**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **(Mark One)**                                                                                                      |
|---------------------------------------------------------------------------------------------------------------------|
| **ý****  QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                |
| **For the quarterly period ended  March 30, 2004**                                                             |
|                                                                                                                |
| **OR**                                                                                                              |
|                                                                                                                |
| **o****  TRANSITION REPORT UNDER SECTION 13 OR  15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**           |
|                                                                                                                |
| **Commission File Number 0-27148**                                                                                  |

 

**New World Restaurant Group, Inc**.

(Name of Registrant as Specified in itsCharter)

 

| **Delaware**                                                      |   | **13-3690261**                        |
|-------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction  of Incorporation or Organization)   |   | (I.R.S. Employer  Identification No.) |
|                                                              |   |                                  |
| **1687 Cole Blvd., Golden, Colorado  80401**                 |
| (Address of principal executive offices,  including zip code)     |
|                                                              |   |                                  |
| **(303) 568-8000**                                                |
| (Registrant’s telephone number, including  area code)        |
|                                                              |   |                                  |
| Securities registered pursuant to  Section 12(b) of the Act: |
| **None**                                                          |
|                                                              |   |                                  |
| Securities registered pursuant to  Section 12(g) of the Act: |
| **Common Stock, $.001 par value**                                 |

 

 

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

 

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

 

As of May 10, 2004, 9,842,385 shares of Common Stockof the registrant were outstanding.

 

 

----

 

**NEW WORLD RESTAURANT GROUP, INC.**

 

March 30, 2004

 

TABLE OF CONTENTS

 
| **Part I**.  **Financial Information** |                                                                                                                         |
|---------------------------------------------|------------------------------------------------------------------------------------------------------------------------------|
|                                        |                                                                                                                         |   |
| Item  1.                                    | Financial Statements:                                                                                                        |   |
|                                        |                                                                                                                         |   |
|                                        | Consolidated  Balance Sheets, March 30, 2004 (unaudited) and December 30, 2003                                     |   |
|                                        |                                                                                                                         |   |
|                                        | Consolidated Statements of Operations, for the thirteen weeks ended  March 30, 2004 and April 1, 2003 (unaudited)  |   |
|                                        |                                                                                                                         |   |
|                                        | Consolidated  Statements of Cash Flows, for the thirteen weeks ended March 30, 2004  and April 1, 2003 (unaudited) |   |
|                                        |                                                                                                                         |   |
|                                        | Notes to the Consolidated Financial Statements                                                                               |   |
|                                        |                                                                                                                         |   |
| Item 2.                                     | Management’s Discussion and Analysis of Financial Condition and  Results of Operations                                  |   |
|                                        |                                                                                                                         |   |
| Item 3.                                     | Quantitative and Qualitative Disclosures  about Market Risk                                                                  |   |
|                                        |                                                                                                                         |   |
| Item 4.                                     | Controls and Procedures                                                                                                      |   |
|                                        |                                                                                                                         |   |
| **Part II. Other Information**              |                                                                                                                         |
|                                        |                                                                                                                         |   |
| Item 1.                                     | Legal Proceedings                                                                                                            |   |
|                                        |                                                                                                                         |   |
| Item 6.                                     | Exhibits and Reports on Form 8-K                                                                                             |   |

 

2

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**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**AS OF MARCH 30, 2004 AND DECEMBER 30, 2003**

(in thousands, except share information)

 
|                                                                                                                                                                       |   | **March 30,  2004** |    | **December 30,  2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                                                                                                                                                                       |   | **(Unaudited)**          |    |                        |   |
| **ASSETS**                                                                                                                                                                 |   |                     |    |                        |   |
| Current assets:                                                                                                                                                            |   |                     |    |                        |   |
| Cash and cash equivalents                                                                                                                                                  |   | $                        | 2,039   |                        | $      | 9,575 |   |
| Restricted cash                                                                                                                                                            |   | 1,961                    |    | 1,815                       |   |
| Franchise and other receivables, net of  allowance                                                                                                                         |   | 5,570                    |    | 5,842                       |   |
| Inventories                                                                                                                                                                |   | 4,572                    |    | 4,831                       |   |
| Prepaid expenses and other current assets                                                                                                                                  |   | 3,064                    |    | 2,650                       |   |
| Total current assets                                                                                                                                                       |   | 17,206                   |    | 24,713                      |   |
|                                                                                                                                                                       |   |                     |    |                        |   |
| Restricted cash long-term                                                                                                                                                  |   | 3,037                    |    | 3,036                       |   |
| Property, plant and equipment, net                                                                                                                                         |   | 66,879                   |    | 67,800                      |   |
| Trademarks and other intangibles, net                                                                                                                                      |   | 83,474                   |    | 85,431                      |   |
| Goodwill                                                                                                                                                                   |   | 4,875                    |    | 4,875                       |   |
| Debt issuance costs and other assets                                                                                                                                       |   | 8,712                    |    | 9,170                       |   |
| Total assets                                                                                                                                                               |   | $                        | 184,183 |                        | $      | 195,025 |   |
|                                                                                                                                                                       |   |                     |    |                        |   |
| **LIABILITIES AND  STOCKHOLDERS’ DEFICIT**                                                                                                                            |   |                     |    |                        |   |
| Current liabilities:                                                                                                                                                       |   |                     |    |                        |   |
| Accounts payable                                                                                                                                                           |   | $                        | 8,051   |                        | $      | 8,189 |   |
| Accrued expenses                                                                                                                                                           |   | 30,987                   |    | 37,871                      |   |
| Short term debt and current portion of  long-term debt                                                                                                                     |   | 1,105                    |    | 2,105                       |   |
| Current portion of obligations under  capital leases                                                                                                                       |   | 104                      |    | 180                         |   |
| Total current liabilities                                                                                                                                                  |   | 40,247                   |    | 48,345                      |   |
|                                                                                                                                                                       |   |                     |    |                        |   |
| Senior notes and other long-term debt                                                                                                                                      |   | 161,120                  |    | 161,120                     |   |
| Obligations under capital leases                                                                                                                                           |   | 29                       |    | 29                          |   |
| Other liabilities                                                                                                                                                          |   | 10,209                   |    | 10,397                      |   |
| Mandatorily redeemable, Series Z Preferred  Stock, $.001 par value, $1,000 per share liquidation value; 2,000,000 shares  authorized; 57,000 shares issued and outstanding |   | 57,000                   |    | 57,000                      |   |
| Total liabilities                                                                                                                                                          |   | 268,605                  |    | 276,891                     |   |
|                                                                                                                                                                       |   |                     |    |                        |   |
| Stockholders’ deficit:                                                                                                                                                |   |                     |    |                        |   |
| Common stock, $.001 par value; 15,000,000  shares authorized; 9,841,828 shares issued and outstanding                                                                      |   | 10                       |    | 10                          |   |
| Additional paid-in capital                                                                                                                                                 |   | 175,585                  |    | 175,585                     |   |
| Accumulated deficit                                                                                                                                                        |   | (260,017                 | )       | (257,461                    | )      |
| Total stockholders’ deficit                                                                                                                                           |   | (84,422                  | )       | (81,866                     | )      |
| Total liabilities and stockholders’ deficit                                                                                                                           |   | $                        | 184,183 |                        | $      | 195,025 |   |

 

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

 

3

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**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**FOR THE THIRTEEN WEEKS ENDED MARCH 30, 2004 ANDAPRIL 1, 2003**

 

**(UNAUDITED)**

(in thousands, except earnings per share and related share information)

 
|                                                   |   | **Thirteen  weeks ended:** |   |
|--------------------------------------------------------|--------|----------------------------|--------|
|                                                   |   | **March 30,  2004**   |   | **April 1,  2003** |   |
| Revenues:                                              |   |                       |   |   |   |
| Retail sales                                           |   | $                          | 84,623 |   | $ | 88,449 |   |
| Manufacturing revenues                                 |   | 5,413                      |   | 5,424 |   |
| Franchise and license related revenues                 |   | 1,160                      |   | 1,338 |   |
|                                                   |   |                       |   |   |   |
| Total revenues                                         |   | 91,196                     |   | 95,211 |   |
|                                                   |   |                       |   |   |   |
| Cost of sales:                                         |   |                       |   |   |   |
| Retail costs                                           |   | 70,087                     |   | 72,954 |   |
| Manufacturing costs                                    |   | 4,578                      |   | 5,041 |   |
|                                                   |   |                       |   |   |   |
| Total cost of sales                                    |   | 74,665                     |   | 77,995 |   |
|                                                   |   |                       |   |   |   |
| Gross profit                                           |   | 16,531                     |   | 17,216 |   |
| Gross profit percentage                                |   | 18.1                       | %      | 18.1 | % |
|                                                   |   |                       |   |   |   |
| General and administrative expenses                    |   | 8,818                      |   | 10,254 |   |
| Depreciation and amortization                          |   | 5,238                      |   | 7,205 |   |
| Adjustment of integration and  reorganization cost     |   | (760                       | )      | — |   |
|                                                   |   |                       |   |   |   |
| Income (loss) from operations                          |   | 3,235                      |   | (243 | ) |
|                                                   |   |                       |   |   |   |
| Interest expense, net                                  |   | (5,799                     | )      | (8,295 | ) |
| Cumulative change in the fair value of  derivatives    |   | —                     |   | 657 |   |
| Other income                                           |   | 63                         |   | 249 |   |
|                                                   |   |                       |   |   |   |
| Loss before income taxes                               |   | (2,501                     | )      | (7,632 | ) |
|                                                   |   |                       |   |   |   |
| Provision for state income taxes                       |   | (55                        | )      | (110 | ) |
|                                                   |   |                       |   |   |   |
| Net loss                                               |   | (2,556                     | )      | (7,742 | ) |
| Dividends and accretion on Preferred Stock             |   | —                     |   | (4,602 | ) |
|                                                   |   |                       |   |   |   |
| Net loss available to common stockholders              |   | $                          | (2,556 | ) | $ | (12,344 | ) |
|                                                   |   |                       |   |   |   |
| Net loss per common share – Basic and  Diluted    |   | $                          | (0.26  | ) | $ | (8.10 | ) |
|                                                   |   |                       |   |   |   |
| Weighted average number of common shares  outstanding: |   |                       |   |   |   |
| Basic and Diluted                                      |   | 9,841,828                  |   | 1,523,152 |   |

 

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

 

4

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**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**FOR THE THIRTEEN WEEKS ENDED MARCH 30, 2004 ANDAPRIL 1, 2003**

 

 

**(UNAUDITED)**

(in thousands)

 
|                                                                         |   | **Thirteen  weeks ended:** |   |
|------------------------------------------------------------------------------|--------|----------------------------|--------|
|                                                                         |   | **March 30,  2004**   |   | **April 1,  2003** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                        |   |                       |   |   |   |
| Net loss                                                                     |   | $                          | (2,556 | ) | $ | (7,742 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                       |   |   |   |
| Depreciation and amortization                                                |   | 5,238                      |   | 7,205 |   |
| Adjustments of integration and  reorganization costs                         |   | (760                       | )      | — |   |
| Cumulative change in fair value of  derivatives                              |   | —                     |   | (657 | ) |
| Amortization of debt issuance and debt  discount costs                       |   | 462                        |   | 574 |   |
| Notes issued as paid in kind for interest  on Bridge Loan                    |   | —                     |   | 227 |   |
| Greenlight interest                                                          |   | —                     |   | 517 |   |
| Changes in operating assets and  liabilities:                                |   |                       |   |   |   |
| Franchise and other receivables                                              |   | 272                        |   | (405 | ) |
| Accounts payable and accrued expenses                                        |   | (6,262                     | )      | 2,273 |   |
| Other assets and liabilities                                                 |   | (570                       | )      | (5,409 | ) |
|                                                                         |   |                       |   |   |   |
| Net cash used in operating activities                                        |   | (4,176                     | )      | (3,417 | ) |
|                                                                         |   |                       |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                        |   |                       |   |   |   |
| Purchase of property and equipment                                           |   | (2,360                     | )      | (2,080 | ) |
|                                                                         |   |                       |   |   |   |
| Net cash used in investing activities                                        |   | (2,360                     | )      | (2,080 | ) |
|                                                                         |   |                       |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                        |   |                       |   |   |   |
| Proceeds (repayments) of line of credit,  net                                |   | (1,000                     | )      | 1,050 |   |
|                                                                         |   |                       |   |   |   |
| Net cash provided by (used in) financing  activities                         |   | (1,000                     | )      | 1,050 |   |
|                                                                         |   |                       |   |   |   |
| Net decrease in cash                                                         |   | (7,536                     | )      | (4,447 | ) |
| Cash and cash equivalents, beginning of  period                              |   | 9,575                      |   | 10,705 |   |
|                                                                         |   |                       |   |   |   |
| Cash and cash equivalents, end of period                                     |   | $                          | 2,039  |   | $ | 6,258 |   |
|                                                                         |   |                       |   |   |   |
| SUPPLEMENTAL CASH FLOW INFORMATION:                                          |   |                       |   |   |   |
| Cash paid for interest                                                       |   | $                          | 10,130 |   | $ | 6,967 |   |
|                                                                         |   |                       |   |   |   |
| Cash paid for income taxes                                                   |   | $                          | 98     |   | $ | 110 |   |

 

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

 

5

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**NEW WORLD RESTAURANT GROUP, INC.**

 

Notes to Consolidated Financial Statements(Unaudited)

 

Thirteen week period ended March 30,2004 and April 1, 2003

**1.****             ****Basis ofPresentation**

 

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

 

The accompanying consolidated financial statements as of March 30, 2004 andDecember 30, 2003 and for the thirteen weeks ended March 30, 2004 andApril 1, 2003 have been prepared without audit (except for thebalance sheet information as of December 30, 2003, which is derived fromour audited financial statements). The information furnished herein reflectsall adjustments (consisting only of normal recurring accruals and adjustments),which are, in our opinion, necessary to fairly state the interim operatingresults for the respective periods.  However, these operating results arenot necessarily indicative of the results expected for the full fiscalyear.  Certain information and footnote disclosures normally included inannual financial statements prepared in accordance with generally acceptedaccounting principles in the United States have been omitted pursuant to SECrules and regulations. The notes to the consolidated financial statements(unaudited) should be read in conjunction with the notes to the consolidatedfinancial statements contained in our annual report on Form 10-K for the fiscalyear ended December 30, 2003. We believe that the disclosures aresufficient for interim financial reporting purposes.

 

Certain reclassificationshave been made to conform previously reported data to the current presentation.These reclassifications have no effect on net income or financialposition as previously reported.

 

6

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

 

Statement of Financial Accounting Standards (SFAS) No. 142provides that goodwill and other indefinite-lived intangibles should not beamortized, but be subject to an annual assessment for impairment, or morefrequently if circumstances indicate potential impairment, through a comparisonof fair value to its carrying amount. The two-step approach to assess goodwillimpairment requires that we first compare the estimated fair value of eachreporting unit that houses goodwill to the carrying amount of the unit’s assetsand liabilities, including its goodwill and intangible assets. If the fairvalue of the reporting unit is below its carrying amount, then the second stepof the impairment test is performed, in which the current fair value of theunit’s assets and liabilities will determine the current implied fair value ofthe unit’s goodwill. The impairment tests relating to goodwill and trademarks areperformed as of year-end, unless events and circumstances indicate otherwise.We have determined that no impairment indicators were present during thethirteen weeks ended March 30, 2004, and accordingly no interim tests forimpairment of goodwill, trademarks or amortizing intangibles were performed.

 

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

 

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

 
|                                        |   | **March 30,  2004** |   | **December 30,  2003** |   |
|---------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| Amortizing intangibles (5 year  lives):     |   |                     |   |                        |   |
| Trade secrets                               |   | $                        | 5,385  |                        | $      | 5,385 |   |
| Patents-manufacturing process               |   | 33,741                   |   | 33,741                      |   |
|                                        |   | 39,126                   |   | 39,126                      |   |
| Less accumulated amortization               |   | (21,520                  | )      | (19,563                     | )      |
| Total amortizing intangibles, net           |   | $                        | 17,606 |                        | $      | 19,563 |   |
|                                        |   |                     |   |                        |   |
| Non-amortizing intangibles:                 |   |                     |   |                        |   |
| Trademarks                                  |   | 65,868                   |   | 65,868                      |   |
| Total trademarks and other intangibles, net |   | $                        | 83,474 |                        | $      | 85,431 |   |

 

7

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

 

Debt consists of the following (in thousands of dollars):

 
|                                                        |   | **March 30,  2004** |    | **December 30, 2003** |   |
|-------------------------------------------------------------|--------|--------------------------|---------|----------------------------|--------|
|                                                        |   |                     |    |                       |   |
| $160  Million Facility (a)                                  |   | $                        | 160,000 |                       | $      | 160,000 |   |
| AmSouth  Revolver (b)                                       |   | 3⁄4                   |    | 1,000                      |   |
| Chesapeake  Bagel Bakery Note Payable (c)                   |   | 825                      |    | 825                        |   |
| New  Jersey Economic Development Authority Note Payable (d) |   | 1,400                    |    | 1,400                      |   |
|                                                        |   | 162,225                  |    | 163,225                    |   |
| Less  current portion of debt                               |   | (1,105                   | )       | (2,105                     | )      |
| Long-term  debt                                             |   | $                        | 161,120 |                       | $      | 161,120 |   |

 

----

**(a)****    ****$160 MillionFacility**

 

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

 

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

 

The $160 Million Facility contains certain covenants, which, amongothers, include certain financial covenants such as limitations on capitalexpenditures and minimum EBITDA as defined in the agreement. These covenantsare measured on a rolling twelve-month period and fiscal quarter basis,respectively. This debt contains usual and customary default provisions. As ofMarch 30, 2004, we were in compliance with all our financial and operatingcovenants.

 

Interest payments under the $160 Million Facility are payable inarrears at the rate of 13% per year on July 1 and January 1,commencing January 1, 2004. The notes are redeemable, at our option, inwhole or in part at any time after July 1, 2004 at the followingredemption prices (as expressed in percentages of the principal amount):

 

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

 

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

 

8

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

 

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

 

The AmSouth Revolver is collateralized by substantiallyall of our assets in which we have an interest and is senior to the $160Million Facility pursuant to an Intercreditor Agreement.

 

The AmSouth Revolver contains certain covenants, which, among others,include certain financial covenants such as limitations on capitalexpenditures, operating lease obligations, minimum EBITDA as defined in theagreement, operating cash flow coverage ratio and minimum net worth. Thesecovenants are measured on a rolling twelve-month period at each fiscal quarter orannually at year-end. Additional covenant restrictions exist if the totalborrowings, including outstanding letters of credit exceed $10.0 million.This debt also contains usual and customary default provisions. As ofMarch 30, 2004, we are in compliance with all of our financial andoperating covenants.

 

Interest payments under the AmSouth Revolver are payable in arrears onthe first of each month. The net borrowings under the AmSouth Revolver bear aninterest rate equal to the base rate plus an applicable margin with the baserate being the AmSouth Bank “prime rate” and the applicable margin being basedon our fixed charge coverage ratio with a minimum and maximum applicable marginof 0.5% and 2.5% respectively. As of March 30, 2004, the interest rate underthe AmSouth Revolver was 5.0%.

 

We are required to pay an unused credit line fee of 0.50% per annum onthe average daily unused amount. The unused line fee is payable monthly inarrears. Additionally, we are required to pay a letter of credit fee based onthe average daily undrawn face amount for each letter of credit issued, of anapplicable margin being based on our fixed charge coverage ratio with a minimumand maximum applicable margin of 2.0% and 4.5% respectively. Letters of creditreduce our availability under the AmSouth Revolver. At March 30, 2004, wehad a $3.9 million letter of credit outstanding. The letter of credit expireson February 1, 2005, is automatically renewable for one additional yearand is payable upon demand in the event that we fail to pay certain insuranceclaims. Our availability under the AmSouth Revolver was $11.1 million atMarch 30, 2004.

 

Debt issuance costs are capitalized and amortized using the effectiveinterest method over the term of the AmSouth Revolver.

 

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

 

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

 

**(d)****     New****JerseyEconomic****Development Authority Note Payable**

 

In December 1998, Manhattan Bagel Company, Inc. entered into anote payable in the principal amount of $2,800,000 with the New Jersey EconomicDevelopment Authority (“NJEDA”) at an interest rate of 9% per annum. Principalis paid annually and interest is paid quarterly. The note matures onDecember 1, 2008 and is secured by the assets of Manhattan Bagel Company,Inc.

 

9

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On July 3, 2003, we placed an advanced funding of the note inescrow to enact a debt defeasance as allowed for in the agreement. Thisadvanced funding is shown as restricted cash and the note is included in bothcurrent portion and long-term portion of debt in the March 30, 2004 andDecember 30, 2003 consolidated balance sheets in accordance with thepayment terms. This classification will continue until the note is fully paidfrom the escrow amount proceeds. The escrow has a maturity date ofDecember 1, 2008.

 

**4.****             ****Net Loss PerCommon Share**

 

We compute basic net loss per common share by dividing the net loss forthe period by the weighted average number of shares of common stock outstanding(which includes shares contingently issuable for little or no consideration)during the period. During the thirteen weeks ended April 1, 2003, therewere 847,413 shares contingently issuable included in the weighted averagenumber of shares of common stock outstanding.

 

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

 

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

 
|                                                                                                                             |   | **Thirteen weeks ended:** |   |
|----------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|--------|
|                                                                                                                             |   | **March 30,  2004**  |   | **April 1,  2003** |   |
|                                                                                                                             |   |                      |   |   |   |
| Weighted  average shares outstanding                                                                                             |   | 9,841,828                 |   | 1,523,152 |   |
|                                                                                                                             |   |                      |   |   |   |
| Net  loss available to common stockholders (in thousands of dollars)                                                             |   | $                         | (2,556 | ) | $ | (12,344 | ) |
|                                                                                                                             |   |                      |   |   |   |
| Basic  and diluted net loss per share                                                                                            |   | $                         | (0.26  | ) | $ | (8.10 | ) |
|                                                                                                                             |   |                      |   |   |   |
| Outstanding  options and warrants that were not included in the diluted calculation  because their effect would be anti-dilutive |   | 1,877,679                 |   | 102,214 |   |

 

10

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**5.****             ****Stock BasedCompensation**

 

We apply the intrinsic value-based method of accounting prescribed byAccounting Principles Board (APB) Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations, in accounting for our fixed award stock options.As such, compensation expense is recorded only if the current market price ofthe underlying common stock exceeded the exercise price of the option on thedate of grant. Statements of Financial Accounting Standards (SFAS)Nos. 123 and 148, *Accounting forStock-Based Compensation*, established accounting and disclosurerequirements using a fair value-based method of accounting for stock-basedemployee compensation plans. As allowed by SFAS No. 148, we elected tocontinue to apply the intrinsic value-based method of accounting describedabove, and adopted the disclosure requirements of SFAS No. 148.

 

Had compensation cost been determined on the basis of fair value ascomputed using the assumptions herein, net loss and loss per share would havebeen increased to the following pro forma amounts (in thousands of dollars,except per share amounts):

 
|                                                                     |   | **Thirteen weeks ended:** |   |
|--------------------------------------------------------------------------|--------|---------------------------|--------|
|                                                                     |   | **March 30,  2004**  |   | **April 1,  2003** |   |
|                                                                     |   |                      |   |   |   |
| Net  loss available to common stockholders, as reported                  |   | $                         | (2,556 | ) | $ | (12,344 | ) |
| Add:  stock based compensation included in net loss                      |   | 3⁄4                    |   | 3⁄4 |   |
| Deduct:  stock based compensation determined under the fair value method |   | (239                      | )      | (45 | ) |
| Pro  forma net loss available to common stockholders                     |   | $                         | (2,795 | ) | $ | (12,389 | ) |
|                                                                     |   |                      |   |   |   |
| Basic  and diluted loss per common share:                                |   |                      |   |   |   |
| As  reported                                                             |   | $                         | (0.26  | ) | $ | (8.10 | ) |
| Pro  forma                                                               |   | $                         | (0.28  | ) | $ | (8.13 | ) |

 

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

 
|                                         |   | **Thirteen weeks ended:** |   |
|----------------------------------------------|--------|---------------------------|--------|
|                                         |   | **March 30,  2004**  |   | **April 1,  2003** |   |
| Expected  life of options from date of grant |   | 4.0                       | years  | 4.0 | years |
| Risk-free  interest rate                     |   | 3.0                       | %      | 3.0 | % |
| Volatility                                   |   | 100.0                     | %      | 100.0 | % |
| Assumed  dividend yield                      |   | 0.0                       | %      | 0.0 | % |

 

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

 

*Guarantees*

 

In the past, we would sometimes guarantee leases for the benefit ofcertain of our franchisees. The lease guarantees extend through 2008. Under theguarantees, we may be required by the lessor to make monthly rental payments orproperty tax and common area maintenance payments if the franchisee does notmake the required payments in a timely manner. The guarantees do not providefor any limitation to our maximum exposure, however, we believe that most, ifnot all, of the franchised locations could be subleased to third partiesminimizing our potential exposure. Additionally, we have indemnificationagreements with our franchisees under which the franchisees would be obligatedto reimburse us for any amounts paid under such guarantees. As ofMarch 30, 2004, our maximum exposure under these contingent liabilitieswas approximately $2.1 million.

 

*Employment Related*

 

On July 31, 2002, Tristan Goldstein, a former store manager, andValerie Bankhordar, a current store manager, filed a putative class actionagainst Einstein and Noah Corp. (“ENC”) in the Superior Court for the State ofCalifornia, County of San Francisco. The plaintiffs allege that ENC failed topay overtime wages to managers and assistant managers of its California storeswho were improperly designated as exempt employees in violation of Californiawage and hour laws and Business Profession Code Section 17200. DuringApril 2004, we reached an agreement in principle for the settlement oflitigation with the plaintiffs, subject to court approval. Amounts representingour estimate to settle this litigation were previously recorded during thequarter ended December 30, 2003.

 

On March 31, 2003, Jerold E. Novack, our former Chief FinancialOfficer and Secretary, filed a complaint in the United States District Courtfor the District of New Jersey against us, Anthony D. Wedo, our former Chairmanand Chief Executive Officer, and William J. Nimmo, a former member of our boardof directors.  The complaint purports tostate claims for breach of plaintiff’s employment contract, breach of Messrs.Wedo and Nimmo’s fiduciary duties to plaintiff, defamation, and violation ofthe New Jersey Conscientious Employee Protection Act, and in addition seeks adeclaration that the termination of plaintiff “for cause” was invalid.  We have answered and filed counterclaimsagainst Mr. Novack and on January 20, 2004, the Court granted theCompany’s motion to dismiss the breach of fiduciary duty claims. Discovery isto be completed by May 25, 2004. At this time, it is not possible to reasonablyestimate the possible loss or range of loss, if any.

 

On June 4, 2003, R. Ramin Kamfar, our former Chairman of the Boardand Chief Executive Officer, filed an action in the United States DistrictCourt for the Southern District of New York against us and Anthony D. Wedo, ourformer Chairman and Chief Executive Officer, alleging causes of action forbreach of contract, defamation, declaratory relief and punitive damages. Webelieve that the claims of Mr. Kamfar are without merit. We have answered andfiled counterclaims against Mr. Kamfar, including claims for breach offiduciary duty, fraud, and breach of contract. Discovery is to be completed by June 27, 2004. . At this time, itis not possible to reasonably estimate the possible loss or range of loss, ifany.

 

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*Real Estate and Leasing*

 

On March 18, 2003, Industrial Way, LLC, owner of premises leasedby Manhattan in Eatontown, NJ, filed a lawsuit against us and Manhattan in theSuperior Court of New Jersey for wrongful conversion of personal property(consisting of fixtures and equipment), damage to leasehold property, andbreach of the lease. During April 2004, we settled this litigation. Previouslyrecorded integration and reorganization estimates associated with closing thisfacility were adjusted down by $700,000 during the thirteen weeks endedMarch 30, 2004 as a result of this settlement.

 

*Franchise Issues and Claims*

 

On February 23, 2000, New World Coffee of Forest Hills, Inc.,a franchisee, filed a demand for arbitration with the American ArbitrationAssociation against us alleging fraudulent inducement and violations of NewYork General Business Law Article 33. The franchisee seeks damages of$750,000. We dispute the franchisee claims and are seeking amounts owed underthe franchise agreement and monies owed for goods purchased by the franchiseein the amount of $200,000. An arbitrator has been selected and documentexchange is complete. Negotiations to settle have commenced with thefranchisee. We do not anticipate settlement of this litigation to have amaterial adverse effect on our consolidated financial condition or results ofoperations.

 

*Investigations*

 

On April 3, 2002, the Securities and Exchange Commission notifiedus that the Commission was conducting an investigation into the resignation ofour former Chairman, R. Ramin Kamfar, and the termination for cause of ourformer Chief Financial Officer, Jerold Novack, and the delay in filing ourForm 10-K for 2001. We have cooperated fully with the investigation aswell as with a Department of Justice inquiry relating to these issues. Further,several of the former and present officers and directors have requested that weadvance reasonable legal expenses on their respective behalves to the extentany of them is or has been requested to provide information to the Commissionin connection with its investigation. We are fulfilling our obligations asrequired by applicable law and our By-Laws. We have no knowledge of anyactivity with respect to the Company relating to the Securities and Exchange Commission investigation, or theDepartment of Justice inquiry for more than nine months.

 

On August 7, 2003, supplemented on November 25, 2003 andJanuary 9, 2004, we received a subpoena for documents from the Office ofthe Attorney General of the State of New York requesting information primarilyrelated to whether our subsidiary, Manhattan Bagel Company, Inc., qualified fora net worth exemption from franchise registration in light of the restatement of the Company’sfinancial results for 2000 and 2001, the facts and circumstances leading to theresignation of the Company’s former Chief Executive officer and the terminationof its former Chief Financial Officer, and issues relating to cost of bageldough. We have responded to these requests and are awaiting further word from the Attorney General’s Office.The Attorney General’s Office has indicated that the Uniform Franchise OfferingCircular (UFOC) application for registration of our Manhattan Bagel brand willbe processed and has agreed that Einstein Bros. Bagel licensed stores can beopened under existing licensing agreements with Aramark and Sodexho while theinvestigation is pending.

 

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*Financial Impact of Litigation*

 

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

 

*InsurancePrograms*

 

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

 

We are also self-insured for healthcare claims for eligibleparticipating employees subject to certain deductibles and limitations. We haveaccounted for our liabilities related to the insurance losses and healthcareclaims, including reported and incurred but not reported claims, based oninformation provided by actuaries.

 

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

 

**7.****             ****Recent AccountingPronouncements**

 

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

 

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**ITEM2.  MANAGEMENT’S****DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

###### **ForwardLooking Statements**

###### ** **

The Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontains “forward looking statements” as that term is defined in the PrivateSecurities Litigation Reform Act of 1995. These forward-looking statements arebased on a number of assumptions by us about the future, usually based oncurrent conditions or on the broader expectations of others. These assumptionsmay or may not prove to be correct and, as a result, our own forward-lookingstatements may also be inaccurate. On the other hand, based on what we knowtoday and what we expect in the future, we believe that the forward-lookingstatements we make in this report are reasonable. In most cases, when we usewords like “believe,” “expect,” “estimate,” “anticipate,” “project,” “plan,” or“predict” to describe something which has not yet occurred, we are making aforward-looking statement.

 

We cannot list here all of the risks and uncertainties that could causeour actual future financial and operating results to differ materially from ourhistorical experience and our present expectations or projections but we canidentify many of them. These risks and uncertainties include, but are notlimited to, the following:

 

•                  Our ability toachieve our business strategy of revitalizing our concept and menus;

•                  Our ability toopen new company-owned or licensed Einstein Bros. locations;

•                  Our ability tosatisfy our obligations under our indebtedness;

•                  Changes in theprice of our ingredients;

•                  Our ability toattract, retain and motivate qualified employees;

•                  Changes in laborcosts;

•                  Increasingenergy costs;

**•**                  The effect ofinflation on our operating expenses;

•                  Our dependenceon our suppliers and distributors;

•                  Fluctuations inconsumer preferences;

•                  The impact offederal, state or local government regulations;

•                  Competition inthe restaurant industry;

•                  Availability andcost of additional capital;

•                  Litigation inconnection with our business, including food quality claims;

•                  Our ability toprotect our trademarks, service marks and other proprietary rights;

•                  Actions takenby, and claims made against us by, our franchisees; and

•                  Other risksdescribed from time to time in our periodic reports filed with the Securitiesand Exchange Commission, or the SEC.

 

It is also important toremember that forward-looking statements speak only as of the date when theyare made and we do not promise that we will publicly update or revise thosestatements whenever conditions change or future events occur. Accordingly, wedo not recommend that any person seeking to evaluate our company should placeundue reliance on any forward-looking statement in this report.

 

**Overview of ourBusiness**

 

We are a leader in the quick casual segment of the restaurant industry.With 735 locations in 33 states and the District of Columbia as ofMarch 30, 2004, we operate and license locations primarily under theEinstein Bros. and Noah’s brand names, and franchise locations primarily underthe Manhattan and Chesapeake brand names. We also operate dough production andcoffee roasting facilities. We operate as a single business segment with afocus on our company-operated restaurants. Our manufacturing and franchiseoperations are either supportive or ancillary to our main business focus.

 

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

 
|                                |   | **Total Open  at End  of First Quarter:** |   |
|-------------------------------------|--------|-------------------------------------------|--------|
|                                |   | **2004**                                  |   | **2003** |   |
| Einstein Bros.:                     |   |                                      |   |   |   |
| Company-owned                       |   | 373                                       |   | 371 |   |
| Licensed                            |   | 46                                        |   | 24 |   |
| Noah’s:                        |   |                                      |   |   |   |
| Company-owned                       |   | 82                                        |   | 83 |   |
| Licensed                            |   | 3                                         |   | 3 |   |
| Manhattan:                          |   |                                      |   |   |   |
| Company-owned                       |   | 3⁄4                                    |   | 3⁄4 |   |
| Franchised                          |   | 171                                       |   | 196 |   |
| Chesapeake:                         |   |                                      |   |   |   |
| Company-owned                       |   | 3⁄4                                    |   | 3⁄4 |   |
| Franchised                          |   | 41                                        |   | 45 |   |
| New World Coffee/Willoughby’s: |   |                                      |   |   |   |
| Company-owned                       |   | 8                                         |   | 9 |   |
| Franchised                          |   | 11                                        |   | 10 |   |
|                                |   |                                      |   |   |   |
| Total Restaurants                   |   | 735                                       |   | 741 |   |

 

**Results of Operations for the Thirteen Week Period endedMarch 30, 2004 Compared to the Thirteen Week Period ended April 1,2003**

 

***Revenues***

 

Total revenues decreased 4.2% to $91.2 million for the thirteenweeks ended March 30, 2004 compared with $95.2 million for thirteenweeks ended April 1, 2003. The decrease in revenue consisted primarily ofa $3.8 million decrease in retail sales (e.g. company-operated storesales).

 

**Retail sales decreased 4.3% to $84.6 million, or 92.8% of totalrevenues for the thirteen weeks ended March 30, 2004 compared with$88.4 million, or 92.9% of total revenues for the thirteen weeks endedApril 1, 2003. The decrease was primarily due to lower comparable storesales at Einstein Bros. and Noah’s company-owned units.  The comparable store sales decrease of 4.9%consisted of a 5.9% reduction in transactions partially offset by a 1.1%increase in average check primarily related to both an increase in menu pricingand a shift in product mix to higher priced items. Due to the increasingcompetitive pressure of the restaurant industry, we currently are experiencingand believe we will continue to experience lower retail sales until such timeas we can make the planned modifications to our customer service system, menuofferings and the “look and feel” of our company-operated restaurants. Webelieve that our plans to revitalize our restaurant concepts in 2004 and beyondmay address issues in each of these areas that have negatively affected sales.Additionally, recent dietary trends and negative publicity on products high incarbohydrate content may have had and may continue to have an adverse impact onour sales. We believe that we are addressing such trends with modifications toour menus. In addition, the planned modification of our menu and menu offeringsincludes pricing increases to our menu items. We anticipate that these plannedprice changes will have the effect of increasing our average check in futureperiods.**

 

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**Manufacturing revenues were $5.4 million for both periods, or 5.9% oftotal revenues for the thirteen weeks ended March 30, 2004 compared with5.7% of total revenues for the thirteen weeks ended April 1, 2003. Theincrease in manufacturing revenues as a percentage of total revenues is theresult of the decline in total sales due to lower retail sales.**

** **

Franchise and license related revenues decreased 13.3% to$1.2 million, or 1.3% of total revenues for the thirteen weeks endedMarch 30, 2004 compared with  $1.3million, or 1.4% of total revenues for the thirteen weeks ended April 1,2003.  The decrease is primarilyattributable to revenues associated with the decline in store count of ourManhattan franchised stores partially offset by revenues associated with thegrowth in store count of our Einstein Bros. licensed stores.

 

***Cost of Sales***

 

Total cost of sales decreased 4.3% to $74.7 million for thethirteen weeks ended March 30, 2004 compared with $78.0 million forthe thirteen weeks ended April 1, 2003. The dollar decline in cost ofsales is driven by the decline in retail revenue, which resulted in lowerassociated costs. Our gross profit for the thirteen weeks ended March 30,2004 and April 1, 2003, respectively, remained flat at 18.1%.

 

Retail costs is comprised of all store-level operating expenses otherthan depreciation, amortization and taxes. Cost of sales decreased$2.9 million to $70.1 million, or 82.8% of retail sales for thethirteen weeks ended March 30, 2004 compared with $73.0 million, or82.5% of retail sales for the thirteen weeks ended April 1, 2003. Certainelements of costs of sales are fixed in nature. Accordingly, when sales volumesdecrease, cost of sales does not decrease in the same proportion as thereduction in related revenues. Therefore, cost of sales as a percentage ofsales may be adversely affected by reduced volumes. Conversely, cost of salesas a percentage of sales that remains constant in a period of decreasingrevenues reflects our ability to improve upon fixed or variable elements of ourcost of sales. During the thirteen weeks ended March 30, 2004, our grossprofit decline is due to the absorption of fixed store level costs on a lowervolume of retail sales, partially offset by our decision to reduce marketingexpenditures as we focus on modifications to our customer service system, menuofferings and the “look and feel” of our company operated restaurants.

 

Manufacturing costs is comprised of all manufacturing-level operatingexpenses other than depreciation, amortization and taxes. Manufacturing costsdecreased $463,000 to $4.6 million, or 84.6% of manufacturing revenues forthe thirteen weeks ended March 30, 2004 compared with $5.0 million,or 92.9% of manufacturing revenues for the thirteen weeks ended April 1,2003. The decrease is primarily due to the results of manufacturingefficiencies achieved from the consolidation of our west coast bagelmanufacturing facilities, which was finalized during the first quarter of 2003.

 

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***Other Expenses***

 

**General and administrative expenses decreased 14.0% to$8.8 million, or 9.7% of total revenues for the thirteen weeks endedMarch 30, 2004 compared with $10.3 million, or 10.8% of totalrevenues for the thirteen weeks ended April 1, 2003.  The decline in general and administrativeexpenses is primarily due to legal and consulting expenses associated withrefinancing and the 2000 and 2001 re-audit efforts that occurred during 2003.**

** **

Depreciation and amortization expense decreased 27.3% to$5.2 million, or 5.7% of total revenues for the thirteen weeks endedMarch 30, 2004 compared to $7.2 million, or 7.6% of total revenues for thethirteen weeks ended April 1, 2003. The decrease in depreciation andamortization expense is primarily due to a portion of our asset base becomingfully depreciated during the thirteen weeks ended March 30, 2004. In the nearfuture, we anticipate spending additional capital on existing stores, whichwould result in a corresponding increase in our depreciable asset base, andthus depreciation expense. Over the past several years, former management didnot invest significant capital in our store equipment due to limitedavailability of resources and covenant restrictions under our former creditfacilities. During the current year, we have placed greater emphasis on therequirements of our existing company-operated stores. For additionalinformation, see the discussion under “Liquidity and Capital Resources.”

 

Adjustment of integration and reorganization cost primarily representsan adjustment to previously recorded liabilities associated with the closingand corporate consolidation of our Eatontown facilities during 2002. As furtherdiscussed in Item I “Note 6 to the Consolidated Financial Statements,” duringApril 2004, we reached an agreement with the landlord of the Eatontownfacility to settle outstanding litigation. Previously recorded integration andreorganization estimates associated with closing this facility were adjusteddown by $700,000 during the thirteen weeks ended March 30, 2004 as aresult of this settlement.

 

Due to the factors described above, income from operations for thethirteen weeks ended March 30, 2004 was $3.2 million, or 3.5% of totalrevenues compared to a loss from operations of $243,000 for the thirteen weeksended April 1, 2003.

 

Interest expense, net for the thirteen weeks ended March 30, 2004decreased 30.1% to $5.8 million, or 6.4% of total revenues compared with$8.3 million, or 8.7% of total revenues for the thirteen weeks endedApril 1, 2003. The primary cause of the decline in interest expense is theresult of the debt restructuring that occurred during the third quarter offiscal 2003. As a result of the debt restructuring, our interest rate on ourprimary debt facility declined from 19% to 13% per year.

 

Due tothe factors described above, we reduced our net loss for the thirteen weeksended March 30, 2004 to $2.6 million compared with $7.7 millionfor the thirteen weeks ended April 1, 2003.

 

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**Liquidity and Capital Resources**

 

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

 

The primary driver of our operating cash flow is our restaurantoperations, specifically the gross margin from our company-operated restaurants.Therefore, we focus on the elements of those operations including comparablestore sales to ensure a steady stream of operating profits that enable us tomeet our cash obligations. On a weekly basis, we review our company-operatedstore performance compared with the same period in the prior year and ouroperating plan. We are continuously identifying and implementing cost reductioninitiatives, not only at the store operations level, but also within otherdisciplines such as supply chain, manufacturing operations and overhead.Examples of these cost reduction initiatives include:

 

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

 

•                  Upgrade/deploymentof technology to enable more accurate sales identification and tracking of costof products sold thereby identifying opportunities to improve store margins;

 

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

 

During fiscal year 2004, we anticipate the majority of our capital expenditureswill be focused on the following:  (1)requirements of our existing company-operated stores, primarily equipmentreplacement, (2) upgrades and remodeling costs associated with therevitalization of our concept, (3) a modest amount of new company-operatedstore development related to approximately four to six new store openings, (4)a modest amount of capital spent on our manufacturing operations and (5)additional capital for our support center in Golden, Colorado, primarilyrelated to spending on information technology upgrades and maintenance.

 

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

 

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

 

At March 30, 2004, we had unrestricted cash of $2.0 millionand short-term restricted cash of $2.0 million. We reduced our workingcapital deficit to $23.0 million at March 30, 2004 compared with aworking capital deficit of $23.6 million at December 30, 2003.

 

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During the thirteen weeks ended March 30, 2004, we consumed $4.2 millionof cash from operations compared with $3.4 million during the thirteenweeks ended April 1, 2003. The cash consumption during the thirteen weeksended March 30, 2004 was primarily attributable to a semi-annual interestpayment of $10 million under our $160 Million Facility, prepayments towardannual insurance premium renewals and other annual system maintenance contractrenewals. These cash payments, which aggregated approximately $11.1 million,were partially offset by $2.4 million improvements in our cash operatingperformance (defined as net loss as adjusted for non-cash charges) and accruedinterest of approximately $5.2 million.

 

During the thirteen weeks ended March 30, 2004, we used$2.4 million of cash in investing activities compared with $2.1 millionof cash during the thirteen weeks ended April 1, 2003. During the thirteenweeks ended March 30, 2004, we used cash to purchase additional propertyand equipment which included $0.9 million for new stores, $1.1 million forreplacement and new equipment at our existing company-operated stores,$0.1 million for our manufacturing operations and $0.3 million forgeneral corporate purposes.

 

During the thirteen weeksended March 30, 2004, we used $1.0 million of cash in financingactivities compared to generating $1.1 million of cash during the thirteenweeks ended April 1, 2003. During the thirteen weeks ended March 30,2004, we reduced our debt outstanding on the AmSouth Revolver by $1.0 million.

 

***ContractualObligations***

 

There were no material changes to our contractual obligations for thethirteen weeks ended March 30, 2004. For information regarding ourcontractual obligations at December 30, 2003, see our Annual Report onForm 10-K for the fiscal year ended December 30, 2003.

 

***Guarantees***

 

In the past, we would sometimes guarantee leases for the benefit ofcertain of our franchisees. The lease guarantees extend through 2008. Under theguarantees, we may be required by the lessor to make monthly rental payments orproperty tax and common area maintenance payments if the franchisee does notmake the required payments in a timely manner. The guarantees do not providefor any limitation to our maximum exposure, however, we believe that most, ifnot all, of the franchised locations could be subleased to third partiesminimizing our potential exposure. Additionally, we have indemnificationagreements with our franchisees under which the franchisees would be obligatedto reimburse us for any amounts paid under such guarantees. As ofMarch 30, 2004, our maximum exposure under this contingent liability wasapproximately $2.1 million.

 

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

###### ** **

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

 

We are also self-insured for healthcare claims for eligibleparticipating employees subject to certain deductibles and limitations. We haveaccounted for our liabilities related to the insurance losses and healthcareclaims, including reported and incurred but not reported claims, based oninformation provided by actuaries.

 

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

 

***General EconomicTrends and Seasonality***

 

We anticipate that our business will be affected by general economictrends that affect retailers in general. While we have not operated during aperiod of high inflation, we believe based on industry experience that we wouldgenerally be able to pass on increased costs resulting from inflation to ourconsumers. Our business may be affected by other factors, including increasesin the commodity prices of flour, butter and/or green coffee, existing andadditional competition, marketing programs, weather and variations in thenumber of company-owned or licensed location openings. Although few, if any,employees are paid at the minimum wage, an increase in the minimum wage maycreate pressure to increase the pay scale for our employees, which wouldincrease our labor costs and those of our franchisees and licensees.

 

Currently, the restaurant industry is experiencing increases in thecost of dairy and other raw ingredients, as well as increases in energy costs.We have begun to see the impact of such increases in our food costs, utilitybills and transportation charges. These increases directly impact the profitabilityof company-owned locations, manufacturing operations and distribution channels.While we have purchase commitments for our dairy and other raw ingredients thatmitigate immediate increases in food costs, our purchase commitments are notlong-term in nature. Accordingly, in the near future we may experiencedegradation in our profit margins until such time as we are able to pass onincreased costs to our consumers.

 

Our business is subject to seasonal trends. Generally, our revenues inthe first fiscal quarter are somewhat lower than in the other three fiscalquarters.

 

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### ***Risk Factors***

### * *

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

 

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

 

Our successdepends on part on our ability to understand our customers’ needs. We believesuccessful deployment of our current business strategy will address customers’needs and contribute to overall company growth. If we improperly perceivecustomers’ needs and/or are not successful in implementing any or all of theinitiatives of our business strategy, it could have a material adverse effecton our business, results of operations, and financial condition.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

*There is intense competition in therestaurant industry.*

 

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

 

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

 

The cost, availability and quality of the ingredients we use to prepareour food are subject to a range of factors, many of which are beyond ourcontrol. Fluctuations in economic and political conditions, weather and demandcould adversely affect the cost of our ingredients. We have no control overfluctuations in the price of commodities, and we may not be able to passthrough any cost increases to our customers. We are dependent on frequentdeliveries of fresh ingredients, thereby subjecting us to the risk of shortagesor interruptions in supply. All of these factors could adversely affect ourbusiness and financial results.

 

*We heavily depend on our suppliers anddistributors.*

 

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

 

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

 

*Increasing labor costs could adversely affectour continued profitability.*

 

We are dependent upon an available labor pool of unskilled employees,many of whom are hourly employees whose wages may be affected by an increase inthe federal or state minimum wage. Numerous proposals have been made onfederal, state and local levels to increase minimum wage levels. Although few,if any, of our employees are paid at the minimum wage level, an increase in theminimum wage may create pressure to increase the pay scale for our employees,which would increase our labor costs and those of our franchisees andlicensees. A shortage in the labor pool or other general inflationary pressuresor changes could also increase labor costs. In addition, changes in labor lawsor reclassifications of employees from management to hourly employees couldaffect our labor cost. An increase in labor costs could have a material adverseeffect on our income from operations and decrease our profitability and cash availableto service our debt obligations if we are unable to recover these increases byraising the prices we charge our customers.

 

*We face the risk of adverse publicity andlitigation in connection with our operations.*

 

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

 

*We rely in part on our franchisees.*

 

We rely in part on our franchisees and the manner in which they operatetheir locations to develop and promote our business. Although we have developedcriteria to evaluate and screen prospective franchisees, franchisees may nothave the business acumen or financial resources necessary to operate successfulfranchises in their franchise areas. The failure of franchisees to operatefranchises successfully could have a material adverse effect on us, ourreputation, our brands and our ability to attract prospective franchisees.

 

*We face risks associated with governmentregulation.*

 

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

 

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

 

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

 

*We may not be ableto protect our trademarks, service marks and other proprietary rights.*

 

We believe that our trademarks, service marks and other proprietaryrights are important to our success and our competitive position. Accordingly,we devote substantial resources to the establishment and protection of ourtrademarks, service marks and proprietary rights. However, the actions taken byus may be inadequate to prevent imitation of our products and concepts byothers or to prevent others from claiming violations of their trademarks andproprietary rights by us. In addition, others may assert rights in our trademarks,service marks and other proprietary rights.

 

*We have a majoritystockholder.*

 

Greenlight Capital, L.L.C. and its affiliates beneficially ownapproximately 97 percent of our common stock. As a result, Greenlight hassufficient voting power, without the vote of any other stockholders, todetermine what matters will be submitted for approval by our stockholders, toapprove actions by written consent without the approval of any otherstockholders, to elect all of our board of directors, and to determine whethera change in control of our company occurs. Greenlight’s interests on matterssubmitted to stockholders may be different from those of other stockholders.Greenlight is not involved in our day-to-day operations. Greenlight has votedits shares to elect a majority of our current board of directors.  One of our directors is a former employee ofGreenlight. The remaining four directors are not affiliated with Greenlight.Additionally, a nominee for director at our 2004 annual meeting of stockholdersis a current officer of Greenlight.

 

Our common stock is not currently listed on any stock exchange orNasdaq. As a result, we are not subject to corporate governance rules recentlyadopted by the New York Stock Exchange, American Stock Exchange and Nasdaq requiringa majority of directors to be independent and requiring audit, compensation andnominating committees that are composed solely of independent directors. Inaddition, under the rules of these stock exchanges and Nasdaq, if a singlestockholder holds more that 50% of the voting power of a listed company, thatcompany is considered a controlled company, and except for the rules relatingto independence of the audit committee, is exempt from the above-mentionedindependence rules. Since Greenlight owns approximately 92% of our commonstock, we may take advantage of the controlled company exemption if our commonstock becomes listed on an exchange or Nasdaq in the future. As a result, ourstockholders do not have, and may never have the protections that these rulesare intended to provide.

 

*Future sales of shares of our common stock by ourstockholders could cause our stock price to fall.*

 

If a substantial number of shares of our common stock are sold in thepublic market, the market price of our common stock could fall.  The perception among investors that thesesales will occur could also produce this effect.  Our majority stockholder Greenlight beneficially ownsapproximately 97 percent of our common stock and sales by Greenlight or aperception that Greenlight will sell could cause a decrease in the market priceof our common stock.

 

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*Holders may find it difficult to effect transactions in ourcommon stock.*

 

Our common stock is currently trading on the “pink sheets” under thesymbol “NWRG.PK.”  Before changing oursymbol on October 20, 2003, our common stock traded on the “pink sheets”under the symbol “NWCI.PK.”  Since ourcommon stock is not listed on Nasdaq, Amex or the New York Stock Exchange,holders of our common stock may find that the liquidity of our common stock isimpaired – not only in the number of securities that can be bought and sold,but also through delays in the timing of transactions, reduction in securityanalysts’ and the news media’s coverage of us, and lower prices for oursecurities than might otherwise be attained.

 

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

 

Before May 22, 2002, our common stock was quoted on the OTCBulletin Board under the symbol “NWCI.OB.” On May 22, 2002, our commonstock was removed from the eligible list on the OTC Bulletin Board for afailure to comply with NASD Rule 6530, which resulted from our failure totimely file our Form 10-K for the year ended January 1, 2002.  Before November 27, 2001, our commonstock was quoted on the Nasdaq National Market under the symbol “NWCI.”  Effective November 27, 2001, our commonstock was delisted from the Nasdaq National Market. We received a Nasdaq StaffDetermination on September 7, 2001 asserting violations of two rulesrelating to stockholder approval for equity issuances and stating that ourcommon stock was subject to delisting. We appealed the Staff Determination at ahearing before the Nasdaq Listings Qualifications Panel on October 18,2001. The Panel issued a ruling on October 30, 2001 that cited conditionsfor maintaining our listing and provided us with an extension of time untilNovember 19, 2001 to attempt to satisfy them. We timely appealed theOctober 30, 2001 ruling, while simultaneously endeavoring to satisfy theconditions imposed by the Panel. We were not able to satisfy all of theconditions before the November 19, 2001 deadline and sought additionaltime to attempt to satisfy them, a request that the Panel denied. The Panellater informed us by letter that, effective November 27, 2001, our stockwould be delisted. The Panel cited both corporate governance violations andpublic interest concerns as separate and independent bases for its ultimatedetermination.

 

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**Item 3.  Quantitative and****QuantitativeDisclosures About Market Risk**

 

Through March 30, 2004, our results of operations, financialposition and cash flows have not been materially affected by changes in therelative values of non-U.S. currencies to the U.S. dollar. We do not usederivative financial instruments to limit our foreign currency risk exposure.

 

Our debt as of March 30, 2004 is principally comprised of the $160Million Facility due July 1, 2008 and the AmSouth Revolver. A 100 basispoint increase in market interest rates would have an immaterial effect on ourborrowing costs, since the interest rate on the $160 Million Facility is fixed.The interest rate on the AmSouth Revolver does fluctuate with changes in theprime rate, but is minor in relation to interest expense in our results ofoperations and financial condition.

 

**Item 4.  Controls****andProcedures**

 

Our chief executive officer and our principal financial officer haveevaluated the effectiveness of our “disclosure controls and procedures” (asdefined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as ofMarch 30, 2004. Based on that evaluation, our chief executive officer andour principal financial officer have concluded that our disclosure controls andprocedures were effective to provide reasonable assurance that information thatwe are required to disclose in reports that we file with the SEC is recorded,processed, summarized and reported within the time periods specified by theExchange Act rules.

 

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

 

During the fiscal quarter ended March 30, 2004, there were nochanges to our internal control over financial reporting which were identifiedin connection with the evaluation of our disclosure controls and proceduresrequired by the Exchange Act rules and which have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

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**PARTII - OTHER INFORMATION**

**NEWWORLD RESTAURANT GROUP, INC.**

**MARCH 30,2004**

 

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

 

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

 

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

 

(a)          Exhibits

 
| 31.1   |   | Certification by Chief Executive Officer pursuant to  Exchange Act Rule 13a-15(e), as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                          |
| 31.2   |   | Certification by Chief Financial Officer pursuant to  Exchange Act Rule 13a-15(e), as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 |
|   |   |                                                                                                                                                          |
| 32.1   |   | Certification by Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|   |   |                                                                                                                                                          |
| 32.2   |   | Certification by Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

(b)         Reports on Form 8-K filedduring the quarter ended March 30, 2004:

 

A report on Form 8-K datedDecember 30, 2003 under Items 5 and 7, was filed with the Securities andExchange Commission on January 5, 2004. The Form 8-K announced theexecution of an amendment to the Loan and Security Agreement with AmSouthCapital Corp. dated July 8, 2003.

 

A report on Form 8-Kdated January 29, 2004 under Item 5, was filed with the Securities andExchange Commission on February 5, 2004. The Form 8-K announced the Boardof Directors decision not to renew the Consulting Agreement dated July 16,2003 with Herbert Buchwald, P.A. to provide certain legal, consulting andadvisory services to the Company.

 

A report on Form 8-Kdated February 17, 2004 under Items 5 and 7, was filed with the Securitiesand Exchange Commission on February 18, 2004. The Form 8-K furnished acopy of the Company’s press release naming S. Garrett Stonehouse, Jr. as aDirector of the Company.

 

A report on Form 8-Kdated February 24, 2004 under Items 5 and 7, was filed with the Securitiesand Exchange Commission on February 25, 2004. The Form 8-K furnished acopy of the Company’s press release relating to certain operational initiativesplanned for 2004.

 

A report on Form 8-Kdated March 26, 2004 under Items 5 and 7, was filed with the Securitiesand Exchange Commission on March 29, 2004. The Form 8-K furnished a copyof the Company’s press release and conference call script relating to financialresults for the fourth quarter and fiscal year 2003.

 

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**Signatures**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|   |         | NEW WORLD RESTAURANT GROUP, INC.                          |
|--------|--------------|-----------------------------------------------------------|
|   |         |                                                      |
|   |         |                                                      |
| Date:  | May 10, 2004 | By: /s/ PAUL J. B. MURPHY, III                            |
|   |         | Paul J.B. Murphy, III                                     |
|   |         | Chairman and Chief Executive Officer                      |
|   |         |                                                      |
| Date:  | May 10, 2004 | By: /s/ RICHARD P. DUTKIEWICZ                             |
|   |         | Richard P. Dutkiewicz                                     |
|   |         | Chief Financial Officer and Principal Accounting  Officer |

 

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