**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-Q/A**

 

**Amendment No. 1**

 

**(MarkOne)**

| **ý** |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|------------|--------|------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended September 28, 2004**

 

**OR**

** **

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

 

**Commission File Number 0-27148**

 

**New WorldRestaurant Group, Inc**.

(Name of Registrant as Specified in its Charter)

 

| **Delaware**                                                    | ** ** | **13-3690261**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction  of Incorporation or Organization) |       | (I.R.S. Employer  Identification No.) |

 

**1687 Cole Blvd., Golden, Colorado 80401**

(Address of principal executive offices, including zip code)

 

**(303) 568-8000**

(Registrant’s telephone number, including area code)

 

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

**None**

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes ý  No o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Securities Exchange Act of 1934).  Yes o  No ý

 

As ofNovember 8, 2004, 9,842,385 shares of Common Stock of the registrant wereoutstanding.

 

 

----

 

**Explanatory Note**

 

Thepurpose of this amendment on Form 10-Q/A for the quarterly period endedSeptember 28, 2004 is to restate our consolidated financial statements as ofSeptember 28, 2004 and December 30, 2003 and for the thirteen and thirty-nineweeks ended September 28, 2004 and September 30, 2003, and the relateddisclosures, as described in Note 1 to the Consolidated Financial Statements.Additional information regarding our decision to restate these financialstatements can be found in our Current Report on Form 8-K, filed with theSecurities and Exchange Commission (SEC) on March 3, 2005.

 

Noattempt has been made in this Form 10-Q/A to modify or update other disclosurespresented in the original report on Form 10-Q, except as required to reflectthe restatement. The Form 10-Q/A does not reflect events occurring after thefiling of the Form 10-Q or modify or update those disclosures, including theexhibits to the Form 10-Q affected by subsequent events. Information notaffected by the restatement is unchanged and reflects the disclosures made atthe time of the original filing of the Form 10-Q. Accordingly, this Form 10-Q/Ashould be read in conjunction with our filings made with the SEC subsequent tothe filing of the original Form 10-Q, including any amendments to thosefilings. The following items have been amended as a result of the restatement:

 

Part I – Item 1 –Financial Statements

PartII – Item II – Management’s Discussion and Analysis of Financial Condition andResults of Operations

 

*Descriptionof Restatement*

 

It has been our longstanding historical accountingpolicy to amortize our leasehold improvements over a period that included boththe noncancelable term of the lease and its option periods (or the useful lifeof the asset, if shorter). Concurrently, we used the noncancelable lease termin determining whether each of our leases was an operating lease or a capitallease and in calculating our straight-line rent expense. We believed that theseaccounting treatments were appropriate under generally accepted accountingprinciples. Furthermore, we believed that these accounting treatments werecomparable to the practices of other public companies. However, we have sinceconcluded that we should use the same lease term in amortizing leaseholdimprovements as we use in determining capital versus operating leases and incalculating straight-line rent expense. Accordingly, we have adopted thefollowing policy: the depreciable lives for our leasehold improvements, whichare subject to a lease, will be limited to the lesser of the useful life or thenoncancelable lease term. In circumstances where we would incur an economicpenalty by not exercising one or more option periods, as contemplated byStatement of Financial Accounting Standards (SFAS) No. 13 “Accounting forLeases,” we may include one or more option periods when determining thedepreciation period. In either circumstance, our policy requires consistencywhen calculating the depreciation period, in classifying the lease, and incomputing straight-line rent expense.

 

2

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**NEW WORLD RESTAURANT GROUP, INC.**

 

September 28, 2004

 

TABLE OF CONTENTS

 
| **Part I. Financial Information** |
|-----------------------------------|
|                              |   |   |
| Item 1.                           | Financial Statements (as restated): |   |
|                              |   |   |
|                              | Consolidated Balance  Sheets, September 28, 2004 (unaudited) and December 30, 2003 |   |
|                              |   |   |
|                              | Consolidated  Statements of Operations (unaudited), for the thirteen and thirty-nine weeks  ended September 28, 2004 and September 30, 2003 |   |
|                              |   |   |
|                              | Consolidated  Statements of Cash Flows (unaudited), for the thirty-nine weeks ended  September 28, 2004 and September 30, 2003 |   |
|                              |   |   |
|                              | Consolidated  Statement of Changes in Stockholders’ Equity (Deficit), for the thirty-nine  weeks ended September 28, 2004 (unaudited) |   |
|                              |   |   |
|                              | Notes to the  Consolidated Financial Statements |   |
|                              |   |   |
| Item 2.                           | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|                              |   |   |
| Item 3.                           | Quantitative and Qualitative Disclosures about  Market Risk |   |
|                              |   |   |
| Item 4.                           | Controls and Procedures |   |
|                              |   |   |
| **Part  II. Other Information**   |
|                              |   |   |
| Item  1.                          | Legal  Proceedings |   |
|                              |   |   |
| Item 6.                           | Exhibits |   |

 

3

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**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATED BALANCE SHEETS**

**AS OF SEPTEMBER 28, 2004 AND DECEMBER 30, 2003**

**(in thousands, except share information)**

** **
| ** **                                                                                                                                                                 | ** ** | **September 28,  2004** | ** ** | **December 30,  2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                 | ** ** | **(restated)**          | ** ** | **(restated)**         | ** ** |
| ** **                                                                                                                                                                 | ** ** | **(unaudited)**         | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                 | ** ** | ** **              | ** ** | ** **             | ** ** |
| Current assets:                                                                                                                                                            |       |                    |       |                   |       |
| Cash and cash equivalents                                                                                                                                                  |       | $                       | 1,862      |                   | $          | 9,575 |   |
| Restricted cash                                                                                                                                                            |       | 1,267                   |       | 1,815                  |       |
| Franchise and other receivables, net of  allowance of $2,904 and $3,310                                                                                                    |       | 6,372                   |       | 5,842                  |       |
| Inventories                                                                                                                                                                |       | 4,682                   |       | 4,831                  |       |
| Prepaid expenses and other current assets                                                                                                                                  |       | 2,039                   |       | 2,650                  |       |
| Total current assets                                                                                                                                                       |       | 16,222                  |       | 24,713                 |       |
|                                                                                                                                                                       |       |                    |       |                   |       |
| Restricted cash long-term                                                                                                                                                  |       | 2,925                   |       | 3,036                  |       |
| Property, plant and equipment, net                                                                                                                                         |       | 43,604                  |       | 54,513                 |       |
| Trademarks and other intangibles, net                                                                                                                                      |       | 79,304                  |       | 85,431                 |       |
| Goodwill                                                                                                                                                                   |       | 4,875                   |       | 4,875                  |       |
| Debt issuance costs and other assets                                                                                                                                       |       | 7,813                   |       | 9,170                  |       |
| Total assets                                                                                                                                                               |       | $                       | 154,743    |                   | $          | 181,738 |   |
|                                                                                                                                                                       |       |                    |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**                                                                                                                             | ** ** | ** **              | ** ** | ** **             | ** ** |
| Current liabilities:                                                                                                                                                       |       |                    |       |                   |       |
| Cash overdraft                                                                                                                                                             |       | $                       | 1,978      |                   | $          | — |   |
| Accounts payable                                                                                                                                                           |       | 7,867                   |       | 8,189                  |       |
| Accrued expenses                                                                                                                                                           |       | 27,071                  |       | 37,871                 |       |
| Short term debt and current portion of  long-term debt                                                                                                                     |       | 280                     |       | 2,105                  |       |
| Current portion of obligations under  capital leases                                                                                                                       |       | 5                       |       | 180                    |       |
| Total current liabilities                                                                                                                                                  |       | 37,201                  |       | 48,345                 |       |
|                                                                                                                                                                       |       |                    |       |                   |       |
| Senior notes and other long-term debt                                                                                                                                      |       | 161,120                 |       | 161,120                |       |
| Obligations under capital leases                                                                                                                                           |       | 10                      |       | 29                     |       |
| Other liabilities                                                                                                                                                          |       | 9,819                   |       | 10,397                 |       |
| Mandatorily redeemable, Series Z Preferred  Stock, $.001 par value, $1,000 per share liquidation value; 2,000,000 shares authorized;  57,000 shares issued and outstanding |       | 57,000                  |       | 57,000                 |       |
| Total liabilities                                                                                                                                                          |       | 265,150                 |       | 276,891                |       |
|                                                                                                                                                                       |       |                    |       |                   |       |
| Stockholders’ deficit:                                                                                                                                                |       |                    |       |                   |       |
| Common stock, $.001 par value; 15,000,000  shares authorized; 9,842,385 and 9,841,828 shares issued and outstanding                                                        |       | 10                      |       | 10                     |       |
| Additional paid-in capital                                                                                                                                                 |       | 175,791                 |       | 175,585                |       |
| Unamortized stock compensation                                                                                                                                             |       | (154                    | )          | —                 |       |
| Accumulated deficit                                                                                                                                                        |       | (286,054                | )          | (270,748               | )          |
| Total stockholders’ deficit                                                                                                                                           |       | (110,407                | )          | (95,153                | )          |
| Total liabilities and stockholders’ deficit                                                                                                                           |       | $                       | 154,743    |                   | $          | 181,738 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

4

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**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**FOR THE THIRTEEN AND THIRTY-NINE WEEKS ENDED SEPTEMBER 28,2004 AND SEPTEMBER 30, 2003**

**(in thousands, except earnings per share and related shareinformation)**

**(unaudited)**

 
| ** **                                                        | ** ** | **Thirteen weeks ended:** | ** ** | **Thirty-nine weeks ended:** | ** ** |
|-------------------------------------------------------------------|------------|---------------------------|------------|------------------------------|------------|
| ** **                                                        | ** ** | **September 28,  2004**   | ** ** | **September 30,  2003**      | ** ** | **September 28,  2004** | ** ** | **September 30,  2003** | ** ** |
| ** **                                                        | ** ** | **(restated)**            | ** ** | **(restated)**               | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Revenues:                                                         |       |                      |       |                         |       |   |   |   |   |
| Retail sales                                                      |       | $                         | 84,763     |                         | $          | 86,975 |   | $ | 256,982 |   | $ | 266,302 |   |
| Manufacturing revenues                                            |       | 4,913                     |       | 4,798                        |       | 15,270 |   | 15,976 |   |
| Franchise and license related revenues                            |       | 1,503                     |       | 1,454                        |       | 4,287 |   | 3,909 |   |
|                                                              |       |                      |       |                         |       |   |   |   |   |
| Total revenues                                                    |       | 91,179                    |       | 93,227                       |       | 276,539 |   | 286,187 |   |
|                                                              |       |                      |       |                         |       |   |   |   |   |
| Cost of sales:                                                    |       |                      |       |                         |       |   |   |   |   |
| Retail costs                                                      |       | 70,315                    |       | 74,277                       |       | 213,805 |   | 224,616 |   |
| Manufacturing costs                                               |       | 4,603                     |       | 4,436                        |       | 13,623 |   | 14,559 |   |
|                                                              |       |                      |       |                         |       |   |   |   |   |
| Total cost of sales                                               |       | 74,918                    |       | 78,713                       |       | 227,428 |   | 239,175 |   |
|                                                              |       |                      |       |                         |       |   |   |   |   |
| Gross profit                                                      |       | 16,261                    |       | 14,514                       |       | 49,111 |   | 47,012 |   |
|                                                              |       |                      |       |                         |       |   |   |   |   |
| Operating expenses:                                               |       |                      |       |                         |       |   |   |   |   |
| General and administrative expenses                               |       | 8,442                     |       | 9,716                        |       | 25,260 |   | 30,574 |   |
| Depreciation and amortization                                     |       | 7,005                     |       | 8,665                        |       | 20,882 |   | 25,889 |   |
| Adjustment of integration and  reorganization cost                |       | (44                       | )          | (153                         | )          | (843 | ) | (153 | ) |
| Impairment charges and other related costs                        |       | 402                       |       | —                       |       | 402 |   | — |   |
|                                                              |       |                      |       |                         |       |   |   |   |   |
| Income (loss) from operations                                     |       | 456                       |       | (3,714                       | )          | 3,410 |   | (9,298 | ) |
|                                                              |       |                      |       |                         |       |   |   |   |   |
| Other expense (income):                                           |       |                      |       |                         |       |   |   |   |   |
| Interest expense, net                                             |       | 5,723                     |       | 10,188                       |       | 17,426 |   | 28,458 |   |
| Cumulative change in the fair value of  derivatives               |       | —                    |       | (1,063                       | )          | — |   | (993 | ) |
| Loss (gain) on sale, disposal or  abandonment of assets, net      |       | (70                       | )          | (390                         | )          | 1,395 |   | (592 | ) |
| Loss on exchange of Series F Preferred  Stock due to Equity Recap |       | —                    |       | 23,007                       |       | — |   | 23,007 |   |
| Other                                                             |       | (98                       | )          | 255                          |       | (197 | ) | (113 | ) |
|                                                              |       |                      |       |                         |       |   |   |   |   |
| Loss before income taxes                                          |       | (5,099                    | )          | (35,711                      | )          | (15,214 | ) | (59,065 | ) |
|                                                              |       |                      |       |                         |       |   |   |   |   |
| Benefit (provision) for state income taxes                        |       | 147                       |       | —                       |       | (92 | ) | (430 | ) |
|                                                              |       |                      |       |                         |       |   |   |   |   |
| Net loss                                                          |       | (4,952                    | )          | (35,711                      | )          | (15,306 | ) | (59,495 | ) |
| Dividends and accretion on Preferred Stock                        |       | —                    |       | —                       |       | — |   | (14,423 | ) |
|                                                              |       |                      |       |                         |       |   |   |   |   |
| Net loss available to common stockholders                         |       | $                         | (4,952     | )                            | $          | (35,711 | ) | $ | (15,306 | ) | $ | (73,918 | ) |
| Net loss per common share – Basic and  Diluted               |       | $                         | (0.50      | )                            | $          | (14.16 | ) | $ | (1.56 | ) | $ | (39.24 | ) |
| Weighted average number of common shares  outstanding:            |       |                      |       |                         |       |   |   |   |   |
| Basic and Diluted                                                 |       | 9,842,385                 |       | 2,521,491                    |       | 9,842,169 |   | 1,883,770 |   |
|                                                                   |            |                           |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

5

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**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**FOR THE THIRTY-NINE WEEKS ENDED SEPTEMBER 28, 2004 ANDSEPTEMBER 30, 2003**

**(in thousands)**

**(unaudited)**

 
| ** **                                                                   | ** ** | **Thirty-nine weeks ended:** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                   | ** ** | **September 28,  2004**      | ** ** | **September 30,  2003** | ** ** |
| ** **                                                                   | ** ** | **(restated)**               | ** ** | **(restated)** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                        |       |                         |       |   |   |
| Net loss                                                                     |       | $                            | (15,306    | ) | $ | (59,495 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                         |       |   |   |
| Depreciation and amortization                                                |       | 20,882                       |       | 25,889 |   |
| Stock based compensation expense                                             |       | 51                           |       | — |   |
| Loss (gain) on disposal of assets and  impairment charges                    |       | 1,625                        |       | (592 | ) |
| Adjustments of integration and  reorganization costs                         |       | (843                         | )          | (153 | ) |
| Cumulative change in fair value of  derivatives                              |       | —                       |       | (993 | ) |
| Amortization of debt issuance and debt  discount costs                       |       | 1,387                        |       | 2,675 |   |
| Notes issued as paid in kind for interest  on Bridge Loan                    |       | —                       |       | 510 |   |
| Issuance of standstill warrants                                              |       | —                       |       | 3,132 |   |
| Greenlight interest                                                          |       | —                       |       | 1,025 |   |
| Loss on exchange of Series F Preferred  Stock due to Equity Recap            |       | —                       |       | 23,007 |   |
| Reduction in Bridge Loan due to Equity  Recap                                |       | —                       |       | (615 | ) |
| Changes in operating assets and  liabilities:                                |       |                         |       |   |   |
| Franchise and other receivables                                              |       | (530                         | )          | (46 | ) |
| Cash overdraft                                                               |       | 1,978                        |       | — |   |
| Accounts payable and accrued expenses                                        |       | (10,279                      | )          | 2,289 |   |
| Other assets and liabilities                                                 |       | 617                          |       | (2,999 | ) |
|                                                                         |       |                         |       |   |   |
| Net cash used in operating activities                                        |       | (418                         | )          | (6,366 | ) |
|                                                                         |       |                         |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                        |       |                         |       |   |   |
| Purchase of property and equipment                                           |       | (5,605                       | )          | (5,838 | ) |
| Proceeds from the sale of equipment                                          |       | 134                          |       | 546 |   |
|                                                                         |       |                         |       |   |   |
| Net cash used in investing activities                                        |       | (5,471                       | )          | (5,292 | ) |
|                                                                         |       |                         |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                        |       |                         |       |   |   |
| Proceeds (repayments) of line of credit,  net                                |       | (1,000                       | )          | (1,500 | ) |
| Repayment of notes payable                                                   |       | (825                         | )          | (801 | ) |
| Proceeds from issuance of $160 Million  Indenture                            |       | —                       |       | 160,000 |   |
| Repayment of $140 Million Facility                                           |       | —                       |       | (140,000 | ) |
| Advance funding of NJEDA (restricted cash)                                   |       | —                       |       | (2,028 | ) |
| Debt issuance costs                                                          |       | —                       |       | (8,538 | ) |
| Common stock issued upon warrant exercise                                    |       | 1                            |       | — |   |
|                                                                         |       |                         |       |   |   |
| Net cash provided by (used in) financing  activities                         |       | (1,824                       | )          | 7,133 |   |
|                                                                         |       |                         |       |   |   |
| Net decrease in cash                                                         |       | (7,713                       | )          | (4,525 | ) |
| Cash and cash equivalents, beginning of  period                              |       | 9,575                        |       | 10,705 |   |
| Cash and cash equivalents, end of period                                     |       | $                            | 1,862      |   | $ | 6,180 |   |
|                                                                         |       |                         |       |   |   |
| SUPPLEMENTAL CASH FLOW INFORMATION:                                          |       |                         |       |   |   |
| Cash paid for interest                                                       |       | $                            | 20,958     |   | $ | 16,993 |   |
| Cash paid for income taxes                                                   |       | $                            | 572        |   | $ | 430 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

6

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**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENT OF CHANGES****IN STOCKHOLDERS’ EQUITY(DEFICIT)**

**FOR THE THIRTY-NINE WEEKS ENDED SEPTEMBER 28, 2004**

**(in thousands, except share information)**

**(unaudited)**

 
| ** **                                     | ** ** | ** **        | ** ** | ** **  | ** ** | **Additional** | ** ** | **Unamortized**  | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|-------------------|------------|-------------|------------|----------------|------------|------------------|------------|-----------------|------------|------------|------------|
| ** **                                     | ** ** | **Common  Stock** | ** ** | **Paid In** | ** ** | **Stock**      | ** ** | **Deficit**      | ** ** | ** **      | ** ** |
| ** **                                     | ** ** | **Shares**        | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Compensation** | ** ** | **Amount**      | ** ** | **Total**  | ** ** |
|                                           |       |              |       |        |       |           |       |             |       |            |       |       |       |
| Balance, December  30, 2003 (as restated)      |       | 9,841,828         |       | $           | 10         |           | $          | 175,585          |       | $               | —     |       | $          | (270,748 | ) | $ | (95,153 | ) |
| Net loss (as restated)                         |       | —            |       | —      |       | —         |       | —           |       | (15,306         | )          | (15,306    | )          |
| Stock  compensation expense of options granted |       | —            |       | —      |       | 205            |       | (205             | )          | —          |       | —     |       |
| Amortization of  stock compensation expense    |       | —            |       | —      |       | —         |       | 51               |       | —          |       | 51         |       |
| Common stock  issued upon warrant exercise     |       | 557               |       | —      |       | 1              |       | —           |       | —          |       | 1          |       |
|                                           |       |              |       |        |       |           |       |             |       |            |       |       |       |
| Balance,  September 28, 2004 (as restated)     |       | 9,842,385         |       | $           | 10         |           | $          | 175,791          |       | $               | (154       | )          | $          | (286,054 | ) | $ | (110,407 | ) |
|                                                |            |                   |            |             |            |                |            |                  |            |                 |            |            |            |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

7

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**NEW WORLD RESTAURANT GROUP, INC.**

 

Notes to ConsolidatedFinancial Statements (Unaudited)

 

Thirteen and thirty-nineweeks ended September 28, 2004 and September 30, 2003

 

**1.****             ****Basisof Presentation**

 

The accompanying consolidated financialstatements of New World Restaurant Group, Inc. and its wholly-ownedsubsidiaries (collectively, “the Company”) have been prepared pursuant to therules and regulations of the Securities and Exchange Commission (“SEC”). As ofSeptember 28, 2004, the Company owns, franchises or licenses various restaurantconcepts under the brand names of Einstein Bros. Bagels (“Einstein Bros.”),Noah’s New York Bagels (“Noah’s”), Manhattan Bagel Company (“Manhattan”),Chesapeake Bagel Bakery (“Chesapeake”), New World Coffee (“New World”), andWilloughby’s Coffee and Tea (“Willoughby’s”). Our business is subject to seasonal trends.Generally, our revenues in the first fiscal quarter are somewhat lower than inthe other three fiscal quarters.

 

Theaccompanying consolidated financial statements as ofSeptember 28, 2004 and December 30, 2003 and for the thirteen and thirty-nineweeks ended September 28, 2004 and September 30, 2003 have been prepared without audit (except forthe balance sheet information as of December 30, 2003, which is derived fromour audited financial statements). The information furnished herein reflectsall adjustments (consisting only of normal recurring accruals and adjustments),which are, in our opinion, necessary to fairly state the interim operating resultsfor the respective periods.  However, these operating results are notnecessarily indicative of the results expected for the full fiscal year. Certain information and footnote disclosures normally included in annualfinancial statements prepared in accordance with generally accepted accountingprinciples in the United States have been omitted pursuant to SEC rules andregulations. The notes to the consolidated financial statements (unaudited)should be read in conjunction with the notes to the consolidated financialstatements contained in our annual report on Form 10-K for the fiscal yearended December 30, 2003. We believe that the disclosures are sufficient forinterim financial reporting purposes.

 

Certain reclassifications have been madeto conform previously reported data to the current presentation. These reclassifications have no effect on netincome or financial position as previouslyreported.

 

**Restatement of****PriorFinancial Information**

 

Ithas been our longstanding historical accounting policy to amortize ourleasehold improvements over a period that included both the noncancelable termof the lease and its option periods (or the useful life of the asset, ifshorter). Concurrently, we used the noncancelable lease term in determiningwhether each of our leases was an operating lease or a capital lease and incalculating our straight-line rent expense. We believed that these accountingtreatments were appropriate under generally accepted accounting principles.Furthermore, we believed that these accounting treatments were comparable tothe practices of other public companies. However, we have since concluded thatwe should use the same lease term in amortizing leasehold improvements as weuse in determining capital versus operating leases and in calculatingstraight-line rent expense. Accordingly, we have adopted the following policy:the depreciable lives for our leasehold improvements, which are subject to alease, will be limited to the lesser of the useful life or the noncancelablelease term. In circumstances where we would incur an economic penalty by notexercising one or more option periods, as contemplated by Statement ofFinancial Accounting Standards (SFAS) No. 13 “Accounting for Leases,” we mayinclude one or more option periods when determining the depreciation period. Ineither circumstance, our policy requires consistency when calculating thedepreciation period, in classifying the lease, and in computing straight-linerent expense.

 

8

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Asa result of this change, our financial statements have been restated as follows(dollars in thousands, except per share data):

 
| ** **                       | ** ** | **As of September 28, 2004** | ** ** | **As of December 30, 2003** | ** ** |
|----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **As reported**              | ** ** | **Adjustments**             | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Balance Sheet:                   |       |                         |       |                        |       |   |   |   |   |   |   |   |   |
| Property and equipment, net      |       | $                            | 61,419     |                        | $          | (17,815 | ) | $ | 43,604 |   | $ | 67,800 |   | $ | (13,287 | ) | $ | 54,513 |   |
| Total assets                     |       | 172,558                      |       | (17,815                     | )          | 154,743 |   | 195,025 |   | (13,287 | ) | 181,738 |   |
| Accumulated deficit              |       | (268,239                     | )          | (17,815                     | )          | (286,054 | ) | (257,461 | ) | (13,287 | ) | (270,748 | ) |
| Total stockholders’ deficit |       | (92,592                      | )          | (17,815                     | )          | (110,407 | ) | (81,866 | ) | (13,287 | ) | (95,153 | ) |
|                                  |            |                              |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                   | ** ** | **Thirteen weeks ended Sept. 28, 2004** | ** ** | **Thirty-nine weeks ended Sept. 28, 2004** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                   | ** ** | **As reported**                         | ** ** | **Adjustments**                            | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Statement of Operations:                                     |       |                                    |       |                                       |       |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                |       | $                                       | 5,182      |                                       | $          | 1,823 |   | $ | 7,005 |   | $ | 15,764 |   | $ | 5,118 |   | $ | 20,882 |   |
| Income from operations                                       |       | 2,279                                   |       | (1,823                                     | )          | 456 |   | 8,528 |   | (5,118 | ) | 3,410 |   |
| Loss (gain) on sale, disposal or abandonment  of assets, net |       | 273                                     |       | (343                                       | )          | (70 | ) | 1,985 |   | (590 | ) | 1,395 |   |
| Loss before income taxes                                     |       | (3,619                                  | )          | (1,480                                     | )          | (5,099 | ) | (10,686 | ) | (4,528 | ) | (15,214 | ) |
| Net loss                                                     |       | (3,472                                  | )          | (1,480                                     | )          | (4,952 | ) | (10,778 | ) | (4,528 | ) | (15,306 | ) |
| Net loss available to common stockholders                    |       | (3,472                                  | )          | (1,480                                     | )          | (4,952 | ) | (10,778 | ) | (4,528 | ) | (15,306 | ) |
| Net loss per common share                                    |       | $                                       | (0.35      | )                                          | $          | (0.15 | ) | $ | (0.50 | ) | $ | (1.10 | ) | $ | (0.46 | ) | $ | (1.56 | ) |

 
| ** **                                | ** ** | **Thirteen weeks ended Sept. 30, 2003** | ** ** | **Thirty-nine weeks ended Sept. 30, 2003** | ** ** |
|-------------------------------------------|------------|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **As reported**                         | ** ** | **Adjustments**                            | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Statement of Operations:                  |       |                                    |       |                                       |       |   |   |   |   |   |   |   |   |
| Depreciation and amortization             |       | $                                       | 7,128      |                                       | $          | 1,537 |   | $ | 8,665 |   | $ | 21,425 |   | $ | 4,464 |   | $ | 25,889 |   |
| Loss from operations                      |       | (2,177                                  | )          | (1,537                                     | )          | (3,714 | ) | (4,834 | ) | (4,464 | ) | (9,298 | ) |
| Loss before income taxes                  |       | (34,174                                 | )          | (1,537                                     | )          | (35,711 | ) | (54,601 | ) | (4,464 | ) | (59,065 | ) |
| Net loss                                  |       | (34,174                                 | )          | (1,537                                     | )          | (35,711 | ) | (55,031 | ) | (4,464 | ) | (59,495 | ) |
| Net loss available to common stockholders |       | (34,174                                 | )          | (1,537                                     | )          | (35,711 | ) | (69,454 | ) | (4,464 | ) | (73,918 | ) |
| Net loss per common share                 |       | $                                       | (13.55     | )                                          | $          | (0.61 | ) | $ | (14.16 | ) | $ | (36.87 | ) | $ | (2.37 | ) | $ | (39.24 | ) |

 

9

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**2.****             ****Goodwill,Trademarks and Other Intangibles**

 

Statementof Financial Accounting Standards (SFAS) No. 142 provides that goodwilland other indefinite-lived intangibles should not be amortized, but be subjectto an annual assessment for impairment, or more frequently if circumstancesindicate potential impairment, through a comparison of fair value to itscarrying amount. The two-step approach to assess goodwill impairment requiresthat we first compare the estimated fair value of each reporting unit thathouses goodwill to the carrying amount of the unit’s assets and liabilities, includingits goodwill and intangible assets. If the fair value of the reporting unit isbelow its carrying amount, then the second step of the impairment test isperformed, in which the current fair value of the unit’s assets and liabilitieswill determine the current implied fair value of the unit’s goodwill. Theimpairment tests relating to goodwill and indefinite-lived trademarks areperformed as of year-end, unless events and circumstances indicate otherwise.During the thirteen weeks ended June 29, 2004, we began an evaluation ofwhether each of our brands should be a part of our overall strategic businessplan. As a result of this evaluation, we determined that certain brands may nolonger fit strategically. Accordingly, we performed an impairment analysis anddetermined that no impairment of these brands existed at June 29, 2004. We alsoperformed a longevity analysis of certain brands and determined that certaintrademarks had an estimated remaining useful life of 4 years. These trademarkswere previously treated as a non-amortizing intangible and accordingly, werereclassified as an amortizing intangible at June 29, 2004. During the thirteenweeks ended September 28, 2004, no additional impairment indicators werepresent and accordingly no additional interim tests for impairment of goodwill,trademarks or amortizing intangibles were performed.

 

Goodwill represents the excess of costover fair value of net assets acquired in the acquisition of Manhattan BagelCompany, Inc.

 

Trademarks and other intangibles consistof the following (in thousands of dollars):

 
| ** **                                  | ** ** | **September 28,  2004** | ** ** | **December 30,  2003** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| Amortizing intangibles:                     |       |                    |       |                   |       |
| Trade secrets                               |       | $                       | 5,385      |                   | $          | 5,385 |   |
| Trademarks                                  |       | 2,062                   |       | —                 |       |
| Patents-manufacturing process               |       | 33,741                  |       | 33,741                 |       |
|                                        |       | 41,188                  |       | 39,126                 |       |
| Less accumulated amortization               |       | (25,690                 | )          | (19,563                | )          |
| Total amortizing intangibles, net           |       | $                       | 15,498     |                   | $          | 19,563 |   |
|                                        |       |                    |       |                   |       |
| Non-amortizing intangibles:                 |       |                    |       |                   |       |
| Trademarks                                  |       | 63,806                  |       | 65,868                 |       |
|                                        |       |                    |       |                   |       |
| Total trademarks and other intangibles, net |       | $                       | 79,304     |                   | $          | 85,431 |   |

 

10

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**3.****             ****Debt**

 

Debt consists of the following (inthousands of dollars):

 
| ** **                                                  | ** ** | **September 28,  2004** | ** ** | **December 30,  2003** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
|                                                        |       |                    |       |                   |       |
| $160 Million Indenture  (a)                                 |       | $                       | 160,000    |                   | $          | 160,000 |   |
| AmSouth Revolver (b)                                        |       | 3⁄4                  |       | 1,000                  |       |
| Chesapeake Bagel Bakery  Note Payable (c)                   |       | 3⁄4                  |       | 825                    |       |
| New Jersey Economic  Development Authority Note Payable (d) |       | 1,400                   |       | 1,400                  |       |
|                                                        |       | 161,400                 |       | 163,225                |       |
| Less current portion of  debt                               |       | (280                    | )          | (2,105                 | )          |
|                                                        |       |                    |       |                   |       |
| Long-term debt                                              |       | $                       | 161,120    |                   | $          | 161,120 |   |

 

 

**(a)****         ****$160 Million Indenture**

 

On July 8, 2003, we issued $160 million of13% senior secured notes maturing on July 1, 2008 (“$160 Million Indenture”) ina private placement.

 

The $160 Million Indenture is guaranteed,fully and unconditionally, jointly and severally, by us and all present andfuture subsidiaries of ours and is collateralized by substantially all of ourassets in which we have an interest. Pursuant to an Intercreditor Agreement,the $160 Million Indenture is subordinate to the AmSouth Revolver as describedbelow.

 

The$160 Million Indenture contains certain covenants, which, among others, includecertain financial covenants such as limitations on capital expenditures andminimum EBITDA as defined in the agreement. These covenants are measured on arolling twelve-month period and fiscal quarter basis, respectively. This debtcontains usual and customary default provisions. As of September 28, 2004, wewere in compliance with all our financial and operating covenants.

 

Interestpayments under the $160 Million Indenture are payable in arrears at the rate of13% per year on July 1 and January 1, commencing January 1, 2004. The notes areredeemable, at our option, in whole or in part at any time after July 1, 2004at the following redemption prices (as expressed in percentages of theprincipal amount):

 

| **Year**            | ** ** | **Percentage** | ** ** |
|---------------------|------------|----------------|------------|
| 2004                |       | 104.0          | %          |
| 2005                |       | 103.0          | %          |
| 2006                |       | 102.0          | %          |
| 2007                |       | 101.0          | %          |
| 2008 and thereafter |       | 100.0          | %          |

 

Debtissuance costs are capitalized and amortized using the effective interest methodover the term of the $160 Million Indenture.

 

11

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**(b)   AmSouthRevolver**

 

Also on July 8, 2003, we entered into athree-year, $15 million senior secured revolving credit facility with AmSouthBank (“AmSouth Revolver”). The AmSouth Revolver has been subsequently amendedto make technical corrections, clarify ambiguous terms and provide forincreased limits with respect to letters of credit.

 

The AmSouth Revolver is collateralized bysubstantially all of our assets in which we have an interest and is senior tothe $160 Million Indenture pursuant to an Intercreditor Agreement.

 

TheAmSouth Revolver contains certain covenants, which, among others, includecertain financial covenants such as limitations on capital expenditures,operating lease obligations, minimum EBITDA as defined in the agreement,operating cash flow coverage ratio and minimum net worth. These covenants aremeasured on a rolling twelve-month period at each fiscal quarter or annually atyear-end. Additional covenant restrictions exist if the total borrowings,including outstanding letters of credit exceed $10.0 million. This debtalso contains usual and customary default provisions. As of September 28, 2004,we are in compliance with all of our financial and operating covenants.

 

Interestpayments under the AmSouth Revolver are payable in arrears on the first of eachmonth. The net borrowings under the AmSouth Revolver bear an interest rateequal to the base rate plus an applicable margin with the base rate being theAmSouth Bank “prime rate” and the applicable margin being based on our fixedcharge coverage ratio with a minimum and maximum applicable margin of 0.5% and2.5% respectively. As of September 28, 2004, the prime interest rate under theAmSouth Revolver was 4.5%.

 

Weare required to pay an unused credit line fee of 0.50% per annum on the averagedaily unused amount. The unused line fee is payable monthly in arrears.Additionally, we are required to pay a letter of credit fee based on the averagedaily undrawn face amount for each letter of credit issued, of an applicablemargin being based on our fixed charge coverage ratio with a minimum andmaximum applicable margin of 2.0% and 4.5% respectively. Letters of creditreduce our availability under the AmSouth Revolver. At September 28, 2004, wehad $5.0 million of letters of credit outstanding. The letters of credit expireon various dates during 2005, are automatically renewable for one additionalyear and are payable upon demand in the event that we fail to pay certainworkers compensation claims. Our availability under the AmSouth Revolver was$10.0 million at September 28, 2004.

 

Debtissuance costs are capitalized and amortized using the effective interestmethod over the term of the AmSouth Revolver.

 

**(c)****         ****Chesapeake Bagel Bakery NotePayable**

 

Asa part of the acquisition of the assets of Chesapeake Bagel Bakery, we enteredinto a note payable to the seller. The note provides for quarterly payments ofinterest only at 10%. The note was paid in full on August 31, 2004according to its terms.

 

**(d)****         ****New Jersey Economic DevelopmentAuthority Note Payable**

 

InDecember 1998, Manhattan Bagel Company, Inc. entered into a note payablein the principal amount of $2,800,000 with the New Jersey Economic DevelopmentAuthority (“NJEDA”) at an interest rate of 9% per annum. Principal is paidannually and interest is paid quarterly. The note matures on December 1, 2008and is secured by the assets of Manhattan Bagel Company, Inc.

 

12

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On July 3, 2003, weplaced an advanced funding of the note in escrow to enact a debt defeasance asallowed for in the agreement. This advanced funding is shown as restricted cashand the note is included in both current portion and long-term portion of debtin the September 28, 2004 and December 30, 2003 consolidated balancesheets in accordance with the payment terms. This classification will continueuntil the note is fully paid from the escrow amount proceeds.

 

**4.****             ****NetLoss Per Common Share**

 

We compute basic net lossper common share by dividing the net loss for the period by the weightedaverage number of shares of common stock outstanding (which includes sharescontingently issuable for little or no consideration) during the period.

 

Diluted net loss per shareis computed by dividing the net loss for the period by the weighted averagenumber of shares of common stock and potential common stock equivalentsoutstanding during the period, if dilutive. Potential common stock equivalents includeincremental shares of common stock issuable upon the exercise of stock options.The effects of potential common stock equivalents have not been included in thecomputation of diluted net loss per share as their effect is anti-dilutive.

 

The following tablesummarizes the weighted average number of common shares outstanding, as well assets forth the computation of basic and diluted net loss per common share forthe periods indicated (in thousands, except per share data):

 
| ** **                                                                                                                       | ** ** | **Thirteen weeks  ended:** | ** ** | **Thirty-nine weeks  ended:** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                       | ** ** | **September 28,  2004**    | ** ** | **September 30,  2003**       | ** ** | **September 28,  2004** | ** ** | **September 30,  2003** | ** ** |
| ** **                                                                                                                       | ** ** | **(restated)**             | ** ** | **(restated)**                | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
|                                                                                                                             |       |                       |       |                          |       |   |   |   |   |
| Weighted average shares  outstanding                                                                                             |       | 9,842,385                  |       | 2,521,491                     |       | 9,842,169 |   | 1,883,770 |   |
|                                                                                                                             |       |                       |       |                          |       |   |   |   |   |
| Net loss available to  common stockholders  (in thousands of dollars)                                                            |       | $                          | (4,952     | )                             | $          | (35,711 | ) | $ | (15,306 | ) | $ | (73,918 | ) |
|                                                                                                                             |       |                       |       |                          |       |   |   |   |   |
| Basic and diluted net  loss per share                                                                                            |       | $                          | (0.50      | )                             | $          | (14.16 | ) | $ | (1.56 | ) | $ | (39.24 | ) |
|                                                                                                                             |       |                       |       |                          |       |   |   |   |   |
| Shares contingently issuable included in  the weighted average number of shares of common stock                                  |       | 3⁄4                     |       | 982,200                       |       | 3⁄4 |   | 805,731 |   |
|                                                                                                                             |       |                       |       |                          |       |   |   |   |   |
| Outstanding options and  warrants that were not included in the diluted calculation because their  effect would be anti-dilutive |       | 1,802,120                  |       | 99,438                        |       | 1,802,120 |   | 17,829 |   |

 

13

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**5.****             ****StockBased Compensation**

 

We apply the intrinsicvalue-based method of accounting prescribed by Accounting Principles Board(APB) Opinion No. 25, *Accounting for StockIssued to Employees*, and related interpretations, in accounting forour fixed award stock options to our employees. As such, compensation expenseis recorded only if the current market price of the underlying common stockexceeded the exercise price of the option on the date of grant. We apply thefair value-basis of accounting as prescribed by Statements of FinancialAccounting Standards (SFAS) Nos. 123 and 148, *Accountingfor Stock-Based Compensation*in accounting for our fixed award stockoptions to our consultants. Under SFAS Nos. 123 and 148, compensation expenseis recognized based on the fair value of stock options granted.  Had compensation cost for stock optionsgranted to employees been determined on the basis of fair value as computed usingthe assumptions herein, net loss and loss per share would have been increasedto the following pro forma amounts (in thousands of dollars, except per shareamounts):

 
| ** **                                                               | ** ** | **Thirteen weeks  ended:** | ** ** | **Thirty-nine weeks  ended:** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------|------------|-------------------------------|------------|
| ** **                                                               | ** ** | **September 28,  2004**    | ** ** | **September 30,  2003**       | ** ** | **September 28,  2004** | ** ** | **September 30,  2003** | ** ** |
| ** **                                                               | ** ** | **(restated)**             | ** ** | **(restated)**                | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
|                                                                     |       |                       |       |                          |       |   |   |   |   |
| Net loss available to  common stockholders, as reported                  |       | $                          | (4,952     | )                             | $          | (35,711 | ) | $ | (15,306 | ) | $ | (73,918 | ) |
| Deduct: stock based  compensation determined under the fair value method |       | (183                       | )          | (48                           | )          | (628 | ) | (138 | ) |
| Pro forma net loss  available to common stockholders                     |       | $                          | (5,135     | )                             | $          | (35,759 | ) | $ | (15,934 | ) | $ | (74,056 | ) |
|                                                                     |       |                       |       |                          |       |   |   |   |   |
| Basic and diluted loss  per common share:                                |       |                       |       |                          |       |   |   |   |   |
| As reported                                                              |       | $                          | (0.50      | )                             | $          | (14.16 | ) | $ | (1.56 | ) | $ | (39.24 | ) |
| Pro forma                                                                |       | $                          | (0.52      | )                             | $          | (14.18 | ) | $ | (1.62 | ) | $ | (39.31 | ) |
|                                                                          |            |                            |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |

 

Compensation cost of optionsgranted for the SFAS No. 123 pro forma amounts disclosed above wasestimated using the Black-Scholes option-pricing model with the followingassumptions:

 
| ** **                                   | ** ** | **Thirteen weeks  ended:** | ** ** | **Thirty-nine weeks  ended:** | ** ** |
|----------------------------------------------|------------|----------------------------|------------|-------------------------------|------------|
| ** **                                   | ** ** | **September 28,  2004**    | ** ** | **September 30,  2003**       | ** ** | **September 28,  2004** | ** ** | **September 30,  2003** | ** ** |
| Expected life of options  from date of grant |       | 3⁄4                     |       | 4.0 years                     |       | 4.0 years |   | 4.0 years |   |
| Risk-free interest rate                      |       | 3⁄4                     |       | 3.0                           | %          | 3.1 | % | 3.0 | % |
| Volatility                                   |       | 3⁄4                     |       | 100.0                         | %          | 100.0 | % | 100.0 | % |
| Assumed dividend yield                       |       | 3⁄4                     |       | 0.0                           | %          | 0.0 | % | 0.0 | % |

 

There were no optionsgranted during the thirteen weeks ended September 28, 2004. 

 

14

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**6.****             ****IncomeTaxes**

 

Werecord deferred tax assets and liabilities based on the difference between thefinancial statement and income tax basis of assets and liabilities using theenacted statutory tax rate. Deferred income tax expenses or credits are basedon the changes in the asset or liability from period to period. The recordeddeferred tax assets are reviewed for impairment on a quarterly basis byreviewing our internal estimates for future net income. If we determine it tobe more likely than not that the recovery of the asset is in question in theimmediate, foreseeable future, we record a valuation allowance. On September28, 2004 and September 30, 2003, we recorded a full valuation allowance againstour net deferred tax asset. We will continue to record valuation allowancesagainst additional deferred tax assets until such time that recoverability ofsuch assets is demonstrated.

 

Duringthe thirteen weeks ended September 28, 2004, we recorded a state income taxbenefit of $147,000 as a result of finalization of our 2003 tax returns,representing the difference between our original estimates and actual taxespayable. The state income taxes recorded for the thirty-nine weeks endedSeptember 28, 2004 represent our estimate of minimum state franchise taxespayable for 2004.

 

**7.****             ****Adjustmentof Integration and Reorganization Cost**

 

The adjustment ofintegration and reorganization cost primarily represents adjustments topreviously recorded liabilities associated with the closing and corporateconsolidation of our Eatontown facilities during 2002. During April 2004, wereached an agreement with the landlord of our Eatontown facility to settleoutstanding litigation. Previously recorded integration and reorganizationestimates associated with closing this facility were adjusted down by $700,000during the thirteen weeks ended March 30, 2004 as a result of this settlement.

 

**8.****             ****ImpairmentCharges and Other Related Costs**

 

Inaccordance with Statement of Financial Accounting Standard No. 144, *Accounting for the Impairment or Disposal of Long Lived Assets*,impairment losses are recorded on long-lived assets on arestaurant-by-restaurant basis whenever impairment indicators are determined tobe present. We consider a history of cash flow losses to be the primaryindicator of potential impairment for individual restaurant locations. Wedetermine whether a restaurant location is impaired based on expectedundiscounted future cash flows, considering location, local competition,current store management performance, existing pricing structure andalternatives available for the site. If impairment exists, the amount ofimpairment is measured as the excess of the carrying amount of the asset overits fair value as determined utilizing the estimated discounted future cashflows or the expected proceeds, net of costs to sell, upon sale of the asset.

 

Forthe thirteen and thirty-nine weeks ended September 28, 2004, we recorded$402,000 in impairment charges for long-lived asset impairments and exit costsfrom the decision to close two restaurants and to write down the assets of fourunder-performing restaurants.

 

**9.****             ****Losson Disposal or Abandonment of Assets**

 

For the thirty-nine weeksended September 28, 2004, we recorded a loss on disposal or abandonment ofassets of approximately $1.4 million primarily due to the disposal of menuboards as a result of our new menu offerings and due to the abandonment ofleasehold improvements related to closed restaurants and our administrativefacilities located in New Jersey.

 

15

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**10.****      ****ThirdQuarter 2003 Financings**

 

DebtFinancing – As further described in Note 3, on July 8, 2003, we issued $160million in aggregate principal amount of 13% senior secured notes due in 2008to replace our $140 million in aggregate principal amount of senior securedincreasing rate notes due in 2003. On that same date, we also entered into athree-year, $15 million senior secured revolving credit facility with Am SouthBank.

 

EquityRecapitalization – In September 2003, we completed an equity recapitalizationwith our preferred stockholders, who held a substantial portion of our commonstock. Among other things, our Mandatorily Redeemable Series F Preferred Stockwas eliminated. In exchange, we issued 57,000 shares of our MandatorilyRedeemable Series Z Preferred Stock to Halpern Denny Fund III, L.P. (“HalpernDenny”) and we issued 9,380,843 shares of our common stock to GreenlightCapital and affiliates (“Greenlight”).

 

Theexchange of the Halpern Denny interest resulted in a reduction of our effectivedividend rate and as a result of this and other factors, we accounted for thistransaction as troubled debt restructuring. This exchange did not result in again from troubled debt restructuring. The exchange of the Greenlight interestinto common shares was recorded at fair value, which resulted in a loss uponexchange of approximately $23.0 million. Refer to our annual report on Form 10-K for the fiscalyear ended December 30, 2003 for more information regarding thistransaction.

 

**11.****      ****Litigation,Commitments and Contingencies**

 

*Guarantees*

 

In the past, we wouldsometimes guarantee leases for the benefit of certain of our franchisees. Thelease guarantees extend through 2008. Under the guarantees, we may be requiredby the lessor to make all of the remaining monthly rental payments or propertytax and common area maintenance payments if the franchisee does not make therequired payments in a timely manner. However, we believe that most, if notall, of the franchised locations could be subleased to third parties minimizingour potential exposure. Additionally, we have indemnification agreements withour franchisees under which the franchisees would be obligated to reimburse usfor any amounts paid under such guarantees. As of September 28, 2004, ourmaximum exposure under these contingent liabilities was approximately $1.7million.

 

*EmploymentRelated*

 

On July 31, 2002,Tristan Goldstein, a former store manager, and Valerie Bankhordar, a currentstore manager, filed a putative class action against Einstein and Noah Corp. (“ENC”)in the Superior Court for the State of California, County of San Francisco. Theplaintiffs allege that ENC failed to pay overtime wages to managers andassistant managers of its California stores who were improperly designated asexempt employees in violation of California wage and hour laws and BusinessProfession Code Section 17200. During April 2004, we reached an agreementin principle for the settlement of litigation with the plaintiffs, subject to courtapproval. Amounts representing our estimate to settle this litigation werepreviously recorded during the quarter ended December 30, 2003.

 

16

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On March 31, 2003, Jerold E.Novack, our former Chief Financial Officer and Secretary, filed a complaint inthe United States District Court for the District of New Jersey against us,Anthony D. Wedo, our former Chairman and Chief Executive Officer, and WilliamJ. Nimmo, a former member of our board of directors.  The plaintiff claims breach of employmentcontract, breach of Messrs. Wedo and Nimmo’s fiduciary duties to plaintiff,defamation, violation of the New Jersey Conscientious Employee Protection Act,and for a declaration that the termination of plaintiff “for cause” wasinvalid.  We have answered and assertedcounterclaims against Mr. Novack. On January 20, 2004, the Court granted ourmotion to dismiss the breach of fiduciary duty claims. On October 4, 2004, theCourt granted the motion for summary judgment dismissing the plaintiff’sdefamation claims against Messrs. Nimmo and Wedo, and denied the plaintiff’sand defendant’s remaining motions for summary judgment. We have accrued anestimate of the loss, but do not believe the resolution of this issue will havea material adverse effect on our consolidated financial condition or results ofoperations.

 

On June 4, 2003, R. RaminKamfar, our former Chairman of the Board and Chief Executive Officer, filed anaction in the United States District Court for the Southern District of NewYork against us and Anthony D. Wedo, our former Chairman and Chief ExecutiveOfficer, alleging causes of action for breach of contract, defamation,declaratory relief and punitive damages. We believe that the claims of Mr.Kamfar are without merit. We have answered and filed counterclaims against Mr.Kamfar, including claims for breach of fiduciary duty, fraud, and breach ofcontract.  Motions for summary judgmentwere filed on July 15, 2004. At this time, it is not possible to reasonably estimatethe loss or range of loss, if any.

 

Investigations

 

On April 3, 2002, theSecurities and Exchange Commission notified us that the Commission wasconducting an investigation into the resignation of our former Chairman, R.Ramin Kamfar, and the termination for cause of our former Chief FinancialOfficer, Jerold Novack, and the delay in filing our Form 10-K for 2001. Wehave cooperated fully with the investigation as well as with a Department ofJustice inquiry relating to these issues. Further, several of the former andpresent officers and directors have requested that, under applicable law andour by-laws, we advance reasonable legal expenses on their respective behalvesto the extent any of them is or has been requested to provide information tothe Commission in connection with its investigation. We have advanced certainexpenses in connection with these claims. At this time, it is not possible toreasonably estimate the loss or range of loss, if any.

 

*FinancialImpact of Litigation*

 

We are engaged in variousother legal proceedings and have certain unresolved claims pending. Theultimate liability, if any, for the aggregate amounts claimed cannot bedetermined at this time. However, we believe based upon consultation with legalcounsel that there are no other matters pending or threatened which areexpected to have a material adverse effect, individually or in the aggregate,on our consolidated financial condition or results of operations.

 

17

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*Insurance Programs*

 

We are self-insured for asubstantial portion of our current and prior years’ coverage including workers’compensation, employment practices liability and general liability(collectively, “insurance losses”). To mitigate the potential cost of ourexposures for certain of the insurance losses, we make annual decisions toself-fund the risks of loss up to defined maximum per occurrence retentions ona policy-by-policy basis. We then purchase insurance coverage, up to a certainlimit, for losses that exceed the self-insurance per occurrence or aggregateretention. The insurers’ maximum aggregate loss limits are significantly aboveour actuarially determined probable losses; therefore, we believe thelikelihood of losses exceeding the insurers’ maximum aggregated loss limits isremote. We are also self-insured for healthcare claims for eligibleparticipating employees subject to certain deductibles and limitations. We haveaccounted for our liabilities related to the insurance losses and healthcare claims,including reported and incurred but not reported claims, based on informationprovided by actuaries.

 

We believe that we haverecorded reserves adequate to cover our insurance losses based upon informationwe have today. Due to the inherent volatility of actuarially determinedinsurance loss estimates, it is reasonably possible that we could experiencechanges in estimated losses, which could be material to our consolidatedfinancial position or results of operations.

 

**12.****      ****RecentAccounting Pronouncements**

 

We haveevaluated all recently issued but not yet effective accounting pronouncementsand believe such pronouncements will not have a material effect on ourfinancial statements.

 

**13.****      ****SubsequentEvent - Sale of Assets of Willoughby’s Coffee & Tea**

 

EffectiveOctober 6, 2004, we executed an Asset Purchase Agreement and sold the assets ofWilloughby’s to the original founders. The Willoughby’s business consisted of a coffee roasting plant, threeretail locations and an office space. Components of the asset sale included,but were not limited to:

 

•                  The “Willoughby’sCoffee & Tea” trade name, trademark and logo,

•                  The “SeriousCoffee” trademark,

•                  Thewilloughbyscoffee.com domain name and existing website,

•                  Allproperty and equipment of Willoughby’s, and

•                  Cash indrawer, accounts receivable, and inventory at all Willoughby’s locations.

 

Underthe terms of agreement, we sold the assets for a total sales price ofapproximately $400,000, which was received in cash. In connection with the saleof Willoughby’s, we also executed a two-year supply agreement to purchasecoffee from the buyer for our New World stores.

 

We have considered Statement of FinancialAccounting Standard No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets.*We have determined thatthe revenues, cost of sales, other operating expenses and the net book value ofthe assets related to the sale of the coffee roasting plant and three retaillocations included in the Willoughby’s business were immaterial in relation toour Einstein Bros., Noah and Manhattan restaurants, as well as the financialstatements taken as a whole. Accordingly, we have not presented discontinuedoperations in the accompanying consolidated statements of operations for thethirteen and thirty-nine weeks ended September 28, 2004 and September 30, 2003,respectively, nor have we reflected assets as held for sale in the accompanyingconsolidated balance sheet as of September 28, 2004.  We have determined that net book value of theassets is less than the sales price and accordingly, no impairment existed atSeptember 28, 2004.

 

18

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**ITEM 2****. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

Thefollowing discussion and analysis supplements the management’s discussion andanalysis in our Annual Report on Form 10-K for the year ended December 30, 2003and presumes that readers have read or have access to the discussion andanalysis in our Annual Report. The following discussion and analysis includeshistorical and certain forward-looking information that should be read togetherwith the accompanying Consolidated Financial Statements, related footnotes andthe discussion below of certain risks and uncertainties that could cause futureoperating results to differ materially from historical results or from theexpected results indicated by forward looking statements.

 

***Restatement of Prior Financial Information***

 

During late 2004 and early2005, several restaurant companies and other multi-location retailers reviewedtheir treatment of lease accounting and leasehold amortization. During thistime, many companies including but not limited to Brinker International, CKERestaurants, Darden Restaurants, Jack in the Box, Starbucks and Wild Oats restatedtheir historic financial statements. In late January 2005, we commenced areview of our accounting policies and practices with respect to leaseholdamortization and deferred rent. On February 7, 2005, the Office of the ChiefAccountant of the Securities and Exchange Commission expressed its viewsregarding lease accounting issues and their application under GenerallyAccepted Accounting Principles (GAAP). Based upon the results of our internalreview and after discussions with our independent auditors, Grant Thornton LLP,we determined on March 1, 2005 that it was appropriate to adjust certain priorfinancial statements for leasehold amortization. The resulting adjustments wereall non-cash and had no impact on our cash flows, cash position, revenues, samestore sales, loss from operations plus depreciation and amortization, or ourcompliance with the covenants under our $160 Million Notes or AmSouth Revolver.The adjustments were not attributable to any intentional non-compliance withany financial reporting requirements under securities laws, and we believethere will not be any further adjustments as a result of our internal review ofthis matter.

 

Theissue requiring restatement related to our historical accounting practice ofamortizing our leasehold improvements over a period that included both thenoncancelable term of the lease and its option periods (or the useful life ofthe asset, if shorter). Concurrently, we used the noncancelable lease term indetermining whether each of our leases was an operating lease or a capitallease and in calculating our straight-line rent expense. We believed that theselongstanding accounting treatments were appropriate under generally acceptedaccounting principles. Furthermore, we believed that these accounting treatmentswere comparable to the practices of other public companies. However, afternoting recent Form 8-K filings of various restaurant companies and othermulti-location entities and following discussions with Grant Thornton LLP, wehave now interpreted the authoritative accounting literature to require that weuse the same lease term in amortizing leasehold improvements as we use indetermining capital versus operating leases and in calculating straight-linerent expense. Accordingly, we have adopted the following policy: We willgenerally limit the depreciable lives for our leasehold improvements, which aresubject to a lease, to the lesser of the useful life or the noncancelable leaseterm. However, in circumstances where we would incur an economic penalty by notexercising one or more option periods, as contemplated by Statement ofFinancial Accounting Standard (SFAS) No. 13, “Accounting for Leases,” we mayinclude one or more option periods when determining the amortization period. Ineither circumstance, our policy requires consistency when calculating theamortization period, in classifying the lease, and in computing straight-linerent expense.

 

19

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Asa result of the adjustments to leasehold amortization, our financial resultshave been restated as follows (dollars in thousands, except per share data):

 
| ** **                       | ** ** | **As of September 28, 2004** | ** ** | **As of December 30, 2003** | ** ** |
|----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **As reported**              | ** ** | **Adjustments**             | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Balance Sheet:                   |       |                         |       |                        |       |   |   |   |   |   |   |   |   |
| Property and equipment, net      |       | $                            | 61,419     |                        | $          | (17,815 | ) | $ | 43,604 |   | $ | 67,800 |   | $ | (13,287 | ) | $ | 54,513 |   |
| Total assets                     |       | 172,558                      |       | (17,815                     | )          | 154,743 |   | 195,025 |   | (13,287 | ) | 181,738 |   |
| Accumulated deficit              |       | (268,239                     | )          | (17,815                     | )          | (286,054 | ) | (257,461 | ) | (13,287 | ) | (270,748 | ) |
| Total stockholders’ deficit |       | (92,592                      | )          | (17,815                     | )          | (110,407 | ) | (81,866 | ) | (13,287 | ) | (95,153 | ) |
|                                  |            |                              |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                   | ** ** | **Thirteen weeks ended Sept. 28, 2004** | ** ** | **Thirty-nine weeks ended Sept. 28, 2004** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                   | ** ** | **As reported**                         | ** ** | **Adjustments**                            | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Statement of Operations:                                     |       |                                    |       |                                       |       |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                |       | $                                       | 5,182      |                                       | $          | 1,823 |   | $ | 7,005 |   | $ | 15,764 |   | $ | 5,118 |   | $ | 20,882 |   |
| Income from operations                                       |       | 2,279                                   |       | (1,823                                     | )          | 456 |   | 8,528 |   | (5,118 | ) | 3,410 |   |
| Loss (gain) on sale, disposal or abandonment  of assets, net |       | 273                                     |       | (343                                       | )          | (70 | ) | 1,985 |   | (590 | ) | 1,395 |   |
| Loss before income taxes                                     |       | (3,619                                  | )          | (1,480                                     | )          | (5,099 | ) | (10,686 | ) | (4,528 | ) | (15,214 | ) |
| Net loss                                                     |       | (3,472                                  | )          | (1,480                                     | )          | (4,952 | ) | (10,778 | ) | (4,528 | ) | (15,306 | ) |
| Net loss available to common stockholders                    |       | (3,472                                  | )          | (1,480                                     | )          | (4,952 | ) | (10,778 | ) | (4,528 | ) | (15,306 | ) |
| Net loss per common share                                    |       | $                                       | (0.35      | )                                          | $          | (0.15 | ) | $ | (0.50 | ) | $ | (1.10 | ) | $ | (0.46 | ) | $ | (1.56 | ) |

 
| ** **                                | ** ** | **Thirteen weeks ended Sept. 30, 2003** | ** ** | **Thirty-nine weeks ended Sept. 30, 2003** | ** ** |
|-------------------------------------------|------------|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **As reported**                         | ** ** | **Adjustments**                            | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Statement of Operations:                  |       |                                    |       |                                       |       |   |   |   |   |   |   |   |   |
| Depreciation and amortization             |       | $                                       | 7,128      |                                       | $          | 1,537 |   | $ | 8,665 |   | $ | 21,425 |   | $ | 4,464 |   | $ | 25,889 |   |
| Loss from operations                      |       | (2,177                                  | )          | (1,537                                     | )          | (3,714 | ) | (4,834 | ) | (4,464 | ) | (9,298 | ) |
| Loss before income taxes                  |       | (34,174                                 | )          | (1,537                                     | )          | (35,711 | ) | (54,601 | ) | (4,464 | ) | (59,065 | ) |
| Net loss                                  |       | (34,174                                 | )          | (1,537                                     | )          | (35,711 | ) | (55,031 | ) | (4,464 | ) | (59,495 | ) |
| Net loss available to common stockholders |       | (34,174                                 | )          | (1,537                                     | )          | (35,711 | ) | (69,454 | ) | (4,464 | ) | (73,918 | ) |
| Net loss per common share                 |       | $                                       | (13.55     | )                                          | $          | (0.61 | ) | $ | (14.16 | ) | $ | (36.87 | ) | $ | (2.37 | ) | $ | (39.24 | ) |
|                                           |            |                                         |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

**Business Overview**

 

Weare a leader in the quick casual segment of the restaurant industry. With 707locations in 33 states and in the District of Columbia as of September 28,2004, we operate and license locations primarily under the Einstein Bros. andNoah’s brand names, and franchise locations primarily under the Manhattan andChesapeake brand names. We also operate a dough production facility. We operateas a single business segment with a focus on our company-operated restaurants.Our manufacturing and franchise operations are either supportive or ancillaryto our main business focus.

 

Ourfinancial focus is on long term, sustainable growth in free cash flow. Freecash flow represents net cash provided by operations less purchases of fixedassets. In achieving free cash flow, we are more capable of paying down debt,saving cash for future use and building shareholder equity. We also believefree cash flow will allow us the opportunity to pursue new opportunities,acquire other businesses, or pay dividends. Increasing our operating profit andefficiently managing working capital and capital expenditures primarily drivefree cash flow.

 

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Therestaurant industry, in which we compete, is intensely competitive with respectto food quality, price, service, convenience, location and concept. Theindustry is often affected by changes in consumer tastes, economic conditions,demographic trends, traffic patterns, the type, number and location ofcompeting food retailers and products and disposable purchasing power.

 

Inmeasuring our overall growth and progress, we focus on various key performanceindicators. Such key performance indicators include: same-store sales growth,number of restaurant openings and closings, number of franchise and licensedlocations opened, restaurant level and concept level margins, cash generatedfrom operations and free cash flow. Our progress against some of these key performanceindicators is discussed throughout the Management’s Discussion and Analysis.

 

**CurrentEvents**

 

EffectiveOctober 6, 2004, we completed the sale of theWilloughby’s Coffee & Tea business in Connecticut. The business wassold to the original founders for a total sales price of approximately$400,000, which was received in cash. In connection with the transaction, we also executed a two-year supplyagreement to purchase coffee from the buyer for our New World stores. The transaction allowed us to place anon-core asset in the hands of experienced operators and, concurrently, assurea quality source of supply for our New World Coffee shops.

 

OnOctober 13, 2004, we announced that E. Nelson Heumannwas named Chairman of the Board of Directors. Paul Murphy, Chief ExecutiveOfficer, who had been serving as Acting Chairman since October 2003, willcontinue on the Board as a Director. Additionally, Michael W. Arthur waselected as a Director to our Board expanding the panel to seven members. Mr. Arthurwill also serve on the Audit Committee and has been designated as the “financialexpert.” Other members of the Audit Committee are Directors Leonard Tannenbaum and Frank Meyer.

 

Alsoon October 13, 2004, we announced that Susan Daggett, who had been ChiefOperating Officer since October 2003, was named to the new position ofChief Strategy Officer.  Mike Mrlik, formerly the Executive Vice President of Operations,was promoted to Chief Operating Officer.

 

OnOctober 14, 2004, we announced the introduction of our new test concept,Einstein Bros. Café. In addition to our core bagel offerings and expandedbreakfast menu, the new concept offers a lunch and dinner menu with a culinaryfocus on innovative items using fresh and high quality ingredients. The firstunit of the quick casual restaurant, located within Denver’s Stapletonneighborhood, opened on October 18, 2004. By the end of fiscal year 2004, we will have retrofitted one additionalEinstein Bros. restaurant in the Denver, Colorado market and intend to retrofitall three of our Einstein Bros. restaurants in the Colorado Springs, Coloradomarket.  Conversion of the remainingEinstein Bros. Bagel locations will be rolled out on a market-by-market basis.

 

**SignificantKnown Events, Trends or Uncertainties Expected to Impact 2004 Results**

 

Thefollowing factors impact comparability of operating performance or could impactcomparisons for the remainder of 2004.

 

*EconomicTrends*

 

Weanticipate that our business will be affected by general economic trends thataffect retailers in general. While we have not operated during a period of highinflation, we believe based on industry experience that we would generally beable to pass on increased costs resulting from inflation to our consumers. Ourbusiness may be affected by other factors, including increases in the commodityprices of flour, butter and/or fresh produce, energy costs, existing andadditional competition, marketing programs, weather and variations in thenumber of company-owned or licensed location openings.

 

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Althoughfew, if any, employees are paid at the minimum wage, an increase in the minimumwage may create pressure to increase the pay scale for our employees, whichwould increase our labor costs and those of our franchisees and licensees.

 

*RevenueTrends*

 

**Due tothe increasing competitive pressure of the restaurant industry, we continued toexperience lower retail sales during the thirteen weeks ended September 28,2004. Additionally, recent dietary trends and negative publicity on productshigh in carbohydrate content may have had and may continue to have an adverseimpact on our sales. We believe that we are addressing these trends withmodifications to our menus via pricing increases, as well as limited timeofferings of seasonal menu items. We anticipate that these planned pricechanges will have the effect of increasing our average check in future periods.We have also begun implementation of modifications to our customer servicesystem of our company-operated restaurants. Because of these modifications, wehave begun to experience little to no further deterioration in October 2004comparable store sales as compared to the same period in the prior year.**

** **

Aspreviously discussed, we opened our first Einstein Bros. Café on October 18,2004 in the Denver, Colorado market. By the end of fiscal year 2004, we willhave retrofitted one additional Einstein Bros. restaurant in the Denver,Colorado market and intend to retrofit all three of our Einstein Bros. restaurantsin the Colorado Springs, Colorado market.

 

Wewill operate the restaurants for approximately 90 days. It is our intention tostudy the financial and operating performance of the restaurants in order todetermine modifications necessary, if any, to our menu offerings and/or thephysical layout of our restaurants before commencing a staggered rollout toadditional markets in 2005.

 

Webelieve that by retrofitting existing restaurants on a market-by-market basis,we can ensure minimal supply chain disruption and send a consistent marketingmessage within each market. 

 

*ExpenseTrends*

 

Commodities- Currently, the restaurant industry is experiencing increases in the cost ofdairy and other raw ingredients, as well as increases in fuel and energy costs.During the current fiscal quarter, we saw the impact of such increases in ourfood costs, packaging materials, utility bills and transportation charges andwe believe this trend will continue through the remainder of the year. For thequarter and year-to-date period ended September 28, 2004, we experienced anegative impact of approximately $0.5 million and $1.8 million, respectively,in our margins due to increases in commodity costs.

 

Theseincreases directly impact the profitability of company-owned locations,manufacturing operations and distribution channels. While we have purchasecommitments for our dairy and other raw ingredients that mitigate immediateincreases in food costs, our purchase commitments are not long-term in nature.Accordingly, in the near future we may experience degradation in our profitmargins until such time as we are able to pass on increased costs to ourconsumers.

 

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Weather- Adverse weather experienced in the southeastern United States during September andOctober 2004 significantly destroyed crops already in the ground, as wellas delayed fall plantings. The result of delayed plantings and expected loweryields/quality is anticipated to be increased costs and added pressure onsuppliers from the desert regions and Mexico throughout the fall season, earlywinter and possibly beyond depending on the future weather. Additionally,hurricanes in Florida caused many of our restaurants to be closed for a shortperiod of time due to evacuations and power shortages. During the quarter endedSeptember 28, 2004, we estimate a loss of approximately $0.5 million inrevenue due to the temporary closure. The loss of revenue resulted in anegative impact to our margins of approximately $0.3 million. We have filed aclaim under our business interruption insurance coverage. At this time, we havenot recorded any gain contingency associated with the estimated losses that webelieve are covered under our business interruption insurance policy.

 

*StorePortfolio Strategy*

 

Fromtime to time, we close restaurants that are performing poorly, we relocaterestaurants to a new site within the same trade area or we consolidate two ormore of our existing units into a single unit. Generally, the closures coincidewith the expiration of an existing lease and result in little or no impairmentcharges.

 

Thefollowing table details the total restaurants open at the end of the respectivethird quarter:

 
| ** **                              | ** ** | **Company  owned** | ** ** | **Licensed** | ** ** | **Franchised** | ** ** | **Total**  | ** ** |
|-----------------------------------------|------------|--------------------|------------|--------------|------------|----------------|------------|------------|------------|
| **Einstein Bros.:**                     | ** ** | ** **         | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** |
| 2004                                    |       | 371                |       | 53           |       | —         |       | 424        |       |
| 2003                                    |       | 373                |       | 30           |       | —         |       | 403        |       |
| **Noah’s:**                        |       |               |       |         |       |           |       |       |       |
| 2004                                    |       | 78                 |       | 3            |       | —         |       | 81         |       |
| 2003                                    |       | 83                 |       | 3            |       | —         |       | 86         |       |
| **Manhattan:**                          |       |               |       |         |       |           |       |       |       |
| 2004                                    |       | —             |       | —       |       | 154            |       | 154        |       |
| 2003                                    |       | —             |       | —       |       | 188            |       | 188        |       |
| **Chesapeake:**                         |       |               |       |         |       |           |       |       |       |
| 2004                                    |       | —             |       | —       |       | 32             |       | 32         |       |
| 2003                                    |       | —             |       | —       |       | 44             |       | 44         |       |
| **New World Coffee/Willoughby’s:** |       |               |       |         |       |           |       |       |       |
| 2004                                    |       | 7                  |       | —       |       | 9              |       | 16         |       |
| 2003                                    |       | 8                  |       | —       |       | 11             |       | 19         |       |
| **Total Restaurants:**                  |       |               |       |         |       |           |       |       |       |
| 2004                                    |       | 456                |       | 56           |       | 195            |       | 707        |       |
| 2003                                    |       | 464                |       | 33           |       | 243            |       | 740        |       |

 

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Webelieve we have a strong platform for growth through store licensing of ourEinstein and Noah’s brands. During the latter half of 2003, we began expansionof our licensed stores. During the thirty-nine weeks ended September 28,2004, we added 15 new licensed stores. We anticipate opening an additional 1 -3 licensed stores during the fourth quarter of 2004.

 

Thelicensing program is available to qualified foodservice operators and typicallyrequires an upfront license fee that is fully earned at the time the licenseecommences operations. Stores are developed on college campuses, hospitals,airports, military installations and other locations. The licensed stores aregenerally opened during the third and fourth calendar quarters consistent withthe timing of many government and higher education projects and federalfunding. We typically receive continuing royalties on sales from each licensedstore location. Our licensees are not required to buy all of their proprietaryproducts directly from us, but rather their product sources must be approved byus.

 

OurManhattan and Chesapeake brands primarily represent our franchise base. Ourfranchised locations generate a recurring revenue stream through royaltypayments on sales from each franchised location and create a built-in customerbase for our manufacturing operations.

 

Wecontinually evaluate the rationale for each of our brands with a view towarddetermining whether the brand should be a part of our overall strategicbusiness plan.

 

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**Results of Operations**

 
| ** **                                                       | ** ** | **For the  thirteen weeks ended** | ** ** | **Increase**              | ** ** | **For the  thirty-nine weeks ended** | ** ** | **Increase**        | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------|------------|---------------------------|------------|--------------------------------------|------------|---------------------|------------|
| ** **                                                       | ** ** | **(in  thousands)**               | ** ** | **(percent  of revenue)** | ** ** | **(Decrease)**                       | ** ** | **(in  thousands)** | ** ** | **(percent  of revenue)** | ** ** | **(Decrease)** | ** ** |
| ** **                                                       | ** ** | **Sept 28,**                      | ** ** | **Sept 30,**              | ** ** | **Sept 28,**                         | ** ** | **Sept 30,**        | ** ** | **2004** | ** ** | **Sept 28,** | ** ** | **Sept 30,** | ** ** | **Sept 28,** | ** ** | **Sept 30,** | ** ** | **2004** | ** ** |
| ** **                                                       | ** ** | **2004**                          | ** ** | **2003**                  | ** ** | **2004**                             | ** ** | **2003**            | ** ** | **vs. 2003** | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** | **vs. 2003** | ** ** |
| ** **                                                       | ** ** | **(restated)**                    | ** ** | **(restated)**            | ** ** | **(restated)**                       | ** ** | **(restated)**      | ** ** | ** ** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | ** ** | ** ** |
| **Revenues:**                                                    |       |                              |       |                      |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Retail  sales**                                                |       | 84,763                            |       | 86,975                    |       | 93.0                                 | %          | 93.3                | %          | -2.5 | % | 256,982 |   | 266,302 |   | 92.9 | % | 93.1 | % | -3.5 | % |
| **Manufacturing  revenues**                                      |       | 4,913                             |       | 4,798                     |       | 5.4                                  | %          | 5.1                 | %          | 2.4 | % | 15,270 |   | 15,976 |   | 5.5 | % | 5.6 | % | -4.4 | % |
| **Franchise  and license related revenues**                      |       | 1,503                             |       | 1,454                     |       | 1.6                                  | %          | 1.6                 | %          | 3.4 | % | 4,287 |   | 3,909 |   | 1.6 | % | 1.4 | % | 9.7 | % |
|                                                             |       |                              |       |                      |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total  revenues**                                              |       | 91,179                            |       | 93,227                    |       | 100.0                                | %          | 100.0               | %          | -2.2 | % | 276,539 |   | 286,187 |   | 100.0 | % | 100.0 | % | -3.4 | % |
| ** **                                                       |       |                              |       |                      |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Cost of  sales:**                                              |       |                              |       |                      |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Retail  costs**                                                |       | 70,315                            |       | 74,277                    |       | 77.1                                 | %          | 79.7                | %          | -5.3 | % | 213,805 |   | 224,616 |   | 77.3 | % | 78.5 | % | -4.8 | % |
| **Manufacturing  costs**                                         |       | 4,603                             |       | 4,436                     |       | 5.0                                  | %          | 4.8                 | %          | 3.8 | % | 13,623 |   | 14,559 |   | 4.9 | % | 5.1 | % | -6.4 | % |
| ** **                                                       |       |                              |       |                      |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total  cost of sales**                                         |       | 74,918                            |       | 78,713                    |       | 82.2                                 | %          | 84.4                | %          | -4.8 | % | 227,428 |   | 239,175 |   | 82.2 | % | 83.6 | % | -4.9 | % |
|                                                             |       |                              |       |                      |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Gross  profit:**                                               |       |                              |       |                      |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Retail**                                                       |       | 14,448                            |       | 12,698                    |       | 15.8                                 | %          | 13.6                | %          | 13.8 | % | 43,177 |   | 41,686 |   | 15.6 | % | 14.6 | % | 3.6 | % |
| **Manufacturing**                                                |       | 310                               |       | 362                       |       | 0.3                                  | %          | 0.4                 | %          | -14.4 | % | 1,647 |   | 1,417 |   | 0.6 | % | 0.5 | % | 16.2 | % |
| **Franchise  and license**                                       |       | 1,503                             |       | 1,454                     |       | 1.6                                  | %          | 1.6                 | %          | 3.4 | % | 4,287 |   | 3,909 |   | 1.6 | % | 1.4 | % | 9.7 | % |
| **Total  gross profit**                                          |       | 16,261                            |       | 14,514                    |       | 17.8                                 | %          | 15.6                | %          | 12.0 | % | 49,111 |   | 47,012 |   | 17.8 | % | 16.4 | % | 4.5 | % |
|                                                             |       |                              |       |                      |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **General  and administrative expenses**                         |       | 8,442                             |       | 9,716                     |       | 9.3                                  | %          | 10.4                | %          | -13.1 | % | 25,260 |   | 30,574 |   | 9.1 | % | 10.7 | % | -17.4 | % |
| **Depreciation  and amortization**                               |       | 7,005                             |       | 8,665                     |       | 7.7                                  | %          | 9.3                 | %          | -19.2 | % | 20,882 |   | 25,889 |   | 7.6 | % | 9.0 | % | -19.3 | % |
| **Adjustment  of integration and reorganization cost**           |       | (44                               | )          | (153                      | )          | 0.0                                  | %          | 0.0                 | %          | -71.2 | % | (843 | ) | (153 | ) | -0.4 | % | 0.0 | % |   | * |
| **Impairment  charges and other related costs**                  |       | 402                               |       | —                    |       | 0.4                                  | %          | 0.0                 | %          |   | *  | 402 |   | — |   | 0.1 | % | 0.0 | % |   | * |
|                                                             |       |                              |       |                      |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Income  (loss) from operations**                               |       | 456                               |       | (3,714                    | )          | 0.5                                  | %          | -4.0                | %          |   | * | 3,410 |   | (9,298 | ) | 1.2 | % | -3.2 | % |   | * |
|                                                             |       |                              |       |                      |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Other  expense (income):**                                     |       |                              |       |                      |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest  expense, net**                                       |       | 5,723                             |       | 10,188                    |       | 6.3                                  | %          | 10.9                | %          | -43.8 | % | 17,426 |   | 28,458 |   | 6.3 | % | 9.9 | % | -38.8 | % |
| **Cumulative  change in the fair value of derivatives**          |       | —                            |       | (1,063                    | )          | 0.0                                  | %          | -1.1                | %          |   | * | — |   | (993 | ) | 0.0 | % | -0.3 | % |   | * |
| **Loss  (gain) on sale, disposal or abandonment of assets, net** |       | (70                               | )          | (390                      | )          | -0.1                                 | %          | -0.4                | %          |   | * | 1,395 |   | (592 | ) | 0.5 | % | -0.2 | % |   | * |
| **Loss on  exchange of Series F Preferred Stock**                |       | —                            |       | 23,007                    |       | 0.0                                  | %          | 24.7                | %          |   | * | — |   | 23,007 |   | 0.0 | % | 8.0 | % |   | * |
| **Other**                                                        |       | (98                               | )          | 255                       |       | -0.1                                 | %          | 0.3                 | %          |   | * | (197 | ) | (113 | ) | -0.1 | % | 0.0 | % | 74.3 | % |
|                                                             |       |                              |       |                      |       |                                 |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Loss  before income taxes**                                    |       | (5,099                            | )          | (35,711                   | )          | -5.6                                 | %          | -38.3               | %          | -85.7 | % | (15,214 | ) | (59,065 | ) | -5.5 | % | -20.6 | % | -74.2 | % |

 

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*** not meaningful**

 

Thistable sets forth, for the periods indicated, certain amounts included in ourConsolidated Statements of Operations, the relative percentage that thoseamounts represent to total revenue (unless otherwise indicated), and thepercentage change in those amounts from period to period. All percentages arecalculated using actual amounts rounded to the nearest thousand.

 

Weoperate as a single business segment with a focus on our company-operatedrestaurants. Our manufacturing and franchise operations are either supportiveor ancillary to our main business focus.

 

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***Revenues***

 

**Totalrevenues for the thirteen and thirty-nine weeks ended September 28, 2004were consistent with our expectations. Our total revenues decreased 2.2% and3.4% for the thirteen and thirty-nine weeks ended September 28, 2004,respectively, when compared to the same periods in fiscal 2003. The decreasesprimarily resulted from the dollar decline in retail sales (e.g. company-operatedstore sales which represents the most significant component of revenue).  Our retail comparable store sales decrease of1.6% and 3.4% for the thirteen and thirty-nine weeks ended September 28,2004, respectively, consisted of a 6.3% and 6.3% reduction in transactionspartially offset by a 5.0% and 3.1% increase in average check primarily relatedto both an increase in menu pricing and a shift in product mix to higher priceditems. Comparable store sales represent sales at stores that were open for onefull year and have not been relocated or closed during the current year.Comparable store sales are also referred to as “same-store” sales and as “compsales” within the restaurant industry.**

** **

***Gross Profit***

 

Ourtotal gross profit improved 12.0% and 4.5% for the thirteen and thirty-nineweeks ended September 28, 2004, respectively, when compared to the sameperiods in fiscal 2003. The improvement was primarily due to improvements inour retail costs of sales. Our retail margins improved by 13.8% for thethirteen weeks ended September 28, 2004 when compared to the same periodin fiscal 2003. All store-level operating expenses other than depreciation,amortization and taxes impact our retail margins. For the thirteen weeks ended September 28,2004, approximately $1.9 million of the improvement we have experienced isattributable to our decision to reduce marketing expenditures as we focus onmodifications to our customer service system, menu offerings and the “look andfeel” of our company-operated restaurants. Additionally we have experienced animprovement in labor utilization and reductions in group insurance claims ofapproximately $2.4 million, offset by increases of approximately $0.5 millionin commodity costs. We will continue to implement solutions that improve ourmargins but expect this trend to level out during the next quarter, as many ofour store-level cost reduction initiatives will have been in place forapproximately one year.

 

**Hurricanesin Florida caused many of our restaurants to be closed for a short period oftime due to evacuations and power shortages. During the quarter ended September 28,2004, we estimate a loss of approximately $0.5 million in revenue due to thetemporary closures. The loss of revenue resulted in a negative impact to ourmargins of approximately $0.3 million. We have filed a claim under our businessinterruption insurance coverage. At this time, we have not recorded any gaincontingency associated with the estimated losses that we believe are coveredunder our business interruption insurance policy.**

 

***Other Expenses***

 

**Ourgeneral and administrative expenses decreased 13.1% and 17.4% for the thirteenand thirty-nine weeks ended September 28, 2004, respectively, whencompared to the same periods in fiscal 2003. The decline in general andadministrative expenses is primarily due to reduced spending of $0.7 millionand $2.2 million, respectively for the thirteen and thirty-nine weeks ended September 28,2004, for non-capitalizable legal and consultingexpenses associated with our debt refinancing and equity recapitalization, andthe re-audit of our 2000 and 2001 financial results that occurred during 2003.**

 

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Ourdepreciation and amortization expenses decreased 19.2% and 19.3% for thethirteen and thirty-nine weeks ended September 28, 2004, respectively,when compared to the same periods in fiscal 2003. The decreases in depreciationand amortization expense are primarily due to a portion of our asset basebecoming fully depreciated during the fiscal year 2004. In the near future, weanticipate spending additional capital on existing stores, which would resultin a corresponding increase in our depreciable asset base, and thusdepreciation expense. Over the past several years, former management did notinvest significant capital in our store equipment due to limited availabilityof resources and covenant restrictions under our former credit facilities.During the current year, we have placed greater emphasis on the requirements ofour existing company-operated stores. For additional information, see thediscussion under “Liquidity and Capital Resources.”

 

Theadjustment of integration and reorganization cost primarily representsadjustments to previously recorded liabilities associated with the closing andcorporate consolidation of our Eatontown facilities during 2002. During April 2004,we reached an agreement with the landlord of our Eatontown facility to settleoutstanding litigation. Previously recorded integration and reorganizationestimates associated with closing this facility were adjusted down by $700,000during the thirteen weeks ended March 30, 2004 as a result of this settlement.

 

For the thirteen and thirty-nine weeksended September 28, 2004, we recorded $402,000 in impairment charges forlong-lived asset impairments and exit costs from the decision to close tworestaurants and to write down the assets of four under-performing restaurants.

 

Interestexpense decreased 43.8% and 38.8% for the thirteen and thirty-nine weeks ended September 28,2004, respectively, when compared to the same periods in fiscal 2003. Theprimary cause of the decline in interest expense is the result of the debtrefinancing that occurred during the third quarter of fiscal 2003. As a resultof the debt refinancing, our interest rate on our primary debt facilitydeclined from 19% to 13% per year.

 

Forthe thirty-nine weeks ended September 28, 2004, we recorded a loss ondisposal or abandonment of assets of approximately $1.4 million, primarily dueto the disposal of menu boards as a result of our new menu offerings and due tothe abandonment of leasehold improvements related to closed restaurants and ouradministrative facilities located in New Jersey.

 

In September 2003, we completed anequity recapitalization with our preferred stockholders, who held a substantialportion of our common stock. Among other things, our MandatorilyRedeemable Series F Preferred Stock was eliminated. In exchange, we issued57,000 shares of Series Z Preferred Stock to HalpernDenny Fund III, L.P. and we issued 9,380,843 shares of our common stock to Greenlight Capital and affiliates.  The exchange of the HalpernDenny interest resulted in a reduction of our effective dividend rate and as aresult of this and other factors, we accounted for this transaction as troubleddebt restructuring. This exchange did not result in a gain from troubled debtrestructuring. The exchange of the Greenlightinterest into common shares was recorded at fair value, which resulted in aloss upon exchange of approximately $23.0 million. Refer to our annual report on Form 10-K for thefiscal year ended December 30, 2003 for more information regarding thistransaction.

 

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**Liquidity and Capital Resources**

 

Wehave historically relied upon our major preferred and common stockholders toprovide us with supplemental financing at times when our cash flows fromoperations have been insufficient to cover our capital requirements or therequirements of other debt. The restaurant industry is predominantly a cashbusiness where cash is received at the time of the transaction. We have aminimal amount of accounts receivable, which are predominantly from ourfranchisees, licensees and distributors. Additionally, our investment ininventory is minimal since our products are perishable. Our accounts payableare on terms that we believe are consistent with those of other companieswithin the industry.

 

Theprimary driver of our operating cash flow is our restaurant operations,specifically the gross margin from our company-operated restaurants. Therefore,we focus on the elements of those operations including comparable store salesto ensure a steady stream of operating profits that enable us to meet our cashobligations. On a weekly basis, we review our company-operated storeperformance compared with the same period in the prior year and our operatingplan. We are continuously identifying and implementing cost reductioninitiatives, not only at the store operations level, but also within otherdisciplines such as supply chain, manufacturing operations and overhead.Examples of these cost reduction initiatives include:

 

•      Menu optimization to remove and/or modifyinefficient products and thus reduce waste;

 

•      Upgrade/deployment of technology to enablemore accurate sales identification and tracking of daily volumes and cost ofproducts sold thereby identifying opportunities to improve store margins andreduce waste;

 

•      Reduction of the various elements of costthat were historically non-recurring in nature.

 

Forthe remainder of fiscal year 2004, we anticipate the majority of our capitalexpenditures will be focused on the following: (1) requirements of our existing company-operated stores, primarilyequipment replacement and new computer hardware, (2) upgrades andremodeling costs associated with the openings of Einstein Bros. Café , (3) capitalspent on our manufacturing operations and upgrades to our bagel manufacturingequipment located at our contract manufacturer’s site and (4) additionalcapital for our support center in Golden, Colorado, primarily related tospending on information technology upgrades and maintenance.

 

Basedupon our projections for fiscal 2004 and beyond, we believe that the cash flowfrom operations coupled with the continued availability of our AmSouth Revolverwill be adequate to fund our operations, capital expenditures and required debtand interest repayments for the foreseeable future.

 

OurAmSouth Revolver is a $15 million senior secured revolvingcredit facility, which matures on July 8, 2006. On September 28,2004, our unused credit facility totaled $10.0 million, net of outstandingletters of credit of $5.0 million. Our credit facility contains financialcovenants relating to the maintenance of leverage and coverage ratios. Thecredit facility also contains affirmative and negative covenants including,among other things, limitations on certain additional indebtedness, capitalexpenditures and minimum EBITDA as defined in theagreement. We were in compliance with all covenants at September 28, 2004and do not anticipate that the covenants will impact our ability to borrowunder our credit facility for its remaining term.

 

Weare currently in discussions with AmSouth to increase the amount of our seniorsecured revolving credit facility and potentially convert some portion of thefacility to a term loan. Such modifications would assist in increasing ourletter of credit capacity, as well as, increasing limits on capital spendingfor future years.

 

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Ifat some point in the future we require additional financing, no assurance canbe given that any additional financing would be available on acceptable terms,or at all.  If we are unable to obtain additional financing, we maybe required to further reduce costs associated with our current infrastructure,decrease spending on marketing and advertising campaigns, curtail research anddevelopment programs and/or halt all other discretionary spending programs, anyof which could further reduce sales and adversely affect liquidity andoperations.

 

OnSeptember 28, 2004, we had unrestricted cash of $1.9 million andshort-term restricted cash of $1.3 million. We reduced our working capitaldeficit to $21.0 million on September 28, 2004 compared with a workingcapital deficit of $23.6 million on December 30, 2003. Additionally,we experienced an improvement of $13.4 million in our cash operatingperformance (defined as net loss as adjusted for non-cash charges). We believethis improvement is a direct result of our ability to better manage fixed andvariable elements of our cost of sales and an overall reduction in spendingdollars for general and administrative purposes. We also improved our free cashflow deficit by $6.1 million during the thirty-nine weeks ended September 28,2004 compared to the same period in the prior year.

 

Cashoperating performance and free cash flow are not intended to represent cashflow from operations in accordance with accounting principles generallyaccepted in the United States (GAAP) and should notbe used as an indicator of operating performance or to cash flow as a measureof liquidity. Rather, our cash operating performance and free cash flow are abasis upon which we measure our financial performance, as well as our abilityto pay down debt, save cash for future use and build shareholder equity. Wealso believe that the presentation of these calculations provides meaningfulnon-GAAP financial measures to help investorsunderstand and compare business trends among different reporting periods on aconsistent basis. Cash operating performance and free cash flow are notnecessarily comparable to other similarly titled measures of other companiesdue to the potential inconsistencies in the method of calculation.

 

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**Reconciliationof Net Loss to Cash Operating Performance:**

 
| ** **                                                        | ** ** | **Thirty-nine weeks ended:** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                        | ** ** | **Sept 28, 2004**            | ** ** | **Sept 30, 2003** | ** ** |
| ** **                                                        | ** ** | **(restated)**               | ** ** | **(restated)** | ** ** |
| Net loss                                                          |       | $                            | (15,306    | ) | $ | (59,495 | ) |
| Adjustments for non-cash charges:                                 |       |                         |       |   |   |
| Depreciation and amortization                                     |       | 20,882                       |       | 25,889 |   |
| Stock-based compensation expense                                  |       | 51                           |       | — |   |
| Loss (gain) on disposal of assets and  impairment charges         |       | 1,625                        |       | (592 | ) |
| Adjustments of integration and  reorganization costs              |       | (843                         | )          | (153 | ) |
| Cumulative change in fair value of  derivatives                   |       | —                       |       | (993 | ) |
| Amortization of debt issuance and debt  discount costs            |       | 1,387                        |       | 2,675 |   |
| Notes issued as paid in kind for interest  on Bridge Loan         |       | —                       |       | 510 |   |
| Issuance of standstill warrants                                   |       | —                       |       | 3,132 |   |
| Greenlight  non-cash interest                                     |       |                         |       | 1,025 |   |
| Loss on exchange of Series F Preferred  Stock due to Equity Recap |       |                         |       | 23,007 |   |
| Reduction in Bridge Loan due to Equity  Recap                     |       | —                       |       | (615 | ) |
| Cash Operating Performance                                        |       | $                            | 7,796      |   | $ | (5,610 | ) |

 

**Reconciliationof Net Cash Used in Operating Activities to Free Cash Flow:**

 
| ** **                            | ** ** | **Thirty-nine weeks ended:** | ** ** |
|---------------------------------------|------------|------------------------------|------------|
|                                  |       | **Sept 28,  2004**           | ** ** | **Sept 30,  2003** |   |
| Net cash used in operating activities |       | $                            | (418       | ) | $ | (6,366 | ) |
| Less: purchases of fixed assets       |       | (5,605                       | )          | (5,838 | ) |
| Free Cash Flow                        |       | $                            | (6,023     | ) | $ | (12,204 | ) |

 

Duringthe thirty-nine weeks ended September 28, 2004, operations consumed $0.4million of cash, primarily attributable to two semi-annual interest payments ofapproximately $20.4 million in the aggregate under our $160 Million Indenture,compared to consumption of $6.4 million during the thirty-nine weeks endedSeptember 30, 2003. We believe we will continue to see improvements in ourcash operating performance during the next quarter. Due to the timing of thecash interest payment under our $160 Million Indenture, which is due January 1and July 1, we generally consume cash from operations during the first andthird fiscal quarters of each year. During the second and fourth fiscalquarters of each year, we generally generate cash from operations.Historically, our fourth quarter is our strongest quarter for generating cashdue to seasonality and gift card promotions. We believe the cash generated fromour company-operated stores, along with the availability under our AmSouthRevolver will be adequate to satisfy our cash obligations in the future.

 

Duringthe thirty-nine weeks ended September 28, 2004, we used $5.6 millionof cash to purchase additional property and equipment which included $1.0million for new stores, $3.5 million for replacement and new equipment atour existing company-operated stores, $0.3 million for our manufacturingoperations and $0.8 million for general corporate purposes.

 

Duringthe thirty-nine weeks ended September 28, 2004, we used $1.0 millionof cash to reduce our debt outstanding on the AmSouth Revolver andapproximately $0.8 million to repay our obligations under the Chesapeake BagelBakery Note Payable.

 

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***Contractual Obligations***

 

Therewere no material changes to our contractual obligations during the thirty-nineweeks ended September 28, 2004. For information regarding our contractualobligations at December 30, 2003, see our Annual Report on Form 10-Kfor the fiscal year ended December 30, 2003.

 

***Guarantees***

 

Inthe past, we would sometimes guarantee leases for the benefit of certain of ourfranchisees. The lease guarantees extend through 2008. Under the guarantees, wemay be required by the lessor to make all of theremaining monthly rental payments or property tax and common area maintenancepayments if the franchisee does not make the required payments in a timelymanner. However, we believe that most, if not all, of the franchised locationscould be subleased to third parties minimizing our potential exposure.Additionally, we have indemnification agreements with our franchisees underwhich the franchisees would be obligated to reimburse us for any amounts paidunder such guarantees. As of September 28, 2004, our maximum exposureunder this contingent liability was approximately $1.7 million.

 

###### ***Insurance Programs***

###### ** **

Weare self-insured for a substantial portion of our current and prior years’ coverageincluding workers’ compensation, employment practices liability and generalliability (collectively, “insurance losses”). To mitigate the potential cost ofour exposures for certain of the insurance losses, we make annual decisions toself-fund the risks of loss up to defined maximum per occurrence retentions ona policy-by-policy basis. We then purchase insurance coverage, up to a certainlimit, for losses that exceed the self-insurance per occurrence or aggregateretention. The insurers’ maximum aggregate loss limits are significantly aboveour actuarially determined probable losses; therefore, we believe thelikelihood of losses exceeding the insurers’ maximum aggregated loss limits isremote.

 

Weare also self-insured for healthcare claims for eligible participatingemployees subject to certain deductibles and limitations. We have accounted forour liabilities related to the insurance losses and healthcare claims,including reported and incurred but not reported claims, based on informationprovided by actuaries.

 

Webelieve that we have recorded reserves adequate to cover our insurance lossesbased upon information we have today. Due to the inherent volatility ofactuarially determined insurance loss estimates, it is reasonably possible thatwe could experience changes in estimated losses, which could be material to ourconsolidated financial position or results of operations.

 

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### ***Risk Factors***

### * *

Youshould consider each of the following factors as well as other information inthe Quarterly Report in evaluating our business and prospects. The risks anduncertainties described below are not the only ones we face. Additional risksand uncertainties not presently known to us or that we currently consider immaterialmay also impair our business operations. If any of these risks actually occur,our business and financial results could be harmed and the trading price of ourcommon stock could decline. You should also refer to the other information setforth in the Quarterly Report and in our Annual Report on Form 10-K forthe fiscal year ended December 30, 2003, including our consolidatedfinancial statements and the related notes.

 

*We maynot be successful in implementing any or all of the initiatives of our businessstrategy.*

 

Oursuccess depends in part on our ability to understand our customers’ needs. Webelieve successful deployment of our current business strategy will addresscustomers’ needs and contribute to overall company growth. If we improperlyperceive customers’ needs and/or are not successful in implementing any or allof the initiatives of our business strategy, it could have a material adverseeffect on our business, results of operations, and financial condition.

 

*We haveand expect to continue to have a substantial amount of debt.*

 

Wehave a high level of debt and are highly leveraged. In addition, we may,subject to certain restrictions, incur substantial additional indebtedness inthe future. Our high level of debt, among other factors, could:

 

•      make it difficult for us to satisfy ourobligations under our indebtedness;

 

•      limit our ability to obtain additionalfinancing for working capital, capital expenditures, acquisitions and generalcorporate purposes;

 

•      increase our vulnerability to downturns inour business or the economy generally;

 

•      limit our ability to withstand competitivepressures from our less leveraged competitors; and

 

•      harm us because a failure by us to complywith the covenants in the instruments and agreements governing our indebtednesscould result in an event of default that, if not cured or waived, could resultin all of our indebtedness becoming immediately due and payable, which couldrender us insolvent.

 

*We maynot be able to generate sufficient cash flow to make payments on ourindebtedness.*

 

Economic,financial, competitive, legislative and other factors beyond our control mayaffect our ability to generate cash flow from operations to make payments onour indebtedness and to fund necessary working capital. A significant reductionin operating cash flow would likely increase the need for alternative sourcesof liquidity. If we are unable to generate sufficient cash flow to makepayments on our debt, we will have to pursue one or more alternatives, such asreducing or delaying capital expenditures, refinancing our debt, selling assetsor raising equity. We may not be able to accomplish any of these alternativeson satisfactory terms, if at all, and even if accomplished, they may not yieldsufficient funds to service our debt.

 

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*We arevulnerable to changes in consumer preferences and economic conditions thatcould harm our financial results.*

 

Foodservice businesses are often affected by changes in consumer tastes, dietarytrends, national, regional and local economic conditions and demographictrends. Factors such as traffic patterns, local demographics and the type,number and location of competing restaurants may adversely affect theperformance of individual locations. Shifts in consumer preferences away fromour type of cuisine and/or the quick casual dining style could have a materialadverse affect on our results of operations. We believe that the trend towardconsumption of food low in carbohydrate content may have had and may continueto have a negative impact on our sales and revenues. In addition, inflation andincreased food and energy costs may harm the restaurant industry in general andour locations in particular. Adverse changes in any of these factors couldreduce consumer traffic or impose practical limits on pricing, which could harmour business prospects, financial condition, operating results and cash flow.Our continued success will depend in part on our ability to anticipate,identify and respond to changing consumer preferences and economic conditions.

 

*Thereis intense competition in the restaurant industry for personnel, real estate,advertising space, and customers, among other things.*

 

Ourindustry is intensely competitive and there are many well-establishedcompetitors with substantially greater financial and other resources than wehave. In addition to current competitors, one or more new major competitorswith substantially greater financial, marketing and operating resources couldenter the market at any time and compete directly against us. In addition, invirtually every major metropolitan area in which we operate or expect to enter,local or regional competitors already exist. This may make it more difficult toobtain real estate, advertising space, and retain customers and personnel.

 

*We arevulnerable to fluctuations in the cost, availability and quality of our rawingredients.*

 

Thecost, availability and quality of the ingredients we use to prepare our foodare subject to a range of factors, many of which are beyond our control.Fluctuations in economic and political conditions, weather and demand couldadversely affect the cost of our ingredients. We have limited control overfluctuations in the price of commodities, and we may not be able to passthrough any cost increases to our customers. We are dependent on frequentdeliveries of fresh ingredients, thereby subjecting us to the risk of shortagesor interruptions in supply. All of these factors could adversely affect ourbusiness and financial results.

 

*Weheavily depend on our suppliers and distributors.*

 

Wecurrently purchase our raw materials from various suppliers. We purchase amajority of our frozen bagel dough from one supplier. Though to date we havenot experienced significant difficulties with our suppliers, our reliance onour suppliers subjects us to a number of risks, including possible delays orinterruption in supplies, diminished control over quality and a potential lackof adequate raw material capacity. Any disruption in the supply or degradationin the quality of the materials provided by our suppliers could have a materialadverse effect on our business, operating results and financial condition. Inaddition, such disruptions in supply or degradations in quality could have along-term detrimental impact on our efforts to develop a strong brand identityand a loyal consumer base.

 

Wedepend on our network of six regional custom distributors to distribute frozenbagel dough and other materials to our locations. If any one or more of thesedistributors fails to perform as anticipated, or if there is any disruption inany of our distribution relationships for any reason, it could have a materialadverse effect on our business, financial condition and results of operations.

 

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*Increasinglabor costs could adversely affect our continued profitability.*

 

Weare dependent upon an available labor pool of employees, many of whom arehourly employees whose wages may be affected by an increase in the federal orstate minimum wage. Numerous proposals have been made on federal, state andlocal levels to increase minimum wage levels. Although few, if any, of ouremployees are paid at the minimum wage level, an increase in the minimum wage maycreate pressure to increase the pay scale for our employees, which wouldincrease our labor costs and those of our franchisees and licensees. A shortagein the labor pool or other general inflationary pressures or changes could alsoincrease labor costs. In addition, changes in labor laws or reclassificationsof employees from management to hourly employees could affect our labor cost.For example, new federal overtime regulations under the Fair Labor StandardsAct, which went into effect on August 23, 2004, may impact theclassification of several of our positions. We are continuing to evaluate thespecific impact of these changes. An increase in labor costs could have amaterial adverse effect on our income from operations and decrease ourprofitability and cash available to service our debt obligations if we areunable to recover these increases by raising the prices we charge ourcustomers.

 

*We facethe risk of adverse publicity and litigation in connection with our operations.*

 

Weare from time to time the subject of complaints or litigation from ourconsumers alleging illness, injury or other food quality, health or operationalconcerns. Adverse publicity resulting from these allegations may materiallyadversely affect us, regardless of whether the allegations are valid or whetherwe are liable. In addition, employee claims against us based on, among otherthings, discrimination, harassment or wrongful termination may divert financialand management resources that would otherwise be used to benefit our futureperformance. We have been subject to claims from time to time, and althoughthese claims have not historically had a material impact on our operations, asignificant increase in the number of these claims or the number that aresuccessful could materially adversely affect our business, prospects, financialcondition, operating results or cash flows.

 

*We relyin part on our franchisees.*

 

Werely in part on our franchisees and the manner in which they operate theirlocations to develop and promote our business. Although we have developedcriteria to evaluate and screen prospective franchisees, franchisees may nothave the business acumen or financial resources necessary to operate successfulfranchises in their franchise areas. The failure of franchisees to operatefranchises successfully could have a material adverse effect on us, our abilityto collect royalties, our reputation, our brands and our ability to attractprospective franchisees.

 

*We facerisks associated with government regulation.*

 

Eachof our locations is subject to licensing and regulation by the health,sanitation, safety, labor, building and fire agencies of the respective statesand municipalities in which it is located. A failure to comply with one or moreregulations could result in the imposition of sanctions, including the closingof facilities for an indeterminate period of time, or third-party litigation,any of which could have a material adverse effect on us and our results ofoperations.

 

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Inaddition, our franchise operations are subject to regulation by the FederalTrade Commission. Our franchisees and we must also comply with statefranchising laws and a wide range of other state and local rules andregulations applicable to our business. The failure to comply with federal,state and local rules and regulations would have an adverse effect on ourfranchisees and us.

 

Undervarious federal, state and local laws, an owner or operator of real estate maybe liable for the costs of removal or remediation of certain hazardous or toxicsubstances on or in such property. Such liability may be imposed without regardto whether the owner or operator knew of, or was responsible for, the presenceof such hazardous or toxic substances. Although we are not aware of anyenvironmental conditions that require remediation by us under federal, state orlocal law at our properties, we have not conducted a comprehensiveenvironmental review of our properties or operations. We may not have identifiedall of the potential environmental liabilities at our properties, and any suchliabilities that are identified in the future may have a material adverseeffect on our financial condition.

 

*We may not be able to protect our trademarks, service marks and otherproprietary rights.*

 

Webelieve that our trademarks, service marks and other proprietary rights areimportant to our success and our competitive position. Accordingly, we devotesubstantial resources to the establishment and protection of our trademarks,service marks and proprietary rights. However, the actions taken by us may beinadequate to prevent imitation of our products and concepts by others or toprevent others from claiming violations of their trademarks and proprietaryrights by us. In addition, others may assert rights in our trademarks, servicemarks and other proprietary rights.

 

*We have a majority stockholder.*

 

Greenlight Capital, L.L.C.and its affiliates beneficially own approximately 97 percent of our commonstock. As a result, Greenlight has sufficient votingpower, without the vote of any other stockholders, to determine what matterswill be submitted for approval by our stockholders, to approve actions bywritten consent without the approval of any other stockholders, to elect all ofour board of directors, and to determine whether a change in control of ourcompany occurs. Greenlight’s interests on matterssubmitted to stockholders may be different from those of other stockholders. Greenlight is not involved in our day-to-day operations,but Greenlight has voted its shares to elect ourcurrent board of directors. The chairman of our board of directors is a currentemployee of Greenlight. The remaining six directorsare not affiliated with Greenlight.

 

Ourcommon stock is not currently listed on any stock exchange or Nasdaq. As a result, we are not subject to corporategovernance rules recently adopted by the New York Stock Exchange, AmericanStock Exchange and Nasdaq requiring a majority ofdirectors to be independent and requiring compensation and nominatingcommittees that are composed solely of independent directors. However, we aresubject to rules requiring that the audit committee consist entirely ofindependent directors. Under the rules of these stock exchanges and Nasdaq, if a single stockholder holds more that 50% of thevoting power of a listed company, that company is considered a controlledcompany, and except for the rules relating to independence of the auditcommittee, is exempt from the above-mentioned independence rules. Since Greenlight beneficially owns approximately 97% of ourcommon stock, we may take advantage of the controlled company exemption if ourcommon stock becomes listed on an exchange or Nasdaqin the future. As a result, our stockholders do not have, and may never havethe protections that these rules are intended to provide.

 

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*Futuresales of shares of our common stock by our stockholders could cause our stockprice to fall.*

 

Ifa substantial number of shares of our common stock are sold in the publicmarket, the market price of our common stock could fall.  The perception among investors that thesesales will occur could also produce this effect.  Our majority stockholder Greenlightbeneficially owns approximately 97 percent of our common stock and sales by Greenlight or a perception that Greenlightwill sell could cause a decrease in the market price of our common stock.Additionally, holders of outstanding warrants may convert and sell theunderlying shares in the public market. Pursuant to our obligations underregistration rights agreements, we recently registered 957,872 shares of commonstock underlying certain warrants, of which Greenlightowns warrants to purchase approximately 493,683 shares of our common stock.Sales of shares or a perception that there will be sales of the underlyingshares could also cause a decrease in the market price of our common stock.

 

*Holdersmay find it difficult to effect transactions in our common stock.*

 

Our common stockis currently trading on the “pink sheets” under the symbol “NWRG.PK.”  Before changing our symbol on October 20,2003, our common stock traded on the “pink sheets” under the symbol “NWCI.PK.”  Since ourcommon stock is not listed on Nasdaq, Amex or the NewYork Stock Exchange, holders of our common stock may find that the liquidity ofour common stock is impaired – not only in the number of securities that can bebought and sold, but also through delays in the timing of transactions,reduction in security analysts’ and the news media’s coverage of us, and lowerprices for our securities than might otherwise be attained.

 

Securities thatare not listed on a stock exchange, the NasdaqNational Market or the Nasdaq  SmallCapMarket are subject to an SEC rule that imposes special requirements onbroker-dealers who sell those securities to persons other than theirestablished customers and accredited investors. The broker-dealer mustdetermine that the security is suitable for the purchaser and must obtain the purchaser’swritten consent prior to the sale. These requirements may make it moredifficult for you to sell our stock than the stock of some other companies. Itmay also affect our ability to raise more capital if and when necessary.

 

BeforeMay 22, 2002, our common stock was quoted on the OTC Bulletin Board underthe symbol “NWCI.OB.” On May 22, 2002, ourcommon stock was removed from the eligible list on the OTC Bulletin Board for afailure to comply with NASD Rule 6530, whichresulted from our failure to timely file our Form 10-K for the year ended January 1,2002.  Before November 27, 2001, ourcommon stock was quoted on the Nasdaq National Marketunder the symbol “NWCI.”  Effective November 27, 2001, NASDAQ delisted our common stock from the NasdaqNational Market due to corporate governance violations and public interestconcerns.

 

**Item 3.****  Qualitativeand Quantitative Disclosures About Market Risk**

 

ThroughSeptember 28, 2004, our results of operations, financial position and cashflows have not been materially affected by changes in the relative values ofnon-U.S. currencies to the U.S. dollar. We do not usederivative financial instruments to limit our foreign currency risk exposuresince virtually all of our business is conducted in the United States.

 

Ourdebt as of September 28, 2004 is principally comprised of the $160 MillionIndenture due July 1, 2008 and the AmSouth Revolver. A 100 basis pointincrease in market interest rates would have an immaterial effect on ourborrowing costs, since the interest rate on the $160 Million Indenture isfixed. The interest rate on the AmSouth Revolver does fluctuate with changes inthe prime rate, but is minor in relation to interest expense in our results ofoperations and financial condition.

 

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**Item 4****.  Controlsand Procedures**

 

Ourchief executive officer and our principal financial officer have evaluated theeffectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act) as of September 28, 2004. Based onthat evaluation, our chief executive officer and our principal financialofficer have concluded that our disclosure controls and procedures wereeffective to provide reasonable assurance that information that we are requiredto disclose in reports that we file with the SEC is recorded, processed,summarized and reported within the time periods specified by the Exchange Actrules.

 

Itshould be noted that any system of controls, however well designed andoperated, can provide only reasonable assurance regarding management’s controlobjectives. In addition, the design of any control system is based in part uponcertain assumptions about the likelihood of future events. Because of these andother inherent limitations of control systems, there can be no assurance thatany design will succeed in achieving its stated goals under all potentialfuture conditions, regardless of how remote.

 

Duringthe fiscal quarter ended September 28, 2004, there were no changes to ourinternal control over financial reporting which were identified in connectionwith the evaluation of our disclosure controls and procedures required by theExchange Act rules and which have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

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**PART II****- OTHER INFORMATION**

**NEW WORLD RESTAURANTGROUP, INC.**

 

**Item 1.****   ****Legal****Proceedings.**

 

Information regarding legalproceedings is incorporated by reference from Note 10 to our ConsolidatedFinancial Statements set forth in Part I of this report.

 

**Item 6****.  Exhibits**

 

31.1         Certification by Chief Executive Officerpursuant to Exchange Act Rule 13a-15(e), as adopted pursuant to Section 302of the Sarbanes-Oxley Act of 2002

 

31.2         Certification by Chief Financial Officerpursuant to Exchange Act Rule 13a-15(e), as adopted pursuant to Section 302of the Sarbanes-Oxley Act of 2002

 

32.1         Certification by Chief Executive Officerpursuant to 18 U.S.C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2         Certification by Chief Financial Officerpursuant to 18 U.S.C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

**Signatures**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisAmendment No. 1 on Form 10-Q/A to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|   |             | NEW WORLD RESTAURANT  GROUP, INC.                         |
|--------|------------------|-----------------------------------------------------------|
|   |             |                                                      |
|   |             |                                                      |
| Date:  | May 6, 2005 | By:                                                       | /s/ PAUL J. B.  MURPHY, III |   |
|   |             | Paul J.B.  Murphy, III                               |
|   |             | Chief Executive Officer                                   |
|   |             |                                                      |
| Date:  | May 6, 2005 | By:                                                       | /s/ RICHARD P. DUTKIEWICZ |   |
|   |             | Richard P. Dutkiewicz                                     |
|   |             | Chief Financial Officer  and Principal Accounting Officer |
|   |             |                                                      |

 

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