**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-Q/A**

 

**Amendment No. 1**

 
| **(Mark One)**                                    |
|---------------------------------------------------|
| **ý**                                        | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15  (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                              |
| **For the quarterly period ended June 29,  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 itsCharter)

 
| **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**                                                      |
|                                                          |
| Securities registered pursuant to Section  12(g) of the Act:  |
| **Common Stock, $.001 par value**                             |

 

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

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of1934).  Yes o  No ý

 

As of August 5, 2004, 9,842,385 shares of CommonStock of the registrant were outstanding.

 

 

----

 

**Explanatory Note**

 

The purpose of this amendment on Form 10-Q/A for the quarterly periodended June 29, 2004 is to restate our consolidated financial statements as ofJune 29, 2004 and December 30, 2003 and for the thirteen and twenty six weeksended June 29, 2004 and July 1, 2003, and the related disclosures, as describedin Note 1 to the Consolidated Financial Statements. Additional informationregarding our decision to restate these financial statements can be found inour Current Report on Form 8-K, filed with the Securities and ExchangeCommission (SEC) on March 3, 2005. 

 

No attempt has been made in this Form 10-Q/A to modify or update otherdisclosures presented in the original report on Form 10-Q, except as requiredto reflect the restatement. The Form 10-Q/A does not reflect events occurringafter the filing of the Form 10-Q or modify or update those disclosures,including the exhibits to the Form 10-Q affected by subsequent events.Information not affected by the restatement is unchanged and reflects the disclosuresmade at the time of the original filing of the Form 10-Q. Accordingly, thisForm 10-Q/A should be read in conjunction with our filings made with the SECsubsequent to the filing of the original Form 10-Q, including any amendments tothose filings. The following items have been amended as a result of therestatement:

 

Part I– Item 1 – Financial Statements

 

Part II – Item II – Management’s Discussion and Analysis of FinancialCondition and Results of Operations

 

*Description of Restatement*

* *

It has been our longstanding historical accounting policy to amortizeour leasehold improvements over a period that included both the noncancelableterm of 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.

 

2

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**NEW WORLD RESTAURANT GROUP, INC.**

 

June 29, 2004

 

TABLE OF CONTENTS

 
| ** ** | ** ** | **Part I. Financial Information**                                                                                                    | ** ** |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|
|       |       |                                                                                                                                 |       |
| Item  1.   |       | Financial  Statements (as restated):                                                                                                 |       |
|       |       |                                                                                                                                 |       |
|       |       | Consolidated Balance Sheets, June 29, 2004 (unaudited) and December  30, 2003                                                        |       |
|       |       |                                                                                                                                 |       |
|       |       | Consolidated Statements of Operations, for  the thirteen and twenty-six weeks ended June 29, 2004 and July 1, 2003  (unaudited)      |       |
|       |       |                                                                                                                                 |       |
|       |       | Consolidated Statements of Cash Flows, for  the twenty-six weeks ended June 29, 2004 and July 1, 2003 (unaudited)                    |       |
|       |       |                                                                                                                                 |       |
|       |       | Consolidated  Statement of Changes in Stockholders’ Equity (Deficit), for the twenty-six  weeks ended June 29, 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 2.    |       | Changes in Securities and Use of Proceeds                                                                                            |       |
|       |       |                                                                                                                                 |       |
| Item 4.    |       | Submission of Matters to a Vote of Security Holders                                                                                  |       |
|       |       |                                                                                                                                 |       |
| Item 6.    |       | Exhibits and Reports on Form 8-K                                                                                                     |       |

 

3

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**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**AS OF JUNE 29, 2004 AND DECEMBER 30, 2003**

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

 
| ** **                                                                                                                                                                 | ** ** | **June 29,  2004**          | ** ** | **December 30,  2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                 | ** ** | **(restated)  (unaudited)** | ** ** | **(restated)**         | ** ** |
| **ASSETS**                                                                                                                                                                 | ** ** | ** **                  | ** ** | ** **             | ** ** |
| Current assets:                                                                                                                                                            |       |                        |       |                   |       |
| Cash and cash equivalents                                                                                                                                                  |       | $                           | 10,323     |                   | $          | 9,575 |   |
| Restricted cash                                                                                                                                                            |       | 1,158                       |       | 1,815                  |       |
| Franchise and other receivables, net of  allowance of $2,947 and $3,310                                                                                                    |       | 5,995                       |       | 5,842                  |       |
| Inventories                                                                                                                                                                |       | 4,807                       |       | 4,831                  |       |
| Prepaid expenses and other current assets                                                                                                                                  |       | 2,328                       |       | 2,650                  |       |
| Total current assets                                                                                                                                                       |       | 24,611                      |       | 24,713                 |       |
|                                                                                                                                                                       |       |                        |       |                   |       |
| Restricted cash long-term                                                                                                                                                  |       | 3,037                       |       | 3,036                  |       |
| Property, plant and equipment, net                                                                                                                                         |       | 46,899                      |       | 54,513                 |       |
| Trademarks and other intangibles, net                                                                                                                                      |       | 81,389                      |       | 85,431                 |       |
| Goodwill                                                                                                                                                                   |       | 4,875                       |       | 4,875                  |       |
| Debt issuance costs and other assets                                                                                                                                       |       | 8,262                       |       | 9,170                  |       |
| Total assets                                                                                                                                                               |       | $                           | 169,073    |                   | $          | 181,738 |   |
|                                                                                                                                                                       |       |                        |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**                                                                                                                             | ** ** | ** **                  | ** ** | ** **             | ** ** |
| Current liabilities:                                                                                                                                                       |       |                        |       |                   |       |
| Accounts payable                                                                                                                                                           |       | $                           | 7,849      |                   | $          | 8,189 |   |
| Accrued expenses                                                                                                                                                           |       | 37,250                      |       | 37,871                 |       |
| Short term debt and current portion of long-term  debt                                                                                                                     |       | 1,105                       |       | 2,105                  |       |
| Current portion of obligations under  capital leases                                                                                                                       |       | 57                          |       | 180                    |       |
| Total current liabilities                                                                                                                                                  |       | 46,261                      |       | 48,345                 |       |
|                                                                                                                                                                       |       |                        |       |                   |       |
| Senior notes and other long-term debt                                                                                                                                      |       | 161,120                     |       | 161,120                |       |
| Obligations under capital leases                                                                                                                                           |       | 29                          |       | 29                     |       |
| Other liabilities                                                                                                                                                          |       | 10,135                      |       | 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                                                                                                                                                          |       | 274,545                     |       | 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                                                                                                                                                 |       | 175,620                     |       | 175,585                |       |
| Accumulated deficit                                                                                                                                                        |       | (281,102                    | )          | (270,748               | )          |
| Total stockholders’ deficit                                                                                                                                           |       | (105,472                    | )          | (95,153                | )          |
| Total liabilities and stockholders’ deficit                                                                                                                           |       | $                           | 169,073    |                   | $          | 181,738 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

4

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**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**FOR THE THIRTEEN AND TWENTY-SIX WEEKS ENDED JUNE 29, 2004 ANDJULY 1, 2003**

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

**(unaudited)**

 
| ** **                                                   | ** ** | **Thirteen weeks ended:** | ** ** | **Twenty-six weeks ended:** | ** ** |
|--------------------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|
| ** **                                                   | ** ** | **June 29,  2004**        | ** ** | **July 1,  2003**           | ** ** | **June 29,  2004** | ** ** | **July 1,  2003** | ** ** |
| ** **                                                   | ** ** | **(restated)**            | ** ** | **(restated)**              | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Revenues:                                                    |       |                      |       |                        |       |   |   |   |   |
| Retail sales                                                 |       | $                         | 87,596     |                        | $          | 90,878 |   | $ | 172,219 |   | $ | 179,328 |   |
| Manufacturing revenues                                       |       | 4,944                     |       | 5,754                       |       | 10,357 |   | 11,178 |   |
| Franchise and license related revenues                       |       | 1,624                     |       | 1,117                       |       | 2,784 |   | 2,454 |   |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Total revenues                                               |       | 94,164                    |       | 97,749                      |       | 185,360 |   | 192,960 |   |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Cost of sales:                                               |       |                      |       |                        |       |   |   |   |   |
| Retail costs                                                 |       | 73,403                    |       | 77,385                      |       | 143,490 |   | 150,339 |   |
| Manufacturing costs                                          |       | 4,442                     |       | 5,082                       |       | 9,020 |   | 10,123 |   |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Total cost of sales                                          |       | 77,845                    |       | 82,467                      |       | 152,510 |   | 160,462 |   |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Gross profit                                                 |       | 16,319                    |       | 15,282                      |       | 32,850 |   | 32,498 |   |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Operating expenses:                                          |       |                      |       |                        |       |   |   |   |   |
| General and administrative expenses                          |       | 8,000                     |       | 10,604                      |       | 16,818 |   | 20,858 |   |
| Depreciation and amortization                                |       | 7,058                     |       | 8,607                       |       | 13,877 |   | 17,224 |   |
| Adjustment of integration and  reorganization cost           |       | (39                       | )          | —                      |       | (799 | ) | — |   |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Income (loss) from operations                                |       | 1,300                     |       | (3,929                      | )          | 2,954 |   | (5,584 | )  |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Other expense (income):                                      |       |                      |       |                        |       |   |   |   |   |
| Interest expense, net                                        |       | 5,904                     |       | 9,975                       |       | 11,703 |   | 18,271 |   |
| Cumulative change in the fair value of  derivatives          |       | —                    |       | 727                         |       | — |   | 70 |   |
| Loss (gain) on sale, disposal or  abandonment of assets, net |       | 1,472                     |       | (202                        | )          | 1,466 |   | (385 | )  |
| Other income                                                 |       | (36                       | )          | (119                        | )          | (100 | ) | (186 | )  |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Loss before income taxes                                     |       | (6,040                    | )          | (14,310                     | )          | (10,115 | ) | (23,784 | )  |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Provision for state income taxes                             |       | (184                      | )          | (320                        | )          | (239 | ) | (430 | )  |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Net loss                                                     |       | (6,224                    | )          | (14,630                     | )          | (10,354 | ) | (23,784 | )  |
| Dividends and accretion on Preferred Stock                   |       | —                    |       | (9,821                      | )          | — |   | (14,424 | )  |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Net loss available to common stockholders                    |       | $                         | (6,224     | )                           | $          | (24,451 | ) | $ | (10,354 | ) | $ | (38,208 | )  |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Net loss per common share – Basic and  Diluted          |       | $                         | (0.63      | )                           | $          | (15.22 | ) | $ | (1.05 | ) | $ | (24,42 | )  |
|                                                         |       |                      |       |                        |       |   |   |   |   |
| Weighted average number of common shares  outstanding:       |       |                      |       |                        |       |   |   |   |   |
| Basic and Diluted                                            |       | 9,842,293                 |       | 1,606,665                   |       | 9,842,061 |   | 1,564,909 |   |

 

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 TWENTY-SIX WEEKS ENDED JUNE 29, 2004 AND JULY 1, 2003**

**(in thousands)**

**(unaudited)**

 
| ** **                                                                       | ** ** | **Twenty-six weeks ended:** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                       | ** ** | **June 29,  2004**          | ** ** | **July 1,  2003** | ** ** |
| ** **                                                                       | ** ** | **(restated)**              | ** ** | **(restated)** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                            |       |                        |       |   |   |
| Net loss                                                                         |       | $                           | (10,354    | ) | $ | (23,784 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities: |       |                        |       |   |   |
| Depreciation and amortization                                                    |       | 13,877                      |       | 17,224 |   |
| Stock based compensation expense                                                 |       | 35                          |       | — |   |
| Loss on disposal of assets                                                       |       | 1,466                       |       | (385 | ) |
| Adjustments of integration and  reorganization costs                             |       | (799                        | )          | — |   |
| Cumulative change in fair value of  derivatives                                  |       | —                      |       | 70 |   |
| Amortization of debt issuance and debt  discount costs                           |       | 908                         |       | 2,212 |   |
| Notes issued as paid in kind for interest  on Bridge Loan                        |       | —                      |       | 510 |   |
| Issuance of standstill warrants                                                  |       | —                      |       | 1,238 |   |
| Greenlight interest                                                              |       | —                      |       | 1,025 |   |
| Changes in operating assets and  liabilities:                                    |       |                        |       |   |   |
| Franchise and other receivables                                                  |       | (153                        | )          | 573 |   |
| Accounts payable and accrued expenses                                            |       | (162                        | )          | 8,307 |   |
| Other assets and liabilities                                                     |       | 617                         |       | (5,771 | ) |
|                                                                             |       |                        |       |   |   |
| Net cash provided by operating activities                                        |       | 5,435                       |       | 1,219 |   |
|                                                                             |       |                        |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                            |       |                        |       |   |   |
| Purchase of property and equipment                                               |       | (3,687                      | )          | (3,494 | ) |
|                                                                             |       |                        |       |   |   |
| Net cash used in investing activities                                            |       | (3,687                      | )          | (3,494 | ) |
|                                                                             |       |                        |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                            |       |                        |       |   |   |
| Proceeds (repayments) of line of credit,  net                                    |       | (1,000                      | )          | 937 |   |
|                                                                             |       |                        |       |   |   |
| Net cash provided by (used in) financing  activities                             |       | (1,000                      | )          | 937 |   |
|                                                                             |       |                        |       |   |   |
| Net increase (decrease) in cash                                                  |       | 748                         |       | (1,338 | ) |
| Cash and cash equivalents, beginning of  period                                  |       | 9,575                       |       | 10,705 |   |
|                                                                             |       |                        |       |   |   |
| Cash and cash equivalents, end of period                                         |       | $                           | 10,323     |   | $ | 9,367 |   |
|                                                                             |       |                        |       |   |   |
| SUPPLEMENTAL CASH FLOW INFORMATION:                                              |       |                        |       |   |   |
| Cash paid for interest                                                           |       | $                           | 10,280     |   | $ | 7,669 |   |
| Cash paid for income taxes                                                       |       | $                           | 165        |   | $ | 320 |   |

 

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 STOCKHOLDER****S’ EQUITY (DEFICIT)**

**FOR THE TWENTY-SIX WEEKS ENDED JUNE 29, 2004**

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

**(unaudited)**

 
| ** **                                | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------------|------------|-------------|------------|----------------|------------|-----------------|------------|------------|------------|
| ** **                                | ** ** | **Common Stock** | ** ** | **Paid In** | ** ** | **Deficit**    | ** ** | ** **      | ** ** |
| ** **                                | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Amount**      | ** ** | **Total**  | ** ** |
|                                      |       |             |       |        |       |           |       |            |       |       |       |
| Balance, December 30, 2003 (as restated)  |       | 9,841,828        |       | $           | 10         |           | $          | 175,585         |       | $          | (270,748   | ) | $ | (95,153 | ) |
| Net loss (as restated)                    |       | —           |       | —      |       | —         |       | (10,354         | )          | (10,354    | )          |
| Stock based compensation expense          |       |             |       |        |       | 35             |       |            |       | 35         |       |
| Common stock issued upon warrant exercise |       | 557              |       | —      |       | —         |       | —          |       | —     |       |
| Balance, June 29, 2004 (as restated)      |       | 9,842,385        |       | $           | 10         |           | $          | 175,620         |       | $          | (281,102   | ) | $ | (105,472 | ) |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

7

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**NEW WORLD RESTAURANT GROUP, INC.**

 

**Notes to Consolidated Financial St****atements (Unaudited)**

 

**Thirteen and twenty-six weeks ended June 29,2004 and July 1, 2003**

 

**1.****    ****Basis of Presentation**

 

The accompanyingconsolidated financial statements of New World Restaurant Group, Inc. and itswholly-owned subsidiaries (collectively, “the Company”) have been preparedpursuant to the rules and regulations of the Securities and Exchange Commission(“SEC”). The Company owns, franchises or licenses various restaurant conceptsunder the brand names of Einstein Bros. Bagels (“Einstein Bros.”), Noah’s NewYork Bagels (“Noah’s”), Manhattan Bagel Company (“Manhattan”), Chesapeake BagelBakery (“Chesapeake”), New World Coffee (“New World”), and Willoughby’s Coffeeand Tea (“Willoughby’s”). Our business is subject to seasonaltrends. Generally, our revenues in the first fiscal quarter are somewhat lowerthan in the other three fiscal quarters.

 

The accompanying consolidated financial statements as of June 29, 2004 and December30, 2003 and for the thirteen and twenty-six weeks ended June 29, 2004 and July1, 2003 have been prepared without audit (except for the balance sheetinformation as of December 30, 2003, which is derived from our auditedfinancial statements). The information furnished herein reflects alladjustments (consisting only of normal recurring accruals and adjustments),which are, in our opinion, necessary to fairly state the interim operatingresults for the respective periods.  However, these operating results arenot necessarily indicative of the results expected for the full fiscalyear.  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 reclassificationshave been made to conform previously reported data to the current presentation.These reclassifications have no effect on net income or financialposition as previously reported.

 

# **Restatementof Prior Financial Information**

 

It has been our longstanding historical accounting policy to amortizeour leasehold improvements over a period that included both the noncancelableterm of 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 determiningcapital versus operating leases and in calculating straight-line rent expense.Accordingly, we have adopted the following policy: the depreciable lives forour leasehold improvements, which are subject to a lease, will be limited tothe lesser of the useful life or the noncancelable lease term. In circumstanceswhere we would incur an economic penalty by not exercising one or more optionperiods, as contemplated by Statement of Financial Accounting Standards (SFAS)No. 13 “Accounting for Leases,” we may include one or more option periods whendetermining the depreciation period. In either circumstance, our policyrequires consistency when calculating the depreciation period, in classifyingthe lease, and in computing straight-line rent expense.

 

8

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As a result of this change, ourfinancial statements have been restated as follows (dollars in thousands,except per share data):

 
| ** **                       | ** ** | **As of June 29, 2004** | ** ** | **As of December 30, 2003** | ** ** |
|----------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **As reported**         | ** ** | **Adjustments**             | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Balance Sheet:                   |       |                    |       |                        |       |   |   |   |   |   |   |   |   |
| Property and equipment, net      |       | $                       | 63,234     |                        | $          | (16,335 | ) | $ | 46,899 |   | $ | 67,800 |   | $ | (13,287 | ) | $ | 54,513 |   |
| Total assets                     |       | 185,408                 |       | (16,335                     | )          | 169,073 |   | 195,025 |   | (13,287 | ) | 181,738 |   |
| Accumulated deficit              |       | (264,767                | )          | (16,335                     | )          | (281,102 | ) | (257,461 | ) | (13,287 | ) | (270,748 | ) |
| Total stockholders’ deficit |       | (89,137                 | )          | (16,335                     | )          | (105,472 | ) | (81,866 | ) | (13,287 | ) | (95,153 | ) |
|                                  |            |                         |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                   | ** ** | **Thirteen weeks ended June 29, 2004** | ** ** | **Twenty-six weeks ended June 29, 2004** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------------|------------|------------------------------------------|------------|
| ** **                                                   | ** ** | **As reported**                        | ** ** | **Adjustments**                          | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Statement of Operations:                                     |       |                                   |       |                                     |       |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                |       | $                                      | 5,344      |                                     | $          | 1,714 |   | $ | 7,058 |   | $ | 10,582 |   | $ | 3,295 |   | $ | 13,877 |   |
| Income from operations                                       |       | 3,014                                  |       | (1,714                                   | )          | 1,300 |   | 6,249 |   | (3,295 | ) | 2,954 |   |
| Loss (gain) on sale, disposal or abandonment  of assets, net |       | 1,712                                  |       | (240                                     | )          | 1,472 |   | 1,713 |   | (247 | ) | 1,466 |   |
| Loss before income taxes                                     |       | (4,566                                 | )          | (1,474                                   | )          | (6,040 | ) | (7,067 | ) | (3,048 | ) | (10,115 | ) |
| Net loss                                                     |       | (4,750                                 | )          | (1,474                                   | )          | (6,224 | ) | (7,306 | ) | (3,048 | ) | (10,354 | ) |
| Net loss available to common stockholders                    |       | (4,750                                 | )          | (1,474                                   | )          | (6,224 | ) | (7,306 | ) | (3,048 | ) | (10,354 | ) |
| Net loss per common share                                    |       | $                                      | (0.48      | )                                        | $          | (0.15 | ) | $ | (0.63 | ) | $ | (0.74 | ) | $ | (0.31 | ) | $ | (1.05 | ) |
|                                                              |            |                                        |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                | ** ** | **Thirteen weeks ended July 1, 2003** | ** ** | **Twenty-six weeks ended July 1, 2003** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------|------------|
| ** **                                | ** ** | **As reported**                       | ** ** | **Adjustments**                         | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Statement of Operations:                  |       |                                  |       |                                    |       |   |   |   |   |   |   |   |   |
| Depreciation and amortization             |       | $                                     | 7,092      |                                    | $          | 1,515 |   | $ | 8,607 |   | $ | 14,297 |   | $ | 2,927 |   | $ | 17,224 |   |
| Loss from operations                      |       | (2,414                                | )          | (1,515                                  | )          | (3,929 | ) | (2,657 | ) | (2,927 | ) | (5,584 | ) |
| Loss before income taxes                  |       | (12,795                               | )          | (1,515                                  | )          | (14,310 | ) | (20,427 | ) | (2,927 | ) | (23,354 | ) |
| Net loss                                  |       | (13,115                               | )          | (1,515                                  | )          | (14,630 | ) | (20,857 | ) | (2,927 | ) | (23,784 | ) |
| Net loss available to common stockholders |       | (22,936                               | )          | (1,515                                  | )          | (24,451 | ) | (35,281 | ) | (2,927 | ) | (38,208 | ) |
| Net loss per common share                 |       | $                                     | (14.28     | )                                       | $          | (0.94 | ) | $ | (15.22 | ) | $ | (22.55 | ) | $ | (1.87 | ) | $ | (24.42 | ) |

 

9

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

 

Statement of Financial Accounting Standards (SFAS) No. 142provides that goodwill and other indefinite-lived intangibles should not beamortized, but be subject to an annual assessment for impairment, or morefrequently if circumstances indicate potential impairment, through a comparisonof fair value to its carrying amount. The two-step approach to assess goodwillimpairment requires that we first compare the estimated fair value of eachreporting unit that houses goodwill to the carrying amount of the unit’s assetsand liabilities, including its goodwill and intangible assets. If the fairvalue of the reporting unit is below its carrying amount, then the second stepof the impairment test is performed, in which the current fair value of theunit’s assets and liabilities will determine the current implied fair value ofthe unit’s goodwill. The impairment tests relating to goodwill and indefinite-livedtrademarks are performed as of year-end, unless events and circumstancesindicate otherwise. During the thirteen weeks ended June 29, 2004, we began anevaluation of whether each of our brands should be a part of our overallstrategic business plan. As a result of this evaluation, we determined thatcertain brands no longer fit strategically. Accordingly, we performed animpairment analysis and determined that no impairment of these brands existedat June 29, 2004. We also performed a longevity analysis of certain brands anddetermined that certain trademarks had an estimated remaining useful life of 4years. These trademarks were previously treated as a non-amortizing intangibleand accordingly were reclassified as an amortizing intangible at June 29, 2004.Additionally, we recorded $129,000 in amortization expense specifically relatedto these trademarks for the thirteen weeks ended June 29, 2004. 

 

Goodwill represents theexcess of cost over fair value of net assets acquired in the acquisition ofManhattan Bagel Company, Inc.

 

Trademarks and otherintangibles consists of the following (in thousands of dollars):

 
| ** **                                  | ** ** | **June 29,  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               |       | (23,605            | )          | (19,563                | )          |
|                                        |       |               |       |                   |       |
| Total amortizing intangibles, net           |       | $                  | 17,583     |                   | $          | 19,563 |   |
|                                        |       |               |       |                   |       |
| Non-amortizing intangibles:                 |       |               |       |                   |       |
| Trademarks                                  |       | 63,806             |       | 65,868                 |       |
|                                        |       |               |       |                   |       |
| Total trademarks and other intangibles, net |       | $                  | 81,389     |                   | $          | 85,431 |   |

 

10

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

 

Debt consists of thefollowing (in thousands of dollars):

 
| ** **                                                  | ** ** | **June 29,  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)                   |       | 825                |       | 825                    |       |
| New Jersey Economic  Development Authority Note Payable (d) |       | 1,400              |       | 1,400                  |       |
|                                                        |       | 162,225            |       | 163,225                |       |
| Less current portion of  debt                               |       | (1,105             | )          | (2,105                 | )          |
| Long-term debt                                              |       | $                  | 161,120    |                   | $          | 161,120 |   |

 

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

 

On July 8, 2003, we issued$160 million of 13% senior secured notes maturing on July 1, 2008 (“$160Million Indenture”) in a private placement. 

 

The $160 Million Indentureis guaranteed, fully and unconditionally, jointly and severally, by us and allpresent and future subsidiaries of ours and is collateralized by substantiallyall of our assets in which we have an interest. Pursuant to an IntercreditorAgreement, the $160 Million Indenture is subordinate to the AmSouth Revolver asdescribed below. 

 

The $160 Million Indenture contains certain covenants, which, amongothers, include certain financial covenants such as limitations on capitalexpenditures and minimum EBITDA as defined in the agreement. These covenantsare measured on a rolling twelve-month period and fiscal quarter basis,respectively. This debt contains usual and customary default provisions. As ofJune 29, 2004, we were in compliance with all our financial and operatingcovenants. 

 

Interest payments under the $160 Million Indenture are payable inarrears at the rate of 13% per year on July 1 and January 1, commencing January1, 2004. The notes are redeemable, at our option, in whole or in part at anytime after July 1, 2004 at the following redemption prices (as expressed in percentages ofthe principal amount):

 

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

 

Debt issuance costs are capitalized and amortized using the effectiveinterest method over the term of the $160 Million Indenture.

 

11

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**(b)****  ****AmSouth Revolver**

 

Also on July 8, 2003, weentered into a three-year, $15 million senior secured revolving credit facilitywith AmSouth Bank (“AmSouth Revolver”). The AmSouth Revolver has beensubsequently amended to make technical corrections, clarify ambiguous terms andprovide for increased limits with respect to letters of credit. 

 

The AmSouth Revolver iscollateralized by substantially all of our assets in which we have an interestand is senior to the $160 Million Indenture pursuant to an IntercreditorAgreement. 

 

The AmSouth 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, includingoutstanding letters of credit exceed $10.0 million. This debt alsocontains usual and customary default provisions. As of June 29, 2004, we are incompliance with all of our financial and operating covenants. 

 

Interest payments under the AmSouth Revolver are payable in arrears onthe first of each month. The net borrowings under the AmSouth Revolver bear aninterest rate equal to the base rate plus an applicable margin with the baserate being the AmSouth Bank “prime rate” and the applicable margin being basedon our fixedcharge coverage ratio with a minimum and maximum applicable margin of 0.5% and2.5% respectively. As of June 29, 2004, the prime interest rate under theAmSouth Revolver was 4.0%. 

 

We are required to pay an unused credit line fee of 0.50% per annum onthe average daily unused amount. The unused line fee is payable monthly inarrears. Additionally, we are required to pay a letter of credit fee based onthe average daily 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 June 29, 2004, we had$5.0 million letters of credit outstanding. The letters of credit expire onvarious dates during 2005, are automatically renewable for one additional yearand are payable upon demand in the event that we fail to pay certain workerscompensation claims. Our availability under the AmSouth Revolver was $10.0million at June 29, 2004.  

 

Debt issuance costs are capitalized and amortized using the effective interest methodover the term of the AmSouth Revolver. 

 

**(c)****   ChesapeakeBagel****Bakery NotePayable**

 

As a part of the acquisition of the assets of Chesapeake Bagel Bakery,we entered into a note payable to the seller. The note provides for quarterlypayments of interest only at 10%. The note is due in full on August 31,2004 and is secured by the assets of Chesapeake Bagel Bakery. 

 

**(d)****   NewJersey****EconomicDevelopment Authority Note Payable**

 

In December 1998, Manhattan Bagel Company, Inc. entered into anote payable in the principal amount of $2,800,000 with the New Jersey EconomicDevelopment Authority (“NJEDA”) at an interest rate of 9% per annum. Principalis paid annually and interest is paid quarterly. The note matures on December1, 2008 and is secured by the assets of Manhattan Bagel Company, Inc. 

 

12

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On July 3, 2003, we placed an advanced funding of the note inescrow to enact a debt defeasance as allowed for in the agreement. Thisadvanced funding is shown as restricted cash and the note is included in bothcurrent portion and long-term portion of debt in the June 29, 2004 and December 30,2003 consolidated balance sheets in accordance with the payment terms. Thisclassification will continue until the note is fully paid from the escrowamount proceeds. The escrow has a maturity date of December 1, 2008.

 

**4.****    ****Net Loss Per Common Share**

 

We compute basic net loss per common share by dividing the net loss forthe period by the weighted average number of shares of common stock outstanding(which includes shares contingently issuable for little or no consideration)during the period. There were 1,434,993 and 1,393,236 shares contingentlyissuable included in the weighted average number of shares of common stockoutstanding during the thirteen and twenty six weeks ended July 1, 2003,respectively.

 

Diluted net loss per share is computed by dividing the net loss for theperiod by the weighted average number of shares of common stock and potentialcommon stock equivalents outstanding during the period, if dilutive. Potentialcommon stock equivalents include incremental shares of common stock issuableupon the exercise of stock options. The effects of potential common stockequivalents have not been included in the computation of diluted net loss pershare as their effect is anti-dilutive. 

 

The following table summarizes the weighted average number of commonshares outstanding, as well as sets forth the computation of basic and dilutednet loss per common share for the periods indicated (in thousands, except pershare data):

 
| ** **                                                                                                                       | ** ** | **Thirteen weeks  ended:** | ** ** | **Twenty-six weeks  ended:** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------------------|------------|
| ** **                                                                                                                       | ** ** | **June 29,  2004**         | ** ** | **July 1,  2003**            | ** ** | **June 29,  2004** | ** ** | **July 1,  2003** | ** ** |
| ** **                                                                                                                       | ** ** | **(restated)**             | ** ** | **(restated)**               | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
|                                                                                                                             |       |                       |       |                         |       |   |   |   |   |
| Weighted average shares  outstanding                                                                                             |       | 9,842,293                  |       | 1,606,665                    |       | 9,842,061 |   | 1,564,909 |   |
|                                                                                                                             |       |                       |       |                         |       |   |   |   |   |
| Net loss available to  common stockholders (in thousands of dollars)                                                             |       | $                          | (6,224     | )                            | $          | (24,451 | ) | $ | (10,354 | ) | $ | (38,208 | ) |
|                                                                                                                             |       |                       |       |                         |       |   |   |   |   |
| Basic and diluted net  loss per share                                                                                            |       | $                          | (0.63      | )                            | $          | (15.22 | ) | $ | (1.05 | ) | $ | (24.42 | ) |
|                                                                                                                             |       |                       |       |                         |       |   |   |   |   |
| Outstanding options and  warrants that were not included in the diluted calculation because their  effect would be anti-dilutive |       | 1,856,125                  |       | 102,214                      |       | 1,856,125 |   | 102,214 |   |

 

13

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**5.****    ****Stock Based Compensation**

 

We apply the intrinsic value-based method of accounting prescribed byAccounting Principles Board (APB) Opinion No. 25, *Accounting for Stock Issued to Employees*, and relatedinterpretations, in accounting for our fixed award stock options to ouremployees. As such, compensation expense is recorded only if the current marketprice of the underlying common stock exceeded the exercise price of the optionon the date of grant. We apply the fair value-based of accounting as prescribedby Statements of Financial Accounting Standards (SFAS) Nos. 123 and 148, *Accounting for Stock-Based Compensation*in accounting forour fixed award stock options to our consultants. Under SFAS Nos. 123 and 148,compensation expense is recognized based on the fair value of stock optionsgranted.  Had compensation cost for stockoptions granted to employees been determined on the basis of fair value ascomputed using the assumptions herein, net loss and loss per share would havebeen increased to the following pro forma amounts (in thousands of dollars,except per share amounts):

 
| ** **                                                               | ** ** | **Thirteen weeks  ended:** | ** ** | **Twenty-six weeks  ended:** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------|------------|------------------------------|------------|
| ** **                                                               | ** ** | **June 29,  2004**         | ** ** | **July 1,  2003**            | ** ** | **June 29,  2004** | ** ** | **July 1,  2003** | ** ** |
| ** **                                                               | ** ** | **(restated)**             | ** ** | **(restated)**               | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
|                                                                     |       |                       |       |                         |       |   |   |   |   |
| Net loss available to  common stockholders, as reported                  |       | $                          | (6,224     | )                            | $          | (24,451 | ) | $ | (10,354 | ) | $ | (38,208 | ) |
| Deduct: stock based  compensation determined under the fair value method |       | (222                       | )          | (45                          | )          | (444 | ) | (90 | ) |
| Pro forma net loss  available to common stockholders                     |       | $                          | (6,446     | )                            | $          | (24,496 | ) | $ | (10,798 | ) | $ | (38,298 | ) |
|                                                                     |       |                       |       |                         |       |   |   |   |   |
| Basic and diluted loss  per common share:                                |       |                       |       |                         |       |   |   |   |   |
| As reported                                                              |       | $                          | (0.63      | )                            | $          | (15.22 | ) | $ | (1.05 | ) | $ | (24.42 | ) |
| Pro forma                                                                |       | $                          | (0.65      | )                            | $          | (15.25 | ) | $ | (1.10 | ) | $ | (24.47 | ) |

 

Compensation cost of options granted for the SFAS No. 123 proforma amounts disclosed above was estimated using the Black-Scholes option-pricingmodel with the following assumptions:

 
| ** **                                   | ** ** | **Thirteen weeks  ended:** | ** ** | **Twenty-six weeks  ended:** | ** ** |
|----------------------------------------------|------------|----------------------------|------------|------------------------------|------------|
| ** **                                   | ** ** | **June 29,  2004**         | ** ** | **July 1,  2003**            | ** ** | **June 29,  2004** | ** ** | **July 1,  2003** | ** ** |
| Expected life of options  from date of grant |       | 4.0 years                  |       | 4.0 years                    |       | 4.0 years |   | 4.0 years |   |
| Risk-free interest rate                      |       | 3.1                        | %          | 3.0                          | %          | 3.1 | % | 3.0 | % |
| Volatility                                   |       | 100.0                      | %          | 100.0                        | %          | 100.0 | % | 100.0 | % |
| Assumed dividend yield                       |       | 0.0                        | %          | 0.0                          | %          | 0.0 | % | 0.0 | % |

 

14

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**6.****    ****Litigation, Commitments and Contingencies**

 

*Guarantees*

* *

In the past, we would sometimes guarantee leases for the benefit ofcertain of our franchisees. The lease guarantees extend through *2008*. Under the guarantees, we may be required by the lessorto make all of the remaining monthly rental payments or property tax and commonarea maintenance payments if the franchisee does not make the required paymentsin a timely manner. However, we believe that most, if not all, of thefranchised locations could be subleased to third parties minimizing ourpotential exposure. Additionally, we have indemnification agreements with ourfranchisees under which the franchisees would be obligated to reimburse us forany amounts paid under such guarantees. As of June 29, 2004, our maximumexposure under these contingent liabilities was approximately $2.0 million. 

 

*Employment Related*

* *

On July 31, 2002, Tristan Goldstein, a former store manager, andValerie Bankhordar, a current store manager, filed a putative class actionagainst Einstein and Noah Corp. (“ENC”) in the Superior Court for the State ofCalifornia, County of San Francisco. The plaintiffs allege that ENC *failed* to pay overtime wages to managers and assistantmanagers of its California stores who were improperly designated as exemptemployees in violation of California wage and hour laws and Business ProfessionCode Section 17200. During April 2004, we reached an agreement inprinciple for the settlement of litigation with the plaintiffs, subject tocourt approval. Amounts representing our estimate to settle this litigationwere previously recorded during the quarter ended December 30, 2003.

 

On March 31, 2003, Jerold E. Novack, our former Chief Financial Officerand Secretary, filed a complaint in the United States District Court for theDistrict of New Jersey against us, Anthony D. Wedo, our former Chairman andChief Executive Officer, and William J. Nimmo, a former member of our board ofdirectors.  The complaint purports tostate claims for breach of plaintiff’s employment contract, breach of Messrs.Wedo and Nimmo’s fiduciary duties to plaintiff, defamation, and violation ofthe New Jersey Conscientious Employee Protection Act, and in addition seeks adeclaration that the termination of plaintiff “for cause” was invalid.  We have answered and filed counterclaimsagainst Mr. Novack and on January 20, 2004, the Court granted the Company’smotion to dismiss the breach of fiduciary duty claims. On July 9, 2004, boththe plaintiffs and defendants filed motions for summary judgment. Arguments onmotions are scheduled for September 7, 2004. At this time, it is not possibleto reasonably estimate the possible loss or range of loss, if any. 

 

On June 4, 2003, R. Ramin Kamfar, our former Chairman of the Board andChief Executive Officer, filed an action in the United States District Courtfor the Southern District of New York against us and Anthony D. Wedo, ourformer Chairman and Chief Executive Officer, alleging causes of action forbreach of contract, defamation, declaratory relief and punitive damages. Webelieve that the claims of Mr. Kamfar are without merit. We have answered andfiled counterclaims against Mr. Kamfar, including claims for breach offiduciary duty, fraud, and breach of contract. Motions for summary judgment were filed on July 15, 2004. At this time,it is not possible to reasonably estimate the possible loss or range of loss,if any.

 

15

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*Investigations*

* *

On April 3, 2002, the Securities and Exchange Commission notifiedus that the Commission was conducting an investigation into the resignation ofour former Chairman, R. Ramin Kamfar, and the termination for cause of ourformer Chief Financial Officer, Jerold Novack, and the delay in filing ourForm 10-K for 2001. We have cooperated fully with the investigation as wellas with a Department of Justice inquiry relating to *these*issues. Further, several of the former and present officers and directors haverequested that we advance reasonable legal expenses on their respectivebehalves to the extent any of them is or has been requested to provideinformation to the Commission in connection with its investigation. We arefulfilling our obligations as required by applicable law and our By-Laws. Atthis time, it is not possible to reasonably estimate the possible loss or rangeof loss, if any.

 

On August 7, 2003, supplemented on November 25, 2003 and January 9,2004, we received a subpoena for documents from the Office of the AttorneyGeneral of the State of New York requesting information primarily related towhether our subsidiary, Manhattan Bagel Company, Inc., qualified for a networth exemption from franchise registration in light of the restatement of theCompany’s financial results for 2000 and 2001, the facts and circumstancesleading to the resignation of the Company’s former Chief Executive Officer andthe termination of our former Chief Financial Officer and others, and issuesrelating to cost of bagel dough. We have responded to these requests and havenot received any further inquiries in this regard for the past six months.During July 2004, the Attorney General’s Office informed us that our UniformFranchise Offering Circular (UFOC) application for registration (the franchiseregistration) of Manhattan and Chesapeake has been processed and approved forregistration. 

 

*Financial Impact of Litigation*

* *

We are engaged in various other legal proceedings and have certainunresolved claims pending. The ultimate liability, if any, for the aggregateamounts claimed cannot be determined at this time. However, we believe basedupon consultation with legal counsel that there are no other matters pending orthreatened which are expected to have a material adverse effect, individuallyor in the aggregate, on our consolidated financial condition or results ofoperations. 

 

*InsurancePrograms*

* *

We are self-insured for a substantial portion of our current and prioryears’ coverage including workers’ compensation, employment practices liabilityand general liability (collectively, “insurance losses”). To mitigate thepotential cost of our exposures for certain of the insurance losses, we makeannual decisions to *self*-fund therisks of loss up to defined maximum per occurrence retentions on apolicy-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 have recorded reserves adequate to cover ourinsurance losses based upon information we have today. Due to the inherentvolatility of actuarially determined insurance loss estimates, it is reasonablypossible that we could experience changes in estimated losses, which could bematerial to our consolidated financial position or results of operations.

 

16

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**7.**     **Adjustment of Integration andReorganization Cost**

 

The adjustment of integration and reorganization cost primarilyrepresents an adjustment to previously recorded liabilities associated with theclosing and corporate consolidation of our Eatontown facilities during 2002.During April 2004, we reached an agreement with the landlord of our Eatontownfacility to settle outstanding litigation. Previously recorded integration andreorganization estimates associated with closing this facility were adjusteddown by $700,000 during the thirteen weeks ended March 30, 2004 as a result ofthis settlement. 

 

**8.****     Loss****on Disposal or Abandonment of Assets**

 

During the thirteen and twenty-six weeks ended June 29, 2004, werecorded a loss of $1.5 million, primarily due the disposal of menu boards as aresult of our new menu offerings and due to the abandonment of leaseholdimprovements related to closed restaurants and our administrative facilitieslocated in New Jersey.

 

**9.****    ****Potential Sale of Assets of Willoughby’s Coffee& Tea**

 

On June 22, 2004, weentered into a letter of intent to sell the assets of Willoughby’s to anindependent third party.  The Willoughby’sbusiness consists of a coffee roasting plant, two retail locations and anoffice space. Assets of the sale include, but are not limited to:

 

•      The “Willoughby’s Coffee & Tea” trade name, trademark andlogo,

•      The “Serious Coffee” trademark,

•      The willoughbyscoffee.com domain name and existing website,

•      All property and equipment of Willoughby’s, and

•      Cash in drawer, accounts receivable, and inventory at allWilloughby’s locations. 

 

Under the terms ofagreement, we will sell the assets for a total sales price of $426,000 to bereceived in cash, subject to post-closing adjustments for changes from May 25,2004 to closing in inventory, accounts receivable and cash in drawer.Additionally, we may be entitled to post-closing payments of up to $100,000contingent upon the landlord’s option to terminate the lease at one of ourretail locations. In connection with the sale of Willoughby’s, we intend toexecute a two-year supply agreement to purchase coffee from the buyer for ourNew World stores. The sale is expected to close by the end of August 2004. 

 

We have consideredStatement of Financial Accounting Standard No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets.*We havedetermined that the revenues, cost of sales, other operating expenses and thenet book value of the assets related to the sale of the coffee roasting plantand two retail locations included in the Willoughby’s business are immaterialin relation to our Einstein Bros., Noah and Manhattan restaurants, as well asthe financial statements taken as a whole. Accordingly, we have not presenteddiscontinued operations in the accompanying consolidated statements ofoperations for the thirteen and twenty-six weeks ended June 29, 2004 and July1, 2003, respectively, nor have we reflected assets as held for sale in theaccompanying consolidated balance sheets as of June 29, 2004.  We have determined that net book value of theassets is less than the sales price and accordingly, no impairment exists atJune 29, 2004. 

 

**10.**** ****Recent Accounting Pronouncements**

 

We have evaluated all recent accounting pronouncements and believe suchpronouncements do not have a material effect on our financial statements.

 

17

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**ITEM 2.  MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF 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 late2004 and early 2005, several restaurant companies and other multi-locationretailers reviewed their treatment of lease accounting and leaseholdamortization. During this time, many companies including but not limited toBrinker International, CKE Restaurants, Darden Restaurants, Jack in the Box,Starbucks and Wild Oats restated their historic financial statements. In lateJanuary 2005, we commenced a review of our accounting policies and practiceswith respect to leasehold amortization and deferred rent. On February 7, 2005,the Office of the Chief Accountant of the Securities and Exchange Commissionexpressed its views regarding lease accounting issues and their applicationunder Generally Accepted Accounting Principles (GAAP). Based upon the resultsof our internal review and after discussions with our independent auditors,Grant Thornton LLP, we determined on March 1, 2005 that it was appropriate toadjust certain prior financial statements for leasehold amortization. Theresulting adjustments were all non-cash and had no impact on our cash flows,cash position, revenues, same store sales, loss from operations plusdepreciation and amortization, or our compliance with the covenants under our$160 Million Notes or AmSouth Revolver. The adjustments were not attributableto any intentional non-compliance with any financial reporting requirementsunder securities laws, and we believe there will not be any further adjustmentsas a result of our internal review of this 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 accountingtreatments were comparable to the practices of other public companies. However,after noting 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.

 

18

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As a result of the adjustments to leasehold amortization, our financialresults have been restated as follows (dollars in thousands, except per sharedata):

 
| ** **                       | ** ** | **As of June 29, 2004** | ** ** | **As of December 30, 2003** | ** ** |
|----------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **As reported**         | ** ** | **Adjustments**             | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Balance Sheet:                   |       |                    |       |                        |       |   |   |   |   |   |   |   |   |
| Property and equipment, net      |       | $                       | 63,234     |                        | $          | (16,335 | ) | $ | 46,899 |   | $ | 67,800 |   | $ | (13,287 | ) | $ | 54,513 |   |
| Total assets                     |       | 185,408                 |       | (16,335                     | )          | 169,073 |   | 195,025 |   | (13,287 | ) | 181,738 |   |
| Accumulated deficit              |       | (264,767                | )          | (16,335                     | )          | (281,102 | ) | (257,461 | ) | (13,287 | ) | (270,748 | ) |
| Total stockholders’ deficit |       | (89,137                 | )          | (16,335                     | )          | (105,472 | ) | (81,866 | ) | (13,287 | ) | (95,153 | ) |
|                                  |            |                         |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                   | ** ** | **Thirteen weeks ended June 29, 2004** | ** ** | **Twenty-six weeks ended June 29, 2004** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------------|------------|------------------------------------------|------------|
| ** **                                                   | ** ** | **As reported**                        | ** ** | **Adjustments**                          | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Statement of Operations:                                     |       |                                   |       |                                     |       |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                |       | $                                      | 5,344      |                                     | $          | 1,714 |   | $ | 7,058 |   | $ | 10,582 |   | $ | 3,295 |   | $ | 13,877 |   |
| Income from operations                                       |       | 3,014                                  |       | (1,714                                   | )          | 1,300 |   | 6,249 |   | (3,295 | ) | 2,954 |   |
| Loss (gain) on sale, disposal or abandonment  of assets, net |       | 1,712                                  |       | (240                                     | )          | 1,472 |   | 1,713 |   | (247 | ) | 1,466 |   |
| Loss before income taxes                                     |       | (4,566                                 | )          | (1,474                                   | )          | (6,040 | ) | (7,067 | ) | (3,048 | ) | (10,115 | ) |
| Net loss                                                     |       | (4,750                                 | )          | (1,474                                   | )          | (6,224 | ) | (7,306 | ) | (3,048 | ) | (10,354 | ) |
| Net loss available to common stockholders                    |       | (4,750                                 | )          | (1,474                                   | )          | (6,224 | ) | (7,306 | ) | (3,048 | ) | (10,354 | ) |
| Net loss per common share                                    |       | $                                      | (0.48      | )                                        | $          | (0.15 | ) | $ | (0.63 | ) | $ | (0.74 | ) | $ | (0.31 | ) | $ | (1.05 | ) |
|                                                              |            |                                        |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                | ** ** | **Thirteen weeks ended July 1, 2003** | ** ** | **Twenty-six weeks ended July 1, 2003** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------|------------|
| ** **                                | ** ** | **As reported**                       | ** ** | **Adjustments**                         | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Statement of Operations:                  |       |                                  |       |                                    |       |   |   |   |   |   |   |   |   |
| Depreciation and amortization             |       | $                                     | 7,092      |                                    | $          | 1,515 |   | $ | 8,607 |   | $ | 14,297 |   | $ | 2,927 |   | $ | 17,224 |   |
| Loss from operations                      |       | (2,414                                | )          | (1,515                                  | )          | (3,929 | ) | (2,657 | ) | (2,927 | ) | (5,584 | ) |
| Loss before income taxes                  |       | (12,795                               | )          | (1,515                                  | )          | (14,310 | ) | (20,427 | ) | (2,927 | ) | (23,354 | ) |
| Net loss                                  |       | (13,115                               | )          | (1,515                                  | )          | (14,630 | ) | (20,857 | ) | (2,927 | ) | (23,784 | ) |
| Net loss available to common stockholders |       | (22,936                               | )          | (1,515                                  | )          | (24,451 | ) | (35,281 | ) | (2,927 | ) | (38,208 | ) |
| Net loss per common share                 |       | $                                     | (14.28     | )                                       | $          | (0.94 | ) | $ | (15.22 | ) | $ | (22.55 | ) | $ | (1.87 | ) | $ | (24.42 | ) |

 

**BusinessOverview**

 

We are a leader in the quick casual segment of the restaurant industry.With 720 locations in 33 states and in the District of Columbia as of June 29,2004, 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.

 

Our financial focus is on long term, sustainable growth in free cashflow. Free cash flow represents net cash provided by operations less purchasesof fixed assets. In achieving free cash flow, we are more capable of payingdown debt, saving cash for future use and building shareholder equity. We alsobelieve free cash flow will allow us the opportunity to pursue newopportunities, acquire other businesses, or pay dividends. Increasing ouroperating profit and efficiently managing working capital and capitalexpenditures primarily drive free cash flow.

 

19

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The restaurant industry, in which we compete, is intensely competitivewith respect to food quality, price, service, convenience, location andconcept. The industry is often affected by changes in consumer tastes, economicconditions, demographic trends, traffic patterns, the type, number and locationof competing food retailers and products and disposable purchasing power.

 

In measuring our overall growth and progress, we focus on various keyperformance indicators. Such key performance indicators include: same-storesales growth, number of restaurant openings and closings, number of franchiseand licensed locations opened, restaurant level and concept level margins, cashgenerated from operations and free cash flow. Our progress against some ofthese key performance indicators is discussed throughout the Management’sDiscussion and Analysis.

 

**Significant Known Events, Trends orUncertainties Expected to Impact 2004 Results**

 

The following factors impact comparability of operating performance orcould impact comparisons for the remainder of 2004.

 

*Economic Trends*

 

We anticipate that our business will be affected by general economictrends that affect retailers in general. While we have not operated during aperiod of high inflation, we believe based on industry experience that we wouldgenerally be able to pass on increased costs resulting from inflation to ourconsumers. Our business may be affected by other factors, including increasesin the commodity prices of flour, butter and/or green coffee, existing andadditional competition, marketing programs, weather and variations in thenumber of company-owned or licensed location openings.

 

Although few, if any, employees are paid at the minimum wage, anincrease in the minimum wage may create pressure to increase the pay scale forour employees, which would increase our labor costs and those of ourfranchisees and licensees.

 

*Revenue Trends*

* *

**Due to the increasing competitive pressure of the restaurant industry,we currently are experiencing and believe we will continue to experience lowerretail sales until such time as we can make the planned modifications to ourcustomer service system, menu offerings and the “look and feel” of our company-operatedrestaurants. We believe that our plans to revitalize our restaurant concepts inlate 2004 and beyond may address issues in each of these areas that havenegatively affected sales. Additionally, recent dietary trends and negativepublicity on products high in carbohydrate content may have had and maycontinue to have an adverse impact on our sales. We believe that we areaddressing these trends with modifications to our menus. In addition, theplanned modifications of our menu offerings include pricing increases, as wellas limited time offerings of seasonal menu items. We anticipate that theseplanned price changes will have the effect of increasing our average check infuture periods.**

 

*Expense Trends*

* *

Currently, the restaurant industry is experiencing increases in thecost of dairy and other raw ingredients, as well as increases in energy costs.During the current fiscal quarter, we saw the impact of such increases in ourfood costs, utility bills and transportation charges and we believe this trendwill continue through the remainder of the year. These increases directlyimpact the profitability of company-owned locations, manufacturing operationsand distribution channels. While we have purchase commitments for our dairy andother raw ingredients that mitigate immediate increases in food costs, ourpurchase commitments are not long-term in nature. Accordingly, in the nearfuture we may experience degradation in our profit margins until such time aswe are able to pass on increased costs to our consumers.

 

20

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*Revitalization of our Restaurant Concepts*

* *

We intend to begin revitalization of our Einstein Bros.company-operated restaurants in late 2004. The planned modifications includechanges to our customer service system, menu offerings and the “look and feel”of our company-operated restaurants. We have two prototypes scheduled to openduring the fourth quarter of this year. We will operate the two prototypes forapproximately 90 days before commencing a staggered rollout on amarket-by-market basis. By the end of the current fiscal year, we anticipatethe completion of our first market. It is our intention to thoroughly study thefinancial and operating performance of the two prototypes in order to determinemodifications necessary, if any, to our menu offerings and/or the physicallayout of our restaurants for future prototypes.

 

*Store Portfolio Strategy*

* *

From time to time, we close restaurants that are performing poorly, werelocate restaurants to a new site within the same trade area or we consolidatetwo or more of our existing units into a single unit. Generally, the closurescoincide with the expiration of an existing lease and result in little or noimpairment charges.

 

During the second quarter ended 2004, we completed our evaluation ofthe Willoughby’s brand, determined that it did not fit within our overallstrategic plan and we have identified a buyer to purchase the business. The Willoughby’s business consistsof a coffee roasting plant, two retail locations and office space.  Under the terms of agreement, we will sellthe assets for a total purchase price of $426,000 to be received in cash,subject to post-closing adjustments for changes from May 25, 2004 to closing ininventory, accounts receivable and cash in drawer. Additionally, we may be entitledto post-closing payments of up to $100,000 contingent upon the landlord’soption to terminate the lease at one of our retail locations.

 

In connection with thesale of Willoughby’s, we intend to execute a two-year supply agreement topurchase coffee from the buyer for our New World Coffee outlets. The sale isexpected to close by the end of August 2004.

 

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 two retaillocations included in the Willoughby’s business are 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 twenty-six weeks ended June 29, 2004 and July 1, 2003,respectively, nor have we reflected assets as held for sale in the accompanyingconsolidated balance sheets as of June 29, 2004.

 

21

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The following table details the total restaurants open at the end ofthe respective second quarter:

 
| ** **                              | ** ** | **Company  owned** | ** ** | **Licensed** | ** ** | **Franchised** | ** ** | **Total**  | ** ** |
|-----------------------------------------|------------|--------------------|------------|--------------|------------|----------------|------------|------------|------------|
| **Einstein Bros.:**                     | ** ** | ** **         | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** |
| 2004                                    |       | 371                |       | 46           |       | —         |       | 417        |       |
| 2003                                    |       | 371                |       | 25           |       | —         |       | 396        |       |
| **Noah’s:**                        |       |               |       |         |       |           |       |       |       |
| 2004                                    |       | 80                 |       | 3            |       | —         |       | 83         |       |
| 2003                                    |       | 83                 |       | 3            |       | —         |       | 86         |       |
| **Manhattan:**                          |       |               |       |         |       |           |       |       |       |
| 2004                                    |       | —             |       | —       |       | 165            |       | 165        |       |
| 2003                                    |       | —             |       | —       |       | 192            |       | 192        |       |
| **Chesapeake:**                         |       |               |       |         |       |           |       |       |       |
| 2004                                    |       | —             |       | —       |       | 37             |       | 37         |       |
| 2003                                    |       | —             |       | —       |       | 46             |       | 46         |       |
| **New World Coffee/Willoughby’s:** |       |               |       |         |       |           |       |       |       |
| 2004                                    |       | 8                  |       | —       |       | 10             |       | 18         |       |
| 2003                                    |       | 8                  |       | —       |       | 11             |       | 19         |       |
| **Total Restaurants:**                  |       |               |       |         |       |           |       |       |       |
| 2004                                    |       | 459                |       | 49           |       | 212            |       | 720        |       |
| 2003                                    |       | 462                |       | 28           |       | 249            |       | 739        |       |

 

We believe we have a strong platform for growth through store licensingof our Einstein and Noah’s brands. During the latter half of 2003, we beganexpansion of our licensed stores and we intend to continue our expansion byopening approximately 30 licensed store locations by the end 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.

 

Our Manhattan and Chesapeake brands primarily represent our franchisebase. Our franchised locations generate a recurring revenue stream throughroyalty payments on sales from each franchised location. Our franchisee baseprovides us with the ability to grow our brands with minimal commitment ofcapital by us, and creates a built-in customer base for our manufacturingoperations. Duringthe thirteen weeks ended June 29, 2004, we began an evaluation of the rationalefor each of our brands with a view toward determining whether the brand shouldbe a part of our overall strategic business plan.

 

22

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**Results ofOperations**

 

The following table sets forth, for the periods indicated, certainamounts included in our Consolidated Statements of Operations, the relativepercentage that those amounts represent to total revenue (unless otherwiseindicated), and the percentage change in those amounts from period to period.All percentages are calculated using actual amounts rounded to the nearestthousand.

 
| ** **                                                       | ** ** | **For the  thirteen weeks ended** | ** ** | **Increase    (Decrease)** | ** ** | **For the  twenty-six weeks ended** | ** ** | **Increase    (Decrease)** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------|------------|----------------------------|------------|-------------------------------------|------------|----------------------------|------------|
| ** **                                                       | ** ** | **(in  thousands)**               | ** ** | **(percent  of revenue)**  | ** ** | ** **                          | ** ** | **(in  thousands)**        | ** ** | **(percent  of revenue)** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **June  29,  2004**               | ** ** | **July 1,  2003**          | ** ** | **June  29,  2004**                 | ** ** | **July 1,  2003**          | ** ** | **2004  vs. 2003** | ** ** | **June  29,  2004** | ** ** | **July 1,  2003** | ** ** | **June  29,  2004** | ** ** | **July 1,  2003** | ** ** | **2004  vs. 2003** | ** ** |
| ** **                                                       | ** ** | **(restated)**                    | ** ** | **(restated)**             | ** ** | **(restated)**                      | ** ** | **(restated)**             | ** ** | ** ** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | ** ** | ** ** |
| **Revenues:**                                                    | ** ** | ** **                        | ** ** | ** **                 | ** ** | ** **                          | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Retail  sales**                                                |       | 87,596                            |       | 90,878                     |       | 93.0                                | %          | 93.0                       | %          | -3.6 | % | 172,219 |   | 179,328 |   | 92.9 | % | 92.9 | % | -4.0 | % |
| **Manufacturing  revenues**                                      |       | 4,944                             |       | 5,754                      |       | 5.3                                 | %          | 5.9                        | %          | -14.1 | % | 10,357 |   | 11,178 |   | 5.6 | % | 5.8 | % | -7.3 | % |
| **Franchise  and license related revenues**                      |       | 1,624                             |       | 1,117                      |       | 1.7                                 | %          | 1.1                        | %          | 45.4 | % | 2,784 |   | 2,454 |   | 1.5 | % | 1.3 | % | 13.4 | % |
|                                                             |       |                              |       |                       |       |                                |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total  revenues**                                              |       | 94,164                            |       | 97,749                     |       | 100.0                               | %          | 100.0                      | %          | -3.7 | % | 185,360 |   | 192,960 |   | 100.0 | % | 100.0 | % | -3.9 | % |
|                                                             |       |                              |       |                       |       |                                |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Cost of  sales:**                                              |       |                              |       |                       |       |                                |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Retail  costs**                                                |       | 73,403                            |       | 77,385                     |       | 78.0                                | %          | 79.2                       | %          | -5.1 | % | 143,490 |   | 150,339 |   | 77.4 | % | 77.9 | % | -4.6 | % |
| **Manufacturing  costs**                                         |       | 4,442                             |       | 5,082                      |       | 4.7                                 | %          | 5.2                        | %          | -12.6 | % | 9,020 |   | 10,123 |   | 4.9 | % | 5.2 | % | -10.9 | % |
|                                                             |       |                              |       |                       |       |                                |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total  cost of sales**                                         |       | 77,845                            |       | 82,467                     |       | 82.7                                | %          | 84.4                       | %          | -5.6 | % | 152,510 |   | 160,462 |   | 82.3 | % | 83.2 | % | -5.0 | % |
|                                                             |       |                              |       |                       |       |                                |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Gross  profit:**                                               |       |                              |       |                       |       |                                |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Retail**                                                       |       | 14,193                            |       | 13,493                     |       | 15.1                                | %          | 13.8                       | %          | 5.2 | % | 28,729 |   | 28,989 |   | 15.5 | % | 15.0 | % | -0.9 | % |
| **Manufacturing**                                                |       | 502                               |       | 672                        |       | 0.5                                 | %          | 0.7                        | %          | -25.3 | % | 1,337 |   | 1,055 |   | 0.7 | % | 0.5 | % | 26.7 | % |
| **Franchise  and license**                                       |       | 1,624                             |       | 1,117                      |       | 1.7                                 | %          | 1.1                        | %          | 45.4 | % | 2,784 |   | 2,454 |   | 1.5 | % | 1.3 | % | 13.4 | % |
| **Total  gross profit**                                          |       | 16,319                            |       | 15,282                     |       | 17.3                                | %          | 15.6                       | %          | 6.8 | % | 32,850 |   | 32,498 |   | 17.7 | % | 16.8 | % | 1.1 | % |
|                                                             |       |                              |       |                       |       |                                |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **General  and administrative expenses**                         |       | 8,000                             |       | 10,604                     |       | 8.5                                 | %          | 10.8                       | %          | -24.6 | % | 16,818 |   | 20,858 |   | 9.1 | % | 10.8 | % | -19.4 | % |
| **Depreciation  and amortization**                               |       | 7,058                             |       | 8,607                      |       | 7.5                                 | %          | 8.8                        | %          | -18.0 | % | 13,877 |   | 17,224 |   | 7.5 | % | 8.9 | % | -19.4 | % |
| **Adjustment  of integration and reorganization cost**           |       | (39                               | )          | —                     |       | 0.0                                 | %          | 0.0                        | %          |   | *  | (799 | ) | — |   | -0.4 | % | 0.0 | % |   | * |
|                                                             |       |                              |       |                       |       |                                |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Income  (loss) from operations**                               |       | 1,300                             |       | (3,929                     | )          | 1.4                                 | %          | -4.0                       | %          |   | *  | 2,954 |   | (5,584 | ) | 1.6 | % | -2.9 | % |   | * |
|                                                             |       |                              |       |                       |       |                                |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Other  expense (income):**                                     |       |                              |       |                       |       |                                |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest  expense, net**                                       |       | 5,904                             |       | 9,975                      |       | 6.3                                 | %          | 10.2                       | %          | -40.8 | % | 11,703 |   | 18,271 |   | 6.3 | % | 9.5 | % | -35.9 | % |
| **Cumulative  change in the fair value of derivatives**          |       | —                            |       | 727                        |       | 0.0                                 | %          | 0.7                        | %          |   | *  | — |   | 70 |   | 0.0 | % | 0.0 | % | * |   |
| **Loss  (gain) on sale, disposal or abandonment of assets, net** |       | 1,472                             |       | (202                       | )          | 1.6                                 | %          | -0.2                       | %          |   | *  | 1,466 |   | (385 | ) | 0.8 | % | -0.2 | % | * |   |
| **Other  income**                                                |       | (36                               | )          | (119                       | )          | 0.0                                 | %          | -0.1                       | %          | -69.7 | % | (100 | ) | (186 | ) | -0.1 | % | -0.1 | % | -46.2 | % |
| **Loss  before income taxes**                                    |       | (6,040                            | )          | (14,310                    | )          | -6.4                                | %          | -14.6                      | %          | -57.8 | % | (10,115 | ) | (23,354 | ) | -5.5 | % | -12.1 | % | -56.7 | % |

 

----

*** not meaningful**

 

We operate 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.

 

23

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***Revenues***

 

**Total revenues for the thirteen and twenty-six weeks ended June 29,2004 were consistent with our expectations. Our total revenues decreased 3.7%and 3.9% for the thirteen and twenty-six weeks ended June 29, 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 of3.7% and 4.3% for the thirteen and twenty-six weeks ended June 29, 2004,respectively, consisted of a 7.3% and 6.3% reduction in transactions partiallyoffset by a 3.9% and 2.2% increase in average check primarily related to bothan increase in menu pricing and a shift in product mix to higher priced items.We consider comparable store sales to represent sales at stores that were openfor one full year and have not been relocated or closed during the currentyear. Comparable store sales are also referred to as “same-store” sales and as “compsales” within the restaurant industry.**

 

***Gross Profit***

 

Our total gross profit improved 6.8% and 1.1% for the thirteen andtwenty-six weeks ended June 29, 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 5.2% for the thirteenweeks ended June 29, 2004 when compared to the same period in fiscal 2003. Allstore-level operating expenses other than depreciation, amortization and taxesimpact our retail margins. The improvement we have experienced is primarilyattributable 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. We will continue to implementsolutions that improve our margins but expect this trend to level out duringthe next two quarters, as many of our store-level cost reduction initiativeswill have been in place for approximately one year.  Additionally during the thirteen weeks endedJune 29, 2004, we experienced reductions in our group insurance claims ratingsand we also incurred lower costs for regularly scheduled store maintenance.

 

***Other Expenses***

 

**Our general and administrative expenses decreased 24.6% and 19.4% forthe thirteen and twenty-six weeks ended June 29, 2004, respectively, whencompared to the same periods in fiscal 2003. The decline in general andadministrative expenses is primarily due to reduced spending fornon-capitalizable legal and consulting expenses associated with our debtrefinancing and equity recapitalization, and the re-audit of our 2000 and 2001financial results that occurred during 2003.**

 

Our depreciation and amortization expenses decreased 18.0% and 19.4%for the thirteen and twenty-six weeks ended June 29, 2004, respectively, whencompared to the same periods in fiscal 2003. The decreases in depreciation andamortization expense are primarily due to a portion of our asset base becomingfully 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.”

 

The adjustment of integration and reorganization cost primarily representsan adjustment to previously recorded liabilities associated with the closingand corporate consolidation of our Eatontown facilities during 2002. DuringApril 2004, we reached an agreement with the landlord of our Eatontown facilityto settle outstanding litigation.

 

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Previously recorded integration and reorganization estimates associatedwith closing this facility were adjusted down by $700,000 during the thirteenweeks ended March 30, 2004 as a result of this settlement.

 

Interestexpense decreased 40.8% and 35.9% for the thirteen and twenty-six weeks endedJune 29, 2004, respectively, when compared to the same periods in fiscal 2003.The primary 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.

 

Duringthe thirteen and twenty-six weeks ended June 29, 2004, we recorded a loss of$1.5 million, primarily due the disposal of menu boards as a result of our newmenu offerings and due to the abandonment of leasehold improvements related toclosed restaurants and our administrative facilities located in New Jersey.

 

**Liquidity and Capital Resources**

 

We have historically relied upon our major preferred and commonstockholders to provide us with supplemental financing at times when our cashflows from operations have been insufficient to cover our capital requirementsor the requirements of other debt. The restaurant industry is predominantly acash business 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.

 

The primary driver of our operating cash flow is our restaurantoperations, specifically the gross margin from our company-operatedrestaurants. Therefore, we focus on the elements of those operations includingcomparable store sales to ensure a steady stream of operating profits that enableus to meet our cash obligations. On a weekly basis, we review our company-operatedstore performance compared with the same period in the prior year and ouroperating plan. 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:

 

•      Menuoptimization to remove and/or modify inefficient products and thus reducewaste;

 

•      Upgrade/deploymentof technology to enable more accurate sales identification and tracking ofdaily volumes and cost of products sold thereby identifying opportunities toimprove store margins and reduce waste;

 

•      Reduction ofthe various elements of cost that were historically non-recurring in nature.

 

During fiscal year 2004, we anticipate the majority of our capitalexpenditures will be focused on the following: (1) requirements of our existing company-operated stores, primarily equipmentreplacement and new computer hardware, (2) upgrades and remodeling costsassociated with the revitalization of our concept, (3) a modest amount of newcompany-operated store development related to approximately four to six newstore openings, (4) a modest amount of capital spent on our manufacturingoperations and (5) additional capital for our support center in Golden,Colorado, primarily related to spending on information technology upgrades andmaintenance.

 

Based upon our projections for fiscal 2004 and beyond, we believe thatthe cash flow from operations coupled with the continued availability of ourAmSouth Revolver will be adequate to fund our operations, capital expendituresand required debt and interest repayments for the foreseeable future.

 

Our AmSouth Revolver is a $15 million senior secured revolving credit facility, whichmatures on July 8, 2006. At June 29, 2004, our unused credit facility totaled$10.0 million, net of outstanding letters of credit of $5.0 million.

 

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Our credit facilitycontains financial covenants relating to the maintenance of leverage andcoverage ratios. The credit facility also contains affirmative and negativecovenants including, among other things, limitations on certain additionalindebtedness, capital expenditures and minimum EBITDA as defined in theagreement. We were in compliance with all covenants at June 29, 2004 and do notanticipate that the covenants will impact our ability to borrow under ourcredit facility for its remaining term.

 

If at some point in the future we require additional financing, noassurance can be given that any additional financing would be available onacceptable terms, or at all.  If we are unable to obtain additionalfinancing, we may be required to further reduce costs associated with ourcurrent infrastructure, decrease spending on marketing and advertisingcampaigns, curtail research and development programs and/or halt all otherdiscretionary spending programs, any of which could further reduce sales andadversely affect liquidity and operations.

 

At June 29, 2004, we had unrestricted cash of $10.3 million andshort-term restricted cash of $1.2 million. We reduced our working capitaldeficit to $21.7 million at June 29, 2004 compared with a working capitaldeficit of $23.6 million at December 30, 2003. Additionally, weexperienced an improvement of $7.0 million in our cash operating performance(defined as net loss as adjusted for non-cash charges). We believe this improvementis a direct result of our ability to better manage fixed and variable elementsof our cost of sales and an overall reduction in spending dollars for generaland administrative purposes. We also generated $1.7 million in free cash flowduring the twenty-six weeks ended June 29, 2004.

 

Cash operating performance and free cash flow are not intended torepresent cash flow from operations in accordance with accounting principlesgenerally accepted in the United States (GAAP) and should not be used as anindicator of operating performance or to cash flow as a measure of liquidity.Rather, our cash operating performance and free cash flow are a basis uponwhich we measure our financial performance, as well as our ability to pay downdebt, save cash for future use and build shareholder equity. We also believethat the presentation of these calculations provides meaningful non-GAAPfinancial measures to help investors understand and compare business trendsamong different reporting periods on a consistent basis. Cash operatingperformance and free cash flow are not necessarily comparable to othersimilarly titled measures of other companies due to the potentialinconsistencies in the method of calculation.

 

**Reconciliation of Net Loss to Cash OperatingPerformance:**

 
| ** **                                                | ** ** | **Twenty-six weeks ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                | ** ** | **June 29, 2004**          | ** ** | **July 1, 2003** | ** ** |
| ** **                                                | ** ** | **(restated)**             | ** ** | **(restated)** | ** ** |
| ** **                                                | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Net loss                                                  |       | $                          | (10,354    | ) | $ | (23,784 | ) |
| Adjustments for non-cash charges:                         |       |                       |       |   |   |
| Depreciation and amortization                             |       | 13,877                     |       | 17,224 |   |
| Stock-based compensation expense                          |       | 35                         |       | — |   |
| Loss on disposal of assets                                |       | 1,466                      |       | (385 | ) |
| Adjustments of integration and  reorganization costs      |       | (799                       | )          | — |   |
| Cumulative change in fair value of  derivatives           |       | —                     |       | 70 |   |
| Amortization of debt issuance and debt  discount costs    |       | 908                        |       | 2,212 |   |
| Notes issued as paid in kind for interest  on Bridge Loan |       | —                     |       | 510 |   |
| Issuance of standstill warrants                           |       | —                     |       | 1,238 |   |
| Greenlight non-cash interest                              |       | —                     |       | 1,025 |   |
| Cash Operating Performance                                |       | $                          | 5,133      |   | $ | (1,890 | ) |

 

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**Reconciliationof Net Cash Provided by Operating Activities to Free Cash Flow:**

 
| ** **                                | ** ** | **Twenty-six weeks ended** | ** ** |
|-------------------------------------------|------------|----------------------------|------------|
| ** **                                | ** ** | **June 29, 2004**          | ** ** | **July 1, 2003** | ** ** |
| Net cash provided by operating activities |       | $                          | 5,435      |   | $ | 1,219 |   |
| Less: purchases of fixed assets           |       | (3,687                     | )          | (3,494 | ) |
| Free Cash Flow                            |       | $                          | 1,748      |   | $ | (2,275 | ) |

 

During the twenty-six weeks ended June 29, 2004, operations generated$5.4 million of cash compared to $1.2 million during the twenty-sixweeks ended July 1, 2003. We believe we will continue to see improvements inour company operated store cash operating performance during the next quarter.Due to the timing of the cash interest payment under our $160 MillionIndenture, which is due January 1 and July 1, we anticipate consuming cash fromoperations during the first and third fiscal quarters of each year. During thesecond and fourth fiscal quarters of each year, we anticipate generating cashfrom operations. Historically, our fourth quarter is our strongest quarter forgenerating cash due to seasonality and gift card promotions. We believe thecash generated during the twenty-six weeks ended June 29, 2004 and December 28,2004, along with the availability under our AmSouth Revolver will be adequateto satisfy our cash obligations.

 

During the twenty-six weeks ended June 29, 2004, we used$3.7 million of cash to purchase additional property and equipment whichincluded $1.0 million for new stores, $1.9 million for replacement and newequipment at our existing company-operated stores, $0.3 million for ourmanufacturing operations and $0.5 million for general corporate purposes.

 

Duringthe twenty-six weeks ended June 29, 2004, we used $1.0 million of cash toreduce our debt outstanding on the AmSouth Revolver.

 

***Contractual Obligations***

 

There were no material changes to our contractual obligations duringthe twenty-six weeks ended June 29, 2004. For information regarding ourcontractual obligations at December 30, 2003, see our Annual Report on Form10-K for the fiscal year ended December 30, 2003.

 

***Guarantees***

 

In the past, we would sometimes guarantee leases for the benefit ofcertain of our franchisees. The lease guarantees extend through 2008. Under theguarantees, we may be required by the lessor to make all of the remainingmonthly rental payments or property tax and common area maintenance payments ifthe franchisee does not make the required payments in a timely manner. However,we believe that most, if not all, of the franchised locations could besubleased to third parties minimizing our potential exposure. Additionally, wehave indemnification agreements with our franchisees under which thefranchisees would be obligated to reimburse us for any amounts paid under suchguarantees. As of June 29, 2004, our maximum exposure under this contingentliability was approximately $2.0 million.

 

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

 

We are self-insured for a substantial portion of our current and prioryears’ coverage including workers’ compensation, employment practices liabilityand general liability (collectively, “insurance losses”). To mitigate thepotential cost of our exposures for certain of the insurance losses, we makeannual decisions to self-fund the risks of loss up to defined maximum peroccurrence retentions on a policy-by-policy basis. We then purchase insurancecoverage, up to a certain limit, for losses that exceed the self-insurance peroccurrence or aggregate retention. The insurers’ maximum aggregate loss limitsare significantly above our actuarially determined probable losses; therefore,we believe the likelihood of losses exceeding the insurers’ maximum aggregatedloss limits is remote.

 

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 healthcareclaims, including reported and incurred but not reported claims, based oninformation provided by actuaries.

 

We believe that we have recorded reserves adequate to cover ourinsurance losses based upon information we have today. Due to the inherentvolatility of actuarially determined insurance loss estimates, it is reasonablypossible that we could experience changes in estimated losses, which could bematerial to our consolidated financial position or results of operations.

 

### ***Risk Factors***

### * *

You should consider each of the following factors as well as otherinformation in the Quarterly Report in evaluating our business and prospects.The risks and uncertainties described below are not the only ones we face.Additional risks and uncertainties not presently known to us or that wecurrently consider immaterial may also impair our business operations. If anyof these risks actually occur, our business and financial results could beharmed and the trading price of our common stock could decline. You should alsorefer to the other information set forth in the Quarterly Report and in ourAnnual Report on Form 10-K for the fiscal year ended December 30, 2003,including our consolidated financial statements and the related notes.

 

*We may not be successful in implementing any or all of the initiativesof our business strategy.*

* *

Our success depends on part on our ability to understand our customers’needs. We believe successful deployment of our current business strategy willaddress customers’ needs and contribute to overall company growth. If weimproperly perceive customers’ needs and/or are not successful in implementingany or all of the initiatives of our business strategy, it could have amaterial adverse effect on our business, results of operations, and financialcondition.

 

*We have and expect to continue to have asubstantial amount of debt.*

* *

We have a high level of debt and are highly leveraged. In addition, wemay, subject to certain restrictions, incur substantial additional indebtednessin the future. Our high level of debt, among other factors, could:

 

•      make itdifficult for us to satisfy our obligations under our indebtedness;

 

•      limit ourability to obtain additional financing for working capital, capitalexpenditures, acquisitions and general corporate purposes;

 

•      increase ourvulnerability to downturns in our business or the economy generally;

 

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•      limit ourability to withstand competitive pressures from our less leveraged competitors;and

 

•      harm us becausea failure by us to comply with the covenants in the instruments and agreementsgoverning our indebtedness could result in an event of default that, if notcured or waived, could result in all of our indebtedness becoming immediatelydue and payable, which could render us insolvent.

 

*We may not be able to generate sufficientcash flow to make payments on our indebtedness.*

 

Economic, financial, competitive, legislative and other factors beyondour control may affect our ability to generate cash flow from operations tomake payments on our indebtedness and to fund necessary working capital. Asignificant reduction in operating cash flow would likely increase the need foralternative sources of liquidity. If we are unable to generate sufficient cashflow to make payments on our debt, we will have to pursue one or morealternatives, such as reducing or delaying capital expenditures, refinancingour debt, selling assets or raising equity. We may not be able to accomplishany of these alternatives on satisfactory terms, if at all, and even ifaccomplished, they may not yield sufficient funds to service our debt.

 

*We are vulnerable to changes in consumerpreferences and economic conditions that could harm our financial results.*

* *

Food service businesses are often affected by changes in consumertastes, dietary trends, national, regional and local economic conditions anddemographic trends. Factors such as traffic patterns, local demographics andthe 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.

 

*There is intense competition in therestaurant industry.*

* *

Our industry is intensely competitive and there are manywell-established competitors with substantially greater financial and otherresources than we have. In addition to current competitors, one or more newmajor competitors with substantially greater financial, marketing and operatingresources could enter the market at any time and compete directly against us.In addition, in virtually every major metropolitan area in which we operate orexpect to enter, local or regional competitors already exist.

 

*We are vulnerable to fluctuations in thecost, availability and quality of our raw ingredients.*

* *

The cost, availability and quality of the ingredients we use to prepareour food are subject to a range of factors, many of which are beyond ourcontrol. Fluctuations in economic and political conditions, weather and demandcould adversely affect the cost of our ingredients. We have limited controlover fluctuations in the price of commodities, and we may not be able to passthrough any cost increases to our customers. We are dependent on frequent deliveriesof fresh ingredients, thereby subjecting us to the risk of shortages orinterruptions in supply. All of these factors could adversely affect ourbusiness and financial results.

 

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*We heavily depend on our suppliers anddistributors.*

* *

We currently purchase our raw materials from various suppliers. Wepurchase a majority of our frozen bagel dough from one supplier. Though to datewe have not experienced significant difficulties with our suppliers, ourreliance on our suppliers subjects us to a number of risks, including possibledelays or interruption in supplies, diminished control over quality and apotential lack of adequate raw material capacity. Any disruption in the supplyor degradation in the quality of the materials provided by our suppliers couldhave a material adverse effect on our business, operating results and financialcondition. In addition, such disruptions in supply or degradations in qualitycould have a long-term detrimental impact on our efforts to develop a strongbrand identity and a loyal consumer base.

 

We depend on our network of six regional custom distributors todistribute frozen bagel dough and other materials to our locations. If any oneor more of these distributors fails to perform as anticipated, or if there isany disruption in any of our distribution relationships for any reason, itcould have a material adverse effect on our business, financial condition andresults of operations.

 

*Increasing labor costs could adversely affectour continued profitability.*

* *

We are dependent upon an available labor pool of unskilled employees,many of whom are hourly employees whose wages may be affected by an increase inthe federal or state minimum wage. Numerous proposals have been made onfederal, state and local levels to increase minimum wage levels. Although few,if any, of our employees are paid at the minimum wage level, an increase in theminimum wage may create pressure to increase the pay scale for our employees,which would increase our labor costs and those of our franchisees andlicensees. A shortage in the labor pool or other general inflationary pressuresor changes could also increase labor costs. In addition, changes in labor lawsor reclassifications of employees from management to hourly employees couldaffect our labor cost. For example, new federal overtime regulations under theFair Labor Standards Act, which go into effect on August 23, 2004, may impactthe classification of several of our positions. We are continuing to evaluatethe specific 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 face the risk of adverse publicity andlitigation in connection with our operations.*

* *

We are from time to time the subject of complaints or litigation fromour consumers alleging illness, injury or other food quality, health oroperational concerns. Adverse publicity resulting from these allegations maymaterially adversely affect us, regardless of whether the allegations are validor whether we are liable. In addition, employee claims against us based on,among other things, discrimination, harassment or wrongful termination maydivert financial and management resources that would otherwise be used tobenefit our future performance. We have been subject to claims from time totime, and although these claims have not historically had a material impact onour operations, a significant increase in the number of these claims or thenumber that are successful could materially adversely affect our business,prospects, financial condition, operating results or cash flows.

 

*We rely in part on our franchisees.*

* *

We rely in part on our franchisees and the manner in which they operatetheir locations 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.

 

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*We face risks associated with governmentregulation.*

* *

Each of our locations is subject to licensing and regulation by thehealth, sanitation, safety, labor, building and fire agencies of the respectivestates and municipalities in which it is located. A failure to comply with oneor more regulations could result in the imposition of sanctions, including theclosing of facilities for an indeterminate period of time, or third-partylitigation, any of which could have a material adverse effect on us and ourresults of operations.

 

In addition, our franchise operations are subject to regulation by theFederal Trade 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.

 

Under various federal, state and local laws, an owner or operator ofreal estate may be liable for the costs of removal or remediation of certainhazardous or toxic substances on or in such property. Such liability may beimposed without regard to whether the owner or operator knew of, or wasresponsible for, the presence of such hazardous or toxic substances. Althoughwe are not aware of any environmental conditions that require remediation by usunder federal, state or local law at our properties, we have not conducted acomprehensive environmental review of our properties or operations. We may nothave identified all of the potential environmental liabilities at ourproperties, and any such liabilities that are identified in the future may havea material adverse effect on our financial condition.

 

*We may notbe able to protect our trademarks, service marks and other proprietary rights.*

 

We believe that our trademarks, service marksand other proprietary rights are important to our success and our competitiveposition. Accordingly, we devote substantial resources to the establishment andprotection of our trademarks, service marks and proprietary rights. However,the actions taken by us may be inadequate to prevent imitation of our productsand concepts by others or to prevent others from claiming violations of theirtrademarks and proprietary rights by us. In addition, others may assert rightsin our trademarks, service marks and other proprietary rights.

 

*We have amajority stockholder.*

* *

Greenlight Capital, L.L.C. and its affiliates beneficially ownapproximately 97 percent of our common stock. As a result, Greenlight hassufficient voting power, without the vote of any other stockholders, todetermine what matters will be submitted for approval by our stockholders, toapprove actions by written consent without the approval of any otherstockholders, to elect all of our board of directors, and to determine whethera change in control of our company 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 hasvoted its shares to elect our current board of directors. One of our directorsis a current employee of Greenlight. The remaining five directors are notaffiliated with Greenlight.

 

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Our common stock is not currently listed on any stock exchange orNasdaq. As a result, we are not subject to corporate governance rules recentlyadopted by the New York Stock Exchange, American Stock Exchange and Nasdaqrequiring a majority of directors to be independent and requiring compensationand nominating committees that are composed solely of independent directors.However, we are subject to rules requiring that the audit committee consistentirely of independent directors. Under the rules of these stock exchanges andNasdaq, if a single stockholder holds more that 50% of the voting power of alisted company, that company is considered a controlled company, and except forthe rules relating to independence of the audit committee, is exempt from theabove-mentioned independence rules. Since Greenlight beneficially owns approximately97% of our common stock, we may take advantage of the controlled companyexemption if our common stock becomes listed on an exchange or Nasdaq in thefuture. As a result, our stockholders do not have, and may never have theprotections that these rules are intended to provide.

 

*Future sales of shares of our common stock by our stockholders couldcause our stock price to fall.*

* *

If a substantial number of shares of our common stock are sold in thepublic market, 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 byGreenlight or a perception that Greenlight will sell could cause a decrease inthe market price of our common stock. Additionally, holders of outstandingwarrants may convert and sell the underlying shares in the public market.Pursuant to our obligations under registration rights agreements, we arecurrently registering 957,872 shares of common stock underlying certainwarrants, of which Greenlight owns warrants to purchase approximately 493,683shares of our common stock. Sales of shares or a perception that there will besales of the underlying shares could also cause a decrease in the market priceof our common stock.

 

*Holders may find it difficult to effect transactions in our commonstock.*

* *

Our common stock is currently trading on the “pink sheets” under thesymbol “NWRG.PK.”  Before changing oursymbol 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 New York Stock Exchange,holders of our common stock may find that the liquidity of our common stock isimpaired – not only in the number of securities that can be bought and sold,but also through delays in the timing of transactions, reduction in securityanalysts’ and the news media’s coverage of us, and lower prices for oursecurities than might otherwise be attained.

 

Securities that are not listed on a stock exchange, the Nasdaq NationalMarket or the Nasdaq SmallCap Market are subject to an SEC rule that imposesspecial requirements on broker-dealers who sell those securities to personsother than their established customers and accredited investors. Thebroker-dealer must determine that the security is suitable for the purchaserand must obtain the purchaser’s written consent prior to the sale. Theserequirements may make it more difficult for you to sell our stock than thestock of some other companies. It may also affect our ability to raise morecapital if and when necessary.

 

Before May 22, 2002, our common stock was quoted on the OTCBulletin Board under the symbol “NWCI.OB.” On May 22, 2002, our commonstock was removed from the eligible list on the OTC Bulletin Board for afailure to comply with NASD Rule 6530, which resulted from our failure totimely file our Form 10-K for the year ended January 1, 2002.  Before November 27, 2001, our commonstock was quoted on the Nasdaq National Market under the symbol “NWCI.”  Effective November 27, 2001, NASDAQdelisted our common stock from the Nasdaq National Market due to corporategovernance violations and public interest concerns.

 

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

 

Through June 29, 2004, our results of operations, financial positionand cash flows have not been materially affected by changes in the relativevalues of non-U.S. currencies to the U.S. dollar. We do not use derivativefinancial instruments to limit our foreign currency risk exposure sincevirtually all of our business is conducted in the United States.

 

Our debt as of June 29, 2004 is principally comprised of the $160Million Indenture 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 is fixed.The interest rate on the AmSouth Revolver does fluctuate with changes in theprime rate, but is minor in relation to interest expense in our results ofoperations and financial condition.

 

**Item 4.  Controls andProcedures**

 

Our chief executive officer and our principal financial officer haveevaluated the effectiveness of our “disclosure controls and procedures” (asdefined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as ofJune 29, 2004. Based on that evaluation, our chief executive officer and ourprincipal financial officer have concluded that our disclosure controls andprocedures were effective to provide reasonable assurance that information thatwe are required to disclose in reports that we file with the SEC is recorded,processed, summarized and reported within the time periods specified by theExchange Act rules.

 

It should be noted that any system of controls, however well designedand operated, can provide only reasonable assurance regarding management’scontrol objectives. In addition, the design of any control system is based inpart upon certain assumptions about the likelihood of future events. Because ofthese and other inherent limitations of control systems, there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions, regardless of how remote.

 

During the fiscal quarter ended June 29, 2004, there were no changes toour internal control over financial reporting which were identified inconnection with the evaluation of our disclosure controls and proceduresrequired by the Exchange Act rules and which have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

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

**NEW WORLDRESTAURANT GROUP, INC.**

**JUNE 29,2004**

 

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

 

Informationregarding legal proceedings is incorporated by reference from Note 6 to ourConsolidated Financial Statements set forth in Part I of this report.

 

**Item 2. Changes in Securities and Use of Proceeds**

 

During the thirteen weeks ended June 29, 2004,we received consideration of $568 and issued 557 shares of our common stockupon the exercise of certain warrants granted by us subject to registrationrights agreements. We issued these warrants to the warrant holder in a privatefinancing transaction related to our issuance of increasing rate notes whichwere repaid in July 2003.

 

**Item 4. Submission of Matters to a Vote ofSecurity Holders**

 

The Company’s Proxy Statement dated April 6,2004 for the Annual Meeting of Shareholders held on May 20, 2004, as filed withSecurities and Exchange Commission on April 8, 2004 is incorporated herein byreference.

 

1)     The Annual Meeting of Shareholders of the Companywas held on May 20, 2004.

 

2)     Each of the nominees, as described in the ProxyStatement reference above, was elected a director to hold office until the nextAnnual Meeting of Shareholders or until his successor is elected and qualified.

 

| **Name**                   | ** ** | **Vote For** | ** ** | **Votes Against or  Withheld** |   |
|----------------------------|------------|--------------|------------|--------------------------------|--------|
| John S. Clark, II          |       | 9,799,470    |       | 4,171                          |   |
| E. Nelson Heumann          |       | 9,799,470    |       | 4,171                          |   |
| Frank C. Meyer             |       | 9,799,470    |       | 4,171                          |   |
| Paul J.B. Murphy, III      |       | 9,799,470    |       | 4,171                          |   |
| S. Garrett Stonehouse, Jr. |       | 9,799,470    |       | 4,171                          |   |
| Leonard Tannenbaum         |       | 9,799,471    |       | 4,171                          |   |

 

3)     The following matter was also voted upon at themeeting and approved by the shareholders:

 

a)     Proposal to approve the Executive EmployeeIncentive Plan

 

| **Votes  For** | ** ** | **Votes Against** | ** ** | **Abstentions** | ** ** |
|----------------|------------|-------------------|------------|-----------------|------------|
| 9,587,428      |       | 7,763             |       | 2,553           |       |

 

b)    Proposal to approve the Stock Option Plan forIndependent Directors

 

| **Votes  For** | ** ** | **Votes Against** | ** ** | **Abstentions** | ** ** |
|----------------|------------|-------------------|------------|-----------------|------------|
| 9,585,688      |       | 9,706             |       | 2,350           |       |

 

c)     Proposal to ratify the appointment of GrantThornton LLP as independent auditors for the fiscal year ending December 28,2004

 

| **Votes  For** | ** ** | **Votes Against** | ** ** | **Abstentions** | ** ** |
|----------------|------------|-------------------|------------|-----------------|------------|
| 9,800,921      |       | 1,672             |       | 1,048           |       |

 

34

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**Item 6.  Exhibits and Reports on Form 8-K.**

 

(a)   Exhibits

 

31.1         Certificationby Chief Executive Officer pursuant to Exchange Act Rule 13a-15(e), as adoptedpursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

31.2         Certificationby Chief Financial Officer pursuant to Exchange Act Rule 13a-15(e), as adoptedpursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

32.1         Certificationby Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2         Certificationby Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(b)   Reportson Form 8-K filed during the quarter ended June 29, 2004:

 

A report onForm 8-K dated May 10, 2004 under Items 5 and 7, was filed with the Securitiesand Exchange Commission on May 13, 2004. The Form 8-K furnished a copy of theCompany’s press release and conference call script relating to financialresults for the thirteen weeks ended March 30, 2004.

 

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**Signatures**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this Amendment No.1 to Form 10-Q/A to be signed on its behalf bythe undersigned thereunto duly authorized.

 

 
|   |        | NEW WORLD  RESTAURANT GROUP, INC.                         |
|--------|-------------|-----------------------------------------------------------|
|   |        |                                                      |
|   |        |                                                      |
| Date:  | May 6, 2005 | By: /s/ PAUL  J. B. MURPHY, III                      |   |
|   |        | Paul J.B.  Murphy, III                                    |
|   |        | Chairman and  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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