**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

 

**(Mark One)**

**x**                                  QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

**For the quarterlyperiod ended April 3, 2007**

**OR**

**o**                                    TRANSITIONREPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

** **

**Commission File Number 0-27148**

 

**Einstein Noah Restaurant Group,Inc.(formerly New World Restaurant Group, Inc**.)

(Name of Registrant asSpecified in its Charter)

 

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

 

**1687 Cole Blvd., Golden, Colorado80401**

(Address of principalexecutive offices, including zip code)

 

**(303) 568-8000**

(Registrant’s telephonenumber, including area code)

 

Securities registeredpursuant to Section 12(b) of the Act:

**None**

** **

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes x  No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Actof 1934). 

| Large accelerated  filer o |   | Accelerated  filer o |   | Non-accelerated  filer x |
|---------------------------------|--------|---------------------------|--------|-------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934). Yes o  No x

As of May 2, 2007,10,642,227 shares of Common Stock of the registrant were outstanding.

 

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**EINSTEINNOAH RESTAURANT GROUP, INC.**

April 3, 2007

TABLE OF CONTENTS

** **
|           | ** ** | **Part I. Financial Information**                                                                           |   |   |   |
|-----------|------------|-------------------------------------------------------------------------------------------------------------|--------|--------|--------|
|      |       |                                                                                                        |   |   |   |
| Item 1.   |       | Unaudited Financial Statements:                                                                             |   |   |   |
|      |       |                                                                                                        |   |   |   |
|      |       | Consolidated Balance Sheets, January 2, 2007 and April  3, 2007                                             |   |   |   |
|      |       |                                                                                                        |   |   |   |
|      |       | Consolidated Statements of Operations, for the first  quarters ended April 4, 2006 and April 3, 2007        |   |   |   |
|      |       |                                                                                                        |   |   |   |
|      |       | Consolidated Statements of Cash Flows, for the first  quarters ended April 4, 2006 and April 3, 2007        |   |   |   |
|      |       |                                                                                                        |   |   |   |
|      |       | Consolidated Statement of Changes in Stockholders’  Deficit, for the first quarter ended April 3, 2007 |   |   |   |
|      |       |                                                                                                        |   |   |   |
|      |       | 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  1A. |       | Risk Factors                                                                                                |   |   |   |
|      |       |                                                                                                        |   |   |   |
| Item 6.   |       | Exhibits                                                                                                    |   |   |   |

 

2

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

**CONSOLIDATED BALANCE SHEETS**

**AS OF JANUARY 2, 2007 AND APRIL 3, 2007**

**(inthousands, except share information)**

(unaudited)
| ** **                                                                                                                                                                  | ** ** | **January 2,** | ** ** | **April 3,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                  | ** ** | **2007**            | ** ** | **2007**          | ** ** |
| **ASSETS**                                                                                                                                                                  | ** ** | ** **          | ** ** | ** **        | ** ** |
| Current assets:                                                                                                                                                             |       |                |       |              |       |
| Cash and cash  equivalents                                                                                                                                                  |       | $                   | 5,477      |              | $          | 5,122 |   |
| Restricted cash                                                                                                                                                             |       | 2,403               |       | 2,817             |       |
| Franchise and  other receivables, net of allowance of $480 and $442, respectively                                                                                           |       | 6,393               |       | 6,971             |       |
| Inventories                                                                                                                                                                 |       | 4,948               |       | 4,984             |       |
| Prepaid expenses  and other current assets                                                                                                                                  |       | 4,529               |       | 5,336             |       |
| Assets held for  sale                                                                                                                                                       |       | 1,144               |       | —            |       |
|                                                                                                                                                                        |       |                |       |              |       |
| Total current  assets                                                                                                                                                       |       | 24,894              |       | 25,230            |       |
|                                                                                                                                                                        |       |                |       |              |       |
| Restricted cash  long-term                                                                                                                                                  |       | 284                 |       | 284               |       |
| Property, plant  and equipment, net                                                                                                                                         |       | 33,889              |       | 35,547            |       |
| Trademarks and  other intangibles, net                                                                                                                                      |       | 63,806              |       | 63,806            |       |
| Goodwill                                                                                                                                                                    |       | 4,875               |       | 4,875             |       |
| Debt issuance costs  and other assets, net                                                                                                                                  |       | 5,406               |       | 5,421             |       |
|                                                                                                                                                                        |       |                |       |              |       |
| Total assets                                                                                                                                                                |       | $                   | 133,154    |              | $          | 135,163 |   |
|                                                                                                                                                                        |       |                |       |              |       |
| **LIABILITIES AND STOCKHOLDERS’  DEFICIT**                                                                                                                             | ** ** | ** **          | ** ** | ** **        | ** ** |
| Current  liabilities:                                                                                                                                                       |       |                |       |              |       |
| Accounts payable                                                                                                                                                            |       | $                   | 3,347      |              | $          | 4,792 |   |
| Accrued expenses                                                                                                                                                            |       | 25,855              |       | 25,042            |       |
| Short term debt  and current portion of long-term debt                                                                                                                      |       | 3,605               |       | 4,080             |       |
| Current portion  of obligations under capital leases                                                                                                                        |       | 76                  |       | 80                |       |
|                                                                                                                                                                        |       |                |       |              |       |
| Total current  liabilities                                                                                                                                                  |       | 32,883              |       | 33,994            |       |
|                                                                                                                                                                        |       |                |       |              |       |
| Senior notes and  other long-term debt                                                                                                                                      |       | 166,556             |       | 166,112           |       |
| Obligations  under capital leases                                                                                                                                           |       | 124                 |       | 103               |       |
| Other  liabilities                                                                                                                                                          |       | 8,822               |       | 8,660             |       |
| Mandatorily  redeemable, Series Z Preferred Stock, $.001 par value, $1,000 per share  liquidation value; 2,000,000 shares authorized; 57,000 shares issued and  outstanding |       | 57,000              |       | 57,000            |       |
|                                                                                                                                                                        |       |                |       |              |       |
| Total liabilities                                                                                                                                                           |       | 265,385             |       | 265,869           |       |
|                                                                                                                                                                        |       |                |       |              |       |
| Commitments and  contingencies                                                                                                                                              |       |                |       |              |       |
|                                                                                                                                                                        |       |                |       |              |       |
| Stockholders’  deficit:                                                                                                                                                |       |                |       |              |       |
| Series A junior  participating preferred stock, 700,000 shares authorized no shares issued and  outstanding                                                                 |       | —              |       | —            |       |
| Common stock,  $.001 par value; 25,000,000 shares authorized; 10,596,419 and 10,612,227  shares issued and outstanding                                                      |       | 11                  |       | 11                |       |
| Additional  paid-in capital                                                                                                                                                 |       | 176,797             |       | 177,190           |       |
| Accumulated  deficit                                                                                                                                                        |       | (309,039            | )          | (307,907          | )          |
|                                                                                                                                                                        |       |                |       |              |       |
| Total  stockholders’ deficit                                                                                                                                           |       | (132,231            | )          | (130,706          | )          |
|                                                                                                                                                                        |       |                |       |              |       |
| Total liabilities and  stockholders’ deficit                                                                                                                           |       | $                   | 133,154    |              | $          | 135,163 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

3

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**FOR THE FIRST QUARTERS ENDED APRIL 4, 2006 AND APRIL3, 2007**

**(inthousands, except earnings per share and related share information)**

**(unaudited)**
| ** **                                                              | ** ** | **April 4,** | ** ** | **April 3,** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                              | ** ** | **2006**          | ** ** | **2007**          | ** ** |
| Revenues:                                                               |       |              |       |              |       |
| Company-owned  restaurant sales                                         |       | $                 | 90,580     |              | $          | 89,115 |   |
| Manufacturing  and commissary revenue                                   |       | 5,273             |       | 5,818             |       |
| License and  franchise revenue                                          |       | 1,223             |       | 1,322             |       |
|                                                                    |       |              |       |              |       |
| Total revenues                                                          |       | 97,076            |       | 96,255            |       |
|                                                                    |       |              |       |              |       |
| Cost of sales:                                                          |       |              |       |              |       |
| Company-owned  restaurant costs                                         |       | 73,526            |       | 71,332            |       |
| Manufacturing  and commissary costs                                     |       | 5,005             |       | 5,422             |       |
|                                                                    |       |              |       |              |       |
| Total cost of sales                                                     |       | 78,531            |       | 76,754            |       |
|                                                                    |       |              |       |              |       |
| Gross profit                                                            |       | 18,545            |       | 19,501            |       |
|                                                                    |       |              |       |              |       |
| Operating expenses:                                                     |       |              |       |              |       |
| General and  administrative expenses                                    |       | 10,561            |       | 10,731            |       |
| Depreciation and  amortization                                          |       | 6,004             |       | 2,419             |       |
| Loss on sale,  disposal or abandonment of assets, net                   |       | 21                |       | 374               |       |
| Impairment  charges and other related costs                             |       | 76                |       | 19                |       |
|                                                                    |       |              |       |              |       |
| Income from operations                                                  |       | 1,883             |       | 5,958             |       |
| Other expense:                                                          |       |              |       |              |       |
| Interest  expense, net                                                  |       | 5,209             |       | 4,789             |       |
| Prepayment  penalty upon redemption of $160 Million Notes               |       | 4,800             |       | —            |       |
| Write-off of  debt issuance costs upon redemption of $160 Million Notes |       | 3,956             |       | —            |       |
| Other, net                                                              |       | 10                |       | —            |       |
|                                                                    |       |              |       |              |       |
| Income (loss) before  income taxes                                      |       | (12,092           | )          | 1,169             |       |
| Provision for income  taxes                                             |       | —            |       | 37                |       |
|                                                                    |       |              |       |              |       |
| Net income (loss)                                                       |       | $                 | (12,092    | )                 | $          | 1,132 |   |
|                                                                    |       |              |       |              |       |
| Net income (loss) per  common share — Basic                        |       | $                 | (1.20      | )                 | $          | 0.11 |   |
| Net income (loss) per  common share — Diluted                      |       | $                 | (1.20      | )                 | $          | 0.10 |   |
|                                                                    |       |              |       |              |       |
| Weighted average number  of common shares outstanding:                  |       |              |       |              |       |
| Basic                                                                   |       | 10,065,072        |       | 10,605,626        |       |
| Diluted                                                                 |       | 10,065,072        |       | 11,136,699        |       |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

4

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**FOR THE FIRST QUARTERS ENDED APRIL 4, 2006 AND APRIL3, 2007**

**(inthousands)**

**(unaudited)**
| ** **                                                                                | ** ** | **April 4,** | ** ** | **April 3,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                                | ** ** | **2006**          | ** ** | **2007**          | ** ** |
| OPERATING ACTIVITIES:                                                                     |       |              |       |              |       |
| Net income (loss)                                                                         |       | (12,092           | )          | 1,132             |       |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |              |       |              |       |
| Depreciation and  amortization                                                            |       | 6,004             |       | 2,419             |       |
| Stock based  compensation expense                                                         |       | 216               |       | 331               |       |
| Loss on disposal  of assets, net of gains                                                 |       | 21                |       | 374               |       |
| Impairment  charges and other related costs                                               |       | 76                |       | 19                |       |
| Provision for  losses on accounts receivable, net                                         |       | 128               |       | 26                |       |
| Amortization of  debt issuance and debt discount costs                                    |       | 227               |       | 201               |       |
| Write-off of  debt issuance costs                                                         |       | 3,956             |       | —            |       |
| Paid-in-kind  interest                                                                    |       | —            |       | 487               |       |
| Changes in  operating assets and liabilities:                                             |       |              |       |              |       |
| Franchise and  other receivables                                                          |       | 396               |       | 540               |       |
| Accounts payable  and accrued expenses                                                    |       | 1,732             |       | 2,358             |       |
| Other assets and  liabilities                                                             |       | (528              | )          | (1,450            | )          |
|                                                                                      |       |              |       |              |       |
| Net cash  provided by operating activities                                                |       | 136               |       | 6,437             |       |
|                                                                                      |       |              |       |              |       |
| INVESTING ACTIVITIES:                                                                     |       |              |       |              |       |
| Purchase of property  and equipment                                                       |       | (2,559            | )          | (6,228            | )          |
| Proceeds from the sale  of equipment                                                      |       | 48                |       | 32                |       |
|                                                                                      |       |              |       |              |       |
| Net cash used in  investing activities                                                    |       | (2,511            | )          | (6,196            | )          |
|                                                                                      |       |              |       |              |       |
| FINANCING ACTIVITIES:                                                                     |       |              |       |              |       |
| Proceeds from line of  credit                                                             |       | 11                |       | —            |       |
| Repayments of line of  credit                                                             |       | (11               | )          | —            |       |
| Payments under capital  lease obligations                                                 |       | (4                | )          | (17               | )          |
| Repayment of notes  payable                                                               |       | (160,000          | )          | —            |       |
| Borrowings under First  Lien                                                              |       | 80,000            |       | —            |       |
| Repayments under First  Lien                                                              |       | —            |       | (475              | )          |
| Borrowings under Second  Lien                                                             |       | 65,000            |       | —            |       |
| Borrowings under  Subordinated Note                                                       |       | 24,375            |       | —            |       |
| Proceeds upon stock  option exercises                                                     |       | —            |       | 62                |       |
| Debt issuance costs                                                                       |       | (4,705            | )          | —            |       |
| Costs incurred with  proposed offering of our common stock                                |       | —            |       | (166              | )          |
|                                                                                      |       |              |       |              |       |
| Net cash  provided by (used in) financing activities                                      |       | 4,666             |       | (596              | )          |
|                                                                                      |       |              |       |              |       |
| Net increase (decrease)  in cash and cash equivalents                                     |       | 2,291             |       | (355              | )          |
| Cash and cash  equivalents, beginning of period                                           |       | 1,556             |       | 5,477             |       |
| Cash and cash equivalents, end of period                                                  |       | $                 | 3,847      |              | $          | 5,122 |   |
|                                                                                           |            |                   |            |                   |            |  |  |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

5

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’DEFICIT**

**FOR THE FIRST QUARTER ENDED APRIL 3, 2007**

**(inthousands, except share information)**

**(unaudited)**
| ** **                                      | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|-----------------|------------|------------|------------|
| ** **                                      | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Deficit**    | ** ** | ** **      | ** ** |
| ** **                                      | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Amount**      | ** ** | **Total**  | ** ** |
|                                            |       |                  |       |        |       |           |       |            |       |       |       |
| Balance, January 2,  2007                       |       | 10,596,419            |       | $           | 11         |           | $          | 176,797         |       | $          | (309,039   | ) | $ | (132,231 | ) |
| Net income                                      |       | —                |       | —      |       | —         |       | 1,132           |       | 1,132      |       |
| Common stock  issued upon stock option exercise |       | 15,808                |       | —      |       | 62             |       | —          |       | 62         |       |
| Stock based  compensation expense               |       | —                |       | —      |       | 331            |       | —          |       | 331        |       |
|                                            |       |                  |       |        |       |           |       |            |       |       |       |
| Balance, April 3, 2007                          |       | 10,612,227            |       | $           | 11         |           | $          | 177,190         |       | $          | (307,907   | ) | $ | (130,706 | ) |

 

The accompanying notes are an integral part of this consolidatedfinancial statement.

6

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

Notes toConsolidated Financial Statements (Unaudited)

For the FirstQuarters ended April 4, 2006 and April 3, 2007

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

The consolidatedfinancial statements of Einstein Noah Restaurant Group, Inc. (formerly NewWorld Restaurant Group, Inc.) and its wholly-owned subsidiaries (collectively,the “Company”) have been prepared pursuant to the rules and regulations of theSecurities and Exchange Commission (“SEC”). As of April 3, 2007, the Companyowns, franchises or licenses various restaurant concepts under the brand namesof Einstein Bros. Bagels (“Einstein Bros.”), Noah’s New York Bagels (“Noah’s”),Manhattan Bagel Company (“Manhattan Bagel”), Chesapeake Bagel Bakery (“Chesapeake”)and New World Coffee (“New World”). Our business is subject to seasonaltrends. Generally, our revenues and results of operations in the fourth fiscalquarter tend to be the most significant.

The consolidated financial statements as of April 3, 2007 and for thefirst quarters ended April 4, 2006 and April 3, 2007 have been preparedwithout audit. The balance sheet information as of January 2, 2007 has beenderived from our audited consolidated financial statements. The informationfurnished herein reflects all adjustments (consisting only of normal recurringaccruals and adjustments), which are, in our opinion, necessary to fairly statethe interim operating results for the respective periods.  However, theseoperating results are not necessarily indicative of the results expected forthe full fiscal year.  Certain information and footnote disclosuresnormally included in annual financial statements prepared in accordance withgenerally accepted accounting principles in the United States have been omittedpursuant to SEC rules and regulations. The notes to the consolidated financialstatements (unaudited) should be read in conjunction with the notes to theconsolidated financial statements contained in our annual report on Form 10-Kfor the fiscal year ended January 2, 2007. We believe that the disclosures aresufficient for interim financial reporting purposes.

Certain immaterial reclassifications have been made toconform previously reported data to the current presentation. Thesereclassifications have no effect on our net loss or financial position aspreviously reported.

**2.****             ****Stock Based Compensation**

In December 2004, the Financial Accounting Standards Board (FASB)issued Statement of Financial Accounting Standard (SFAS) No. 123R, Share-BasedPayment.  SFAS No. 123R is a revision ofSFAS No. 123, Accounting for Stock-Based Compensation, and supersedesAccounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issuedto Employees and its related implementation guidance. SFAS No. 123R focusesprimarily on accounting for transactions in which an entity obtains employeeservices in share-based payment transactions. The Statement requires entitiesto recognize compensation expense for awards of equity instruments to employeesbased on the grant-date fair value of those awards (with limited exceptions).Effective January 4, 2006, we adopted the provisions of SFAS No. 123R using themodified prospective transition method.

7

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Our stock-based compensation cost for the firstquarters ended April 4, 2006 and April 3, 2007 was $216,000 and $331,000,respectively and has been included in general and administrative expenses. Thefair value of stock options and stock appreciation rights (SARs) are estimatedusing the Black-Scholes option-pricing model with the following weighted averageassumptions: 

|                                              | ** ** | **First quarter ended:** | ** ** |
|----------------------------------------------|------------|------------------------------------|------------|
| ** **                                   | ** ** | **April 4,**                  | ** ** | **April 3,** | ** ** |
| ** **                                   | ** ** | **2006**                           | ** ** | **2007** | ** ** |
| Expected life of  options from date of grant |       | 4.0 years                          |       | 4.0 years |   |
| Risk-free  interest rate                     |       | 4.35                               | %          | 4.73 | % |
| Volatility                                   |       | 100.0                              | %          | 97.0 | % |
| Assumed dividend yield                       |       | 0.0                                | %          | 0.0 | % |

 

The expected term of options is based upon evaluationsof historical and expected future exercise behavior. The risk-free interestrate is based on the U.S. Treasury rates at the date of grant with maturitydates approximately equal to the expected life at the grant date. Impliedvolatility is based on the mean reverting average of our stock’s historicalvolatility and that of an industry peer group. The use of mean reversion issupported by evidence of a correlation between stock price volatility and acompany’s leverage combined with the effects mandatory principal payments willhave on our capital structure, as defined under our new debt facility. We havenot historically paid any dividends and are currently precluded from doing so underour debt covenants.

**StockPlans**

*1994 and 1995 Plans*

Our 1994 Stock Plan (1994 Plan) provided for thegranting to employees of incentive stock options and for the granting toemployees and consultants of non-statutory stock options and stock purchase rights.On November 21, 2003, the board of directors terminated the authority toissue any additional options under the 1994 Plan. At April 3, 2007, options topurchase 17 shares of common stock at an exercise price of $210.71 per shareand a remaining contractual life of 0.23 years remained outstanding under thisplan.

Our 1995 Directors’Stock Option Plan (Directors’ Option Plan) provided for the automatic grant ofnon-statutory stock options to non-employee directors of the Company. OnDecember 19, 2003, our board of directors terminated the authority toissue any additional options under the Directors’ Option Plan. At April 3,2007, options to purchase 2,324 shares of common stock at a weighted averageexercise price of $32.43 per share and a weighted average remaining contractuallife of 5.41 years remained outstanding under this plan.

8

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*2003Executive Employee Incentive Plan*

On November 21,2003, our board of directors adopted the Executive Employee Incentive Plan, asamended on December 19, 2003, March 1, 2005 and April 24, 2007 (2003 Plan). The2003 Plan provides for granting incentive stock options to employees andgranting non-statutory stock options to employees and consultants. Unlessterminated sooner, the 2003 Plan will terminate automatically in December 2013.The board of directors has the authority to amend, modify or terminate the 2003Plan, subject to any required approval by our stockholders under applicable lawor upon advice of counsel. No such action may affect any options previously grantedunder the 2003 Plan without the consent of the holders. There are 2,000,000shares reserved for issuance pursuant to options granted under the 2003 Plan.Options generally are granted with an exercise price equal to the fair marketvalue on the date of grant, have a contractual life of ten years and typicallyvest over a three-year service period. Generally, 50% of options granted vestbased solely upon the passage of time. We recognize compensation costs forthese awards using a graded vesting attribution method over the requisiteservice period. The remaining 50% of options granted vest based on service andperformance conditions. Options that do not vest due to the failure to achievespecific financial performance criteria are forfeited. Options to purchaseapproximately 233,776 shares of our common stock, which are not yetexercisable, are subject to company performance conditions. We recognizecompensation costs for performance based options over the requisite serviceperiod when conditions for achievement become probable. Excluding 850,000additional shares that have been reserved as a result of the April 24, 2007amendment to the 2003 Plan, as of April 3, 2007, there were 57,352 sharesreserved for future issuance under the 2003 Plan.

In February 2007,we granted options to purchase 124,250 shares of our common stock relating to aproposed public offering as further described in Note 14. The option awardswill vest upon closing of the offering, contingent upon completion beforeDecember 31, 2007. We will recognize approximately $470,000 in stock-basedcompensation expense over the requisite service period which commences on thedate of grant and concludes on the date of vesting.

*2004Stock Option Plan for Independent Directors*

On December 19,2003, our board of directors adopted the Stock Option Plan for IndependentDirectors, effective January 1, 2004, as amended on March 1, 2005 and February28, 2007 (2004 Directors’ Plan). Our board of directors may amend, suspend, orterminate the 2004 Directors’ Plan at any time, provided, however, that no suchaction may adversely affect any outstanding option without the option holdersconsent. A total of 300,000 shares of common stock have been reserved forissuance under the 2004 Directors’ Plan. The 2004 Directors’ Plan provides forthe automatic grant of non-statutory stock options to independent directors onJanuary 1 of each year and a prorated grant of options for any director electedduring the year. Options are granted with an exercise price equal to the fairmarket value on the date of grant, become exercisable six months after thegrant date and are exercisable for 5 years from the date of grant unlessearlier terminated. Excluding 100,000 additional shares that have been reservedas a result of the February 28, 2007 amendment to the 2004 Directors’ Plan, asof April 3, 2007, there were 14,192 shares reserved for future issuance underthe 2004 Directors’ Plan.

9

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*StockAppreciation Rights Plan*

On February 17,2007, our board of directors adopted the Stock Appreciation Rights Plan (SARPlan). The SAR Plan provides for granting stock appreciation rights toemployees. Unless terminated sooner, the SAR Plan will terminate automaticallyon March 31, 2012. The board of directors has the authority to amend, modify orterminate the SAR Plan, subject to any required approval by our stockholdersunder applicable law or upon advice of counsel, provided that, with limitedexception, no modification will adversely affect outstanding rights. There are150,000 shares issuable pursuant to stock appreciation rights granted under theSAR Plan. On February 20, 2007, we granted 133,000 rights under the SAR Plan.The rights were subject to certain conditions and as of April 3, 2007, thoseconditions have been satisfied with respect to 81,250 rights.

The value of ashare from which appreciation is determined is 100% of the fair market value ofa share on the date of grant. The rights expire upon the earlier of terminationdate of the SAR Plan or termination of employment and typically vest over atwo-year service period. Generally, 50% of rights granted vest based solelyupon the passage of time. We recognize compensation costs for these awardsusing a graded vesting attribution method over the requisite service period.The remaining 50% of rights granted vest based on performance conditions.Rights to approximately 40,625 shares of our common stock, which are not yetexercisable, are subject to company performance conditions. We will recognizecompensation costs for performance based stock appreciation rights over therequisite service period when conditions for achievement become probable.Rights that do not vest are forfeited.

*James W.Hood Stock Award Agreement*

On May 3, 2007,our board of directors adopted the James W. Hood Stock Award Agreement (theStock Award Plan).  The Stock Award Planprovides for the issuance of 22,000 shares of our common stock to Mr. Hood asinducement for accepting employment with us as our Chief Marketing Officer. Thecommon stock award includes 7,333 shares that have no restrictions, 7,333shares that become unrestricted on the first anniversary and 7,334 shares thatbecome unrestricted on the second anniversary of the date of grant; providedthat Mr. Hood is continuously employed by us on those dates.

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**StockOption Plan Activity**

Transactionsduring the first quarter ended April 3, 2007 were as follows:
| ** **                             | ** ** | ** **  | ** ** | **Weighted** | ** ** | **Weighted** | ** ** | ** **    | ** ** | **Weighted**          | ** ** |
|----------------------------------------|------------|-------------|------------|--------------|------------|--------------|------------|---------------|------------|-----------------------|------------|
| ** **                             | ** ** | **Number**  | ** ** | **Average**  | ** ** | **Average**  | ** ** | **Aggregate** | ** ** | **Average**           | ** ** |
| ** **                             | ** ** | **of**      | ** ** | **Exercise** | ** ** | **Fair**     | ** ** | **Intrinsic** | ** ** | **Remaining**         | ** ** |
| ** **                             | ** ** | **Options** | ** ** | **Price**    | ** ** | **Value**    | ** ** | **Value**     | ** ** | **Life (Years)** | ** ** |
| Outstanding,  January 2, 2007          |       | 993,707     |       | $            | 3.79       |         |       |          |       |                  |       |   |
| Granted                                |       | 256,458     |       | $            | 7.75       |         |       |          |       |                  |       |   |
| Exercised                              |       | (15,808     | )          | $            | 3.95       |         |       |          |       |                  |       |   |
| Forfeited                              |       | (17,853     | )          | $            | 4.58       |         |       |          |       |                  |       |   |
| Outstanding,  April 3, 2007            |       | 1,216,504   |       | $            | 4.61       |         | $          | 3.24          |       | $                     | 7,468,300  |   | 7.31 |   |
| Exercisable and Vested,  April 3, 2007 |       | 634,739     |       | $            | 3.71       |         | $          | 2.61          |       | $                     | 4,466,058  |   | 6.02 |   |

 
| ** **                         | ** ** | ** **  | ** ** | **Weighted**   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------|------------|-------------|------------|----------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                         | ** ** | **Number**  | ** ** | **Average**    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **of**      | ** ** | **Grant Date** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **Options** | ** ** | **Fair Value** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Non-vested shares, January 2, 2007 |       | 370,045     |       | $         | 2.81       |       |       |       |       |       |       |   |
| Granted                            |       | 256,458     |       | $         | 5.41       |       |       |       |       |       |       |   |
| Vested                             |       | (26,885)    |       | $         | 3.11       |       |       |       |       |       |       |   |
| Forfeited                          |       | (17,853)    |       | $         | 3.21       |       |       |       |       |       |       |   |
| Non-vested shares, April 3, 2007   |       | 581,765     |       | $         | 3.93       |       |       |       |       |       |       |   |

 

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**StockAppreciation Rights Plan Activity**

Transactionsduring the first quarter ended April 3, 2007 were as follows:
| ** **                            | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Weighted** | ** ** | ** **    | ** ** | **Weighted**          | ** ** |
|---------------------------------------|------------|------------|------------|--------------|------------|--------------|------------|---------------|------------|-----------------------|------------|
| ** **                            | ** ** | **Number** | ** ** | **Average**  | ** ** | **Average**  | ** ** | **Aggregate** | ** ** | **Average**           | ** ** |
| ** **                            | ** ** | **of**     | ** ** | **Exercise** | ** ** | **Fair**     | ** ** | **Intrinsic** | ** ** | **Remaining**         | ** ** |
| ** **                            | ** ** | **Rights** | ** ** | **Price**    | ** ** | **Value**    | ** ** | **Value**     | ** ** | **Life (Years)** | ** ** |
| Outstanding, January 2,  2007         |       | —     |       | $            | —     |         |       |          |       |                  |       |   |
| Granted                               |       | 81,250     |       | $            | 8.00       |         |       |          |       |                  |       |   |
| Exercised                             |       | —     |       | $            | —     |         |       |          |       |                  |       |   |
| Forfeited                             |       | —     |       | $            | —     |         |       |          |       |                  |       |   |
| Outstanding, April 3,  2007           |       | 81,250     |       | $            | 8.00       |         | $          | 5.59          |       | $                     | 223,438    |   | 4.89 |   |
| Exercisable and Vested, April 3, 2007 |       | —     |       | $            | —     |         | $          | —        |       | $                     | —     |   | — |   |

 

At April 3, 2007,we have approximately $1.4 million of total unrecognized compensation costrelated to non-vested awards granted under our stock option and stockappreciation rights plans, which we expect to recognize over a weighted averageperiod of 9.1 months. Total compensation costs related to the non-vested awardsoutstanding as of April 3, 2007 will be fully recognized by second quarter offiscal 2010, which represents the end of the requisite service period.

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**3.****             ****Supplemental Cash FlowInformation**

|                                                           | ** ** | **April 4,**                            | ** ** | **April 3,** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------|------------|-------------------|------------|
| ** **                                                | ** ** | **2006**                                     | ** ** | **2007**          | ** ** |
| ** **                                                | ** ** | **(in thousands of dollars)** | ** ** |
| Cash paid during the  year to date period ended:          |       |                                         |       |              |       |
| Interest                                                  |       | $                                            | 3,570      |              | $          | 4,186 |   |
| Prepayment  penalty upon redemption of $160 Million Notes |       | $                                            | 4,800      |              | $          | — |   |
| Income taxes                                              |       | $                                            | —     |              | $          | — |   |
|                                                      |       |                                         |       |              |       |
| Non-cash investing  activities:                           |       |                                         |       |              |       |
| Non-cash purchase of  equipment through capital leasing   |       | $                                            | 141        |              | $          | — |   |

 

**4.****             ****Inventories**

Inventories, which consist of food, beverage, papersupplies and bagel ingredients, are stated at the lower of cost or market, withcost being determined by the first-in, first-out method. Inventories consist ofthe following:

|                   | ** ** | **January 2,**                          | ** ** | **April 3,** | ** ** |
|-------------------|------------|----------------------------------------------|------------|-------------------|------------|
| ** **        | ** ** | **2007**                                     | ** ** | **2007**          | ** ** |
| ** **        | ** ** | **(in thousands of dollars)** | ** ** |
| Finished goods    |       | $                                            | 3,835      |              | $          | 3,764 |   |
| Raw materials     |       | 1,113                                        |       | 1,220             |       |
| Total inventories |       | $                                            | 4,948      |              | $          | 4,984 |   |

 

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**5.****             ****Goodwill, Trademarks and OtherIntangibles**

Intangible assets include both goodwill and identifiableintangibles arising from the allocation of the purchase prices of assetsacquired. Goodwill represents the excess of cost over fair value of net assetsacquired in the acquisition of Manhattan Bagel. As of April 3, 2007, intangibleassets of $63,806 were not subject to amortization and consisted primarily ofthe Einstein Bros. and Manhattan Bagel trademarks.

During the firstquarters ended April 4, 2006 and April 3, 2007, there were no events or changesin circumstances that indicated that our intangible assets might be impaired ormay not be recoverable.

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

Senior notes and other long-term debt consist of the following:

|                                                                | ** ** | **January 2,**                          | ** ** | **April 3,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------|------------|-------------------|------------|
| ** **                                                     | ** ** | **2007**                                     | ** ** | **2007**          | ** ** |
| ** **                                                     | ** ** | **(in thousands of dollars)** | ** ** |
| $80 Million First Lien  Term Loan                              |       | $                                            | 78,575     |              | $          | 78,100 |   |
| $65 Million Second Lien  Term Loan                             |       | 65,000                                       |       | 65,000            |       |
| $25 Million  Subordinated Note                                 |       | 26,026                                       |       | 26,532            |       |
| New Jersey Economic  Development Authority Note Payable        |       | 560                                          |       | 560               |       |
|                                                           |       | $                                            | 170,161    |              | $          | 170,192 |   |
| Less current portion of  senior notes and other long-term debt |       | 3,605                                        |       | 4,080             |       |
| Senior notes and other  long-term debt                         |       | $                                            | 166,556    |              | $          | 166,112 |   |

 

**Debt Redemption andRefinancing**

On February 28,2006, we completed the refinancing of the AmSouth Revolver and $160Million Notes. Our newdebt obligations consist of the following:

·                  $15 million revolving creditfacility (Revolving Facility);

·                  $80 million first lien term loan(First Lien Term Loan);

·                  $65 million second lien term loan(Second Lien Term Loan); and

·                  $25 million subordinated note(Subordinated Note).

Proceeds from thenew debt facility were used to repay the $160 Million Notes plus a 3%redemption premium of $4.8 million and accrued and unpaid interest to theredemption date.

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**Revolving Facility**

The Revolving Facility has a maturity date of March 31, 2011 andprovides for interest based upon the prime rate or LIBOR plus a margin. Themargin may increase or decrease up to 0.25% based upon our consolidatedleverage ratio as defined in the agreement. The initial margin is at prime plus2.00% or LIBOR plus 3.00%. This facility may be used in whole or in part forletters of credit.  As of April 3, 2007,the stated interest rate under the Revolving Facility was at prime plus 2.00%,or 10.25%.

In the event that we have not extended the maturity date of theMandatorily Redeemable Series Z Preferred Stock (Series Z) to a date that is onor after July 26, 2012 or redeemed the Series Z by December 30, 2008, then theRevolving Facility will mature on December 30, 2008.

We are required topay an unused credit line fee of 0.5% per annum on the average daily unusedamount. The unused line fee is payable quarterly in arrears. Additionally, weare required to pay a letter of credit fee based on the ending daily undrawnface amount for each letter of credit issued, of an applicable margin beingbased on our consolidated leverage ratio with a minimum and maximum applicablemargin of 2.75% and 3.25%, respectively, plus a 0.5% arranger fee payablequarterly. Letters of credit reduce our availability under the RevolvingFacility. At April 3, 2007, we had $6.7 million in letters of creditoutstanding. The letters of credit expire on various dates during 2008, areautomatically renewable for one additional year and are payable upon demand inthe event that we fail to pay the underlying obligation. Our availability underthe Revolving Facility was $8.3 million at April 3, 2007.

The RevolvingFacility contains usual and customary covenants including consolidated leverageratios, fixed charge coverage ratios, limitations on capital expenditures, etc.The ratio covenants are based on a Consolidated EBITDA calculation (asdefined in our loan agreement) and are measured on a twelve month period endingon the last day of each fiscal quarter. The loan is guaranteed by our material subsidiaries.  The Revolving Facility and the relatedguarantees are secured by a first priority security interest in all of ourassets and our material subsidiaries, including a pledge of 100% of ourinterest in all shares of capital stock (or other ownership or equity interests)of each material subsidiary.  Asof April 3, 2007, we were in compliance with all our financial and operatingcovenants.

Approximately $0.4million in debt issuance costs have been capitalized and are being amortizedusing the straight-line method over the term of the Revolving Facility.

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**First Lien Term Loan**

The First Lien Term Loan has a maturity date of March 31, 2011 andprovides for a floating interest rate based upon the prime rate or LIBOR plus amargin. The margin may increase or decrease 0.25% based upon our consolidatedleverage ratio as defined in the agreement. The initial margin is at prime plus2.00% and/or LIBOR plus 3.00% and is payable in arrears quarterly and/or at theLIBOR date, dependent upon the rate in effect. As of April 3, 2007, the statedinterest rate under the First Lien Term Loan was 8.39%, which represents aweighted average of 6-Month LIBOR plus 3.00%, or 8.39%, 3-Month LIBOR plus3.00%, or 8.35%, and prime plus 2.00%, or 10.25%. The effective interest rateduring the first quarter ended April 3, 2007 was 9.06%.  The facility is fully amortizing with annualaggregate principal reductions payable in quarterly installments over the termof the loan as follows:

| For the 2006 fiscal year ending  January 2, 2007   |   | $ | 1.425 million  |   |
|----------------------------------------------------|--------|---|----------------|--------|
| For the 2007 fiscal year ending January 1, 2008    |   | $ | 3.325 million  |   |
| For the 2008 fiscal year ending December 30, 2008  |   | $ | 5.950 million  |   |
| For the 2009 fiscal year ending December 29, 2009  |   | $ | 11.250 million |   |
| For the 2010 fiscal year ending December 28, 2010  |   | $ | 32.150 million |   |
| For the 2011 fiscal quarter  ending March 29, 2011 |   | $ | 25.900 million |   |

 

In addition to the repayment schedule discussed above, the FirstLien Term Loan also requires additional principal reductions based upon apercentage of excess cash flow as defined in the loan agreement in any fiscalyear. The First Lien Term Loan also provides us the opportunity to repay theSecond Lien Term Loan or the Subordinated Note with the proceeds of a capitalstock offering provided that certain consolidated leverage ratios are met.

In the event that we have not extended the maturity date of theSeries Z to a date that is on or after July 26, 2012 or redeemed the Series Zby December 30, 2008, then the First Lien Term Loan will mature on December 30,2008.

The First LienTerm Loan has usual and customary covenants including consolidated leverageratios, fixed charge coverage ratios, limitations on capital expenditures, etc.The ratio covenants are based on a Consolidated EBITDA calculation (asdefined in our loan agreement) and are measured on a twelve month period endingon the last day of each fiscal quarter. The loan is guaranteed by our material subsidiaries.  The First Lien Term Loan and the relatedguarantees are secured by a first priority security interest in all of ourassets and our material subsidiaries, including a pledge of 100% of ourinterest in all shares of capital stock (or other ownership or equityinterests) of each material subsidiary.  Asof April 3, 2007, we were in compliance with all our financial and operatingcovenants.

Approximately $2.2million in debt issuance costs have been capitalized and are being amortizedusing the effective interest method over the term of the First Lien Term Loan.

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**Second Lien Term Loan**

The Second Lien Term Loan has a maturity date of February 28, 2012and provides for a floating interest rate based upon the prime rate plus 5.75%or LIBOR plus 6.75%. Interest is payable in arrears on a quarterly basis. As ofApril 3, 2007, the stated interest rate under the Second Lien Term Loan was atLIBOR plus 6.75%, or 12.21% and the effective interest rate during the firstquarter ended April 3, 2007 was 12.69%. The Second Lien Term Loan has a prepayment penalty of 2.0% and 1.0% ofthe amount of any such optional prepayment that occurs prior to the first orsecond anniversary date, respectively. The Second Lien Term Loan requiresprincipal reductions based upon a percentage of excess cash flow (as defined inthe credit agreement) in any fiscal year and is also subject to certainmandatory prepayment provisions. In the event that we have not extended thematurity date of the Series Z to a date that is on or after July 26, 2012 orredeemed the Series Z by March 30, 2009, then the Second Lien Term Loan willmature on March 30, 2009.

The Second LienTerm Loan has usual and customary covenants including consolidated leverageratios, fixed charge coverage ratios, limitations on capital expenditures, etc.The ratio covenants are based on a Consolidated EBITDA calculation (asdefined in our loan agreement) and are measured on a twelve month period endingon the last day of each fiscal quarter. The loan is guaranteed by our material subsidiaries.  The Second Lien Term Loan and the related guaranteesare secured by a second priority security interest in all our assets and ourmaterial subsidiaries, including a pledge of 100% of our interest in all sharesof capital stock (or other ownership or equity interests) of each materialsubsidiary.  As of April 3, 2007,we were in compliance with all our financial and operating covenants.

Approximately $1.7million in debt issuance costs have been capitalized and are being amortizedusing the effective interest method over the term of the Second Lien Term Loan.

**Subordinated Note**

The Subordinated Note has a maturity date of February 28, 2013,carries a fixed interest rate of 13.75% per annum and requires a quarterly cashinterest payment in arrears at 6.5% and quarterly paid-in-kind interest that isadded to the principal balance outstanding at 7.25%. As of April 3, 2007, theeffective interest rate during the first quarter ended April 3, 2007 was13.94%. The Subordinated Note is held by Greenlight Capital L.L.C. and itsaffiliates (collectively referred to as “Greenlight”). Based on an originalissue discount of 2.5%, proceeds of approximately $24.4 million were loaned tothe Company. The Subordinated Note is subject to certain mandatory prepaymentprovisions. In the event that we have not extended the maturity date of theSeries Z to a date that is on or after July 26, 2013 or redeemed the Series Zby June 29, 2009, then the Subordinated Note will mature on June 29, 2009.

The SubordinatedNote has usual and customary covenants including consolidated leverage ratios,fixed charge coverage ratios, limitations on capital expenditures, etc. Theloan is guaranteed by our material subsidiaries.   The Subordinated Note is unsecured.  As of April 3, 2007, we were incompliance with all our financial and operating covenants.

Approximately $0.7million in debt issuance costs have been capitalized and are being amortizedusing the effective interest method over the term of the Subordinated Note. Thedebt discount of $625,000 is accretive to the Subordinated Note and isamortized to interest expense using the effective interest method over the termof the Subordinated Note.

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**New Jersey Economic Development Authority NotePayable**

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

On July 3, 2003, we placed an advanced funding ofthe note in escrow to enact a debt defeasance as allowed for in the agreement.This advanced funding is shown as restricted cash and the note is included inboth current portion and long-term portion of debt in the January 2, 2007 andApril 3, 2007 consolidated balance sheets in accordance with the payment terms.This classification will continue until the note is fully paid from the escrowamount proceeds.

**7.****             ****Net Income (Loss) Per CommonShare**

In accordance with SFAS No. 128, Earnings per Share,we compute basic net income (loss) per common share by dividing the net income(loss) for the period by the weighted average number of shares of common stockoutstanding during the period.

Diluted net income per share is computed by dividingthe net income for the period by the weighted average number of shares ofcommon stock and potential common stock equivalents outstanding during theperiod using the treasury stock method. Potential common stock equivalentsinclude incremental shares of common stock issuable upon the exercise of stockoptions and warrants. Potential common stock equivalents are excluded from thecomputation of diluted net income (loss) per share when their effect isanti-dilutive.

The followingtable summarizes the weighted average number of common shares outstanding, andthe computation of basic and diluted net income (loss) per common share for theperiods indicated:  

|                                                  | ** ** | **Quarter ended:**                                                                                 | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **April 4,**                                                                                       | ** ** | **April 3,** | ** ** |
| ** **                                       | ** ** | **2006**                                                                                                | ** ** | **2007** | ** ** |
| ** **                                       | ** ** | **(in thousands of dollars, except  share and per share data)** | ** ** |
| Net income  (loss) (a)                           |       | $                                                                                                       | (12,092    | ) | $ | 1,132 |   |
|                                             |       |                                                                                                    |       |   |   |
| Basic weighted  average shares outstanding (b)   |       | 10,065,072                                                                                              |       | 10,605,626 |   |
| Dilutive effect  of stock options and SARs       |       | —                                                                                                  |       | 531,073 |   |
| Diluted weighted  average shares outstanding (c) |       | 10,065,072                                                                                              |       | 11,136,699 |   |
| Basic earnings  (loss) per share (a)/(b)         |       | $                                                                                                       | (1.20      | ) | $ | 0.11 |   |
| Diluted earnings  (loss) per share (a)/(c)       |       | $                                                                                                       | (1.20      | ) | $ | 0.10 |   |
|                                             |       |                                                                                                    |       |   |   |
| Antidilutive stock  options, SARs and warrants   |       | 1,750,941                                                                                               |       | 382,404 |   |

 

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** **

**8.****             ****Income Taxes**

As of April 3,2007, net operating loss carryforwards of $153.7 million were available to beutilized against future taxable income for years through fiscal 2026, subjectin part to annual limitations. Our ability to utilize our net operating losses,including those that are not currently subject to limitation, could be limitedor further limited in the event that we undergo an “ownership change” as thatterm is defined for purposes of Section 382 of the Internal Revenue Code.

Our net operatingloss carryforwards are one of our deferred income tax assets; however, theultimate realization of these deferred income tax assets is dependent upon thegeneration of future taxable income. Due to the uncertainty of future taxableincome, deferred tax assets resulting from these net operating losses have beenfully reserved.

In accordance withSFAS No. 109, “Accountingfor Income Taxes,” we will assess the continuing need for a valuation allowancethat results from uncertainty regarding our ability to realize the benefits ofour deferred tax assets. As we move closer toward achieving net income for afull year, we will review various qualitative and quantitative data, includingevents within the restaurant industry, the cyclical nature of our business, ourfuture forecasts and historical trending. If we conclude that our prospects forthe realization of our deferred tax assets are more likely than not, we willthen reduce our valuation allowance as appropriate and credit income taxexpense after considering the following factors:

·                                          The level of historical taxableincome and projections for future taxable income over periods in which the deferredtax assets would be deductible, and

·                                          Accumulation of net income beforetax utilizing a look-back period of three years.

The amount of thedeferred tax asset considered realizable, however, could be reduced ifestimates of future taxable income during the carryforward periods are reduced.

On January 3, 2007, we adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). Previously, we accounted for tax contingencies in accordance with Statement of Financial Accounting Standards 5, Accounting for Contingencies. As required by FIN 48, which clarifies SFAS No. 109, we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority. At the adoption date, we applied FIN 48 to all tax positions for which the statute of limitations remained open. As a result of the implementation of FIN 48, we recorded a reduction of approximately $1.8 million of the gross deferred tax asset and a corresponding reduction of the valuation allowance.  There was no net effect to the financial statements and none of the unrecognized tax benefits will impact our effective tax rate.

The income tax uncertainties relate to periods in which net operating losses were generated. Upon adoption of Interpretation 48, the net operating loss carryforwards were reduced and thus no tax liability was recorded.  Additionally, we maintain a full valuation allowance against our net deferred tax assets.  Therefore, our valuation allowance was correspondingly reduced by $1.8 million. Of the $1.8 million reduction in gross deferred tax assets, we believe it is reasonably possible that approximately $1.5 million of the unrecognized tax benefits will become highly certain when Forms 3115, Application for Change in Accounting Method are filed before year-end.

We are subject to income taxes in the U.S. federal jurisdiction, and various states and local jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. We remain subject to examination by U.S. federal, state and local tax authorities for tax years 2003 through 2006. With a few exceptions, we are no longer subject to U.S. federal, state or local examinations by tax authorities for the tax year 2002 and prior.

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**9.****             ****Impairment Charges and OtherRelated Costs**

In accordance withSFAS No. 144, Accounting for the Impairment or Disposal of Long Lived Assets,impairment losses are recorded on long-lived assets on arestaurant-by-restaurant basis whenever impairment indicators are determined tobe present. We consider a history of cash flow losses to be the primaryindicator of potential impairment for individual restaurants. We determinewhether a restaurant is impaired based on expected undiscounted future cashflows, considering location, local competition, current restaurant managementperformance, existing pricing structure and alternatives available for thesite. If impairment exists, the amount of impairment is measured as the excessof the carrying amount of the asset over its fair value as determined utilizingthe estimated discounted future cash flows or the expected proceeds, net ofcosts to sell, upon sale of the asset.

During the firstquarters ended April 4, 2006 and April 3, 2007, we recorded $76,000 and$19,000, respectively in impairment charges and other related costs.

**10.****      ****Litigation and Contingencies**

We are subject to claims and legal actions in theordinary course of our business, including claims by or against ourfranchisees, licensees and employees or former employees and/or contractdisputes. We do not believe that any currently pending or threatened matterwould have a material adverse effect on our business, results of operations orfinancial condition.

*Guarantees*

Prior to 2001, wewould occasionally guarantee leases for the benefit of certain of ourfranchisees. None of the guarantees have been modified since their inceptionand we have since discontinued this practice. Current franchisees are theprimary lessees under the vast majority of these leases. Under the leaseguarantees, we may be required by the lessor to make all of the remainingmonthly rental payments or property tax and common area maintenance payments ifthe franchisee does not make the required payments in a timely manner. However,we believe that most, if not all, of the franchised restaurants could besubleased to third parties minimizing our potential exposure. Additionally, wehave indemnification agreements with our franchisees under which thefranchisees would be obligated to reimburse us for any amounts paid under suchguarantees. Historically, we have not been required to make such payments insignificant amounts. We record a liability for our exposure under theguarantees in accordance with SFAS No. 5, “Accounting for Contingencies,”following a probability related approach. Minimum future rental paymentsremaining under these leases were approximately $0.6 million as of April 3,2007. We believe the ultimate disposition of these matters will not have amaterial adverse effect on our financial position or results of operations.

*Insurance*

We are insured forlosses related to health, general liability and workers’ compensation underlarge deductible policies. The insurance liability represents an estimate ofthe ultimate cost of claims incurred and unpaid as of the balance sheet date.The estimated liability is established based on actuarial estimates, isdiscounted at 10% based upon a discrete analysis of actual claims andhistorical data and is reviewed on a quarterly basis to ensure that theliability is appropriate. If actual trends, including the severity or frequencyof claims, differ from our estimates our financial results could be favorablyor unfavorably impacted.  The estimatedliability is included in accrued expenses in our consolidated balance sheets.

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**11.****      ****Assets Held for Sale**

As of January 2,2007, certain manufacturing equipment was located at the plant of HarlanBakeries, Inc. (Harlan), our frozen bagel dough supplier. In late 2006, we werenotified of Harlan’s intent, under the terms of the contract, to purchase theequipment and we agreed to sell the equipment to Harlan for $1.1 million. Theassets were classified as held for sale on the consolidated balance sheet as ofJanuary 2, 2007. The assets were sold to Harlan in the first quarter of 2007and the note receivable was paid in the second quarter of 2007.

**12.****      ****Recent Accounting Pronouncements**

In February 2007,the FASB issued SFAS No. 159 The Fair Value Option for Financial Assets andFinancial Liabilities — Including an Amendment of SFAS No. 115, which becomeseffective for fiscal periods beginning after November 15, 2007.  Under SFAS No. 159, companies may elect tomeasure specified financial instruments and warranty and insurance contracts atfair value on a contract-by-contract basis, with changes in fair valuerecognized in earnings each reporting period. This election, called the “fair value option”, will enable somecompanies to reduce volatility in reported earnings caused by measuring relatedassets and liabilities differently. We do not expect the impact of adoption tohave a material impact on our consolidated financial statements.

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements”, which defines fairvalue, establishes a framework for measuring fair value and expands disclosuresabout fair value measurements. The statement is effective for fiscal yearsbeginning after November 15, 2007. We are still in the process of evaluatingSFAS No. 157 and are not able to estimate the impact of adoption to ourconsolidated financial statements.

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

**13.****      ****Related Party Transactions**

E. Nelson Heumannis the chairman of our board of directors and is a current employee ofGreenlight Capital, Inc.  Greenlight andits affiliates beneficially own approximately 94% of our common stock on afully diluted basis. As a result, Greenlight has sufficient voting powerwithout the vote of any other stockholders to determine what matters will besubmitted for approval by our stockholders, to approve actions by writtenconsent without the approval of any other stockholders, to elect all of ourboard of directors, and among other things, to determine whether a change incontrol of our company occurs.

Greenlight owned$35.0 million of our $160 Million Notes when we called the Notes for redemptionin January 2006. The Notes were redeemed from the proceeds of our refinancingin February 2006 as further described in Note 6.

We entered intothe Subordinated Note with Greenlight in February 2006 as further described inNote 6. The Subordinated Note has a maturity date of February 28, 2013, carriesa fixed interest rate of 13.75% per annum and requires a quarterly cashinterest payment in arrears at 6.5% and quarterly paid-in-kind interest that isadded to the principal balance outstanding at 7.25%. Total interest expenserelated to the Subordinated Note with Greenlight was $3.0 million for the yearended January 2, 2007 and $0.9 million for the first quarter ended April 3,2007.

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LeonardTannenbaum, a director, is a limited partner and 10% owner in BET. BETpurchased $7.5 million of our $160 Million Notes and Mr. Tannenbaum purchasedan additional $0.5 million of our $160 Million Notes in the market. In January2006, Mr. Tannenbaum and BET’s Notes were called for redemption and wereredeemed from the proceeds of our refinancing in February 2006 as furtherdescribed in Note 6.

On December 8,2003, we entered into a consulting agreement with Jill B.W. Sisson to providelegal, consulting and advisory services to us and to serve as our GeneralCounsel and Secretary. Pursuant to the agreement, Ms. Sisson is eligible toreceive stock options to purchase shares of our common stock. Ms. Sisson alsoreceives an annual compensation based upon company performance and personalperformance, subject to an annual adjustment, and is reimbursed for reasonableand necessary out-of-pocket expenses. The agreement provides fornon-solicitation of company employees for a year after termination of theagreement, and can be terminated by either party upon 30 days’ notice.

**14.****      ****Subsequent Events**

On April 10, 2007,we filed a registration statement on Form S-1 with the SEC relating to aproposed public offering of up to $125 million of our common stock. Applicationhas been made to list our common stock on the Nasdaq Global Market under thesymbol “BAGL.” These securities may not be sold nor may offers to buy thesesecurities be accepted prior to the time the registration statement becomeseffective. The number of shares to be offered and the price range for theoffering have not been determined. We will use the proceeds of the offering topay down our existing indebtedness.

Concurrently withour proposed public offering of common stock, we intend to amend our existingRevolving Facility and our existing First Lien Term Loan and to pay off in fullour existing Second Lien Term Loan as well as our existing Subordinated Noteheld by Greenlight.  On April 27, 2007,we signed a commitment letter for this amendment or, if an amendment is notpossible, a new $90.0 million senior secured credit facility.  Pursuant to the amendment, we expect toincrease the amount of our Revolving Facility to $20.0 million and decrease theamount of our term loan to a principal amount of $70.0 million or less.  Both the amended Revolving Facility and theamended term loan are expected to have new five-year terms and will continue tobe secured by substantially all of our assets and guaranteed by all of oursubsidiaries. The commitment letter provides for the loans to bear interest ina range from 1.75% to 2.25% for LIBOR loans and in a range from 0.75% to 1.25%for base rate loans, depending on our consolidated leverage ratio.  A portion of the Revolving Facility will beavailable for letters of credit. We expect that the amended term loan willrequire mandatory prepayments in certain circumstances that are similar to ourexisting First Lien Term Loan and will contain customary events of default.

In addition, wehave obtained a commitment for an incremental term loan in an aggregateprincipal amount of up to $57.0 million which may be used by us, if needed,solely for the purpose of redeeming the zero coupon Series Z preferred stockwhich is not due until June 2009.

The closing of theproposed offering of our common stock is not conditioned on the amendment ofour existing indebtedness.  Thecommitment from our lender for this amendment or new credit facility (asapplicable) is contingent upon negotiation of definitive loan documentation andother normal and customary conditions.

On May 3, 2007, wehired James W. Hood, a director, as our Chief Marketing Officer at an annualsalary of $250,000. Mr. Hood is also eligible to receive a bonus based uponcompany performance and personal performance. Mr. Hood was granted options to purchase 125,000 shares of common stockpursuant to the 2003 Plan, which vest over three years in part upon length ofservice and in part upon the achievement of specific financial goals by theCompany.  Mr. Hood was also awarded22,000 shares of common stock consisting of 7,333 which have no restrictions,7,333 shares which become unrestricted on the first anniversary and 7,334shares become unrestricted on the second anniversary of the date of grant;provided that Mr. Hood is continuously employed by us on those dates.

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**ITEM 2.**                    MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis supplements themanagement’s discussion and analysis in our Annual Report on Form 10-K for theyear ended January 2, 2007 and presumes that readers have read or have accessto the discussion and analysis in our Annual Report. The following discussionand analysis includes historical and certain forward-looking information thatshould be read together with the accompanying consolidated financialstatements, related footnotes and the discussion below of certain risks anduncertainties that could cause future operating results to differ materiallyfrom historical results or from the expected results indicated by forwardlooking statements.

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

On January 3, 2007, we adopted the provisions of FASBInterpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN48 is an interpretation of SFAS No. 109 and it seeks to reduce the diversity inpractice associated with certain aspects of measurement and recognition inaccounting for income taxes. FIN 48 prescribes a recognition threshold andmeasurement criterion for the financial statement recognition and measurementof tax positions taken or expected to be taken in a tax return. For thosebenefits to be recognized, a tax position must be more-likely-than-not to besustained upon examination by taxing authorities. The amount recognized ismeasured as the largest amount of benefit that is greater than 50% likely ofbeing realized upon ultimate settlement. As a result of the implementation ofFIN 48, we recorded a reduction of approximately $1.8 million of the grossdeferred tax asset.  There was no effectto the financial statements due to the recording of a full valuation allowance.

There were no other material changes in our criticalaccounting policies since the filing of our 2006 Form 10-K. As discussed in our2006 Form 10-K, the preparation of the consolidated financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make certain estimates and assumptions that affect theamount of reported assets and liabilities and disclosure of contingent assetsand liabilities at the date of the consolidated financial statements andrevenues and expenses during the periods reported. Actual results may differfrom those estimates.

**Company Overview**

We are the largest owner/operator, franchisor andlicensor of bagel specialty restaurants in the United States. We haveapproximately 600 restaurants in 36 states and the District of Columbia underthe Einstein Bros. Bagels, Noah’s New York Bagels and Manhattan Bagel brands.As a leading fast-casual restaurant chain, our restaurants specialize in highquality foods for breakfast, lunch and afternoon snacks in a café atmospherewith a neighborhood emphasis. Collectively, our concepts span the nation withEinstein Bros. restaurants in 33 states and the District of Columbia, Noah’srestaurants in three states on the West Coast and Manhattan Bagel restaurantsconcentrated in the Northeast. Our Einstein Bros. and Noah’s restaurants arecompany-owned or licensed, while Manhattan Bagel restaurants are predominantlyfranchised.

Our product offerings include fresh bagels and otherbakery items baked on-site, made-to-order breakfast and lunch sandwiches on avariety of bagels and breads, gourmet soups and salads, decadent desserts,premium coffees and an assortment of snacks. Our manufacturing and commissaryoperations prepare and assemble consistent, high quality ingredients that aredelivered fresh to our restaurants through our network of independentdistributors.

On May 3, 2007, we changed our name from New WorldRestaurant Group, Inc. to Einstein Noah Restaurant Group, Inc.

**PublicOffering of Our Common Stock**

On April 10, 2007,we filed a registration statement on Form S-1 with the SEC relating to aproposed public offering of up to $125 million of our common stock. Applicationhas been made to list our common stock on the Nasdaq Global Market under thesymbol “BAGL.” These securities may not be sold nor may offers to buy thesesecurities be accepted prior to the time the registration statement becomeseffective. The number of shares to be offered and the price range for theoffering have not been determined. We will use the proceeds of the offering to paydown our existing indebtedness.

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**Current Restaurant Base**

As of April 3, 2007, we owned and operated, franchisedor licensed 597 restaurants. Our current base of company-owned restaurantsunder our core brands includes 336 Einstein Bros. restaurants and 74 Noah’srestaurants. Also, we franchise 79 Manhattan Bagel restaurants andlicense/franchise 97 Einstein Bros. restaurants and three Noah’s restaurants.In addition, we have eight restaurants which we operate/franchise under ournon-core brands.

Our company-owned restaurants vary in their unitvolume, profitability and recent comparable store sales performance. As ofJanuary 2, 2007, we had 96 restaurants that generated an average annual unitvolume (AUV) in excess of $1.0 million. These restaurants have an AUV ofapproximately $1.2 million and an average gross profit of $342,000. In theaggregate, these restaurants contribute approximately 31.6% of total restaurantsales and 44.7% of total restaurant operating profit. Since 2003, as part ofour efforts to improve financial performance, we completed a thoroughevaluation of our restaurant base. At the end of 2003, we had 735 restaurantsacross 33 states and the District of Columbia. Since that time through April 3,2007, we have closed 66 company-owned restaurants and 155 licensed andfranchised restaurants. Most of our closed company-owned restaurants wereeither located in inferior real estate locations, had an AUV below $550,000 orwere unprofitable or marginally profitable. Substantially all of the franchisedrestaurants that were closed either:

• Involved thefailure of the franchisee to conform with the requirements of the franchiseagreement;

• Were geographicallylocated outside Manhattan Bagel’s core market; or

• Were restaurantsoperating under our non-core brands, Chesapeake Bagel Bakery and New WorldCoffee.

The following table includes only restaurants thathave been open for at least one full year as of January 2, 2007, and have notbeen relocated or closed during fiscal 2006. It summarizes our improvingfinancial performance since 2003 by reporting company-owned restaurants bysales level and the related revenue (in thousands of dollars) and gross marginpercentage:
| ** **            | ** ** | **Fiscal 2004** | ** ** | **Fiscal 2005** | ** ** | **Fiscal 2006** | ** ** |
|-----------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
| ** **            | ** ** | **Number of**   | ** ** | **Net**              | ** ** | **Gross**            | ** ** | **Number of** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Number of** | ** ** | **Net** | ** ** | **Gross** | ** ** |
| **Sales Level:** | ** ** | **Restaurants**      | ** ** | **Revenue**          | ** ** | **Margin**           | ** ** | **Restaurants** | ** ** | **Revenue** | ** ** | **Margin** | ** ** | **Restaurants** | ** ** | **Revenue** | ** ** | **Margin** | ** ** |
| greater than $1,000   |       | 60                   |       | $                    | 70,000     |                 | 26.7       | % | 81 |   | $ | 96,700 |   | 27.9 | % | 96 |   | $ | 115,000 |   | 28.5 | % |
| $900 - $1,000         |       | 35                   |       | $                    | 33,300     |                 | 23.7       | % | 53 |   | $ | 50,100 |   | 22.4 | % | 57 |   | $ | 54,300 |   | 23.2 | % |
| $800 - $900           |       | 68                   |       | $                    | 57,700     |                 | 19.9       | % | 78 |   | $ | 66,300 |   | 19.0 | % | 76 |   | $ | 64,600 |   | 19.7 | % |
| $700 - $800           |       | 89                   |       | $                    | 66,900     |                 | 16.6       | % | 83 |   | $ | 62,400 |   | 15.5 | % | 73 |   | $ | 55,200 |   | 16.7 | % |
| $600 - $700           |       | 98                   |       | $                    | 63,800     |                 | 12.2       | % | 82 |   | $ | 52,700 |   | 11.2 | % | 72 |   | $ | 46,700 |   | 12.6 | % |
| less than $600        |       | 95                   |       | $                    | 49,600     |                 | 5.2        | % | 54 |   | $ | 28,100 |   | 2.8 | % | 35 |   | $ | 18,700 |   | 4.8 | % |
| Totals                |       | 445                  |       | $                    | 341,300    |                 | 17.5       | % | 431 |   | $ | 356,300 |   | 18.9 | % | 409 |   | $ | 354,500 |   | 20.9 | % |

 

As of April 3, 2007, we have identified approximately20 company-owned restaurants that we anticipate closing over the next threeyears as their leases expire. Generally, these restaurants have an AUV ofapproximately $550,000 or less and contribute negligible cash flow.

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We have recently implemented a number of initiativesin an effort to drive sales and improve profitability, including qualityservice checklists, secret shopper inspections, improved ordering systems andenhanced training programs. These initiatives have led to our positivecomparable store sales over the past ten quarters, which reversed a two-yearnegative trend. In addition, we have started to upgrade restaurants where wehave the opportunity to improve sales. The upgrades are intended to providesuperior merchandising, enhance our guests’ experience and increase the speedof service while maintaining the neighborhood feel of the restaurants. We areupgrading our Einstein Bros. restaurants based on sales volume, demographictraits and the related cost of the upgrade. Only those restaurants that offerthe potential for a superior return on investment are considered for anupgrade. We anticipate the costs of upgrades in the future to approximate$100,000 per restaurant.

**New Restaurant Openings**

Using the knowledge gained from our upgrade program,we plan to pursue a measured approach to new company-owned restaurant openings.During 2004, 2005 and 2006, we opened four, four and five new company-ownedrestaurants, respectively. Our ability to open new restaurants during thoseyears was limited by the capital expenditure restrictions of the debtagreements in place at that time. Our current plan is to open new company-ownedrestaurants in existing markets where we have an established brand name. Oursite selection process focuses on identifying markets, trade areas and specificsites based on several factors, including visibility, ready accessibility(particularly for morning and lunch time traffic), parking, signage and adaptabilityof any current structures.

For Einstein Bros., we have targeted Atlanta, Chicago,Las Vegas, Phoenix, and various cities in Florida for development. For Noah’s,we intend to focus our development efforts on Portland, Seattle and variouscities in California. In 2007, we plan to open approximately 11 to 15 newcompany-owned restaurants. As of April 3, 2007, we have opened one new Noah’slocation located in Portland, Oregon. We are in the process of identifying newrestaurant sites for 2008 to ensure that we achieve our development goals.

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The following table details our restaurant openingsand closings for each respective period:

|                                 | ** ** | **First Quarter  Activity** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **Fiscal**                       | ** ** | **Fiscal** | ** ** |
| ** **                      | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| **Einstein  Bros.**             | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Company-owned beginning balance |       | 360                              |       | 341 |   |
| Opened restaurants              |       | 1                                |       | — |   |
| Closed restaurants              |       | (3                               | )          | (5 | ) |
| Company-owned ending balance    |       | 358                              |       | 336 |   |
|                            |       |                             |       |   |   |
| Licensed beginning balance      |       | 67                               |       | 93 |   |
| Opened restaurants              |       | 3                                |       | 4 |   |
| Closed restaurants              |       | (1                               | )          | — |   |
| Licensed ending balance         |       | 69                               |       | 97 |   |
|                            |       |                             |       |   |   |
| **Noah’s**                 | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Company-owned beginning balance |       | 73                               |       | 73 |   |
| Opened restaurants              |       | —                           |       | 1 |   |
| Closed restaurants              |       | (1                               | )          | — |   |
| Company-owned ending balance    |       | 72                               |       | 74 |   |
|                            |       |                             |       |   |   |
| Licensed beginning balance      |       | 3                                |       | 3 |   |
| Opened restaurants              |       | —                           |       | — |   |
| Closed restaurants              |       | —                           |       | — |   |
| Licensed ending balance         |       | 3                                |       | 3 |   |
|                            |       |                             |       |   |   |
| **Manhattan**                   | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Franchised beginning balance    |       | 109                              |       | 80 |   |
| Opened restaurants              |       | 2                                |       | — |   |
| Closed restaurants              |       | (4                               | )          | (1 | ) |
| Franchised ending balance       |       | 107                              |       | 79 |   |
|                            |       |                             |       |   |   |
| **Non-Core  Brands**            | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Company-owned beginning balance |       | 2                                |       | 2 |   |
| Opened restaurants              |       | —                           |       | — |   |
| Closed restaurants              |       | —                           |       | — |   |
| Company-owned ending balance    |       | 2                                |       | 2 |   |
|                            |       |                             |       |   |   |
| Franchised beginning balance    |       | 12                               |       | 6 |   |
| Opened restaurants              |       | —                           |       | — |   |
| Closed restaurants              |       | (2                               | )          | — |   |
| Franchised ending balance       |       | 10                               |       | 6 |   |
|                            |       |                             |       |   |   |
| **Consolidated  Total**         | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Total beginning balance         |       | 626                              |       | 598 |   |
| Opened restaurants              |       | 6                                |       | 5 |   |
| Closed restaurants              |       | (11                              | )          | (6 | ) |
| Total ending  balance           |       | 621                              |       | 597 |   |

 

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**Our Sources of Revenue**

*Company-Owned Restaurant Sales*

Approximately 93% of our revenue is generated byrestaurant sales at our Einstein Bros. and Noah’s company-owned restaurants.Restaurant sales also include catering sales where the food is prepared at therestaurant and either delivered to or held for pick-up by the guest. Theprincipal factors that affect our restaurant sales in the aggregate are:

·              the number of restaurants inoperation for the period;

·              the AUV of the restaurants; and

·              the change in comparable storesales.

*Manufacturing and Commissary Revenue*

Approximately 5% to 6% of our total revenue is generatedby our manufacturing and commissary operations. Our manufacturing revenue isprimarily derived from the sale of frozen bagel dough to our franchisees,licensees and third party accounts. Our commissaries generate revenue from thesale of sliced meats (turkey, ham and beef), dairy products (cheese), andpre-portioned salad kits to our licensees. Additionally, our commissaries sellbagels, cream cheese, salad toppers and salads through various supplierrelationships, typically with conventional grocery stores as the customer.These products are sold either through a private label program or under theEinstein Bros. or Noah’s brand.

The principal factors affecting manufacturing andcommissary revenue are:

·                                          thenumber of licensed and franchised restaurants that purchase frozen bagel doughand commissary products from us;

·                                          salesof our products in existing licensed and franchised restaurants; and

·                                          salesto third parties, including conventional grocery chains and warehouse clubs.

*License and Franchise Revenue*

License and franchise revenue consists of a license orfranchise fee at the execution of the agreement and ongoing royalty paymentsbased on a percentage of the restaurant’s gross sales. Our costs associatedwith licensing and franchising are minimal compared with the costs associatedwith company-owned restaurants. Approximately 1% to 2% of our total revenue isgenerated from these fees. The principal factors affecting license andfranchise revenue are the number of licensed and franchised restaurants as wellas the level of sales at those restaurants.

**Our Primary Expenses**

***Company-Owned Restaurant Expenses***

*Food, Beverage and Packaging Costs.*Food, beverage and packaging costs are the largest expense elements at ourcompany-owned restaurants. The most important factor that affects the cost ofthese products is the underlying cost of the agricultural commodities such asflour, butter, cheese, coffee, turkey and other products. In order to mitigatethe impact of rising commodity costs, our suppliers enter into agreements tofix the cost of these products for a specified period of time that is generallyone year or less. We do not engage in the practice of buying futures contractsand therefore we do not have derivative accounting. Packaging and distributioncosts are primarily affected by the cost of oil because petroleum-basedmaterial is often used to manufacture certain packaged products; the cost ofdiesel fuel affects distribution costs. Although we have generally been able toincrease our retail prices at our company-owned restaurants to offset theincreased costs of these items, we may not be able to do so in the future.

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Compared to 2006, we expect most of our food coststhat are commodity-based to either remain relatively stable or decreaseslightly during 2007. Flour represents the most significant raw ingredient wepurchase and we believe the supply of wheat is strong at this time and thus thecost of wheat will decline in 2007. However, there can be no assurance that wewill benefit from a decline in the cost of any of the commodity-based productsthat we purchase.

Most of the fresh produce that we purchase, such as lettuceand tomatoes, is subject to normal market fluctuations. We purchasesubstantially all of our orange juice from a single supplier, which hasproduction in Arizona, California and Florida. During 2006, when citrusorchards in California experienced adverse weather conditions, we were notsignificantly affected because of our supplier’s multiple sources ofproduction. We have locked in our prices for orange juice for 2007 with thissupplier. Accordingly, while the cost of oranges and orange related products isgenerally increasing by approximately 30%, we expect that our cost for orangejuice will only slightly increase compared to 2006.

In late 2006, we negotiated contract terms with twonew distributors. In early 2007, these new distributors began deliveringproducts to our company-owned, licensed and franchised restaurants in therespective geographic regions. Currently, the new distributors are providing ahigher level of services at a lower cost for our company-owned restaurants.However, there is no assurance that the new distributors will continue toperform as we expect, or that their cost structure will continue to provide forthe cost savings that we anticipate.

*Compensation Costs.* Compensationcosts reflect the hourly wages, salary, bonus, taxes and insurance that we payour associates at each restaurant. Compensation costs tend to vary bygeographic region based upon the labor market, local minimum wages, and thesupply and demand of workers. Also, compensation costs tend to be semi-variablein nature and increase or decrease somewhat based upon units produced.

There is significant competition for personnel andlimited availability in the labor pool. In most of the states in which weoperate, increases in state minimum hourly wage rates became effective January1, 2007. Accordingly, we anticipate increases in hourly wages during 2007. Wecontinue to make improvements in labor efficiencies that may help to offset aportion of the increases in labor costs.

*Other Operating Costs.* Otheroperating costs consist of utilities, restaurant and other supplies, repairsand maintenance, laundry and uniforms, bank charges and other costs related tothe operation of company-owned restaurants. Certain of these costs generallytend to be fixed in nature and are only modestly impacted by changes in thevolume of products sold. Utilities, distribution costs and other expensesimpacted by fuel price fluctuations are not fixed and are contingent uponcontract rates negotiated by third parties outside of our control. Many of ourcontracts are re-priced quarterly based on the prior quarter’s marketfluctuations resulting in a delayed effect upon our operating costs. During2005 and part of 2006, due to the increase in the cost of diesel fuel, ourdistributors and common freight carriers passed on fuel surcharges to us.During periods of uncertainty and significant market fluctuations, we cannot becertain of the impact on our future operating results. If we are unable toleverage cost increases with operating efficiencies or price increases, it maynegatively impact our operating results. Conversely, decreases in fuel priceswill positively impact our utilities, distribution costs and other relatedexpenses.

*Facility, Marketing and Other Costs.*Facility, marketing and other costs include rent, common area costs, propertytaxes and insurance, liability insurance, delivery fees and allocated marketingexpenses. We exclude depreciation and amortization expense from company-ownedrestaurant expenses. Changes in these costs are generally the result of changesin our rent and other related facility costs. Accordingly, these costs arepredominantly fixed in nature and are modestly impacted by changes in thevolume of products sold.

Certain states and local governments have increased boththe rate and nature of taxes on businesses in their regions. These increasedtaxes include real estate and property taxes, state and local income taxes, andvarious employment taxes.

** **

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**Manufacturing and Commissary Costs**

Manufacturing costs are comprised of raw materialssuch as flour, dairy products and meats, compensation costs and the relatedtaxes and employee benefits, rents, supplies and repairs and maintenance. Thesecosts are directly related to the manufacturing revenue they produce. Some of theraw materials used are commodity-based products and are subject to the samemarket fluctuations previously mentioned. We purchase certain raw materialsunder volume-based pricing agreements and, as manufacturing productionincreases, we experience more favorable pricing arrangements. Fixed overheadcosts, such as rent, utilities, property taxes and manager salaries, areproportionately allocated based on total units produced. Operating results fromour manufacturing operations consist of third party sales whose profitabilitycan be significantly impacted by the allocation of fixed overhead costs.Results can also be negatively impacted by rapidly increasing variable costsuntil such time as we are able to pass increased costs to our consumers.

**General and Administrative Expenses**

General and administrative expenses include corporateand administrative functions that support our company-owned restaurants as wellas our manufacturing and license and franchise operations. These costs includeemployee wages, taxes and related benefits, travel costs, information systems,recruiting and training costs, corporate rent, and general insurance costs.

**Depreciation and Amortization**

Depreciation and amortization are periodic non-cashcharges that represent the reduction in usefulness and value of our tangibleand intangible assets. The majority of our depreciation and amortizationrelates to equipment and leasehold improvements located in our company-ownedrestaurants. Based on our current purchases of capital assets, our existingbase of assets, and our projections for new purchases of fixed assets, webelieve depreciation expense for 2007 will be approximately $12.0 million.

**Consumer Spending Habits and Impact of Inflation**

Our results depend on consumer spending, which isinfluenced by consumer confidence and disposable income. In particular, theeffects of higher energy costs, an increase in minimum balances payable onconsumer debt and increasing interest rates, among other things, may impactdiscretionary consumer spending in restaurants. Accordingly, we believe weexperience declines in comparable store sales during economic downturns orduring periods of economic uncertainty. Any material decline in the amount ofdiscretionary spending could have a material adverse effect on our sales andincome.

We have experienced only a modest impact frominflation as evidenced by a slight increase in the level of consumer prices.However, the impact of inflation on labor, food and occupancy costs could, inthe future, significantly affect our operations. We pay many of our employeeshourly rates slightly above the applicable federal, state or municipal “livingwage” rates. Recent changes in minimum wage laws may create pressure toincrease the pay scale for our associates, which would increase our laborcosts. Food costs as a percentage of sales have remained relatively stable dueto procurement efficiencies and menu price adjustments, although no assurancecan be made that our procurement will continue to be efficient or that we willbe able to raise menu prices in the future. Costs for construction, taxes,repairs, maintenance and insurance all impact our occupancy costs. We believeour current strategy, which is to seek to maintain operating margins through acombination of menu price increases, cost controls, efficient purchasingpractices and careful evaluation of property and equipment needs, has been aneffective tool for dealing with inflation.

**Seasonality and Quarterly Results**

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

 

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**Results of Operations**

Thistable sets forth, for the periods indicated, certain amounts included in ourconsolidated statements of operations, the relative percentage that thoseamounts represent to total revenue (unless otherwise indicated), and the percentagechange in those amounts from period to period. All percentages are calculatedusing actual amounts rounded to the nearest thousand.

 
| ** **                                                              | ** ** | **First quarter ended:  (in thousands of dollars)** | ** ** | **Increase  (Decrease)** | ** ** | **First quarter ended:  (percent of total revenue)** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|--------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **April 4,**                                                            | ** ** | **April 3,**        | ** ** | **2006**                                                                      | ** ** | **April 4,** | ** ** | **April 3,** | ** ** |
| ** **                                                              | ** ** | **2006**                                                                     | ** ** | **2007**                 | ** ** | **vs. 2007**                                                             | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenues:                                                               |       |                                                                         |       |                     |       |                                                                          |       |   |   |   |   |
| Company-owned  restaurant sales                                         |       | $                                                                            | 90,580     |                     | $          | 89,115                                                                        |       | (1.6 | )% | 93.3 | % | 92.6 | % |
| Manufacturing  and commissary revenue                                   |       | 5,273                                                                        |       | 5,818                    |       | 10.3                                                                          | %          | 5.4 | % | 6.0 | % |
| License and  franchise revenue                                          |       | 1,223                                                                        |       | 1,322                    |       | 8.1                                                                           | %          | 1.3 | % | 1.4 | % |
| Total revenues                                                          |       | 97,076                                                                       |       | 96,255                   |       | (0.8                                                                          | )%         | 100.0 | % | 100.0 | % |
|                                                                    |       |                                                                         |       |                     |       |                                                                          |       |   |   |   |   |
| Cost of sales  (percentage of corresponding revenue stream):            |       |                                                                         |       |                     |       |                                                                          |       |   |   |   |   |
| Food, beverage  and packaging costs                                     |       | 27,298                                                                       |       | 26,274                   |       | (3.8                                                                          | )%         | 30.1 | % | 29.5 | % |
| Compensation  costs                                                     |       | 27,532                                                                       |       | 26,606                   |       | (3.4                                                                          | )%         | 30.4 | % | 29.9 | % |
| Other operating  costs                                                  |       | 8,494                                                                        |       | 8,771                    |       | 3.3                                                                           | %          | 9.4 | % | 9.8 | % |
| Facility,  marketing and other costs                                    |       | 10,202                                                                       |       | 9,681                    |       | (5.1                                                                          | )%         | 11.3 | % | 10.9 | % |
| Total  company-owned restaurant expenses:                               |       | 73,526                                                                       |       | 71,332                   |       | (3.0                                                                          | )%         | 81.2 | % | 80.0 | % |
| Manufacturing  and commissary costs                                     |       | 5,005                                                                        |       | 5,422                    |       | 8.3                                                                           | %          | 94.9 | % | 93.2 | % |
| Total cost of sales                                                     |       | 78,531                                                                       |       | 76,754                   |       | (2.3                                                                          | )%         | 80.9 | % | 79.7 | % |
|                                                                    |       |                                                                         |       |                     |       |                                                                          |       |   |   |   |   |
| Gross profit  (percentage of corresponding revenue stream):             |       |                                                                         |       |                     |       |                                                                          |       |   |   |   |   |
| Company-owned  restaurants                                              |       | 17,054                                                                       |       | 17,783                   |       | 4.3                                                                           | %          | 18.8 | % | 20.0 | % |
| Manufacturing  and commissary                                           |       | 268                                                                          |       | 396                      |       | 47.8                                                                          | %          | 5.1 | % | 6.8 | % |
| License and  franchise                                                  |       | 1,223                                                                        |       | 1,322                    |       | 8.1                                                                           | %          | 100.0 | % | 100.0 | % |
| Total gross profit                                                      |       | 18,545                                                                       |       | 19,501                   |       | 5.2                                                                           | %          | 19.1 | % | 20.3 | % |
|                                                                    |       |                                                                         |       |                     |       |                                                                          |       |   |   |   |   |
| Operating expenses:                                                     |       |                                                                         |       |                     |       |                                                                          |       |   |   |   |   |
| General and  administrative expenses                                    |       | 10,561                                                                       |       | 10,731                   |       | 1.6                                                                           | %          | 10.9 | % | 11.1 | % |
| Depreciation and  amortization                                          |       | 6,004                                                                        |       | 2,419                    |       | *                                                                             |       | 6.2 | % | 2.5 | % |
| Loss on sale,  disposal or abandonment of assets, net                   |       | 21                                                                           |       | 374                      |       | *                                                                             |       | 0.0 | % | 0.4 | % |
| Impairment  charges and other related costs                             |       | 76                                                                           |       | 19                       |       | *                                                                             |       | 0.1 | % | 0.0 | % |
| Income from operations                                                  |       | 1,883                                                                        |       | 5,958                    |       | 216.4                                                                         | %          | 1.9 | % | 6.2 | % |
| Other expense:                                                          |       |                                                                         |       |                     |       |                                                                          |       |   |   |   |   |
| Interest  expense, net                                                  |       | 5,209                                                                        |       | 4,789                    |       | (8.1                                                                          | )%         | 5.4 | % | 5.0 | % |
| Prepayment  penalty upon redemption of $160 Million Notes               |       | 4,800                                                                        |       | —                   |       | *                                                                             |       | 4.9 | % | 0.0 | % |
| Write-off of  debt issuance costs upon redemption of $160 Million Notes |       | 3,956                                                                        |       | —                   |       | *                                                                             |       | 4.1 | % | 0.0 | % |
| Other, net                                                              |       | 10                                                                           |       | —                   |       | *                                                                             |       | 0.0 | % | 0.0 | % |
| Income (loss) before  income taxes                                      |       | (12,092                                                                      | )          | 1,169                    |       | *                                                                             |       | (12.5 | )% | 1.2 | % |
| Provision for income taxes                                              |       | —                                                                       |       | 37                       |       | *                                                                             |       | 0.0 | % | 0.0 | % |
| Net income (loss)                                                       |       | $                                                                            | (12,092    | )                        | $          | 1,132                                                                         |       | * |   | (12.5 | )% | 1.2 | % |

----

*                    notmeaningful

 

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*Company-Owned RestaurantOperations*

**Wehave a 52/53-week fiscal year ending on the Tuesday closest to December 31. Thefirst quarters in fiscal years 2006 and 2007 ended on April 4, 2006 and April3, 2007, respectively, and each contained 13 weeks.**

**Comparablestore sales is a key performance indicator widely used throughout therestaurant industry. Comparable store sales represent sales at restaurants openfor one full year that have not been relocated or closed during the currentyear. Comparable store sales include company-owned restaurants only andrepresent the change in period-over-period sales for the comparable restaurantbase. A restaurant becomes comparable in its 13th full month of operation.**

**Forthe first quarter of 2007, our comparable store sales increased 1.0% over thefirst quarter of 2006 partially due to a system-wide price increase and aslight shift in product mix to higher priced items. We also saw growth inmarkets in which we offer catering by our company-owned restaurants. Our cateringbusiness contributed 0.7% of the increase to our comparable store sales.**

The slight dollar decline in our company-ownedrestaurant sales of $1.5 million, or 1.6%, when compared to the first quarterof 2006 was primarily due to approximately 20 fewer company-owned restaurantscontributing to sales offset by the increase in comparable store sales.Additionally, we estimate unfavorable weather conditions across the UnitedStates negatively impacted our company-owned restaurant sales for the firstquarter of 2007. Generally, a guest’s decision to eat at home rather than dineout is influenced by various factors, including adverse weather conditions,economic downturns or periods of economic uncertainty.

Although our company-owned restaurant sales decreasedin the first quarter of 2007 compared to the same quarter in 2006, ourcompany-owned restaurant gross profit increased $0.7 million, or 1.2 percentagepoints. The improvement in our company-owned restaurant gross profit wasprimarily driven by a reduction of $0.8 million in marketing expense, $0.4million in decreased workers’ compensation loss reserves and $0.3 millionsavings in quarterly bonus accruals. These savings were partially offset byincreases of approximately $0.3 million in higher bank fees, property taxes andrepair and maintenance expenses and $0.5 million due to fewer salestransactions.

Our restaurant margins are impacted by variousrestaurant-level operating and non-operating expenses such as the cost ofproducts sold, salaries and benefits, insurance, supplies, repair andmaintenance expenses, advertising, rent, utilities and property taxes.Depreciation, amortization and income taxes do not impact our company-ownedrestaurant gross profit.

*Manufacturing and Commissary Operations*

Our manufacturing operations, which include our USDAinspected commissaries, predominantly support our company-owned restaurants andgenerate revenue from the sale of food products to franchisees, licensees,third-party distributors and other third parties. All inter-companytransactions have been eliminated during consolidation.

During the latter half of the 2006 fiscal year, westudied ways to gain efficiencies within our manufacturing and commissaryoperations. We also engaged a third party consulting firm to assist us indeveloping manufacturing cost models. As a result of our efforts, weimplemented the following initiatives:

·                  implemented price increases to someof our third-party customers;

·                  opened two new commissary locations,aggregating our commissary system to five locations; and

·                  increased our current productioncapacity, thereby allowing us to provide new products to new and existingcustomers.

We are beginning to see the positive results of ourinitiatives. During the first quarter of 2007, manufacturing and commissaryrevenues improved $0.5 million, or 10.3% as compared to the first quarter of2006. This increase was predominantly driven by price increases, an increase involume of units sold to our more significant customers, and to a lesser extent,by sales of new products. The increase in revenue combined with an overheadcost structure that 

 

31

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is primarily fixed in nature translated to a slightimprovement of $0.1 million, or 1.7 percentage points, in gross profit.

*Franchise and License Operations*

Revenues for the license and franchise operationsconsist primarily of initial fees and royalty income earned as a result ofsales within licensed and franchised restaurants. Overall, licensee andfranchisee revenue improved $99,000, or 8.1%, in the first quarter of 2007 ascompared to the first quarter of 2006. The percentage increase waspredominantly due to improved comparable sales in the Manhattan Bagel andEinstein Bros. brands and a net increase of 28 licensed restaurants, slightlyoffset by a net decrease of 32 franchised restaurants.

*General and Administrative Expenses*

For the first quarter of 2007, our general andadministrative expenses increased 1.6%, or $0.2 million as compared to the samequarter in 2006. Contributing to the increase was $0.3 million in increasedtravel and management development expenses, $0.3 million in recruiting,relocation and referral fees related to senior level management positions, $0.1million in expenses related to the cost of transitioning to a new distributor,$0.1 million in new manager training expenses and $0.1 million in additionalstock based compensation expense offset by $0.7 million savings in quarterlybonus accruals.

*Depreciation and Amortization*

Depreciation and amortization expenses decreased $3.6million for the first quarter of 2007 when compared to the first quarter of2006. The decrease is primarily due to all of our amortizing intangible assets becoming fully amortizedand a substantial portion of our other assets becoming fully depreciated withinthe second and third quarters of fiscal 2006. Depreciation and amortization expense is predominantly related tothe assets of Einstein/Noah Bagel Corp. that we acquired in bankruptcyproceedings in June 2001. The sale of certain manufacturing equipment locatedat the plant of Harlan Bakeries, Inc., our frozen bagel dough supplier, duringthe first quarter of 2007 also contributed to the decrease in depreciationexpense. The assets were classified as held for sale on the consolidatedbalance sheet as of January 2, 2007. Proceeds from the sale were received inthe second quarter of 2007.

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

Loss on the disposal, sale or abandonment of assetsrepresents the excess of proceeds received, if any, over the net book value ofan asset. We establish estimated useful lives for our assets, which range fromthree to eight years, and depreciate using the straight-line method. Leaseholdimprovements are limited to the lesser of the useful life or the noncancelablelease term. The useful lives of the assets are based upon our expectations ofthe period of time that the asset will be used to generate revenue. Weperiodically review the assets for changes in circumstances, which may impacttheir useful lives. Duringthe first quarters ended April 4, 2006 and April 3, 2007, we recorded a loss onthe disposal, sale or abandonment of assets in the amount of $21,000 and$374,000, respectively.

*Impairment Charges and Other Related Costs*

Impairment losses are non-cash charges recorded onlong-lived assets, goodwill, trademarks and our other intangible assets.Generally, an indicator of impairment would include significant change in anasset’s ability to generate positive cash flow in the future or in the fairvalue of an asset. Whenever impairment indicators are determined to be present,the amount of impairment is measured as the excess of the carrying amount ofthe asset over its fair value. During the first quarters ended April 4, 2006 and April 3, 2007,we recorded impairment charges of $76,000 and $19,000, respectively.

* *

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*Other Expense*

On February 28, 2006, we completed a debt refinancingthat redeemed our $160 Million Notes and retired our $15 million AmSouthRevolver. During the first quarter ended 2006, we wrote off $4.0 million ofdebt issuance costs and paid a 3% redemption premium on the $160 Million Notesin the amount of $4.8 million.

*NetIncome (Loss) and Income Taxes*

For GAAP, wereported net income for the first quarter of 2007 of $1.1 million as comparedto net loss of $12.1 million for the first quarter of 2006. For tax purposes,our net operating loss carryforward reduced our federal and state income taxliability incurred for the first quarter of 2007. We have recorded a provisionfor income taxes in the amount of $37,000 as a result of our estimate ofalternative minimum income tax due on taxable earnings for the first quarter of2007.

As ofApril 3, 2007, our net operating loss carryforwards for U.S. federal income taxpurposes were $153.7 million, $95.7 million of which are subject to an annualusage limitation of $4.7 million, and were subject to the following expirationschedule: 

| Net Operating Loss Carryforwards | ** ** |
|-------------------------------------------------|------------|
| **Expiration Date**                        | ** ** | **Amount** | ** ** |
| ** **                                      | ** ** | **(in thousands of dollars)** | ** ** |
| 12/31/2010                                      |       | $ | 1,702 |   |
| 12/31/2011                                      |       | 4,862 |   |
| 12/31/2012                                      |       | 9,589 |   |
| 12/31/2018                                      |       | 14,553 |   |
| 12/31/2019                                      |       | 6,862 |   |
| 12/31/2020                                      |       | 10,424 |   |
| 12/31/2021                                      |       | 10,515 |   |
| 12/31/2022                                      |       | 35,688 |   |
| 12/31/2023                                      |       | 40,649 |   |
| 12/31/2024                                      |       | 11,938 |   |
| 12/31/2025                                      |       | 5,391 |   |
| 12/31/2026                                      |       | 1,552 |   |
|                                            |       | $ | 153,725 |   |

 

Our ability to utilize theapproximately $58.0 million of our net operating losses that are not currentlysubject to limitation could become limited, and our ability to utilize ourremaining net operating losses could be limited further, in the event that weundergo an “ownership change” as that term is defined for purposes of Section382 of the Internal Revenue Code.

Our net operating losscarryforwards are one of our deferred income tax assets; however, the ultimaterealization of these deferred income tax assets is dependent upon generation offuture taxable income. Due to the uncertainty of future taxable income,deferred tax assets resulting from these net operating losses have been fullyreserved. In accordance with SFAS 109, “Accounting for Income Taxes,” we willassess the continuing need for a valuation allowance that results fromuncertainty regarding our ability to realize the benefits of our deferred taxassets.

** **

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**Financial Condition, Liquidityand Capital Resources**

The restaurant industry is predominantly a cashbusiness where cash is received at the time of the transaction. We believe wewill generate sufficient cash flow and have sufficient availability under ourRevolving Facility to fund operations, capital expenditures and required debtand interest payments. Our inventory turns frequently since our products areperishable. Accordingly, our investment in inventory is minimal. Our accountspayable are on terms that we believe are consistent with those of othercompanies within the industry.

The primary driver of ouroperating cash flow is our restaurant operations, specifically the gross marginfrom our company-owned restaurants. Therefore, we focus on the elements ofthose operations including comparable store sales and cash flows to ensure asteady stream of operating profits that enable us to meet our cash obligations.On a weekly basis, we review our company-owned restaurant performance comparedwith the same period in the prior year and our operating plan.

Based upon ourprojections for 2007 and 2008, we believe our various sources of capital,including availability under existing debt facilities, and cash flow fromoperating activities of continuing operations, are adequate to financeoperations as well as the repayment of current debt obligations.

*2006 Debt Redemption and Refinancing*

On February 28, 2006, we completed the refinancing ofthe AmSouth Revolver and $160 Million Notes. Our new financing consists of a:

·                  $15million revolving credit facility maturing on March 31, 2011;

·                  $80million first lien term loan maturing on March 31, 2011;

·                  $65million second lien term loan maturing on February 28, 2012; and

·                  $25million subordinated note maturing on February 28, 2013.

Each of the loans requires the payment of interest inarrears on a quarterly basis commencing on March 31, 2006. Additionally, theFirst Lien Term Loan requires quarterly scheduled minimum principal reductionscommencing June 30, 2006. In the event that we have not extended the maturitydate of the Mandatorily Redeemable Series Z Preferred Stock (Series Z) to adate that is on or after July 26, 2012 (July 26, 2013 for the SubordinatedNote) or redeemed the Series Z by various dates in 2008 and 2009, then each ofthe loans have various accelerated maturity dates beginning in December 2008.

*Public Offering of Our Common Stock*

On April 10, 2007, we filed a registration statementon Form S-1 with the SEC relating to a proposed public offering of up to $125million of our common stock. These securities may not be sold nor may offers tobuy these securities be accepted prior to the time the registration statementbecomes effective. The number of shares to be offered and the price range forthe offering have not been determined. We will use the proceeds of the offeringto pay down our existing indebtedness.

* *

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*2007 Proposed Amendments to Debt Facilities*

Concurrently withour proposed public offering of common stock, we intend to amend our existingRevolving Facility and our existing First Lien Term Loan and to pay off in fullour existing Second Lien Term Loan as well as our existing Subordinated Noteheld by Greenlight. On April 27, 2007, we signed a commitment letter for thisamendment or, if an amendment is not possible, a new $90.0 million seniorsecured credit facility.  Pursuant to theamendment, we expect to increase the amount of our Revolving Facility to $20.0million and decrease the amount of our term loan to a principal amount of $70.0million or less. Both the amended Revolving Facility and the amended term loanare expected to have new five-year terms and will continue to be secured bysubstantially all of our assets and guaranteed by all of our subsidiaries. Thecommitment letter provides for the loans to bear interest in a range from 1.75%to 2.25% for LIBOR loans and in a range from 0.75% to 1.25% for base rateloans, depending on our consolidated leverage ratio. A portion of the RevolvingFacility will be available for letters of credit. We expect that the amendedterm loan will require mandatory prepayments in certain circumstances that aresimilar to our existing First Lien Term Loan and will contain customary eventsof default.

In addition, wehave obtained a commitment for an incremental term loan in an aggregateprincipal amount of up to $57.0 million which may be used by us if, needed,solely for the purpose of redeeming the zero coupon Series Z preferred stockwhich is not due until June 2009.

The closing of theproposed offering of our common stock is not conditioned on the amendment ofour existing indebtedness. The commitment from our lender for this amendment ornew credit facility (as applicable) is contingent upon negotiation ofdefinitive loan documentation and other normal and customary conditions.

*Working Capital Deficit*

At April 3, 2007,we had unrestricted cash of $5.1 million and restricted cash of $3.1 million.Under our Revolving Facility, there were no outstanding borrowings, $6.7million in letters of credit outstanding and borrowing availability of $8.3million. Our working capital deficit improved $0.8 million to $8.8 million atApril 3, 2007 compared to $8.0 million at January 2, 2007.

*CashProvided by Operations*

Due to increasedprofitability at our company-owned restaurants and the timing of operationalreceipts and payments, net cash generated by operating activities was $6.4million for the first quarter of 2007 compared to $0.1 million for thecomparable quarter in 2006. Cash provided by operations for the first quarterof 2006 includes a $4.8 million cash prepayment penalty incurred uponredemption of the $160 million notes.

*Cash Usedin Investing Activities*

For the firstquarter of 2007, we used approximately $6.2 million of cash to purchaseadditional property and equipment that included $1.1 million for newrestaurants, $0.6 million for upgrading existing restaurants, $3.0 million forreplacement and new equipment at our existing company-owned restaurants, $0.7million for our manufacturing operations and $0.8 million for general corporatepurposes.

We anticipate thatthe majority of our capital expenditures for fiscal 2007 will be focused on theaddition of 11 to 15 new company-owned restaurants during 2007 at an averagegross capital investment of approximately $550,000 per restaurant, which variesdepending upon square footage, layout and location. We also intend to upgradeapproximately 25 of our current restaurants to the front of the houseconfiguration of our prototype restaurant, during 2007. The upgrade includesnew self-service coolers, an expanded coffee bar, and a separate station forquick “to go” items. Finally, we plan to acquire additional equipment for newmenu items and an improved ordering system that uses wireless technology toreduce the time our guests wait in line before they receive their food.

 

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*Cash Used in Financing Activities*

As a result of our refinancing of our $160 MillionNotes with $170 million in new term loans in February 2006, we borrowed $169.4million in term loans and incurred approximately $5.0 million in debt issuancecosts. Upon closing of our new debt facility, we began amortizing these costsand the debt issuance costs related to our $160 Million Notes and AmSouthrevolver were written-off.

*Contractual Obligations*

The following table summarizes the amounts of paymentsdue under specified contractual obligations as of April 3, 2007: 
| ** **                                           | ** ** | **Payments Due by Fiscal Period** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                              | ** ** | **2008 to  2010** | ** ** | **2011 to  2012** | ** ** | **2013 and  thereafter** | ** ** | **Total** | ** ** |
| ** **                                           | ** ** | **(in thousands of dollars)**          | ** ** |
| Accounts payable and  accrued expenses               |       | $                                                     | 29,834     |   | $ | — |   | $ | — |   | $ | — |   | $ | 29,834 |   |
| Debt (a)                                             |       | 3,130                                                 |       | 49,630 |   | 25,900 |   | 105,795 |   | 184,455 |   |
| Estimated interest  expense on our Debt Facility (b) |       | 12,604                                                |       | 46,077 |   | 17,051 |   | — |   | 75,732 |   |
| Manditorily Redeemable  Series Z                     |       | —                                                |       | 57,000 |   | — |   | — |   | 57,000 |   |
| Minimum lease payments  under capital leases         |       | 90                                                    |       | 114 |   | 3 |   | — |   | 207 |   |
| Minimum lease payments  under operating leases       |       | 26,402                                                |       | 55,921 |   | 10,672 |   | 10,311 |   | 103,306 |   |
| Purchase obligations  (c)                            |       | 4,237                                                 |       | — |   | — |   | — |   | 4,237 |   |
| Other long-term  obligations (d)                     |       | —                                                |       | 752 |   | 506 |   | 5,833 |   | 7,091 |   |
| Total                                                |       | $                                                     | 76,297     |   | $ | 209,494 |   | $ | 54,132 |   | $ | 121,939 |   | $ | 461,862 |   |

 

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(a) Debt facility includes the full face value of thesubordinated note and the full accrual of paid-in-kind interest that is dueupon maturity.

(b) Calculated using the LIBOR rate as of April 3,2007, plus the applicable margin in effect. Because the interest rates on thefirst lien term loan facility, the second lien term loan facility and therevolving credit facility are variable, actual payments could differmaterially.

(c) Purchase obligations consist of non-cancelableminimum purchases of frozen dough and certain other raw ingredients that areused in our products.

(d) Other long-term obligations primarily consist ofthe remaining liability related to minimum future purchase commitments with asupplier that advanced us $10.0 million in 1996.

* *

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*Insurance*

We are insured forlosses related to health, general liability and workers’ compensation underlarge deductible policies. The insurance liability represents an estimate ofthe ultimate cost of claims incurred and unpaid as of the balance sheet date.The estimated liability is established based on actuarial estimates, isdiscounted at 10% based upon a discrete analysis of actual claims andhistorical data and is reviewed on a quarterly basis to ensure that theliability is appropriate. If actual trends, including the severity or frequencyof claims, differ from our estimates our financial results could be favorablyor unfavorably impacted.  The estimatedliability is included in accrued expenses in our consolidated balance sheets.

**Off-BalanceSheet Arrangements**

*Guarantees*

Prior to 2001, wewould occasionally guarantee leases for the benefit of certain of ourfranchisees. None of the guarantees have been modified since their inceptionand we have since discontinued this practice. Current franchisees are theprimary lessees under the vast majority of these leases. Under the leaseguarantees, we may be required by the lessor to make all of the remainingmonthly rental payments or property tax and common area maintenance payments ifthe franchisee does not make the required payments in a timely manner. However,we believe that most, if not all, of the franchised restaurants could besubleased to third parties minimizing our potential exposure. Additionally, wehave indemnification agreements with our franchisees under which thefranchisees would be obligated to reimburse us for any amounts paid under suchguarantees. Historically, we have not been required to make such payments insignificant amounts. We record a liability for our exposure under theguarantees in accordance with SFAS No. 5, “Accounting for Contingencies,”following a probability related approach. Minimum future rental paymentsremaining under these leases were approximately $0.6 million as of April 3,2007. We believe the ultimate disposition of these matters will not have amaterial adverse effect on our financial position or results of operations.

*Letters of Credit*

We have $6.7 million in letters of credit outstandingunder our Revolving Facility at April 3, 2007. The letters of credit expire onvarious dates during 2007, are automatically renewable for one additional yearand are payable upon demand in the event that we fail to pay the underlyingobligation related to certain workers compensation claims or distributor claims.

** **

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**Item3.  Qualitative and Quantitative Disclosures about Market Risk**

During the first quarters ended April 4, 2006 andApril 3, 2007, our results of operations, financial position and cash flowshave not been materially affected by changes in the relative values of non-U.S.currencies to the U.S. dollar. We do not use derivative financial instrumentsto limit our foreign currency risk exposure since virtually all of our businessis conducted in the United States.

Our manufacturing operations sell bagels to awholesaler and a distributor who take possession in the United States and selloutside of the United States. As the product is shipped FOB domestic dock,there are no international risks of loss or foreign exchange currency issues.Approximately $0.6 million and $0.7 million of sales shipped internationallyare included in manufacturing and commissary revenue for the first quarter in2006 and 2007, respectively.

Our debt as of April 3, 2007 was principally comprisedof the Revolving Facility, First Lien Term Loan, Second Lien Term Loan, andSubordinated Note. For fixed rate debt, interest rate changes affect the fairmarket value of such debt but do not impact earnings or cash flows. Converselyfor variable rate debt, including borrowings under our Revolving Facility,First Lien Term Loan and Second Lien Term Loan, interest rate changes generallydo not affect the fair market value of such debt, but do impact future earningsand cash flows, assuming other factors are held constant. A 100 basis point increasein short-term effective interest rates would decrease our net income byapproximately $1.5 million annually, assuming no change in the size orcomposition of debt at April 3, 2007. Currently, the interest rates on ourFirst Lien Term Loan, Second Lien Term Loan and Revolving Facility arepredominantly at LIBOR rates plus an applicable margin through short-term fixedrate financing. The estimated increase in interest expense incorporates thefixed interest financing into its assumptions.

We purchase certain commodities such as butter,cheese, coffee, turkey and flour. These commodities are generally purchasedbased upon market prices established with vendors. Our purchase arrangementsmay contain contractual features that limit the price paid by establishingcertain price floors or caps. We do not use financial instruments to hedgecommodity prices because our purchase arrangements help control the ultimatecost paid and any commodity price aberrations are generally short-term innature.

This market risk discussion contains forward-lookingstatements. Actual results may differ materially from this discussion basedupon general market conditions and changes in domestic and global financialmarkets.

** **

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**Item4.  Controls and Procedures**

An evaluation was carried out under the supervisionand with the participation of company management, including our chief executiveofficer and chief financial officer, of the effectiveness of the design andoperation of our disclosure controls and procedures (as defined in Rule 13a-15(e)under the Securities Exchange Act of 1934, as amended) as of April 3, 2007.Based upon that evaluation, our chief executive officer and our chief financialofficer have concluded that the design and operation of our disclosure controlsand procedures were effective in timely making known to them materialinformation relating to the Company required to be disclosed in reports that wefile or submit under the Exchange Act rules.

It should be noted that any system of controls,however well designed and operated, can provide only reasonable assuranceregarding management’s control objectives. In addition, the design of anycontrol system is based in part upon certain assumptions about the likelihoodof future events. Because of these and other inherent limitations of controlsystems, there can be no assurance that any design will succeed in achievingits stated goals under all potential future conditions, regardless of howremote.

During the quarter ended April 3, 2007, there were nochanges to our internal controls over financial reporting that were identifiedin connection with the evaluation of our disclosure controls and proceduresrequired by the Exchange Act rules and that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

 

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**PART II - OTHER INFORMATION**

**EINSTEINNOAH RESTAURANT GROUP, INC.**

**Item 1.**           Legal Proceedings

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

**Item 1A. Risk Factors**

We wish to cautionour readers that the following important factors, among others, could cause theactual results to differ materially from those indicated by forward-lookingstatements made in this report and from time to time in news releases, reports,proxy statements, registration statements and other written communications, aswell as verbal forward-looking statements made from time to time byrepresentatives of the company. Such forward-looking statements involve risksand uncertainties that may cause our actual results, performance orachievements to be materially different from any future performance orachievements expressed or implied by these forward-looking statements. Factorsthat might cause actual events or results to differ materially from thoseindicated by these forward-looking statements may include matters such asfuture economic performance, restaurant openings or closings, operatingmargins, the availability of acceptable real estate locations, the sufficiencyof our cash balances and cash generated from operating and financing activitiesfor our future liquidity and capital resource needs, and other matters, and aregenerally accompanied by words such as: believes, anticipates, estimates,predicts, expects, and similar expressions that convey the uncertainty offuture events or outcomes. An expanded discussion of some of these risk factorsfollows.

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

*Failure to protect food suppliesand adhere to food safety standards could result in food-borne illnesses and/orinjuries to our guests.*

Food safety is the mostsignificant risk to any company that operates in the restaurant industry. It isthe focus of increased government regulatory initiatives at the local, stateand federal levels.

Failure to protect ourfood supply or enforce food safety policies, such as proper food temperaturesand adherence to shelf life dates, could result in food-borne illnesses and/orinjuries to our guests. Instances of foodborne illness, including listeriosis,salmonella and e-coli, whether or not traced to our restaurants, could reducedemand for our menu offerings. If any of our guests become ill from consumingour products, the affected restaurants may be forced to close. An instance offood contamination originating from one of our restaurants, our commissaries orsuppliers, or our manufacturing plant could have far-reaching effects, as thecontamination could affect substantially all of our restaurants. In addition,product contamination or recalls may cause our guests to cease frequenting ourrestaurants based on fear of such illnesses.

*Changes in consumer preferencesand discretionary spending priorities could harm our financial results.*

Numerous factorsincluding changes in consumer tastes and discretionary spending prioritiesoften affect restaurants. Shifts in consumer preferences away from our type ofcuisine and/or the fast-casual style could have a material adverse effect onour results of operations. Dietary trends, such as the consumption of food lowin carbohydrate content have, in the past, and may, in the future, negativelyimpact our sales.

 

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Changes in our guests’spending habits could also have a material adverse effect on our sales. Avariety of factors could affect discretionary consumer spending, includingnational, regional and local economic conditions, weather, inflation, consumerconfidence and energy costs. Adverse changes in any of these factors couldreduce consumers’ discretionary spending which in turn could reduce our guesttraffic or average check. For example, traffic to restaurants industry-wide wasadversely affected in 2006 as a result of reduced consumer spending due torising fuel and energy costs. Adverse changes to consumer preferences orconsumer discretionary spending, each of which could be affected by manydifferent factors which are out of our control, could harm our businessprospects, financial condition, operating results and cash flows. Our continuedsuccess will depend in part on our ability to anticipate, identify and respondto changing consumer preferences and economic and other conditions.

*We may not be successful inimplementing any or all of the initiatives of our business strategy.*

Our success depends inpart on our ability to understand and satisfy the needs of our guests,franchisees and licensees. Our business strategy consists of severalinitiatives:

·                  expand sales at our existingcompany-owned restaurants;

·                  open new company-owned restaurants;and

·                  open new licensed and franchisedrestaurants.

Our ability to achieveany or all of these initiatives is uncertain. Our success in expanding sales atcompany-owned restaurants through various sub-initiatives including: developingnew menu offerings and broadening our offerings across multiple dayparts,improving our ordering and production systems, expanding our catering programand upgrading our restaurants is dependent in part on our ability to predictand satisfy consumer preferences. Our success in growing our business throughopening new company-owned restaurants is dependent on a number of factors,including our ability to: find suitable locations, reach acceptable leaseterms, have adequate capital, find available contractors, obtain licenses andpermits, locate and train appropriate staff and properly manage the newrestaurant. Our success in opening new licensed and franchised restaurants isdependent upon, among other factors, our ability to: attract quality businessesto invest in our core brands, maintain the effectiveness of our franchise offeringcirculars in target states, offer restaurant solutions for a variety oflocation types and the ability of our licensees and franchisees to: findsuitable locations, reach acceptable lease terms, have adequate capital, findavailable contractors, obtain licenses and permits, locate and train staffappropriately and properly manage the new restaurants. Accordingly, we may notbe able to open or upgrade as many restaurants as we project or otherwiseexecute on our strategy. If we are not successful in implementing any or all ofthe initiatives of our business strategy, it could have a material adverseeffect on our business, results of operations, and financial condition.

*Our sales and profit growth couldbe adversely affected if comparable store sales are less than we expect.*

The level of growth incomparable store sales significantly affects our overall sales growth and willbe a critical factor affecting profit growth. Our ability to increasecomparable store sales depends in part on our ability to offer hospitality andattractive menu items, and successfully implement our initiatives to increasethroughput, such as increasing the speed at which our employees serve eachguest. Factors such as traffic patterns, local demographics and the type,number and location of competing restaurants may adversely affect theperformance of individual restaurants. It is possible that we will not achieveour targeted comparable store sales growth or that the change in comparablestore sales could be negative and could adversely impact our sales and profitgrowth. We expect quarterly comparable restaurant sales increases to declinethroughout the year as compared to the same period of the prior year.

* *

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

Our industry is highlycompetitive and there are many well-established competitors with substantiallygreater financial and other resources than we have. Although we operate in thefast-casual segment of the restaurant industry, we also consider restaurants inthe fast-food and full-service segments to be our competitors. Severalfast-casual and fast-food chains have recently announced their intentions tofocus more on breakfast offerings. This could further increase competition inthe breakfast daypart. 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.Also, in virtually every major metropolitan area in which we operate or expectto enter, local or regional competitors already exist. This may make it moredifficult to obtain real estate and advertising space, and to attract andretain guests and personnel.

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

We do not own any realproperty, and all of our company-owned restaurants are located in leasedpremises. Many of our current leases are non-cancelable and typically haveterms ranging from five to ten years with two three- to five-year renewaloptions. We believe leases that we enter into in the future likely will also belong-term and non-cancelable and have similar renewal options. Most of ourleases provide that the landlord may increase the rent over the term of thelease, and require us to pay our proportionate share of the cost of insurance,taxes, maintenance and utilities. If we close a restaurant, we generally remaincommitted to perform our obligations under the applicable lease, which wouldinclude, among other things, payment of the base rent for the balance of the leaseterm. In some instances, we may be unable to close an underperformingrestaurant due to continuous operation clauses in our lease agreements. Ourobligation to continue making rental payments in respect of leases for closedor underperforming restaurants could have a material adverse effect on ourbusiness and results of operations.

Alternatively, at the endof the lease term and any renewal period for a restaurant, we may be unable torenew the lease without substantial additional cost, if at all. If we areunable to renew our restaurant leases, we may be forced to close or relocate arestaurant, which could subject us to construction and other costs and risks,and could have a material adverse effect on our business and results ofoperations. For example, closing a restaurant, even during the time ofrelocation, will reduce the sales that the restaurant would have contributed toour revenues. Additionally, the revenue and profit, if any, generated at arelocated restaurant may not equal the revenue and profit generated at theexisting restaurant. We also face competition from both restaurants and otherretailers for suitable sites for new restaurants. As a result, we may not beable to secure or renew leases for adequate sites at acceptable rent levels.

*Fluctuations in the cost,availability and quality of our raw ingredients and natural resources such asenergy affect our results of operations.*

The cost, availabilityand quality of the ingredients that we use to prepare our food are subject to arange of factors, many of which are beyond our control. Fluctuations ineconomic and political conditions, weather and demand could adversely affectthe cost of our ingredients. We have limited control over these changes in theprice and quality of commodities, since we typically do not enter intolong-term pricing agreements for our ingredients. We may not be able to passthrough any future cost increases by increasing menu prices, as we have done inthe past. We and our licensees and franchisees are dependent on frequentdeliveries of fresh ingredients, thereby subjecting us to the risk of shortagesor interruptions in supply. Additionally, in the event of massive culling ofspecific animals such as chickens or turkeys to prevent the spread of disease,the supply and availability of ingredients may become limited. This coulddramatically increase the price of certain menu items which could decreasesales of those items or could force us to eliminate those items from our menusentirely. All of these factors could adversely affect our business, reputationand financial results.

* *

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*Our operations may be negativelyimpacted by adverse weather conditions.*

Adverse weatherconditions could seriously affect regions in which our company-owned, licensedand franchised restaurants are located or regions that produce raw ingredientsfor our restaurants. If adverse weather conditions affect our restaurants, wecould experience closures, repair and restoration costs, food spoilage, andother significant reopening costs as well as increased food costs and delayedsupply shipments, any of which would adversely affect our business.Additionally, during periods of extreme temperatures (either hot or cold) orprecipitation, many individuals choose to stay inside. This negatively impactstransaction counts in our restaurants and over extended periods of time couldadversely affect our business and results of operations. For example, sales incertain of our restaurants in the first quarter of 2007 were adversely impactedby the extreme weather experienced in the Northeast and Midwest.

The effects ofhurricanes, freezes and other adverse weather conditions are likely to affectsupply of and costs for raw ingredients and natural resources, near-termconstruction costs for our new restaurants as well as sales in our restaurantsgoing forward. If we are not able to anticipate or react to changing costs offood and other raw materials by adjusting our purchasing practices or menuprices, our operating margins would likely deteriorate.

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

We currently purchase ourraw materials from various suppliers; however, we have only one supplier foreach of our key ingredients. We purchase a majority of our frozen bagel doughfrom a single supplier, who utilizes our proprietary processes and on whom weare dependent in the short-term. All of our remaining frozen bagel dough isproduced at our dough manufacturing facility in Whittier, CA. Additionally, wepurchase all of our cream cheese from a single source under a contract thatexpires at the end of 2007, and we have a single supplier for our coffee.Although to date we have not experienced significant difficulties with our suppliers,our reliance on a single supplier for each of our key ingredients subjects usto a number of risks, including possible delays or interruption in supplies,diminished control over quality and a potential lack of adequate raw materialcapacity. Any disruption in the supply or degradation in the quality of thematerials provided by our suppliers could have a material adverse effect on ourbusiness, operating results and financial condition. In addition, any suchdisruptions in supply or degradations in quality could have a long-termdetrimental impact on our efforts to maintain a strong brand identity and aloyal consumer base.

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

We depend on our networkof independent distributors to distribute frozen bagel dough and other productsand materials to our company-owned, licensed and franchised restaurants. Anyfailure by one or more of our distributors to perform as anticipated, or anydisruption in any of our distribution relationships for any reason, wouldsubject us to a number of risks, including inadequate products delivered to ourrestaurants, diminished control over quality of products delivered, and increasedoperating costs to prevent delays in deliveries. Any of these events could harmour relationships with our franchisees or licensees, or diminish the reputationof our menu offerings or our brands in the marketplace. In addition, a negativechange in the volume of products ordered from our distributors by ourcompany-owned, franchised and/or licensed restaurants could increase ourdistribution costs. These risks could have a material adverse effect on ourbusiness, financial condition and results of operations.

In late 2006, wenegotiated contract terms with two new distributors. In early 2007, these newdistributors began delivering products to our company-owned, licensed andfranchised restaurants in the respective geographic regions. We believe the newdistributors will provide a higher level of performance at a lower cost.However, the new distributors may not perform as we expect, or their coststructure may not provide for the cost savings that we anticipate.

* *

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*Increasing labor costs couldadversely affect our results of operations and cash flows.*

We are dependent upon anavailable labor pool of associates, many of whom are hourly employees whosewages may be affected by increases in the federal, state or municipal “livingwage” rates. Numerous proposals have been made on federal, state and locallevels to increase minimum wage levels. Increases in state minimum hourly wagerates in most of the states in which we operate became effective January 1,2007. An increase in the minimum wage may create pressure to increase the payscale for our associates, which would increase our labor costs and those of ourfranchisees and licensees.

A shortage in the laborpool or other general inflationary pressures or changes could also increaselabor costs. In addition, changes in labor laws or reclassifications ofassociates from management to hourly employees could affect our labor cost. Anincrease in labor costs could have a material adverse effect on our income fromoperations and decrease our profitability and cash flows if we are unable torecover these increases by raising the prices we charge our guests.

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

We have a high level ofdebt and are highly leveraged. As of April 3, 2007, we had $170.2 million interm loans outstanding, which includes the full face value of the $25.0 millionsubordinated note and the accrual of paid-in-kind interest. We also have $57.0million of mandatorily redeemable preferred stock due June 30, 2009 which willremain in place after the offering. In addition, we may, subject to certainrestrictions, incur substantial additional indebtedness in the future. Our highlevel of debt, among other things, could:

·                  make it difficult for us to satisfyour obligations under our indebtedness;

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

·                  increase our vulnerability todownturns in our business or the economy generally;

·                  increase our vulnerability tovolatility in interest rates; and

·                  limit our ability to withstandcompetitive pressures from our less leveraged competitors.

Economic, financial,competitive, legislative and other factors beyond our control may affect ourability to generate cash flow from operations to make payments on ourindebtedness and to fund necessary working capital. A significant reduction inoperating cash flow would likely increase the need for alternative sources ofliquidity. If we are unable to generate sufficient cash flow to make paymentson our debt, we will have to pursue one or more alternatives, such as reducingor delaying capital expenditures, refinancing our debt on terms that are notfavorable to us, selling assets or issuing additional equity securities. We maynot be able to accomplish any of these alternatives on satisfactory terms, ifat all, and even if accomplished, they may not yield sufficient funds toservice our debt.

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

Our current debtagreements contain, and we expect that our amended debt arrangements to beentered into upon completion of the proposed offering of our common stock willalso contain, certain covenants, which, among others, include certain financialcovenants such as limitations on capital expenditures, maintenance of thebusiness, use of proceeds from sales of assets and consolidated leverage andfixed charge coverage ratios as defined in the agreements. The covenants alsopreclude the declaration and payment of dividends or other distributions toholders of our common stock. We are subject to multiple economic, financial,competitive, legal and other risks that are beyond our control and could harmour future financial results. Any adverse effect on our business or financialresults could affect our ability to maintain compliance with our debtcovenants, and any failure by us to comply with these covenants could result inan event of default. If we were to default under our covenants and such defaultwere not cured or waived, our indebtedness could become immediately due andpayable, which could render us insolvent.

 

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*We face the risk of adversepublicity and litigation in connection with our operations.*

We are from time to timethe subject of complaints or litigation from our consumers alleging illness,injury or other food quality, health or operational concerns. Adverse publicityresulting from these allegations may materially adversely affect us, regardlessof whether the allegations are valid or whether we are liable. In addition,employee claims against us based on, among other things, discrimination,harassment or wrongful termination may divert financial and managementresources that would otherwise be used to benefit our future performance. Thereis also a risk of litigation from our franchisees with regard to the terms ofour franchise arrangements. We have been subject to a variety of claims fromtime to time, and although these claims have not historically had a materialimpact on our operations, a significant increase in the number of these claimsor the number that are successful could materially adversely affect ourbusiness, prospects, financial condition, operating results or cash flows.

*A regional or global healthpandemic could severely affect our business.*

A health pandemic is adisease that spreads rapidly and widely by infection and affects many individualsin an area or population at the same time. In 2004, 2005 and 2006, Asian andEuropean countries experienced outbreaks of avian flu and it is possible thatit will continue to migrate to the United States where our restaurants arelocated. If a regional or global health pandemic were to occur, depending uponits duration and severity, our business could be severely affected. We havepositioned ourselves as a “neighborhood atmosphere” between home and work wherepeople can gather for human connection and high quality food. Customers mightavoid public gathering places in the event of a health pandemic, and local,regional or national governments might limit or ban public gatherings to haltor delay the spread of disease. A regional or global pandemic might alsoadversely impact our business by disrupting or delaying production and deliveryof products and materials in our supply chain and causing staff shortages inour restaurants. The impact of a health pandemic might be disproportionatelygreater on us than on other companies that depend less on the gathering ofpeople in a neighborhood atmosphere.

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

We rely in part on ourlicensees and franchisees and the manner in which they operate theirrestaurants to develop and promote our business. Although we have developedcriteria to evaluate and screen prospective candidates, the candidates may nothave the business acumen or financial resources necessary to operate successfulrestaurants in their respective areas. In addition, licensees and franchiseesare subject to business risks similar to what we face such as competition,consumer acceptance, fluctuations in the cost, availability and quality of rawingredients, and increasing labor costs. The failure of licensees andfranchisees to operate successfully could have a material adverse effect on us,our reputation, our ability to collect royalties, our brands and our ability toattract prospective candidates. As we move into offering franchises for ourEinstein Bros. brand, our reliance on our franchisees is expected to increasein proportion to growth of the franchisee base. With respect to franchising ourEinstein Bros. brand, we may not be able to identify franchisees that meet ourcriteria, or to enter into franchise area development agreements withprospective franchisee candidates that we identify. As a result, our franchiseprogram for the Einstein Bros. brand may not grow at the rate we currentlyexpect, or at all.

* *

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

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

Many recent governmentbodies have begun to legislate or regulate high-fat and high sodium foods as away of combating concerns about obesity and health. The New York City HealthDepartment recently adopted an amendment to the New York City Health Code thatrequires New York City restaurants and other food service establishments tophase out artificial trans-fat by July 1, 2008. In addition, the City ofPhiladelphia recently passed a law that requires restaurants to phase outartificial trans-fat by September 1, 2008. Many other states are consideringlaws banning trans-fat in restaurant food. Because we do use trans-fat in a fewof our products, federal, state or local regulations in the future may limitsales of certain of our foods or ingredients. Public interest groups have alsofocused attention on the marketing of high-fat and high-sodium foods tochildren in a stated effort to combat childhood obesity. Additional cities orstates may propose or adopt similar regulations. The cost of complying withthese regulations could increase our expenses and the negative publicityarising from such legislative initiatives could reduce our future sales.

Our franchisingoperations are subject to regulation by the Federal Trade Commission. We mustalso comply with state franchising laws and a wide range of other state andlocal rules and regulations applicable to our business. The failure to complywith federal, state and local rules and regulations would have an adverseeffect on us.

Under various federal,state and local laws, an owner or operator of real estate may be liable for thecosts of removal or remediation of certain hazardous or toxic substances on orin such property. Such liability may be imposed without regard to whether theowner or operator knew of, or was responsible for, the presence of suchhazardous or toxic substances. Although we are not aware of any environmentalconditions that require remediation by us under federal, state or local law atour properties, we have not conducted a comprehensive environmental review ofour properties or operations. We may not have identified all of the potentialenvironmental liabilities at our properties, and any such liabilities that areidentified in the future may have a material adverse effect on our financialcondition.

*We may not be able to protect ourtrademarks, service marks and other proprietary rights.*

We believe ourtrademarks, service marks and other proprietary rights are important to oursuccess and our competitive position. Accordingly, we devote substantialresources to the establishment and protection of our trademarks, service marksand proprietary rights. However, the actions we take may be inadequate toprevent imitation of our products and concepts by others or to prevent othersfrom claiming violations of their trademarks and proprietary rights by us. Inaddition, others may assert rights in our trademarks, service marks and otherproprietary rights.

* *

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*Our ability to use net operatingloss carryforwards to offset future taxable income for U.S. federal income taxpurposes is subject to limitation and may be limited further as a result of theproposed public offering of our common stock.*

In general, under Section382 of the Internal Revenue Code, a corporation that undergoes an “ownershipchange” is subject to limitations on its ability to utilize its pre-change netoperating losses, or NOLs, to offset future taxable income. A corporationgenerally undergoes an “ownership change” when the stock ownership percentage(by value) of its “5 percent stockholders” increases by more than 50 percentagepoints over any three-year testing period.

As of April 3, 2007, ournet operating loss carryforwards for U.S. federal income tax purposes wereapproximately $153.7 million. As a result of prior ownership changes,approximately $95.7 million of our NOL carryforwards are subject to an annualusage limitation of $4.7 million. Due to transactions involving the sale orother transfer of our stock from the date of our last ownership change throughthe date of the proposed public offering of our common stock, and changes inthe value of our stock during that period, such offering may result in anadditional ownership change for purposes of Section 382 or will significantlyincrease the likelihood that we will undergo an additional ownership change inthe future (which could occur as a result of transactions involving our stockthat are outside of our control). In either event, the occurrence of anadditional ownership change would limit our ability to utilize theapproximately $58.0 million of our NOLs that are not currently subject tolimitation, and could further limit our ability to utilize our remaining NOLsand possibly other tax attributes. Limitations imposed on our ability to useNOLs and other tax attributes to offset future taxable income could cause us topay U.S. federal income taxes earlier than we otherwise would if suchlimitations were not in effect, and could cause such NOLs and other taxattributes to expire unused, in each case reducing or eliminating the benefitof such NOLs and other tax attributes to us and adversely affecting our futurecash flow. There can be no assurance that we will realize any U.S. federalincome tax benefit from any of our net operating loss carryforwards. Similarrules and limitations may apply for state income tax purposes as well.

**Risk Factors Relating to OurCommon Stock**

*We have a majority stockholder.*

Greenlight Capital,L.L.C. and its affiliates beneficially own approximately 94% of our commonstock. As a result, Greenlight has sufficient voting power, without the vote ofany other stockholders, to determine what matters will be submitted forapproval by our stockholders, to approve actions by written consent without theapproval of any other stockholders, to elect all of the members of our board ofdirectors, and to determine whether a change in control of our company occurs.Greenlight’s interests on matters submitted to stockholders may be differentfrom those of other stockholders. Greenlight is not involved in our day-to-dayoperations, but Greenlight has voted its shares to elect our current board ofdirectors. The chairman of our board of directors is a current employee ofGreenlight.

We have applied to listour common stock on the Nasdaq Global Market. Nasdaq rules will require us tohave an audit committee consisting entirely of independent directors. However,under Nasdaq rules, if a single stockholder holds more that 50% of the votingpower of a listed company, that company is considered a controlled company, andis exempt from several other corporate governance rules, including therequirement that companies have a majority of independent directors andindependent director involvement in the selection of director nominees and inthe determination of executive compensation. As a result, our stockholders willnot have, and may never have, the protections that these rules are intended toprovide.

* *

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*Future sales of shares of ourcommon stock by our stockholders could cause our stock price to fall.*

If a substantial numberof shares of our common stock are sold in the public market, the market priceof our common stock could fall. The perception among investors that these saleswill occur could also produce this effect. Our majority stockholder,Greenlight, beneficially owns approximately 94% of our common stock and salesby Greenlight or a perception that Greenlight will sell could cause a decreasein the market price of our common stock.

*We have not yet completed ourevaluation of our internal control over financial reporting in compliance withSection 404 of the Sarbanes-Oxley Act.*

We will be required tocomply with the internal control evaluation and certification requirements ofSection 404 of the Sarbanes-Oxley Act by the end of our 2007 fiscal year. Wehave not yet completed our evaluation of whether our current internal controlover financial reporting is compliant with Section 404. We may not be compliantand may not be able to meet the Section 404 requirements in a timely manner. Ifit is determined that we are not in compliance with Section 404, we may berequired to implement new internal control procedures and re-evaluate ourfinancial reporting. We may experience higher than anticipated operatingexpenses as well as outside auditor fees during the implementation of thesechanges and thereafter. Further, we may need to hire additional qualifiedpersonnel in order for us to be compliant with Section 404. If we are unable toimplement these changes effectively or efficiently, it could harm ouroperations, financial reporting or financial results and could result in ourconclusion that our internal control over financial reporting is not effective.

 

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**Item6.  Exhibits**

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

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

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

32.2           Certification by Chief Financial Officerpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002

**Signatures**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|        |   |        | EINSTEIN NOAH RESTAURANT GROUP, INC. |
|--------|--------|-------------|--------------------------------------|
|   |   |        |                                 |   |
| Date:  |   | May 4, 2007 | By:                                  | /s/ PAUL J. B. MURPHY, III |
|   |   |        |                                 | Paul J.B. Murphy, III |
|   |   |        |                                 | Chief Executive Officer |
|   |   |        |                                 |   |
| Date:  |   | May 4, 2007 | By:                                  | /s/ RICHARD P. DUTKIEWICZ |
|   |   |        |                                 | Richard P. Dutkiewicz |
|   |   |        |                                 | Chief Financial Officer and Principal Accounting  Officer |

 

 

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