**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark  One)**                                                                                                  |
|------------------------------------------------------------------------------------------------------------------|
| **x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                             |
| **For the quarterly period ended April 1,  2008**                                                           |
|                                                                                                             |
| **OR**                                                                                                           |
| ** **                                                                                                       |
| **o   TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE  SECURITIES EXCHANGE ACT OF 1934**      |
|                                                                                                             |
| **Commission File Number 0-27148**                                                                               |

 

**EinsteinNoah Restaurant Group, Inc.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                                        | ** ** | **13-3690261**                         |
|-------------------------------------------------------------------------------------|------------|----------------------------------------|
| (State or other jurisdiction   of incorporation or organization)                    |       | (I.R.S. Employer   Identification No.) |
|                                                                                |       |                                   |
| **555 Zang Street, Suite 300, Lakewood,  Colorado**                            | ** ** | **80228**                              |
| (Address of principal executive offices)                                            |       | (Zip Code)                             |
| ** **                                                                          | ** ** | ** **                             |
| **(303) 568-8000**                                                                  |
| (Registrant’s telephone number, including area code)                           |
|                                                                                |       |                                   |
|                                                                                |       |                                   |
| (Former name, former address and former fiscal year, if changed since  last report) |

 

Indicate by check mark whether the registrant (1) hasfiled 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) hasbeen subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of theExchange Act.

 
| Large accelerated filer  o | Accelerated filer  x | Non-accelerated filer  o(Do not check if a smaller reporting company) | Smaller reporting company o |
|---------------------------------|---------------------------|----------------------------------------------------------------------------|-----------------------------|

 

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

 

As of May 1, 2008, there were 15,923,227 sharesof the registrant’s Common Stock, par value of $0.001 per share outstanding.

 

 

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

 

TABLE OF CONTENTS

** **
| **Part I.  Financial Information** |
|----------------------------------------------|
|                                         |   |   |
| Item 1.                                      | Financial Statements (Unaudited): |   |
|                                         |   |   |
|                                         | Consolidated Balance Sheets, January 1,  2008 and April 1, 2008 | 3 |
|                                         |   |   |
|                                         | Consolidated Statements of Operations, for the first quarters ended April 3,  2007 and April 1, 2008 | 4 |
|                                         |   |   |
|                                         | Consolidated Statements of Cash Flows, for the first quarters ended April 3,  2007 and April 1, 2008 | 5 |
|                                         |   |   |
|                                         | Consolidated Statement of Changes in Stockholders’ Deficit, for the  first quarter ended April 1, 2008 | 6 |
|                                         |   |   |
|                                         | Notes to the Consolidated Financial  Statements | 7 |
|                                         |   |   |
| Item 2.                                      | Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 16 |
|                                         |   |   |
| Item 3.                                      | Quantitative and Qualitative Disclosures  about Market Risk | 28 |
|                                         |   |   |
| Item 4.                                      | Controls and Procedures | 29 |
|                                         |   |   |
| **Part II. Other Information**          |
|                                         |   |   |
| Item 1.                                      | Legal Proceedings | 30 |
|                                         |   |   |
| Item 1A.                                     | Risk Factors | 30 |
|                                         |   |   |
| Item 6.                                      | Exhibits | 38 |

 

2

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PART I. FINANCIALINFORMATION

Item 1.  Financial Statements

 

**EINSTEIN NOAH RESTAURANT GROUP, INC.**

**CONSOLIDATED BALANCE SHEETSAS OF JANUARY 1, 2008 AND APRIL 1, 2008**

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

**(Unaudited)**

** **
| ** **                                                                                                                                                                          | ** ** | **January 1,** | ** ** | **April 1,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **2008**            | ** ** | **2008**          | ** ** |
| **ASSETS**                                                                                                                                                                          | ** ** | ** **          | ** ** | ** **        | ** ** |
| Current assets:                                                                                                                                                                     |       |                |       |              |       |
| Cash and cash equivalents                                                                                                                                                           |       | $                   | 9,436      |              | $          | 13,945 |   |
| Restricted cash                                                                                                                                                                     |       | 1,203               |       | 1,170             |       |
| Franchise and other receivables, net of  allowance of $606 and $582, respectively                                                                                                   |       | 7,807               |       | 7,808             |       |
| Inventories                                                                                                                                                                         |       | 5,313               |       | 5,042             |       |
| Prepaid expenses and other current assets                                                                                                                                           |       | 5,281               |       | 4,791             |       |
| Total current assets                                                                                                                                                                |       | 29,040              |       | 32,756            |       |
|                                                                                                                                                                                |       |                |       |              |       |
| Property, plant and equipment, net                                                                                                                                                  |       | 47,714              |       | 49,599            |       |
| Trademarks and other intangibles, net                                                                                                                                               |       | 63,831              |       | 63,831            |       |
| Goodwill                                                                                                                                                                            |       | 4,981               |       | 4,981             |       |
| Debt issuance costs and other assets, net                                                                                                                                           |       | 2,996               |       | 2,992             |       |
|                                                                                                                                                                                |       |                |       |              |       |
| Total assets                                                                                                                                                                        |       | $                   | 148,562    |              | $          | 154,159 |   |
|                                                                                                                                                                                |       |                |       |              |       |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**                                                                                                                                      | ** ** | ** **          | ** ** | ** **        | ** ** |
| Current liabilities:                                                                                                                                                                |       |                |       |              |       |
| Accounts payable                                                                                                                                                                    |       | $                   | 5,072      |              | $          | 4,481 |   |
| Accrued expenses and other current  liabilities                                                                                                                                     |       | 19,279              |       | 22,068            |       |
| Short term debt and current portion of  long-term debt                                                                                                                              |       | 955                 |       | 1,180             |       |
| Current portion of obligations under capital  leases                                                                                                                                |       | 80                  |       | 79                |       |
| Total current liabilities                                                                                                                                                           |       | 25,386              |       | 27,808            |       |
|                                                                                                                                                                                |       |                |       |              |       |
| Senior notes and other long-term debt                                                                                                                                               |       | 88,875              |       | 87,425            |       |
| Long-term obligations under capital leases                                                                                                                                          |       | 67                  |       | 48                |       |
| Other liabilities                                                                                                                                                                   |       | 10,841              |       | 10,953            |       |
| Mandatorily redeemable, Series Z  Preferred Stock, $.001 par value, $1,000 per share liquidation value; 57,000  shares  authorized; 57,000 shares  issued and outstanding |       | 57,000              |       | 57,000            |       |
|                                                                                                                                                                                |       |                |       |              |       |
| Total liabilities                                                                                                                                                                   |       | 182,169             |       | 183,234           |       |
|                                                                                                                                                                                |       |                |       |              |       |
| Commitments and contingencies                                                                                                                                                       |       |                |       |              |       |
|                                                                                                                                                                                |       |                |       |              |       |
| Stockholders’ deficit:                                                                                                                                                         |       |                |       |              |       |
| Series A junior participating  preferred stock, 700,000 shares authorized; no shares issued and outstanding                                                                    |       |                |       |              |       |
| Common stock, $.001 par value; 25,000,000  shares authorized; 15,878,811 and 15,923,227 shares issued and outstanding                                                               |       | 16                  |       | 16                |       |
| Additional paid-in capital                                                                                                                                                          |       | 262,830             |       | 263,520           |       |
| Accumulated deficit                                                                                                                                                                 |       | (296,453            | )          | (292,611          | )          |
| Total stockholders’ deficit                                                                                                                                                    |       | (33,607             | )          | (29,075           | )          |
|                                                                                                                                                                                |       |                |       |              |       |
| Total liabilities and stockholders’ deficit                                                                                                                                    |       | $                   | 148,562    |              | $          | 154,159 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

3

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONSFOR THE FIRST QUARTERS ENDED APRIL 3, 2007 AND APRIL 1, 2008**

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

**(unaudited)**

** **
| ** **                                             | ** ** | **Quarter ended:** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
| ** **                                             | ** ** | **April 3,**       | ** ** | **April 1,** | ** ** |
| ** **                                             | ** ** | **2007**                | ** ** | **2008** | ** ** |
| Revenues:                                              |       |                    |       |   |   |
| Company-owned restaurant sales                         |       | $                       | 89,115     |   | $ | 93,610 |   |
| Manufacturing and commissary revenues                  |       | 5,818                   |       | 8,088 |   |
| Franchise and license related revenues                 |       | 1,322                   |       | 1,566 |   |
|                                                   |       |                    |       |   |   |
| Total revenues                                         |       | 96,255                  |       | 103,264 |   |
|                                                   |       |                    |       |   |   |
| Cost of sales:                                         |       |                    |       |   |   |
| Company-owned restaurant costs                         |       | 71,332                  |       | 75,825 |   |
| Manufacturing and commissary costs                     |       | 5,422                   |       | 7,860 |   |
|                                                   |       |                    |       |   |   |
| Total cost of sales                                    |       | 76,754                  |       | 83,685 |   |
|                                                   |       |                    |       |   |   |
| Gross profit                                           |       | 19,501                  |       | 19,579 |   |
|                                                   |       |                    |       |   |   |
| Operating expenses:                                    |       |                    |       |   |   |
| General and administrative expenses                    |       | 10,731                  |       | 10,743 |   |
| Depreciation and amortization                          |       | 2,419                   |       | 3,204 |   |
| Loss on sale, disposal or abandonment of  assets, net  |       | 374                     |       | 69 |   |
| Impairment charges and other related costs             |       | 19                      |       | — |   |
|                                                   |       |                    |       |   |   |
| Income from operations                                 |       | 5,958                   |       | 5,563 |   |
| Other expense:                                         |       |                    |       |   |   |
| Interest expense, net                                  |       | 4,789                   |       | 1,579 |   |
|                                                   |       |                    |       |   |   |
| Income before income taxes                             |       | 1,169                   |       | 3,984 |   |
| Provision for income taxes                             |       | 37                      |       | 142 |   |
|                                                   |       |                    |       |   |   |
| Net income                                             |       | $                       | 1,132      |   | $ | 3,842 |   |
|                                                   |       |                    |       |   |   |
| Net income per common share – Basic               |       | $                       | 0.11       |   | $ | 0.24 |   |
| Net income per common share – Diluted             |       | $                       | 0.10       |   | $ | 0.23 |   |
|                                                   |       |                    |       |   |   |
| Weighted average number of common shares  outstanding: |       |                    |       |   |   |
| Basic                                                  |       | 10,605,626              |       | 15,890,879 |   |
| Diluted                                                |       | 11,136,699              |       | 16,451,556 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

4

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE FIRST QUARTERS ENDED APRIL 3, 2007 AND APRIL 1, 2008**

**(in thousands)**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **April 3,** | ** ** | **April 1,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                         | ** ** | **2007**          | ** ** | **2008**          | ** ** |
| OPERATING ACTIVITIES:                                                              |       |              |       |              |       |
| Net income                                                                         |       | $                 | 1,132      |              | $          | 3,842 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |              |       |              |       |
| Depreciation and amortization                                                      |       | 2,419             |       | 3,204             |       |
| Stock based compensation expense                                                   |       | 331               |       | 506               |       |
| Loss, net of gains, on disposal of assets                                          |       | 374               |       | 69                |       |
| Impairment charges and other related costs                                         |       | 19                |       | —            |       |
| Provision for losses on accounts  receivable, net                                  |       | 26                |       | (24               | )          |
| Amortization of debt issuance and debt  discount costs                             |       | 201               |       | 113               |       |
| Paid-in-kind interest                                                              |       | 487               |       | —            |       |
| Changes in operating assets and liabilities:                                       |       |              |       |              |       |
| Restricted cash                                                                    |       | —            |       | 33                |       |
| Franchise and other receivables                                                    |       | 540               |       | 23                |       |
| Accounts payable and accrued expenses                                              |       | 2,358             |       | 2,890             |       |
| Other assets and liabilities                                                       |       | (1,450            | )          | 659               |       |
|                                                                               |       |              |       |              |       |
| Net cash provided by operating activities                                          |       | 6,437             |       | 11,315            |       |
|                                                                               |       |              |       |              |       |
| INVESTING ACTIVITIES:                                                              |       |              |       |              |       |
| Purchase of property and equipment                                                 |       | (6,228            | )          | (5,742            | )          |
| Proceeds from the sale of equipment                                                |       | 32                |       | 4                 |       |
| Acquisition of restaurant assets                                                   |       | —            |       | (7                | )          |
|                                                                               |       |              |       |              |       |
| Net cash used in investing activities                                              |       | (6,196            | )          | (5,745            | )          |
|                                                                               |       |              |       |              |       |
| FINANCING ACTIVITIES:                                                              |       |              |       |              |       |
| Costs incurred with offering of our common  stock                                  |       | (166              | )          | —            |       |
| Payments under capital lease obligations                                           |       | (17               | )          | (20               | )          |
| Repayments under First Lien Term Loan                                              |       | (475              | )          | (1,225            | )          |
| Proceeds upon stock option exercises                                               |       | 62                |       | 184               |       |
|                                                                               |       |              |       |              |       |
| Net cash used in financing activities                                              |       | (596              | )          | (1,061            | )          |
|                                                                               |       |              |       |              |       |
| Net (decrease) increase in cash and cash  equivalents                              |       | (355              | )          | 4,509             |       |
| Cash and cash equivalents, beginning of  period                                    |       | 5,477             |       | 9,436             |       |
| Cash and cash equivalents, end of period                                           |       | $                 | 5,122      |              | $          | 13,945 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

5

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’DEFICITFOR THE YEAR TO DATE PERIOD ENDED**

**APRIL 1, 2008**

(inthousands, except share information)

(Unaudited)

 
| ** **                                      | ** ** | ** **            | ** ** | ** **       | ** ** | **Additional** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|-----------------|------------|------------|------------|
| ** **                                      | ** ** | **Common Stock** | ** ** | **Paid In** | ** ** | **Deficit**    | ** ** | ** **      | ** ** |
| ** **                                      | ** ** | **Shares**            | ** ** | **Amount**       | ** ** | **Capital**    | ** ** | **Amount**      | ** ** | **Total**  | ** ** |
|                                            |       |                  |       |             |       |           |       |            |       |       |       |
| Balance, January 1, 2008                   |       | 15,878,811            |       | $                | 16         |           | $          | 262,830         |       | $          | (296,453   | ) | $ | (33,607 | ) |
| Net income                                      |       | —                |       | —           |       | —         |       | 3,842           |       | 3,842      |       |
| Common stock issued upon stock option  exercise |       | 44,416                |       | —           |       | 184            |       | —          |       | 184        |       |
| Stock based compensation expense                |       | —                |       | —           |       | 506            |       | —          |       | 506        |       |
|                                            |       |                  |       |             |       |           |       |            |       |       |       |
| Balance, April 1, 2008                     |       | 15,923,227            |       | $                | 16         |           | $          | 263,520         |       | $          | (292,611   | ) | $ | (29,075 | ) |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

6

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

Notes to ConsolidatedFinancial Statements (Unaudited)

 

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

 

The consolidated financialstatements of Einstein Noah Restaurant Group, Inc. and its wholly-ownedsubsidiaries (collectively, the “Company”) have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”). As of April 1,2008, the Company owned, franchised or licensed various restaurant conceptsunder the brand names of Einstein Bros. Bagels (“Einstein Bros.”), Noah’s NewYork Bagels (“Noah’s”), Manhattan Bagel Company (“Manhattan Bagel”), ChesapeakeBagel Bakery (“Chesapeake”) and New World Coffee (“New World”). Ourbusiness is subject to seasonal trends. Generally, our revenues and results ofoperations in the fourth fiscal quarter tend to be the most significant.

 

The consolidated financial statements as of April 1, 2008 and forthe first quarters ended April 3, 2007 and April 1, 2008 havebeen prepared without audit. The balance sheet information as of January 1,2008 has been derived from our audited consolidated financial statements. Theinformation furnished herein reflects all adjustments (consisting only ofnormal recurring accruals and adjustments), which are, in our opinion,necessary to fairly state the interim operating results for the respectiveperiods.  However, these operating results are not necessarily indicativeof the results expected for the full fiscal year.

 

Certain information and footnote disclosures normally included in annualfinancial statements prepared in accordance with generally accepted accountingprinciples in the United States have been omitted pursuant to Security ExchangeCommission (“SEC”) rules and regulations. The notes to the consolidatedfinancial statements (unaudited) should be read in conjunction with the notesto the consolidated financial statements contained in our annual report on Form 10-Kfor the fiscal year ended January 1, 2008. We believe that the disclosuresare sufficient for interim financial reporting purposes.

 

**2.****    ****Recent Accounting Pronouncements**

 

Effective January 1,2008, the Company adopted Financial Accounting Standards Board (“FASB”)Statement of Financial Accounting Standards (“SFAS”) No. 157, *Fair Value Measurements,* (“SFAS 157”). SFAS157 defines fair value, establishes a framework for using fair value to measureassets and liabilities, and expands disclosure about fair value measurements.SFAS 157 applies whenever other statements require or permit assets orliabilities to be measured at fair value. The adoption of SFAS 157 did not havean impact on the Company’s consolidated financial statements.

 

We adopted SFAS No. 159,*The Fair Value Option for Financial Assets andFinancial Liabilities-Including an Amendment of FASB Statement No. 115*(“SFAS No. 159”) on January 2, 2008, which became effective forfiscal periods beginning after November 15, 2007. This standard permitsentities to choose to measure many financial instruments and certain otheritems at fair value. While SFAS No. 159 became effective for our 2008fiscal year, we did not elect the fair value measurement option for any of ourfinancial assets or liabilities.

 

In December 2007,the FASB issued SFAS 141 (revised 2007), *BusinessCombinations*, (“SFAS 141R”). SFAS 141R establishesprinciples and requirements for how an acquirer recognizes and measures in itsfinancial statements the identifiable assets acquired, including goodwill, theliabilities assumed and any non-controlling interest in the acquiree. TheStatement also establishes disclosure requirements to enable users of thefinancial statements to evaluate the nature and financial effects of thebusiness combination. SFAS 141R is effective for business combinations forwhich the acquisition date is on or after the beginning of the first annualreporting period beginning on or after December 15, 2008. The impact ofadopting SFAS 141R will be dependent on the future business combinationsthat the Company may pursue after its effective date.

 

In December 2007,the SEC issued Staff Accounting Bulletin (“SAB”) 110 *Share-Based Payment*(“SAB110”)*.*  SAB 110 amends and replaces Question 6 of Section D.2of Topic 14, *Share-Based Payment,*of the Staff Accounting Bulletin series. Question 6 of Section D.2 ofTopic 14 expresses the views of the staff regarding the use of the “simplified”method in developing an estimate of the expected term of “plain vanilla” shareoptions and allows usage of the “simplified” method for share option grantsprior to December 31, 2007. SAB 110 allows public companies which do nothave historically sufficient experience to provide a reasonable estimate tocontinue

 

7

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use of the “simplified” method for estimating the expected term of “plainvanilla” share option grants after December 31, 2007. SAB 110 is effectiveJanuary 1, 2008. We currently use the “simplified” method to estimate theexpected term for share option grants as we do not have enough historicalexperience to provide a reasonable estimate. We will continue to use the “simplified”method until we have enough historical experience to provide a reasonableestimate of expected term in accordance with SAB 110.

 

We have consideredall other recently issued accounting pronouncements and do not believe theadoption of such pronouncements will have a material impact on our consolidatedfinancial statements.

 

**3.****    ****Stock Based Compensation**

 

Our stock-based compensation cost for the first quarters ended April 3,2007 and April 1, 2008 was $331,000 and $506,000, respectively and hasbeen included in general and administrative expenses. The fair value of stockoptions and stock appreciation rights (“SARs”) are estimated using theBlack-Scholes option-pricing model with the following weighted averageassumptions:

 

| ** **                                            | ** ** | **April 3,** | ** ** | **April 1,** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                            | ** ** | **2007**          | ** ** | **2008**          | ** ** |
| Expected life of options and SARs from date  of grant |       | 4.0 years         |       | 3.25 - 6.0 years  |       |
| Risk-free interest rate                               |       | 4.73%             |       | 2.49%             |       |
| Volatility                                            |       | 97.0%             |       | 31.0%             |       |
| Assumed dividend yield                                |       | 0.0%              |       | 0.0%              |       |

 

The expected term of options is based upon evaluations of historicaland expected future exercise behavior. The risk-free interest rate is based onthe U.S. Treasury rates at the date of grant with maturity dates approximatelyequal to the expected life at the grant date. Implied volatility is based onthe mean reverting average of our stock’s historical volatility and that of anindustry peer group. The use of mean reversion is supported by evidence of acorrelation between stock price volatility and a company’s leverage combinedwith the effects mandatory principal payments will have on our capitalstructure, as defined under our debt facility. We have not historically paidany dividends and are currently precluded from doing so under our debtcovenants.

 

As of April 1, 2008, we had approximately $1.9 million of totalunrecognized compensation cost related to non-vested awards granted under ourstock option and stock appreciation rights plans, which we expect to recognizeover a weighted average period of 2.2 years. Total compensation costs relatedto the non-vested awards outstanding as of April 1, 2008 will be fullyrecognized by the first quarter of fiscal 2011, which represents the end of therequisite service period.

 

8

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**Stock Option Plan Activity**

 

Transactions during the first quarter ended April 1,2008 were as follows:

 
| ** **                                 | ** ** | ** **  | ** ** | **Weighted** | ** ** | **Weighted** | ** ** | ** **    | ** ** | **Weighted**          | ** ** |
|--------------------------------------------|------------|-------------|------------|--------------|------------|--------------|------------|---------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **Number**  | ** ** | **Average**  | ** ** | **Average**  | ** ** | **Aggregate** | ** ** | **Average**           | ** ** |
| ** **                                 | ** ** | **of**      | ** ** | **Exercise** | ** ** | **Fair**     | ** ** | **Intrinsic** | ** ** | **Remaining**         | ** ** |
| ** **                                 | ** ** | **Options** | ** ** | **Price**    | ** ** | **Value**    | ** ** | **Value**     | ** ** | **Life (Years)** | ** ** |
| Outstanding, January 1, 2008          |       | 1,108,361   |       | $            | 8.06       |         |       |          |       |                  |       |   |
| Granted                                    |       | 116,738     |       | 15.61        |       |         |       |          |       |                  |       |
| Exercised                                  |       | (44,416     | )          | 4.15         |       |         |       |          |       |                  |       |
| Forfeited                                  |       | —      |       | —       |       |         |       |          |       |                  |       |
| Outstanding, April 1, 2008            |       | 1,180,683   |       | $            | 8.95       |         | $          | 4.07          |       | $                     | 3,573,992  |   | 7.37 |   |
| Exercisable and vested, April 1, 2008 |       | 627,002     |       | $            | 4.70       |         | $          | 3.30          |       | $                     | 2,958,589  |   | 6.15 |   |

 
| ** **                              | ** ** | ** **  | ** ** | **Weighted**    | ** ** |
|-----------------------------------------|------------|-------------|------------|-----------------|------------|
| ** **                              | ** ** | **Number**  |       | **Average**     |       |
| ** **                              | ** ** | **of**      |       | **Grant  Date** |       |
| ** **                              | ** ** | **Options** |       | **Fair  Value** |       |
| Non-vested shares, January 1, 2008 |       | 470,368     |       | $               | 4.80       |   |
| Granted                                 |       | 116,738     |       | 5.46            |       |
| Vested                                  |       | (33,425     | )          | 4.53            |       |
| Forfeited                               |       | —      |       | —          |       |
| Non-vested shares, April 1, 2008   |       | 553,681     |       | $               | 4.96       |   |

 

9

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**Stock Appreciation Rights Plan Activity**

 

Transactions during the first quarter ended April 1,2008 were as follows:

 
| ** **                                 | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Weighted** | ** ** | ** **    | ** ** | **Weighted**          | ** ** |
|--------------------------------------------|------------|------------|------------|--------------|------------|--------------|------------|---------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **Number** | ** ** | **Average**  | ** ** | **Average**  | ** ** | **Aggregate** | ** ** | **Average**           | ** ** |
| ** **                                 | ** ** | **of**     | ** ** | **Exercise** | ** ** | **Fair**     | ** ** | **Intrinsic** | ** ** | **Remaining**         | ** ** |
| ** **                                 | ** ** | **SARs**   | ** ** | **Price**    | ** ** | **Value**    | ** ** | **Value**     | ** ** | **Life (Years)** | ** ** |
| Outstanding, January 1, 2008          |       | 76,913     |       | $            | 11.69      |         |       |          |       |                  |       |   |
| Granted                                    |       | 3,350      |       | 15.76        |       |         |       |          |       |                  |       |
| Exercised                                  |       | —     |       | —       |       |         |       |          |       |                  |       |
| Forfeited                                  |       | (6,888     | )          | 10.98        |       |         |       |          |       |                  |       |
| Outstanding, April 1, 2008            |       | 73,375     |       | $            | 11.95      |         | $          | 5.51          |       | $                     | 60,897     |   | 4.06 |   |
| Exercisable and vested, April 1, 2008 |       | 22,674     |       | $            | 11.41      |         | $          | 5.55          |       | $                     | 20,298     |   | 4.00 |   |

 
| ** **                              |       | ** ** | ** ** | **Weighted**    |   |
|-----------------------------------------|------------|------------|------------|-----------------|--------|
| ** **                              | ** ** | **Number** | ** ** | **Average**     |   |
| ** **                              | ** ** | **of**     | ** ** | **Grant  Date** |   |
| ** **                              | ** ** | **SARs**   | ** ** | **Fair  Value** |   |
| Non-vested shares, January 1, 2008 |       | 76,913     |       | $               | 5.60   |   |
| Granted                                 |       | 3,350      |       | 3.88            |   |
| Vested                                  |       | (22,674    | )          | 5.55            |   |
| Forfeited                               |       | (6,888     | )          | 5.55            |   |
| Non-vested shares, April 1, 2008   |       | 50,701     |       | $               | 5.49   |   |

 

**4.****    ****Supplemental Cash FlowInformation**

** **
| ** **                                                          | ** ** | **April 3,**       | ** ** | **April 1,** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------|------------|-------------------|------------|
| ** **                                                          | ** ** | **2007**                | ** ** | **2008**          | ** ** |
| ** **                                                          | ** ** | **(in thousands)** | ** ** |
| Cash paid during the year to date period  ended:                    |       |                    |       |              |       |
| Interest related to:                                                |       |                    |       |              |       |
| Term Loans                                                          |       | $                       | 3,681      |              | $          | 1,655 |   |
| $25 Million Subordinated Note                                       |       | 432                     |       | —            |       |
| Other                                                               |       | 73                      |       | 63                |       |
|                                                                |       |                    |       |              |       |
| Income taxes                                                        |       | $                       | 65         |              | $          | 233 |   |
|                                                                |       |                    |       |              |       |
| Non-cash investing activities:                                      |       |                    |       |              |       |
| Change in accrued expenses for purchases of  property and equipment |       | $                       | (1,727     | )                 | $          | (580 | ) |

 

10

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**5.****    ****Inventories**

 

Inventories, which consist of food, beverage,paper supplies and bagel ingredients, are stated at the lower of cost ormarket, with cost being determined by the first-in, first-out method.Inventories consist of the following:

 

| ** **        | ** ** | **January 1,**                          | ** ** | **April 1,** | ** ** |
|-------------------|------------|----------------------------------------------|------------|-------------------|------------|
| ** **        | ** ** | **2008**                                     | ** ** | **2008**          | ** ** |
| ** **        | ** ** | **(in thousands of dollars)** | ** ** |
| Finished goods    |       | $                                            | 4,056      |              | $          | 3,842 |   |
| Raw materials     |       | 1,257                                        |       | 1,200             |       |
|              |       |                                         |       |              |       |
| Total inventories |       | $                                            | 5,313      |              | $          | 5,042 |   |

 

**6.****    ****Goodwill, Trademarks and OtherIntangibles**

 

Intangible assets includeboth goodwill and identifiable intangibles arising from the allocation of thepurchase prices of assets acquired. Goodwill represents the excess of cost overfair value of net assets acquired in the acquisition of Manhattan Bagel. As of April 1,2008, intangible assets of $63.8 were not subject to amortization and consistedprimarily of the Einstein Bros., Noah’s and Manhattan Bagel trademarks.

 

We performed an impairment analysis of the goodwill and indefinitelived intangible assets related to our Einstein Bros., Noah’s and ManhattanBagel brands as of January 1, 2008 to which there was no indication ofimpairment.  During the first quarters ended April 3,2007 and April 1, 2008, there were no events or changes in circumstancesthat indicated that our goodwill or intangible assets might be impaired or maynot be recoverable.

 

**7.****    ****Senior Notes and Other Long-TermDebt**

 

Senior notes and otherlong-term debt consist of the following:

 

| ** **                                                  | ** ** | **January 1,**                          | ** ** | **April 1,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------|------------|-------------------|------------|
| ** **                                                  | ** ** | **2008**                                     | ** ** | **2008**          | ** ** |
| ** **                                                  | ** ** | **(in thousands of dollars)** | ** ** |
| $90 Million First Lien Term Loan                            |       | $                                            | 89,550     |              | $          | 88,325 |   |
| New Jersey Economic Development Authority  Note Payable     |       | 280                                          |       | 280               |       |
| Total senior notes and other debt                           |       | $                                            | 89,830     |              | $          | 88,605 |   |
| Less short-term debt and current portion of  long-term debt |       | 955                                          |       | 1,180             |       |
| Senior notes and other long-term debt                       |       | $                                            | 88,875     |              | $          | 87,425 |   |

 

*First Lien Term Loan and Revolving Facility*

 

Our debt is comprised of amodified term loan with a principal amount of $90 million and a $20 millionrevolving credit facility. We may prepay amounts outstanding under the seniorsecured credit facility and may terminate commitments in whole at any timewithout penalty or premium upon prior written notice.  Borrowings under this senior secured creditfacility bear interest at a rate equal to an applicable margin plus, at ouroption, either a variable base rate or a Eurodollar rate. As of April 1,2008 the stated interest rate under the $90 million First Lien Term Loan (“FirstLien Term Loan”) was 5.55%. The revolving facility and the First Lien Term Loancontain usual and customary covenants including consolidated leverage ratios,fixed charge coverage ratios, limitations on capital expenditures, etc. As of January 1,2008 and April 1, 2008 we were in compliance with all our financial andoperating covenants

 

11

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The revolving creditfacility remains available, subject to certain conditions, to finance ourongoing working capital, capital expenditure and general corporate needs.  In addition, all of the revolving creditfacility is available for letters of credit. As of April 1, 2008, we had$7.3 million in letters of credit outstanding under this facility. The lettersof credit expire on various dates during 2008, are automatically renewable forone additional year and are payable upon demand in the event that we fail topay the underlying obligation. Our availability under the revolving facilitywas $12.7 million at April 1, 2008.

 

For the revolvingfacility, the capitalized debt issuance costs are being amortized on astraight-line basis while the capitalized debt issuance costs for the FirstLien Term Loan are being amortized on the effective interest rate method. As ofApril 1, 2008, approximately $0.4 million and $2.0 million in debtissuance costs have been capitalized for the revolving facility and the FirstLien Term Loan, respectively, net of amortization.

 

**8.****    ****Net Income Per Common Share**

 

In accordance with SFAS No. 128, *Earnings perShare*, we compute basic net income per common share by dividing thenet income for the period by the weighted average number of shares of commonstock outstanding during the period. Diluted net income per share is computedby dividing the net income for the period by the weighted average number ofshares of common stock and potential common stock equivalents outstandingduring the period using the treasury stock method. Potential common stockequivalents include incremental shares of common stock issuable upon theexercise of stock options and warrants. Potential common stock equivalents areexcluded from the computation of diluted net income per share when their effectis anti-dilutive.

 

The following table sets forth the computation of basic and dilutedearnings per share:

 

| ** **                                       | ** ** | **For the quarters ended** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                       | ** ** | **April 3,**                         | ** ** | **April 1,** | ** ** |
| ** **                                       | ** ** | **2007**                                  | ** ** | **2008** | ** ** |
|                                             |       |                                      |       |   |   |
| Net income (a)                                   |       | $                                         | 1,132      |   | $ | 3,842 |   |
|                                             |       |                                      |       |   |   |
| Basic weighted average shares outstanding  (b)   |       | 10,605,626                                |       | 15,890,879 |   |
| Dilutive effect of stock options and SARs        |       | 531,073                                   |       | 560,677 |   |
| Diluted weighted average shares outstanding  (c) |       | 11,136,699                                |       | 16,451,556 |   |
| Basic earnings per share (a)/(b)                 |       | $                                         | 0.11       |   | $ | 0.24 |   |
| Diluted earnings per share (a)/(c)               |       | $                                         | 0.10       |   | $ | 0.23 |   |
|                                             |       |                                      |       |   |   |
| Antidilutive stock options, SARs and  warrants   |       | 382,404                                   |       | 412,011 |   |

 

12

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**9.****    ****Income Taxes**

 

Utilization of our net operating loss (“NOL”) carryforwards reduced ourfederal and state income tax liability incurred for the first quarter of 2008.We have recorded a provision for income taxes in the amount of $142,000 relatedto our estimate of income taxes due on taxable earnings for the first quarterof 2008.

 

As of April 1, 2008,NOL carryforwards of $144.9 million were available to be utilized againstfuture taxable income for years through fiscal 2026, subject in part to annuallimitations. As a result of prior ownership changes, approximately $98.3million of our NOL carryforwards are subject to an annual usage limitation of$4.7 million.  Our ability to utilize ourNOL carryforwards, including those that are not currently subject tolimitation, could be limited or further limited in the event that we undergo an“ownership change” as that term is defined for purposes of Section 382 ofthe Internal Revenue Code.  We are in theprocess of filing a request with the Internal Revenue Service to review ourmethodology for determining ownership changes in accordance with InternalRevenue Code Section 382. Upon acceptance of our request, we believe thatour NOL carryforwards will be available for utilization. In the event that ourrequest is not accepted, approximately $17.9 million of NOL carryforwardswill be at risk to expire prior to utilization.

 

Our NOL carryforwards areincluded in our deferred income tax assets; however, the ultimate realizationof these deferred income tax assets is dependent upon the generation of futuretaxable income. Due to the uncertainty of future taxable income, deferred taxassets resulting from these net operating losses have been fully reserved.  Additionally, we maintain a full valuationallowance against our total net deferred tax assets.

 

In accordance with SFAS No. 109,*Accounting for Income Taxes*, (“SFASNo. 109”) we will assess the continuing need for a valuation allowancethat results from uncertainty regarding our ability to realize the benefits of ourdeferred tax assets.  Although weachieved $12.6 million of net income for 2007 and $3.8 million of net incomefor the quarter ended April 1, 2008, we will continue to review variousqualitative and quantitative data, including events within the restaurantindustry, the cyclical nature of our business, our future forecasts andhistorical trending. If we conclude that our prospects for the realization ofour deferred tax assets are more likely than not, we will then reduce ourvaluation allowance as appropriate and credit income tax expense afterconsidering the following factors:

 

·  The level of historicaltaxable income and projections for future taxable income over periods in whichthe deferred tax assets would be deductible, and

 

·  Accumulation of net incomebefore tax utilizing a look-back period of three years.

 

The amount of the deferredtax asset considered realizable, however, could be reduced if estimates offuture taxable income during the carryforward periods are reduced.

 

We are subject to incometaxes in the U.S. federal jurisdiction, and various states and localjurisdictions. Tax regulations within each jurisdiction are subject to theinterpretation of the related tax laws and regulations and require significantjudgment to apply. We remain subject to examination by U.S. federal, state andlocal tax authorities for tax years 2004 through 2007. With a few exceptions,we are no longer subject to U.S. federal, state or local examinations by taxauthorities for the tax year 2003 and prior.

 

**10.**** ****Commitments and Contingencies**

 

*Letters ofCredit and Line of Credit*

 

As of April 1, 2008,we had $7.9 million in letters of credit outstanding. The letters of creditexpire on various dates during 2008, are automatically renewable for oneadditional year and are payable upon demand in the event that we fail to paythe underlying obligation. Of the total letters of credit outstanding, $7.3million reduce our availability under the Revolving Facility. Our availabilityunder the revolving facility was $12.7 million at April 1, 2008.

 

13

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*Litigation*

 

We are subject to claimsand legal actions in the ordinary course of our business, including claims byor against our franchisees, licensees and employees or former employees and/orcontract disputes. We do not believe any currently pending or threatenedmatter, other than as described below, would have a material adverse effect onour business, results of operations or financial condition.

 

On August 31, 2007,the Company was served in an action brought by Fiera Foods Company in theSuperior Court of Justice of Ontario, Canada. Fiera claims that the Company failed to negotiate in good faith for afrozen bagel dough supply agreement, which was not concluded, and mademisrepresentations in the negotiations. Fiera is seeking damages of $17.0 million (Canadian) as well as interestand costs. The Company believes that these claims are not valid, is defendingthis action and has not recorded an accrual.

 

On September 18,2007, Eric Mathistad, a former store manager, filed a putative class actionagainst the Company in the Superior Court of California for the State ofCalifornia, County of San Diego.  Theplaintiff alleges that we failed to pay overtime wages to “salaried restaurantemployees” of our California stores who were improperly designated asexempt employees, and that these employees were deprived of mandated mealperiods and rest breaks.  Plaintiffalleges that these actions were in violation of the California Labor CodeSections 1194, et seq., 500, et seq., California Business and Professions Code Section 17200,et seq., and applicable wage order(s) issued by the Industrial WelfareCommission.  Plaintiff seeks injunctiverelief, declaratory relief, attorney’s fees, restitution and an unspecifiedamount of damages for unpaid overtime and for missed meal and/or restperiods.  The Company filed a Demurrer onOctober 18, 2007 claiming that, inter alia, plaintiff fails to state aclaim against the Company; plaintiff does not state a claim for a jointventure, partnership, common enterprise, or aiding and abetting; plaintiff’sdefinition of the class is deficient and plaintiff’s claims for declaratoryjudgment regarding Labor Code violations should be dismissed.   On January 15,2008, Plaintiffs filed a First Amended Complaint.  On November 14,2007, Bernadette Mejia, another former store manager, filed a similarcase.    On April 10, 2008, theMathistad and Meija cases were consolidated into one case, and on May 6, 2008, Plaintiffsfiled an Amended Consolidated Complaint.  Because limited discovery has been conducted and no classcertification proceeding has occurred, we cannot predict the outcome ofthis matter.

 

On February 8, 2008,Gloria Webber and Hakan Mikado, non-exempt employees, brought aputative class action against the Company in the Superior Court of Californiafor the State of California, County of San Diego, claiming failure to payminimum wages, failure to pay overtime and failure to provide rest periodsand meal breaks, among other charges.  The parties have agreed to stayformal discovery and a formal response to the complaint pendingexchange of information.  Because this case is in its infancy, we cannotpredict the outcome of this matter.

 

*Guarantees*

 

Prior to 2001, we wouldoccasionally guarantee leases for the benefit of certain of our franchisees.None of the guarantees have been modified since inception and we have sincediscontinued this practice. Current franchisees are the primary lessees under thevast majority of these leases. Under the lease guarantees, we may be requiredby the lessor to make all of the remaining monthly rental payments or propertytax and common area maintenance payments if the franchisee does not make therequired payments in a timely manner. However, we believe most, if not all, ofthe franchised locations could be subleased to third parties reducing 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. Historically, we have not been requiredto make such payments in significant amounts. We record a liability for ourexposure under the guarantees in accordance with Financial Accounting StandardsBoard (“FASB”) Interpretation (“FIN”) No. 45, *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others*. In the event that trendschange in the future, our financial results could be impacted. As of April 1,2008, we had outstanding guarantees of indebtedness under certain leases ofapproximately $1.2 million. Approximately $14,000 is reflected in accrued expenses in ourconsolidated balance sheet at April 1, 2008 for the guarantee of afranchisee’s lease.

 

14

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**11.**** ****Subsequent Events**

 

On May 7, 2008, we enteredinto an interest rate swap agreement relating to our $90 million First LienTerm Loan, effectively fixing our rate on $60 million of our debt to 3.52% plusan applicable margin for the next two years, effective starting August 2008.  Underthis interest rate swap agreement, the Company will pay a fixed rate plus amargin every quarter on the notional amount of the debt and will receive theLondon InterBank Offered Rate (“LIBOR”).

 

The Company’s interestrate swap agreement qualifies as a cash flow hedge, as defined by SFAS 133, *Accounting for Derivative Instruments and Hedging Activities*.  Thefair value of the interest rate swap agreement, which is adjusted regularly,will be recorded in the Company’s balance sheet as an asset or liability, asnecessary, with a corresponding adjustment to other comprehensive income withinequity.

 

15

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

### ***Cautionary Note RegardingForward-Looking Statements***

### * *

*We wish tocaution our readers that the following important factors, among others, couldcause the actual results to differ materially from those indicated byforward-looking statements made in this report and from time to time in newsreleases, reports, proxy statements, registration statements and other writtencommunications, as well as verbal forward-looking statements made from time totime by representatives of the company. Such forward-looking statements involverisks and uncertainties that may cause our actual results, performance orachievements to be materially different from any future performance orachievements expressed or implied by these forward-looking statements. Factorsthat might cause actual events or results to differ materially from thoseindicated by these forward-looking statements may include matters such asfuture economic performance, restaurant openings or closings, operatingmargins, the availability of acceptable real estate locations, the sufficiencyof our cash balances and cash generated from operating and financing activitiesfor our future liquidity and capital resource needs, and other matters, and aregenerally accompanied by words such as: “believes”, “anticipates”, “plans”, “intends”,“estimates”, “predicts”, “targets”, “expects”, “contemplates” and similarexpressions that convey the uncertainty of future events or outcomes. Anexpanded discussion of some of these risk factors follows.  These risks and uncertainties include, but are not limited to, the riskfactors described in our annual report on Form 10-K for the year ended January 1,2008 as updated in subsequent quarterly reports on Form 10-Q, includingItem 1A of Part II of this report*

 

**General**

 

Thisinformation should be read in conjunction with the consolidated financialstatements and the notes included in Item 1 of Part I of thisQuarterly Report and the audited consolidated financial statements and notes,and Management’s Discussion and Analysis of Financial Condition and Results ofOperations, contained in the Form 10-K for the fiscal year ended January 1,2008.  The following discussion and analysis includes historical andcertain forward-looking information that should be read together with the accompanyingconsolidated financial statements, related footnotes and the discussion belowof certain risks and uncertainties that could cause future operating results todiffer materially from historical results or from the expected resultsindicated by forward-looking statements.

 

**CompanyOverview**

 

We are aleading fast-casual restaurant chain, specializing in high-quality foods forbreakfast and lunch in a café atmosphere with a neighborhood emphasis.  As of April 1, 2008, we owned andoperated, franchised or licensed 617 restaurants in 35 states and in theDistrict of Columbia, primarily under the Einstein Bros., Noah’s and ManhattanBagel brands.  Einstein Bros. is anational fast-casual restaurant chain. Noah’s is a regional fast-casual restaurant chain operated exclusivelyon the West Coast and Manhattan Bagel is a regional fast-casual restaurantchain operated predominantly in the Northeast. Our product offerings include fresh bagels and other goods bakedon-site, made-to-order sandwiches on a variety of bagels and breads, gourmetsoups and salads, decadent desserts, premium coffees and other cafébeverages.  Our manufacturing andcommissary operations prepare and assemble consistent, high-quality ingredientsand we deliver them to our restaurants quickly and efficiently through ournetwork of independent distributors.  Ourmanufacturing and commissary operations support our main business focus,restaurant operations, by exposing our brands to new product channels as wellas enabling sales of our products to third parties.

 

16

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**Current Restaurant Base**

 

As of April 1, 2008, we owned and operated, franchised or licensed617 restaurants. Our current base of company-owned restaurants under our corebrands includes 338 Einstein Bros. restaurants, 76 Noah’s restaurants and oneManhattan Bagel restaurant. Also, we franchise one Einstein Bros. restaurantand 69 Manhattan Bagel restaurants, and license 125 Einstein Bros. restaurantsand three Noah’s restaurants. In addition, we have four restaurants which weoperate/franchise under our non-core brands.

 

The following table details our restaurant openings and closings foreach respective period:

 
| ** **              | ** ** | **2007 First Quarter Activity** | ** ** | **2008 First Quarter Activity** | ** ** |
|-------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **              | ** ** | **Company**                                    | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | **Company** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **Owned**                                      | ** ** | **Franchised**                                 | ** ** | **Licensed** | ** ** | **Total** | ** ** | **Owned** | ** ** | **Franchised** | ** ** | **Licensed** | ** ** | **Total** | ** ** |
| **Einstein Bros.**      |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning balance       |       | 341                                            |       | —                                         |       | 93 |   | 434 |   | 337 |   | — |   | 121 |   | 458 |   |
| Opened restaurants      |       | —                                         |       | —                                         |       | 4 |   | 4 |   | 3 |   | 1 |   | 4 |   | 8 |   |
| Closed restaurants      |       | (5                                             | )          | —                                         |       | — |   | (5 | ) | (2 | ) | — |   | — |   | (2 | ) |
| Ending balance          |       | 336                                            |       | —                                         |       | 97 |   | 433 |   | 338 |   | 1 |   | 125 |   | 464 |   |
|                    |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Noah’s**         |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning balance       |       | 73                                             |       | —                                         |       | 3 |   | 76 |   | 77 |   | — |   | 3 |   | 80 |   |
| Opened restaurants      |       | 1                                              |       | —                                         |       | — |   | 1 |   | — |   | — |   | — |   | — |   |
| Closed restaurants      |       | —                                         |       | —                                         |       | — |   | — |   | (1 | ) | — |   | — |   | (1 | ) |
| Ending balance          |       | 74                                             |       | —                                         |       | 3 |   | 77 |   | 76 |   | — |   | 3 |   | 79 |   |
|                    |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Manhattan Bagel**     |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning balance       |       | —                                         |       | 80                                             |       | — |   | 80 |   | 1 |   | 69 |   | — |   | 70 |   |
| Opened restaurants      |       | —                                         |       | —                                         |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Closed restaurants      |       | —                                         |       | (1                                             | )          | — |   | (1 | ) | — |   | — |   | — |   | — |   |
| Ending balance          |       | —                                         |       | 79                                             |       | — |   | 79 |   | 1 |   | 69 |   | — |   | 70 |   |
|                    |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Non-Core Brands**     |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning balance       |       | 2                                              |       | 6                                              |       | — |   | 8 |   | 1 |   | 3 |   | — |   | 4 |   |
| Opened restaurants      |       | —                                         |       | —                                         |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Closed restaurants      |       | —                                         |       | —                                         |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Ending balance          |       | 2                                              |       | 6                                              |       | — |   | 8 |   | 1 |   | 3 |   | — |   | 4 |   |
|                    |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Consolidated Total**  |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total beginning balance |       | 416                                            |       | 86                                             |       | 96 |   | 598 |   | 416 |   | 72 |   | 124 |   | 612 |   |
| Opened restaurants      |       | 1                                              |       | —                                         |       | 4 |   | 5 |   | 3 |   | 1 |   | 4 |   | 8 |   |
| Closed restaurants      |       | (5                                             | )          | (1                                             | )          | — |   | (6 | ) | (3 | ) | — |   | — |   | (3 | ) |
| Total ending balance    |       | 412                                            |       | 85                                             |       | 100 |   | 597 |   | 416 |   | 73 |   | 128 |   | 617 |   |

 

17

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The following table details our restaurant openings and closings overthe last twelve months:

 
| ** **                           | ** ** | **Trailing 12 Months Activity** | ** ** |
|--------------------------------------|------------|------------------------------------------------|------------|
| ** **                           | ** ** | **Company**                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Owned**                                      | ** ** | **Franchised** | ** ** | **Licensed** | ** ** | **Total** | ** ** |
| **Einstein Bros.**                   |       |                                           |       |   |   |   |   |   |   |
| Beginning balance April 3, 2007 |       | 336                                            |       | — |   | 97 |   | 433 |   |
| Opened restaurants                   |       | 11                                             |       | 1 |   | 31 |   | 43 |   |
| Closed restaurants                   |       | (9                                             | )          | — |   | (3 | ) | (12 | ) |
| Ending balance April 1, 2008    |       | 338                                            |       | 1 |   | 125 |   | 464 |   |
|                                 |       |                                           |       |   |   |   |   |   |   |
| **Noah’s**                      |       |                                           |       |   |   |   |   |   |   |
| Beginning balance April 3, 2007 |       | 74                                             |       | — |   | 3 |   | 77 |   |
| Opened restaurants                   |       | 3                                              |       | — |   | — |   | 3 |   |
| Closed restaurants                   |       | (1                                             | )          | — |   | — |   | (1 | ) |
| Ending balance April 1, 2008    |       | 76                                             |       | — |   | 3 |   | 79 |   |
|                                 |       |                                           |       |   |   |   |   |   |   |
| **Manhattan Bagel**                  |       |                                           |       |   |   |   |   |   |   |
| Beginning balance April 3, 2007 |       | —                                         |       | 79 |   | — |   | 79 |   |
| Opened restaurants                   |       | 1                                              |       | 2 |   | — |   | 3 |   |
| Closed restaurants                   |       | —                                         |       | (12 | ) | — |   | (12 | ) |
| Ending balance April 1, 2008    |       | 1                                              |       | 69 |   | — |   | 70 |   |
|                                 |       |                                           |       |   |   |   |   |   |   |
| **Non-Core Brands**                  |       |                                           |       |   |   |   |   |   |   |
| Beginning balance April 3, 2007 |       | 2                                              |       | 6 |   | — |   | 8 |   |
| Opened restaurants                   |       | —                                         |       | — |   | — |   | — |   |
| Closed restaurants                   |       | (1                                             | )          | (3 | ) | — |   | (4 | ) |
| Ending balance April 1, 2008    |       | 1                                              |       | 3 |   | — |   | 4 |   |
|                                 |       |                                           |       |   |   |   |   |   |   |
| **Consolidated Total**               |       |                                           |       |   |   |   |   |   |   |
| Beginning balance April 3, 2007 |       | 412                                            |       | 85 |   | 100 |   | 597 |   |
| Opened restaurants                   |       | 15                                             |       | 3 |   | 31 |   | 49 |   |
| Closed restaurants                   |       | (11                                            | )          | (15 | ) | (3 | ) | (29 | ) |
| Ending balance April 1, 2008    |       | 416                                            |       | 73 |   | 128 |   | 617 |   |

 

**New Restaurant Openings**

 

In 2008, we plan to open at least 18 new company-ownedrestaurants.  For the first quarter of2008 we opened three company-owned Einstein Bros. restaurants in Largo,Florida, Chicago, Illinois and Naperville, Illinois.  For Einstein Bros., we have targeted Atlanta,Georgia, Baltimore, Maryland, Chicago, Illinois, Las Vegas, Nevada, Phoenix,Arizona, Tucson, Arizona and various cities in Florida and Texas fordevelopment.  For Noah’s, we intend tofocus our development efforts on various cities in California. We are also inthe process of identifying new cities for restaurant development sites for 2009to ensure that we achieve our development goals.

 

We plan to open at least 5 franchise restaurants and atleast 35 license restaurants in 2008. The license restaurants will be located primarily in airports, colleges and universities, officebuildings, hospitals and military bases and on turnpikes.  In the first quarter of 2008 we opened oneEinstein Bros. franchise restaurant and four license restaurants.

 

18

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**Results ofOperations**

 

**We have a 52/53-week fiscal year ending on the Tuesday closest to December 31.The first quarters in fiscal years 2007 and 2008 ended on April 3, 2007and April 1, 2008, respectively, and each contained 13 weeks.**

** **

This table sets forth, for the periods indicated, certain amountsincluded in our consolidated statements of operations, the relative percentagethat those amounts represent to total revenue (unless otherwise indicated), andthe percentage change in those amounts from period to period. All percentagesare calculated using actual amounts rounded to the nearest thousand.

 
| ** **                                            | ** ** | **First quarter ended:**           | ** ** | **Increase/**     | ** ** | **First quarter ended:**            | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------|------------|-------------------|------------|-----------------------------------------------|------------|
| ** **                                            | ** ** | **(in thousands of dollars)** | ** ** | **(Decrease)**    | ** ** | **(percent of total revenue)** | ** ** |
| ** **                                            | ** ** | **April 3,**                            | ** ** | **April 1,** | ** ** | **2008**                                      | ** ** | **April 3,** | ** ** | **April 1,** | ** ** |
| ** **                                            | ** ** | **2007**                                     | ** ** | **2008**          | ** ** | **vs. 2007**                             | ** ** | **2007** | ** ** | **2008** | ** ** |
| Revenues:                                             |       |                                         |       |              |       |                                          |       |   |   |   |   |
| Company-owned restaurant sales                        |       | $                                            | 89,115     |              | $          | 93,610                                        |       | 5.0 | % | 92.6 | % | 90.7 | % |
| Manufacturing and commissary revenues                 |       | 5,818                                        |       | 8,088             |       | 39.0                                          | %          | 6.0 | % | 7.8 | % |
| Franchise and license related revenues                |       | 1,322                                        |       | 1,566             |       | 18.5                                          | %          | 1.4 | % | 1.5 | % |
| Total revenues                                        |       | 96,255                                       |       | 103,264           |       | 7.3                                           | %          | 100.0 | % | 100.0 | % |
|                                                  |       |                                         |       |              |       |                                          |       |   |   |   |   |
| Cost of sales:                                        |       |                                         |       |              |       |                                          |       |   |   |   |   |
| Company-owned restaurant costs                        |       |                                         |       |              |       |                                          |       |   |   |   |   |
| Cost of goods sold                                    |       | 26,274                                       |       | 27,985            |       | 6.5                                           | %          | 27.3 | % | 27.1 | % |
| Labor costs                                           |       | 26,606                                       |       | 28,950            |       | 8.8                                           | %          | 27.6 | % | 28.0 | % |
| Other operating costs                                 |       | 8,771                                        |       | 8,878             |       | 1.2                                           | %          | 9.1 | % | 8.6 | % |
| Rent and related, and marketing costs                 |       | 9,681                                        |       | 10,012            |       | 3.4                                           | %          | 10.1 | % | 9.7 | % |
| Total company-owned restaurant costs                  |       | 71,332                                       |       | 75,825            |       | 6.3                                           | %          | 74.1 | % | 73.4 | % |
|                                                  |       |                                         |       |              |       |                                          |       |   |   |   |   |
| Manufacturing and commissary costs                    |       | 5,422                                        |       | 7,860             |       | 45.0                                          | %          | 5.6 | % | 7.6 | % |
| Total cost of sales                                   |       | 76,754                                       |       | 83,685            |       | 9.0                                           | %          | 79.7 | % | 81.0 | % |
|                                                  |       |                                         |       |              |       |                                          |       |   |   |   |   |
| Gross profit:                                         |       |                                         |       |              |       |                                          |       |   |   |   |   |
| Company-owned restaurant                              |       | 17,783                                       |       | 17,785            |       | 0.0                                           | %          | 18.5 | % | 17.2 | % |
| Manufacturing and commissary                          |       | 396                                          |       | 228               |       | (42.4                                         | )%         | 0.4 | % | 0.2 | % |
| Franchise and license                                 |       | 1,322                                        |       | 1,566             |       | 18.5                                          | %          | 1.4 | % | 1.5 | % |
| Total gross profit                                    |       | 19,501                                       |       | 19,579            |       | 0.4                                           | %          | 20.3 | % | 18.9 | % |
|                                                  |       |                                         |       |              |       |                                          |       |   |   |   |   |
| Gross profit percentages:                             |       |                                         |       |              |       |                                          |       |   |   |   |   |
| Company-owned restaurant                              |       | 20.0                                         | %          | 19.0              | %          | (4.8                                          | )%         |   | * |   | * |
| Manufacturing and commissary                          |       | 6.8                                          | %          | 2.8               | %          | (58.6                                         | )%         |   | * |   | * |
| Franchise and license                                 |       | 100.0                                        | %          | 100.0             | %          |                                          | *          |   | * |   | * |
|                                                  |       |                                         |       |              |       |                                          |       |   |   |   |   |
| Operating expenses:                                   |       |                                         |       |              |       |                                          |       |   |   |   |   |
| General and administrative expenses                   |       | 10,731                                       |       | 10,743            |       | 0.1                                           | %          | 11.1 | % | 10.4 | % |
| Depreciation and amortization                         |       | 2,419                                        |       | 3,204             |       | 32.5                                          | %          | 2.5 | % | 3.1 | % |
| Loss on sale, disposal or abandonment of  assets, net |       | 374                                          |       | 69                |       | (81.6                                         | )%         | 0.4 | % | 0.1 | % |
| Impairment charges and other related costs            |       | 19                                           |       | —            |       |                                          | *          | 0.0 | % | 0.0 | % |
| Income from operations                                |       | 5,958                                        |       | 5,563             |       | (6.6                                          | )%         | 6.2 | % | 5.4 | % |
| Other expense:                                        |       |                                         |       |              |       |                                          |       |   |   |   |   |
| Interest expense, net                                 |       | 4,789                                        |       | 1,579             |       | (67.0                                         | )%         | 5.0 | % | 1.5 | % |
|                                                  |       |                                         |       |              |       |                                          |       |   |   |   |   |
| Income before taxes                                   |       | 1,169                                        |       | 3,984             |       | 240.8                                         | %          | 1.2 | % | 3.9 | % |
| Provision for income taxes                            |       | 37                                           |       | 142               |       | 283.8                                         | %          | 0.0 | % | 0.1 | % |
| Net income                                            |       | $                                            | 1,132      |              | $          | 3,842                                         |       | 239.4 | % | 1.2 | % | 3.7 | % |

 

----

| * not meaningful |   |
|------------------|--------|

 

19

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***Company-Owned Restaurant Operations***

 

***Revenues***

** **

**Comparable store sales represent sales at restaurants open for one fullyear that have not been relocated or closed during the current year.  Comparable store sales include company-ownedrestaurants only and represent the change in period-over-period sales for thecomparable restaurant base.  A restaurantbecomes comparable in its 13th full month of operation.**

** **

**For the first quarter of 2008, our comparable store sales increased3.6% over the first quarter of 2007. This increase was primarily due to system-wide price increases of 5.8%since April 3, 2007 and a 2.2% shift in product mix to higher priceditems, partially offset by a 4.1% decrease in the volume of units sold which webelieve was mostly due to the economic climate and its negative impact onconsumer discretionary spending.**

** **

The increase in our company-owned restaurant sales of $4.5 million, or5.0%, when compared to the first quarter of 2007 was primarily due to theaforementioned price increases coupled with a net increase in restaurantsopened over the last twelve months.  Onaverage, the restaurants opened since April 3, 2007 are higher volumerestaurants relative to those that were closed over the same period, which alsopositively contributed to the increase in sales.  Additionally, unfavorable weather conditionsacross the United States negatively impacted our company-owned restaurant salesfor the first quarter of 2007, which were not present in the first quarter of2008.

 

*Cost of Sales*

 

Cost of sales consists of cost of goods sold, labor expenses, otheroperating costs and rent and related and marketing costs.

 

*Cost of Goods Sold*

 

Food, beverage and packaging costs are three elementsthat make up cost of goods sold and constitute a large portion of the cost ofsales at our company-owned restaurants. These costs increased $1.7 million to $28.0 million for the firstquarter of 2008 from $26.3 in the first quarter of 2007, predominantly due toan increase in commodity and distribution costs. Compared to 2007, we expectthat most of our commodity-based food costs will increase in 2008 with the greatestimpact in the first half of the year compared to 2007.  Flour represents the most significant rawingredient we purchase. The cost of wheat and the cost of flour increasedsubstantially in the last half of 2007 and are expected to stay at record levelsduring 2008. To mitigate this risk of increasing prices, we have contractedwith a subsidiary of Cargill, Incorporated to manage our wheat purchases forour company-owned production facility. We will continue to work with Cargill, Incorporated to strategicallysource our key ingredient.  However,there can be no assurance that we will benefit from a decline in the cost ofany of the commodity-based products that we purchase.

 

*Labor Expenses*

 

Labor expenses, which includes our general managers andrestaurant-level labor costs, including taxes and associated employee benefits,increased $2.4 million to $29.0 million for the first quarter ended April 1,2008 compared to $26.6 million for the same period of the prior year. $1.7million of the increase was primarily due to the growth of new restaurantopenings that occurred throughout 2007 and the first quarter of 2008, anincrease in base pay year-over-year, off-set partially by a decrease in managerbonus pay, and increased minimum wage rate increases at the federal level andin several states in which we operate that went into effect starting January 2008.

 

*Other Operating Costs*

 

Other operating costs consist of other restaurant-leveloccupancy expenses such as utilities, repairs and maintenance costs, creditcard fees and supplies.  Other operating costs increased $0.1 million to$8.9 million for the first quarter ended April 1, 2008 compared to$8.8 million for the same period of the prior year.  This increasewas attributable to an increase in credit card fees of $0.2 million, offset bya decrease in repairs and maintenance costs of $0.1 million.

 

20

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*Rent and related, and marketingcosts*

 

Rent and related, and marketing costs consist ofrestaurant-level rent expense, common area maintenance expense, property taxesand marketing expense.  Rent and related and marketing costs increased$0.3 million to $10.0 million for the first quarter ended April 1, 2008compared to $9.7 million for the same period of the prior year.  Thisincrease was principally attributable to an increase in rent expense of $0.4million, offset by a decrease in marketing expense of $0.1 million.

 

***Manufacturing and Commissary Operations***

 

Ourmanufacturing operations, which include our USDA inspected commissaries,predominantly support our company-owned restaurants and generate revenue fromthe sale of food products to franchisees, licensees, third-party distributorsand other third parties. All inter-company transactions have been eliminatedduring consolidation.

 

*Revenues*

 

Manufacturingand commissary revenues increased $2.3 million or 39.0% to $8.1 million in thefirst quarter 2008 from $5.8 million in the same period in 2007.  $0.8 million of this increase was attributedto a rise in the volume of units sold to our more significant customers and$0.7 million was related to price increases.  $0.4 million of the increase was attributed to our entry into thedistribution chain for sales to our franchise and license locations, slightlyoff-set by a drop in the volume of units sold to these customers.  The remaining $0.4 million of the increasewas from an increase in sales to our franchisees and licensees.

 

*Cost of Sales*

 

Cost of sales consists of cost of goods sold, labor expenses and otheroperating costs and expenses.

 

*Cost of Goods Sold*

 

Manufacturingcosts are comprised of raw materials such as flour, dairy products andmeats.  These costs increased $2.1million to $4.8 million for the first quarter of 2008 from $2.7 in the firstquarter of 2007, predominantly due to an increase in commodity costs and to alesser extent, an increase in volume of units sold.  Some of the raw materials used arecommodity-based products and are subject to the same market fluctuationspreviously mentioned. We purchase certain raw materials under volume-basedpricing agreements and, as manufacturing production increases we experiencemore favorable pricing arrangements.

 

*LaborExpenses*

 

Laborexpenses, which include manufacturing-level labor costs, including taxes andassociated employee benefits, increased $0.3 million to $1.9 million forthe first quarter ended April 1, 2008 compared to $1.6 million for thesame period of the prior year. There was a negligible increase in employeebenefits, and the remainder this increase was due to an increase in unitsproduced as well as an increase in merit pay year-over-year, and increasedminimum wage rate increases at the federal level and in some states in which weoperate that went into effect starting January 2008.

 

*Other Operating Costs and Expenses*

 

Otheroperating costs and expenses consist of occupancy expenses (rent, insurance,licenses, taxes and utilities) and other operating expenses (excluding foodcosts and labor expenses reported separately). The change from the firstquarter 2008 compared to the same quarter in 2007 was negligible.

 

21

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***Franchise and License Operations***

 

Franchise and license revenue consists of a license orfranchise fee that is recorded in deferred revenue and recognized as incomeupon the fulfillment of certain start up support obligations, such as training,and ongoing royalty payments based on a percentage of the restaurant’s grosssales. Overall, licensee and franchisee revenue improved $0.2 million,or 18.5%, in the first quarter of 2008 as compared to the first quarter of2007. The percentage increase was predominantly due to improved comparablesales by franchisees and licensees of the Manhattan Bagel and Einstein Bros.brands and a net increase of 28 licensed restaurants, slightly offset by anet decrease of 12 franchised Manhattan Bagel restaurants.

 

***General and Administrative Expenses***

 

General andadministrative expenses include corporate and administrative functions thatsupport our company-owned restaurants as well as our manufacturing andcommissary, and franchise and license operations.  These costs include employee wages, taxes andrelated benefits, travel costs, information systems, recruiting and trainingcosts, corporate rent, and general insurance costs.

 

Overall, ourgeneral and administrative expenses were flat the first quarter ended April 1,2008 when compared to the same period in 2007. As a percentage of totalrevenues, our general and administrative expenses were 10.4% in the firstquarter ended April 1, 2008 compared to 11.1% for the same period in2007.  Compared to the first quarter of2007 there were increases in compensation expense primarily related toadditional merit pay and higher bonus expenses, and an increase in stock-basedcompensation expense.  These weredirectly offset by decreases in travel and management development expenses,costs of transitioning to a new distributor, recruiting, relocation andreferral fees related to senior level management positions and other expenses.

 

***Depreciation and Amortization***

 

Depreciation and amortization are periodic non-cash charges thatrepresent the reduction in usefulness and value of our tangible and intangibleassets.  The majority of our depreciationand amortization relates to equipment and leasehold improvements located in ourcompany-owned restaurants. Based on our current purchases of capital assets,our existing base of assets, and our projections for new purchases of fixedassets, we believe depreciation expense for 2008 will be approximately $13.9million.

 

Depreciation and amortization expenses increased $0.8 million for thefirst quarter of 2008 when compared to the same period in 2007. The increase isdue to the additional depreciation expense on our new corporate headquartersthat we moved into in May 2007 and the additional assets invested in thecompany-owned restaurants that were added since the first quarter of 2007.

 

***Loss on Sale, Disposal or Abandonment of Assets***

 

Gains andlosses on the sale, disposal or abandonment of assets represent the differenceof proceeds received, if any, and the net book value of an asset. We establishestimated useful lives for our assets, which range from three to eight years,and depreciate using the straight-line method. Leasehold improvements arelimited to the lesser of the useful life or the non-cancelable lease term. Theuseful lives of the assets are based upon our expectations of the period oftime that the asset will be used to generate revenue. We periodically reviewthe assets for changes in circumstances, which may impact their usefullives.  During the first quarter ended April 1,2008, we recorded $69,000 in losses on the disposal, sales or abandonment ofassets, compared to $374,000 for the same period in 2007.

 

***Interest Expense, Net***

 

In June 2007,we amended our debt facility and reduced our debt outstanding to $90 million,substantially decreasing our interest expense. The outstanding senior notes and other long-term debt as of April 1,2008 was $88.6 million compared to $170.2 million as of April 3,2007.   Net interest expense for thefirst quarter ended April 1, 2008 was $1.6 million, compared to $4.8 millionfor the same period in 2007.

 

22

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***Income Taxes***

 

We reported net income for the first quarter of 2008 of $3.8 million ascompared to net income of $1.1 million for the first quarter of 2007. For taxpurposes, utilization of our net operating loss (“NOL”) carryforwards reducedour effective tax rate and our federal and state income tax liability incurredfor the first quarter of 2008. We have recorded a provision for income taxes inthe amount of $142,000 related to our estimate of income taxes due on taxableearnings for the first quarter of 2008.

 

As of April 1, 2008, our NOL carryforwards for U.S. federal incometax purposes were $144.9 million, $98.3 million of which are subject to anannual usage limitation of $4.7 million, and were subject to the followingexpiration schedule:

 

**Net Operating Loss Carryforwards**

 

| **Expiration Date** | ** ** | **Amount**                                   | ** ** |
|--------------------------|------------|----------------------------------------------|------------|
| ** **               | ** ** | **(in thousands of dollars)** | ** ** |
| December 31,  2012  |       | $                                            | 2,201      |   |
| December 31,  2018  |       | $                                            | 14,553     |   |
| December 31,  2019  |       | $                                            | 6,862      |   |
| December 31,  2020  |       | $                                            | 10,424     |   |
| December 31,  2021  |       | $                                            | 10,515     |   |
| December 31,  2022  |       | $                                            | 35,688     |   |
| December 31,  2023  |       | $                                            | 42,362     |   |
| December 31,  2024  |       | $                                            | 12,003     |   |
| December 31,  2025  |       | $                                            | 5,413      |   |
| December 31,  2026  |       | $                                            | 4,900      |   |
|                     |       | $                                            | 144,921    |   |

 

Our ability to utilize theapproximately $46.6 million of our NOL carryforwards that are not currentlysubject to limitation could become limited, and our ability to utilize ourremaining net operating losses could be limited further, in the event that weundergo an “ownership change” as that term is defined for purposes of Section 382of the Internal Revenue Code.

 

Our net operating losscarryforwards are included in our deferred income tax assets; however, theultimate realization of these deferred income tax assets is dependent upon thegeneration of future taxable income. Due to the uncertainty of future taxableincome, deferred tax assets resulting from these NOL carryforwards have beenfully reserved.  Additionally, wemaintain a full valuation allowance against our total net deferred tax assets.If we conclude that our prospects for the realization of our deferred taxassets are more likely than not, we will then reduce our valuation allowance asappropriate and credit income tax expense after considering the following factors:

 

·  The level of historicaltaxable income and projections for future taxable income over periods in whichthe deferred tax assets would be deductible, and

 

·  Accumulation of net incomebefore tax utilizing a look-back period of three years.

 

**Consumer Spending Habits and Impact ofInflation**

 

Our results depend on consumer spending, which is influenced byconsumer confidence and disposable income. In particular, the effects of higherenergy and food costs, an increase in minimum balances payable on consumer and mortgagedebt, among other things, may impact discretionary consumer spending inrestaurants. Accordingly, we believe we experience declines in comparable storesales during economic downturns or during periods of 

 

23

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economic uncertainty. Any material decline in the amount ofdiscretionary spending could have a material adverse effect on our sales andincome.

 

**Impact of Agricultural Commodities**

 

Our cost of sales consists of cost of goods sold, labor expenses, andother operating costs and expenses. Wheat, butter, and cheese are our primary agricultural commodities andrepresent 11.2%, 3.4% and 2.5% of our cost of goods sold, respectively. Inaddition, coffee, chicken and turkey are the other major agriculturalcommodities and represent 3.6% of our cost of goods sold.   For the last few years, cost increases inone or more of our agricultural commodities were generally modest in relationto our total cost of sales. In 2007, however the price for a bushel of wheatbegan to rise at a rapid rate and reached new price levels that were, and arestill, in 2008, at unprecedented levels. The increase is due to substantiallylower harvests due to lower plantings, unfavorable weather conditions, and lostacreage to other competing crops. This situation was intensified by growingdemand both domestically and internationally which has resulted in low levelsof wheat inventory.

 

Towards the end of 2007, we entered into an agreement with a Cargill,Incorporated subsidiary to assist us in managing the price of our purchases ofwheat. Through this relationship we have secured our wheat requirements as wellas established the price for wheat for virtually all of our needs in fiscal2008. To offset the impact of higher wheat prices, we implemented a priceincrease in early 2008 at our Einstein Bros. restaurants and we intend toimplement a price increase in 2008 for our Noah’s restaurants.

 

**Impact of Inflation on Labor**

 

We pay many of our employee’s hourly rates slightly above theapplicable federal, state or municipal “living wage” rates. Ongoing changes inminimum wage laws have created pressure to increase the pay scale for ourassociates, which would increase our labor costs.

 

**Impact of Inflation on Other Elements of Cost**

 

We have experienced only a modest impact from inflation.  However, the impact of inflation on food andoccupancy costs could, in the future, significantly affect our operations.Costs for construction, taxes, repairs, maintenance and insurance all impactour occupancy costs. We believe our current strategy, which is to seek tomaintain operating margins through a combination of menu price increases, menumix, cost controls, efficient purchasing practices and careful evaluation ofproperty and equipment needs, has been an effective tool for dealing withinflation.

 

**Seasonality and Quarterly Results**

 

Our business is subject to seasonal fluctuations. Significant portionsof our net revenues and results of operations are realized during the fourthquarter of the fiscal year, which includes the December holiday season.Because of the seasonality of the business and the industry, results for anyquarter are not necessarily indicative of the results that may be achieved forany other quarter or the full fiscal year.

 

**Financial Condition, Liquidityand Capital Resources**

 

The restaurantindustry is predominantly a cash business where cash is received at the time ofthe transaction. We believe we will generate sufficient cash flow and havesufficient availability under our Revolving Facility to fund operations,capital expenditures and required debt and interest payments. Our inventoryturns frequently since our products are perishable. Accordingly, our investmentin inventory is minimal. Our accounts payable are on terms that we believe areconsistent with those of other companies within the industry.

 

24

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The primary driver of our operating cash flow is our restaurantoperations, specifically the gross margin from our company-owned restaurants.Therefore, we focus on the elements of those operations including comparablestore sales and cash flows to ensure a steady stream of operating profits thatenable us to meet our cash obligations. On a weekly basis, we review ourcompany-owned restaurant performance compared with the same period in the prioryear and our operating plan.

 

Based upon our projections for 2008 and 2009, we believe our varioussources of capital, including availability under existing debt facilities, andcash flow from operating activities of continuing operations, are adequate tofinance operations as well as the repayment of current debt obligations.

 

*Working Capital Surplus*

 

On April 1, 2008, we had unrestricted cash of $13.9 million andrestricted cash of $1.2 million. Under the Revolving Facility, there were nooutstanding borrowings, $7.3 million in letters of credit outstanding andborrowing availability of $12.7 million. Our working capital surplus improved$1.3 million to $4.9 million on April 1, 2008 compared to $3.7 million on January 1,2008, primarily due to the increased cash flow stemming from an increase inprofitability at our company-owned restaurants, a decrease in the accrual forproperty, plant and equipment that has been received but not paid, slightlyoffset by an increase in accrued expenses related to accrued bonuses.Short-term debt and the current portion of long-term debt increased by $0.2million related to the timing of when the payments are due compared to ourfiscal year-end.

 

*Cash Provided by Operations*

 

This $4.9 million increase was due primarily to a $2.7 million increasein net income and $2.1 million of changes to our operating assets andliabilities such as inventories, prepaid expenses and accrued expenses. Netcash generated by operating activities was $11.3 million for the first quarterof 2008 compared to $6.4 million for the first quarter of 2007.

 

*Cash Used in Investing Activities*

 

During the year to date period ended April 1, 2008, we usedapproximately $5.7 million of cash to purchase additional property andequipment that included $1.4 million to open three new restaurants in 2008,$0.7 million in payments for restaurants that opened in 2007, and $0.3 milliontowards eight restaurants that are currently under construction and arescheduled to open in 2008; $1.0 million for upgrading existing restaurants in2008, $0.1 million for restaurants that were upgraded in 2007 and $0.1 millionof upgrades that are in process and are scheduled to be completed in 2008; $1.7million for replacement of equipment at our existing company-owned restaurants,$0.1 million for equipment at our manufacturing operations, and $0.3 millionfor general corporate purposes.

 

We anticipate that the majority of our capital expenditures for fiscal2008 will be focused on the addition of at least 18 new company-ownedrestaurants during 2008 at an average capital investment of approximately$550,000 per restaurant, which varies depending upon square footage, layout andlocation. We also upgraded nine of our current restaurants during the quarterended April 1, 2008 and intend to upgrade at least 36 more during theremainder of 2008.

 

*Cash Used in Financing Activities*

 

Cash used in financing activities increased to $1.1 million for thefirst quarter of 2008 from $0.6 million in the first quarter of 2007 as aresult of repayments on our debt.

 

25

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*ContractualObligations*

 

The following table summarizes the amounts of payments due underspecified contractual obligations as of April 1, 2008:

 
| ** **                                             | ** ** | **Payments Due by Fiscal Period** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                              | ** ** | **2009 to 2011** | ** ** | **2012 to  2013** | ** ** | **2014 and  thereafter** | ** ** | **Total** | ** ** |
| ** **                                             | ** ** | **(in thousands of dollars)**                         | ** ** |
| Accounts payable and accrued expenses                  |       | $                                                     | 26,549     |   | $ | — |   | $ | — |   | $ | — |   | $ | 26,549 |   |
| Senior notes and other long-term debt                  |       | 730                                                   |       | 2,925 |   | 84,950 |   | — |   | 88,605 |   |
| Estimated interest expense on our debt  facility (a)   |       | 3,856                                                 |       | 15,315 |   | 2,822 |   | — |   | 21,993 |   |
| Manditorily redeemable, Series Z  Preferred Stock |       | —                                                |       | 57,000 |   | — |   | — |   | 57,000 |   |
| Minimum lease payments under capital leases            |       | 69                                                    |       | 73 |   | — |   | — |   | 142 |   |
| Minimum lease payments under operating  leases         |       | 20,855                                                |       | 64,122 |   | 12,153 |   | 11,039 |   | 108,169 |   |
| Purchase obligations (b)                               |       | 23,899                                                |       | 9,400 |   | — |   | — |   | 33,299 |   |
| Other long-term obligations (c)                        |       | —                                                |       | 750 |   | 500 |   | 5,575 |   | 6,825 |   |
| Total                                                  |       | $                                                     | 75,958     |   | $ | 149,585 |   | $ | 100,425 |   | $ | 16,614 |   | $ | 342,582 |   |

 

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(a)                                 Calculatedas of April 1, 2008, using the LIBOR and U.S. Prime rates, plus theapplicable margin in effect.  Because theinterest rates on the first lien term loan facility and the revolving creditfacility are variable, actual payments could differ materially.

 

(b)                                Purchaseobligations consist of non-cancelable minimum purchases of frozen dough andcertain other raw ingredients that are used in our products.

 

(c)                                 Otherlong-term obligations primarily consist of the remaining liability related tominimum future purchase commitments with a supplier that advanced us $10.0million in 1996.

 

*Insurance*

 

We are insured for losses related to health, general liability and workers’compensation under large deductible policies. The insurance liabilityrepresents an estimate of the ultimate cost of claims incurred and unpaid as ofthe balance sheet date. The estimated liability is established based onactuarial estimates, is discounted at 10% based upon a discrete analysis ofactual claims and historical data and is reviewed on a quarterly basis toensure that the liability is appropriate. If actual trends, including theseverity or frequency of claims, differ from our estimates our financialresults could be favorably or unfavorably impacted.  The estimated liability is included inaccrued expenses in our consolidated balance sheets.

 

**Off-Balance Sheet Arrangements**

 

*Guarantees*

 

Prior to 2001, we would occasionally guarantee leases for the benefitof certain of our franchisees. None of the guarantees has been modified sincetheir inception and we have since discontinued this practice. Currentfranchisees are the primary lessees under the vast majority of these leases.Under the lease guarantees, we may be required by the lessor to make all of theremaining monthly rental payments or property tax and common area maintenancepayments if the franchisee does not make the required payments in a timelymanner. However, we believe most, if not all, of the franchised locations couldbe subleased to third parties reducing 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. In 2007, and through the end of the first quarter of 2008, we havenot been required to make such payments in significant amounts. We record a 

 

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liability for our exposure under the guarantees in accordance withFinancial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 45,*Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers**.* In the event that trends changein the future, our financial results could be impacted. As of April 1,2008, we had outstanding guarantees of indebtedness under certain leases ofapproximately $1.2 million. Approximately $22,000 is reflected in accrued expenses in our consolidatedbalance sheet at April 1, 2008 for the guarantee of a franchisee’s lease.

 

*Letters of Credit*

 

As of April 1, 2008,we had $7.9 million in letters of credit outstanding. The letters of creditexpire on various dates during 2008, are automatically renewable for oneadditional year and are payable upon demand in the event that we fail to paythe underlying obligation. Of the total letters of credit outstanding, $7.3million reduce our availability under the Revolving Facility. Our availabilityunder the revolving facility was $12.7 million at April 1, 2008.

 

### ***Critical Accounting Policies and Estimates***

### * *

Inthe first quarter of 2008, we reviewed the depreciable lives of our assets anddetermined that the economic useful life for leasehold improvements on newrestaurants should be the shorter of 10 years or the life of the lease, whichis typically 10 years.  We alsodetermined that the economic useful lives of our restaurant upgrades should bethe shorter of 5 years or the life of the lease. However, as we approve ourrestaurants to be upgraded, we simultaneously review the lease, and typicallyonly upgrade those locations that have a renewal option and we are reasonablyassured that the lease will be renewed.

 

Inthe first quarter of 2008, we reviewed the expected term of our options and SAR’susing the guidance under SFAS 123(R) and SAB 110.  Previously, all options had an expected termof 4 years, but subsequent to our secondary offering and listing back onto theNASDAQ Global Market exchange, we determined that each plan should be evaluatedseparately and we revised the expected term for newly issued options.  We estimated that the expected term for the2003 Executive Employee Incentive Plan, the 2004 Stock Option Plan forIndependent Directors, and the Stock Appreciation Rights Plan should be 6years, 2.75 years and 3.25 years, respectively.

 

Theaffect of these two changes in estimates are recorded prospectively inaccordance with SFAS 154 *AccountingChanges and Error Corrections*. These changes, individually and in the aggregate, do not materiallychange the income from operations, net income or the net income per commonshare.

 

Therewere no other material changes in our critical accounting policies since thefiling of our 2007 Form 10-K. As discussed in that filing, the preparationof the consolidated financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makecertain estimates and assumptions that affect the amount of reported assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and revenues and expenses during theperiods reported. Actual results may differ from those estimates.

 

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**Item 3.  Qualitative and Quantitative Disclosures aboutMarket Risk**

 

During thefirst quarters ended April 1, 2008 and April 3, 2007, our results ofoperations, financial position and cash flows have not been materially affectedby changes in the relative values of non-U.S. currencies to the U.S. dollar. Wedo not use derivative financial instruments to limit our foreign currency riskexposure since virtually all of our business is conducted in the United States.

 

Ourmanufacturing operations sell bagels to a wholesaler and a distributor who takepossession in the United States and sell outside of the United States. As theproduct is shipped FOB domestic dock, there are no international risks of lossor foreign exchange currency issues. Sales shipped internationally are includedin manufacturing and commissary revenue. Approximately $1.2 million and $0.7million were included in manufacturing revenue for these internationalshipments for the first quarter of 2008 and 2007, respectively.

 

Our debt as ofApril 1, 2008 was principally comprised of the amended Revolving Facilityand First Lien Term Loan.  For fixed ratedebt, interest rate changes affect the fair market value of such debt but donot impact earnings or cash flows. Conversely for variable rate debt, includingborrowings under our revolving facility and first lien term loan, interest ratechanges generally do not affect the fair market value of such debt, but doimpact future earnings and cash flows, assuming other factors are heldconstant. A 100 basis point increase in short-term effective interest rateswould increase our interest expense by approximately $0.9 million annually,assuming no change in the size or composition of debt at April 1, 2008,and presuming the utilization of our accumulated net operating losses wouldminimize the tax implications for the next several years.  Currently, the interest rates on ourrevolving facility and first lien term loan are predominantly at LIBOR ratesplus an applicable margin through short-term fixed rate financing. Theestimated increase in interest expense incorporates the fixed interestfinancing into its assumptions. On May 7, 2008, we entered into an interestrate swap agreement, fixing our rate on $60 million of our debt to 3.52% plusan applicable margin for the next two years, effective August 2008.

 

On an annualbasis, we purchase a substantial amount of agricultural products that aresubject to fluctuations in price based upon market conditions. Our purchasearrangements may contain contractual features that limit the price paid byestablishing certain price floors or caps. We do not use financial instrumentsto hedge commodity prices.  We haverecently contracted with a subsidiary of Cargill, Incorporated to manage ourwheat purchases for our company-owned production facility.  In addition to wheat, we have establishedcontracts and entered into commitments with our vendors for butter, cheese,coffee and turkey.

 

This market risk discussion contains forward-looking statements. Actualresults may differ materially from this discussion based upon general marketconditions and changes in domestic and global financial markets.

 

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** **

**Item4.  Controls and Procedures**

 

*Evaluation of Disclosure Controls and Procedures*

 

Anevaluation was carried out under the supervision and with the participation ofcompany management, including our chief executive officer and chief financialofficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Rule 13a-15(e) under theSecurities Exchange Act of 1934, as amended) as of April 1, 2008. Basedupon that evaluation, our chief executive officer and our chief financialofficer have concluded that the design and operation of our disclosure controlsand procedures were effective in timely making known to them materialinformation relating to the Company required to be disclosed in reports that wefile or submit under the Exchange Act rules.

 

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

 

*Changes in Internal Control over Financial Reporting*

 

Duringthe quarter ended April 1, 2008, there were no changes to our internalcontrols over financial reporting that were identified in connection with theevaluation of our disclosure controls and procedures required by the ExchangeAct rules and that have materially affected, or are reasonably likely tomaterially affect, our internal controls over financial reporting.

 

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**PART II- OTHER INFORMATION**

 

**Item 1.    Legal Proceedings**

 

Informationregarding legal proceedings is incorporated by reference from Note 10 to ourConsolidated Financial Statements set forth in Part I of this report.

 

### ***Item 1A. Risk Factors***

### * *

Part I,Item 1A of our Annual Report on Form 10-K for the fiscal year ended January 1,2008 describes important factors that could cause our actual operating resultsto differ materially from those indicated or suggested by forward-lookingstatements made in this Form 10-Q or presented elsewhere by managementfrom time-to-time. These factors include but are not limited to the following:

 

**Risk Factors Relating to Our Business and Our Industry**

 

*Failure to protect food suppliesand adhere to food safety standards could result in food-borne illnesses and/orinjuries to our guests. Damage to our reputation for serving high quality, safefood could adversely affect our results.*

 

Food safety and reputation for quality is the most significant risk toany company that operates in the restaurant industry. Food safety is the focusof increased government regulatory initiatives at the local, state and federallevels.

 

Failure to protect our food supply or enforce food safety policies,such as proper food temperatures and adherence to shelf life dates, couldresult in food-borne illnesses and/or injuries to our guests. Also, ourreputation of providing high quality food is an important factor in choosingour restaurants. Instances of food borne illness, including listeriosis, salmonellaand e-coli, whether or not traced to our restaurants, could reduce demand forour menu offerings. If any of our guests become ill from consuming ourproducts, the affected restaurants may be forced to close. An instance of foodcontamination originating from one of our restaurants, our commissaries orsuppliers, or our manufacturing plant could have far-reaching effects, as thecontamination, or the perception of contamination could affect substantiallyall of our restaurants. In addition, publicity related to either productcontamination or recalls may cause our guests to cease frequenting ourrestaurants based on fear of such illnesses.

 

*Changesin consumer preferences and discretionary spending priorities could harm ourfinancial results.*

 

Numerous factors including changes in consumer tastes and discretionaryspending priorities often affect restaurants. Shifts in consumer preferencesaway from our type of cuisine and/or the fast-casual style could have amaterial adverse effect on our results of operations. Dietary trends, such asthe consumption of food low in carbohydrate content have, in the past, and may,in the future, negatively impact our sales.

 

Changes in our guests’ spending habits could also have a materialadverse effect on our sales. A variety of factors could affect discretionaryconsumer spending, including national, regional and local economic conditions,weather, inflation, consumer confidence, the effect of credit, includingmortgage markets, and energy costs. Adverse changes in any of these factorscould reduce consumers’ discretionary spending which in turn could reduce ourguest traffic or average check. For example, traffic to restaurantsindustry-wide was adversely affected in 2006 and 2007 as a result of reducedconsumer spending due to rising fuel and energy costs. Widespread national andinternational concern over instability in the credit markets has exacerbatedthe decline in consumer spending. The conditions experienced during 2007 andcontinuing into 2008 include, among other things: reduced consumer confidence;on-going concerns about the housing market and concerns over higher-riskmortgage loan products, such as sub-prime mortgage loans and increased energyprices. Adverse changes in consumer preferences or consumer discretionaryspending, each of which could be affected by many different factors which areout of our control, could harm our

 

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business prospects, financial condition, operating results and cashflows. Our continued success will depend in part on our ability to anticipate,identify and respond to changing consumer preferences and economic and otherconditions.

 

*Increasingcommodity prices would adversely affect our gross profit.*

 

Recent global demand for commodities such as wheat has resulted inhigher prices for flour and has increased our costs.  The prices of our main ingredients aredirectly associated with the changing weather conditions as well as economicfactors such as supply and demand of certain commodities within the UnitedStates and other countries.  Our abilityto forecast and manage our commodities could significantly affect our grossmargins.

 

Due to increased demand for ethanol, the cost of corn has increasedsubstantially, which has increased the cost of corn-sourced ingredients as wellas other commodities such as wheat, the primary ingredient in most of ourproducts.  We expect that this demand andthese commodity pressures to continue for 2008 and into 2009 as well. Anyincrease in the prices of the ingredients most critical to our products, suchas wheat, could adversely affect our operating results.

 

Additionally, in the event of massive culling of specific animals suchas chickens or turkeys to prevent the spread of disease, the supply andavailability of ingredients may become limited. This could dramaticallyincrease the price of certain menu items which could decrease sales of thoseitems or could force us to eliminate those items from our menus entirely. Allof these factors could adversely affect our business, reputation and financialresults.

 

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

 

Our success depends in part on our ability to understand and satisfythe needs of our guests, franchisees and licensees. Our business strategyconsists of several initiatives:

 

· expand sales at our existing company-owned restaurants;

· open new company-owned restaurants; and

· open new franchised and licensed restaurants.

 

Our ability to achieve any or all of these initiatives is uncertain.Our success in expanding sales at company-owned restaurants through varioussub-initiatives including: developing new menu offerings and broadening ourofferings across multiple dayparts, improving our ordering and productionsystems, expanding our catering program and upgrading our restaurants isdependent in part on our ability to predict and satisfy consumer preferences.Our success in growing our business through opening new company-ownedrestaurants is dependent on a number of factors, including our ability to: findsuitable locations, reach acceptable lease terms, have adequate capital, findavailable contractors, obtain licenses and permits, locate and trainappropriate staff and properly manage the new restaurant. Our success inopening new franchised and licensed restaurants is dependent upon, among otherfactors, our ability to: attract quality businesses to invest in our corebrands, maintain the effectiveness of our franchise disclosure documents in targetstates, offer restaurant solutions for a variety of location types and theability of our franchisees and licensees to: find suitable locations, reachacceptable lease terms, have adequate capital, find available contractors,obtain licenses and permits, locate and train staff appropriately and properlymanage the new restaurants. Accordingly, we may not be able to open or upgradeas many restaurants or grant as many franchises or licenses as we project orotherwise execute on our strategy. If we are not successful in implementing anyor all of the initiatives of our business strategy, it could have a materialadverse effect on our business, results of operations, and financial condition.

 

*Oursales and profit growth could be adversely affected if comparable store salesare less than we expect.*

 

The level of growth in comparable store sales significantly affects ouroverall sales growth and will be a critical factor affecting profit growth. Ourability to increase comparable store sales depends in part on our ability tooffer 

 

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hospitality and attractive menu items, and successfully implement ourinitiatives to increase throughput, such as increasing the speed at which ouremployees serve each guest. Factors such as traffic patterns, localdemographics and the type, number and location of competing restaurants mayadversely affect the performance of individual restaurants. It is possible thatwe will not achieve our targeted comparable store sales growth or that thechange in comparable store sales could be negative and could adversely impactour sales and profit growth.

 

*Competition in the restaurantindustry is intense, and we may fall short of our revenue and profitabilitytargets if we are unable to compete successfully.*

 

Our industry is highly competitive and there are many well-establishedcompetitors with substantially greater financial and other resources than wehave. Although we operate in the fast-casual segment of the restaurantindustry, we also consider restaurants in the fast-food and full-servicesegments to be our competitors. Several fast-casual and fast-food chains haveannounced their intentions to focus more on breakfast offerings and look toexpand their coffee offerings. This could further increase competition in thebreakfast daypart. In addition to current competitors, one or more new majorcompetitors with substantially greater financial, marketing and operatingresources could enter the market at any time and compete directly against us.Also, in virtually every major metropolitan area in which we operate or expectto enter, local or regional competitors already exist. This may make it moredifficult to obtain real estate and advertising space, and to attract andretain guests and personnel.

 

*We occupy our company-ownedrestaurants under long-term non-cancelable leases, and we may be unable torenew leases at the end of their lease periods or obtain new leases onacceptable terms.*

 

We do not own any real property, and all of our company-ownedrestaurants are located in leased premises. Many of our current leases arenon-cancelable and typically have terms ranging from five to ten years with twothree- to five-year renewal options. We believe leases that we enter into inthe future likely will also be long-term and non-cancelable and have similarrenewal options. Most of our leases provide that the landlord may increase therent over the term of the lease, and require us to pay our proportionate shareof the cost of insurance, taxes, maintenance and utilities. If we close arestaurant, we generally remain committed to perform our obligations under theapplicable lease, which would include, among other things, payment of the baserent for the balance of the lease term. In some instances, we may be unable toclose an underperforming restaurant due to continuous operation clauses in ourlease agreements. Our obligation to continue making rental payments in respectof leases for closed or underperforming restaurants could have a material adverseeffect on our business and results of operations.

 

Alternatively, at the end of the lease term and any renewal period fora restaurant, we may be unable to renew the lease without substantialadditional cost, if at all. If we are unable to renew our restaurant leases, wemay be forced to close or relocate a restaurant, which could subject us toconstruction and other costs and risks, and could have a material adverseeffect on our business and results of operations. For example, closing arestaurant, even during the time of relocation, will reduce the sales that therestaurant would have contributed to our revenues. Additionally, the revenueand profit, if any, generated at a relocated restaurant may not equal therevenue and profit generated at the existing restaurant. We also facecompetition from both restaurants and other retailers for suitable sites fornew restaurants. As a result, we may not be able to secure or renew leases foradequate sites at acceptable rent levels.

 

*The cost of natural resources,such as energy, together with the cost, availability and quality of our rawingredients affect our results of operations.*

 

The cost, availability and quality of the ingredients that we use toprepare our food are subject to a range of factors, many of which are beyondour control. Fluctuations in economic and political conditions, product demandweather, crops planted, and natural resources such as electricity, water, andfuel could adversely affect the cost of our ingredients. We have limitedcontrol over changes in the price and quality of these natural resources, sincewe typically do not enter into long-term pricing agreements for our ingredientsand production costs, such as energy and fuel. We may not be able to passthrough any future cost increases by increasing menu prices, as we have done inthe past. We and our franchisees and licensees are dependent on a constantsupply of energy, frequent deliveries 

 

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of fresh ingredients, and regular consumption of fuel, therebysubjecting us to the risk of shortages or interruptions in supply of any ofthese items.

 

The cost of energy impacts our results of operations in severalways.  We have seen our cost ofelectricity gradually increase over time. Distribution costs related to fuelhave impacted our operations negatively. Additionally, travel costs, includinggas prices and airline fares, have been steadily increasing nationwide. Thesecosts impact our results of operation currently and could impact us negativelyin the future.

 

*Ouroperations may be negatively impacted by adverse weather conditions and naturaldisasters.*

 

Adverse weather conditions and natural disasters could seriously affectregions in which our company-owned, franchised and licensed restaurants arelocated or regions that produce raw ingredients for our restaurants. If adverseweather conditions or natural disasters such as fires and hurricanes affect ourrestaurants, we could experience closures, repair and restoration costs, foodspoilage, and other significant reopening costs as well as increased food costsand delayed supply shipments, any of which would adversely affect our business.Additionally, during periods of extreme temperatures (either hot or cold) orprecipitation, many individuals choose to stay inside. This negatively impactstransaction counts in our restaurants and over extended periods of time couldadversely affect our business and results of operations.

 

The effects of hurricanes, fires, freezes and other adverse weatherconditions are likely to affect supply of and costs for raw ingredients andnatural resources, near-term construction costs for our new restaurants as wellas sales in our restaurants going forward. If we are not able to anticipate orreact to changing costs of food and other raw materials by adjusting ourpurchasing practices or menu prices, our operating margins would likelydeteriorate.

 

*We have single suppliers for mostof our key ingredients, and the failure of any of these suppliers to performcould harm our business.*

 

We currently purchase our raw materials from various suppliers;however, we have only one supplier for each of our key ingredients. We purchasea majority of our frozen bagel dough from a single supplier, who utilizes ourproprietary processes and on whom we are dependent in the short-term. All ofour remaining frozen bagel dough is produced at our dough manufacturingfacility in Whittier, California. Additionally, we purchase all of our creamcheese and coffee from a single source. Although to date we have notexperienced significant difficulties with our suppliers, our reliance on asingle supplier for each of our key ingredients subjects us to a number ofrisks, including possible delays or interruption in supplies, diminished controlover quality and a potential lack of adequate raw material capacity. Anydisruption in the supply or degradation in the quality of the materialsprovided by our suppliers could have a material adverse effect on our business,operating results and financial condition. In addition, any such disruptions insupply or degradations in quality could have a long-term detrimental impact onour efforts to maintain a strong brand identity and a loyal consumer base.

 

*Failure of our distributors toperform adequately or any disruption in our distributor relationships couldadversely affect our business and reputation.*

 

Wedepend on our network of independent regional distributors to distribute frozenbagel dough and other products and materials to our company-owned, franchisedand licensed restaurants. Any failure by one or more of our distributors toperform as anticipated, or any disruption in any of our distributionrelationships for any reason, would subject us to a number of risks, includinginadequate products delivered to our restaurants, diminished control overquality of products delivered, and increased operating costs to prevent delaysin deliveries. Any of these events could harm our relationships with ourfranchisees or licensees, or diminish the reputation of our menu offerings orour brands in the marketplace. In addition, a negative change in the volume ofproducts ordered from our distributors by our company-owned, franchised and/orlicensed restaurants could increase our distribution costs. These risks couldhave a material adverse effect on our business, financial condition and resultsof operations.

 

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In early 2008, one of our distributors announced its intention torelocate part of its distribution network in the southeast.  If this transition or relocation does not gosmoothly, this could adversely affect our operations.

 

*Increasinglabor costs could adversely affect our results of operations and cash flows.*

 

We are dependent upon an available labor pool of associates, many ofwhom are hourly employees whose wages may be affected by increases in thefederal, state or municipal “living wage” rates. Numerous increases have beenmade on federal, state and local levels to increase minimum wage levels. Increasesin state minimum hourly wage rates in some of the states in which we operatebecame effective January 2008, and the federal government has recentlyenacted minimum wage increases for 2008 and we expect the minimum wage will beraised again in 2009. Increases in the minimum wage may create pressure toincrease the pay scale for our associates, which would increase our labor costsand those of our franchisees and licensees.

 

A shortage in the labor pool or other general inflationary pressures orchanges could also increase labor costs. In addition, changes in labor laws orreclassifications of associates from management to hourly employees couldaffect our labor cost. An increase in labor costs could have a material adverseeffect on our income from operations and decrease our profitability and cashflows if we are unable to recover these increases by raising the prices wecharge our guests.

 

*We may not be able to generatesufficient cash flow to make payments on our substantial amount of debt andmandatorily redeemable preferred stock.*

 

We have a considerable amount debt and are substantially leveraged. Asof January 1, 2008, we had $88.6 million in term loans outstanding.  We also have $57.0 million of mandatorilyredeemable preferred stock due June 30, 2009.  In addition, we may, subject to certainrestrictions, incur substantial additional indebtedness in the future. Our highlevel of debt, among other things, could:

 

· make it difficult for us to satisfy our obligations under ourindebtedness;

· limit our ability to obtainadditional financing for working capital, capital expenditures, acquisitionsand general corporate purposes;

· increase our vulnerability to downturns in our business or the economygenerally;

· increase our vulnerability to volatility in interest rates; and

· limit our ability to withstand competitive pressures from our lessleveraged competitors.

 

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 were 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 on terms that are not favorable to us, selling assets or issuingadditional equity securities. We may not be able to accomplish any of thesealternatives on satisfactory terms, if at all, and even if accomplished, theymay not yield sufficient funds to service our debt.

 

*We must comply with certaincovenants inherent in our debt agreements to avoid defaulting under thoseagreements.*

 

Our current debt agreements contain certain covenants, which, amongothers, include certain financial covenants such as limitations on capitalexpenditures, maintenance of the business, use of proceeds from sales of assetsand consolidated leverage and fixed charge coverage ratios as defined in theagreements. The covenants also preclude the declaration and payment ofdividends or other distributions to holders of our common stock. We are subjectto multiple economic, financial, competitive, legal and other risks that arebeyond our control and could harm our future financial results. Any adverseeffect on our business or financial results could affect our ability tomaintain 

 

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compliance with our debt covenants, and any failure by us to complywith these covenants could result in an event of default. If we were to defaultunder our covenants and such default were not cured or waived, our indebtednesscould become immediately due and payable, which could render us insolvent.

 

*We facethe risk of adverse publicity and litigation 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,improper classification of management employees as exempt employees or otherlabor code violations may divert financial and management resources that wouldotherwise be used to benefit our future performance. There is also a risk oflitigation from our franchisees with regard to the terms of our franchisearrangements. We have been subject to a variety of these and other claims fromtime to time, and although these claims have not historically had a materialimpact on our operations, a significant increase in the number of these claimsor the number that are successful, including the claims described in Note 10 toour Consolidated Financial Statements set forth in Part I of this report,could materially adversely affect our business, prospects, financial condition,operating results or cash flows.

 

*Aregional or global health pandemic could severely affect our business.*

 

A health pandemic is a disease that spreads rapidly and widely byinfection and affects many individuals in an area or population at the sametime. In 2004, 2005 and 2006, Asian and European countries experiencedoutbreaks of avian flu and it is possible that it will continue to migrate tothe United States where our restaurants are located. If a regional or globalhealth pandemic were to occur, depending upon its duration and severity, ourbusiness could be severely affected. We have positioned ourselves as a “neighborhoodatmosphere” between home and work where people can gather for human connectionand high quality food. Customers might avoid public gathering places in theevent of a health pandemic, and local, regional or national governments might limitor ban public gatherings to halt or delay the spread of disease. A regional orglobal pandemic might also adversely impact our business by disrupting ordelaying production and delivery of products and materials in our supply chainand causing staff shortages in our restaurants. The impact of a health pandemicmight be disproportionately greater on us than on other companies that dependless on the gathering of people in a neighborhood atmosphere.

 

*Our franchisees and licensees maynot help us develop our business as we expect, or could actually harm ourbusiness.*

 

We rely in part on our franchisees and licensees and the manner inwhich they operate their restaurants to develop and promote our business.Although we have developed criteria to evaluate and screen prospectivecandidates, the candidates may not have the business acumen or financialresources necessary to operate successful restaurants in their respectiveareas. In addition, franchisees and licensees are subject to business riskssimilar to what we face such as competition, consumer acceptance, fluctuationsin the cost, availability and quality of raw ingredients, and increasing laborcosts. The failure of franchisees and licensees to operate successfully couldhave a material adverse effect on us, our reputation, our ability to collectroyalties, our brands and our ability to attract prospective candidates.  Potential franchisees and licensees may havedifficulty obtaining proper financing as a result of the downturn in the creditmarkets.  As we offer and grantfranchises for our Einstein Bros. brand, our reliance on our franchisees isexpected to increase in proportion to growth of the franchisee base. Withrespect to franchising our Einstein Bros. brand, we may not be able to identifyfranchisees that meet our criteria, or to enter into franchise area developmentagreements with prospective franchisee candidates that we identify. As aresult, our franchise program for the Einstein Bros. brand may not grow at therate we currently expect, or at all.

 

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*Our restaurants and products aresubject to numerous and changing government regulations. Failure to complycould negatively affect our sales, increase our costs or result in fines orother penalties against us.*

 

Each of our restaurants is subject to licensing and regulation by thehealth, sanitation, safety, labor, building and fire agencies of the respectivestates, counties, cities and municipalities in which it is located. A failureto comply with one or more regulations could result in the imposition ofsanctions, including the closing of facilities for an indeterminate period oftime, or third party litigation, any of which could have a material adverseeffect on us and our results of operations.

 

Many recent government bodies have begun to legislate or regulatehigh-fat and high sodium foods as a way of combating concerns about obesity andhealth. Several municipalities are requiring restaurants and other food serviceestablishments to phase-out artificial trans-fat by certain dates in 2008,including New York City, New York, Philadelphia, Pennsylvania, and King County(Seattle), Washington. Many other states are considering laws banning trans-fatin restaurant food. Because we do use trans-fat in a few of our products,federal, state or local regulations in the future may limit sales of certain ofour foods or ingredients. Public interest groups have also focused attention onthe marketing of high-fat and high-sodium foods to children in a stated effortto combat childhood obesity. San Francisco and New York City have recentlyadopted regulations requiring disclosure of nutritional, including calorieinformation on menus and/or menu boards. Additional cities or states maypropose or adopt similar regulations. The cost of complying with theseregulations could increase our expenses and the possible negative publicityarising from such legislative initiatives could reduce our future sales.

 

Our franchising operations are subject to regulation by the FederalTrade Commission. We must also comply with state franchising laws and a widerange of other state and local rules and regulations applicable to ourbusiness. The failure to comply with federal, state and local rules andregulations would have an adverse effect on 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 maynot be able to protect our trademarks, service marks and other proprietaryrights.*

 

We believe our trademarks, service marks and other proprietary rightsare important to our success and our competitive position. Accordingly, wedevote substantial resources to the establishment and protection of ourtrademarks, service marks and proprietary rights. However, the actions we takemay be inadequate to prevent imitation of our products and concepts by othersor to prevent others from claiming violations of their trademarks andproprietary rights by us. In addition, others may assert rights in ourtrademarks, service marks and other proprietary rights.

 

*Our ability to use net operatingloss carryforwards to offset future taxable income for U.S. federal income taxpurposes is subject to limitation.*

 

In general, under Section 382 of the Internal Revenue Code, acorporation that undergoes an “ownership change” is subject to limitations onits ability to utilize its pre-change net operating loss (“NOL”) carryforwardsto offset future taxable income. A corporation generally undergoes an “ownershipchange” when the stock ownership percentage (by value) of its “5 percentstockholders” increases by more than 50 percentage points over any three-yeartesting period.

 

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As of April 1, 2008, our NOL carryforwards for U.S. federal incometax purposes were approximately $144.9 million. As a result of prior ownershipchanges, approximately $98.3 million of our NOL carryforwards are subject to anannual usage limitation of $4.7 million. Due to transactions involving the saleor other transfer of our stock from the date of our last ownership changethrough the date of the secondary public offering of our common stock, andchanges in the value of our stock during that period, such offering may resultin an additional ownership change for purposes of Section 382 or willsignificantly increase the likelihood that we will undergo an additionalownership change in the future (which could occur as a result of transactionsinvolving our stock that are outside of our control).   In either event, the occurrence of anadditional ownership change would limit our ability to utilize theapproximately $46.6 million of our NOL carryforwards that are not currentlysubject to limitation, and could further limit our ability to utilize ourremaining NOL carryforwards and possibly other tax attributes. Limitationsimposed on our ability to use NOL carryforwards and other tax attributes tooffset future taxable income could cause us to pay U.S. federal income taxesearlier than we otherwise would if such limitations were not in effect, andcould cause such NOL carryforwards and other tax attributes to expire unused,in each case reducing or eliminating the benefit of such NOL carryforwards andother tax attributes to us and adversely affecting our future cash flow. We arein the process of filing a request with the Internal Revenue Service to reviewour methodology for determining ownership changes in accordance with InternalRevenue Code Section 382.  Uponacceptance of our request, we believe that our NOL carryforwards will beavailable for utilization.  In the eventthat our request is not accepted, approximately $17.9 million of NOLcarryforwards will be at risk to expire prior to utilization.  There can be no assurance that we willrealize any U.S. federal income tax benefit from any of our NOL carryforwards.Similar rules and limitations may apply for state income tax purposes aswell.

 

**Risk Factors Relating to Our Common Stock**

 

*We havea majority stockholder.*

 

Greenlight Capital, L.L.C. and its affiliates beneficially ownapproximately 67.4% of our common stock. As a result, Greenlight has sufficientvoting power, without the vote of any other stockholders, to determine whatmatters will be submitted for approval by our stockholders, to approve actionsby written consent without the approval of any other stockholders, to elect allof the members of our board of directors, and to determine whether a change incontrol of our company occurs. Greenlight’s interests on matters submitted tostockholders may be different from those of other stockholders. Greenlight isnot involved in our day-to-day operations, but Greenlight has voted its sharesto elect our current board of directors. The chairman of our board of directorsis a current employee of Greenlight.

 

We have listed our common stock on the NASDAQ Global Market. NASDAQ rules willrequire us to have an audit committee consisting entirely of independentdirectors. However, under NASDAQ rules, if a single stockholder holds more that50% of the voting power of a listed company, that company is considered acontrolled company, and is exempt from several other corporate governancerules, including the requirement that companies have a majority of independentdirectors and independent director involvement in the selection of directornominees and in the determination of executive compensation. As a result, ourstockholders will not have, and may never have, the protections that these rules areintended to provide. The Company currently has a majority of independentdirectors on the board of directors.

 

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

 

Ifa substantial number of shares of our common stock are sold in the publicmarket, the market price of our common stock could fall. The perception amonginvestors that these sales will occur could also produce this effect. Ourmajority stockholder, Greenlight, beneficially owns approximately 67.4% of ourcommon stock and sales by Greenlight or a perception that Greenlight will sellcould cause a decrease in the market price of our common stock.

 

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**Item 6.  Exhibits**

 

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

 

31.2         Certification by Chief FinancialOfficer pursuant to Exchange Act Rule 13a-15(e), as adopted pursuant to Section302 of the Sarbanes-Oxley Act of 2002

 

32.1         Certification by ChiefExecutive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuantto Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2         Certification by ChiefFinancial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuantto Section 906 of the Sarbanes-Oxley Act of 2002

 

32.3         Certification by ChiefAccounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuantto Section 906 of the Sarbanes-Oxley Act of 2002

 

**Signatures**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|   |        | EINSTEIN NOAH RESTAURANT  GROUP, INC. |
|--------|-------------|---------------------------------------|
|   |        |                                  |
|   |        |                                  |
| Date:  | May 8, 2008 | By: /s/ PAUL J. B. MURPHY, III   |
|   |        | Paul J.B. Murphy, III            |
|   |        | Chief Executive Officer               |
|   |        |                                  |
| Date:  | May 8, 2008 | By: /s/ RICHARD P.  DUTKIEWICZ        |
|   |        | Richard P. Dutkiewicz                 |
|   |        | Chief Financial Officer               |

 

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