Tableof Contents

** **

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark One)**                                                                                                      |
|---------------------------------------------------------------------------------------------------------------------|
| **x****  QUARTERLY REPORT PURSUANT TO SECTION 13  OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                |
| **For the quarterly period ended September 30,  2008**                                                         |
|                                                                                                                |
| **OR**                                                                                                              |
| ** **                                                                                                          |
| **o****  TRANSITION REPORT UNDER SECTION 13  OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**      |
|                                                                                                                |
| **Commission File Number 0-27148**                                                                                  |

 

**Einstein Noah Restaurant Group, Inc.**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                    | ** ** | **13-3690261**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction  of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **555 Zang Street, Suite 300, Lakewood,  Colorado**        | ** ** | **80228**                             |
| (Address of principal executive offices)                        |       | (Zip Code)                            |

 
| **(303) 568-8000**                                                                  |
|-------------------------------------------------------------------------------------|
| (Registrant’s telephone number, including  area code)                          |
| ** **                                                                          |
|                                                                                |
| (Former name, former address and former  fiscal year, if changed since last report) |

 

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

 

Indicate by check mark whether the registrant is alarge accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See the definitions of “large accelerated filer,” “accelerated filer”and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

 

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

 

As of November 3, 2008, there were 15,975,251shares of the registrant’s Common Stock, par value of $0.001 per shareoutstanding.

 

 

 

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

 

TABLE OF CONTENTS

** **
| **Part I. Financial Information** | ** **                                                                                  |
|----------------------------------------|---------------------------------------------------------------------------------------------|
|                                   |                                                                                        |   |
| Item 1.                                | Financial Statements (Unaudited):                                                           |   |
|                                   |                                                                                        |   |
|                                   | Consolidated Balance Sheets                                                                 | 3 |
|                                   |                                                                                        |   |
|                                   | Consolidated Statements of Operations                                                       | 4 |
|                                   |                                                                                        |   |
|                                   | Consolidated Statements of Cash Flows                                                       | 5 |
|                                   |                                                                                        |   |
|                                   | Notes to the  Consolidated Financial Statements                                             | 6 |
|                                   |                                                                                        |   |
| Item 2.                                | Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 14 |
|                                   |                                                                                        |   |
| Item 3.                                | Quantitative and Qualitative Disclosures  about Market Risk                                 | 26 |
|                                   |                                                                                        |   |
| Item 4.                                | Controls and Procedures                                                                     | 27 |
|                                   |                                                                                        |   |
| **Part II. Other Information**    | ** **                                                                                  |
|                                   |                                                                                        |   |
| Item 1.                                | Legal Proceedings                                                                           | 28 |
|                                   |                                                                                        |   |
| Item 1A.                               | Risk Factors                                                                                | 28 |
|                                   |                                                                                        |   |
| Item 6.                                | Exhibits                                                                                    | 37 |

 

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PART I. FINANCIALINFORMATION

Item 1.  Financial Statements

 

**EINSTEINNOAH RESTAURANT GROUP, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(inthousands, except share information)**

**(Unaudited)**

 
| ** **                                                                                                                                                                   | ** ** | **January 1,** | ** ** | **September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                   | ** ** | **2008**            | ** ** | **2008**               | ** ** |
| **ASSETS**                                                                                                                                                                   | ** ** | ** **          | ** ** | ** **             | ** ** |
| Current assets:                                                                                                                                                              |       |                |       |                   |       |
| Cash and cash equivalents                                                                                                                                                    |       | $                   | 9,436      |                   | $          | 22,150 |   |
| Restricted cash                                                                                                                                                              |       | 1,203               |       | 887                    |       |
| Franchise and other receivables, net of  allowance of $606 and $278, respectively                                                                                            |       | 7,807               |       | 7,207                  |       |
| Inventories                                                                                                                                                                  |       | 5,313               |       | 5,033                  |       |
| Prepaid expenses and other current assets                                                                                                                                    |       | 5,281               |       | 4,684                  |       |
| Total current assets                                                                                                                                                         |       | 29,040              |       | 39,961                 |       |
|                                                                                                                                                                         |       |                |       |                   |       |
| Property, plant and equipment, net                                                                                                                                           |       | 47,714              |       | 56,180                 |       |
| Trademarks and other intangibles, net                                                                                                                                        |       | 63,831              |       | 63,831                 |       |
| Goodwill                                                                                                                                                                     |       | 4,981               |       | 4,981                  |       |
| Debt issuance costs and other assets, net                                                                                                                                    |       | 2,996               |       | 2,769                  |       |
|                                                                                                                                                                         |       |                |       |                   |       |
| Total assets                                                                                                                                                                 |       | $                   | 148,562    |                   | $          | 167,722 |   |
|                                                                                                                                                                         |       |                |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**                                                                                                                               | ** ** | ** **          | ** ** | ** **             | ** ** |
| Current liabilities:                                                                                                                                                         |       |                |       |                   |       |
| Accounts payable                                                                                                                                                             |       | $                   | 5,072      |                   | $          | 4,976 |   |
| Accrued expenses and other current  liabilities                                                                                                                              |       | 19,279              |       | 23,375                 |       |
| Short-term debt and current portion of  long-term debt                                                                                                                       |       | 955                 |       | 9,180                  |       |
| Current portion of obligations under  capital leases                                                                                                                         |       | 80                  |       | 86                     |       |
| Mandatorily redeemable, Series Z  Preferred Stock, $.001 par value, $1,000 per share liquidation value; 57,000  shares authorized; 57,000 shares issued and outstanding |       | —              |       | 57,000                 |       |
|                                                                                                                                                                         |       |                |       |                   |       |
| Total current liabilities                                                                                                                                                    |       | 25,386              |       | 86,617                 |       |
|                                                                                                                                                                         |       |                |       |                   |       |
| Senior notes and other long-term debt                                                                                                                                        |       | 88,875              |       | 78,975                 |       |
| Long-term obligations under capital leases                                                                                                                                   |       | 67                  |       | 72                     |       |
| Other liabilities                                                                                                                                                            |       | 10,841              |       | 11,386                 |       |
| Mandatorily redeemable, Series Z  Preferred Stock, $.001 par value, $1,000 per share liquidation value; 57,000  shares authorized; 57,000 shares issued and outstanding |       | 57,000              |       | —                 |       |
|                                                                                                                                                                         |       |                |       |                   |       |
| Total liabilities                                                                                                                                                            |       | 182,169             |       | 185,050                |       |
|                                                                                                                                                                         |       |                |       |                   |       |
| Commitments and contingencies                                                                                                                                                |       |                |       |                   |       |
|                                                                                                                                                                         |       |                |       |                   |       |
| Stockholders’ deficit:                                                                                                                                                  |       |                |       |                   |       |
| Series A junior participating  preferred stock, 700,000 shares authorized; no shares issued and outstanding                                                             |       |                |       |                   |       |
| Common stock, $.001 par value; 25,000,000  shares authorized; 15,878,811 and 15,975,251 shares issued and outstanding                                                        |       | 16                  |       | 16                     |       |
| Additional paid-in capital                                                                                                                                                   |       | 262,830             |       | 264,105                |       |
| Accumulated other comprehensive loss                                                                                                                                         |       | —              |       | (289                   | )          |
| Accumulated deficit                                                                                                                                                          |       | (296,453            | )          | (281,160               | )          |
| Total stockholders’ deficit                                                                                                                                             |       | (33,607             | )          | (17,328                | )          |
|                                                                                                                                                                         |       |                |       |                   |       |
| Total liabilities and stockholders’ deficit                                                                                                                             |       | $                   | 148,562    |                   | $          | 167,722 |   |

 

The accompanying notes arean integral part of these consolidated financial statements.

 

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(unaudited)**

 
| ** **                                                        | ** ** | **13 weeks ended** | ** ** | **39 weeks ended** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                        | ** ** | **October 2,**          | ** ** | **September 30,**       | ** ** | **October 2,** | ** ** | **September 30,** | ** ** |
| ** **                                                        | ** ** | **2007**                     | ** ** | **2008**                     | ** ** | **2007** | ** ** | **2008** | ** ** |
| Revenues:                                                         |       |                         |       |                         |       |   |   |   |   |
| Company-owned restaurant sales                                    |       | $                            | 93,026     |                         | $          | 92,400 |   | $ | 276,283 |   | $ | 282,331 |   |
| Manufacturing and commissary revenues                             |       | 5,910                        |       | 6,991                        |       | 17,409 |   | 22,719 |   |
| Franchise and license related revenues                            |       | 1,442                        |       | 1,504                        |       | 3,996 |   | 4,523 |   |
|                                                              |       |                         |       |                         |       |   |   |   |   |
| Total revenues                                                    |       | 100,378                      |       | 100,895                      |       | 297,688 |   | 309,573 |   |
|                                                              |       |                         |       |                         |       |   |   |   |   |
| Cost of sales:                                                    |       |                         |       |                         |       |   |   |   |   |
| Company-owned restaurant costs                                    |       | 74,527                       |       | 75,189                       |       | 221,116 |   | 227,662 |   |
| Manufacturing and commissary costs                                |       | 6,330                        |       | 6,523                        |       | 17,132 |   | 21,607 |   |
|                                                              |       |                         |       |                         |       |   |   |   |   |
| Total cost of sales                                               |       | 80,857                       |       | 81,712                       |       | 238,248 |   | 249,269 |   |
|                                                              |       |                         |       |                         |       |   |   |   |   |
| Gross profit                                                      |       | 19,521                       |       | 19,183                       |       | 59,440 |   | 60,304 |   |
|                                                              |       |                         |       |                         |       |   |   |   |   |
| Operating expenses:                                               |       |                         |       |                         |       |   |   |   |   |
| General and administrative expenses                               |       | 9,794                        |       | 7,652                        |       | 31,381 |   | 27,935 |   |
| California wage and hour settlements                              |       | —                       |       | 1,900                        |       | — |   | 1,900 |   |
| Depreciation and amortization                                     |       | 2,868                        |       | 3,644                        |       | 7,910 |   | 10,193 |   |
| Loss (gain) on sale, disposal or  abandonment of assets, net      |       | 25                           |       | (10                          | )          | 429 |   | 122 |   |
| Impairment charges and other related costs                        |       | 28                           |       | —                       |       | 213 |   | 54 |   |
|                                                              |       |                         |       |                         |       |   |   |   |   |
| Income from operations                                            |       | 6,806                        |       | 5,997                        |       | 19,507 |   | 20,100 |   |
|                                                              |       |                         |       |                         |       |   |   |   |   |
| Other expense:                                                    |       |                         |       |                         |       |   |   |   |   |
| Interest expense, net                                             |       | 1,752                        |       | 1,250                        |       | 10,685 |   | 4,157 |   |
| Write-off of debt discount upon redemption  of senior notes       |       | —                       |       | —                       |       | 528 |   | — |   |
| Prepayment penalty upon redemption of  senior notes               |       | —                       |       | —                       |       | 240 |   | — |   |
| Write-off of debt issuance costs upon  redemption of senior notes |       | —                       |       | —                       |       | 2,071 |   | — |   |
|                                                              |       |                         |       |                         |       |   |   |   |   |
| Income before income taxes                                        |       | 5,054                        |       | 4,747                        |       | 5,983 |   | 15,943 |   |
| Provision for income taxes                                        |       | 111                          |       | 210                          |       | 158 |   | 650 |   |
|                                                              |       |                         |       |                         |       |   |   |   |   |
| Net income                                                        |       | $                            | 4,943      |                         | $          | 4,537 |   | $ | 5,825 |   | $ | 15,293 |   |
|                                                              |       |                         |       |                         |       |   |   |   |   |
| Net income per common share – Basic                          |       | $                            | 0.31       |                         | $          | 0.28 |   | $ | 0.46 |   | $ | 0.96 |   |
| Net income per common share – Diluted                        |       | $                            | 0.30       |                         | $          | 0.28 |   | $ | 0.43 |   | $ | 0.93 |   |
|                                                              |       |                         |       |                         |       |   |   |   |   |
| Weighted average number of common shares  outstanding:            |       |                         |       |                         |       |   |   |   |   |
| Basic                                                             |       | 15,772,931                   |       | 15,948,180                   |       | 12,718,051 |   | 15,921,645 |   |
| Diluted                                                           |       | 16,572,486                   |       | 16,412,748                   |       | 13,436,884 |   | 16,425,235 |   |

 

The accompanying notes arean integral part of these consolidated financial statements.

 

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**EINSTEINNOAH RESTAURANT GROUP, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(inthousands)**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **39 weeks ended** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                         | ** ** | **October 2,**          | ** ** | **September 30,** | ** ** |
| ** **                                                                         | ** ** | **2007**                     | ** ** | **2008** | ** ** |
| OPERATING ACTIVITIES:                                                              |       |                         |       |   |   |
| Net income                                                                         |       | $                            | 5,825      |   | $ | 15,293 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                         |       |   |   |
| Depreciation and amortization                                                      |       | 7,910                        |       | 10,193 |   |
| Stock-based compensation expense                                                   |       | 1,588                        |       | 877 |   |
| Loss, net of gains, on disposal of assets                                          |       | 429                          |       | 122 |   |
| Impairment charges and other related costs                                         |       | 213                          |       | 54 |   |
| Provision for losses on accounts receivable                                        |       | 25                           |       | 98 |   |
| Amortization of debt issuance and debt  discount costs                             |       | 545                          |       | 366 |   |
| Write-off of debt issuance costs                                                   |       | 2,071                        |       | — |   |
| Write-off of debt discount                                                         |       | 528                          |       | — |   |
| Paid-in-kind interest                                                              |       | 904                          |       | — |   |
| Changes in operating assets and  liabilities:                                      |       |                         |       |   |   |
| Restricted cash                                                                    |       | —                       |       | 316 |   |
| Franchise and other receivables                                                    |       | 87                           |       | 502 |   |
| Accounts payable and accrued expenses                                              |       | 1,973                        |       | 4,873 |   |
| Other assets and liabilities                                                       |       | (2,829                       | )          | 1,001 |   |
|                                                                               |       |                         |       |   |   |
| Net cash provided by operating activities                                          |       | 19,269                       |       | 33,695 |   |
|                                                                               |       |                         |       |   |   |
| INVESTING ACTIVITIES:                                                              |       |                         |       |   |   |
| Purchase of property and equipment                                                 |       | (18,255                      | )          | (19,649 | ) |
| Proceeds from the sale of equipment                                                |       | 1,166                        |       | 17 |   |
| Acquisition of restaurant assets                                                   |       | —                       |       | (7 | ) |
|                                                                               |       |                         |       |   |   |
| Net cash used in investing activities                                              |       | (17,089                      | )          | (19,639 | ) |
|                                                                               |       |                         |       |   |   |
| FINANCING ACTIVITIES:                                                              |       |                         |       |   |   |
| Proceeds from secondary common stock  offering                                     |       | 90,000                       |       | — |   |
| Costs incurred with offering of our common  stock                                  |       | (6,666                       | )          | — |   |
| Payments under capital lease obligations                                           |       | (58                          | )          | (65 | ) |
| Borrowings under First Lien Term Loan                                              |       | 11,900                       |       | — |   |
| Repayments under First Lien Term Loan                                              |       | (700                         | )          | (1,675 | ) |
| Repayments under Second Lien Term Loan                                             |       | (65,000                      | )          | — |   |
| Repayments under Subordinated Note                                                 |       | (25,000                      | )          | — |   |
| Debt issuance costs                                                                |       | (921                         | )          | — |   |
| Proceeds upon stock option exercises                                               |       | 779                          |       | 398 |   |
|                                                                               |       |                         |       |   |   |
| Net cash provided by (used in) financing  activities                               |       | 4,334                        |       | (1,342 | ) |
|                                                                               |       |                         |       |   |   |
| Net increase in cash and cash equivalents                                          |       | 6,514                        |       | 12,714 |   |
| Cash and cash equivalents, beginning of  period                                    |       | 5,477                        |       | 9,436 |   |
|                                                                               |       |                         |       |   |   |   |   |
| Cash and cash equivalents, end of period                                           |       | $                            | 11,991     |   | $ | 22,150 |   |

 

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

 

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**EINSTEINNOAH RESTAURANT GROUP, INC.**

Notes to the Consolidated FinancialStatements (Unaudited)

 

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

 

The accompanyingconsolidated balance sheet as of January 1, 2008, which has been derivedfrom audited financial statements, and the unaudited consolidated financialstatements of Einstein Noah Restaurant Group, Inc. and its wholly-ownedsubsidiaries (collectively, the “Company”) have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”).  The information furnishedherein reflects all adjustments (consisting only of normal recurring accrualsand adjustments), which are, in our opinion, necessary to fairly state theinterim operating results for the respective periods.

 

As of September 30,2008, the Company owned, franchised or licensed various restaurant conceptsunder the brand names of Einstein Bros. Bagels (“Einstein Bros.”), Noah’s NewYork Bagels (“Noah’s”), Manhattan Bagel Company (“Manhattan Bagel”), and NewWorld Coffee (“New World”).

 

Certain information and footnote disclosures normally included inannual financial statements prepared in accordance with generally acceptedaccounting principles in the United States have been omitted pursuant toSecurity Exchange Commission (“SEC”) rules and regulations. The notes tothe consolidated financial statements (unaudited) should be read in conjunctionwith the notes to the consolidated financial statements contained in our annualreport on Form 10-K for the fiscal year ended January 1, 2008. Webelieve that the disclosures are sufficient for interim financial reportingpurposes.  However, these operatingresults are not necessarily indicative of the results expected for the fullfiscal year.  Additionally, our business is subject to seasonal trends.Generally, our revenues and results of operations in the fourth fiscal quartertend to be the most significant.

 

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

 

We adoptedFinancial Accounting Standards Board (“FASB”) Statement of Financial AccountingStandards (“SFAS”) No. 157, *Fair ValueMeasurements,* (“SFAS 157”) on January 2, 2008, which becameeffective for fiscal periods beginning after November 15, 2007. SFAS 157defines fair value, establishes a framework for using fair value to measureassets and liabilities, and expands disclosure about fair value measurements.SFAS 157 applies whenever other statements require or permit assets orliabilities to be measured at fair value. The adoption of SFAS 157 did not havean impact on the Company’s consolidated financial statements.

 

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

 

In March 2008, the FASB issued SFAS No. 161, *Disclosures about Derivative Instruments and HedgingActivities, an amendment of FASB Statement No. 133* (“SFAS 161”). This statement changes the disclosure requirements for derivative instrumentsand hedging activities.  SFAS 161 requires enhanced disclosures about(a) how and why an entity uses derivative instruments, (b) howderivative instruments and related hedged items are accounted for underSFAS 133 and its related interpretations, and (c) how derivativeinstruments and related hedged items affect an entity’s financial position,financial performance, and cash flows.  SFAS 161 is effective as ofthe beginning of our 2009 fiscal year. We are currently evaluating thepotential impact, if any, of the adoption of SFAS 161 on our consolidatedfinancial statements.

 

In April 2008, the FASB issued FASB Staff Position No. FAS 142-3,*Determination of the Useful Life ofIntangible Assets* (“FSP 142-3”).  FSP 142-3 amends the factorsthat should be considered in developing renewal or extension assumptions thatare used to determine the useful life of a recognized intangible asset underFASB Statement No. 142, Goodwill and Other Intangible Assets and requiresenhanced related disclosures.  FSP 142-3 must be applied prospectively toall intangible assets acquired as of and subsequent to fiscal years beginningafter

 

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December 15, 2008.  We are currently evaluating the impactthat FSP 142-3 will have on our consolidated financial statements.

 

In May 2008, the FASB issued SFAS No. 162, *The Hierarchy of Generally Accepted AccountingPrinciples* (“SFAS 162”). SFAS 162 identifiesthe sources of accounting principles to be used in the preparation of financialstatements of nongovernmental entities that are presented in conformity withgenerally accepted accounting principles (“GAAP”) in the United States (“theGAAP hierarchy”). This Statement will be effective November 15, 2008. TheCompany currently adheres to the hierarchy of GAAP as presented in SFAS 162 and does not expect its adoption will have a material impacton its consolidated results of operations and financial condition.

 

We have consideredall other recently issued accounting pronouncements and do not believe theadoption of such pronouncements would have a material impact on ourconsolidated financial statements.

 

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

 

Our stock-based compensation cost for the thirteen weeks ended October 2,2007 and September 30, 2008 was $338,000 and $67,000, respectively, andfor the thirty-nine weeks ended October 2, 2007 and September 30,2008 was $1.6 million and $0.9 million, respectively.  These costs are included in general andadministrative expenses in our statements of operations. The fair value ofstock options and stock appreciation rights (“SARs”) are estimated using theBlack-Scholes option-pricing model with the following weighted averageassumptions:

 
| ** **                                            | ** ** | **13 weeks ended** | ** ** | **39 weeks ended** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                            | ** ** | **October 2,**          | ** ** | **September 30,**       | ** ** | **October 2,** | ** ** | **September 30,** | ** ** |
| ** **                                            | ** ** | **2007**                     | ** ** | **2008**                     | ** ** | **2007** | ** ** | **2008** | ** ** |
| Expected life of options and SARs from date  of grant |       | 4.0 years                    |       | 3.25 - 6.0 years             |       | 4.0 years |   | 3.25 - 6.0 years |   |
| Risk-free interest rate                               |       | 4.13 - 4.85%                 |       | 2.92%                        |       | 4.13-5.02% |   | 2.49 - 2.92% |   |
| Volatility                                            |       | 29.0%                        |       | 33.0%                        |       | 28% - 97% |   | 31 - 33% |   |
| Assumed dividend yield                                |       | 0.0%                         |       | 0.0%                         |       | 0.0% |   | 0.0% |   |

 

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

 

As of September 30, 2008, we had approximately $1.8 million oftotal unrecognized compensation cost related to non-vested awards granted underour stock option and stock appreciation rights plans, which we expect torecognize over a weighted average period of 2.3 years. Total compensation costsrelated to the non-vested awards outstanding as of September 30, 2008 willbe fully recognized through the fourth quarter of fiscal 2011, which representsthe end of the requisite service period.

 

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**Stock Option Plan Activity**

 

Transactions during the thirty-nine weeks ended September 30, 2008were as follows:

 
| ** **                                       | ** ** | ** **  | ** ** | **Weighted**        | ** ** | **Weighted** | ** ** | ** **    | ** ** | **Weighted**          | ** ** |
|--------------------------------------------------|------------|-------------|------------|---------------------|------------|--------------|------------|---------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **Number**  | ** ** | **Average**         | ** ** | **Average**  | ** ** | **Aggregate** | ** ** | **Average**           | ** ** |
| ** **                                       | ** ** | **of**      | ** ** | **Exercise**        | ** ** | **Fair**     | ** ** | **Intrinsic** | ** ** | **Remaining**         | ** ** |
| ** **                                       | ** ** | **Options** | ** ** | **Price**           | ** ** | **Value**    | ** ** | **Value**     | ** ** | **Life (Years)** | ** ** |
| Outstanding, January 1, 2008                |       | 1,108,361   |       | $                   | 8.06       |         |       |          |       |                  |       |   |
| Granted                                          |       | 276,738     |       | 12.92               |       |         |       |          |       |                  |       |
| Exercised                                        |       | (96,276     | )          | 4.14                |       |         |       |          |       |                  |       |
| Forfeited                                        |       | (3,542      | )          | 13.76               |       |         |       |          |       |                  |       |
| Outstanding, September 30, 2008             |       | 1,285,281   |       | $                   | 9.38       |         | $          | 4.12          |       | $                     | 3,856,656  |   | 7.24 |   |
| Exercisable and vested, September 30,  2008 |       | 691,299     |       | $                   | 6.15       |         | $          | 3.47          |       | $                     | 3,401,650  |   | 5.71 |   |
|                                             |       |        |       |                |       |         |       |          |       |                  |       |
| ** **                                       | ** ** | ** **  | ** ** | **Weighted**        | ** ** | ** **   | ** ** | ** **    | ** ** | ** **            | ** ** |
| ** **                                       | ** ** | **Number**  | ** ** | **Average**         | ** ** | ** **   | ** ** | ** **    | ** ** | ** **            | ** ** |
| ** **                                       | ** ** | **of**      | ** ** | **Grant Date** | ** ** | ** **   | ** ** | ** **    | ** ** | ** **            | ** ** |
| ** **                                       | ** ** | **Options** | ** ** | **Fair Value** | ** ** | ** **   | ** ** | ** **    | ** ** | ** **            | ** ** |
| Non-vested shares, January 1, 2008          |       | 470,368     |       | $                   | 4.80       |         |       |          |       |                  |       |   |
| Granted                                          |       | 276,738     |       | 4.68                |       |         |       |          |       |                  |       |
| Vested                                           |       | (149,582    | )          | 4.24                |       |         |       |          |       |                  |       |
| Forfeited                                        |       | (3,542      | )          | 5.45                |       |         |       |          |       |                  |       |
| Non-vested shares, September 30, 2008       |       | 593,982     |       | $                   | 4.88       |         |       |          |       |                  |       |   |

 

**Stock Appreciation Rights Plan Activity**

 

Transactions during the thirty-nine weeks ended September 30, 2008were as follows:

 
| ** **                                       | ** ** | ** ** | ** ** | **Weighted**        | ** ** | **Weighted** | ** ** | ** **    | ** ** | **Weighted**          | ** ** |
|--------------------------------------------------|------------|------------|------------|---------------------|------------|--------------|------------|---------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **Number** | ** ** | **Average**         | ** ** | **Average**  | ** ** | **Aggregate** | ** ** | **Average**           | ** ** |
| ** **                                       | ** ** | **of**     | ** ** | **Exercise**        | ** ** | **Fair**     | ** ** | **Intrinsic** | ** ** | **Remaining**         | ** ** |
| ** **                                       | ** ** | **SARs**   | ** ** | **Price**           | ** ** | **Value**    | ** ** | **Value**     | ** ** | **Life (Years)** | ** ** |
| Outstanding, January 1, 2008                |       | 76,913     |       | $                   | 11.69      |         |       |          |       |                  |       |   |
| Granted                                          |       | 5,002      |       | 14.32               |       |         |       |          |       |                  |       |
| Exercised                                        |       | (388       | )          | 8.00                |       |         |       |          |       |                  |       |
| Forfeited                                        |       | (14,227    | )          | 11.40               |       |         |       |          |       |                  |       |
| Outstanding, September 30, 2008             |       | 67,300     |       | $                   | 11.97      |         | $          | 5.44          |       | $                     | 84,600     |   | 3.59 |   |
| Exercisable and vested, September 30,  2008 |       | 19,973     |       | $                   | 11.49      |         | $          | 5.55          |       | $                     | 27,662     |   | 3.50 |   |
|                                             |       |       |       |                |       |         |       |          |       |                  |       |
| ** **                                       | ** ** | ** ** | ** ** | **Weighted**        | ** ** | ** **   | ** ** | ** **    | ** ** | ** **            | ** ** |
| ** **                                       | ** ** | **Number** | ** ** | **Average**         | ** ** | ** **   | ** ** | ** **    | ** ** | ** **            | ** ** |
| ** **                                       | ** ** | **of**     | ** ** | **Grant Date** | ** ** | ** **   | ** ** | ** **    | ** ** | ** **            | ** ** |
| ** **                                       | ** ** | **SARs**   | ** ** | **Fair Value** | ** ** | ** **   | ** ** | ** **    | ** ** | ** **            | ** ** |
| Non-vested shares, January 1, 2008          |       | 76,913     |       | $                   | 5.60       |         |       |          |       |                  |       |   |
| Granted                                          |       | 5,002      |       | 3.59                |       |         |       |          |       |                  |       |
| Vested                                           |       | (24,212    | )          | 5.55                |       |         |       |          |       |                  |       |
| Forfeited                                        |       | (10,376    | )          | 5.55                |       |         |       |          |       |                  |       |
| Non-vested shares, September 30, 2008       |       | 47,327     |       | $                   | 5.40       |         |       |          |       |                  |       |   |

 

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

** **
| ** **                                                          | ** ** | **39 weeks ended** | ** ** |
|---------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                          | ** ** | **October 2,**          | ** ** | **September 30,** | ** ** |
| ** **                                                          | ** ** | **2007**                     | ** ** | **2008** | ** ** |
| ** **                                                          | ** ** | **(in thousands)**      | ** ** |
| Cash paid during the year to date period  ended:                    |       |                         |       |   |   |
| Interest related to:                                                |       |                         |       |   |   |
| Term Loans                                                          |       | $                            | 9,401      |   | $ | 4,242 |   |
| $25 Million Subordinated Note                                       |       | 825                          |       | — |   |
| Other                                                               |       | 231                          |       | 211 |   |
|                                                                |       |                         |       |   |   |
| Prepayment penalty upon redemption of debt                          |       | $                            | 240        |   | $ | — |   |
|                                                                |       |                         |       |   |   |
| Income taxes                                                        |       | $                            | 274        |   | $ | 665 |   |
|                                                                |       |                         |       |   |   |
| Non-cash investing activities:                                      |       |                         |       |   |   |
| Non-cash purchase of equipment through  capital leasing             |       | $                            | —     |   | $ | 33 |   |
| Non-cash addition of leasehold improvements  provided by lessor     |       | $                            | 1,672      |   | $ | — |   |
| Change in accrued expenses for purchases of  property and equipment |       | $                            | (2,170     | ) | $ | (873 | ) |

 

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

 

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

 
| ** **        | ** ** | **January 1,**                          | ** ** | **September 30,** | ** ** |
|-------------------|------------|----------------------------------------------|------------|------------------------|------------|
| ** **        | ** ** | **2008**                                     | ** ** | **2008**               | ** ** |
| ** **        | ** ** | **(in thousands of dollars)** | ** ** |
| Finished goods    |       | $                                            | 4,056      |                   | $          | 3,859 |   |
| Raw materials     |       | 1,257                                        |       | 1,174                  |       |
| Total inventories |       | $                                            | 5,313      |                   | $          | 5,033 |   |

 

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

 

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

 
| ** **                                                  | ** ** | **January 1,**                          | ** ** | **September 30,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------|------------|
| ** **                                                  | ** ** | **2008**                                     | ** ** | **2008**               | ** ** |
| ** **                                                  | ** ** | **(in thousands of dollars)** | ** ** |
| $90 Million First Lien Term Loan                            |       | $                                            | 89,550     |                   | $          | 87,875 |   |
| New Jersey Economic Development Authority  Note Payable     |       | 280                                          |       | 280                    |       |
| Total senior notes and other debt                           |       | $                                            | 89,830     |                   | $          | 88,155 |   |
| Less short-term debt and current portion of  long-term debt |       | 955                                          |       | 9,180                  |       |
| Senior notes and other long-term debt                       |       | $                                            | 88,875     |                   | $          | 78,975 |   |

 

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*First Lien Term Loan and Revolving Facility*

 

Our debt is composed of amodified term loan with a principal amount of $90 million and a $20 millionrevolving credit facility. We may prepay amounts outstanding under the seniorsecured credit facility and may terminate commitments in whole at any timewithout penalty or premium upon prior written notice.  Borrowings under this senior secured creditfacility bear interest at a rate equal to an applicable margin plus, at ouroption, either a variable base rate or a Eurodollar rate. As of September 30,2008, the weighted average interest rate under the $90 million First Lien TermLoan (“First Lien Term Loan”) was 5.48%. The revolving facility and the FirstLien Term Loan contain usual and customary covenants including consolidated leverageratios, fixed charge coverage ratios, limitations on capital expenditures, etc.As of January 1, 2008 and September 30, 2008 we were in compliancewith all our financial and operating covenants.

 

In addition to our quarterly payments of$225,000 due on our First Lien Term Loan and the $280,000 final installment ofthe New Jersey Economic Development Authority Note Payable, we are alsorequired to make excess cash flow payments on our First Lien Term Loan asdefined in our debt agreement.  We estimatethat approximately $8.0 million will be due and payable in the first quarter of2009.

 

The revolving creditfacility remains available, subject to certain conditions, to finance ourongoing working capital, capital expenditure and general corporate needs.  In addition, all of the revolving creditfacility is available for letters of credit. As of September 30, 2008, wehad $7.0 million in letters of credit outstanding under this facility. Theletters of credit expire on various dates during 2008 and 2009, 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 $13.0 million at September 30, 2008.

 

For the revolving facility,the capitalized debt issuance costs are being amortized on a straight-linebasis while the capitalized debt issuance costs for the First Lien Term Loanare being amortized on the effective interest rate method. As of September 30,2008, approximately $1.8 million and $0.4 million in debt issuance costs havebeen capitalized for the revolving facility and the First Lien Term Loan,respectively, net of amortization.

 

**7.****             ****Interest Rate Swapand****Other Comprehensive Income**

 

On May 7, 2008, we entered into an interest rate swap agreementrelating to our First Lien Term Loan for the next two years, effective startingin August 2008.  The Company is required to make payments basedon a fixed interest rate of 3.52% calculated on an initial notional amount of$60 million. In exchange the Company will receive interest on a $60 million ofnotional amount at a variable rate. The variable rate interest the Company willreceive is based on the 1-month London InterBank Offered Rate (“LIBOR”).  The net effect of the swap is to fix theinterest rate on $60 million of our First Lien Term Loan at 3.52% plus anapplicable margin. As of September 30, 2008 the weighted average interest rateunder the First Lien Term Loan including this swap was 5.35%.

 

The Company’s interest rate swap agreement qualifies as a cash flow hedge, as defined by SFAS133, *Accounting for Derivative Instruments and HedgingActivities*.  The fair value of the interest rate swap agreement, which will be adjustedregularly, will be recorded in the Company’s balance sheet as an asset orliability, as necessary, with a corresponding adjustment to accumulated othercomprehensive loss within equity.

 

There was no impact for adoption of SFAS 157 to the consolidatedfinancial statements as of September 30, 2008.  SFAS 157requires fair value measurement to be classified and disclosed in one of thefollowing three categories:

 

·                  Level 1:Unadjusted quoted prices in active markets that are accessible at themeasurement date for identical, unrestricted assets or liabilities.

 

·                  Level 2:Quoted prices in markets that are not active or inputs which are observable,either directly or indirectly, for substantially the full term of the asset orliability.

 

·                  Level 3:Prices or valuation techniques that require inputs that are both significant tothe fair value measurement and unobservable (i.e., supported by little orno market activity).

 

The interest rate swap discussed above falls into the Level 2category under the guidance of SFAS 157. The fair market value of theinterest rate swap as of September 30, 2008 was a liability of $289,000,which is recorded in other liabilities on the Company’s consolidated balancesheet.  As of September 30, 2008, the unrealized loss associated withthis cash flow hedging instrument is recorded in accumulated othercomprehensive loss within stockholders’ deficit.

 

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Comprehensive income consisted of the following:

 
| ** **                         | ** ** | **39 weeks ended**     | ** ** |
|------------------------------------|------------|----------------------------------|------------|
| ** **                         | ** ** | **September 30, 2008** | ** ** |
| ** **                         | ** ** | **(in thousands)**          | ** ** |
| Net income                         |       | $                                | 15,293     |   |
| Unrealized loss on cash flow hedge |       | (289                             | )          |
| Total comprehensive income         |       | $                                | 15,004     |   |

 

The Company will reclassify any gain or loss from accumulated othercomprehensive loss, net of tax, on the Company’s condensed consolidated balancesheet to other expense/income on the Company’s consolidated statements ofoperations when the interest rate swap expires or at the time the Companychooses to terminate the swap.

 

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

 

In accordance with SFAS No. 128, *Earnings perShare*, we compute basic net income per common share by dividing thenet income for the period by the weighted average number of shares of commonstock outstanding during the period. Diluted net income per share is computedby dividing the net income for the period by the weighted average number of sharesof common 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 per share when their effect is anti-dilutive.

 

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

 
| ** **                                       | ** ** | **13 weeks ended**                                                                                             | ** ** | **39 weeks ended** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                       | ** ** | **October 2,**                                                                                                      | ** ** | **September 30,**       | ** ** | **October 2,** | ** ** | **September 30,** | ** ** |
| ** **                                       | ** ** | **2007**                                                                                                                 | ** ** | **2008**                     | ** ** | **2007** | ** ** | **2008** | ** ** |
| ** **                                       | ** ** | **(in thousands, except earnings per share and related share information)** | ** ** |
| Net income (a)                                   |       | $                                                                                                                        | 4,943      |                         | $          | 4,537 |   | $ | 5,825 |   | $ | 15,293 |   |
|                                             |       |                                                                                                                     |       |                         |       |   |   |   |   |
| Basic weighted average shares outstanding  (b)   |       | 15,772,931                                                                                                               |       | 15,948,180                   |       | 12,718,051 |   | 15,921,645 |   |
| Dilutive effect of stock options and SARs        |       | 799,555                                                                                                                  |       | 464,568                      |       | 718,833 |   | 503,590 |   |
| Diluted weighted average shares outstanding  (c) |       | 16,572,486                                                                                                               |       | 16,412,748                   |       | 13,436,884 |   | 16,425,235 |   |
| Basic earnings per share (a)/(b)                 |       | $                                                                                                                        | 0.31       |                         | $          | 0.28 |   | $ | 0.46 |   | $ | 0.96 |   |
| Diluted earnings per share (a)/(c)               |       | $                                                                                                                        | 0.30       |                         | $          | 0.28 |   | $ | 0.43 |   | $ | 0.93 |   |
|                                             |       |                                                                                                                     |       |                         |       |   |   |   |   |
| Antidilutive stock options, SARs and  warrants   |       | 213,064                                                                                                                  |       | 406,689                      |       | 261,914 |   | 406,689 |   |

 

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

 

Utilization of our fully reserved net operating loss (“NOL”)carryforwards reduced our federal and state income tax liability incurred in2008. We have recorded a provision for income taxes related to our estimate ofincome taxes due on taxable earnings for the thirteen weeks ended October 2,2007 and September 30, 2008 of $111,000 and $210,000, respectively, andfor the thirty-nine weeks ended October 2, 2007 and September 30,2008 of $158,000 and $650,000, respectively.

 

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As of September 30, 2008, NOL carryforwards of $140.4 million wereavailable to be utilized against future taxable income for years through fiscal2026, subject in part to annual limitations. As a result of prior ownershipchanges, approximately $93.8 million of our NOL carryforwards are subject to anannual usage limitation of $4.7 million. Our ability to utilize our NOL carryforwards, including those that arenot currently subject to limitation, could be limited or further limited in theevent that we undergo an “ownership change” as that term is defined forpurposes of Section 382 of the Internal Revenue Code.  We are in the process of filing a requestwith the Internal Revenue Service to review our methodology for determiningownership changes in accordance with Internal Revenue Code Section 382.Upon acceptance of our request, we believe that our NOL carryforwards will beavailable for utilization. In the event that our request is not accepted,approximately $17.9 million of NOL carryforwards will be at risk to expireprior to utilization.

 

Our NOL carryforwards are included in our deferred income tax assetsand have been fully reserved. Additionally, we maintain a full valuation allowance against our totalnet deferred tax assets.  In accordancewith SFAS No. 109, *Accounting forIncome Taxes*, (“SFAS No. 109”) we assess the continuing needfor a valuation allowance that results from uncertainty regarding our abilityto realize the benefits of our deferred tax assets.

 

If we conclude that our prospects for the realization of our deferredtax assets are more likely than not, we will then reduce our valuationallowance as appropriate and credit income tax expense after considering thefollowing factors:

 

·                  The level ofhistorical taxable income and projections for future taxable income overperiods in which the deferred tax assets would be deductible, and

 

·                  Accumulation of income(loss) before taxes utilizing a look-back period of three years.

 

We will continue to reviewvarious qualitative and quantitative data in regards to the realization of ourdeferred tax assets, including:

 

·                  Events within the restaurantindustry,

·                  The cyclical nature of ourbusiness,

·                  The health of the economy,

·                  Our future forecasts of taxableincome and

·                  Historical trending.

 

We are subject to income taxes in the U.S. federal jurisdiction, andvarious states and local jurisdictions. Tax regulations within eachjurisdiction are subject to the interpretation of the related tax laws andregulations and require significant judgment to apply. We remain subject toexamination by U.S. federal, state and local tax authorities for tax years 2005through 2008. With a few exceptions, we are no longer subject to U.S. federal,state or local examinations by tax authorities for the tax year 2004 and prior.

 

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

 

*Letters of Credit and Line of Credit*

 

As of September 30,2008, we had $7.3 million in letters of credit outstanding. The letters ofcredit expire on various dates in the fourth quarter of 2008 through 2010, areautomatically renewable for one additional year and are payable upon demand inthe event that we fail to pay the underlying obligation. $7.0 million  of the total letters of credit outstandingreduce our availability under the revolving facility.

 

*Litigation*

 

We are subject to claims and legal actions in the ordinary course ofour business, including claims by or against our franchisees, licensees andemployees or former employees and/or contract disputes. We do not believe anycurrently pending or threatened matter, other than as described below, wouldhave a material adverse effect on our business, results of operations orfinancial condition.

 

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On September 18, 2007, Eric Mathistad, a former store manager,filed a putative class action against Einstein Noah Restaurant Group, Inc.(the “Company”) in the Superior Court of California for the State ofCalifornia, County of San Diego.  The plaintiff alleged that we failed topay overtime wages to “salaried restaurant employees” of our Californiastores who were misclassified as exempt employees, and that these employeeswere deprived of mandated meal periods and rest breaks.  On November 14,2007, Bernadette Mejia, another former store manager, filed a similar case andthese cases were subsequently consolidated.  On August 27, 2008, wereached an agreement in principle for the settlement of this litigation withthe plaintiffs.

 

On February 8, 2008, Gloria Weber and Hakan Mikado,non-exempt employees, filed a putative class action against the Company inthe Superior Court of California for the State of California, County of SanDiego.  The plaintiff alleged that we failed to pay minimum wages,failed to pay overtime and failed to provide rest periods and meal breaks,among other charges.  On August 27, 2008, we reached an agreement inprinciple for the settlement of this litigation with the plaintiffs.

 

These settlements provide for payment of up to an aggregate of $2.5million by the Company.  Each settlement is subject to completion of asettlement agreement to be signed by the parties, preliminary and final courtapprovals and the participation of a sufficient percentage of each of theputative classes.  There can be no assurance that these conditions will besatisfied.

 

The Company recorded a liability in accrued expenses and a one-timecharge in operating expenses during the third quarter of 2008 pursuant to SFAS No. 5,*Accounting for Contingencies,*inthe amount of $1.9 million to satisfy these settlements. This one-time chargerepresents the Company’s current estimate of the aggregate amount that isprobable to be paid pursuant to these settlements, but there can be noassurance that amounts actually paid will not be more or less than the amountrecorded by the Company.

 

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

### * *

### ***Cautionary Note Regarding Forward-LookingStatements***

### * *

*We wish to caution our readers that the following important factors,among others, could cause the actual results to differ materially from thoseindicated by forward-looking statements made in this report and from time totime in news releases, reports, proxy statements, registration statements andother written communications, as well as verbal forward-looking statements madefrom time to time by representatives of the company. Such forward-lookingstatements involve risks and uncertainties that may cause our actual results,performance or achievements to be materially different from any futureperformance or achievements expressed or implied by these forward-lookingstatements. Factors that might cause actual events or results to differmaterially from those indicated by these forward-looking statements may includematters such as future economic performance, restaurant openings or closings,operating margins, the availability of acceptable real estate locations, thesufficiency of our cash balances and cash generated from operating andfinancing activities for our future liquidity and capital resource needs, andother matters, and are generally accompanied by words such as: “believes”, “anticipates”,“plans”, “intends”, “estimates”, “predicts”, “targets”, “expects”, “contemplates”and similar expressions that convey the uncertainty of future events oroutcomes. An expanded discussion of some of these risk factors follows.  These risks and uncertainties include, but are not limited to, the riskfactors described in our annual report on Form 10-K for the year ended January 1,2008 as updated in subsequent quarterly reports on Form 10-Q, includingItem 1A of Part II of this report*

 

**General**

 

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

 

**Company Overview**

 

We are a leading fast-casual restaurant chain, specializing inhigh-quality foods for breakfast and lunch in a café atmosphere with aneighborhood emphasis.  As of September 30,2008, we owned and operated, franchised or licensed 632 restaurants in 36states and in the District of Columbia, primarily under the Einstein Bros.,Noah’s and Manhattan Bagel brands. Einstein Bros. is a national fast-casual restaurant chain.  Noah’s is a regional fast-casual restaurantchain operated exclusively on the West Coast and Manhattan Bagel is a regionalfast-casual restaurant chain operated predominantly in the Northeast.  Our product offerings include fresh bagelsand other goods baked on-site, made-to-order sandwiches on a variety of bagelsand breads, gourmet soups and salads, decadent desserts, premium coffees andother café beverages.  Our manufacturingand commissary operations prepare and assemble consistent, high-qualityingredients and we deliver them to our restaurants quickly and efficientlythrough our network of independent distributors.  Our manufacturing and commissary operationssupport our main business focus, restaurant operations, by exposing our brandsto new product channels as well as enabling sales of our products to thirdparties.

 

**Executive Summary**

 

The most important themes or significant matters with which managementwas primarily focused on during the quarter are as follows:

 
| ·      Economy – Our  results depend on consumer spending, which is influenced by consumer  confidence, disposable income and general economic conditions. In particular,  the effects of higher energy, food costs, increases in the rate of  foreclosures, |   | See page 28 |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------|

 

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| market uncertainty, and a reduction in the availability of credit,  among other things, may impact discretionary consumer spending in  restaurants. Accordingly, we believe we experience declines in comparable  store sales during economic downturns or during periods of economic  uncertainty. Any material decline in the amount of discretionary spending  could have a material adverse effect on our sales and income.                                                                                                                                                                                                                              |   |                      |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   |                      |
| ·      Commodities – Through our relationship  with a subsidiary of Cargill, Incorporated, we have secured our wheat  requirements as well as established the price for wheat for virtually all of  our needs for the remainder of 2008 and for approximately 77% of our 2009  needs as of October 31, 2008. To offset the impact of higher wheat  prices, we implemented a price increase in early 2008 at our Einstein Bros.  restaurants and in June 2008 at our Noah’s restaurants.                                                                                                                    |   | See page 18          |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   |                      |
| ·      Debt – Our Mandatorily Redeemable  Series Z Preferred Stock has a mandatory redemption on June 30,  2009. As part of the company’s amendment to the First Lien Term Loan, we  obtained a commitment for an incremental term loan in an aggregate principal  amount of up to $57 million to be used by us, if needed, solely for the  purpose of redeeming the zero coupon Series Z preferred stock. This  commitment is subject to successful syndication. We have begun discussion  with our lead lender as well as other institutions that are currently  participating in this credit. |   | See page 23          |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   |                      |
| ·      Interest expense – The Company entered  into an interest rate swap on May 7, 2008 with an effective date of  August 28, 2008. The net effect of the swap is to fix the interest rate  on $60 million of our First Lien Term Loan at 3.52% plus an applicable margin.  The fair value of the swap as of September 30, 2008 was a liability of  $289,000, which was recorded as an unrealized loss in other liabilities and  accumulated other comprehensive loss in stockholders’ deficit.                                                                                                      |   | See pages 10  and 22 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   |                      |
| ·      Taxes – Our NOL carryforwards are  included in our deferred income tax assets and have been fully reserved. We  continue to review various qualitative and quantitative data in regards to  the realization of our deferred tax assets.                                                                                                                                                                                                                                                                                                                                                                            |   | See pages 11  and 22 |

 

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**Current Restaurant Base**

 

As of September 30, 2008, we owned and operated, franchised orlicensed 632 restaurants. Our current base of company-owned restaurants underour core brands includes 339 Einstein Bros. restaurants, 77 Noah’s restaurantsand one Manhattan Bagel restaurant. Also, we franchise two Einstein Bros.restaurants and 69 Manhattan Bagel restaurants, and license 140 Einstein Bros.restaurants and three Noah’s restaurants. In addition, we have one restaurantwhich we operate under New World Coffee, our non-core brand.

 
| ** **              | ** ** | **13 weeks ended October 2, 2007** | ** ** | **13 weeks ended September 30, 2008** | ** ** |
|-------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **              | ** ** | **Company**                                                 | ** ** | ** **                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | **Company** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **Owned**                                                   | ** ** | **Franchised**                                                 | ** ** | **Licensed** | ** ** | **Total** | ** ** | **Owned** | ** ** | **Franchised** | ** ** | **Licensed** | ** ** | **Total** | ** ** |
| **Consolidated Total**  |       |                                                        |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total beginning balance |       | 411                                                         |       | 80                                                             |       | 106 |   | 597 |   | 418 |   | 70 |   | 135 |   | 623 |   |
| Opened restaurants      |       | 3                                                           |       | 1                                                              |       | 7 |   | 11 |   | 3 |   | 1 |   | 10 |   | 14 |   |
| Closed restaurants      |       | (2                                                          | )          | (6                                                             | )          | (2 | ) | (10 | ) | (3 | ) | — |   | (2 | ) | (5 | ) |
| Total ending balance    |       | 412                                                         |       | 75                                                             |       | 111 |   | 598 |   | 418 |   | 71 |   | 143 |   | 632 |   |
|                    |       |                                                        |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **              | ** ** | **39 weeks ended October 2, 2007** | ** ** | **39 weeks ended September 30, 2008** | ** ** |
| ** **              | ** ** | **Company**                                                 | ** ** | ** **                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | **Company** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **Owned**                                                   | ** ** | **Franchised**                                                 | ** ** | **Licensed** | ** ** | **Total** | ** ** | **Owned** | ** ** | **Franchised** | ** ** | **Licensed** | ** ** | **Total** | ** ** |
| **Consolidated Total**  |       |                                                        |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total beginning balance |       | 416                                                         |       | 86                                                             |       | 96 |   | 598 |   | 416 |   | 72 |   | 124 |   | 612 |   |
| Opened restaurants      |       | 5                                                           |       | 1                                                              |       | 17 |   | 23 |   | 9 |   | 2 |   | 22 |   | 33 |   |
| Closed restaurants      |       | (9                                                          | )          | (12                                                            | )          | (2 | ) | (23 | ) | (7 | ) | (3 | ) | (3 | ) | (13 | ) |
| Total ending balance    |       | 412                                                         |       | 75                                                             |       | 111 |   | 598 |   | 418 |   | 71 |   | 143 |   | 632 |   |

 

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

 
| ** **                             | ** ** | **Trailing 12 Months Activity** | ** ** |
|----------------------------------------|------------|------------------------------------------------|------------|
| ** **                             | ** ** | **Company**                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Owned**                                      | ** ** | **Franchised** | ** ** | **Licensed** | ** ** | **Total** | ** ** |
| **Consolidated Total**                 |       |                                           |       |   |   |   |   |   |   |
| Beginning balance October 2, 2007 |       | 412                                            |       | 75 |   | 111 |   | 598 |   |
| Opened restaurants                     |       | 17                                             |       | 4 |   | 36 |   | 57 |   |
| Closed restaurants                     |       | (11                                            | )          | (8 | ) | (4 | ) | (23 | ) |
| Ending balance September 30, 2008 |       | 418                                            |       | 71 |   | 143 |   | 632 |   |

 

**New Restaurant Openings**

 

In2008, we plan to open at least 17 new company-owned restaurants.  Through the thirty-nine weeks ended September 30,2008 we opened nine company-owned restaurants.

 

Wehave opened two franchise restaurants in 2008 and we will have three locationswhich are expected to be in various stages of development during the fourthquarter of 2008 with openings scheduled for the first half of 2009.

 

Throughthe thirty-nine weeks ended September 30, 2008 we opened 22 Einstein Bros.license restaurants.  We plan to open anadditional 10 to 13 license restaurants in the fourth quarter of 2008.  The license restaurants are located primarilyin airports, colleges and universities, office buildings, hospitals and militarybases and on turnpikes.

 

**Results ofOperations**

 

**We have a 52/53-week fiscal year ending on the Tuesday closest to December 31.The third quarters in fiscal years 2007 and 2008 ended on October 2, 2007and September 30, 2008, respectively, and each contained thirteen weeks,and the year to date periods each contained thirty-nine weeks.**

 

**16**

----

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***Consolidated Results***

 
| ** **                 | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|----------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                 | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                 | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                 | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                 | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| Revenue                    |       | 100,378                              |       | 100,895                      |       | 0.5 | % | 297,688 |   | 309,573 |   | 4.0 | % |
| Cost of sales              |       | 80,857                               |       | 81,712                       |       | 1.1 | % | 238,248 |   | 249,269 |   | 4.6 | % |
| Total gross profit         |       | 19,521                               |       | 19,183                       |       | (1.7 | )% | 59,440 |   | 60,304 |   | 1.5 | % |
| Operating expenses         |       | 12,715                               |       | 13,186                       |       | 3.7 | % | 39,933 |   | 40,204 |   | 0.7 | % |
| Income from operations     |       | 6,806                                |       | 5,997                        |       | (11.9 | )% | 19,507 |   | 20,100 |   | 3.0 | % |
| Other expenses             |       | 1,752                                |       | 1,250                        |       | (28.7 | )% | 13,524 |   | 4,157 |   | (69.3 | )% |
| Income before income taxes |       | 5,054                                |       | 4,747                        |       | (6.1 | )% | 5,983 |   | 15,943 |   | 166.5 | % |
| Income taxes               |       | 111                                  |       | 210                          |       | 89.2 | % | 158 |   | 650 |   | 311.4 | % |
| Net income                 |       | $                                    | 4,943      |                         | $          | 4,537 |   | (8.2 | )% | $ | 5,825 |   | $ | 15,293 |   | 162.5 | % |
|                            |            |                                      |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

** **

**For the thirteen weeks ended September 30, 2008 compared to thesame period in 2007, total revenue increased $0.5 million, gross profitdecreased $0.3 million, income from operations decreased $0.8 million and ourincome before income taxes decreased $0.3 million. This overall decrease was aresult of lower consumer spending coupled with higher wheat costs in 2008 ascompared to 2007. While the Company has 34 more locations than a year ago andimplemented price increases, the number of products sold has declined.  While the Company experienced a $2.1 milliondecrease in our general and administrative expenses related to decreasedstock-based compensation expense and other cost savings, we had an increase indepreciation expense from the new restaurants that have been opened andupgrades that have been completed, as well as the $1.9 million related to thesettlement of two class-action lawsuits in California.**

** **

For the thirty-nine weeks ended September 30, 2008 compared to thesame period in 2007, total revenue increased $11.9 million, gross profitincreased $0.9 million, income from operations improved $0.6 million, and ourincome before income taxes increased $10.0 million. This growth is primarilydue to having six additional company-owned restaurants and 28 additionalfranchise and license locations from a year ago, which increased our sales andcost of sales.  Additionally, revenueshave increased as a result of higher comparable store sales, partially offsetby increased cost of sales which was primarily driven by rising commodity costsand labor costs for both the company-owned restaurants and our manufacturingand commissary operations.  Adding tothis was a decrease in our general and administrative expenses related todecreased stock-based compensation expense and other cost savings, decreasedinterest expense related to the debt redemption in 2007, off-set by an increasein depreciation expense from the new restaurants that have been opened andupgrades that have been completed, as well as the $1.9 million related to thesettlement of two class-action lawsuits in California.

 

***Company-Owned Restaurant Operations***

 

***Revenues***

 
| ** **                            | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                            | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                            | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                            | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| Company-owned restaurant sales        |       | $                                    | 93,026     |                         | $          | 92,400 |   | (0.7 | )% | $ | 276,283 |   | $ | 282,331 |   | 2.2 | % |
| Percent of total revenue              |       | 92.7                                 | %          | 91.6                         | %          |   |   | 92.8 | % | 91.2 | % |   |   |
| Company-owned restaurant gross margin |       | 19.9                                 | %          | 18.6                         | %          | (6.5 | )% | 20.0 | % | 19.4 | % | (3.0 | )% |
| Number of company-owned restaurants   |       | 412                                  |       | 418                          |       |   |   | 412 |   | 418 |   |   |   |
|                                       |            |                                      |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Company-owned restaurant sales for the thirteen and thirty-nine weeksended September 30, 2008 decreased $0.6 million and increased $6.0million, respectively, when compared to the same periods in 2007.  These results were**

 

**17**

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**Tableof Contents**

 

**primarily due to a decline in volume, offset by the aforementionedprice increases coupled with a net increase in restaurants opened over the lasttwelve months.  On average, therestaurants opened since October 2, 2007 are higher volume restaurantsrelative to those that were closed over the same period, which positivelycontributed to our sales.**

** **

**For the thirteen weeks ended September 30, 2008, our comparablestore sales showed a decrease of 1.7 % over the same periods in 2007.  This decline was due to a 10.7 % decrease inthe number of units sold, which we believe was mostly due to both the economicclimate and its negative impact on consumer discretionary spending and from adecrease in our hours of operation.  Thiswas partially offset by system-wide price increases of 5.8 % since October 2,2007 and a 4.3 % shift in product mix to higher priced items.**

** **

**For the thirty-nine weeks ended September 30, 2008, our comparablestore sales increased 1.0 % over the same periods in 2007.  This increase was primarily due tosystem-wide price increases of 6.1 % since October 2, 2007 and a 5.4 %shift in product mix to higher priced items, partially offset by a 9.5 %decrease in the number of units sold which we believe was mostly due to theeconomic climate and its negative impact on consumer discretionary spending andfrom a decrease in our hours of operation.**

** **

*Cost of Sales*

 

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

 

*Cost of Goods Sold*

 
| ** **                            | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                            | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                            | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                            | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| Cost of goods sold                    |       | $                                    | 27,504     |                         | $          | 27,602 |   | 0.4 | % | $ | 81,653 |   | $ | 84,520 |   | 3.5 | % |
| As a percentage of restaurant revenue |       | 29.6                                 | %          | 29.9                         | %          |   |   | 29.6 | % | 29.9 | % |   |   |
|                                       |            |                                      |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Food,beverage and packaging costs are three elements that make up cost of goods soldand constitute a large portion of the cost of sales at our company-ownedrestaurants.  Cost of goods soldincreased predominantly due to an increase in commodity costs, an increase indistribution costs that were driven by higher fuel costs, and increased costsassociated with a net opening of six stores over the last twelve months,partially offset by a reduction in the volume of products sold.

 

Comparedto 2007, most of our commodity-based food costs increased in 2008.  Flour represents the most significant rawingredient we purchase. The market cost of wheat and in turn the cost toproduce flour had increased substantially in the last half of 2007 butstabilized by the end of the second quarter of 2008 and are expected to stay atthese levels through the remainder of 2008. To mitigate the risk of increasingmarket prices, we have utilized a subsidiary of Cargill, Incorporated to manageour wheat purchases for our company-owned production facility.  We will continue to work with Cargill,Incorporated to strategically source our key ingredient.  However, there can be no assurance that wewill benefit from a decline in the cost of any of the commodity-based productsthat we purchase.

 

*Labor Expenses*

* *
| ** **                            | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                            | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                            | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                            | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| Labor costs                           |       | $                                    | 27,490     |                         | $          | 27,313 |   | (0.6 | )% | $ | 82,663 |   | $ | 84,464 |   | 2.2 | % |
| As a percentage of restaurant revenue |       | 29.6                                 | %          | 29.6                         | %          |   |   | 29.9 | % | 29.9 | % |   |   |
|                                       |            |                                      |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

18

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Laborexpenses, which includes our general managers and restaurant-level labor costs,including taxes and associated employee benefits decreased $0.2 million for thethirteen weeks ended September 30, 2008****comparedto the same period in 2007,primarily related to a decrease in incentive compensation partially off-set byan increase in base pay.

 

Forthe thirty-nine weeks ended September 30, 2008****comparedto the same period in 2007, laborcosts increased from a combination of the growth of new restaurant openingsthat occurred throughout 2007 and the first thirty-nine weeks of 2008, and anincrease in base pay year-over-year from a combination of merit and an overallinflationary shift in our compensation structure caused by a January 2008increase in minimum wage rates at the federal level and in several statesin which we operate, partiallyoffset by a decrease in incentive compensation and insurance costs.

 

*Other Operating Costs*

* *
| ** **                            | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                            | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                            | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                            | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| Other operating costs                 |       | $                                    | 9,556      |                         | $          | 9,934 |   | 4.0 | % | $ | 27,055 |   | $ | 28,111 |   | 3.9 | % |
| As a percentage of restaurant revenue |       | 10.3                                 | %          | 10.8                         | %          |   |   | 9.8 | % | 10.0 | % |   |   |
|                                       |            |                                      |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

* *

Otheroperating costs consist of other restaurant-level occupancy expenses such asutilities, repairs and maintenance costs, credit card fees and supplies. For the thirteen and thirty-nine weeks ended September 30, 2008, other operating costs increased $0.4 millionand $1.1 million, respectively, compared to the same periods in 2007.  Theseincreases were primarily attributable to an increase in utilities due primarilyto escalating energy costs and an increase in credit card fees due to a shiftin consumer payment practices from using cash to using credit cards.

 

*Rent and related, and marketing costs*

 
| ** **                            | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                            | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                            | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                            | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| Rent and related, and marketing costs |       | $                                    | 9,977      |                         | $          | 10,340 |   | 3.6 | % | $ | 29,745 |   | $ | 30,567 |   | 2.8 | % |
| As a percentage of restaurant revenue |       | 10.7                                 | %          | 11.2                         | %          |   |   | 10.8 | % | 10.8 | % |   |   |
|                                       |            |                                      |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Rentand related, and marketing costs consist of restaurant-level rent expense,common area maintenance expense, property taxes and marketing expense.  For the thirteen and thirty-nine weeksended September 30, 2008, rentand related and marketing costs increased $0.4 million and $0.8 million,respectively, compared to the same periods in 2007.  The increase is principallyattributable to an increase in rent and related expense, partially offset by adecrease in marketing expense.

 

***Manufacturing and Commissary Operations***

 

*Revenues*

 
| ** **                                | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|-------------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                                | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                                | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                                | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                                | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| Manufacturing and commissary revenues     |       | $                                    | 5,910      |                         | $          | 6,991 |   | 18.3 | % | $ | 17,409 |   | $ | 22,719 |   | 30.5 | % |
| Percent of total revenue                  |       | 5.9                                  | %          | 6.9                          | %          |   |   | 5.8 | % | 7.3 | % |   |   |
| Manufacturing and commissary gross margin |       | (7.1                                 | )%         | 6.7                          | %          |   | ** | 1.6 | % | 4.9 | % | 206.3 | % |
|                                           |            |                                      |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

**not meaningful

 

19

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Manufacturingand commissary revenues for the thirteen and thirty-nine weeks ended September 30,2008 increased $1.1****million and$5.3 million, respectively, compared to the same periods in 2007.  This increase was attributed to priceincreases and our expanded role within the distribution chain for sales to ourfranchise and license locations.  For thethirteen weeks ended September 30, 2008 we have seen a slight increase inthe volume of units sold to our more significant customers; for the thirty-nineweeks ended September 30, 2008, we have seen a moderate rise in volume ofunits sold to our more significant customers compared to the same periods in2007.

 

*Cost of Sales*

 

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

 
| ** **                                               | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                                               | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                                               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                                               | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                                               | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| Manufacturing and commissary costs                       |       | $                                    | 6,330      |                         | $          | 6,523 |   | 3.0 | % | $ | 17,132 |   | $ | 21,607 |   | 26.1 | % |
| As a percentage of manufacturing and  commissary revenue |       | 107.1                                | %          | 93.3                         | %          |   |   | 98.4 | % | 95.1 | % |   |   |
|                                                          |            |                                      |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Manufacturing cost of salesare composed of cost of goods sold, labor costs and other operating costs.  For the thirteen and thirty-nine weeksended September 30, 2008, manufacturingcost of sales increased $0.2 million and $4.5 million, respectively,compared to the same periods in 2007.  The component change within manufacturing costof sales is as follows:

 

·                  Manufacturing costs of goods sold areincreased predominantly due to an increase in commodity costs and, to a lesserextent, a rise in volume of units sold.

·                  Labor expenses decreased for thethirteen weeks ended September 30, 2008 compared to the same period in2007.  This was due to a decrease inincentive compensation and a decrease in personnel that occurred late in thesecond quarter of 2008, partially off-set by an increase in merit payyear-over-year coupled with increased minimum wage rates at the federal leveland in some states in which we operate, and to a lesser extent an increase inthe cost of employee benefits.

·                  The change in labor expenses for thethirty-nine weeks ended September 30, 2008 compared to the same period in2007 was negligible.

·                  The changes in other operating costs andexpenses for the thirteen and thirty-nine weeks ended September 30, 2008compared to the same periods in 2007 were negligible.

 

***Franchise and License Operations***

 
| ** **                                  | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                                  | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                                  | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                                  | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| Franchise and license related revenues      |       | $                                    | 1,442      |                         | $          | 1,504 |   | 4.3 | % | $ | 3,996 |   | $ | 4,523 |   | 13.2 | % |
| Percent of total revenue                    |       | 1.4                                  | %          | 1.5                          | %          |   |   | 1.3 | % | 1.5 | % |   |   |
| Franchise and license gross margin          |       | 100.0                                | %          | 100.0                        | %          | 0.0 | % | 100.0 | % | 100.0 | % | 0.0 | % |
| Number of franchise and license restaurants |       | 186                                  |       | 214                          |       |   |   | 186 |   | 214 |   |   |   |
|                                             |            |                                      |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Overall, licensee and franchisee revenue improved predominantly due toimproved comparable sales by franchisees and licensees of the Manhattan Bageland Einstein Bros. brands and a net increase of 32 licensed restaurants,partially offset by a net decrease of four franchised restaurants since October 2,2007.

 

20

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***General and Administrative Expenses***

 
| ** **                                                      | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                                                      | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                                                      | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                                                      | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                                                      | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| General and administrative expenses                             |       | 9,794                                |       | 7,652                        |       | (21.9 | )% | 31,381 |   | 27,935 |   | (11.0 | )% |
| California wage and hour settlements                            |       | —                               |       | 1,900                        |       |   | ** | — |   | 1,900 |   |   | ** |
| Total general and administrative and labor  settlements expense |       | 9,794                                |       | 9,552                        |       |   |   | 31,381 |   | 29,835 |   |   |   |
|                                                            |       |                                 |       |                         |       |   |   |   |   |   |   |   |   |
| As a percentage of revenue                                      |       | 9.8                                  | %          | 9.5                          | %          |   |   | 10.5 | % | 9.6 | % |   |   |

 

----

**not meaningful

 

Our general and administrative expenses decreased $2.1 million and $3.5million for the thirteen and thirty-nine weeks ended September 30, 2008,respectively, compared to the same periods in 2007. The overall decrease waspartially related to a decrease in stock-based compensation expense that wasprimarily due to the additional options that were granted and vested in thesecond quarter of 2007 related to the secondary public offering, which did notoccur again in 2008. Additionally, in 2008 compared to 2007, the Company haddecreases in travel expense, recruiting and referral fees, and relocationexpense related to our corporate headquarters.

 

In addition, for the thirteen weeks ended September 30, 2008compared to the same period in 2007, the Company experienced a decrease incompensation and related benefits as a result of decreased incentivecompensation expense and reduction in administrative positions that occurred inthe third quarter of 2008.

 

The Company recorded a one-time charge in operating expenses during thethird quarter of 2008 pursuant to SFAS No. 5, *Accounting for Contingencies,*in the amount of $1.9 millionto satisfy the two California wage and hour settlements. This one-time chargerepresents the Company’s current estimate of the aggregate amount that isprobable to be paid pursuant to these settlements, but there can be noassurance that amounts actually paid will not be more or less than the amountrecorded by the Company.

 

***Depreciation and Amortization, Disposal andImpairment Charges***

 
| ** **                                                            | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                                                            | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                                                            | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                                                            | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                                                            | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| Depreciation and amortization                                         |       | 2,868                                |       | 3,644                        |       | 27.1 | % | 7,910 |   | 10,193 |   | 28.9 | % |
|                                                                  |       |                                 |       |                         |       |   |   |   |   |   |   |   |   |
| As a percentage of revenue                                            |       | 2.9                                  | %          | 3.6                          | %          |   |   | 2.7 | % | 3.3 | % |   |   |
|                                                                  |       |                                 |       |                         |       |   |   |   |   |   |   |   |   |
| Loss (gain) on sale, disposal or  abandonment of assets, net          |       | 25                                   |       | (10                          | )          |   | ** | 429 |   | 122 |   | (71.6 | )% |
| Impairment charges and other related costs                            |       | 28                                   |       | —                       |       |   | ** | 213 |   | 54 |   | (74.6 | )% |
| Total depreciation and amortization,  disposal and impairment charges |       | 53                                   |       | (10                          | )          |   |   | 642 |   | 176 |   |   |   |
|                                                                  |       |                                 |       |                         |       |   |   |   |   |   |   |   |   |
| As a percentage of revenue                                            |       | 0.1                                  | %          | 0.0                          | %          |   |   | 0.2 | % | 0.1 | % |   |   |

 

----

   ** not meaningful

 

Depreciation and amortization expenses increased $0.8 million and $2.3 millionfor the thirteen and thirty-nine weeks ended September 30, 2008,respectively, when compared to the same periods in 2007. The increase is due tothe additional depreciation expense on our new corporate headquarters that weoccupied in May 2007 and the

 

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additional assets invested in the company-owned restaurants that wereadded or upgraded since the third quarter of 2007.

 

Based on our current purchases of capital assets, our existing base ofassets, and our projections for new purchases of fixed assets, we believedepreciation expense for 2008 will be approximately $14.0 million.

 

***Interest Expense, Net and Other Expenses***

 
| ** **                                                        | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                                                        | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                                                        | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                                                        | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                                                        | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| Interest expense, net                                             |       | 1,752                                |       | 1,250                        |       | (28.7 | )% | 10,685 |   | 4,157 |   | (61.1 | )% |
|                                                              |       |                                 |       |                         |       |   |   |   |   |   |   |   |   |
| As a percentage of revenue                                        |       | 1.7                                  | %          | 1.2                          | %          |   |   | 3.6 | % | 1.3 | % |   |   |
|                                                              |       |                                 |       |                         |       |   |   |   |   |   |   |   |   |
| Other expense:                                                    | ** ** | ** **                           | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Write-off of debt discount upon redemption  of senior notes       |       | —                               |       | —                       |       |   | ** | 528 |   | — |   |   | ** |
| Prepayment penalty upon redemption of  senior notes               |       | —                               |       | —                       |       |   | ** | 240 |   | — |   |   | ** |
| Write-off of debt issuance costs upon redemption  of senior notes |       | —                               |       | —                       |       |   | ** | 2,071 |   | — |   |   | ** |
| Total other expense                                               |       | —                               |       | —                       |       |   |   | 2,839 |   | — |   |   |   |
|                                                              |       |                                 |       |                         |       |   |   |   |   |   |   |   |   |
| As a percentage of revenue                                        |       | 0.0                                  | %          | 0.0                          | %          |   |   | 1.0 | % | 0.0 | % |   |   |

 

----

**not meaningful

 

In June 2007,we amended our debt facility and reduced our debt outstanding to $90 million,substantially decreasing our interest expense. The outstanding senior notes and other long-term debt as of September 30,2008 was $88.2 million compared to $90.3 million as of October 2, 2007.Borrowings under this senior secured credit bear interest at either aEurodollar rate or a variable base rate plus an applicable margin, as definedby our amended and restated credit agreement. We are currently using LIBOR as our base rate but can switch to U.S.prime rate if we choose to do so.

 

As part of thedebt redemption in 2007 we wrote off a discount related to the repayment of the$25 Million Subordinated Notes, paid a redemption premium related to therepayment of the $65 Million Second Lien Term Loan, and wrote off debt issuancecosts.  

 

The Companyentered into an interest rate swap which became effective in August 2008and will expire in two years.  The neteffect of the swap fixed our interest rate on $60.0 million of our First LienTerm Loan at 3.52% plus an applicable margin. While 1-month LIBOR was lowerthan our fixed rate in the first month of the swap, it has increased during thesecond month. On a prospective basis, we cannot estimate the impact of LIBORdue to the uncertainties in the current credit market.

 

***Income Taxes***

 
| ** **                 | ** ** | **13 weeks ended**         | ** ** | **39 weeks ended** | ** ** |
|----------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| ** **                 | ** ** | ** **                           | ** ** | ** **                   | ** ** | **Increase/** | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/** | ** ** |
| ** **                 | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)**               | ** ** | **(dollars in thousands)** | ** ** | **(Decrease)** | ** ** |
| ** **                 | ** ** | **October 2,**                  | ** ** | **September 30,**       | ** ** | **2008** | ** ** | **October 2,** | ** ** | **September 30,** | ** ** | **2008** | ** ** |
| ** **                 | ** ** | **2007**                             | ** ** | **2008**                     | ** ** | **vs. 2007** | ** ** | **2007** | ** ** | **2008** | ** ** | **vs. 2007** | ** ** |
| Provision for income taxes |       | 111                                  |       | 210                          |       | 89.2 | % | 158 |   | 650 |   | 311.4 | % |
|                       |       |                                 |       |                         |       |   |   |   |   |   |   |   |   |
| As a percentage of revenue |       | 0.1                                  | %          | 0.2                          | %          |   |   | 0.1 | % | 0.2 | % |   |   |

 

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For tax purposes, utilization of our fully reserved net operating loss(“NOL”) carryforwards reduced our effective tax rate and our federal and stateincome tax liability incurred for the first thirty-nine weeks of 2008. Althoughwe have substantial NOL carryforwards available to offset federal taxableincome, we are still required to pay income taxes at the state level andrequired to pay alternative minimum tax at the federal level.  For the thirteen and thirty-nine weeks ended September 30, 2008compared to the same periods in 2007, the provision for income taxes increased$99,000 and $492,000, respectively.  Theincrease was primarily driven by the considerable improvement in income beforeincome taxes since the second quarter of 2007 when the Company paid down asubstantial portion of its outstanding debt, thereby reducing interest expense.

 

As of September 30, 2008, our NOL carryforwards for U.S. federalincome tax purposes were $140.4 million, $93.8 million of which are subject toan annual usage limitation of $4.7 million.

 

**Financial Condition, Liquidityand Capital Resources**

 

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

 

The primary driver of our operating cash flow is our restaurantoperations, specifically the gross margin from our company-owned restaurants.Therefore, we focus on the elements of those operations including comparablestore sales and cash flows to ensure a steady stream of operating profits thatenable us to meet our cash obligations.

 

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

 

Our Mandatorily Redeemable Series Z Preferred Stock has beenreclassified to a current liability as the redemption is now within one year.As part of the amended First Lien Term Loan in June 2007, we obtained acommitment for an incremental term loan in an aggregate principal amount of upto $57 million to be used by us, if needed, solely for the purpose ofredeeming the zero coupon Series Z preferred stock due on June 30,2009. Availability of the incremental term loan is subject to customaryborrowing conditions, including absence of any default or material adversechange, and to a requirement of successful syndication of such incremental termloan. It is our intention to continue to focus on generating cash through June 30,2009 to pay down a substantial portion of the Series Z obligation. We havebegun discussions with our lead lender as well as other institutions that arecurrently participating in the credit.

 

*Working Capital Deficit*

 

On September 30, 2008, we had unrestricted cash of $22.2 millionand restricted cash of $0.9 million. Under the Revolving Facility, there wereno outstanding borrowings, $7.0 million in letters of credit outstanding andborrowing availability of $13.0 million. On June 30, 2008 we reclassifiedthe $57 million Mandatorily Redeemable Series Z Preferred Stock as a shortterm liability which resulted in our working capital shifting to a deficit,which was $54.7 million on September 30, 2008 compared to a surplus of$3.7 million on January 1, 2008. Adding to the deficit was a decrease in our non-cash current assets andan increase in current liabilities for the following primary reasons:

 

·                  accountsreceivable has decreased due to improved collection efforts,

·                  other assetsdecreased as we were able to recover several deposits that were held by ourvendors,

·                  accrued expensesincreased primarily due to the two California wage and hour settlements,

·                  short-term debtand the current portion of long-term debt increased by $0.3 million related tothe timing of when the payments are due compared to our fiscal year-end; andincreased $8.0 million that we estimated our excess cash flow payment for theyear will be, as defined by our debt agreement.

 

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These deficit increases were partially offset by the $12.7 millionimprovement in cash and cash equivalents that was primarily due to the improvedcash flow from our company-owned restaurant operations, and to a lesser extentthe reduction in interest expense paid on our debt.

 

*Covenants*

 

We are subject to a number of customary covenants under First Lien TermLoan, including limitations on additional borrowings, acquisitions, andrequirements to maintain certain financial ratios. As of September 30,2008, we were in compliance with all debt covenants.

 

*Capital Expenditures*

 

During the year to date period ended September 30, 2008, we usedapproximately $19.6 million of cash to purchase additional property andequipment that included the following:

 

·                  $5.9 million toopen nine new restaurants in 2008,

·                  $0.9 million inpayments for restaurants that opened in 2007,

·                  $0.7 milliontowards eight restaurants that are currently under construction and arescheduled to open in 2008,

·                  $5.0 million forupgrading existing restaurants in 2008,

·                  $0.1 million forrestaurants that were upgraded in 2007,

·                  $0.6 million ofupgrades that are in process and are scheduled to be completed in 2008,

·                  $4.0 million forreplacement of equipment at our existing company-owned restaurants,

·                  $0.3 million forequipment at our manufacturing operations, and

·                  $2.1 million forgeneral corporate purposes.

 

The majority of our capital expenditures for fiscal 2008 will be forthe addition of 17 new company-owned restaurants during 2008 at an averagecapital investment of approximately $560,000 per restaurant, which variesdepending upon square footage, layout and location. We also upgraded 38 of ourcurrent restaurants during the year to date period ended September 30,2008 and intend to upgrade at least seven more during the remainder of 2008.

 

### ***Off-Balance Sheet Arrangements***

### * *

Exceptfor our line of credit and letters of credit, we do not have any off-balancesheet arrangements.  For the thirteen andthirty-nine weeks ended September 30, 2008, there were no material changesoutside the ordinary course of business to our contractual obligations.

 

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

### * *

Informationregarding recent accounting pronouncements is incorporated by reference fromNote 2 to our Consolidated Financial Statements set forth in Part I ofthis report.

 

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

 

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

 

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

 

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

 

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

 

During thethirteen and thirty-nine weeks ended September 30, 2008 and October 2,2007, our results of operations, financial position and cash flows have notbeen 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.

 

Ourmanufacturing operation sells bagels to a wholesaler and a distributor who bothtake possession in the United States and sell outside of the United States. Asthe product is shipped FOB domestic dock, there are no international risks ofloss or foreign exchange currency issues. Sales shipped internationally areincluded in manufacturing and commissary revenue. We continue to look for otherinternational opportunities.

 

Our debt as ofSeptember 30, 2008 was principally composed of the amended RevolvingFacility and First Lien Term Loan.  Forfixed rate debt, interest rate changes affect the fair market value of suchdebt but do not impact earnings or cash flows. Conversely for variable ratedebt, including borrowings under our revolving facility and first lien termloan, interest rate changes generally do not affect the fair market value ofsuch debt, but do impact future earnings and cash flows, assuming other factorsare held constant.

 

On May 7,2008, we entered into an interest rate swap agreement, to fix our rate on $60million of our debt to 3.52% plus an applicable margin for the next two years,effective August 2008.

 

Assuming nochange in the size or composition of debt as of September 30, 2008, andpresuming the utilization of our accumulated net operating losses wouldminimize the tax implications for the next several years, a 100 basis pointincrease in short-term effective interest rates would increase our interestexpense on our Revolving Facility and First Lien Term Loan, including theinterest rate swap, by approximately $0.3 million annually.  Currently, the interest rates on ourrevolving facility and first lien term loan are predominantly at LIBOR ratesplus an applicable margin through short-term fixed rate financing and theinterest rate swap has fixed our rate on $60 million of our outstanding debt.The estimated increase in interest expense incorporates the fixed interestfinancing into its assumptions.

 

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

 

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

 

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**Item 4.  Controls and Procedures**

 

*Evaluation of Disclosure Controls andProcedures*

 

An evaluation was carried out under the supervision and with theparticipation of company management, including our chief executive officer andchief financial officer, of the effectiveness of the design and operation ofour disclosure controls and procedures (as defined in Rule 13a-15(e) underthe Securities Exchange Act of 1934, as amended) as of September 30, 2008.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 designedand operated, can provide only reasonable assurance regarding management’s controlobjectives. In addition, the design of any control system is based in part uponcertain assumptions about the likelihood of future events. Because of these andother inherent limitations of control systems, there can be no assurance thatany design will succeed in achieving its stated goals under all potentialfuture conditions, regardless of how remote.

 

*Changes in Internal Control over FinancialReporting*

 

During the thirty-nine weeks ended September 30, 2008, there wereno changes to our internal controls over financial reporting that wereidentified in connection with the evaluation of our disclosure controls andprocedures required by the Exchange Act rules and that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**Item 1.    Legal Proceedings**

 

Information regarding legal proceedings is incorporated by referencefrom Note 10 to our Consolidated Financial Statements set forth in Part Iof this report.

 

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

### * *

Part I, Item 1A of our Annual Report on Form 10-K forthe fiscal year ended January 1, 2008 describes important factors thatcould cause our actual operating results to differ materially from thoseindicated or suggested by forward-looking statements made in this Form 10-Qor presented elsewhere by management from time-to-time. These factors includebut are not limited to the following:

 

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

 

*General economicconditions have affected, and could continue to affect, discretionary consumerspending, particularly spending for meals prepared away from home.*

 

International, national and local economicconditions, including credit and mortgage markets, energy costs, lay-offs,foreclosure rates, bankruptcies, and similar adverse economic news and factorsaffect discretionary consumer spending. These factors could reduce consumers’discretionary spending which in turn could reduce our guest traffic or averagecheck.  In 2006, 2007 and currentlythrough 2008, restaurants industry-wide were adversely affected as a result ofreduced consumer spending due to rising fuel and energy costs.  The conditions experienced recently alsoinclude reduced consumer confidence, on-going concerns about the housingmarket, concerns over the stability of financial institutions, and increasedhealth care and energy costs.  Adversechanges in consumer discretionary spending, which could be affected by manydifferent factors which are out of our control, including those listedabove, could harm our business prospects, financial condition, operatingresults and cash flows.  Our success willdepend in part upon our ability to anticipate, identify and respond to changingeconomic and other conditions.

 

The economic turmoil that has arisen in thecredit markets and in the housing markets during and following the thirdquarter of fiscal 2008 may suppress discretionary spending and other consumerpurchasing habits and, as a result, adversely affect our results of operations.

 

*Failure to protect foodsupplies and adhere to food safety standards could result in food-borneillnesses and/or injuries to our guests. Damage to our reputation for servinghigh quality, safe food could adversely affect our results.*

 

Food safety and reputation for quality is themost significant risk to any company that operates in the restaurant industry.Food safety is the focus of increased government regulatory initiatives at thelocal, state and federal levels.

 

Failure to protect our food supply or enforcefood safety policies, such as proper food temperatures and adherence to shelflife dates, could result in food-borne illnesses and/or injuries to our guests.Also, our reputation of providing high quality food is an important factor inchoosing our restaurants. Instances of food borne illness, includinglisteriosis, salmonella and e-coli, whether or not traced to our restaurants,could reduce demand for our menu offerings. If any of our guests become illfrom consuming our products, the affected restaurants may be forced to close.An instance of food contamination originating from one of our restaurants, ourcommissaries or suppliers, or our manufacturing plant could have far-reachingeffects, as the contamination, or the perception of 

 

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contamination could affect substantially allof our restaurants. In addition, publicity related to either productcontamination or recalls may cause our guests to cease frequenting ourrestaurants based on fear of such illnesses*.*

 

*Changes in consumer preferences could harm our financial results.*

 

Numerous factors including changes inconsumer tastes and preferences often affect restaurants.  Shifts in consumer preferences away from ourtype of cuisine and/or the fast-casual style could have a material effect onour results of operations.  Dietarytrends, such as the consumption of food low in carbohydrate content have, inthe past, and may, in the future, negatively impact our sales. Changes in ourguests’ spending habits and preferences could have a material adverse effect onour sales.  Our results will depend onour ability to respond to changing consumer preferences and tastes.

 

*Increasing commodity prices would adversely affect our gross profit.*

 

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

 

Due to increased demand for ethanol, the costof corn has increased substantially, which has increased the cost of corn-sourcedingredients as well as other commodities such as wheat, the primary ingredientin most of our products.  This demand andthese commodity pressures could continue for 2008 and into 2009 as well. Anyincrease in the prices of the ingredients most critical to our products, suchas wheat, could adversely affect our operating results.

 

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

 

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

 

Our success depends in part on our ability tounderstand and satisfy the needs of our guests, franchisees and licensees. Ourbusiness strategy consists of several initiatives:

 

·                  expand sales atour existing company-owned restaurants;

·                  open newcompany-owned restaurants; and

·                  open newfranchised and licensed restaurants.

 

Our ability to achieve any or all of theseinitiatives is uncertain. Our success in expanding sales at company-ownedrestaurants through various sub-initiatives including: developing new menuofferings and broadening our offerings across multiple dayparts, improving ourordering and production systems, expanding our catering program and upgradingour restaurants is dependent in part on our ability to predict and satisfyconsumer preferences and as mentioned above, consumers ability to respondpositively in a troublesome economic environment. Our success in growing ourbusiness through opening new company-owned restaurants is dependent on a numberof factors, including our ability to: find suitable locations, reach acceptablelease terms, have adequate capital, find available contractors, obtain licensesand permits, locate and train appropriate staff and properly manage the newrestaurant. Our success in opening new franchised and licensed restaurants isdependent upon, among other factors, our ability to: attract quality businessesto invest in our core brands, maintain the effectiveness of our franchisedisclosure documents in target states, offer restaurant solutions for a varietyof location types and the ability of our franchisees and licensees to: findsuitable locations, reach acceptable lease terms, have adequate capital, securereasonable 

 

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financing, find available contractors, obtainlicenses and permits, locate and train staff appropriately and properly managethe new restaurants. Accordingly, we may not be able to open or upgrade as manyrestaurants or grant as many franchises or licenses 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 could be adversely affected if comparablestore sales are less than we expect.*

 

The level of growth in comparable store salessignificantly affects our overall sales growth and will be a critical factoraffecting profit growth. Our ability to increase comparable store sales dependsin part on our ability to offer hospitality and attractive menu items, andsuccessfully implement our initiatives to increase throughput, such asincreasing the speed at which our employees serve each guest. Factors such astraffic patterns, local demographics, the type, number and location ofcompeting restaurants and economic climate may adversely affect the performanceof individual restaurants. It is possible that we will not achieve our targetedcomparable store sales growth or that the change in comparable store salescould be negative and could adversely impact our sales and profit growth.

 

*Competition in therestaurant industry is intense, and we may fall short of our revenue andprofitability targets if we are unable to compete successfully.*

 

Our industry is highly competitive and thereare many well-established competitors with substantially greater financial andother resources than we have. Although we operate in the fast-casual segment ofthe restaurant industry, we also consider restaurants in the fast-food andfull-service segments to be our competitors. Several fast-casual and fast-foodchains are focusing more on breakfast offerings and expanding their coffeeofferings. This could further increase competition in the breakfast daypart. Inaddition to current competitors, one or more new major competitors withsubstantially greater financial, marketing and operating resources could enterthe market at any time and compete directly against us. Also, in virtuallyevery major metropolitan area in which we operate or expect to enter, local orregional competitors already exist. This may make it more difficult to obtainreal estate and advertising space, and to attract and retain guests andpersonnel.

 

*We occupy ourcompany-owned restaurants under long-term non-cancelable leases, and we may beunable to renew leases at the end of their lease periods or obtain new leaseson acceptable terms.*

 

We do not own any real property, and all ofour company-owned restaurants are located in leased premises. Many of ourcurrent leases are non-cancelable and typically have terms ranging from five toten years with two three- to five-year renewal options. We believe leases thatwe enter into in the future likely will also be long-term and non-cancelableand have similar renewal options. Most of our leases provide that the landlordmay increase the rent over the term of the lease, and require us to pay ourproportionate share of the cost of insurance, taxes, maintenance and utilities.If we close a restaurant, we generally remain committed to perform ourobligations under the applicable lease, which would include, among otherthings, payment of the base rent for the balance of the lease term. In someinstances, we may be unable to close an underperforming restaurant due tocontinuous operation clauses in our lease agreements. Our obligation tocontinue making rental payments in respect of leases for closed orunderperforming restaurants could have a material adverse effect on ourbusiness and results of operations.

 

Alternatively, at the end of the lease termand any renewal period for a restaurant, we may be unable to renew the leasewithout substantial additional cost, if at all. If we are unable to renew ourrestaurant leases, we may be forced to close or relocate a restaurant, whichcould subject us to construction and other costs and risks, and could have amaterial adverse effect on our business and results of operations. For example,closing a restaurant, even during the time of relocation, will reduce the salesthat the restaurant would have contributed to our revenues. Additionally, therevenue and profit, if any, generated at a relocated restaurant may not equalthe revenue and profit generated at the existing restaurant. We also facecompetition from both restaurants and other retailers for suitable sites fornew restaurants. As a result, we may not be able to secure or renew leases foradequate sites at acceptable rent levels.

 

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*The cost of naturalresources, such as energy, together with the cost, availability and quality ofour raw ingredients affect our results of operations.*

 

The cost, availability and quality of theingredients that we use to prepare our food are subject to a range of factors,many of which are beyond our control. Fluctuations in economic and politicalconditions, product demand, weather, crops planted, and natural resources suchas electricity, water, and fuel could adversely affect the cost of ouringredients. We have limited control over changes in the price and quality ofthese natural resources, since we typically do not enter into long-term pricingagreements for our ingredients and production costs, such as energy and fuel.We may not be able to pass through any future cost increases by increasing menuprices, as we have done in the past. We and our franchisees and licensees aredependent on a constant supply of energy, frequent deliveries of freshingredients, and regular consumption of fuel, thereby subjecting us to the riskof shortages or interruptions in supply of any of these items.

 

The cost of energy impacts our results ofoperations in several ways.  We have seenour cost of electricity gradually increase over time. Distribution costsrelated to fuel have impacted our operations negatively. Additionally, travelcosts, including gas prices and airline fares, have been increasingsignificantly nationwide. These costs impact our results of operation currentlyand could impact us negatively in the future.

 

*Our operations may be negatively impacted by adverse weather conditionsand natural disasters.*

 

Adverse weather conditions and naturaldisasters could seriously affect regions in which our company-owned, franchisedand licensed restaurants are located, regions that produce raw ingredients forour restaurants, or locations of our distribution network. If adverse weatherconditions or natural disasters such as fires and hurricanes affect ourrestaurants, we could experience closures, repair and restoration costs, foodspoilage, and other significant reopening costs as well as increased food costsand delayed supply shipments, any of which would adversely affect ourbusiness.  In addition, if adverseweather or natural disasters affect our distribution network, we couldexperience shortages or delayed shipments at our restaurants, which couldadversely affect them.  Additionally,during periods of extreme temperatures (either hot or cold) or precipitation,many individuals choose to stay inside. This negatively impacts transactioncounts in our restaurants and over extended periods of time could adverselyaffect our business and results of operations.

 

The effects of hurricanes, fires, freezes andother adverse weather conditions are likely to affect supply of and costs forraw ingredients and natural resources, near-term construction costs for our newrestaurants as well as sales in our restaurants going forward. If we are notable to anticipate or react to changing costs of food and other raw materialsby adjusting our purchasing practices or menu prices, our operating marginswould likely deteriorate.

 

*We have single suppliersfor most of our key ingredients, and the failure of any of these suppliers toperform could harm our business.*

 

We currently purchase our raw materials fromvarious suppliers; however, we have only one supplier for each of our keyingredients. We purchase a majority of our frozen bagel dough from a singlesupplier, who utilizes our proprietary processes and on whom we are dependentin the short-term. All of our remaining frozen bagel dough is produced at ourdough manufacturing facility in Whittier, California. Additionally, we purchaseall of our cream cheese from a single source. Although to date we have notexperienced significant difficulties with our suppliers, our reliance on asingle supplier for each of our key ingredients subjects us to a number ofrisks, including possible delays or interruption in supplies, diminishedcontrol over quality and a potential lack of adequate raw material capacity.Any disruption in the supply or degradation in the quality of the materialsprovided by our suppliers could have a material adverse effect on our business,operating results and financial condition. In addition, any such disruptions insupply or degradations in quality could have a long-term detrimental impact onour efforts to maintain a strong brand identity and a loyal consumer base.

 

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*Failure of ourdistributors to perform adequately or any disruption in our distributorrelationships could adversely affect our business and reputation.*

 

We depend on our network of independent regionaldistributors to distribute frozen bagel dough and other products and materialsto our company-owned, franchised and licensed restaurants. Any failure by oneor more of our distributors to perform as anticipated, or any disruption in anyof our distribution relationships for any reason, would subject us to a numberof risks, including inadequate products delivered to our restaurants,diminished control over quality of products delivered, and increased operatingcosts to prevent delays in deliveries. Any of these events could harm ourrelationships with our franchisees or licensees, or diminish the reputation ofour 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.

 

*Increasing labor costs could adversely affect our results of operationsand cash flows.*

 

We are dependent upon an available labor poolof associates, many of whom are hourly employees whose wages may be affected byincreases in the federal, state or municipal “living wage” rates. Numerousincreases have been made on federal, state and local levels to increase minimumwage levels. Increases in state minimum hourly wage rates in some of the statesin which we operate became effective January 2008, and the federal minimumwage increased on July 24, 2008 and the minimum wage will be raised againin 2009. Increases 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 labor pool or other generalinflationary pressures or changes could also increase labor costs. In addition,changes in labor laws or reclassifications of associates from management to hourlyemployees could affect our labor cost. An increase in labor costs could have amaterial adverse effect on our income from operations and decrease ourprofitability and cash flows if we are unable to recover these increases byraising the prices we charge our guests.

 

*We may not be able togenerate sufficient cash flow to make payments on our substantial amount ofdebt and mandatorily redeemable preferred stock.*

 

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

 

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

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

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

·                  increase our vulnerabilityto volatility in interest rates; and

·                  limit our ability towithstand competitive pressures from our less leveraged competitors.

 

Economic, financial, competitive, legislativeand other factors beyond our control may affect our ability to generate cashflow from operations to make payments on our indebtedness and to fund necessaryworking capital. A significant reduction in operating cash flow would likelyincrease the need for alternative sources of liquidity. If we are unable togenerate sufficient cash flow to make payments on our debt, we will have topursue one or more alternatives, such as reducing or delaying capitalexpenditures, refinancing our debt on terms that are not favorable to us,selling assets or issuing additional equity securities. We may not be able toaccomplish any of these alternatives on satisfactory terms, if at all, and evenif accomplished, they may not yield sufficient funds to service our debt.

 

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We also have $57.0 million of mandatorilyredeemable preferred stock due June 30, 2009.  Given the current credit climate  and uncertainties in the banking industry, wemay not be able to successfully syndicate the commitment we have for anincremental loan, or find additional financing at all that would beused to pay the series Z obligation.

 

*We must comply withcertain covenants inherent in our debt agreements to avoid defaulting underthose agreements.*

 

Our current debt agreements contain certaincovenants, which, among others, include certain financial covenants such aslimitations on capital expenditures, maintenance of the business, use ofproceeds from sales of assets and consolidated leverage and fixed chargecoverage ratios as defined in the agreements. The covenants also preclude thedeclaration and payment of dividends or other distributions to holders of ourcommon stock. We are subject to multiple economic, financial, competitive,legal and other risks that are beyond our control and could harm our futurefinancial results. Any adverse effect on our business or financial resultscould affect our ability to maintain compliance with our debt covenants, andany failure by us to comply with these covenants could result in an event ofdefault. If we were to default under our covenants and such default were notcured or waived, our indebtedness could become immediately due and payable,which could render us insolvent.

 

*We face the risk of adverse publicity and litigation in connection withour operations.*

 

We are from time to time the subject ofcomplaints or litigation from our consumers alleging illness, injury or other foodquality, health or operational concerns. Adverse publicity resulting from theseallegations may materially adversely affect us, regardless of whether theallegations are valid or whether we are liable. In addition, employee claimsagainst us based on, among other things, discrimination, harassment or wrongfultermination, or labor code violations may divert financial and managementresources that would otherwise be used to benefit our future performance.  For example, we recently settled two classactions in California as described in Note 10 to our Consolidated FinancialStatements set forth in Part I of this report. There is also a risk oflitigation from our franchisees with regard to the terms of our franchisearrangements. We have been subject to a variety of these and other claims fromtime to time and a significant increase in the number of these claims or thenumber that are successful could materially adversely affect our business,prospects, financial condition, operating results or cash flows.

 

*A regional or global health pandemic could severely affect ourbusiness.*

 

A health pandemic is a disease that spreadsrapidly and widely by infection and affects many individuals in an area orpopulation at the same time. In 2004, 2005 and 2006, Asian and Europeancountries experienced outbreaks of avian flu and it is possible that it willcontinue to migrate to the United States where our restaurants are located. Ifa regional or global health pandemic were to occur, depending upon its durationand severity, our business could be severely affected. We have positionedourselves as a “neighborhood atmosphere” between home and work where people cangather for human connection and high quality food. Customers might avoid publicgathering places in the event of a health pandemic, and local, regional ornational governments might limit or ban public gatherings to halt or delay thespread of disease. A regional or global pandemic might also adversely impactour business by disrupting or delaying production and delivery of products andmaterials in our supply chain and causing staff shortages in our restaurants.The impact of a health pandemic might be disproportionately greater on us thanon other companies that depend less on the gathering of people in a neighborhoodatmosphere.

 

*Our franchisees andlicensees may not help us develop our business as we expect, or could actuallyharm our business.*

 

We rely in part on our franchisees andlicensees and the manner in which they operate their restaurants to develop andpromote our business. Although we have developed criteria to evaluate andscreen prospective candidates, the candidates may not have the business acumenor financial resources necessary to operate successful restaurants in theirrespective areas. In addition, franchisees and licensees are subject tobusiness risks similar to what we face 

 

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such as competition, consumer acceptance,fluctuations in the cost, availability and quality of raw ingredients, andincreasing labor costs. The failure of franchisees and licensees to operatesuccessfully could have a material adverse effect on us, our reputation, ourability to collect royalties, our brands and our ability to attract prospectivecandidates.  Potential franchisees andlicensees may have difficulty obtaining proper financing as a result of thedownturn in the credit markets.  As weoffer and grant franchises for our Einstein Bros. brand, our reliance on ourfranchisees is expected to increase in proportion to growth of the franchiseebase. With respect to franchising our Einstein Bros. brand, we may not be ableto identify franchisees that meet our criteria, or to enter into franchise areadevelopment agreements with prospective franchisee candidates that we identify.As a result, our franchise program for the Einstein Bros. brand may not grow atthe rate we currently expect, or at all.

 

*Our restaurants andproducts are subject to numerous and changing government regulations. Failureto comply could negatively affect our sales, increase our costs or result infines or other penalties against us.*

 

Each of our restaurants is subject tolicensing and regulation by the health, sanitation, safety, labor, building andfire agencies of the respective states, counties, cities and municipalities inwhich it is located. A failure to comply with one or more regulations couldresult in the imposition of sanctions, including the closing of facilities foran indeterminate period of time, or third party litigation, any of which couldhave a material adverse effect on us and our results of operations.

 

Many recent government bodies have begun tolegislate or regulate high-fat and high sodium foods as a way of combatingconcerns about obesity and health. Several municipalities have requiredrestaurants and other food service establishments to phase-out artificialtrans-fat by certain dates in 2008, including New York City, New York, Philadelphia,Pennsylvania, and King County (Seattle), Washington. Many other states areconsidering laws banning trans-fat in restaurant food. Because we do usetrans-fat in a few of our products, federal, state or local regulations in thefuture may limit sales of certain of our foods or ingredients. Public interestgroups have also focused attention on the marketing of high-fat and high-sodiumfoods to children in a stated effort to combat childhood obesity. Some citiesand even states have recently adopted or are considering regulations requiringdisclosure of nutritional, including calorie information on menus and/or menuboards. Additional cities or states may propose or adopt similar regulations.The cost of complying with these regulations could increase our expenses andthe possible negative publicity arising from such legislative initiatives couldreduce our future sales.

 

Our franchising operations are subject toregulation by the Federal Trade Commission. We must also comply with statefranchising laws and a wide range of other state and local rules andregulations applicable to our business. The failure to comply with federal,state and local rules and regulations would have an adverse effect on us.

 

Under various federal, state and local laws,an owner or operator of real estate may be liable for the costs of removal orremediation of certain hazardous or toxic substances on or in such property.Such liability may be imposed without regard to whether the owner or operatorknew of, or was responsible for, the presence of such hazardous or toxicsubstances. Although we are not aware of any environmental conditions thatrequire remediation by us under federal, state or local law at our properties,we have not conducted a comprehensive environmental review of our properties oroperations. We may not have identified all of the potential environmentalliabilities at our properties, and any such liabilities that are identified inthe future may have a material adverse effect on our financial condition.

 

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

 

We believe our trademarks, service marks andother proprietary rights are important to our success and our competitiveposition. Accordingly, we devote substantial resources to the establishment andprotection of our trademarks, service marks and proprietary rights. However,the actions we take may be inadequate to prevent imitation of our products andconcepts by others, to prevent variouschallenges to our registrations or applications or denials of applicationsfor the registration of trademarks, service marks and proprietary rightsin the U.S. or other 

 

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countries, or toprevent others from claiming violations of their trademarks and proprietarymarks. In addition, others may assert rights in our trademarks, service marksand other proprietary rights.

 

*Our ability to use netoperating loss carryforwards to offset future taxable income for U.S. federalincome tax purposes is subject to limitation.*

 

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

 

As of September 30, 2008, our NOL carryforwards for U.S. federalincome tax purposes were approximately $140.4 million. As a result of priorownership changes, approximately $93.8 million of our NOL carryforwards aresubject to an annual usage limitation of $4.7 million. Due to transactionsinvolving the sale or other transfer of our stock from the date of our lastownership change through the date of the secondary public offering of ourcommon stock, and changes in the value of our stock during that period, suchoffering may result in an additional ownership change for purposes of Section 382or will significantly increase the likelihood that we will undergo anadditional ownership change in the future (which could occur as a result oftransactions involving our stock that are outside of our control).   In either event, the occurrence of anadditional ownership change would limit our ability to utilize theapproximately $46.6 million of our NOL carryforwards that are not currentlysubject to limitation, and could further limit our ability to utilize ourremaining NOL carryforwards and possibly other tax attributes. Limitationsimposed on our ability to use NOL carryforwards and other tax attributes tooffset future taxable income could cause us to pay U.S. federal income taxesearlier than we otherwise would if such limitations were not in effect, andcould cause such NOL carryforwards and other tax attributes to expire unused,in each case reducing or eliminating the benefit of such NOL carryforwards andother tax attributes to us and adversely affecting our future cash flow. We arein the process of filing a request with the Internal Revenue Service to reviewour methodology for determining ownership changes in accordance with InternalRevenue Code Section 382.  Uponacceptance of our request, we believe that our NOL carryforwards will beavailable for utilization.  In the eventthat our request is not accepted, approximately $17.9 million of NOLcarryforwards will be at risk to expire prior to utilization.  Similar rules and limitations may applyfor state income tax purposes as well.

 

**Risk Factors Relating to Our Common Stock**

 

*We have a majoritystockholder.*

 

Greenlight Capital, L.L.C. and its affiliates beneficially ownapproximately 67.2% of our common stock. As a result, Greenlight has sufficientvoting power, without the vote of any other stockholders, to determine whatmatters will be submitted for approval by our stockholders to elect all of themembers of our board of directors, and to determine whether a change in controlof our company occurs. Greenlight’s interests on matters submitted tostockholders may be different from those of other stockholders. Greenlight hasvoted its shares to elect our current board of directors, and the chairman ofour board of directors is a current employee of Greenlight.

 

We have listed our common stock on the NASDAQ Global Market. NASDAQ rules requireus to have an audit committee consisting entirely of independent directors.However, under NASDAQ rules, if a single stockholder holds more that 50% of thevoting power of a listed company, that company is considered a controlledcompany, and is exempt from several other corporate governance rules, includingthe requirement 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 areintended to provide. The Company currently has a majority of independentdirectors on the board of directors.

 

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

 

If a substantial number of shares of our common stock are sold in thepublic market, the market price of our common stock could fall. The perceptionamong investors that these sales will occur could also produce this effect. Ourmajority stockholder, Greenlight, beneficially owns approximately 67.2% of ourcommon stock and sales by Greenlight or a perception that Greenlight will sellcould cause a decrease in the market price of our common stock.

 

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**Item 6.  Exhibits**

 
| 31.1   |   | Certification  by Chief Executive Officer pursuant to Exchange Act Rule 13a-15(e), as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                               |
| 31.2   |   | Certification  by Chief Financial Officer pursuant to Exchange Act Rule 13a-15(e), as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|   |   |                                                                                                                                                               |
| 32.1   |   | Certification  by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002      |
|   |   |                                                                                                                                                               |
| 32.2   |   | Certification  by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002      |
|   |   |                                                                                                                                                               |
| 32.3   |   | Certification  by Chief Accounting Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002     |

 

 

**Signatures**

 

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

 

 
|   |                   |   | EINSTEIN  NOAH RESTAURANT GROUP, INC. |
|--------|------------------------|--------|---------------------------------------|
|   |                   |   |                                  |
|   |                   |   |                                  |
| Date:  | November 6,  2008 |   | By: /s/ PAUL  J. B. MURPHY, III  |
|   |                   |   | Paul J.B.  Murphy, III           |
|   |                   |   | Chief  Executive Officer              |
|   |                   |   |                                  |
| Date:  | November 6,  2008 |   | By: /s/  RICHARD P. DUTKIEWICZ        |
|   |                   |   | Richard P.  Dutkiewicz                |
|   |                   |   | Chief Financial  Officer              |

 

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