribution facility with the manufacturing of bagels being
performed in the New Jersey facility, until a new space in San Fernando,
California is constructed and opened. The lease for the 10,844 square foot
facility commenced in September 1994 and has a term which extends through March
31, 2001. I&J has two five-year options to extend this lease through March 31,
2011 and an option to expand the leased space.

Item 3.   Legal Proceedings.

     On June 20, 1996, the Company announced that following the installation of
new management at its I&J West Coast subsidiary. The Company had uncovered
certain improper bookkeeping and accounting practices at the Los Angeles
subsidiary, that it would be restating its 


                                       15
<PAGE>

first quarter 1996 statement of operations to account for these improper
practices. As a result, the Board of Directors of the Company authorized a full
investigation into the accounting practices at the Los Angeles subsidiary and
retained special counsel to assist in the investigation. Based on the conclusion
of that investigation, the Company restated its first quarter 1996 statement of
operations to reduce revenues $90,000 and record additional expenses of
$290,000.

     On the day following the announcement, the stock price of the Company's
Common Stock declined from a closing price of $21.25 on June 20, 1996 to a
closing price of $13.75 on June 21, 1996. As a result, certain class action
lawsuits have been filed claiming violation of the Federal securities laws,
specifically Rule 10b-5 under the Securities Exchange Act of 1934. These
lawsuits from New Jersey and California have now been consolidated into one
class action lawsuit in the Federal District Court in New Jersey. Roger
Copeland, Henry A. Billetet, Soo May Lee & David Y. Lee v. Jack Grumet, Leonard
Johnson, Manhattan Bagel Company, Inc., Eric Cano, Jason Gennusa, Andrew
Gennusa, Allan Boren and Debbie Boren, United States District Court, District of
New Jersey, Master File No. 96-CV-3351 (MLP) (consolidated). There also remains
an additional action filed under California State law and removed to the Federal
Court in New Jersey purporting to be on behalf of a class of plaintiffs, the
status of which in relation to the class action lawsuits referred to above is
unsettled. Christine Overend v. Manhattan Bagel, Co., Inc., et al., Jack Grumet
and Leonard Johnson, United States District Court, District of New Jersey, No.
96-CV-5900(MLP). The plaintiffs in these actions seek unspecified money damages.
The Company has filed a motion to dismiss the actions and all discovery has been
stayed pending the resolution of this motion. Although the Company believes it
has acted properly and has adequate defenses to such actions, no assessment of
the amount or range of any loss that might be incurred by, or the effects
thereof on, the Company should it be found to have violated any law, can be made
at this time. In addition, no estimates can reasonably be made at this time of
the costs of defense of the actions.

Other Litigation

     The Company is a defendant in a lawsuit recently filed by Jeffrey Boren,
Rochelle Boren and the trustees of the JMB Irrevocable Trust. Jeffrey Boren,
Rochell Boren, Stephen Boren, as Trustee of the B Irrevocable Trust, dated June
4, 1979; and Naphtalie Deutsch, as Trustee of the JMB Irrevocable Trust, dated
June 4, 1979 v. Manhattan Bagel Company, Inc., United States District Court for
the Central District of California, Case No. CV97-0276-RAP (ANX).The Plaintiffs
claim that the Company failed to comply with contractual obligations under the
Agreement and Plan of Merger dated as of May 10, 1995, as amended, by and
between the Company, DAB Acquisition Corp., DAB Industries, Inc. and Allan
Boren, with respect to the obligations of the Company to register shares owned
by the Plaintiffs for public sale by them. The Plaintiffs are seeking damages in
unspecified amounts. The Company is defending the claim, and is unable to assess
the effect on the financial condition of the Company should there be an adverse
determination of this lawsuit.

ALMEG Inc. v. Manhattan Bagel Company, Inc. (United States District Court, for
the Central District of California, Case No. CV-96-9046) In December 1996,
Plaintiff brought suit alleging breach of contract, breach of fiduciary duty and
other alleged defaults under a license agreement signed December 15, 1995
between Plaintiff's assignor and I&J Bagel, Inc., a subsidiary of the Company. A
motion to dismiss has been filed by the Company alleging as to certain counts a
failure to state a claim upon which relief can be granted and other counts that
the main Defendant, the Company has no obligations to this Plaintiff. This
motion is pending.


                                       16
<PAGE>

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

     None

                                     PART II


Item 5.     Market for Common Equity and Related Stockholder Matters.

     The Company's Common Stock is quoted on the Nasdaq National Market under
the symbol "BGLS." Prior to October 3, 1995 the Company's Common Stock was
listed on the Nasdaq Small Cap Market under the same symbol. The following table
sets forth, for the quarters indicated, the high and low bid prices of these
securities on the Nasdaq Small Cap Market and the high and low sale prices on
the Nasdaq National Market after October 3, 1995.

                                                       High                Low

Year Ended December 31, 1995:
  First Quarter.................................. $  13                  $ 6 1/2
  Second Quarter.................................    16 3/8               12 7/8
  Third Quarter..................................    15 1/2               11 7/8
  Fourth Quarter*................................    22 7/8               12 1/2

Year Ended December 31, 1996:
   First Quarter................................. $  25 1/2              $14 7/8
   Second Quarter................................    29 1/2               11
   Third Quarter.................................    16                    9 3/8
   Fourth Quarter................................    12 1/2                6 3/8

Year Ended December 31, 1997
   First Quarter................................. $  9 1/4               $5 7/16
   Second Quarter................................    6 1/8                5 1/4

* For October 2 and 3, 1995, the high and low bid prices of the Common Stock on
the Nasdaq Small Cap Market were $13 1/4 and $12 1/2 respectively.

     The quotations in the above table reflect inter-dealer prices without
retail markups, markdowns or commissions. In addition, for all periods prior to
October 3, 1995, the quotations do not represent actual transactions.

     As of April 11, 1997, there were approximately 480 shareholders of record
and 8,683 beneficial shareholders of the Company's Common Stock.

 Dividend Policy

     The Company has not paid any dividends since its inception and for the
foreseeable future intends to follow a policy of retaining all of its earnings,
if any, to finance the development and 


                                       17
<PAGE>

continued expansion of its business. There can be no assurance that dividends
will ever be paid by the Company. Additionally, under the terms of its letter of
credit arrangements with First Union National Bank (formerly First Fidelity
Bank, N.A.), the Company is prohibited from paying dividends. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources." Any future determination as to payment of
dividends will depend upon the Company's financial condition, results of
operations and such other factors as the Board of Directors deems relevant.

Item 6.  Management's Discussion and Analysis of Financial Condition and
         Results of Operations

     The following discussion and analysis should be read in conjunction with
the Company's Consolidated Financial Statements and related notes thereto
appearing elsewhere in this document.

General

     On June 29, 1995, the Company acquired I&J Bagels Inc. I&J was a private
company which owned and licensed a total of 17 bagel bakery stores in the Los
Angeles area operating under the name of I & Joy Bagels. The Company completed
the acquisition through the merging of a newly created, wholly-owned subsidiary
of the Company with DAB, whose sole asset is all of the stock of I&J, in
exchange for 1,500,000 shares of Common Stock of the Company. Accordingly, the
audited consolidated financial statements for periods prior to June 29, 1995
have been restated to include the accounts and results of operations of I&J for
all the periods presented. The costs associated with this acquisition, primarily
legal, accounting and consulting services were charged against earnings in the
second quarter of 1995.

     On January 9, 1996, the Company completed the acquisition of Bay Area
Bagels, Inc., a private company which owned eight bagel bakery stores in the San
Francisco Area. The purchase price was 65,500 shares of Common stock of the
Company and $85,000. The transaction was treated as a purchase for accounting
purposes. The Company made a determination that the eight Holey Bagel stores in
San Francisco acquired in January 1996 will be either franchised, sold or closed
by the end of the first half of 1997. Accordingly, the Company has written off
the goodwill and written down the assets associated with stores to their net
realizable value, which write-offs of $2.3 million are included in the
write-down of investments of $3.0 million.

     On January 17, 1996, the Company completed the acquisition of three stores
in the Los Angeles market, which were licensed locations of I&J Bagels, Inc.
Such stores are being operated as company owned locations. The purchase price
was $1,500,000 and was treated as a purchase for accounting purchases.

     On May 22, 1996, the Company completed the acquisition of Specialty
Bakeries, Inc. ("SBI") a private company which owned and franchised a total of
23 bagel bakery stores in the Southern New Jersey and Philadelphia areas
operating under the name Bagel Builders. The Company completed the acquisition
through the merging of a newly created, wholly owned subsidiary of the Company
with and into SBI and 132,500 shares of common stock of the Company were issued
to the shareholders of SBI. This transaction is being accounted for as a pooling
of interests.

     On June 28, 1996, the Company completed a transaction under which it added
23 Bagel Brothers stores (including two under development) to its franchise
network. Under terms of the 


                                       18
<PAGE>

agreement, the Company purchased the Bagel Brothers bagel dough factories in
Cleveland and Buffalo for $2,000,000 and 50,000 shares of the Company's common
stock. This transaction was treated as a purchase for accounting purposes.
Additionally, the Company provided Bagel Brothers with $6,000,000 in financing,
which, among other things, provided funds to retire existing loans, to pay
franchise fees, and to remodel the 21 operating stores. The Company has the
right to convert the loan to equity should certain profit targets be met.

     Following the installation of new management at its I&J West Coast
subsidiary and subsequent to the Company's filing of its first quarter 10-QSB,
the Company uncovered certain improper bookkeeping and accounting practices at
the Los Angeles subsidiary. As a result, the Board of Directors authorized a
full investigation into the accounting practices at the subsidiary and retained
special counsel to assist in the investigation. Based on the conclusion of that
investigation, the Company has restated its first quarter 1996 Statement of
Operations to reduce revenues $90,000 and record additional expenses of
$290,000. Such adjustments are reflected in the financial statements for the
year ended December 31, 1996. On the day following the announcement, the
Company's common stock declined from a closing price of $21.25 on June 20, 1996
to a closing price of $13.75 on June 21, 1996. As a result, certain class action
law suits have been filed. The Company believes it has acted properly and has
adequate defenses to such actions. Accordingly, no provisions for these
contingencies have been made. Certain costs of defense of these actions have
been included in the non-recurring charge. See Note 15, Notes to the
Consolidated Financial Statements. This non-recurring charge substantially
effects the comparability of the results of operations.

     The Company's completed review of its West Coast operations led to
Management's determination to record a write-down of its investments of $3.0
million relating to such operations. As a result of this review, Management
concluded that in the wake of escalating product demand from the growing store
base, the quality of the bagel dough being produced in the Los Angeles
manufacturing plant was not up to the Company's current standards. Rather than
compromise on quality, during 1996 the Company elected to shut down the plant
and to reopen its plant on Meridian Road in Eatontown, New Jersey, and to supply
bagels to the West Coast from this facility. Approximately, $700,000 of the
$3,010,000 write-down relating to the West Coast operations were the result of
the write-down of machinery, equipment and the leasehold improvements at the Los
Angeles plant.

     On September 30, 1996, the Company entered into an Area Developer Franchise
Agreement with Franchise Concepts, Inc. ("Franchise Concepts") for the Borough
of Manhattan, New York, NY. The initial franchise fee associated with the
agreement is $300,000 which represents a $15,000 fee for each of the first 20
units. Additional franchise fees for each unit after 20 are $15,000 per unit.

     On November 18, 1996, the Company entered into a loan agreement with
Franchise Concepts and Ranch 1 Group, Inc., Ome, Inc. and Dome Enterprises, Inc.
Ranch 1 and Ome are wholly-owned subsidiaries of Franchise Concepts. Dome is a
wholly-owned subsidiary of Ranch 1. They operate fast food restaurants in New
York City which specialize in grilled chicken sandwiches under the name Ranch 1.
Ranch 1 is also a franchisor of restaurants to other operators. The Company
loaned $1,500,000 to Franchise Concepts, the proceeds of the loan were to be
used for expansion and the acquisition of bagel baking equipment for existing
stores.

     In connection by the execution of the Loan Agreement the Company was issued
shares of common stock of Franchise Concepts equal to 5% of the then issued and
outstanding common stock.


                                       19
<PAGE>

Results of Operations

     The total number of operating Manhattan Bagel Company stores has increased
from four at December 31, 1990 to 293 at December 31, 1996.

     The following total number of stores were open and operating on the
following dates:

       December 31, 1990........................................          4
       December 31, 1991........................................         11
       December 31, 1992........................................         27
       December 31, 1993........................................         41
       December 31, 1994........................................         73
       December 31, 1995........................................        152
       December 31, 1996........................................        293

     In addition, on December 31, 1996, the Company had 100 additional stores in
various stages of development.

     The rapid expansion significantly affects the comparability of results of
operations in several ways. Total royalty income and frozen raw bagel dough
sales rise significantly as new franchised and licensed stores open. New store
revenues are not usually as high in the first periods following opening as they
are in later periods as evidenced by the same store sales increases discussed
below. Total expenses have also risen significantly as the Company expanded its
corporate infrastructure. The number of employees as of December 31, 1996 was
617, while the number of employees as of December 31, 1995 was 389. The increase
was primarily due to an increase in the number of Company owned stores, an
increase in manufacturing and production personnel and an increase in
administrative personnel.

     The Company has also granted several master franchises. Under the terms of
the master franchise agreement, a master franchisee is required to pay the
Company an initial fee based on the population of the territory covered by such
master franchise. The granting of new master franchises and the payment of the
initial fees also affects the comparability of results to prior periods.

     The Company also grants area development rights. Under the terms of the
area development agreements, the area developer is required to pay the Company
an initial fee based on the number of stores to be developed within a specified
time period. The granting of new area development rights and the payment of
initial fees also affects the comparability of results to prior periods.

     The Company's revenues are primarily derived from the sale of frozen raw
bagel dough and cheese spreads to franchisees and licensees, retail and
wholesale sale of products by the Company-owned stores, and royalties, franchise
and license fees, including master franchise fees, and area developer fees. The
percentage of revenues derived from product sales to total sales for the year
ended December 31, 1996 was 77.5% compared to 76.2% in 1995.

     For the comparative year ended December 31, 1996 and December 31, 1995,
same store retail sales as reported by the Company's bagel franchisees (which
are unaudited), increased 3.4%, and total sales rose from $40.2 million in the
previous 53 week year to $86.2 million during the 52 week ended December 31,
1996, an increase of $46.0 million or 114.4%. Excluding the additional week from
1995, chainwide sales rose 118.2%, with same-store sales for Manhattan Bagel
franchised units increasing 3.4%. The amounts so reported are exclusive of three
original stores that are on a fixed royalty basis and are not required to report
sales to the Company. The amounts so reported also


                                       20
<PAGE>

exclude the I & Joy stores which were previously operated by I&J and acquired on
June 29, 1995. New stores generally show greater increases in their sales from
period to period during their first years of operation. As stores mature, the
relative increase in their sales from period to period can be expected to
decline. Although the number of new stores in the Company's chain continues to
grow, new stores will increasingly constitute a smaller percentage of total
sales. Accordingly, on average the increase in same store sales is expected to
be at the more moderate levels than reported in prior periods.

1996 Compared with 1995

     In 1996 the Company incurred a net loss of $7,481,000 as compared to net
income of $1,621,000 in 1995. The loss in 1996 was attributable to a number of
factors which the Company believes impacts the comparability of results. These
items are discussed below.

     Revenues. Total revenues of the Company for the year ended December 31,
1996 were $36,945,000 as compared to total revenues of $21,977,000 for the year
ended December 31, 1995, a $14,968,000 or 68.1% increase over the prior year.
The increase is primarily attributable to the increased product sales resulting
from the increase in the number of franchised stores opened as well as an
increase in retail and wholesale sales by the Company owned stores, increased
master franchise and area developer fees, and increased royalty and continuing
license fees. For the year ended December 31, 1996, master franchise and area
developer fees were $680,000 and $1,197,000 respectively. Master franchise fees
for 1996 are net of the repurchase of the master territory in New England
($250,000). For the year ended December 31, 1995 master franchise fees were
$841,000 and no area developer fees were recorded. Ongoing royalty and
continuing license fees increased from $1,627,000 to $2,743,000, a 68.6%
increase.

     Cost of Goods Sold. Cost of goods sold for the year ended December 31, 1996
increased 67.9% to $15,490,000 as compared to $9,224,000 for the year ended
December 31, 1995. This increase in absolute dollars is directly attributable to
the increase in product sales. Costs of goods sold deincreased to 54.1% of
product sales for the year ended December 31, 1996, compared to 55.1% of product
sales for the year ended December 31, 1995. This decrease is due to a
combination of increased purchasing and operating costs, which were offset by
manufacturing efficiencies, and the addition of Company owned stores which have
a positive impact on gross profit margins. The increase in production costs
relates primarily to the Company's decision made during the third quarter of
1996, to stop producing bagel dough at its California commissary to supply the
Los Angeles market, and to transfer production to Eatontown, for bagel dough
supplied to West Coast stores. The Company expects to incur these increased
costs during the first three quarters of 1997 until a new commissary in Los
Angeles is operational.

     Selling, General and Administrative. Selling, general and administrative
expenses increased 159.8% to $26,149,000 for the year ended December 31, 1996,
compared with $10,066,000 for the year ended December 31, 1995. As a percentage
of total revenues, selling general, and administrative expenses increased to
70.8% for the year ended December 31, 1996 from 45.8% for the year ended
December 31, 1995. The increase in both absolute dollars and percentage of
revenues is attributable to the growth of the Company, addition of senior and
middle level personnel to manage the growth, and the addition of Company owned
stores which have a negative impact on SG&A. In addition, unusual items recorded
during the fourth quarter of 1996 included: provisions associated with the
termination of the master franchisee for the Houston and Dallas markets
approximately ($314,000), provisions for and write-offs of accounts and notes
receivable approximately ($915,000); increases in the reserves for franchisee
loan guarantees


                                       21
<PAGE>

approximately ($1,105,000); settlements with lessors approximately ($430,000);
increased professional fees, including legal fees associated with the Company's
defense against shareholder lawsuits and legal settlements approximately
($435,000); and start up costs associated with the Company's Canadian
manufacturing facility approximately ($137,000).

     The Company also incurred a substantial increase in depreciation as a
result of the higher level of investment during the year in manufacturing plants
and company owned stores.

     Non-recurring charges. Non-recurring charges of $1,057,000 for the year
ended December 31, 1996 were comprised of professional fees associated with the
investigation relating to the Company's West Coast operations and financial
reporting (see Note 15, Notes to Consolidated Financial Statements) and the
related class action lawsuits (see Note 15, Notes to Consolidated Financial
Statements) and related settlements of certain consulting agreements.

     Write-off of Investments in Wholly Owned Subsidiary. Write-off of
Investments of $3,010,000 for the year ended December 31, 1996 were comprised of
the goodwill and fixed assets acquired in the Bay Area Bagel acquisition (see
Note 15, Notes to the Consolidated Financial Statements) and the Los Angeles
(I&J) commissary (see Note 15, Notes to the Consolidated Financial Statements).

     Interest Income. Interest income for the year ended December 31, 1996 was
$1,010,000 compared to $204,000 for the year ended December 31, 1995. The
increase of $806,000 was due to the interest earned on proceeds of the November
23, 1995 public offering and proceeds received on April 9, 1996 from the
exercise of the over-allotment option in connection with an underwritten March
22, 1996 public offering by selling shareholders which were invested in
marketable securities. The majority of these securities are short-term tax-free
investments.

     Interest Expense. Interest expense increased from $175,000 for the year
ended December 31, 1995 to $436,000 for the year ended December 31, 1996. The
$261,000 increase was primarily due to interest associated with the EDA loan for
the new Eatontown manufacturing facility which became operational in April,
1996.

     Loss Before Provision for Income Taxes. Loss before provision for income
taxes for the year ended December 31, 1996 was $8,241,000 compared with income
of $2,905,000 for the year ended December 31, 1995. This decrease was attributed
to a non recurring charge of $1,057,000 (See Note 15, Notes to Consolidated
Financial Statements), the $3,010,000 write off of investments (See Note 15,
Notes to Consolidated Financial Statements) and the increases in SG&A expenses
discussed above.

     Income Tax. Income tax benefit for the year ended December 31, 1996 was
$760,000 compared to an expense of $1,284,000 for the year ended December 31,
1995. The effective tax rate for the year ended December 31, 1996 was a benefit
of 9.4% which is due to a valuation allowance against the Company's deferred tax
assets, as well as, permanent differences relating to the write-off of goodwill.

Liquidity and Capital Resources

     On November 20, 1995, the Company completed a public offering of 1,500,000
shares of Common Stock at a public offering price of $19.625 per share. The
proceeds of such offering, net of discounts and offering expenses were
$27,084,000. The Company also received additional proceeds of $2,170,000 on
December 14, 1995 from the sale of 118,000 shares of Common Stock


                                       22

<PAGE>

to the public pursuant to the underwriters' over-allotment option. The proceeds
of the offering are being used to finance the expansion of the Company's
business through remodeling stores, constructing and equipping manufacturing
facilities and acquiring existing bagel businesses as well as providing
financing for future franchisees, and for general corporate and working capital
purposes.

     On April 9, 1996, the Company received net proceeds of $1,911,000 from the
sale of 90,000 shares of common stock pursuant to the exercise of an
over-allotment option in connection with an underwritten public offering of
shares owned by shareholders of the Company. In addition the Company received
$1,745,000 from the sale of stock to employees and consultants through the
Company's stock option plan. These proceeds will be utilized for general
corporate and working capital purposes.

     On May 24, 1996, the Company executed a $25 million dollar franchisee
financing agreement with Atlantic Financial Services. Under the terms of the
Agreement, the Company has agreed to guarantee certain portions of these loans
in exchange for more favorable terms and rates for the Company's franchisees.
The aggregate liability of the company under this arrangement is the greater of
(i) $1,500,000 or (ii) 20% of the first $10,000,000 aggregate principal amount
of loans to franchisees and 10% of the remaining $15,000,000 principal of loans
to franchisees. At December 31, 1996, the Company's contingent liability was
approximately $2,139,000 constituting the full amount of the loans outstanding
to franchisees under the franchise financing program.

     On January 4, 1995, the Company executed a $10 million dollar franchisee
financing agreement with Stephen Diversified Leasing, Inc. d/b/a Stephens
Franchise Finance which was later purchased by SunTrust Credit Corp. Upon
entering into the agreement with Atlantic Financial Services, the Company
terminated its agreement with Stephens except for the loans then outstanding.
Under the terms of the Agreement, which provided for financing to the Company's
franchisees, the Company agreed to guarantee certain portions of the loans in
exchange for more favorable terms and rates for the Company's franchisees. The
aggregate liability of the Company under this arrangement the greater of (i)
$1,000,000 or (ii) 30% of the aggregate principal amount of loans to
franchisees. At December 31, 1996, the Company's contingent liability was
approximately $1,695,000 constituting the full amount of loans outstanding to
franchisees under this franchise financing program.

     On August 8, 1996, the Company obtained a $7.5 million revolving line of
credit from First Union Bank, N.A. The agreement provides for a number of
negative financial covenants, including minimum requirements with respect to a
fixed charge coverage ratio, a current ratio, leverage (as defined), tangible
net worth requirements and that the Company will not incur losses for two
consecutive quarters. The Company was not in compliance with certain of these
covenants at December 31, 1996. A waiver of this non compliance has been
received by the Company from First Union Bank, N.A.

     In April 1997, the Company announced that Global Alliance Finance Company,
LLC (GAFCO), a wholly owned subsidiary of Deutsche Bank North America, has
agreed to provide, on a case-by-case basis, the lending of up to $50 million per
year, chainwide, in franchise financing to qualified applicants. The GAFCO
program is targeted at multi-unit operators from other franchise systems who
plan to open new Manhattan Bagel stores or acquire existing locations. The
Company believe that the new financing program will assist it in attracting new
area developers.

     The Company's cash flow used in operating activities in 1996 was
$8,405,000. Cash used in operations in 1996 is principally related to the net
loss for the year ($7,481,000), an increase in 


                                       23
<PAGE>

accounts receivable ($1,995,000), an increase in inventory ($548,000), an
increase in other assets (1,115,000), an increase in the investments in Company
stores (1,861,000) and a decrease in income taxes payable ($2,889,000); these
changes were offset in part by a decrease in assets due to write-offs
($3,010,000) loss on disposal of assets ($724,000), depreciation ($1,103,000)
and increases in accounts payables and accrued expenses ($2,275,000). Cash used
in investing activities in 1996 amounted to $1,855,000 and is principally
related to an increase in notes receivables ($9,285,000), payments for purchases
of property and equipment ($4,530,000), purchases of businesses ($4,570,000)
offset by the proceeds from the sale of marketable securities ($17,708,000).
Cash flows provided by investing activities amount to $3,865,000 and are
primarily due to proceeds from long term debt ($1,778,000), proceeds from
options exercised ($2,089,000), proceeds from the issuance of common stock
($1,911,000) offset in part by principal payments on long-term debt
($1,577,000).

     The Company had working capital of $9,971,000 at December 31, 1996, which
represents a decrease of $20,407,000 from December 31, 1995. This decrease in
working capital is primarily a result of a decrease of $7,481,000 due to the
results of operations described above, the increase in long-term note receivable
of $8,300,000 primarily related to the Bagel Brothers transaction and Ranch 1
investment and an investment in Company stores of approximately $2,700,000. The
Company believes there are no long-term trends or events that would have a
material negative impact on working capital.

     The Company intends to construct a new bagel dough and cheese spread
manufacturing facility to supply its West Coast stores. The costs to complete
this facility are estimated to be $1.3 million.

     At December 31, 1996, the Company has Federal net operating loss
carryforwards of approximately $672,000 which expires 2011.

     Management believes that the Company's working capital, credit facilities
and funds anticipated to be generated internally from operations will be
sufficient to finance the Company's anticipated growth and to meet the Company's
liquidity requirements for the foreseeable future including the construction of
the new West Coast bagel dough and cheese spread manufacturing facility. The
Company may also find it necessary or desirable to obtain additional funds to
finance its expansion. Such funds could be obtained from strategic alliances
with other companies, including joint venture, joint development or license
agreements or additional equity or debt offerings. However, there can be no
assurance that the Company will be successful in obtaining additional financing
from any of the foregoing sources, if it seeks to do so.

Item 7.           Financial Statements.

     The consolidated financial statements, notes thereto, and reports of
independent auditors appear on pages F-1 through F-25 which begin following this
page.

Item 8.   Changes in and Disagreements with Accountants on
          Accounting and Financial Disclosure.

None


                                       24
<PAGE>

                          MANHATTAN BAGEL COMPANY, INC.
                          Index to Financial Statements

Independent Auditors' Reports.......................................         F-2
Consolidated Balance Sheet as of December 31, 1996.................          F-4
Consolidated Statements of Operations for the Years Ended 
   December 31, 1995 and 1996.......................................         F-5
Consolidated Statements of Stockholders' Equity for 
   the Years Ended December 31, 1995 and 1996.......................         F-6
Consolidated Statements of Cash Flows for the Years
   Ended December 31, 1995 and 1996.................................         F-7
Notes to Consolidated Financial Statements..........................         F-8


                                       F-1
<PAGE>


                         Report of Independent Auditors

The Board of Directors
Manhattan Bagel Company, Inc. and Subsidiaries


We have audited the accompanying consolidated balance sheet of Manhattan Bagel
Company, Inc. and Subsidiaries as of December 31, 1996, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the year ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Manhattan Bagel
Company, Inc. and Subsidiaries at December 31, 1996, and the consolidated
results of their operations and their cash flows for the year then ended, in
conformity with generally accepted accounting principles.

We previously audited and reported on the consolidated balance sheet and the
related consolidated statements of income, stockholders' equity and cash flows
of Manhattan Bagel Company, Inc. and Subsidiaries for the year ended December
31, 1995, prior to their restatement for the 1996 pooling of interests as
described in Note 1. The contribution of Specialty Bakeries, Inc. to total
assets and revenues represented 1% and 14% of the respective restated totals.
Financial statements of the other pooled company included in the 1995 restated
consolidated statements were audited and reported on separately by other
auditors. We also have audited, as to combination only, the accompanying
consolidated statements of operations, stockholders' equity, and cash flows for
the year ended December 31, 1995, after restatement for the 1996 pooling of
interests; in our opinion, such consolidated financial statements have been
properly combined on the basis described in Note 1 to the consolidated financial
statements.
   
                                             Ernst & Young LLP
    
Princeton, New Jersey
March 31, 1997, except for the first
   paragraph of Note 4 as to which the
   date is April 15, 1997


                                      F-2
<PAGE>

                          INDEPENDENT AUDITORS' REPORT



To the Stockholders
Specialty Bakeries, Inc.
Moorestown, New Jersey

   
      We have audited the balance sheet of Specialty Bakeries, Inc. as of
December 31, 1995, and the related statements of operations and retained
(deficit), and cash flows for the year then ended. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
    

      We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. Au audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
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 provide a reasonable basis for our opinion.

      In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Specialty Bakeries, Inc. as
of December 31, 1995, and the results of its operations and its cash flows for
the year then ended in conformity with generally accepted accounting principles.



                                               Rainer & Company



   
February 2, 1996
Newtown Square Pennsylvania
    



                                      F-3
<PAGE>

                          MANHATTAN BAGEL COMPANY, INC.
                                AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET
                                December 31, 1996

            ASSETS

Current assets:
      Cash and cash equivalents                                    $  1,619,494
      Marketable securities                                           6,926,921
      Accounts receivable, net of allowance for doubtful
            accounts of $292,685                                      2,795,478
      Construction costs receivable, net of allowance for doubtful
            accounts of $60,000                                       2,254,842
      Franchise fee receivable area developers, net of allowance
            of $565,000                                                 721,782
      Inventories                                                     1,381,648
      Current maturities of notes receivable, net of reserve
            of $256,000                                                 462,225
      Current maturities of notes receivable - affiliates               250,000
      Income taxes receivable                                         2,053,663
      Prepaid expenses and other current assets                         628,634
                                                                   ------------

            Total current assets                                     19,094,687
                                                                   ------------

Property and equipment, net of accumulated
      depreciation of $1,987,142                                     12,000,338
                                                                   ------------

Other assets:
      Accounts receivable long term                                     480,539
      Franchise fee receivable area developers long term,
            net of allowance of $633,019                                200,000
      Notes receivable, net of current maturities                     7,304,151
      Notes receivable affiliates, net of current maturities          1,250,000
      Goodwill, net of accumulated amortization  of $214,201          4,386,853
      Security deposits                                                 909,053
      Investment in stores, net of reserve of $849,000                3,145,659
      Other assets                                                      819,910
                                                                   ------------

            Total Assets                                           $ 49,591,190
                                                                   ============

            LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
      Current maturities of long-term debt                         $  2,098,408
      Current maturities of capital lease obligations                   164,812
      Accounts payable and accrued expenses                           6,354,511
      Unearned franchise fee income                                     303,451
      Franchise deposits                                                202,500
                                                                   ------------

            Total current liabilities                                 9,123,682
                                                                   ------------

Other liabilities:
      Long-term debt, net of current maturities                       3,897,090
      Capital lease obligations, net of current maturities              410,904
      Security deposits                                                 414,622
      Other liabilities                                                  79,636
                                                                   ------------
            Total other liabilities                                   4,802,252
                                                                   ------------

Stockholders' equity:
      Preferred stock, 2,000,000 shares authorized,
            no shares issued or outstanding                                --
      Common stock, no par value, 25,000,000 shares
            authorized, 7,454,822 issued and outstanding             40,721,233
      Foreign currency translation                                      (12,695)
      Retained earnings                                              (5,043,282)
                                                                   ------------

            Total stockholders' equity                               35,665,256
                                                                   ------------

            Total liabilities and stockholders' equity             $ 49,591,190
                                                                   ============


           See accompanying notes to consolidated financial statements


                                      F-4
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                        For the Years Ended December 31,

<TABLE>
<CAPTION>
                                                                1995           1996
                                                                ----           ----
<S>                                                         <C>            <C>         
Revenues

      Product sales                                         $ 16,747,070   $ 28,637,190
      Franchise & license related revenue                      5,229,619      8,307,359
                                                            ------------   ------------

                  Total revenue                               21,976,689     36,944,549
                                                            ------------   ------------

Operating expenses

      Cost of goods sold                                       9,223,823     15,490,082
      Selling, general & administrative expenses              10,065,761     26,149,441
      Write-off of investment in wholly owned subsidiaries          --        3,010,000
      Non recurring charges                                         --        1,057,000
      Other (income) expense                                    (189,917)        52,088
      Interest income                                           (203,588)    (1,009,814)
      Interest expense                                           175,401        436,414
                                                            ------------   ------------

                  Total operating expenses                    19,071,480     45,185,211
                                                            ------------   ------------

Earnings (loss) before provision for income taxes              2,905,209     (8,240,662)

Provision (benefit) for income taxes                           1,284,213       (760,000)
                                                            ------------   ------------

Net income (loss)                                           $  1,620,996   $ (7,480,662)
                                                            ============   ============

Net income (loss) per share                                 $       0.28   $      (1.02)
                                                            ============   ============

Weighted average number of common &
      common equivalent shares outstanding                     5,692,311      7,358,721
                                                            ============   ============
</TABLE>

           See accompanying notes to consolidated financial statements


                                      F-5
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                 For the Years Ended December 31, 1995 and 1996

<TABLE>
<CAPTION>
                                                                Common Stock          Foreign                         Total
                                                        --------------------------    Currency       Retained     Stockholders'
                                                              Shares        Amount   Translation     Earnings        Equity
                                                        ------------  ------------   -----------     --------        ------
<S>                                                        <C>        <C>                          <C>            <C>         
Balance - January 1, 1995                                  5,351,975  $  4,840,011          --     $    855,453   $  5,695,464

Adjustment to conform fiscal year-end of
      DAB Industries, Inc.                                      --            --            --          (39,069)       (39,069)
Issuance of common stock through a secondary offering
      net of expenses                                      1,618,000    29,260,949          --             --       29,260,949
Exercise of stock options and warrants                       113,267       753,335          --             --          753,335
Issuance of common stock for trademark suit settlement         2,500        49,688          --             --           49,688
Tax benefit from exercise of employee stock options             --          76,539          --             --           76,539
Net income                                                      --            --            --        1,620,996      1,620,996
                                                        ------------  ------------  ------------   ------------   ------------

Balance - December 31, 1995                                7,085,742    34,980,522          --        2,437,380     37,417,902

Issuance of common stock through an over allotment
      from a secondary offerings net of expenses              90,000     1,911,150          --             --        1,911,150
Issuance of common stock for purchase acquisitions           115,500     1,740,313          --             --        1,740,313
Exercise of stock options                                    163,580     1,745,001          --             --        1,745,001
Tax benefit from exercise of employee stock options             --         344,247          --             --          344,247
Foreign currency translation                                    --            --    $    (12,695)          --          (12,695)
Net loss                                                        --            --            --       (7,480,662)    (7,480,662)
                                                        ------------  ------------  ------------   ------------   ------------

Balance - December 31, 1996                                7,454,822  $ 40,721,233  $    (12,695)  ($ 5,043,282)  $ 35,665,256
                                                        ============  ============  ============   ============   ============
</TABLE>

           See accompanying notes to consolidated financial statements


                                      F-6
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                        For the Years Ended December 31,

<TABLE>
<CAPTION>
                                                                                 1995           1996
<S>                                                                          <C>            <C>         
Cash flows from operating activities:
      Net income (loss)                                                      $  1,620,996   ($ 7,480,662)
                                                                             ------------   ------------

      Adjustments to reconcile net income to net cash provided by (used in)
          operating activities:
          Adjustment to conform fiscal year-end                                   (39,069)          --
          Write-off of assets                                                        --        3,010,000
          Loss on disposal of fixed assets                                           --          723,645
          Noncash expenses and other                                               71,675        (12,695)
          Depreciation                                                            576,255      1,102,792
          Amortization                                                             60,417        520,764
      Changes in operating assets and liabilities, net of acquisitions
          Accounts receivable                                                  (2,873,844)    (1,994,637)
          Inventory                                                              (520,109)      (547,768)
          Prepaid expenses and other current assets                              (600,500)       475,240
          Security deposits                                                      (168,970)      (378,414)
          Investment in stores                                                   (270,486)    (1,861,392)
          Other assets                                                           (108,080)    (1,114,655)
          Accounts payable and accrued expenses                                 2,124,991      2,274,830
          Unearned franchise fee income                                           283,667        (28,549)
          Deposits on franchise                                                    96,667       (209,167)
          Other current liabilities                                              (108,187)       (61,189)
          Security deposits                                                       120,784         65,575
          Income taxes                                                            823,797     (2,888,785)
                                                                             ------------   ------------
              Total adjustments                                                  (530,992)      (924,405)
                                                                             ------------   ------------

                  Net cash provided by (used in) operating activities           1,090,004     (8,405,067)
                                                                             ------------   ------------

Cash flows from investing activities:
      Decrease (increase) in notes receivable                                      38,262     (9,285,000)
      Principal payments from notes receivable                                       --          424,126
      Decrease (increase) in notes receivable - related parties                     8,200        111,400
      Payments for the purchase of property and equipment                      (6,663,784)    (4,529,663)
      Purchase of marketable securities                                       (22,625,000)    (2,010,379)
      Proceeds from sale of marketable securities                                    --       17,708,458
      Purchase of business, net of cash acquired                                     --       (4,569,866)
      (Increase) decrease in due from officer/stockholder                        (185,164)       296,164
                                                                             ------------   ------------

                  Net cash (used in) investing activities                     (29,427,486)    (1,854,760)
                                                                             ------------   ------------

Cash flows from financing activities:
      Proceeds from long-term debt                                              4,773,742      1,777,806
      Principal payments on long-term debt                                       (435,612)    (1,576,902)
      Principal payments on capital lease obligations                            (124,894)      (147,500)
      Proceeds from notes receivable franchisees                                   52,715           --
      Decrease in loan payable officer/stockholder                                   --         (189,000)
      Proceeds from options exercised                                             540,000      2,089,248
      Proceeds from issuance of common stock                                   29,474,284      1,911,150
                                                                             ------------   ------------

                  Net cash provided by financing activities                    34,280,235      3,864,802
                                                                             ------------   ------------

Net increase (decrease) in cash and cash equivalents                            5,942,753     (6,395,025)
Cash and cash equivalents-beginning of year                                     2,071,766      8,014,519
                                                                             ------------   ------------
Cash and cash equivalents-end of year                                        $  8,014,519   $  1,619,494
                                                                             ============   ============

Supplemental disclosure of cash paid
Interest                                                                     $    248,395   $    434,348
                                                                             ============   ============
Income taxes                                                                 $    365,552   $  1,486,304
                                                                             ============   ============
</TABLE>


      See accompanying notes to consolidated financial statements


                                      F-7
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

      NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

     The consolidated financial statements include the accounts of Manhattan
Bagel Company, Inc. and its wholly-owned subsidiaries Broadway Chicken, Inc.,
Manhattan Bagel Construction Corp. Manhattan Bagel Calgary Ltd., Specialty
Bakeries, Inc. and DAB, including DAB's subsidiary I & J Bagel, Inc.,
collectively known as the "Company," after elimination of all significant
intercompany balances and transactions.

     The Company manufactures bagel dough and blends a wide variety of cream
cheese spreads that are distributed to its franchised, licensed and
Company-owned stores throughout the United States and Canada under the names
Manhattan Bagel Company and I & J Bagels.

Acquisitions

     Under a definitive Agreement and Plan of Merger ("Agreement") signed on May
10, 1995 Manhattan Bagel Company, Inc. acquired I & J Bagel, Inc. ("I & J"). I &
J was a private company which owned and licensed a total of 17 bagel bakery
stores in the Los Angeles area operating under the name I & Joy Bagels.
Manhattan Bagel Company, Inc. completed the acquisition contemplated under the
Agreement on June 29, 1995, through the merger of a newly created, wholly-owned
subsidiary of Manhattan Bagel Company, Inc. with and into DAB Industries, Inc.,
a California corporation ("DAB") whose assets consisted primarily of all of the
stock of I & J, in exchange for 1.5 million shares of Common Stock of Manhattan
Bagel Company, Inc.

     The financial statements for the periods prior to the merger have been
restated to reflect the acquisition of DAB, which was accounted for as a pooling
of interests. Prior to the merger, DAB's fiscal year ended on January 31. DAB's
fiscal year has been changed to December 31 to conform to the Company's year
end. DAB's results of operations for the one month ended January 31, 1995 is
summarized as follows: 

                                             One Month 
                                             Ended 
                                             January 31, 1995
                                             ----------------
                                             (in thousands)

Net revenues.................................$289
Net income...................................$ 39

     On January 9, 1996, the Company completed the acquisition of Bay Area
Bagels, Inc., a private company which owned eight bagel bakery stores in the San
Francisco Area. The purchase price was 65,500 shares of common stock of the
Company and $85,000. The transaction was treated as a purchase for accounting
purposes.


                                      F-8
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

     NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -
                                   (Continued)

     On January 17, 1996, the Company completed the acquisition of three stores
in the Los Angeles market, which were licensed locations of I & J. Such stores
are being operated as company owned locations. The purchase price was $1,500,000
and was treated as a purchase for accounting purchases.

     On May 22, 1996, the Company completed the acquisition of Specialty
Bakeries, Inc. ("SBI") a private company which owned and franchised a total of
23 bagel bakery stores in the Southern New Jersey and Philadelphia areas
operating under the name Bagel Builders. The Company completed the acquisition
through the merging of a newly created, wholly-owned subsidiary of the Company
with and into SBI and 132,500 shares of common stock of the Company were issued
to the shareholders of SBI. This transaction was accounted for as a pooling of
interests. Net revenues and net income included in the Company's Consolidated
Statements of Operations are as follows:

                                                              Year Ended
                                                             December 31,
                                                             ------------
                                                        1995             1996
                                                        ---------------------
                                                            (in thousands)
Net Revenues:
Manhattan Bagel Company, Inc.                         $ 19,154         $ 34,017
Specialty Bakeries, Inc.                                 3,013            2,875
                                                      --------         --------
                                                      $ 22,167         $ 36,892
                                                      ========         ========
Net Income (Loss):
Manhattan Bagel Company, Inc.                         $  2,048         $ (7,540)
Specialty Bakeries, Inc.                                  (427)              59
                                                      --------         --------
                                                      $  1,621         $ (7,481)
                                                      ========         ======== 

     On June 28, 1996, the Company completed a transaction under which it added
23 Bagel Brothers stores (including two under development) to its franchise
network. Under terms of the agreement, the Company purchased the Bagel Brothers
bagel dough factories in Cleveland and Buffalo for $2,000,000 and 50,000 shares
of the Company's common stock. This transaction was treated as a purchase for
accounting purposes. Additionally, the Company provided Bagel Brothers with
$6,000,000 in financing, which among other things, provided funds to retire
existing loans, to pay franchise fees, and to remodel the 21 operating stores to
the Manhattan Bagel format. The Company has the right to convert the loan, which
is classified as a non-current asset in the Company's December 31, 1996, to
equity should certain profit targets be met.

Concentration of Credit Risk

     The Company grants credit to substantially all of its franchisees. The
Company generally does not require collateral, however, by virtue of the
franchise agreements,


                                      F-9
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

     NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -
                                   (Continued)

the Company believes it maintains sufficient security interests in the
franchises and the amount of credit risk is minimal.

     The Company maintains bank balances which at times may be in excess of the
FDIC insurance limit.

Use of Estimates

     The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.

Cash Equivalents

     The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.

Marketable Securities

     Marketable securities consist of fixed income investments (preferred stock
and short-term commercial paper) which can be readily purchased or sold using
established markets. Management determines the appropriate classification of
debt securities at the time of purchase and reevaluates such designation as of
each balance sheet date. Such securities are classified as available-for-sale
and accordingly, are carried at fair value which approximates cost at December
31, 1996.

Single Unit Franchise Agreements

     Single unit franchise agreements provide for payment of a franchise fee, a
weekly royalty on gross sales, and a monthly cooperative advertising fund
contribution. The Company's material obligations under the terms of all single
unit franchise agreements are assisting in the site selection and training of
the franchisee. Initial franchise fees from these agreements are recognized as
revenue when all material obligations have been provided. As of December 31,
1996, material obligations had yet to be completed for 37 franchises.

Master Franchise Agreements

     Master franchise agreements provide for a payment by the master franchisee
which is based on the population of the territory covered by such master
franchise. Franchise fees from master franchise agreements are recognized as
revenue by the Company when all material obligations required of the Company
have been performed.


                                      F-10
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

     NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -
                                   (Continued)

As of December 31, 1996, all material obligations under then outstanding master
franchise agreements had been performed.

     The master franchisee is responsible for collecting the initial franchise
fee and royalty payment from each franchisee in its territory, as well as,
training the franchisee and providing all ongoing support. As part of the master
franchise agreement, the Company receives one-third (33%) of fees collected by
the master franchisee. The Company's portion of the single unit franchise fee
sold by the master franchisee is recognized as revenue when a location has been
found for the franchise, and the Company has no further obligations.

Area Developer Franchise Agreements

     Area developer franchise agreements are exclusive territories sold to
experienced multi-unit retail operators, preferably with food service
experience. Area developers, are believed to have the financial and
organizational resources to rapidly develop and operate Manhattan Bagel stores
in a given geographic area. Franchise fees from area developer franchise
agreements are recognized as revenue by the Company upon signing of the
agreement as the amounts are non-refundable. In situations where a portion of
the fee is payable over time via a promissory note, the Company evaluates the
financial strength of the area developer to determine the recognition of the
fee related to the note receivable. As of December 31, 1996, all material
obligations required under then outstanding area developer franchise agreements
had been performed.

     Area developers are granted limited exclusivity to develop and operate
stores within a predetermined geographic area. Limits to exclusivity include
supermarket distribution and non-traditional retail opportunities. To maintain
development rights, developers must open units in accordance with a
predetermined schedule, meet all financial obligations to the Company and
operate stores within established operating standards.

License Agreements

     License agreements provide for the Company to receive a payment of an
initial license fee and thereafter continuing license fees. The granting of a
license gives the licensee the right to use the name Manhattan Bagel for a
specific number of stores. Initial license fees are recognized at the time the
license agreement is entered into since there are no continuing obligations of
the Company.

Royalty Revenue

     Franchise royalty revenues for the Company are recognized when earned.


                                      F-11
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

     NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -
                                   (Continued)

Inventory

     Inventory is stated at the lower of cost (first-in, first-out basis) or
market.

Construction Operations

     The Company offers a franchisee the option of contracting with the Company
to have its bagel store constructed by the Company. These contracts are
generally fixed price contracts, upon which the Company has not historically
recognized significant profits or losses. Any amounts due under these contracts
for costs already expended that have yet to be reimbursed are reflected as
"construction costs receivable."

Property and Equipment

     Property and equipment is stated at cost, less accumulated depreciation.
Depreciation is provided on a straight-line basis over the estimated useful
lives of the assets as follows:

           Asset Category                                Estimated Useful Life
Factory equipment........................................5-10 years
Office furniture and equipment...........................5-7 years
Leasehold improvements...................................Shorter of useful life
                                                         or Term of Lease
Transportation equipment.................................5 years

Intangible Assets and Goodwill

     Intangible assets, net of accumulated amortization of $69,154, are included
in other long-term assets and consist of trademark costs and covenants not to
compete. Trademark costs are being amortized on a straight-line basis over
twenty years. Covenants not to compete are being amortized on a straight-line
basis over 36 months or the life of the covenant. Goodwill, which consists
primarily of the excess purchase price over assets acquired, is being amortized
on a straight-line basis over a period from twenty to thirty years.


                                      F-12
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

     NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -
                                   (Continued)

Investment in Stores and Stores Held for Resale

     The Company has an equity of interest in three franchises ("joint-ventured
stores"). These investments are accounted for under the equity method. The
carrying amount of these investments reflects the Company's share of the
underlying equity in net assets.

     In addition, the Company, from time to time, repurchases stores from
franchisees with the intent of upgrading and remodeling and then reselling the
stores to new franchisees. The Company also constructs and operates certain
stores until franchisees are in place. Unless a determination is made that the
Company intends to operate a store and not to seek to sell such store,
repurchased and stores to be franchised stores are recorded on the balance sheet
at the lower of cost or net realizable value and results of operations of these
stores are included in the Company's consolidated statement of operations from
acquisition to disposition. At December 31, 1996 there are 32 stores held for
resale.

Advertising

     The Company and its franchisees advertise products in newspapers, through
direct mailing and on radio and television. Advertising is primarily funded out
of the required contribution to the Company's regional advertising co-operative
by franchisees, which range from 0.5% to 4.0% of gross sales depending on when
the franchise was sold. The Company also advertises and plans to continue
advertising its franchises in current stores, franchise trade shows, newspapers
and business opportunity magazines. Advertising costs are expensed as incurred
and were approximately $496,000 and $1,442,000 for the years ended December 31,
1995 and 1996, respectively.

Net Income (Loss) per Share

     Net income (loss) per share is computed on the basis of the weighted
average number of common shares outstanding during each year. Common stock
options and warrants were included in the computation of net income per share in
1995. In 1996, common stock options and warrants are not included in the
calculation of the weighted average shares outstanding, as their effect is
antidilutive.

Income Taxes

     Deferred income taxes reflect temporary differences in reporting assets and
liabilities for income tax and financial accounting purposes. These temporary
differences arise principally from the use of different methods of franchise fee
revenue recognition and depreciation and amortization for income tax and
financial accounting purposes.


                                      F-13
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       
   
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
    

Long-Lived Assets

     The Company records impairment losses on long-lived assets used in
operations, including goodwill and intangible assets, when events and
circumstances indicate that the assets might be impaired and the undiscounted
cash flows estimated to be generated by those assets are less than the carrying
amounts of those assets.

Stock Based Compensation

     As permitted by FASB Statement No. 123 "Accounting for Stock-Based
Compensation" (FASB 123), the Company has elected to follow Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB
25) and related interpretations in accounting for employee stock option plans.
Under APB 25, no compensation expense is recognized at the time of option grant
because the exercise price of the Company's employee stock option equals the
fair market value of the underlying common stock on the date of grant.

Reclassification

     Certain 1995 balances have been reclassified to conform with 1996
presentation.

NOTE 2 - INVENTORY
                                                         December 31, 1996
                                                         -----------------
Raw materials ..............................................     $  788,977
Finished goods .............................................        592,671
                                                                 ----------
                                                                 $1,381,648
                                                                 ==========

NOTE 3 - PROPERTY AND EQUIPMENT
                                                         December 31, 1996
                                                         -----------------
Land ......................................................      $     62,178
Factory equipment .........................................         8,971,786
Office furniture and equipment ............................           848,344
Leasehold improvements ....................................         2,918,872
Transportation equipment ..................................           711,648
Construction in progress ..................................           474,652
                                                                 ------------
                                                                   13,987,480

Accumulated depreciation and amortization .................        (1,987,142)
                                                                 ------------
Property and equipment - net ..............................      $ 12,000,338
                                                                 ============

     Property and equipment includes assets recorded under capital leases of
$843,303 as of December 31, 1996. Accumulated depreciation and amortization
includes accumulated amortization of assets recorded under capital leases of
$265,283 as of December 31, 1996. Assets recorded under capital leases consist
primarily of factory equipment.


                                      F-14
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

NOTE 4 - LONG TERM DEBT

                                                               December 31, 1996
                                                               -----------------
Lines of Credit:

Payable to New Jersey Economic Development Authority,
bearing interest at an adjustable rate determined by the
remarketing agent, payable in monthly interest only with a
maturity of October 1, 2005. The line is collateralized by a
blanket security interest in all of the assets of the
Company not previously pledged elsewhere. Available
borrowings under this line are $365,069.....................      $3,134,931
                                               

Payable to a bank bearing interest at 0.25% under the bank's
Prime Rate, 8.25% at December 31, 1996 and
payable in monthly interest only installments with a
maturity of August 1, 1999. The line is collateralized by
the Company's assets. Additionally, three letters of credit
totaling $163,121, have been issued and are outstanding
under this line. Available borrowings under this line
are $6,176,879..............................................       1,160,000
                                    

Mortgage payable on South Carolina facility, bearing
interest at prime plus 1.25%, payable in monthly
installments of $3,889 through March 2010...................         312,963

Note payable - Bank - Term loan in the amount of $330,000
payable in equal installments of $6,600 including interest
at 9.25%. The note is collateralized by substantially all
the assets of Specialty Bakeries, Inc.......................         256,285

Payable to a bank bearing interest at 1% over the bank's
Prime Rate, currently 8.25% and payable on demand. This line
is secured by substantially all the assets of Specialty
Bakeries, Inc. .............................................         125,000

Various notes payable to credit companies and others,
collateralized by equipment, maturing at various dates
through 2000 ...............................................         919,357

Note payable to an individual due in monthly installments of
$2,500 including interest at 10%............................          84,735
                                                                               
Unsecured note payable to relatives of one of the Company's
officers payable at $1,000 per month, including interest at
17.3% through March 1997 ...................................           2,227
                                                                  ----------

Total.......................................................      $5,995,498
                                                                  ----------
Less current maturities.....................................      (2,098,408)
                                                                  ----------
Long-term debt, net of current maturities...................      $3,897,090
                                                                  ==========


                                      F-15
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

NOTE 4 - LONG TERM DEBT (Continued)

     The aggregate amount of all long-term debt maturities
for the years ending December 31 is as follows:

1997 .................................................                $2,098,408
1998 .................................................                   704,396
1999 .................................................                   739,435
2000 .................................................                   489,360
2001 .................................................                   378,085
Thereafter ...........................................                 1,585,814

     At December 31, 1996, the Company was in default of certain covenants
related to its line of credit payable with a bank and the letter of credit
supporting the line of credit payable to the New Jersey Economic Development
Authority. The Company received a waiver for the defaults as of December 31,
1996 and on April 15, 1997 amended its letter of credit supporting its line of
credit agreement with the New Jersey Economic Development Authority and its line
of credit agreement with the bank, which, among things, modified certain
covenants. The Company believes that it will be able to meet the modified
covenants throughout 1997.

NOTE 5 - CAPITAL LEASE OBLIGATIONS

     The Company has capital leases for equipment, expiring at various dates
through April 2000, with aggregate monthly payments of approximately $18,791.

     The following is a schedule by years of future minimum lease payments under
capital leases together with the present value of the net minimum lease payments
at December 31, 1996:

                                                             For the Year Ending
                                                             December 31
                                                             -----------

1997 .........................................................        $ 225,494
1998 .........................................................          222,221
1999 .........................................................          199,073
2000 .........................................................           45,519
Thereafter ...................................................             --   
                                                                      ---------
Total minimum lease payments .................................          692,307
Less: amount representing interest ...........................         (116,591)
                                                                      ---------
Present value of net minimum lease payments ..................          575,716
Less: current maturities .....................................         (164,812)
                                                                      ---------
Long-term maturities .........................................        $ 410,904
                                                                      =========

     The present values of minimum future obligations shown above are calculated
based on fixed interest rates determined at the inception of the respective
leases, ranging from 10% to 20%.


                                      F-16
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

NOTE 6 - COMMON STOCK

     On November 14, 1995, the Company completed a public offering of 1,500,000
shares of the Company's common stock at a price of $19.625 per share yielding
net proceeds of $27,084,440. In December 1995, the Company sold an additional
118,000 shares on the same terms upon exercise of the underwriter's
over-allotment option, yielding net proceeds of $2,176,509.

     In April 1996, the Company received net proceeds of $1,911,150 from the
sale of 90,000 shares of common stock pursuant to the exercise of an
over-allotment option in connection with an underwritten public offering of
selling shareholders.

NOTE 7 - OPERATING LEASES

     The Company has agreements to lease equipment, office facilities and
factory space. The leases expire at various dates through July 2005. Rent
expense on these leases for the years ended December 31, 1995 and 1996 was
approximately $1,161,065 and $2,386,316, respectively.

     The following is a schedule by years of approximate future minimum rental
payments required under operating leases that have initial or remaining
noncancelable lease terms in excess of one year at December 31, 1996:

For the Years Ending
  December 31,
  ------------
1997 ............................................     $ 1,863,190
1998 ............................................       1,774,460
1999 ............................................       1,707,924
2000 ............................................       1,524,783
2001 ............................................       1,318,815
Thereafter ......................................       4,211,589
                                                      -----------
Total minimum payments required .................     $12,400,761
                                                      ===========

     The Company has also entered into agreements to lease locations for its
franchisees under various lease terms expiring through December 2007. The
Company is required to pay a share of property taxes and operating costs
relating to some of the leased facilities. The Company subleases these locations
to its franchisees. Net rental income under these agreements was approximately
$15,900 and $14,900 for the years ended December 31, 1995 and 1996,
respectively.

     The following is a schedule by years of the approximate future minimum
lease payments and sublease income under franchisee operating leases that have
initial or remaining non-cancelable lease terms in excess of one year at
December 31, 1996:


                                      F-17
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

   
NOTE 7 - OPERATING LEASES (Continued)
    

For the Years Ending       Sublease           Lease            Net Rental
    December 31,            Income           Payments            Income
    ------------            ------           --------            ------

      1997               $ 6,543,500       $ 6,528,600          $14,900
      1998                 6,531,300         6,521,500            9,800
      1999                 6,290,800         6,285,100            5,700
      2000                 6,211,200         6,211,200               --
      2001                 5,758,200         5,758,200               --
    Thereafter            17,901,000        17,901,000               --

NOTE 8 - RELATED PARTY TRANSACTIONS

     The Company recognizes product sales and royalty income from joint-ventured
stores and other related parties under the same terms as all other franchised
stores. Royalties from related parties totaled approximately $119,800 and
$146,600 for the years ended December 31, 1995 and 1996, respectively. Product
sales to related parties totaled approximately $138,000 and $409,500 for the
years ended December 31, 1995 and 1996, respectively.

     During 1996, the Company loaned an affiliated company $1,500,000 for the
expansion of facilities and for the purchase of bagel baking equipment. Under
the terms of the loan agreement, interest accrues daily on the outstanding
principal balance at a rate of Prime plus 2%. A portion of the principal balance
($250,000) is due in 1997, with the remaining $1,250,000 due upon the earlier of
November 18, 1998 or the consummation of an Initial Public Offering by the
affiliated company. Under certain circumstance as defined in the agreement the
loan is convertible, at the election of the Company, into shares of common stock
of the affiliated company.

NOTE 9 - FRANCHISE AND LICENSE RELATED REVENUE

                                                              Year Ended
                                                             December 31,
                                                             ------------
                                                         1995            1996
                                                         ----            ----
Franchise and license fee ......................      $2,149,506      $2,245,440
Master franchise fees ..........................         841,360         680,000
Area Developer fees ............................            --         1,196,981
Royalties and continuing license fees ..........       1,626,968       2,743,090
Advertising ....................................         611,785       1,441,848
                                                      ----------      ----------
                                                      $5,229,619      $8,307,359
                                                      ==========      ==========


                                      F-18
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

NOTE 10 - INCOME TAXES

     The Company provides for the recognition of deferred tax assets and
liabilities for the tax effects of differences between the financial accounting
and tax basis of the Company's assets and liabilities. The Company also provides
for the recognition of a valuation allowance against deferred tax assets, where
the realization of such assets is not considered to be more likely than not.

     The provision for income taxes consists of the following:

                                                            Year Ended
                                                            December 31,
                                                            ------------
                                                       1995              1996
                                                       ----              ----
Current tax expense (benefit) ..............       $ 1,197,000        $(560,000)
Deferred tax expense (benefit) .............            87,000         (200,000)
                                                   -----------         -------- 
                                                   $ 1,284,000         (760,000)
                                                   ===========        =========

     A reconciliation of the provision recorded by the Company to a provision
computed utilizing the enacted Federal statutory rate is as follows:

                                                           Year Ended
                                                          December 31,
                                                          ------------
                                                      1995               1996
                                                      ----               ----
                                                    (dollars in thousands)
Computed tax at Federal statutory rate ...  $ 1,131    34.0%  $(2,750)  (34.0)%
State income taxes, net of federal benefit      199     5.9%        5     0.1 %
Goodwill amortization/writedown ..........     --        --       634     7.8 %
Valuation allowance ......................     --        --     1,383    17.1 %
Other ....................................      (46)   (1.4)%     (32)   (0.4)%
                                            -------    ----   -------   -----
                                            $ 1,284    38.5%  $  (760)   (9.4)%
                                            =======    ====   =======   =====

     The components of the Company's recorded deferred income tax assets and
liabilities are as follows:

                                                  December 31, 1996
                                                  -----------------
Current:
      Deferred tax assets-other ..................   $ 1,202,000
      Deferred tax liabilities-other reserves ....        (6,000)
      Valuation allowance ........................    (1,196,000)
                                                     -----------
                                                           --
                                                     ===========


                                      F-19
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

   
NOTE 10 - INCOME TAXES (Continued)
    

Long-term:
     Deferred tax assets-other ....................................    214,000
     Deferred tax liabilities - book over tax basis in fixed assets    (78,000)
     Net operating loss carry forward .............................    491,000
     Tax credit carry
     forward ......................................................    100,000
     Valuation allowance ..........................................   (727,000)
                                                                     ---------
                                                                          --
                                                                     ---------
     Net deferred tax liabilities .................................  $    --
                                                                     =========

The Company's recorded valuation allowance for the year ended December 31, 1996,
which constitutes the entire change in the valuation allowance for the year,
consists of the following:

     Federal.......................................................  $1,383,000
     State.........................................................     540,000
                                                                     ----------
                                                                     $1,923,000
                                                                     ==========

     At December 31, 1996 the Company has available Federal net operating loss
carryforwards of $672,000 expiring in the year 2011. A tax benefit of
approximately $344,000 associated with employee stock option exercises has been
credited to stockholder's equity in 1996.

NOTE 11 - NONCASH INVESTING AND FINANCING ACTIVITIES

     During 1995, the Company issued 2,500 shares of common stock as part of a
trademark lawsuit settlement.

     During the years ended December 31, 199 5 and 199 6, capital lease
obligations of $ 505,000 and $ 9,468, respectively were incurred when the
Company entered into leases for new equipment.

     During 1995, t he Company financed a note receivable from a franchisee for
the purchase of equipment in the amount of $60,500. During the year the Company
refinanced long-term debt into a term loan of $330,000.

     During 1996, the Company issued a total of 115,500 shares of common stock
in connection with certain acquisitions (Note 1). The value of the shares issued
totaled approximately $1,740,000.

NOTE 12 - COMMITMENTS AND CONTINGENCIES

On June 20, 1996, the Company announced that following the installation of new
management at its I&J West Coast subsidiary, the Company had uncovered certain
improper bookkeeping and accounting practices at the Los Angeles subsidiary,
that it would be restating its first quarter 1996 Statement of Operation to
account for these improper practices. On the day following the announcement the
stock price of the Company's common stock declined from a closing price of
$21.25 on June 20, 1996 to a closing price of $13.75 on June 21, 1996. As a
result, certain class action law suits


                                      F-20
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

NOTE 12 - COMMITMENTS AND CONTINGENCIES (Continued)

have been filed. These lawsuits from New Jersey and California have been
consolidated into one class action lawsuit in the Federal District Court in New
Jersey. The plaintiffs seek unspecified money damages. The Company has filed a
motion to dismiss the lawsuit and all discovery has been stayed pending the
resolution of this motion. Although the Company believes it has acted properly
and has adequate defenses to such actions, no assessment of the amount or range
of any loss that might be incurred by, or the effects thereof on, the Company
should it be found to have violated any law, can be made at this time.
Accordingly, no provisions for these contingencies have been made. Certain cost
of the defense of these actions have been included in the non-recurring charge
(see Note 15).

     The Company is also involved in various other pending legal proceedings
arising out of the normal course of the Company's business. The adverse outcome
of any of these legal proceedings is not expected to have a material adverse
effect on the financial condition of the Company.

     The Company has executed a $25.0 million franchisee financing agreement
with Atlantic Financial Services, Inc. Under the terms of this agreement, the
Company has agreed to guarantee certain portions of loans in exchange for more
favorable terms and rates for the Company's franchisees. The liability of the
Company under this agreement is the greater of (i) $1,500,000 or (ii) 20% of the
first $10,000,000 of loans to franchisees and 10% of the remaining $15,000,000
of loans to franchisees. At December 31, 1996, the Company's contingent
liability was $2,139,418 for outstanding loans.

     The Company also has executed a $10.0 franchisee financing agreement with
Stephens Franchise Finance which was purchased by SunTrust Credit Corp. Under
the terms of this agreement, the Company has agreed to guarantee certain
portions of loans in exchange for more favorable terms and rates for the
Company's franchisees. The liability of the Company under this agreement is the
greater of (i) $1,000,000 or (ii) 30% of the aggregate principal amount of loans
to franchisees. At December 31, 1996, the Company's contingent liability was
$1,695,026 for outstanding loans. As of June 13, 1996, the Company ceased using
SunTrust Credit Corp. for franchisee financing.

     As of December 31, 1996, there have been no events of default under either
the Atlantic Financial Services, Inc. agreement or the SunTrust Credit Corp.
agreement.

     The Company entered into various employment agreements effective January 1,
1994 through December 31, 1998, with officers and key employees, three of whom
are major stockholders. Each agreement provides for an annual base compensation
of $125,000, with annual increases based on increases in the Consumer Price
Index, capped at 10%. The agreements provide for aggregate bonuses equal to 10%
of the Company's consolidated earnings before taxes.

     In addition, the Company had commitments for the purchase of equipment of
approximately $900,000 at December 31, 1996.


                                      F-21
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

NOTE 13 - STOCK OPTIONS

     In 1994, the Company adopted a stock option plan (the "1994 Plan") under
which stock options to purchase up to 300,000 shares of the Company's common
stock may be granted to employees of and consultants to the Company. Options
granted under this plan must be at an exercise price not less than the fair
market value per share of common stock on the date the option is granted.
Options granted shall become exercisable equally over three years upon each
anniversary of the date of grant. Generally, an option will become fully
exercisable three years from the date of grant. Options will be exercisable for
a term not greater than ten years from the date of grant.

     In 1996, the Company adopted a stock option plan (the "1996 Plan") under
which stock options to purchase up to 750,000 shares of the Company's common
stock may be granted to employees of and consultants to the Company. Options
granted under this plan must be at an exercise price not less than the fair
market value per share of common stock on the date the option is granted.
Options granted shall become exercisable equally over three years upon each
anniversary of the date of grant. Generally, an option will become fully
exercisable three years from the date of grant. Options will be exercisable for
a term not greater than ten years from the date of grant.

     FASB 123 requires pro forma information regarding net income (loss) and
earnings per share as if the Company has accounted for its employee stock
options and warrants granted subsequent to December 31, 1994, under the fair
value method of FASB 123. The fair value of these equity awards was estimated at
the date of grant using a Black-Scholes option pricing model with the following
weighted average assuptions for 1995 and 1996, respectively: risk-free interest
rates of 5.76% and 6.18%; expected volatility of 0.73 expected option life of
one year from vesting and an expected dividend yield of 0.0%.

                                                           1995         1996
                                                           ----         ----

Pro forma net income (loss)                            $ 1,282,127  $(9,486,621)
                                                       ===========  ===========
Pro forma net income (loss) per share of common stock  $       .23  $     (1.29)
                                                       ===========  ===========

     Because FASB 123 is applicable only to equity awards granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1997.


                                      F-22
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

   
NOTE 13 - STOCK OPTIONS (Continued)
    

     A summary of the Company's stock option activity, and related information
for the years ended December 31, 1995 and 1996 follows:

                                           1995                  1996
                                           ----                  ----
                                               Weighted              Weighted
                                    Common      Avg.       Common      Avg.
                                    Stock      Exercise    Stock     Exercise
                                    Options     Price      Options   Price
                                    -------     -----      -------   -----
Outstanding at beginning of year     263,600   $  4.96    $ 444,144   $ 8.90
Granted                              312,360     10.90      549,163    19.53
Canceled                             (18,549)     5.51     (148,357)   13.77
Exercised                           (113,267)     5.79     (163,580)   10.85
                                     -------              ---------         
Outstanding at end of year           444,144      8.90      681,370    15.94
                                     -------              ---------          

Exercisable at end of year           200,111   $ 10.60      101,250   $ 5.95
                                     =======                =======         
                                                                    
Weighted average fair value of                                          
options granted during the year                $  7.03                $12.92
                                               
     Stock options outstanding at December 31, 1996 are summarized as follows:

                         Outstanding        Weighted Average 
 Range of Exercise        Options at             Remaining      Weighted Average
      Prices           December 31, 1996     Contractual Life   Exercise Price
      ------           -----------------     ----------------   --------------

   $3.00 to $7.00          176,257                 7.62              $ 5.27
   $12.00 to 13.50          35,250                 8.58              $12.70
       $16.25              289,863                 9.00              $16.25
       $26.50              180,000                 9.75              $26.50
                           -------                                         
   $3.00 to $26.50         681,370                 8.71              $15.94
                           =======                                         

     In June 1995, the Company granted immediately exercisable options to
purchase 101,250 shares of common stock at $13.50 per share, in exchange for
consulting services. During 1996 84,750 options were exercised and the remaining
16,500 options remain exercisable at December 31, 1996.

     In August 1995, the Company granted options to a key employee to purchase
90,000 shares of common stock at $12.00 per share which represented the fair
market value at the date of grant. The options are exercisable in equal annual
amounts over a three year period beginning December 31, 1995. During 1996 30,000
options were exercised and the remaining 60,000 options were canceled.

     In May 1996, the Company granted options to three key employees of
Specialty Bakeries, Inc. to purchase 180,000 shares of common stock at $26.50
per share which represented the fair market value at the date of grant. The
options are exercisable in equal annual amounts over a three year period
beginning May 1997. 


                                      F-23
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

   
NOTE 13 - STOCK OPTIONS (Continued)
    

     In August 1996, the Company granted options to a former employee to
purchase 220,000 shares of common stock at $20.75 per share which represents the
fair market value on the date of grant. The options are fully exercisable
between November 1, 1996 and October 31, 2003.

NOTE 14 - FRANCHISE AND LICENSE TRANSACTIONS

     Total franchise and license locations opened during the years ended
December 31, 1995 and 1996, were 82 and 108, respectively.

     Franchise locations in operation are as follows:

                                                               December 31, 1996
                                                               -----------------
     Company-owned locations................................            35
     Franchisee and joint venture locations.................           258
                                                                       ---
     Total..................................................           293
                                                                       ===

     During 1995, the Company repurchased three locations and are operating
these as company stores. During 1996, the Company repurchased 20 locations, 7
are operating as company stores, while 13 were sold. Gains and/or losses from
these sales were not material.

NOTE 15 - NON RECURRING CHARGE AND WRITE OFF OF INVESTMENT

     Following the installation of new management at I&J and subsequent to the
Company's filing of its first quarter 10-QSB, the Company uncovered certain
improper bookkeeping and accounting practices at the Los Angeles subsidiary. As
a result, the Board of Directors authorized a full investigation into the
accounting practices at the subsidiary and retained special counsel to assist in
the investigation, the Company restated its first quarter 1996 Statement of
Operations. Professional fees associated with the special investigation, the
class action lawsuits and settlements of certain consulting agreements totaling
approximately $1,057,000, are included in the Statement of Operations for the
year ended December 31, 1996.

     Based upon the results of a review of its West Coast operations, the
Company has decided to close its bagel production facility in Los Angeles and to
temporarily supply its West Coast operations from Eatontown to assure product
quality. The Company has also decided to sell, franchise or close the San
Francisco locations acquired in January 1996, operating under the name Holey
Bagel. The sale, franchising or closure of these locations is expected be
completed in 1997. As a result of these decisions, the Company wrote-off
$3,010,000 comprised of the goodwill ($1,711,000) fixed assets ($874,000) and
other assets and accruals ($425,000) acquired in the Bay Area Bagel acquisition
and the Los Angeles commissary and the sale or closure of the locations. The
amount of goodwill was reflective of the price of Company's common stock at the
time of the acquisition. Therefore, as of December 31, 1996, the Company had
written off its entire investment in Holey Bagel. This write-off is reflected in
the results of operations for the year ended December 31, 1996.


                                      F-24
<PAGE>

                 MANHATTAN BAGEL COMPANY, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
       

NOTE 16 - SUBSEQUENT  EVENT

     In February 1997, the Company signed an area development agreement for the
San Diego and Orange County, California area which calls for 50 locations to be
opened over the course of the next four years. In connection with this agreement
the Company recognized $1,000,000 of revenue.


                                      F-25
<PAGE>

                                    PART III

Item 9.  Directors, Executive Officers, Promoters and Control Persons;
         Compliance with Section 16(a) of the Exchange Act.

     The following table sets forth certain information regarding the Company's
directors and executive officers.

    Name                        Age     Position
-----------------------------   ----    -------------------------------------
Directors and Officers

  Jack Grumet................    60    Chairman of the Board and Chief Executive
                                       Officer
  David Goldsmith                57    Vice Chairman

  Jason Gennusa..............    38    President, Chief Operating Officer and
                                       Director


  Andrew Gennusa.............    31    Executive Vice President and Director

  Jack Levy..................    45    Director

  Julia S. Heckman...........    47    Director

  James J. O'Connor..........    52    Chief Financial Officer

     The business experience, principal occupations and employment of each of
the directors and executive officers and key employees of the Company during at
least the past five years, together with their periods of service as directors,
executive officers and key employees of the Company, are set forth below.

Directors and Officers

     Jack Grumet became Chairman of the Board and Chief Executive Officer of the
Company in April 1991. He was Chairman and Chief Financial Officer of Banner
Financial Services, a wholesale mortgage broker, from April 1989 until April
1991. From 1984 to 1989, Mr. Grumet was involved as an executive officer in a
variety of business enterprises. Prior to 1984 he was the founder and Chief
Executive Officer of Jo-Ann's Nut House and Chez Chocolat, the nation's second
largest retail franchise chain of nut and candy stores at such time. The chain
operated 149 locations in nineteen states with five branch warehouses. The
company was sold in 1983 to Carrols Corp.

     David Goldsmith became a director and Vice Chairman of the Board of the
Company in April 1996, after serving as a consultant to the Company since
December 1995. Prior to joining the Company, from 1973 to 1996, Mr. Goldsmith
was President and Chief Executive Officer of Ventec Inc., a food manufacturing
and distribution concern.

     Jason Gennusa has been President, Chief Operating Officer and director
since he co-founded the Company in 1987. From 1981 until 1991, Mr. Gennusa was
Vice President and a principal owner/operator of five Chicken Holiday
restaurants located throughout New Jersey.


                                       25
<PAGE>

     Andrew Gennusa has been Executive Vice President since June 1996 and a
director (and Vice President) since 1987, and is the other co-founder of the
Company. From 1981 until 1991, Mr. Gennusa was President and a principal
owner/operator of five Chicken Holiday restaurants throughout New Jersey.

     Jack Levy became a director in October 1995. Mr. Levy has been engaged in
the private practice of law in New York City since 1976. Since April 1996, Mr.
Levy has been a partner with the law firm of Morrison Cohen Singer & Weinstein,
LLP, counsel to the Company. From April 1995 to April 1996, he was a partner at
the law firm of Wise & Shepard, LLP and from April 1993 to April 1995, he was a
partner at the law firm of Lane & Mittendorf. From 1978 to April 1993, he was an
attorney at Summit Solomon & Feldesman, first as an associate and from 1984 to
1993 as a partner.

     Julia S. Heckman became a director of the Company in November 1995. Mrs.
Heckman has been a Managing Director with Rodman & Renshaw, Inc.'s Investment
Banking Group since April 1995 and had been a Managing Director with Mabon
Securities Corp.'s Investment Banking Group since 1991. Prior to joining Mabon
Securities Corp., Mrs. Heckman was a Managing Director with Paine Webber Group
Inc.'s Corporate Finance Group. Mrs. Heckman serves as a Director of ATC
Environmental Inc., an environmental consulting and engineering firm.

     James J. O'Connor became Chief Financial Officer in March 1997. Mr.
O'Connor has 30 years experience in finance and accounting having spent the last
eighteen years with RJR Nabisco Holdings and its predecessor companies, most
recently as assistant corporate controller of Nabisco, Inc.

     All directors hold office until the next annual meeting of shareholders or
until their successors are elected and qualify. Officers are elected annually
by, and serve at the discretion of, the Board of Directors. There are no
familial relationships between or among any officers or directors of the
Company, except that Jason Gennusa and Andrew Gennusa are brothers.


                                       36
<PAGE>

Item 10.  Executive Compensation.

The following table sets forth information concerning the annual compensation
paid by the Company for the fiscal years ended December 31, 1994, 1995 and 1996,
respectively, to the Chief Executive Officer and executive officers of the
Company whose compensation exceeded $100,000 in 1996.

Summary Compensation Table

                               Annual Compensation

      Name and                                        Annual
  Principal Position                    Year          Salary       Other(1)
--------------------------------        ----         --------      --------
Jack Grumet....................         1996         $131,506         --
  Chairman of the Board and             1995         $121,880         --
  Chief Executive Officer               1994         $152,404         --

David Goldsmith...............          1996         $101,614         --
  Vice Chairman of the Board

Jason Gennusa...................        1996         $131,506         --
 President and Chief Operating          1995         $120,358         --
 Officer                                1994         $147,840         --
                                        
Andrew Gennusa..................        1996         $131,506         --
  Executive Vice President              1995         $122,084         --
                                        1994         $147,608         --

(1) Excludes perquisites and other personal benefits, securities and properties
otherwise categorized as salary or bonuses which in the aggregate as for each of
the named persons did not exceed the lesser of either $50,000 or ten percent of
the total of annual salary reported for such person.

     The Company entered into five year employment agreements with each of
Messrs. Jack Grumet, Jason Gennusa and Andrew Gennusa extending through December
31, 1998. Each such agreement provides for base annual compensation equal to
$125,000, plus in the second, third, fourth and fifth years, increases based on
increases in the consumer price index capped at ten percent per annum. In
addition, each agreement provides for bonus compensation equal to two percent of
the Company's net income before taxes. Each of Messrs. Grumet, J. Gennusa and A.
Gennusa waived such bonus compensation for 1995 and 1996. The agreements contain
customary provisions regarding benefits and restrictions on competition.

     Mr. Goldsmith is employed under an arrangement which became effective April
23, 1996 and extends until December 31, 1998 under which he will receive
compensation at the rate of $132,000 during 1996 and $150,000 in 1997 and 1998,
plus in each year increases based on increases in the consumer price index
capped at 10% per annum. In addition, Mr. Goldsmith is entitled to bonus
compensation equal to 2% of the Company's net income before taxes, provided the
net income of Manhattan Bagel meets stated amounts. Under the terms of the
arrangement, if Mr. Goldsmith's employment is terminated by Manhattan Bagel
without cause, he will be entitled to receive six month's base salary and
thereafter, during the balance of the term of the agreement,


                                       27
<PAGE>

one year's salary. In addition, if Mr. Goldsmith's employment is terminated
after a change of control of the Company, Mr. Goldsmith will be entitled to
receive eighteen month's base salary, plus the bonus earned to date of
termination. Mr. Goldsmith also receives customary benefits and is restricted in
competing with the Company after his employment is terminated. Mr. Goldsmith
also has been granted ten year options expiring on January 29, 2006 to purchase
130,000 of common stock at an exercise price of $5.50 per share. Of such
options, 30,000 were vested on issuance, and the balance vests in three equal
annual installments, on January 29, 1997, 1998, and 1999, and subject to the
next sentence, unvested amounts will terminate in the event Mr. Goldsmith's
employment is terminated. If Mr. Goldsmith is terminated without cause after
three months, all unvested options will vest immediately. Such options were
granted while Mr. Goldsmith was engaged as a consultant to the Company.

     Jack Levy holds an option issued under the Company's 1994 Stock Option Plan
to purchase 9,000 shares of Common Stock at an exercise price of $7.00 per
share. The right to exercise such option vests in three equal annual
installments, commencing January 3, 1996. Jack Levy also holds an option issued
under the Company's 1996 Stock Option Plan to purchase 10,000 shares of Common
Stock at an exercise price of $16.25 per share. The right to exercise such
option vests in three equal annual installments, commencing January 29, 1997.

      Julia S. Heckman holds an option granted to her under the Company's 1996
Stock Option Plan to purchase 10,000 shares of Common Stock at an exercise price
of $12.00 per share. The option vests in three equal annual installments,
commencing October 4, 1997.

                              Option Grants In 1996
                               (Individual Grants)
<TABLE>
<CAPTION>

                                                      Percent of
                                      Number of      Total Options
                                     Securities       Granted to       Exercise
                                     Underlying      Employees in        Price         Expiration
     Name                              Options          1996           per Share          Date
---------------------------------   ------------   ---------------   -------------   ----------------
<S>                                   <C>              <C>              <C>          <C>
Jack Grumet......................        0               0                 0
David Goldsmith (1)..............     130,000          23.7%            $16.25(2)    January 29, 2006
Jason Gennusa....................        0               0                 0
Andrew Gennusa...................        0               0                 0
</TABLE>

----------

(1)  Options in the amount of 30,000 were vested upon issuance on January 29,
     1996 and the balance becomes exercisable in three annual equal installments
     on January 29, 1997, 1998 and 1999.

(2)  On April 1, 1997, the exercise price per share was reduced to $5.50 from
     $16.25. 


                                       28
<PAGE>

                 Aggregated Option Exercises in Last Fiscal Year
                        and Fiscal Year End Option Values

<TABLE>
<CAPTION>

                                                                                           Value of
                                                        Number of Securities              Unexercised
                                                       Underlying Unexercised            In-the-Money
                            Shares                          Options at,                   Options at
                           Acquired      Value           December 31, 1996             December 31, 1996
   Name                  on Exercise    Realized      Exercisable/Unexercisable    Exercisable/Unexercisable
---------------------    -----------    ---------     -------------------------    -------------------------
<S>                          <C>           <C>                   <C>                         <C>
Jack Grumet........          0             0                     0                           0
David Goldsmith              0             0                     0                           0
Jason Gennusa...             0             0                     0                           0
Andrew Gennusa.              0             0                     0                           0
</TABLE>

Compliance with Section 16(a) of the Securities Exchange Act of 1934

    The Company's executive officers and directors are required under the
Securities Exchange Act of 1934 to file reports of ownership and changes in
beneficial ownership of the Company's common stock. Based solely on a review of
the copies of reports furnished to the Company and written representations that
no Forms 5 were required, the Company believes that during 1996 it was in
compliance with all filing requirements applicable to executive officers and
directors were complied with, except as follows: Julia Heckman filed one late
report (Form 4) in regard to 1 transaction; Eugene Cerrotti filed a Form 5 late
for one late report (Form 4) in regard to 1 transaction; Leonard R. Johnson, the
former Chief Financial Officer of the Company, filed two late reports (Form 3
and a Form 5 in regard to a late report on Form 4) in regard to 1 transaction;
David Goldsmith filed two late reports (Form 3 and a Form 5 in regard to a late
report on Form 4) in regard to 1 transaction; Jack Levy filed a Form 5 for one
late report (Form 4) in regard to 1 transaction; and Walter Cruickshank filed
two late reports (Form 3 and a Form 5 in regard to a late report on Form 4) in
regard to 1 transaction.


                                       29
<PAGE>

Item 11. Security Ownership of Certain Beneficial Owners and Management.

The following table sets forth certain information as of, regarding the
beneficial ownership of the Company's Common Stock by (i) all persons known by
the Company to beneficially own more than five percent of the Company's Common
Stock, (ii) each director and officer of the Company, and (iii) all directors
and officers as a group.

                             Percent of Outstanding
                                   Stock Owned

                                                       Amount and
                                                        Nature of
                                                       Beneficial
                                                        Ownership    Percentage
     Name and Address of Beneficial Owners                (1)         of Class 
----------------------------------------------------   -----------   ----------
Jack Grumet (2)(3)(4) ..............................     596,900        8.0%
David Goldsmith (2)(7) .............................      63,333          *
Jason Gennusa (2)(5) ...............................     700,000        9.4%
Andrew Gennusa (2)(6) ..............................     700,000        9.4%
James J. O'Connor (2) ..............................        --           --
Julia S. Heckman ...................................        --           --
     2 World Financial Center, Tower B, 30th Floor     
     New York, New York 10281                          
Jack Levy (8) ......................................       9,434          *
     750 Lexington Avenue,                             
     8th Floor                                         
     New York, New York 10022                          
Grumet Partners, L.P. (3) ..........................     465,668        6.2%
     19 Seven Oaks Drive                               
     Holmdel, New Jersey 07733                         
All executive officers and directors as a group        
  (7 persons) ......................................   2,069,667       27.8%
                                                     
---------------

* less than 1%

(1) Unless otherwise noted, the Company believes that all persons named in the
table have sole voting and sole investment power with respect to all shares of
Common Stock beneficially owned by such person.

(2) The address of each of Jack Grumet, David Goldsmith, Jason Gennusa, Andrew
Gennusa, and James J. O'Connor, is c/o Manhattan Bagel Company, Inc., 246
Industrial Way West, Eatontown, New Jersey 07724.

(3) Includes 465,668 shares held by Grumet Partners, L.P., a limited partnership
of which Mr. Grumet and his sister, Linda Philips, are the general partners, and
of which trusts for the benefit of Mr. Grumet's children are the limited
partners. Linda Philips' address is 621 Terra Peralta Hills, Anaheim, California
92807.


                                       30
<PAGE>

(4) Includes 100,000 shares owned by the estate of Mr. Grumet's wife.

(5) Includes 33,000 shares held in trust for the benefit of members of Mr.
Gennusa's family.

(6) Includes 21,000 shares held in trust for the benefit of members of Mr.
Gennusa's family.

(7) Includes 63,333 shares of Common Stock issuable upon exercise of currently
exercisable options. Does not include 66,667 shares of Common Stock issuable
upon the exercise of options vesting in equal annual installments on January 29,
1998 and 1999.

(8) Includes 9,334 shares of Common Stock issuable upon exercise of currently
exercisable options and 100 shares owned under the Uniform Gift to Minors Act
for the benefit of Mr. Levy's daughter. Does not include 3,000 shares issuable
upon exercise of options vesting on January 3, 1998, and 6,666 shares of Common
Stock issuable upon the exercise of options vesting in equal annual installments
on January 29, 1998 and 1999, respectively.

Item 12. Certain Relationships and Related Transactions.

     Messrs. Jack Grumet and Jason Gennusa and members of their families are
investors in Manda Associates, which was founded in 1991 to provide equipment
lease and other financing to the Company and the Company's franchisees. Manda
Associates formed separate partnerships to finance individual franchisees. To
date, a total of approximately $542,000 has been invested in 17 separate
partnerships. Additionally, amounts owed by the Company to Manda Associates for
notes payable aggregated approximately $13,000. Although the Company does not
expect that the financing from the principal shareholders and their families to
the Company will continue in the future, circumstances may arise when other
conventional financing may not be available to franchisees, in which event Manda
Associates may assist in financing arrangements with such franchisees.

      Messrs Jack Grumet, Jason Gennusa, Andrew Gennusa and Allan Boren have
from time to time personally guaranteed, jointly and severally, the indebtedness
of the Company. Approximately $189,000 was owed to related parties as reproted
in 1995.

     Two of the Company's franchises are owned by Joseph Grumet, who is the son
of Jack Grumet. The terms of the franchises are the same as in other franchised
stores. Jack Grumet also owns a satellite store which sells bagels baked by
another franchised store.

     Main Street Bagel, Inc. ("Main Street"), a company owned by Messrs. Jason
Gennusa and Andrew Gennusa, owes the Company $81,400, pursuant to a note bearing
interest at nine percent per annum due July 2002 with interest only through
October 1995, and monthly installments of various amounts, including principal
and interest, for November 1995 through June 2002. This loan was made for bona
fide business purposes. Main Street was a franchisee of the Company and
previously operated a Manhattan Bagel Company store. The Company had provided
financing to Main Street to fund the construction and start-up costs of the
store at the time Main Street was two-thirds owned by Messrs. Jason Gennusa and
Andrew Gennusa. The franchise and store were sold to an unrelated third party in
May 1993, for a purchase price of $150,000, payable $40,000 in cash at the
closing and the balance of $110,000 in monthly installments over a period of
eight years with interest at nine percent per annum. Main Street is expected to
pay the outstanding loan to the Company from the proceeds of the monthly
installments it receives from the third party franchisee.


                                       31
<PAGE>

     The Company was founded in October 1987 by Messrs. Jason Gennusa and Andrew
Gennusa, each of whom acquired 50% of the then outstanding shares for nominal
consideration. Mr. Jack Grumet joined the Company in April 1991 and acquired his
portion of the outstanding shares for nominal consideration. Pursuant to an
agreement with First Montauk Securities Corp., the underwriters of the Company's
initial public offering, immediately prior to the effectiveness of the
registration statement relating to the Company's June 1994 public offering, each
of Messrs. Jack Grumet, Jason Gennusa and Andrew Gennusa contributed, for no
consideration, 150,000 shares of Common Stock, leaving each with 850,000 shares
of Common Stock at that time.

     Julia S. Heckman, a director of the Company, is a Managing Director with
Rodman & Renshaw, Inc.'s Investment Banking Group. Rodman & Renshaw, Inc. acted
as co-managing underwriter of Manhattan Bagel's November 1995 public offering in
which the Company sold 1,618,000 shares, including shares sold pursuant to the
underwriters overallotment option. The underwriting discounts on such shares
aggregated $1,909,240. Ms. Heckman was elected to the board in November 1995
pursuant to the underwriting agreement under which Rodman & Renshaw, Inc. had
the right to appoint a member to the Board of Directors to serve until the 1996
Annual Meeting. Rodman & Renshaw, Inc. also acted as one of the underwriters of
an underwritten public offering of shares owned by a selling shareholder
pursuant to which Manhattan Bagel sold 90,000 shares upon exercise of the
underwriters' overallotment option. The aggregate underwriting discount relating
to these overallotment shares was $113,850.

     Law firms of which Jack Levy, a director of Manhattan Bagel since October
1995, has acted as counsel for Manhattan Bagel since 1993.


                                       32
<PAGE>

Item 13. Exhibits and Reports on Form 8-k.

     (a)  The following exhibits are filed as part of this report. Incorporated
          by

Reference to:     No.      Exhibits
-------------     ---      --------

Exhibit 3.1[1]    3.1      Restated Certificate of Incorporation of the
                           Registrant

Exhibit 3.2[5]    3.2      Amendment to Restated Certificate of Incorporation
                           of the Registrant

Exhibit 3.3[8]    3.3      By-Laws of the Registrant

Exhibit 4.2[1]    4.2      Underwriter's Warrant Agreement and Form of
                           Warrant Certificate

Exhibit 10.1[1]   10.1     Employment Agreement dated as of January 1, 1994
                           between the Registrant and Jack Grumet**

Exhibit 10.2[1]   10.2     Employment Agreement dated as of January 1, 1994
                           between the Registrant and Jason Gennusa**

Exhibit 10.3[1]   10.3     Employment Agreement dated as of January 1, 1994
                           between the Registrant and Andrew Gennusa**

Exhibit 10.4[1]   10.4     Employment Agreement dated as of January 15, 1994
                           between the Registrant and Daniel Levy**

Exhibit 10.5[1]   10.5     Form of Registrants Franchise Agreement

Exhibit 10.6[1]   10.6     Form of Registrants Master Franchise Agreement

Exhibit 10.7[1]   10.7     Master Lease Agreement No. 00000562 dated as of
                           August 27, 1992, between the Registrant and
                           Society Equipment Leasing Company.

Exhibit 10.8[1]   10.8     Lease Agreement dated as of September 30, 1992
                           between Hecon Properties, Inc. and the Registrant
                           for executive offices of the Registrant.

Exhibit 10.9[1]   10.9     Form of Sublease Agreement between the Registrant
                           and individual franchisees

Exhibit 10.10[1]  10.10    1994 Stock Option Plan**

Exhibit 10.11[1]  10.11    Promissory Note dated March 1, 1993, payable by
                           the Registrant to Manda Associates for the
                           principal sum of $50,000

Exhibit 10.12[1]  10.12    Promissory note dated January 1, 1992, payable by
                           the Registrant (as successor to Manhattan Bagel
                           Ventures, Inc.) to Manda Associates for the
                           principal sum of $30,000

Exhibit 10.13[1]  10.13    Promissory Note dated May 1, 1994 of Main Street
                           Bagel, Inc., to the Registrant for the principal
                           sum of $81,385


                                       33
<PAGE>

Exhibit 10.14[2]  10.14    Employment Agreement dated as of December 29, 1994
                           between the Registrant and Fred Austin**
                           
Exhibit 10.15[2]  10.15    Office lease dated January 12, 1995 between the
                           Registrant and MBL Life Assurance Corporation for
                           executive office and manufacturing facility of the
                           Registrant, and Amendment thereto dated March 6,
                           1995.
                           
Exhibit 10.15.1            Second Amendment to Office Lease, dated May 6,
                           1996, between the Registrant and MBL Life
                           Assurance Corporation (for the lease of an
                           additional 30,600 square feet of space).*
                           
Exhibit 10.15.2            Third Amendment to Office Lease, dated March 4,
                           1997, between the Registrant and Townsend Property
                           Trust Limited Partnership (as
                           successor-in-interest to MBL Life Assurance
                           Corporation).*
                           
Exhibit 10.15.3            Fourth Amendment to Office Lease, dated March 5,
                           1997, between the Registrant and Townsend Property
                           Trust Limited Partnership (as
                           successor-in-interest to MBL Life Assurance
                           Corporation).*
                        

Exhibit 10.16[3]  10.16    Agreement and Plan of Merger dated as of May 10,
                           1995 and Amendments No. 1 and No. 2 thereto dated
                           as of June 29, 1995 by and among the Registrant,
                           DAB Acquisition Corp., DAB Industries, Inc. and
                           Allan Boren.**

Exhibit 10.17[4]  10.17    Bond Agreement between New Jersey Economic
                           Development Authority and the Registrant dated as
                           of October 1, 1995

Exhibit 10.18[4]  10.18    Letter of Credit and Reimbursement Agreement
                           between First Fidelity Bank, N.A. and the
                           Registrant.

Exhibit 10.19[5]  10.19    Agreement and Plan of Merger dated as of November
                           21, 1995 by and among the Registrant, BAB
                           Acquisition Corp., Bay Area Bagel, Inc., Gary
                           Goldstein and Scott Kronenberg.

Exhibit 10.20[6]  10.20    Agreement dated as of January 17, 1996 by and
                           among BMR Bagel Co., Inc., Another Bagel Co.,
                           Inc., ETR Bagel Co., Inc., Jeff M. Refold and Jay
                           Refold, and I. & J. Bagel Co., Inc.

Exhibit 10,21[7]           Agreement and Plan of Merger, dated as of May 22,
                           1996, by and among SBI Acquisition Corp.,
                           Specialty Bakeries, Inc., Rocco Fiorentino, John
                           Gerber, and Frank Guglielmo.

Exhibit 10.21[8]  10.21    Settlement Agreement dated as of February 26, 1996
                           between the Registrant and Allan Boren.

Exhibit 10.30[9]  10.30    1996 Stock Option Plan **

Exhibit 21                 Subsidiaries of the Registrant.*

Exhibit 23.1               Consent of Amper, Politziner & Mattia.*

Exhibit 23.2               Consent of Singer, Lewak, Greenbaum & Goldstein, 
                           L.L.P.*


                                       34
<PAGE>

Exhibit 23.3               Consent of Ernst & Young LLP.*

Exhibit 27                 Financial Data Schedule

Exhibit 25.4               Consent of Rainer & Company

---------

*    Filed herewith

**   Management Contract or Compensatory Plan

[1]  Registrant's Registration Statement on Form SB-2, File No. 33-77058-NY


[2]  Incorporated by reference to Registrant's Annual Report on Form 10-KSB for
     the year ending December 31, 1994.

[3]  Incorporated by reference to Registrant's Current Report on Form 8-K dated
     June 29, 1995.

[4]  Incorporated by reference to Registrant's Amendment No. 1 to Registration
     Statement on Form SB-2, File No. 97658.

[5]  Incorporated by reference to Exhibit 10.22 to Registrant's current Report
     on Form 8-K dated January 9, 1996.

[6]  Incorporated by reference to Exhibit 10.22 to Registrant's current Report
     on Form 8-K dated January 17, 1996.

[7]  Incorporated by reference to Exhibit 10.22 to Registrant's Current Report
     on Form 8-K dated May 23, 1996.

[8]  Incorporated by reference to Registrant's Registration Statement on Form
     SB-2, File No. 333-1966.

[9]  Incorporated by reference to Registrant's Annual Report on Form 10-KSB for
     the year ended December 31, 1995.

     (b)  There were no reports on Form 8-K filed during the quarter ended
          December 31, 1996.


                                       35
<PAGE>

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly.

Date:                             Manhattan Bagel Company, Inc.
                                  (Registrant)

                                  By:  Jack Grumet
                                  -----------------------------
                                  Jack Grumet
                                  Chairman of the Board
                                  and Chief Executive Officer

     In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capabilities and
the dated indicated.

Signature and Title                                      Date
-------------------                                      ----

Jack Grumet                                         April 15, 1997
------------------------------------
Jack Grumet
Chairman of the Board
and Chief Executive Officer

David Goldsmith                                     April 15, 1997
------------------------------------
David Goldsmith
Vice Chairman of the Board

Jason Gennusa                                       April 15, 1997
------------------------------------
Jason Gennusa
President and Chief Operating
Officer and Director

Andrew Gennusa                                      April 15, 1997
------------------------------------
Andrew Gennusa
Executive Vice President and Director

James J. O'Connor                                   April 15, 1997
------------------------------------
James J. O'Connor
Chief Financial Officer

Walter R. Cruickshank                               April 15, 1997
------------------------------------
Walter R. Cruickshank
Chief Accounting Officer

                                                    April 15, 1997
------------------------------------
Julia S. Heckman
Director

Jack Levy                                           April 15, 1997
------------------------------------
Jack Levy
Director


                                       36