**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**
| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|------------|-----------------------------------------------------------------------------------------------|

 

**For the quarterly period ended March 29, 2005**

 

**OR**

 
| **o** | ** ** | **TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|------------------------------------------------------------------------------------------|

 

**Commission File Number 0-27148**

 

**New World Restaurant Group, Inc**.

(Name of Registrant as Specified in its Charter)

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

 

**1687 Cole Blvd., Golden, Colorado  80401**

(Address of principal executive offices, including zip code)

 

**(303)568-8000**

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

**None**

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes ý  No o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Securities Exchange Act of 1934).  Yes o  No ý

 

As of April14, 2005, 9,848,713 shares of Common Stock of the registrant were outstanding.

 

 

----

 

**NEW WORLD RESTAURANT GROUP, INC.**

 

March 29, 2005

 

TABLE OF CONTENTS

 
| **Part I**. **Financial Information** | ** **                                                                                                                         |
|---------------------------------------|------------------------------------------------------------------------------------------------------------------------------------|
|                                  |                                                                                                                               |   |
| Item 1.                               | Financial Statements:                                                                                                              |   |
|                                  |                                                                                                                               |   |
|                                  | Consolidated Balance  Sheets (unaudited), March 29, 2005 and December 28, 2004                                                     |   |
|                                  |                                                                                                                               |   |
|                                  | Consolidated  Statements of Operations (unaudited), for the first quarter ended March 29,  2005 and March 30, 2004                 |   |
|                                  |                                                                                                                               |   |
|                                  | Consolidated  Statements of Cash Flows (unaudited), for the first quarter ended March 29,  2005 and March 30, 2004                 |   |
|                                  |                                                                                                                               |   |
|                                  | Consolidated  Statement of Changes in Stockholders’ Equity (Deficit), for the first quarter  ended March 29, 2005 (unaudited) |   |
|                                  |                                                                                                                               |   |
|                                  | Notes to the  Consolidated Financial Statements                                                                                    |   |
|                                  |                                                                                                                               |   |
| Item 2.                               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                        |   |
|                                  |                                                                                                                               |   |
| Item  3.                              | Quantitative  and Qualitative Disclosures about Market Risk                                                                        |   |
|                                  |                                                                                                                               |   |
| Item 4.                               | Controls and  Procedures                                                                                                           |   |
|                                  |                                                                                                                               |   |
| **Part II. Other Information**        | ** **                                                                                                                         |
|                                  |                                                                                                                               |   |
| Item 1.                               | Legal Proceedings                                                                                                                  |   |
|                                  |                                                                                                                               |   |
| Item 6.                               | Exhibits                                                                                                                           |   |

 

2

----

 

**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**AS OF MARCH 29, 2005 AND DECEMBER 28, 2004**

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

**(unaudited)**

 
| ** **                                                                                                                                                                 | ** ** | **March 29,** | ** ** | **December 28,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------|------------|------------------|------------|
| ** **                                                                                                                                                                 | ** ** | **2005**      | ** ** | **2004**         | ** ** |
| **ASSETS**                                                                                                                                                                 | ** ** | ** **    | ** ** | ** **       | ** ** |
| Current assets:                                                                                                                                                            |       |          |       |             |       |
| Cash and cash equivalents                                                                                                                                                  |       | $             | 1,341      |             | $          | 9,752 |   |
| Restricted cash                                                                                                                                                            |       | 1,161         |       | 1,269            |       |
| Franchise and other receivables, net of  allowance of $2,185 and $2,475                                                                                                    |       | 5,576         |       | 7,123            |       |
| Inventories                                                                                                                                                                |       | 4,815         |       | 4,941            |       |
| Prepaid expenses and other current assets                                                                                                                                  |       | 2,677         |       | 1,643            |       |
| Total current assets                                                                                                                                                       |       | 15,570        |       | 24,728           |       |
|                                                                                                                                                                       |       |          |       |             |       |
| Restricted cash long-term                                                                                                                                                  |       | 2,526         |       | 2,526            |       |
| Property, plant and equipment, net                                                                                                                                         |       | 39,291        |       | 41,855           |       |
| Trademarks and other intangibles, net                                                                                                                                      |       | 75,171        |       | 77,219           |       |
| Goodwill                                                                                                                                                                   |       | 4,875         |       | 4,875            |       |
| Debt issuance costs and other assets                                                                                                                                       |       | 6,796         |       | 7,253            |       |
| Total assets                                                                                                                                                               |       | $             | 144,229    |             | $          | 158,456 |   |
|                                                                                                                                                                       |       |          |       |             |       |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**                                                                                                                             | ** ** | ** **    | ** ** | ** **       | ** ** |
| Current liabilities:                                                                                                                                                       |       |          |       |             |       |
| Accounts payable                                                                                                                                                           |       | $             | 6,277      |             | $          | 8,243 |   |
| Accrued expenses                                                                                                                                                           |       | 26,847        |       | 34,836           |       |
| Short term debt and current portion of  long-term debt                                                                                                                     |       | 280           |       | 295              |       |
| Current portion of obligations under  capital leases                                                                                                                       |       | 16            |       | 16               |       |
| Total current liabilities                                                                                                                                                  |       | 33,420        |       | 43,390           |       |
|                                                                                                                                                                       |       |          |       |             |       |
| Senior notes and other long-term debt                                                                                                                                      |       | 160,840       |       | 160,840          |       |
| Obligations under capital leases                                                                                                                                           |       | 26            |       | 31               |       |
| Other liabilities                                                                                                                                                          |       | 9,607         |       | 9,678            |       |
| Mandatorily redeemable, Series Z Preferred  Stock, $.001 par value, $1,000 per share liquidation value; 2,000,000 shares authorized;  57,000 shares issued and outstanding |       | 57,000        |       | 57,000           |       |
| Total liabilities                                                                                                                                                          |       | 260,893       |       | 270,939          |       |
|                                                                                                                                                                       |       |          |       |             |       |
| Commitments and contingencies                                                                                                                                              |       |          |       |             |       |
|                                                                                                                                                                       |       |          |       |             |       |
| Stockholders’ deficit:                                                                                                                                                |       |          |       |             |       |
| Common stock, $.001 par value; 15,000,000  shares authorized; 9,848,713 and 9,848,713 shares issued and outstanding                                                        |       | 10            |       | 10               |       |
| Additional paid-in capital                                                                                                                                                 |       | 175,797       |       | 175,797          |       |
| Unamortized stock compensation                                                                                                                                             |       | (120          | )          | (137             | )          |
| Accumulated deficit                                                                                                                                                        |       | (292,351      | )          | (288,153         | )          |
| Total stockholders’ deficit                                                                                                                                           |       | (116,664      | )          | (112,483         | )          |
| Total liabilities and stockholders’ deficit                                                                                                                           |       | $             | 144,229    |             | $          | 158,456 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

3

----

 

**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**FOR THE QUARTERS ENDED MARCH 29, 2005 AND MARCH 30, 2004**

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

**(unaudited)**

 
| ** **                                                   | ** ** | **March 29,** | ** ** | **March 30,** | ** ** |
|--------------------------------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                                                   | ** ** | **2005**      | ** ** | **2004**      | ** ** |
| Revenues:                                                    |       |          |       |          |       |
| Retail sales                                                 |       | $             | 86,859     |          | $          | 84,623 |   |
| Manufacturing revenues                                       |       | 4,994         |       | 5,413         |       |
| Franchise and license related revenues                       |       | 1,442         |       | 1,160         |       |
|                                                         |       |          |       |          |       |
| Total revenues                                               |       | 93,295        |       | 91,196        |       |
|                                                         |       |          |       |          |       |
| Cost of sales:                                               |       |          |       |          |       |
| Retail costs                                                 |       | 71,430        |       | 70,087        |       |
| Manufacturing costs                                          |       | 4,707         |       | 4,578         |       |
|                                                         |       |          |       |          |       |
| Total cost of sales                                          |       | 76,137        |       | 74,665        |       |
|                                                         |       |          |       |          |       |
| Gross profit                                                 |       | 17,158        |       | 16,531        |       |
|                                                         |       |          |       |          |       |
| Operating expenses:                                          |       |          |       |          |       |
| General and administrative expenses                          |       | 8,680         |       | 8,818         |       |
| Depreciation and amortization                                |       | 6,708         |       | 6,819         |       |
| Loss (gain) on sale, disposal or  abandonment of assets, net |       | 4             |       | (7            | )          |
| Charges (adjustments) of integration and  reorganization     |       | 5             |       | (760          | )          |
| Impairment charges and other related costs                   |       | 97            |       | —        |       |
|                                                         |       |          |       |          |       |
| Income from operations                                       |       | 1,664         |       | 1,661         |       |
|                                                         |       |          |       |          |       |
| Other expense (income):                                      |       |          |       |          |       |
| Interest expense, net                                        |       | 5,919         |       | 5,799         |       |
| Other                                                        |       | (57           | )          | (63           | )          |
|                                                         |       |          |       |          |       |
| Loss before income taxes                                     |       | (4,198        | )          | (4,075        | )          |
|                                                         |       |          |       |          |       |
| Provision for state income taxes                             |       | —        |       | 55            |       |
|                                                         |       |          |       |          |       |
| Net loss                                                     |       | $             | (4,198     | )             | $          | (4,130 | ) |
|                                                         |       |          |       |          |       |
| Net loss per common share – Basic and  Diluted          |       | $             | (0.43      | )             | $          | (0.42 | ) |
|                                                         |       |          |       |          |       |
| Weighted average number of common shares  outstanding:       |       |          |       |          |       |
| Basic and Diluted                                            |       | 9,848,713     |       | 9,841,828     |       |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

4

----

 

**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**FOR THE QUARTERS ENDED MARCH 29, 2005 AND MARCH 30, 2004**

**(in thousands)**

**(unaudited)**

 
| ** **                                                                                 | ** ** | **March 29,** | ** ** | **March 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                                                                                 | ** ** | **2005**      | ** ** | **2004**      | ** ** |
| **OPERATING ACTIVITIES:**                                                                  |       |          |       |          |       |
| Net loss                                                                                   |       | $             | (4,198     | )             | $          | (4,130 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |       |          |       |          |       |
| Depreciation and amortization                                                              |       | 6,708         |       | 6,819         |       |
| Stock based compensation expense                                                           |       | 17            |       | —        |       |
| Loss, net of gains, on disposal of assets                                                  |       | 4             |       | (7            | )          |
| Impairment charges and other related costs                                                 |       | 97            |       | —        |       |
| Charges (adjustments) of integration and  reorganization costs                             |       | 5             |       | (760          | )          |
| Provision for (recovery of) losses on  accounts receivable, net                            |       | (91           | )          | —        |       |
| Amortization of debt issuance and debt  discount costs                                     |       | 462           |       | 462           |       |
| Changes in operating assets and  liabilities:                                              |       |          |       |          |       |
| Franchise and other receivables                                                            |       | 1,638         |       | 272           |       |
| Accounts payable and accrued expenses                                                      |       | (9,960        | )          | (6,262        | )          |
| Other assets and liabilities                                                               |       | (970          | )          | (570          | )          |
|                                                                                       |       |          |       |          |       |
| Net cash used in operating activities                                                      |       | (6,288        | )          | (4,176        | )          |
|                                                                                       |       |          |       |          |       |
| **INVESTING ACTIVITIES:**                                                                  |       |          |       |          |       |
| Purchase of property and equipment                                                         |       | (2,178        | )          | (2,360        | )          |
| Proceeds from the sale of equipment                                                        |       | 75            |       | —        |       |
|                                                                                       |       |          |       |          |       |
| Net cash used in investing activities                                                      |       | (2,103        | )          | (2,360        | )          |
|                                                                                       |       |          |       |          |       |
| **FINANCING ACTIVITIES:**                                                                  |       |          |       |          |       |
| Proceeds from line of credit                                                               |       | 5,415         |       | 7,015         |       |
| Repayments of line of credit                                                               |       | (5,430        | )          | (8,015        | )          |
| Repayment of other borrowings                                                              |       | (5            | )          | —        |       |
|                                                                                       |       |          |       |          |       |
| Net cash used in financing activities                                                      |       | (20           | )          | (1,000        | )          |
|                                                                                       |       |          |       |          |       |
| Net decrease in cash                                                                       |       | (8,411        | )          | (7,536        | )          |
| Cash and cash equivalents, beginning of  period                                            |       | 9,752         |       | 9,575         |       |
| Cash and cash equivalents, end of period                                                   |       | $             | 1,341      |          | $          | 2,039 |   |
|                                                                                       |       |          |       |          |       |
| **SUPPLEMENTAL CASH FLOW INFORMATION:**                                                    |       |          |       |          |       |
| Cash paid for interest                                                                     |       | $             | 10,583     |          | $          | 10,130 |   |
| Cash paid for income taxes                                                                 |       | $             | 176        |          | $          | 98 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

5

----

 

**NEW WORLD RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY****(DEFICIT)**

**FOR THE QUARTER ENDED MARCH 29, 2005**

(inthousands, except share information)

(unaudited)

 
| ** **                                 | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional** | ** ** | **Unamortized**  | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------------|------------|-------------|------------|----------------|------------|------------------|------------|-----------------|------------|------------|------------|
| ** **                                 | ** ** | **Common Stock** | ** ** | **Paid In** | ** ** | **Stock**      | ** ** | **Deficit**      | ** ** | ** **      | ** ** |
| ** **                                 | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Compensation** | ** ** | **Amount**      | ** ** | **Total**  | ** ** |
|                                       |       |             |       |        |       |           |       |             |       |            |       |       |       |
| Balance, December 28, 2004                 |       | 9,848,713        |       | $           | 10         |           | $          | 175,797          |       | $               | (137       | )          | $          | (288,153 | ) | $ | (112,483 | ) |
| Net loss                                   |       | —           |       | —      |       | —         |       | —           |       | (4,198          | )          | (4,198     | )          |
| Amortization of stock compensation expense |       | —           |       | —      |       | —         |       | 17               |       | —          |       | 17         |       |
|                                       |       |             |       |        |       |           |       |             |       |            |       |       |       |
| Balance, March 29, 2005                    |       | 9,848,713        |       | $           | 10         |           | $          | 175,797          |       | $               | (120       | )          | $          | (292,351 | ) | $ | (116,664 | ) |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

6

----

 

**NEWWORLD RESTAURANT GROUP, INC.**

 

Notesto Consolidated Financial Statements (Unaudited)

 

Quarterended March 29, 2005 and March 30, 2004

 

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

 

The accompanying consolidated financialstatements of New World Restaurant Group, Inc. and its wholly-ownedsubsidiaries (collectively, “the Company”) have been prepared pursuant to therules and regulations of the Securities and Exchange Commission (“SEC”). As of March29, 2005, the Company owns, franchises or licenses various restaurant conceptsunder the brand names of Einstein Bros. Bagels (“Einstein Bros.”), EinsteinBros. Café, Noah’s New York Bagels (“Noah’s”), Manhattan Bagel Company (“Manhattan”),Chesapeake Bagel Bakery (“Chesapeake”) and New World Coffee (“New World”). Our business is subject to seasonal trends.Generally, our revenues in the first fiscal quarter are somewhat lower than inthe other three fiscal quarters.

 

Theaccompanying consolidated financial statements as of March29, 2005 and for the quarters ended March 29, 2005 and March 30, 2004 have been prepared without audit. The balancesheet information as of December 28, 2004 has been derived from our auditedfinancial statements. The information furnished herein reflects all adjustments(consisting only of normal recurring accruals and adjustments), which are, inour opinion, necessary to fairly state the interim operating results for therespective periods.  However, these operating results are not necessarilyindicative of the results expected for the full fiscal year.  Certaininformation and footnote disclosures normally included in annual financialstatements prepared in accordance with generally accepted accounting principlesin the United States have been omitted pursuant to SEC rules and regulations.The notes to the consolidated financial statements (unaudited) should be readin conjunction with the notes to the consolidated financial statementscontained in our annual report on Form 10-K for the fiscal year ended December 28,2004. We believe that the disclosures are sufficient for interim financialreporting purposes.

 

Certainreclassifications have been made to conform previously reported data to thecurrent presentation. These reclassifications have no effect on our net loss orfinancial position as previously reported.

 

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

 

Weapply the intrinsic value-based method of accounting prescribed by AccountingPrinciples Board (APB) Opinion No. 25, *Accounting for Stock Issued to Employees*, and relatedinterpretations, in accounting for our fixed award stock options to ouremployees. As such, compensation expense is recorded only if the current marketprice of the underlying common stock exceeded the exercise price of the optionon the date of grant. We apply the fair value-basis of accounting as prescribedby Statements of Financial Accounting Standard (SFAS) No. 123, *Accounting for Stock-Based Compensation* (SFAS No. 123)**in accounting for our fixed award stock options toour consultants. Under SFAS No. 123, compensation expense is recognized basedon the fair value of stock options granted. 

 

7

----

 

Hadcompensation cost for stock options granted to employees been determined on thebasis of fair value as computed using the assumptions herein, net loss and lossper share would have been increased to the following pro forma amounts (inthousands of dollars, except per share amounts):

 
| ** **                                     | ** ** | **Quarter ended:** | ** ** |
|------------------------------------------------|------------|--------------------|------------|
| ** **                                     | ** ** | **March 29,**      | ** ** | **March 30,** | ** ** |
| ** **                                     | ** ** | **2005**           | ** ** | **2004** | ** ** |
| Net loss, as reported                          |       | $                  | (4,198     | ) | $ | (4,130 | ) |
| Deduct: fair value based compensation  expense |       | (153               | )          | (239 | ) |
| Pro forma net loss                             |       | (4,351             | )          | (4,369 | ) |
| Basic and diluted loss per common share:       |       |               |       |   |   |
| As reported                                    |       | $                  | (0.43      | ) | $ | (0.42 | ) |
| Pro forma                                      |       | $                  | (0.44      | ) | $ | (0.44 | ) |

 

Compensation cost of optionsgranted for the SFAS No. 123 pro forma amounts disclosed above wasestimated using the Black-Scholes option-pricing model with the followingassumptions:

 
| ** **                                  | ** ** | **Quarter  ended:** | ** ** |
|---------------------------------------------|------------|---------------------|------------|
| ** **                                  | ** ** | **March 29,**       | ** ** | **March  30,** | ** ** |
| ** **                                  | ** ** | **2005**            | ** ** | **2004** | ** ** |
| Expected life of options from date of grant |       | 4.0 years           |       | 4.0 years |   |
| Risk-free interest rate                     |       | 3.55                | %          | 3.00 | % |
| Volatility                                  |       | 100.0               | %          | 100.0 | % |
| Assumed dividend yield                      |       | 0.0                 | %          | 0.0 | % |

 

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

 

Intangible assets include both goodwilland identifiable intangibles arising from the allocation of the purchase pricesof assets acquired. Goodwill represents the excess of cost over fair value ofnet assets acquired in the acquisition of Manhattan. Other intangibles consistmainly of trademarks, trade secrets and patents.

 

Goodwill and other intangible assets withindefinite lives are not subject to amortization but are tested for impairmentannually or more frequently if events or changes in circumstances indicate thatthe asset might be impaired. SFAS No. 142, “Goodwill and Other IntangibleAssets” requires a two-step approach for testing impairment. First, theestimated fair value of each reporting unit is compared to its carrying valueto determine whether an indication of impairment exists. If impairment isindicated, then the second step of the impairment test is performed; the fairvalue of the reporting unit’s goodwill is determined by allocating the unit’sfair value to its assets and liabilities (including any unrecognized intangibleassets) as if the reporting unit had been acquired in a business combination.The amount of impairment for goodwill and other intangible assets is measuredas the excess of its carrying amount over its fair value. Intangible assets notsubject to amortization consist primarily of the Einstein Bros. and Manhattantrademarks.

 

8

----

 

Intangible assets with lives restricted bycontractual, legal or other means are amortized over their useful lives andconsist primarily of patents used in our manufacturing process. Amortizationexpense is calculated using the straight-line method over the estimated usefullives of approximately 5 years. Intangible assets subject to amortization are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable, in accordance with SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets.”

 

Trademarks and other intangibles consistof the following (in thousands of dollars):

 
| ** **                                  | ** ** | **March 29,** | ** ** | **December 28,** | ** ** |
|---------------------------------------------|------------|---------------|------------|------------------|------------|
| ** **                                  | ** ** | **2005**      | ** ** | **2004**         | ** ** |
| Amortizing intangibles:                     |       |          |       |             |       |
| Trade secrets                               |       | $             | 5,385      |             | $          | 5,385 |   |
| Trademarks                                  |       | 2,062         |       | 2,062            |       |
| Patents-manufacturing process               |       | 33,741        |       | 33,741           |       |
|                                        |       | 41,188        |       | 41,188           |       |
| Less accumulated amortization:              |       |          |       |             |       |
| Trade secrets                               |       | 4,034         |       | 3,770            |       |
| Trademarks                                  |       | 515           |       | 387              |       |
| Patents-manufacturing process               |       | 25,274        |       | 23,618           |       |
|                                        |       | 29,823        |       | 27,775           |       |
| Total amortizing intangibles, net           |       | $             | 11,365     |             | $          | 13,413 |   |
|                                        |       |          |       |             |       |
| Non-amortizing intangibles:                 |       |          |       |             |       |
| Trademarks                                  |       | 63,806        |       | 63,806           |       |
| Total trademarks and other intangibles, net |       | $             | 75,171     |             | $          | 77,219 |   |

 

During the first quarter ended 2005, therewere no events or changes in circumstances that indicated that our intangibleassets might be impaired or may not be recoverable.

 

**4.****    ****Debt**

 

Debt consists of the following (inthousands of dollars):

 
| ** **                      | ** ** | **March 29,** | ** ** | **December 28,** | ** ** |
|---------------------------------|------------|---------------|------------|------------------|------------|
| ** **                      | ** ** | **2005**      | ** ** | **2004**         | ** ** |
| $160 Million Notes              |       | $             | 160,000    |             | $          | 160,000 |   |
| AmSouth Revolver                |       | —        |       | 15               |       |
| New Jersey Economic Development |       |          |       |             |       |
| Authority Note Payable          |       | 1,120         |       | 1,120            |       |
|                            |       | 161,120       |       | 161,135          |       |
| Less current portion of debt    |       | 280           |       | 295              |       |
| Long-term debt                  |       | $             | 160,840    |             | $          | 160,840 |   |

 

9

----

 

**$160 Million Notes**

 

On July 8, 2003, we issued $160 million of13% senior secured notes maturing on July 1, 2008 (“$160 Million Notes”).

 

The $160 Million Notes are guaranteed,fully and unconditionally, jointly and severally, by us and all present andfuture subsidiaries of ours and are collateralized by substantially all of ourassets in which we have an interest. Pursuant to an Intercreditor Agreement,the $160 Million Notes are subordinate to the AmSouth Revolver as describedbelow.

 

The$160 Million Notes contain certain covenants, which, among others, includecertain financial covenants such as limitations on capital expenditures andminimum EBITDA as defined in the agreement. The covenants also preclude thedeclaration and payment of dividends or other distributions to holders of ourcommon stock. These covenants are measured on a rolling twelve-month period andfiscal quarter basis, respectively. This debt contains usual and customarydefault provisions. As of March 29, 2005, we were in compliance with all ourfinancial and operating covenants.

 

Interestpayments under the $160 Million Notes are payable in arrears at the rate of 13%per year on July 1 and January 1, commencing January 1, 2004. The notes areredeemable, at our option, in whole or in part at any time after July 1, 2004at the following redemption prices (as expressed in percentages of theprincipal amount):

 

| **Commencing on July 1,** | ** ** | **Percentage** | ** ** |
|---------------------------|------------|----------------|------------|
| 2004                      |       | 104.0          | %          |
| 2005                      |       | 103.0          | %          |
| 2006                      |       | 102.0          | %          |
| 2007                      |       | 101.0          | %          |
| 2008 and thereafter       |       | 100.0          | %          |

 

Debtissuance costs are capitalized and amortized using the effective interestmethod over the term of the $160 Million Notes.

 

**AmSouth Revolver**

 

On July 8, 2003, we entered into athree-year, $15 million senior secured revolving credit facility with AmSouthBank (“AmSouth Revolver”). The AmSouth Revolver was subsequently amended tomake technical corrections, clarify ambiguous terms and provide for increasedlimits with respect to letters of credit. Effective February 11, 2005, the AmSouth Revolver wasamended again to increase our letter of credit sub-facility from $5 million to$7.5 million.

 

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

 

TheAmSouth Revolver contains certain covenants, which, among others, includecertain financial covenants such as limitations on capital expenditures,operating lease obligations, minimum EBITDA as defined in the agreement,operating cash flow coverage ratio and minimum net worth. The covenants alsopreclude the declaration and payment of dividends or other distributions toholders of our common stock. These covenants are measured on a rolling twelve-monthperiod at each fiscal quarter or annually at year-end. Additional covenantrestrictions exist if the total borrowings, including outstanding letters ofcredit exceed $10.0 million. This debt also contains usual and customarydefault provisions. As of March 29, 2005, we are in compliance with all of ourfinancial and operating covenants.

 

10

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Interestpayments under the AmSouth Revolver are payable in arrears on the first of eachmonth. The net borrowings under the AmSouth Revolver bear an interest rateequal to the base rate plus an applicable margin with the base rate being theAmSouth Bank “prime rate” and the applicable margin being based on our fixedcharge coverage ratio with a minimum and maximum applicable margin of 0.5% and2.5% respectively. As of March 29, 2005, the interest rate under the AmSouthRevolver was 5.75%.

 

Weare required to pay an unused credit line fee of 0.50% per annum on the averagedaily unused amount. The unused line fee is payable monthly in arrears.Additionally, we are required to pay a letter of credit fee based on theaverage daily undrawn face amount for each letter of credit issued, of anapplicable margin being based on our fixed charge coverage ratio with a minimumand maximum applicable margin of 2.0% and 4.5% respectively. Letters of creditreduce our availability under the AmSouth Revolver. At March 29, 2005, we had $6.1million of letters of credit outstanding. The letters of credit expire onvarious dates during 2006, are automatically renewable for one additional yearand are payable upon demand in the event that we fail to pay certain workerscompensation claims. Our availability under the AmSouth Revolver was $8.9million at March 29, 2005.

 

Debtissuance costs are capitalized and amortized using the effective interestmethod over the term of the AmSouth Revolver.

 

**New Jersey Economic Development Authority Note Payable**

 

InDecember 1998, Manhattan Bagel Company, Inc. entered into a note payablein the principal amount of $2,800,000 with the New Jersey Economic DevelopmentAuthority (“NJEDA”) at an interest rate of 9% per annum. Principal is paidannually and interest is paid quarterly. The note matures on December 1, 2008and is secured by the assets of Manhattan Bagel Company, Inc.

 

OnJuly 3, 2003, we placed an advanced funding of the note in escrow to enacta debt defeasance as allowed for in the agreement. This advanced funding isshown as restricted cash and the note is included in both current portion andlong-term portion of debt in the March 29, 2005 and December 28, 2004consolidated balance sheets in accordance with the payment terms. Thisclassification will continue until the note is fully paid from the escrowamount proceeds.

 

 

**5.****    ****Net Loss Per Common Share**

 

Inaccordance with SFAS No. 128, “Earnings per Share,” we compute basic net lossper common share by dividing the net loss for the period by the weightedaverage number of shares of common stock outstanding during the period.

 

Dilutednet loss per share is computed by dividing the net loss for the period by theweighted average number of shares of common stock and potential common stockequivalents outstanding during the period, if dilutive. Potential common stockequivalents include incremental shares of common stock issuable upon theexercise of stock options. The effects of potential common stock equivalentshave not been included in the computation of diluted net loss per share astheir effect is anti-dilutive.

 

11

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Thefollowing table summarizes the weighted average number of common sharesoutstanding, as well as sets forth the computation of basic and diluted netloss per common share for the periods indicated (in thousands of dollars,except per share data):

 
| ** **                                                                                                                       | ** ** | **Quarter ended:** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                                                       | ** ** | **March 29,**      | ** ** | **March 30,** | ** ** |
| ** **                                                                                                                       | ** ** | **2005**           | ** ** | **2004** | ** ** |
|                                                                                                                             |       |               |       |   |   |
| Weighted average shares outstanding                                                                                              |       | 9,848,713          |       | 9,841,828 |   |
|                                                                                                                             |       |               |       |   |   |
| Net loss                                                                                                                         |       | $                  | (4,198     | ) | $ | (4,130 | ) |
|                                                                                                                             |       |               |       |   |   |
| Basic and diluted net loss per share                                                                                             |       | $                  | (0.43      | ) | $ | (0.42 | ) |
|                                                                                                                             |       |               |       |   |   |
| Outstanding options and warrants that were  not included in the diluted calculation because their effect would be  anti-dilutive |       | 1,726,154          |       | 1,877,679 |   |

 

**6.****    ****Income Taxes**

 

We record deferred tax assets andliabilities based on the difference between the financial statement and incometax basis of assets and liabilities using the enacted statutory tax rate.Deferred income tax expenses or credits are based on the changes in the assetor liability from period to period. The recorded deferred tax assets arereviewed for impairment on a quarterly basis by reviewing our internalestimates for future net income. If we determine it to be more likely than notthat the recovery of the asset is in question in the immediate, foreseeablefuture, we record a valuation allowance. On March 29, 2005 and December 28,2004, we recorded a full valuation allowance against our net deferred taxasset. We will continue to record valuation allowances against additionaldeferred tax assets until such time that it is more likely than not that someportion or all of the deferred tax assets will be realized.

 

**7.****    ****Charges (Adjustments) of Integration and Reorganization Cost**

 

Charges(adjustments) of integration and reorganization cost primarily representsadjustments to previously recorded liabilities associated with the closing andcorporate consolidation of our Eatontown facilities during 2002. During April2004, we reached an agreement with the landlord of our Eatontown facility tosettle outstanding litigation. Previously recorded integration andreorganization estimates associated with closing this facility resulted in abenefit of $700,000 during the first quarter ended 2004 as a result of thissettlement.

 

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**8.****    ****Impairment Charges and Other Related Costs**

 

In accordance with Statement of FinancialAccounting Standard No. 144, *Accounting forthe Impairment or Disposal of Long Lived Assets*, impairment lossesare recorded on long-lived assets on a restaurant-by-restaurant basis wheneverimpairment indicators are determined to be present. We consider a history ofcash flow losses to be the primary indicator of potential impairment forindividual restaurant locations. We determine whether a restaurant location isimpaired based on expected undiscounted future cash flows, consideringlocation, local competition, current store management performance, existingpricing structure and alternatives available for the site. If impairmentexists, the amount of impairment is measured as the excess of the carryingamount of the asset over its fair value as determined utilizing the estimateddiscounted future cash flows or the expected proceeds, net of costs to sell,upon sale of the asset.

 

For the quarter ended March 29, 2005, werecorded $97,000 in exit costs from the decision to close one restaurant. Theassets associated with the closure of this restaurant were previously impaired.

 

 

**9.****    ****Litigation and Contingencies**

 

We are subject to claims and legal actions in theordinary course of our business, including claims by our franchisees, licenseesand employees or former employees. We do not believe that an adverse outcome inany currently pending or threatened matter would have a material adverse effecton our business, results of operations or financial condition.

 

*Employment Related*

 

On July 31, 2002, Tristan Goldstein, a former storemanager, and Valerie Bankhordar, a current store manager, filed a putativeclass action against Einstein and Noah Corp. (“ENC”) in the Superior Court forthe State of California, County of San Francisco. The plaintiffs alleged thatENC failed to pay overtime wages to managers and assistant managers of itsCalifornia stores who were improperly designated as exempt employees. In April2004, we reached an agreement in principle to settle the litigation, subject tocourt approval. Amounts representing our estimate to settle this litigationwere previously recorded in general and administrative expenses during fiscal2003 and did not have a material adverse effect on our consolidated financialcondition or results of operations.

 

On March 31, 2003, Jerold E. Novack, our formerChief Financial Officer and Secretary, filed a complaint in the United StatesDistrict Court for the District of New Jersey against us, Anthony D. Wedo, ourformer Chairman and Chief Executive Officer, and William J. Nimmo, a formermember of our board of directors. On January 13, 2005, the parties resolved thelitigation. The resolution of this issue did not have a material adverse effecton our consolidated financial condition or results of operations.

 

On June 4, 2003, R. Ramin Kamfar, our formerChairman of the Board and Chief Executive Officer, filed an action in theUnited States District Court for the Southern District of New York against usand Anthony D. Wedo, our former Chairman and Chief Executive Officer, allegingbreach of contract, defamation, declaratory relief and punitive damages. OnFebruary 10, 2005, the case was dismissed with prejudice and the parties haveresolved this litigation. The resolution of this issue did not have a materialadverse effect on our consolidated financial condition or results ofoperations.

 

13

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On September 14, 2004, Atlantic Mutual InsuranceCompany brought an action in the Superior Court of New Jersey Law Division:Morris County, against the Company, Wedo, Nimmo, Novack, Kamfar, LexingtonInsurance Company, and XL Specialty Insurance Company seeking declaratoryjudgment on insurance coverage issues in the Novack litigation and the Kamfarlitigation described above. At this time, we cannot predict the outcome of thismatter and there can be no assurance that we will prevail in this matter, thata determination will be made that we have insurance coverage for expenses thatwe have already incurred, or that damages or other relief will not be awardedagainst us. However, we believe resolution of this issue will not have amaterial adverse effect on our consolidated financial condition or results ofoperations.

 

*Investigations*

 

On April 3, 2002, the Securities and ExchangeCommission notified us that the Commission was conducting an investigation intothe resignation of our former Chairman, R. Ramin Kamfar, and the terminationfor cause of our former Chief Financial Officer, Jerold Novack, and the delayin filing our Form 10-K for 2001. We have cooperated fully with theinvestigation as well as with a Department of Justice inquiry relating to theseissues. Further, several of the former and present officers and directors haverequested that, under applicable law and our by-laws, we advance reasonablelegal expenses on their respective behalves to the extent any of them is or hasbeen requested to provide information to the Commission in connection with itsinvestigation. We have advanced certain expenses in connection with theseclaims. At this time, it is not possible to reasonably estimate the loss orrange of loss, if any. However, we believe resolution of this issue will nothave a material adverse effect on our consolidated financial condition orresults of operations.

 

*Guarantees*

 

Priorto 2001, we would occasionally guarantee leases for the benefit of certain ofour franchisees. None of the guarantees have been modified since theirinception and we have since discontinued this practice. Current franchisees arethe primary lessees under the vast majority of these leases. Under the leaseguarantees, we may be required by the lessor to make all of the remainingmonthly rental payments or property tax and common area maintenance payments ifthe franchisee does not make the required payments in a timely manner. However,we believe that most, if not all, of the franchised locations could besubleased to third parties minimizing our potential exposure. Additionally, wehave indemnification agreements with our franchisees under which thefranchisees would be obligated to reimburse us for any amounts paid under suchguarantees. Historically, we have not been required to make such payments insignificant amounts. We record a liability for our exposure under theguarantees in accordance with SFAS No. 5, “Accounting for Contingencies,”following a probability related approach. In the event that trends change inthe future, our financial results could be impacted. As of March 29, 2005, wehad outstanding guarantees of indebtedness under certain leases ofapproximately $1.3 million.

 

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* *

*Insurance*

 

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

 

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

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004) entitled “Share-Based Payment” that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for a) equity instruments of the enterprise or b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The Statement eliminates the ability to account for share-based compensation transactions using APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and generally would require instead that such transactions be accounted for using a fair-value-based method. This Statement is to be implemented at the beginning of the next fiscal year that begins after June 15, 2005. We have not fully completed our evaluation of the impact this Statement will have on our financial position and results of operations. Based on options granted and various assumptions used to calculate stock based compensation expense as of March 29, 2005, we do not believe that the adoption will result in a material adverse effect to our financial statements taken as a whole.

 

Wehave considered all other recently issued accounting pronouncements and do notbelieve that the adoption of such pronouncements will have a material impact onour financial statements.

 

**11.**** ****Related Party Transactions**

 

GreenlightCapital, L.L.C. and its affiliates beneficially own approximately 97 percent ofour common stock on a fully diluted basis. As a result, Greenlight hassufficient voting power without the vote of any other stockholders to determinewhat matters will be submitted for approval by our stockholders, to approveactions by written consent without the approval of any other stockholders, toelect all of our board of directors, and among other things, to determinewhether a change in control of our company occurs.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS****OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

 

Thefollowing discussion and analysis supplements the management’s discussion andanalysis in our Annual Report on Form 10-K for the year ended December 28, 2004and presumes that readers have read or have access to the discussion andanalysis in our Annual Report. The following discussion and analysis includeshistorical and certain forward-looking information that should be read togetherwith the accompanying consolidated financial statements, related footnotes andthe discussion below of certain risks and uncertainties that could cause futureoperating results to differ materially from historical results or from theexpected results indicated by forward looking statements.

 

**Business Overview**

 

Weare a leader in the quick casual segment of the restaurant industry. With 679locations in 34 states and in the District of Columbia as of March 29, 2005, weoperate and license locations primarily under the Einstein Bros. and Noah’sbrand names, and franchise locations primarily under the Manhattan andChesapeake brand names. We also operate a dough production facility. We viewour business as a single segment with a focus on our company-operatedrestaurants. Our manufacturing and franchise operations are either supportiveor ancillary to our main business focus.

 

Therestaurant industry, in which we operate, is intensely competitive. Theindustry is often affected by changes in demographics, consumers’ eating habitsand preferences, local and national economic conditions affecting consumerspending habits, population trends and local traffic patterns. Key elements ofcompetition in the industry are price, quality and value of products offered,quality and speed of service, advertising effectiveness, brand nameidentification, restaurant locations and attractiveness of facilities.

 

Ourfinancial focus is on long term, sustainable growth in free cash flow. Freecash flow represents net cash provided by operations less the investment in ourfacilities and fixed assets. By achieving free cash flow, we will be morecapable of paying down debt, saving cash for future use and buildingshareholder value. We also believe free cash flow may give us the ability topursue new opportunities and/or acquire other businesses. Increasing ouroperating profit and efficiently managing working capital and capitalexpenditures primarily drive free cash flow.

 

Inmeasuring our overall growth and progress, we focus on various key performanceindicators. Such key performance indicators include:

 

•              same-store sales growth,

•              restaurant level and concept level margins,

•              cash generated by operations,

•              Adjusted EBITDA (as defined in our loanagreements),

•              number of company-owned restaurant openingsand closings,

•              number of franchise and licensed restaurantopenings and closings,

 

Ourprogress against some of these key performance indicators is discussedthroughout the Management’s Discussion and Analysis.

 

16

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**Significant Known Events, Trends or Uncertainties Expected toImpact 2005 Results**

 

Thefollowing factors represent currently known trends or uncertainties that mayimpact the comparability of operating performance or could cause reportedfinancial information not to be necessarily indicative of future operatingresults or future financial condition.

 

*Revenue Trends*

 

Inan effort to strengthen performance of our company-operated Einstein Bros.locations, we have developed a focused brand enhancement strategy with two keyelements. The first element involves the continuation of opening our new,next-generation, quick casual Einstein Bros. Café restaurants. Customerresearch and feedback is being utilized to fine-tune the look, feel and brandpositioning of the Café concept.  Todate, we have opened or converted seven Einstein Bros. Cafés in the Denver andColorado Springs, Colorado markets.  Thenext Einstein Bros. Café is scheduled to open in Longmont, Colo. in May.  The second element will concentrate on improvingthe performance of our existing Einstein Bros. Bagels restaurants byincorporating the most successful aspects of the Café concept in the majorityof our locations.  These efforts willinclude updates of restaurant interiors and improvements to service through newmenu boards and a “pay first” ordering system.

 

**Webelieve that dietary trends and negative publicity on products high incarbohydrate content may have had an adverse impact on our sales historically.Accordingly, we began addressing the issue with modifications to our menubeginning in 2004. Additionally, we introduced limited time offerings featuringseasonal menu items and implemented modifications to our customer servicesystem. We strengthened our catering programs in certain markets and initiatedadvertising campaigns during the fourth quarter ended 2004. We believe thatchanges in the products sold at our restaurants (including new menu items thatare lower in fat and carbohydrate content), price increases and shifts inproduct mixes to higher priced items coupled with initiatives in customerservice and overall appearance at our restaurants, and advertising programsthat build consumer awareness, have recently contributed to positive comparablestore sales.**

 

*Expense Trends*

 

Ourexpense trends are generally affected by the following major categories:

 

•      Changing prices for agricultural commodities;

•      Rising energy costs and increasing costs of other natural resources;

•      Increasing labor costs; and

•      Increasing tax rates and costs of compliance with regulatoryrequirements.

 

Infiscal 2004, prices for agricultural commodities such as dairy, cheese andbutter increased substantially. We believe that dairy prices will decreaseslightly in fiscal 2005, but that decrease may be offset by increased commoditycosts for coffee, flour and packaging.

 

Risingenergy costs and the increasing costs of other natural resources affect notonly the cost of distribution to our restaurants, but also utility bills andthe cost of packaging that is derived from petroleum products. Our distributionpartners and common freight carriers passed on fuel surcharges to us duringfiscal 2004. We believe energy costs will fluctuate during fiscal 2005 but willcontinue to increase on average. We also believe that the cost of packagingmaterials will be greater during 2005 than in 2004. Packaging contracts aregenerally negotiated and set prices on an annual basis.

 

Dueto competition for personnel and limited availability in the labor pool, weanticipate that we will experience an increase in hourly and salaried wagesduring 2005. Additionally, federal overtime regulations of the Fair LaborStandards Act, which went into effect on August 23, 2004, may impact theclassification of several of our positions. Changes in the reclassification ofemployees from management to hourly employees could also affect our laborcosts.

 

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Certainstates and local governments have increased both the rate and nature of taxeson businesses in their regions in an effort to offset budget shortfalls. Theseincreased taxes include real estate and property taxes, state and local incometaxes, and various employment taxes.

 

Changesin any of the aforementioned categories could directly impact the profitabilityof our company-owned locations, manufacturing operations or distributionchannels. Increases in any of these expense trends in the near future maycontribute to degradation in our profit margins until such time as we are ableto pass on increased costs to our consumers.

 

*Impactof Inflation*

 

Wehave not experienced a significant overall impact from inflation. As operatingexpenses increase, we recover increased costs through pricing increases, to theextent permitted by competition. We also review and implement alternativeproducts or processes.

 

*Store Portfolio Strategy*

 

Inmid-2004, we began an in-depth strategic review of all brands and thelikelihood of providing additional capital and other resources to grow eachindependent brand. Additionally, we focused on individual store performance andcompliance at each of our company operated, franchised and licensed stores. Weengaged Birchwood Resultants to build market level and individual site levelmodels to allow for strategic growth and portfolio rationalization decisionsbased on sound metrics. These models were built based on consumer researchconducted at our company operated Einstein Bros. locations and externaldemographic, psychographic and competitive databases. We considered various factorssuch as local market conditions, distribution and supply chain channels,competition, comparable store sales, store-level cash flows and existing leaseterms. Based on the store-level considerations, we then reviewed the economicand financial costs of exiting poorly performing locations (where the leasespermitted cessation of operations) or sub-leasing the location to a thirdparty. We also considered the long-term options of locations that perform atbreak-even or slightly above break-even. As a result of our strategic review, we have deliberately reduced ourstore count based on prudent business decisions in an effort to improve ouroverall profitability. We also believe these efforts will identify optimalmarkets for future store growth and ultimately contribute to long-termsustainable growth in free cash flow.

 

Webelieve we have a solid platform for growth through store licensing of ourEinstein Bros. and Noah’s brands. The licensing program is available toqualified foodservice operators and typically requires an upfront license feethat is fully earned at the time the licensee commences operations. Stores aredeveloped on college campuses, hospitals, airports, military installations andother locations. The licensed stores are generally opened during the third andfourth calendar quarters consistent with the timing of many government andhigher education projects and federal funding. We typically receive continuingroyalties on sales from each licensed store location. Our licensees are not requiredto buy all of their non-proprietary products directly from us, but rather theirproduct sources must be approved by us.

 

Wehave a franchise base primarily in our Manhattan and Chesapeake brands thatgenerates a recurring revenue stream through fee and royalty payments. Ourfranchise base provides us with the ability to grow our brands with minimalcommitment of capital by us, and creates a built-in customer base for ourmanufacturing operations. We continue to look for franchisee candidates withappropriate operational experience and financial stability, including specificnet worth and liquidity requirements. During 2004, we worked diligently toimprove our relationship and communication with performing franchisees. In aneffort to strengthen the brands, we terminated certain relationships withfranchisees that were not performing in accordance with their franchiseagreements. We believe that active involvement in and management of restaurantoperations will result in a successful franchise strategy.

 

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Wecontinually assess the financial and operational alignment of our Manhattan,Chesapeake and New World brands. As the Manhattan and Chesapeake brandsrepresent the majority of our franchise operations, revitalizing andstrengthening these brands remains a challenge for our management team. Werecognize that our historic franchise model is not consistent with futureoperating plans for certain brands due to geographic separation from coremarkets. As a result, we are currently executing a regionalization strategythat would include exiting certain markets. We believe regionalization willbuild stronger brand awareness, consistent levels of performance and customerloyalty.

 

Thefollowing table details the total restaurants open at the end of the respectivefirst quarter:

 
| ** **                               | ** ** | **Company** | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** |
|------------------------------------------|------------|-------------|------------|--------------|------------|----------------|------------|------------|------------|
| ** **                               | ** ** | **owned**   | ** ** | **Licensed** | ** ** | **Franchised** | ** ** | **Total**  | ** ** |
| **Einstein Bros. Bagels:**               | ** ** | ** **  | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** |
| 2005                                     |       | 363         |       | 57           |       | —         |       | 420        |       |
| 2004                                     |       | 373         |       | 46           |       | —         |       | 419        |       |
| **Einstein Bros. Cafe:**                 | ** ** | ** **  | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** |
| 2005                                     |       | 7           |       | —       |       | —         |       | 7          |       |
| 2004                                     |       | —      |       | —       |       | —         |       | —     |       |
| **Noah’s:**                         |       |        |       |         |       |           |       |       |       |
| 2005                                     |       | 76          |       | 3            |       | —         |       | 79         |       |
| 2004                                     |       | 82          |       | 3            |       | —         |       | 85         |       |
| **Manhattan:**                           |       |        |       |         |       |           |       |       |       |
| 2005                                     |       | —      |       | —       |       | 138            |       | 138        |       |
| 2004                                     |       | —      |       | —       |       | 171            |       | 171        |       |
| **Chesapeake:**                          |       |        |       |         |       |           |       |       |       |
| 2005                                     |       | —      |       | —       |       | 25             |       | 25         |       |
| 2004                                     |       | —      |       | —       |       | 41             |       | 41         |       |
| **New World Coffee/Willoughby’s*:** |       |        |       |         |       |           |       |       |       |
| 2005                                     |       | 3           |       | —       |       | 7              |       | 10         |       |
| 2004                                     |       | 8           |       | —       |       | 11             |       | 19         |       |
| **Total Restaurants:**                   |       |        |       |         |       |           |       |       |       |
| 2005                                     |       | 449         |       | 60           |       | 170            |       | 679        |       |
| 2004                                     |       | 463         |       | 49           |       | 223            |       | 735        |       |

 

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*On October 6, 2004, we sold Willoughby’s. The Willoughby’s business consisted of acoffee roasting plant, three retail locations and office space.

 

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**Results ofOperations**

 

Thistable sets forth, for the periods indicated, certain amounts included in our consolidatedstatements of operations, the relative percentage that those amounts representto total revenue (unless otherwise indicated), and the percentage change inthose amounts from period to period. All percentages are calculated usingactual amounts rounded to the nearest thousand. 

 
| ** **                                                    | ** ** | ** **                       | ** ** | ** **     | ** ** | **Increase** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|----------------|------------|--------------|------------|
| ** **                                                    | ** ** | **For the first quarter ended:** | ** ** | **(Decrease)** | ** ** |
| ** **                                                    | ** ** | **(percent of total revenue)**   | ** ** | **2005**       | ** ** |
| ** **                                                    | ** ** | **2005**                         | ** ** | **2004**       | ** ** | **vs. 2004** | ** ** |
| Revenues:                                                     |       |                             |       |           |       |         |       |
| Retail sales                                                  |       | 93.1                             | %          | 92.8           | %          | 2.6          | %          |
| Manufacturing revenues                                        |       | 5.4                              | %          | 5.9            | %          | (7.7         | )%         |
| Franchise and license related revenues                        |       | 1.5                              | %          | 1.3            | %          | 24.3         | %          |
| Total revenues                                                |       | 100.0                            | %          | 100.0          | %          | 2.3          | %          |
|                                                          |       |                             |       |           |       |         |       |
| Cost of sales:                                                |       |                             |       |           |       |         |       |
| Retail costs                                                  |       | 76.6                             | %          | 76.9           | %          | 1.9          | %          |
| Manufacturing costs                                           |       | 5.0                              | %          | 5.0            | %          | 2.8          | %          |
| Total cost of sales                                           |       | 81.6                             | %          | 81.9           | %          | 2.0          | %          |
|                                                          |       |                             |       |           |       |         |       |
| Gross profit:                                                 |       |                             |       |           |       |         |       |
| Retail                                                        |       | 16.5                             | %          | 15.9           | %          | 6.1          | %          |
| Manufacturing                                                 |       | 0.3                              | %          | 0.9            | %          | (65.6        | )%         |
| Franchise and license                                         |       | 1.5                              | %          | 1.3            | %          | 24.3         | %          |
| Total gross profit                                            |       | 18.4                             | %          | 18.1           | %          | 3.8          | %          |
|                                                          |       |                             |       |           |       |         |       |
| General and administrative expenses                           |       | 9.3                              | %          | 9.7            | %          | (1.6         | )%         |
| Depreciation and amortization                                 |       | 7.2                              | %          | 7.5            | %          | (1.6         | )%         |
| Loss (gain) on sale, disposal or  abandonment of assets, net  |       | 0.0                              | %          | (0.0           | )%         |         | *          |
| Charges (adjustments) of integration and  reorganization cost |       | (0.0                             | )%         | (0.8           | )%         |         | *          |
| Impairment charges and other related costs                    |       | 0.1                              | %          | 0.0            | %          |         | *          |
| Income (loss) from operations                                 |       | 1.8                              | %          | 1.8            | %          | 0.2          | %          |
| Other expense (income):                                       |       |                             |       |           |       |         |       |
| Interest expense, net                                         |       | 6.3                              | %          | 6.4            | %          | 2.1          | %          |
| Other                                                         |       | (0.1                             | )%         | (0.1           | )%         | (9.5         | )%         |
| Loss before income taxes                                      |       | (4.5                             | )%         | (4.5           | )%         | 3.0          | %          |
|                                                               |            |                                  |            |                |            |              |            |  |

 

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* not meaningful

 

*Revenues*

 

**Totalrevenues for the first quarter ended 2005 were consistent with ourexpectations. Our total revenues increased 2.3% when compared to the firstquarter ended 2004. This increase primarily resulted from an increase in retailsales (e.g. company-operated store sales which represent the most significantcomponent of revenue).  Our retailcomparable store sales increase of 4.6% consisted of a 6.4% increase in averagecheck partially offset by a 1.7% reduction in transactions. The increasesexperienced in average check were primarily related to a price increase coupledwith a shift in product mix to higher priced items. Comparable store salesrepresent sales at stores that were open for one full year and have not beenrelocated or closed during the current year. Comparable store sales are alsoreferred to as “same-store” sales and as “comp sales” within the restaurantindustry.**

 

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**Throughoutfiscal 2004, the trend of lower comparable store sales began to reverse andultimately became positive during the fourth quarter of 2004. The followingtable summarizes the elements of comparable store sales for each quarter infiscal 2004 and the first quarter ended 2005:**

** **
| ** **                  | ** ** | **Comparable**  | ** ** | **Average** | ** ** | ** **       | ** ** |
|-----------------------------|------------|-----------------|------------|-------------|------------|------------------|------------|
| **Period**                  | ** ** | **Store Sales** | ** ** | **Check**   | ** ** | **Transactions** | ** ** |
| First quarter, fiscal 2004  |       | (4.8            | )%         | 0.7         | %          | (5.5             | )%         |
| Second quarter, fiscal 2004 |       | (3.7            | )%         | 3.9         | %          | (7.3             | )%         |
| Third quarter, fiscal 2004  |       | (1.6            | )%         | 5.0         | %          | (6.3             | )%         |
| Fourth quarter, fiscal 2004 |       | 2.6             | %          | 5.2         | %          | (2.5             | )%         |
| First quarter, fiscal 2005  |       | 4.6             | %          | 6.4         | %          | (1.7             | )%         |

** **

**Webelieve the positive trend in comparable store sales is a result of priceincreases coupled with a shift in the product mix to higher priced items,improvements in the operation of our restaurants including initiatives incustomer service and overall store appearance, the introduction of new menuitems, further development of catering programs in selected markets, andadvertising campaigns that were initiated in the fourth quarter ended 2004 thatstrengthened consumer awareness.**

 

*Gross Profit*

 

Ourtotal gross profit increased 3.8% for the first quarter ended 2005 whencompared to the first quarter ended 2004. This increase was primarily due to animprovement of 6.1% in our retail margins. Our retail margins are impacted byvarious store-level operating expenses such as the cost of products sold,salaries and benefits, insurance, supplies, repair and maintenance expenses,advertising, rent, utilities and property taxes. Similarly, our manufacturingmargins are impacted by various manufacturing-level operating expenses such asthe cost of products sold, salaries and benefits, insurance, supplies, repairand maintenance expenses, rent, utilities and property taxes. Depreciation,amortization and income taxes do not impact our retail or manufacturingmargins.

 

Forthe first quarter ended 2005, approximately $1.4 million of the improvement weexperienced in retail margins was due to improvements in labor utilization andreductions in group insurance and workers’ compensation claims, offset by anincrease of approximately $0.6 million in bonus wages payable to various levelsof restaurant managers due to improved operating performance.

 

Forthe first quarter ended 2005, our manufacturing margins decreased 65.6% whencompared to first quarter ended 2004. Manufacturing margins for the firstquarter ended 2005 were predominately impacted by increases in commodity costs.We are striving to identify cost reduction solutions to offset the impact ofincreases in commodity costs. However, our manufacturing operations areancillary to our company-operated stores and for the first quarters ended 2005and 2004, our manufacturing margins represented less than 1% of total revenues.

 

*Other Operating Expenses*

 

**Ourgeneral and administrative expenses decreased 1.6% for the first quarter ended2005 when compared to the first quarter ended 2004. The first quarter ended2004 included a charge of approximately $0.2 million related to non-performanceunder certain lease guarantees entered into prior to 2001. The first quarterended 2005 included a reduction of approximately $0.6 million in legal spendingrelated to former employee matters that were resolved in early 2005 (as morefully discussed in note 9 to our consolidated financial statements), offset byan increase of approximately $0.8 million in bonus wages payable to corporateoffice staff due to improved operating performance.**

 

Depreciationand amortization expenses decreased 1.6% for the first quarter ended 2005 whencompared to the first quarter ended 2004. The slight decrease is primarily dueto a portion of our asset base becoming fully depreciated.

 

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Duringthe latter part of fiscal 2004, we spent additional capital on existing stores,which will result in a corresponding increase in our depreciable asset base,and thus depreciation expense.

 

Theadjustment of integration and reorganization cost primarily representsadjustments to previously recorded liabilities associated with the closing andcorporate consolidation of our Eatontown facilities during 2002. During April2004, we reached an agreement with the landlord of our Eatontown facility tosettle outstanding litigation. Previously recorded integration andreorganization estimates associated with closing this facility resulted in abenefit of $700,000 during the first quarter ended 2004 as a result of thissettlement.

 

**Liquidityand Capital Resources**

 

Priorto 2004, we relied upon our major preferred and common stockholders to provideus with supplemental financing at times when our cash flows from operationshave been insufficient to cover our capital requirements or the requirements ofother debt. During the past six quarters, we have generated sufficient cashflow to fund operations, capital expenditures and required debt and interestpayments. The restaurant industry is predominantly a cash business where cashis received at the time of the transaction. We have a minimal amount ofaccounts receivable, which are predominantly from our franchisees, licenseesand distributors. Additionally, our investment in inventory is minimal sinceour products are perishable. Our accounts payable are on terms that we believeare consistent with those of other companies within the industry.

 

Theprimary driver of our operating cash flow is our restaurant operations,specifically the gross margin from our company-operated restaurants. Therefore,we focus on the elements of those operations including comparable store salesto ensure a steady stream of operating profits that enable us to meet our cashobligations. On a weekly basis, we review our company-operated storeperformance compared with the same period in the prior year and our operatingplan. We are continuously identifying and implementing cost reductioninitiatives, not only at the store operations level, but also within otherdisciplines such as supply chain, manufacturing operations and overhead.  During 2005, we will continue to identifycost reduction initiatives, including but not limited to: menu optimization toremove and/or modify inefficient products and thus reduce waste, reductions incost of goods sold through purchasing efficiencies and further refinement ofprograms that monitor theoretical food cost.

 

*Credit Facility*

 

OurAmSouth Revolver is a $15 million senior secured revolving credit facility,which matures on July 8, 2006. On March 29, 2005, our unused credit facilitytotaled approximately $8.9 million, net of outstanding letters of credit of$6.1 million. Our credit facility contains financial covenants relating to themaintenance of leverage and coverage ratios. The credit facility also containsaffirmative and negative covenants including, among other things, limitationson certain additional indebtedness, capital expenditures and minimum EBITDA asdefined in the AmSouth agreement. We were in compliance with all covenants atMarch 29, 2005 and do not anticipate that the covenants will impact our abilityto borrow under our credit facility for its remaining term.

 

Basedupon our projections for fiscal 2005 and beyond, we believe that the cash flowfrom operations coupled with the continued availability of our AmSouth Revolverwill be adequate to fund our operations, capital expenditures and required debtand interest repayments for the foreseeable future.

 

Infirst quarter 2005, we engaged Bear Stearns, investment bankers, to assist usin the potential refinancing of our $160 Million Notes and the AmSouthRevolver. We believe that refinancing this outstanding debt at a favorableinterest rate could increase our letter of credit capacity, reduce interestexpense and provide additional flexibility for future store growth.

 

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*OperatingActivities*

 

Duringthe first quarter ended 2005, operations consumed $6.3 million of cash. Thecash consumption was primarily attributable to a semi-annual interest paymentof $10.4 million under our $160 Million Notes. We believe we will seeimprovements in our cash flow from operations during 2005 and that such cashflow will be adequate to fund operating costs. Due to the timing of interestpayments under our $160 Million Notes, which are due January 1 and July 1, wegenerally consume cash from operations during the first and third fiscalquarters of each year. During the second and fourth fiscal quarters of eachyear, we generally generate cash from operations. Historically, our fourthquarter is our strongest quarter for generating cash due to seasonality andgift card promotions.

 

*InvestingActivities*

 

Duringthe first quarter ended 2005, we used approximately $2.2 million of cash topurchase additional property and equipment which included $0.2 million for newstores, $0.3 million for retrofit of existing stores to the Café concept, $1.1million for replacement and new equipment at our existing company-operatedstores, $0.5 million for our manufacturing operations and less than $0.1million for general corporate purposes.

 

Inan effort to strengthen performance of our company-operated Einstein Bros.locations, we have developed a focused brand enhancement strategy with two keyelements. The first element involves the continuation of opening new,next-generation, quick casual concept Einstein Bros. Café restaurants. Customerresearch and feedback is being utilized to fine-tune the look, feel and brandpositioning of the Café concept. The second element will concentrate onimproving the performance of the existing Einstein Bros. Bagels restaurants byincorporating the most successful aspects of the Café concept in the majority oflocations. These efforts will include updates of restaurant interiors andimprovements to service through new menu boards and a “pay first” orderingsystem. To support this strategy, our capital expenditure program will befocused on Einstein Bros. Bagels’ remodeling efforts and targeted openings ofnew Einstein Bros. Cafés.  We intend toimplement the enhancements in a significant number of Einstein Bros. storesduring fiscal years 2005 to 2007 at an average cost of approximately $60,000per location related to retrofit costs, while continuing to open a number ofEinstein Bros. Cafés.  Both programs areestimated to have a payback period of less than 2.5 years.

 

*ContractualObligations*

 

Therewere no material changes to our contractual obligations during the firstquarter ended 2005. For information regarding our contractual obligations atDecember 28, 2004, see our Annual Report on Form 10-K for the fiscal year endedDecember 28, 2004.

 

*Guarantees*

 

Priorto 2001, we would occasionally guarantee leases for the benefit of certain ofour franchisees. None of the guarantees have been modified since theirinception and we have since discontinued this practice. Current franchisees arethe primary lessees under the vast majority of these leases. Under the lease guarantees,we may be required by the lessor to make all of the remaining monthly rentalpayments or property tax and common area maintenance payments if the franchiseedoes not make the required payments in a timely manner. However, we believethat most, if not all, of the franchised locations could be subleased to thirdparties minimizing our potential exposure. Additionally, we haveindemnification agreements with our franchisees under which the franchiseeswould be obligated to reimburse us for any amounts paid under such guarantees.Historically, we have not been required to make such payments in significantamounts. We record a liability for our exposure under the guarantees inaccordance with SFAS No. 5, “Accounting for Contingencies,” following a probabilityrelated approach. In the event that trends change in the future, our financialresults could be impacted. As of March 29, 2005, we had outstanding guaranteesof indebtedness under certain leases of approximately $1.3 million.

 

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* *

*Insurance*

 

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

 

*Non-GAAPFinancial Measures*

 

AdjustedEBITDA is a typical non-GAAP measurement for companies that issue public debtand a measure used by our lenders. Adjusted EBITDA, as defined in our IndentureAgreement relating to the $160 Million Notes and the revolving credit facilitywith AmSouth Bank (collectively referred to herein as our loan agreements)represents earnings before interest, taxes, depreciation and amortization, andis further adjusted by various items including: (1) integration andreorganization charges and credits, (2) cumulative change in fair value ofderivatives, (3) gain/loss on the investment, sale, disposal or exchange ofassets, (4) impairment and other related charges and (5) other income. AdjustedEBITDA may also be further adjusted by certain legal, financing and advisoryfees, acquisition and integration expenses, and other unusual charges. Our loanagreements require that Adjusted EBITDA be measured on a twelve month periodending on the last day of each fiscal quarter and be greater than $33 million.We present Adjusted EBITDA because it relates to a covenant contained in eachof our loan agreements which are material to us, our financial condition andliquidity. If we do not comply with the Adjusted EBITDA covenant, an Event ofDefault (as defined in our loan agreements) would occur and, subject to theapplicable notice and cure periods, the lenders could declare all amountsoutstanding immediately due and payable and pursue all available remedies forpayment of such amounts.  As of March 29,2005, we were in compliance with the Adjusted EBITDA covenant and we do notanticipate that the covenant will impact our ability to borrow under theAmSouth revolving credit facility.

 

Dataregarding Adjusted EBITDA is provided as additional information to help ourbondholders understand our compliance with the Adjusted EBITDA covenant. Wealso believe Adjusted EBITDA is useful to our bondholders as an indicator ofearnings available to service debt. Adjusted EBITDA is not a recognized term under GAAP and does not purportto be an alternative to income (loss) from operations, an indicator of cashflow from operations or a measure of liquidity. Because not all companiescalculate Adjusted EBITDA identically, this presentation may not be comparableto similarly titled measures of other companies. We believe Adjusted EBITDA is amore meaningful indicator of earnings available to service debt when certaincharges (such as the gain or loss from the disposal of assets, impairment ofassets and cumulative change in the fair value of derivatives) are excludedfrom income (loss) from continuing operations. Adjusted EBITDA is not intendedto be a measure of free cash flow for management’s discretionary use, as itdoes not consider certain cash requirements such as interest expense, incometaxes, debt service payments and cash costs arising from integration andreorganization activities.

 

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Thefollowing tables reconcile Adjusted EBITDA to net loss and cash flows used inoperating activities, respectively:

 
| ** **                                                    | ** ** | **First quarter ended:** | ** ** |
|---------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                    | ** ** | **2005**                 | ** ** | **2004** | ** ** |
| **Reconciliation of Net Loss to Adjusted EBITDA:**            |       |                     |       |   |   |
| Net loss                                                      |       | $                        | (4,198     | ) | $ | (4,130 | ) |
| Adjustments as defined in the loan  agreements:               |       |                     |       |   |   |
| Interest expense, net                                         |       | 5,919                    |       | 5,799 |   |
| Taxes                                                         |       | —                   |       | 55 |   |
| Depreciation and amortization                                 |       | 6,708                    |       | 6,819 |   |
| Loss (gain) on sale, disposal or  abandonment of assets, net  |       | 4                        |       | (7 | ) |
| Charges (adjustments) of integration and  reorganization cost |       | 5                        |       | (760 | ) |
| Impairment charges and other related costs                    |       | 97                       |       | — |   |
| Other expense (income)                                        |       | (57                      | )          | (63 | ) |
| Certain legal, financing and advisory fees                    |       | —                   |       | 75 |   |
| Certain corporate expenses                                    |       | —                   |       | 225 |   |
| Certain other charges                                         |       | —                   |       | 25 |   |
| Adjusted EBITDA                                               |       | $                        | 8,478      |   | $ | 8,038 |   |

 
| ** **                                                                       | ** ** | **First  quarter ended:** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                                       | ** ** | **2005**                  | ** ** | **2004** | ** ** |
| **Reconciliation of Net Cash Used in  Operating Activities to Adjusted EBITDA:** |       |                      |       |   |   |
| Net cash used in operating activities                                            |       | $                         | (6,288     | ) | $ | (4,176 | ) |
| Adjustments as defined in the loan  agreements:                                  |       |                      |       |   |   |
| Changes in operating assets and liabilities                                      |       | 9,292                     |       | 6,560 |   |
| Provision for (recovery of) losses on accts  receivable                          |       | 91                        |       | — |   |
| Amortization of debt issue costs                                                 |       | (462                      | )          | (462 | ) |
| Stock based compensation expense                                                 |       | (17                       | )          | — |   |
| Interest expense, net                                                            |       | 5,919                     |       | 5,799 |   |
| Other income                                                                     |       | (57                       | )          | (63 | ) |
| Provision (benefit) for state income taxes                                       |       | —                    |       | 55 |   |
| Certain legal, financing and advisory fees                                       |       | —                    |       | 75 |   |
| Certain corporate expenses                                                       |       | —                    |       | 225 |   |
| Certain other charges                                                            |       | —                    |       | 25 |   |
| Adjusted EBITDA                                                                  |       | $                         | 8,478      |   | $ | 8,038 |   |

 

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### ***Risk Factors***

####  

Wewish to caution our readers that the following important factors, among others,could cause the actual results to differ materially from those indicated byforward-looking statements made in this report and from time to time in newsreleases, reports, proxy statements, registration statements and other writtencommunications, as well as verbal forward-looking statements made from time totime by representatives of the company. Such forward-looking statements involverisks and uncertainties that may cause our actual results, performance orachievements to be materially different from any future performance orachievements expressed or implied by these forward-looking statements. Factorsthat might cause actual events or results to differ materially from thoseindicated by these forward-looking statements include, but are not limited to(i) future economic performance, (ii) success of cost reduction initiatives,(iii) the refinancing of our debt, (iv) restaurant openings or closings, (v)openings and conversions to Einstein Bros. Café, (vi) our ability toincorporate elements of Einstein Bros. Café to improve performance of existingEinstein Bros. Bagels, (vii) our ability to identify new markets and locations,(viii) our ability to execute our franchise strategy, (ix)operating margins,(x) the availability of acceptable real estate locations, (xi) the success andconsumer acceptance of our Einstein Bros. Café, (xii) our ability toappropriately allocate capital expenditures to our Einstein Bros. Bagels andEinstein Bros. Café, (xiii) the sufficiency of our cash balances, (xiv) cashgenerated from operating and financing activities for our future liquidity andcapital resource needs, and (xv) other matters, and are generally accompaniedby words such as: believes, anticipates, estimates, predicts, expects, andsimilar expressions that convey the uncertainty of future events or outcomes.An expanded discussion of some of these risks factors follows. You should alsorefer to the other information set forth in our Annual Report on Form 10-K forthe fiscal year ended December 28, 2004, including our consolidated financialstatements and the related notes.

 

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

 

Oursuccess depends in part on our ability to understand our customers’ needs. We believesuccessful deployment of our current business strategy will address customers’needs and contribute to overall company growth. While we believe our newEinstein Bros. Café concept and even elements of that concept will strengthenthe performance of our Einstein Bros. brand, its success is dependent uponvarious factors, including customer acceptance of new menu offerings andpricings, the look and feel of the restaurant, and the new service system. Inaddition, the availability of capital and opportunities to make modificationsto existing stores will be significant factors in the success of our businessstrategy. If we improperly perceive customers’ needs and/or are not successfulin implementing any or all of the initiatives of our business strategy, itcould have a material adverse effect on our business, results of operations,and financial condition.

 

*We haveand expect to continue to have a substantial amount of debt.*

 

Wehave a high level of debt and are highly leveraged. In addition, we may, subjectto certain restrictions, incur substantial additional indebtedness in thefuture. Our high level of debt, among other factors, could:

 

•      make it difficult for us to satisfy ourobligations under our indebtedness;

•      limit our ability to obtain additionalfinancing for working capital, capital expenditures, acquisitions and generalcorporate purposes;

•      increase our vulnerability to downturns inour business or the economy generally;

•      limit our ability to withstand competitivepressures from our less leveraged competitors; and

•      harm us because a failure by us to complywith the covenants in the instruments and agreements governing our indebtednesscould result in an event of default that, if not cured or waived, could resultin all of our indebtedness becoming immediately due and payable, which couldrender us insolvent.

 

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Our AmSouth Revolver and$160 Million Notes expire in July 2006 and July 2008, respectively. In firstquarter 2005, we engaged Bear Stearns, investment bankers, to assist us inrefinancing our $160 Million Notes and the AmSouth Revolver. We believe thatrefinancing this outstanding debt could increase our letter of credit capacity,reduce interest expense and provide additional flexibility for future storegrowth. There can be no assurance that we will be successful in our refinancingefforts or that refinancing will be on terms that are more favorable to us.

 

*We maynot be able to generate sufficient cash flow to make payments on our indebtedness.*

 

Economic,financial, competitive, legislative and other factors beyond our control mayaffect our ability to generate cash flow from operations to make payments onour indebtedness, including the $160 Million Notes, and to fund necessary workingcapital. A significant reduction in operating cash flow would likely increasethe need for alternative sources of liquidity. If we are unable to generatesufficient cash flow to make payments on our debt, we will have to pursue oneor more alternatives, such as reducing or delaying capital expenditures,refinancing our debt on terms that are not favorable to us, selling assets orraising equity. We may not be able to accomplish any of these alternatives onsatisfactory terms, if at all, and even if accomplished, they may not yieldsufficient funds to service our debt.

 

*We arevulnerable to changes in consumer preferences and economic conditions thatcould harm our financial results.*

 

Foodservice businesses are often affected by changes in consumer tastes, dietarytrends, national, regional and local economic conditions and demographictrends. Factors such as traffic patterns, local demographics and the type,number and location of competing restaurants may adversely affect theperformance of individual locations. Shifts in consumer preferences away fromour type of cuisine and/or the quick casual style could have a material adverseaffect on our results of operations. We believe that the trend towardconsumption of food low in carbohydrate content may have had and may continueto have a negative impact on our sales and revenues. In addition, increasedfood, labor and energy costs have affected our results and may, in the future,together with inflation, harm the restaurant industry in general and our locationsin particular. Adverse changes in any of these factors could reduce consumertraffic or impose practical limits on pricing, which could harm our businessprospects, financial condition, operating results and cash flow. Our continuedsuccess will depend in part on our ability to anticipate, identify and respondto changing consumer preferences and economic conditions.

 

*Thereis intense competition in the restaurant industry for personnel, real estate,advertising space, and customers, among other things.*

 

Ourindustry is intensely competitive and there are many well-establishedcompetitors with substantially greater financial and other resources than wehave. In addition to current competitors, one or more new major competitorswith substantially greater financial, marketing and operating resources couldenter the market at any time and compete directly against us. In addition, invirtually every major metropolitan area in which we operate or expect to enter,local, regional or national competitors already exist. This may make it moredifficult to obtain real estate, advertising space, and retain customers andpersonnel.

 

*We arevulnerable to fluctuations in the cost, availability and quality of our rawingredients.*

 

Thecost, availability and quality of the ingredients we use to prepare our foodare subject to a range of factors, many of which are beyond our control.Fluctuations in economic and political conditions, weather and demand couldadversely affect the cost of our ingredients. We have limited control overfluctuations in the price and quality of commodities, and we may not be able topass through any cost increases to our customers. We are dependent on frequentdeliveries of fresh ingredients, thereby subjecting us to the risk of shortagesor interruptions in supply. All of these factors could adversely affect ourbusiness and financial results.

 

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*Weheavily depend on our suppliers and distributors.*

 

Wecurrently purchase our raw materials from various suppliers. We purchase amajority of our frozen bagel dough from one supplier (who utilizes ourproprietary processes), which we are dependent upon in the short-term.Additionally, we purchase all of our cream cheese from a single source. Thoughto date we have not experienced significant difficulties with our suppliers,our reliance on our suppliers subjects us to a numberof risks, 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, such disruptions in supplyor degradations in quality could have a long-term detrimental impact on ourefforts to develop a strong brand identity and a loyal consumer base.

 

Wedepend on our network of six regional custom distributors to distribute frozenbagel dough and other materials to our locations. If any one or more of thesedistributors fails to perform as anticipated, or if there is any disruption inany of our distribution relationships for any reason, it could have a materialadverse effect on our business, financial condition and results ofoperations.  We are continuallyevaluating our distribution network to ensure it meets our internal criteriawith respect to improved quality and service. In the event that certaindistributors fail to meet our internal criteria, we could incur an increase indistribution costs.

 

*Increasinglabor costs could adversely affect our continued profitability.*

 

Weare dependent upon an available labor pool of employees, many of whom arehourly employees whose wages may be affected by an increase in the federal orstate minimum wage. Numerous proposals have been made on federal, state andlocal levels to increase minimum wage levels. Although few, if any, of ouremployees are paid at the minimum wage level, an increase in the minimum wage maycreate pressure to increase the pay scale for our employees, which wouldincrease our labor costs and those of our franchisees and licensees. A shortagein the labor pool or other general inflationary pressures or changes could alsoincrease labor costs. In addition, changes in labor laws or reclassificationsof employees from management to hourly employees could affect our labor cost.For example, federal overtime regulations under the Fair Labor Standards Act,which went into effect on August 23, 2004, may impact the classification ofseveral of our positions. We are continuing to evaluate the specific impact ofthese changes. An increase in labor costs could have a material adverse effecton our income from operations and decrease our profitability and cash availableto service our debt obligations if we are unable to recover these increases byraising the prices we charge our customers.

 

*We facethe risk of adverse publicity and litigation in connection with our operations.*

 

Weare from time to time the subject of complaints or litigation from ourconsumers alleging illness, injury or other food quality, health or operationalconcerns. Adverse publicity resulting from these allegations may materiallyadversely affect us, regardless of whether the allegations are valid or whetherwe are liable. In addition, employee claims against us based on, among otherthings, discrimination, harassment or wrongful termination may divert financialand management resources that would otherwise be used to benefit our futureperformance. We have been subject to claims from time to time, and althoughthese claims have not historically had a material impact on our operations, asignificant increase in the number of these claims or the number that aresuccessful could materially adversely affect our business, prospects, financialcondition, operating results or cash flows.

 

*We relyin part on our franchisees.*

 

Werely in part on our franchisees and the manner in which they operate theirlocations to develop and promote our business. Although we have developedcriteria to evaluate and screen prospective franchisees, franchisees may nothave the business acumen or financial resources necessary to operate successfulfranchises in their franchise areas. The failure of franchisees to operatefranchises successfully could have a material adverse effect on us, our abilityto collect royalties, our reputation, our brands and our ability to attractprospective franchisees.

 

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*We facerisks associated with government regulation.*

 

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

 

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

 

Undervarious federal, state and local laws, an owner or operator of real estate maybe liable for the costs of removal or remediation of certain hazardous or toxicsubstances on or in such property. Such liability may be imposed without regardto whether the owner or operator knew of, or was responsible for, the presenceof such hazardous or toxic substances. Although we are not aware of anyenvironmental conditions that require remediation by us under federal, state orlocal law at our properties, we have not conducted a comprehensiveenvironmental review of our properties or operations. We may not have identifiedall of the potential environmental liabilities at our properties, and any suchliabilities that are identified in the future may have a material adverseeffect on our financial condition.

 

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

 

Webelieve that our trademarks, service marks and other proprietary rights areimportant to our success and our competitive position. Accordingly, we devotesubstantial resources to the establishment and protection of our trademarks,service marks and proprietary rights. However, the actions we take may beinadequate to prevent imitation of our products and concepts by others or toprevent others from claiming violations of their trademarks and proprietaryrights by us. In addition, others may assert rights in our trademarks, servicemarks and other proprietary rights.

 

*We have a majority stockholder.*

 

GreenlightCapital, L.L.C. and its affiliates beneficially own approximately 97 percent ofour common stock on a fully diluted basis. As a result, Greenlight hassufficient voting power, without the vote of any other stockholders, todetermine what matters will be submitted for approval by our stockholders, toapprove actions by written consent without the approval of any other stockholders,to elect all of our board of directors, and among other things, to determinewhether a change in control of our company occurs. Greenlight’s interests onmatters submitted to stockholders may be different from those of otherstockholders. Greenlight is not involved in our day-to-day operations, butGreenlight has voted its shares to elect our current board of directors. Thechairman of our board of directors is a current employee of Greenlight.

 

Ourcommon stock is not currently listed on any stock exchange or Nasdaq. As a result, we are not subject to corporategovernance rules adopted by the New York Stock Exchange, American StockExchange and Nasdaq requiring a majority of directorsto be independent and requiring compensation and nominating committees that arecomposed solely of independent directors. However, we are subject to rulesrequiring that the audit committee consist entirely of independent directors.Under the rules of these stock exchanges and Nasdaq, if a single stockholderholds more that 50% of the voting power of a listed company, that company isconsidered a controlled company, and except for the rules relating toindependence of the audit committee, is exempt from the above-mentionedindependence rules. Because Greenlight beneficially owns approximately 97percent of our common stock, we may take advantage of the controlled companyexemption if our common stock becomes listed on an exchange or Nasdaq in the future. As a result, our stockholderscurrently do not have, and may never have, the protections that these rules areintended to provide.

 

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

 

Ifa substantial number of shares of our common stock are sold in the publicmarket, the market price of our common stock could fall.  The perception among investors that thesesales will occur could also produce this effect.  Our majority stockholder Greenlightbeneficially owns approximately 97 percent of our common stock and sales byGreenlight or a perception that Greenlight will sell could cause a decrease inthe market price of our common stock. Additionally, holders of outstandingwarrants may convert and sell the underlying shares in the public market.Pursuant to our obligations under registration rights agreements, we haveregistered 957,872 shares of common stock underlying certain warrants, of whichGreenlight owns warrants to purchase approximately 493,683 shares of our commonstock. Sales of shares or a perception that there will be sales of theunderlying shares could also cause a decrease in the market price of our commonstock.

 

*Holdersmay find it difficult to effect transactions in our common stock.*

 

Our common stockis currently quoted on the “pink sheets” under the symbol “NWRG.PK.” Since ourcommon stock is not listed on Nasdaq, the American Stock Exchange or the NewYork Stock Exchange, holders of our common stock may find that the liquidity ofour common stock is impaired – not only in the number of securities that can bebought and sold, but also through delays in the timing of transactions,reduction in security analysts’ and the news media’s coverage of us, and lowerprices for our securities than might otherwise be attained.

 

Securities thatare not listed on a stock exchange, the Nasdaq National Market or the NasdaqSmallCap Market are subject to an SEC rule that imposes special requirements onbroker-dealers who sell those securities to persons other than theirestablished customers and accredited investors. The broker-dealer mustdetermine that the security is suitable for the purchaser and must obtain thepurchaser’s written consent prior to the sale. These requirements may make itmore difficult for stockholders to sell our stock than the stock of some othercompanies. It may also affect our ability to raise more capital if and whennecessary.

 

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**Item 3.****  Qualitative andQuantitative Disclosures About Market Risk**

 

Duringthe first quarter ended 2005 and 2004, our results of operations, financialposition and cash flows were not affected by changes in the relative values ofnon-U.S. currencies to the U.S. dollar. We do not use derivative financialinstruments to limit our foreign currency risk exposure since virtually all ofour business is conducted in the United States.

 

Ourdebt at March 29, 2005 and March 28, 2004 was principally comprised of the $160Million Notes due July 1, 2008 and the AmSouth Revolver. A 100 basis pointincrease in market interest rates would have an immaterial effect on ourborrowing costs, since the interest rate on the $160 Million Notes is fixed.The interest rate on the AmSouth Revolver fluctuates with changes in the primerate, but is immaterial in relation to interest expense under the $160 MillionNotes and in our results of operations and financial condition.

 

Wepurchase certain commodities such as butter, cheese, coffee and flour. Thesecommodities are generally purchased based upon market prices established withvendors. These purchase arrangements may contain contractual features thatlimit the price paid by establishing certain price floors or caps. We do notuse financial instruments to hedge commodity prices because these purchase arrangementshelp control the ultimate cost paid and any commodity price aberrations aregenerally short-term in nature.

 

Thismarket risk discussion contains forward-looking statements. Actual results maydiffer materially from this discussion based upon general market conditions andchanges in domestic and global financial markets.

 

**Item 4.****  Controls and Procedures**

 

Anevaluation was carried out under the supervision and with the participation ofcompany management, including our chief executive officer and chief financialofficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in rule 13a-15(e) under the SecuritiesExchange Act of 1934, as amended) as of March 29, 2005. Based upon thatevaluation, our chief executive officer and our chief financial officer haveconcluded that the design and operation of our disclosure controls andprocedures were effective in timely making known to them material informationrelating to the Company required to be disclosed in reports that we file orsubmit under the Exchange Act rules.

 

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

 

Duringthe quarter ended March 29, 2005, there were no significant changes to ourinternal controls over financial reporting that were identified in connectionwith the evaluation of our disclosure controls and procedures required by theExchange Act rules and that have materially affected, or are reasonably likelyto materially affect, our internal controls over financial reporting.

 

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**PART II - OTHERINFORMATION**

**NEWWORLD RESTAURANT GROUP, INC.**

 

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

 

Informationregarding legal proceedings is incorporated by reference from Note 9 to ourConsolidated Financial Statements set forth in Part I of this report.

 

**Item 6.****  Exhibits**

 

31.1         Certification by Chief Executive Officerpursuant to Exchange Act Rule 13a-15(e), as adopted pursuant to Section 302 ofthe Sarbanes-Oxley Act of 2002

 

31.2         Certification by Chief Financial Officerpursuant to Exchange Act Rule 13a-15(e), as adopted pursuant to Section 302 ofthe Sarbanes-Oxley Act of 2002

 

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

 

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

 

 

**Signatures**

 

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

 

 
|   |        | NEW WORLD RESTAURANT  GROUP, INC.                         |
|--------|-------------|-----------------------------------------------------------|
|   |        |                                                      |
|   |        |                                                      |
| Date:  | May 9, 2005 | By: /s/ PAUL J. B. MURPHY,  III                           |
|   |        | Paul J.B. Murphy, III                                     |
|   |        | Chief Executive Officer                                   |
|   |        |                                                      |
| Date:  | May 9, 2005 | By: /s/ RICHARD P.  DUTKIEWICZ                            |
|   |        | Richard P. Dutkiewicz                                     |
|   |        | Chief Financial Officer  and Principal Accounting Officer |

 

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