**UNITED STATES**

**SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-Q**

**(Mark One)**

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

**For the quarterly period ended July 3, 2007**

**OR**

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

**Commission File Number0-27148**

**Einstein NoahRestaurant Group, Inc.**

(Exact name of registrant as specified in its charter)

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

 

**(303) 568-8000**

(Registrant’s telephone number, including area code)

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

(Former name, former address and former fiscal year,if changed since last report)

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

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. 

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

 

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

As of August 2, 2007 there were 15,739,355 shares ofthe registrant’s Common Stock, par value of $0.001 per share outstanding.

 

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**EINSTEINNOAH RESTAURANT GROUP, INC.**

July 3, 2007

TABLE OF CONTENTS

 
|            | **Part I. Financial Information**                                                                                           | ** ** |
|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|
|       |                                                                                                                        |       |
| Item 1.    | Unaudited Financial Statements:                                                                                             |       |
|       |                                                                                                                        |       |
|       | Consolidated Balance Sheets, January 2, 2007 and July  3, 2007                                                              |       |
|       |                                                                                                                        |       |
|       | Consolidated Statements of Operations, for the second quarter  and year to date periods ended July 4, 2006 and July 3, 2007 |       |
|       |                                                                                                                        |       |
|       | Consolidated Statements of Cash Flows, for the year to  date periods ended July 4, 2006 and July 3, 2007                    |       |
|       |                                                                                                                        |       |
|       | Consolidated Statement of Changes in Stockholders’  Deficit, for the year to date period ended July 3, 2007            |       |
|       |                                                                                                                        |       |
|       | Notes to the Consolidated Financial Statements                                                                              |       |
|       |                                                                                                                        |       |
| Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                 |       |
|       |                                                                                                                        |       |
| Item 3.    | Quantitative  and Qualitative Disclosures about Market Risk                                                                 |       |
|       |                                                                                                                        |       |
| Item 4.    | Controls  and Procedures                                                                                                    |       |
|       |                                                                                                                        |       |
| ** ** | **Part  II. Other Information**                                                                                             | ** ** |
|       |                                                                                                                        |       |
| Item 1.    | Legal  Proceedings                                                                                                          |       |
|       |                                                                                                                        |       |
| Item 1A.   | Risk Factors                                                                                                                |       |
|       |                                                                                                                        |       |
| Item 4.    | Submission  of Matters to a Vote of Security Holders                                                                        |       |
|       |                                                                                                                        |       |
| Item 6.    | Exhibits                                                                                                                    |       |

 

2

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**EINSTEINNOAH RESTAURANT GROUP, INC.CONSOLIDATED BALANCE SHEETSAS OF JANUARY 2, 2007 AND JULY 3, 2007(in thousands, except share information)(unaudited)**
| ** **                                                                                                                                                               | ** ** | **January 2,** | ** ** | **July 3,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------|------------|
| ** **                                                                                                                                                               | ** ** | **2007**            | ** ** | **2007**         | ** ** |
| **ASSETS**                                                                                                                                                               | ** ** | ** **          | ** ** | ** **       | ** ** |
| Current assets:                                                                                                                                                          |       |                |       |             |       |
| Cash and cash  equivalents                                                                                                                                               |       | $                   | 5,477      |             | $          | 7,110 |   |
| Restricted cash                                                                                                                                                          |       | 2,403               |       | 1,715            |       |
| Franchise and  other receivables, net of allowance of $505 and $432, respectively                                                                                        |       | 6,393               |       | 6,010            |       |
| Inventories                                                                                                                                                              |       | 4,948               |       | 4,966            |       |
| Prepaid expenses  and other current assets                                                                                                                               |       | 4,529               |       | 4,780            |       |
| Assets held for  sale                                                                                                                                                    |       | 1,144               |       | —           |       |
| Total current  assets                                                                                                                                                    |       | 24,894              |       | 24,581           |       |
|                                                                                                                                                                     |       |                |       |             |       |
| Restricted cash  long-term                                                                                                                                               |       | 284                 |       | 278              |       |
| Property, plant  and equipment, net                                                                                                                                      |       | 33,889              |       | 38,733           |       |
| Trademarks and  other intangibles, net                                                                                                                                   |       | 63,806              |       | 63,806           |       |
| Goodwill                                                                                                                                                                 |       | 4,875               |       | 4,875            |       |
| Debt issuance  costs and other assets, net                                                                                                                               |       | 5,406               |       | 3,853            |       |
|                                                                                                                                                                     |       |                |       |             |       |
| Total assets                                                                                                                                                             |       | $                   | 133,154    |             | $          | 136,126 |   |
|                                                                                                                                                                     |       |                |       |             |       |
| **LIABILITIES AND STOCKHOLDERS’  DEFICIT**                                                                                                                          | ** ** | ** **          | ** ** | ** **       | ** ** |
| Current  liabilities:                                                                                                                                                    |       |                |       |             |       |
| Accounts payable                                                                                                                                                         |       | $                   | 3,347      |             | $          | 4,834 |   |
| Accrued expenses                                                                                                                                                         |       | 25,855              |       | 21,067           |       |
| Short term debt  and current portion of long-term debt                                                                                                                   |       | 3,605               |       | 1,180            |       |
| Current portion  of obligations under capital leases                                                                                                                     |       | 76                  |       | 77               |       |
|                                                                                                                                                                     |       |                |       |             |       |
| Total current  liabilities                                                                                                                                               |       | 32,883              |       | 27,158           |       |
|                                                                                                                                                                     |       |                |       |             |       |
| Senior notes and  other long-term debt, net of discount                                                                                                                  |       | 166,556             |       | 89,380           |       |
| Obligations  under capital leases                                                                                                                                        |       | 124                 |       | 84               |       |
| Other  liabilities                                                                                                                                                       |       | 8,822               |       | 8,591            |       |
| Mandatorily  redeemable, Series Z Preferred Stock, $.001 par value, $1,000 per share  liquidation value; 57,000 shares authorized; 57,000 shares issued and  outstanding |       | 57,000              |       | 57,000           |       |
|                                                                                                                                                                     |       |                |       |             |       |
| Total  liabilities                                                                                                                                                       |       | 265,385             |       | 182,213          |       |
|                                                                                                                                                                     |       |                |       |             |       |
| Commitments and  contingencies (see Note 10)                                                                                                                             |       |                |       |             |       |
|                                                                                                                                                                     |       |                |       |             |       |
| Stockholders’  deficit:                                                                                                                                             |       |                |       |             |       |
| Series A junior  participating preferred stock, 700,000 shares authorized; no shares issued  and outstanding                                                             |       |                |       |             |       |
| Common stock,  $.001 par value; 25,000,000 shares authorized; 10,596,419 and 15,739,355  shares issued and outstanding                                                   |       | 11                  |       | 16               |       |
| Additional  paid-in capital                                                                                                                                              |       | 176,797             |       | 262,055          |       |
| Accumulated  deficit                                                                                                                                                     |       | (309,039            | )          | (308,158         | )          |
|                                                                                                                                                                     |       |                |       |             |       |
| Total  stockholders’ deficit                                                                                                                                        |       | (132,231            | )          | (46,087          | )          |
|                                                                                                                                                                     |       |                |       |             |       |
| Total liabilities and  stockholders’ deficit                                                                                                                        |       | $                   | 133,154    |             | $          | 136,126 |   |

 

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

3

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**EINSTEIN NOAH RESTAURANT GROUP, INC.CONSOLIDATED STATEMENTS OF OPERATIONSFOR THE SECOND QUARTER AND YEAR TO DATE PERIODS ENDED JULY 4, 2006 AND JULY 3,2007(in thousands, except earnings per share and related share information)(unaudited)**
| ** **                                                        | ** ** | **Second quarter ended:** | ** ** | **Year to date ended:** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------|------------|----------------------------------------|------------|
| ** **                                                        | ** ** | **July 4,**                    | ** ** | **July 3,**                       | ** ** | **July 4,** | ** ** | **July 3,** | ** ** |
| ** **                                                        | ** ** | **2006**                            | ** ** | **2007**                               | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenues:                                                         |       |                                |       |                                   |       |   |   |   |   |
| Company-owned restaurant sales                                    |       | $                                   | 91,507     |                                   | $          | 94,141 |   | $ | 182,087 |   | $ | 183,256 |   |
| Manufacturing and commissary revenues                             |       | 5,196                               |       | 5,682                                  |       | 10,469 |   | 11,500 |   |
| Franchise and license related revenues                            |       | 1,253                               |       | 1,232                                  |       | 2,476 |   | 2,554 |   |
|                                                              |       |                                |       |                                   |       |   |   |   |   |
| Total revenues                                                    |       | 97,956                              |       | 101,055                                |       | 195,032 |   | 197,310 |   |
|                                                              |       |                                |       |                                   |       |   |   |   |   |
| Cost of sales:                                                    |       |                                |       |                                   |       |   |   |   |   |
| Company-owned restaurant costs                                    |       | 73,964                              |       | 75,257                                 |       | 147,490 |   | 146,589 |   |
| Manufacturing and commissary costs                                |       | 5,502                               |       | 5,380                                  |       | 10,507 |   | 10,802 |   |
|                                                              |       |                                |       |                                   |       |   |   |   |   |
| Total cost of  sales                                              |       | 79,466                              |       | 80,637                                 |       | 157,997 |   | 157,391 |   |
|                                                              |       |                                |       |                                   |       |   |   |   |   |
| Gross profit                                                      |       | 18,490                              |       | 20,418                                 |       | 37,035 |   | 39,919 |   |
|                                                              |       |                                |       |                                   |       |   |   |   |   |
| Operating  expenses:                                              |       |                                |       |                                   |       |   |   |   |   |
| General and administrative expenses                               |       | 9,727                               |       | 10,855                                 |       | 20,288 |   | 21,587 |   |
| Depreciation and amortization                                     |       | 5,594                               |       | 2,623                                  |       | 11,598 |   | 5,042 |   |
| Loss (gain) on sale, disposal or abandonment of  assets, net      |       | (8                                  | )          | 31                                     |       | 13 |   | 405 |   |
| Impairment charges and other related costs                        |       | 7                                   |       | 166                                    |       | 83 |   | 185 |   |
|                                                              |       |                                |       |                                   |       |   |   |   |   |
| Income from  operations                                           |       | 3,170                               |       | 6,743                                  |       | 5,053 |   | 12,700 |   |
| Other expense:                                                    |       |                                |       |                                   |       |   |   |   |   |
| Interest expense, net                                             |       | 4,712                               |       | 4,144                                  |       | 9,921 |   | 8,933 |   |
| Write-off of debt discount upon redemption of senior  notes       |       | —                              |       | 528                                    |       | — |   | 528 |   |
| Prepayment penalty upon redemption of senior notes                |       | —                              |       | 240                                    |       | 4,800 |   | 240 |   |
| Write-off of debt issuance costs upon redemption of  senior notes |       | —                              |       | 2,071                                  |       | 3,956 |   | 2,071 |   |
| Other                                                             |       | —                              |       | —                                 |       | 10 |   | — |   |
|                                                              |       |                                |       |                                   |       |   |   |   |   |
| Income (loss)  before income taxes                                |       | (1,542                              | )          | (240                                   | )          | (13,634 | ) | 928 |   |
|                                                              |       |                                |       |                                   |       |   |   |   |   |
| Provision for  income taxes                                       |       | —                              |       | 10                                     |       | — |   | 47 |   |
|                                                              |       |                                |       |                                   |       |   |   |   |   |
| Net income  (loss)                                                |       | $                                   | (1,542     | )                                      | $          | (250 | ) | $ | (13,634 | ) | $ | 881 |   |
|                                                              |       |                                |       |                                   |       |   |   |   |   |
| Net income  (loss) per common share — Basic                  |       | $                                   | (0.15      | )                                      | $          | (0.02 | ) | $ | (1.35 | ) | $ | 0.08 |   |
| Net income  (loss) per common share — Diluted                |       | $                                   | (0.15      | )                                      | $          | (0.02 | ) | $ | (1.35 | ) | $ | 0.07 |   |
|                                                              |       |                                |       |                                   |       |   |   |   |   |
| Weighted average  number of common shares outstanding:            |       |                                |       |                                   |       |   |   |   |   |
| Basic                                                             |       | 10,171,236                          |       | 11,775,597                             |       | 10,118,154 |   | 11,190,612 |   |
| Diluted                                                           |       | 10,171,236                          |       | 11,775,597                             |       | 10,118,154 |   | 11,874,874 |   |

 

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

4

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**EINSTEINNOAH RESTAURANT GROUP, INC.****CONSOLIDATEDSTATEMENTS OF CASH FLOWS****FOR THE YEAR TODATE PERIODS ENDED JULY 4, 2006 AND JULY 3, 2007****(in thousands)****(unaudited)**
| ** **                                                                       | ** ** | **July 4,** | ** ** | **July 3,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                       | ** ** | **2006**         | ** ** | **2007**         | ** ** |
| OPERATING ACTIVITIES:                                                            |       |             |       |             |       |
| Net income (loss)                                                                |       | $                | (13,634    | )                | $          | 881 |   |
| Adjustments to  reconcile net loss to net cash provided by operating activities: |       |             |       |             |       |
| Depreciation and  amortization                                                   |       | 11,598           |       | 5,042            |       |
| Stock based  compensation expense                                                |       | 408              |       | 1,250            |       |
| Loss, net of  gains, on disposal of assets                                       |       | 13               |       | 405              |       |
| Impairment  charges and other related costs                                      |       | 83               |       | 185              |       |
| Provision for  losses on accounts receivable, net                                |       | 132              |       | 25               |       |
| Amortization of  debt issuance and debt discount costs                           |       | 419              |       | 392              |       |
| Write-off of  debt issuance costs                                                |       | 3,956            |       | 2,071            |       |
| Write-off of  debt discount                                                      |       | —           |       | 528              |       |
| Paid-in-kind  interest                                                           |       | 643              |       | 904              |       |
| Changes in  operating assets and liabilities:                                    |       |             |       |             |       |
| Franchise and  other receivables                                                 |       | 433              |       | 358              |       |
| Accounts payable  and accrued expenses                                           |       | 332              |       | (1,225           | )          |
| Other assets and  liabilities                                                    |       | (105             | )          | (2,500           | )          |
|                                                                             |       |             |       |             |       |
| Net cash provided  by operating activities                                       |       | 4,278            |       | 8,316            |       |
|                                                                             |       |             |       |             |       |
| INVESTING ACTIVITIES:                                                            |       |             |       |             |       |
| Purchase of property  and equipment                                              |       | (5,400           | )          | (12,404          | )          |
| Proceeds from the sale  of equipment                                             |       | 153              |       | 1,164            |       |
|                                                                             |       |             |       |             |       |
| Net cash used in  investing activities                                           |       | (5,247           | )          | (11,240          | )          |
|                                                                             |       |             |       |             |       |
| FINANCING ACTIVITIES:                                                            |       |             |       |             |       |
| Proceeds from secondary  common stock offering                                   |       | —           |       | 90,000           |       |
| Costs incurred with  offering of our common stock                                |       | —           |       | (6,417           | )          |
| Proceeds from line of  credit                                                    |       | 24               |       | —           |       |
| Repayments of line of  credit                                                    |       | (24              | )          | —           |       |
| Payments under capital  lease obligations                                        |       | (20              | )          | (39              | )          |
| Repayment of notes  payable                                                      |       | (160,000         | )          | —           |       |
| Borrowings under First  Lien                                                     |       | 80,000           |       | 11,900           |       |
| Repayments under First  Lien                                                     |       | (475             | )          | (475             | )          |
| Borrowing under Second  Lien                                                     |       | 65,000           |       | —           |       |
| Repayments under Second  Lien                                                    |       | —           |       | (65,000          | )          |
| Borrowings under  Subordinated Note                                              |       | 24,375           |       | —           |       |
| Repayments under  Subordinated Note                                              |       | —           |       | (25,000          | )          |
| Debt issuance costs                                                              |       | (4,916           | )          | (842             | )          |
| Proceeds upon stock  option and warrant exercises                                |       | 187              |       | 430              |       |
|                                                                             |       |             |       |             |       |
| Net cash  provided by financing activities                                       |       | 4,151            |       | 4,557            |       |
|                                                                             |       |             |       |             |       |
| Net increase in cash  and cash equivalents                                       |       | 3,182            |       | 1,633            |       |
| Cash and cash  equivalents, beginning of period                                  |       | 1,556            |       | 5,477            |       |
| Cash and cash equivalents, end of period                                         |       | $                | 4,738      |             | $          | 7,110 |   |

 

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

5

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**EINSTEIN NOAH RESTAURANT GROUP, INC.****CONSOLIDATEDSTATEMENT OF CHANGES IN STOCKHOLDERS’ DEFICIT****FOR THE YEAR TODATE PERIOD ENDED JULY 3, 2007** (in thousands, except shareinformation) (unaudited)
| ** **                                     | ** ** | ** **            | ** ** | ** **       | ** ** | **Additional** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|-----------------|------------|------------|------------|
| ** **                                     | ** ** | **Common Stock** | ** ** | **Paid In** | ** ** | **Deficit**    | ** ** | ** **      | ** ** |
| ** **                                     | ** ** | **Shares**            | ** ** | **Amount**       | ** ** | **Capital**    | ** ** | **Amount**      | ** ** | **Total**  | ** ** |
|                                           |       |                  |       |             |       |           |       |            |       |       |       |
| Balance, January  2, 2007                      |       | 10,596,419            |       | $                | 11         |           | $          | 176,797         |       | $          | (309,039   | ) | $ | (132,231 | ) |
| Net income                                     |       | —                |       | —           |       | —         |       | 881             |       | 881        |       |
| Common stock issued upon stock option exercise |       | 142,936               |       | —           |       | 430            |       | —          |       | 430        |       |
| Common stock issued in secondary offering      |       | 5,000,000             |       | 5                |       | 89,995         |       | —          |       | 90,000     |       |
| Costs to issue common stock                    |       | —                |       | —           |       | (6,417         | )          | —          |       | (6,417     | )          |
| Stock based compensation expense               |       | —                |       | —           |       | 1,250          |       | —          |       | 1,250      |       |
|                                           |       |                  |       |             |       |           |       |            |       |       |       |
| Balance, July 3, 2007                          |       | 15,739,355            |       | $                | 16         |           | $          | 262,055         |       | $          | (308,158   | ) | $ | (46,087 | ) |

 

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

6

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

Notes toConsolidated Financial Statements (Unaudited)

For the Second Quarters and Year to Date Periods ended July 4,2006 and July 3, 2007

**1.     Basis of Presentation**

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

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

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

**2.     StockBased Compensation**

In December 2004,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standard (“SFAS”) No. 123R, *Share-Based Payment*(“SFASNo. 123R”).  SFAS No. 123R is a revisionof SFAS No. 123, *Accounting for Stock-Based Compensation*,and supersedes Accounting Principles Board Opinion (“APB”) No. 25, *Accounting for Stock Issued to Employees* and its relatedimplementation guidance. SFAS No. 123R focuses primarily on accounting fortransactions in which an entity obtains employee services in share-basedpayment transactions. The Statement requires entities to recognize compensationexpense for awards of equity instruments to employees based on the grant-datefair value of those awards (with limited exceptions). Effective January 4,2006, we adopted the provisions of SFAS No. 123R using the modified prospectivetransition method.

7

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Our stock-basedcompensation cost for the second quarters ended July 4, 2006 and July 3, 2007 was $192,000 and $919,000, respectively,and $408,000 and $1,250,000 for the year to date periods ended July 4, 2006 andJuly 3, 2007, respectively, and has been included in general and administrativeexpenses. The fair value of stock options and stock appreciation rights (“SARs”)are estimated using the Black-Scholes option-pricing model with the followingweighted average assumptions: 
| ** **                                   | ** ** | **Second quarter ended:** | ** ** | **Year to date ended:** | ** ** |
|----------------------------------------------|------------|-------------------------------------|------------|----------------------------------------|------------|
| ** **                                   | ** ** | **July 4,  2006**              | ** ** | **July 3,  2007**                 | ** ** | **July 4,  2006** | ** ** | **July 3,  2007** | ** ** |
| Expected life of  options from date of grant |       | *                                   |       | 4.0 years                              |       | 4.0 years |   | 4.0 years |   |
| Risk-free interest rate                      |       | *                                   |       | 4.60 - 5.02                            | %          | 4.35 | % | 4.60 - 5.02 | % |
| Volatility                                   |       | *                                   |       | 28% - 97                               | %          | 100.0 | % | 28% - 97 | % |
| Assumed dividend yield                       |       | *                                   |       | 0.0                                    | %          | 0.0 | % | 0.0 | % |
|                                         |       |                                |       |                                   |       |   |   |   |   |

----

* There were no grants ofstock options or stock appreciation rights during the second quarter ended July4, 2006

The expected term of options is based upon evaluationsof historical and expected future exercise behavior. The risk-free interestrate is based on the U.S. Treasury rates at the date of grant with maturitydates approximately equal to the expected life at the grant date. During thequarter ended July 3, 2007, we updated the assumptions of our impliedvolatility based on the mean reverting average of our stock’s historicalvolatility, and our industry peer group of competitors whose shares are tradedon the public markets, adjusted to reflect anticipated behavior specific to theCompany. The use of mean reversion is supported by evidence of a correlationbetween stock price volatility and a company’s leverage combined with theeffects mandatory principal payments will have on our capital structure, asdefined under our new debt facility. This change and use of our competitors to calculate the volatility isdirectly related to our recent listing on the NASDAQ and not having enoughhistory to refine our estimate. We have not historically paid any dividends andare currently precluded from doing so under our debt covenants.

As of July 3,2007, we had approximately $1.7 million of total unrecognized compensation costrelated to non-vested awards granted under our stock option and stockappreciation rights plans, which we expect to recognize over a weighted averageperiod of 2.3 years. Total compensation costs related to the non-vested awardsoutstanding as of July 3, 2007 will be fully recognized by second quarter offiscal 2010, which represents the end of the requisite service period.

**StockPlans**

*1994 and 1995 Plans*

Our 1994 Stock Plan (“1994 Plan”) provided for thegranting to employees of incentive stock options and for the granting toemployees and consultants of non-statutory stock options and stock purchaserights. On November 21, 2003, the board of directors terminated the authorityto issue any additional options under the 1994 Plan. As of July 3, 2007, alloptions under the 1994 Plan had expired.

Our 1995 Directors’Stock Option Plan (“Directors’ Option Plan”) provided for the automatic grantof non-statutory stock options to non-employee directors of the Company. OnDecember 19, 2003, our board of directors terminated the authority toissue any additional options under the Directors’ Option Plan. As of July 3,2007, options to purchase 1,826 shares of common stock at a weighted averageexercise price of $38.16 per share and a weighted average remaining contractuallife of 4.92 years remained outstanding under this plan.

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*2003Executive Employee Incentive Plan*

On November 21,2003, our board of directors adopted the Executive Employee Incentive Plan, asamended on December 19, 2003, March 1, 2005 and April 24, 2007 (“2003 Plan”).The 2003 Plan provides for granting incentive stock options to employees andgranting non-statutory stock options to employees and consultants. Unlessterminated sooner, the 2003 Plan will terminate automatically in December 2013.The board of directors has the authority to amend, modify or terminate the 2003Plan, subject to any required approval by our stockholders under applicable lawor upon advice of counsel. No such action may affect any options previouslygranted under the 2003 Plan without the consent of the holders. There are2,000,000 shares reserved for issuance pursuant to options granted under the2003 Plan. Options generally are granted with an exercise price equal to thefair market value on the date of grant, have a contractual life of ten yearsand typically vest over a three-year service period. Generally, 50% of optionsgranted vest based solely upon the passage of time. We recognize compensationcosts for these awards using a graded vesting attribution method over therequisite service period. The remaining 50% of options granted vest based onservice and performance conditions. Options that do not vest due to the failureto achieve specific financial performance criteria are forfeited. Options topurchase approximately 162,857 shares of our common stock, which are not yetexercisable, are subject to company performance conditions. We recognizecompensation costs for performance based options over the requisite serviceperiod when conditions for achievement become probable. As of July 3, 2007,there were 747,352 shares reserved for future issuance under the 2003 Plan.

In February 2007,we granted options to purchase 124,250 shares of our common stock relating tothe secondary public offering as further described in Note 6. The option awardsvested upon closing of the offering and we recognized approximately $470,000 instock-based compensation expense.

*2004Stock Option Plan for Independent Directors*

On December 19,2003, our board of directors adopted the Stock Option Plan for IndependentDirectors, effective January 1, 2004, as amended on March 1, 2005 and February28, 2007 (“2004 Directors’ Plan”). Our board of directors may amend, suspend,or terminate the 2004 Directors’ Plan at any time, provided, however, that nosuch action may adversely affect any outstanding option without the optionholders consent. A total of 300,000 shares of common stock have been reservedfor issuance under the 2004 Directors’ Plan. The 2004 Directors’ Plan providesfor the automatic grant of non-statutory stock options to independent directorson January 1 of each year and a prorated grant of options for any directorelected during the year. Options are granted with an exercise price equal tothe fair market value on the date of grant, become exercisable six months afterthe grant date and are exercisable for 5 years from the date of grant unlessearlier terminated. As of July 3, 2007, there were 114,192 shares reserved forfuture issuance under the 2004 Directors’ Plan.

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*StockAppreciation Rights Plan*

On February 17,2007, our board of directors adopted the Stock Appreciation Rights Plan (“SARPlan”). The SAR Plan provides for granting stock appreciation rights toemployees. Unless terminated sooner, the SAR Plan will terminate automaticallyon March 31, 2012. The board of directors has the authority to amend, modify orterminate the SAR Plan, subject to any required approval by our stockholdersunder applicable law or upon advice of counsel, provided that, with limitedexception, no modification will adversely affect outstanding rights. There are150,000 shares issuable pursuant to stock appreciation rights under the SARPlan.

The value of ashare from which appreciation is determined is 100% of the fair market value ofa share on the date of grant. The rights expire upon the earlier of terminationdate of the SAR Plan or termination of employment and typically vest over atwo-year service period. Generally, 50% of rights granted vest based solelyupon the passage of time. We recognize compensation costs for these awardsusing a graded vesting attribution method over the requisite service period.The remaining 50% of rights granted vest based on performance conditions.Rights to approximately 54,575 shares of our common stock, which are not yetexercisable, are subject to company performance conditions. We will recognizecompensation costs for performance based stock appreciation rights over therequisite service period when conditions for achievement become probable.Rights that do not vest are forfeited. As of July 3, 2007, there were 40,850shares reserved for future issuance under the SAR Plan.

*James W.Hood Stock Award Agreement*

On May 3, 2007,our board of directors adopted the James W. Hood Stock Award Agreement (the “StockAward Plan”).  The Stock Award Planprovides for the issuance of 22,000 shares of our common stock to Mr. Hood asinducement for accepting employment with us as our Chief Marketing Officer. Thecommon stock award includes 7,333 shares that have no restrictions, 7,333shares that become unrestricted on the first anniversary and 7,334 shares thatbecome unrestricted on the second anniversary of the date of grant; providedthat Mr. Hood is continuously employed by us on those dates.  We recognize compensation costs for theseawards using a graded vesting attribution method over the requisite serviceperiod.  We recognized stock basedcompensation expense of $168,000 related to this agreement for the year to dateperiod ended July 3, 2007.

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**StockOption Plan Activity**

Transactionsduring the year to date period ended July 3, 2007 were as follows:
| ** **                           | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Fair  Value** | ** ** | **Aggregate  Intrinsic  Value** | ** ** | **Weighted  Average  Remaining  Life (Years)** | ** ** |
|--------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------|------------|
| Outstanding, January 2,  2007        |       | 993,707                 |       | $                                      | 3.79       |                               |       |                            |       |                                                |       |   |
| Granted                              |       | 416,458                 |       | $                                      | 11.75      |                               |       |                            |       |                                                |       |   |
| Exercised                            |       | (120,936                | )          | $                                      | 3.56       |                               |       |                            |       |                                                |       |   |
| Forfeited                            |       | (17,870                 | )          | $                                      | 4.78       |                               |       |                            |       |                                                |       |   |
| Outstanding, July 3,  2007           |       | 1,271,359               |       | $                                      | 6.41       |                               | $          | 3.59                            |       | $                                                   | 14,422,077 |   | 7.68 |   |
| Exercisable and vested, July 3, 2007 |       | 762,032                 |       | $                                      | 4.51       |                               | $          | 3.16                            |       | $                                                   | 10,090,484 |   | 6.71 |   |

 

|                                     | ** ** | **Number   of   Options** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|-------------------------------------|------------|-------------------------------------|------------|---------------------------------------------------------|------------|
| Non-vested shares,  January 2, 2007 |       | 370,045                             |       | $                                                       | 2.81       |   |
| Granted                             |       | 416,458                             |       | $                                                       | 5.46       |   |
| Vested                              |       | (259,306                            | )          | $                                                       | 4.24       |   |
| Forfeited                           |       | (17,870                             | )          | $                                                       | 3.35       |   |
| Non-vested shares, July 3, 2007     |       | 509,327                             |       | $                                                       | 4.23       |   |

 

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**StockAppreciation Rights Plan Activity**

Transactionsduring the year to date period ended July 3, 2007 were as follows:
| ** **                           | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Fair  Value** | ** ** | **Aggregate  Intrinsic  Value** | ** ** | **Weighted  Average  Remaining  Life (Years)** | ** ** |
|--------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------|------------|
| Outstanding, January 2,  2007        |       | —                  |       | $                                      | —     |                               |       |                            |       |                                                |       |   |
| Granted                              |       | 113,950                 |       | $                                      | 11.01      |                               |       |                            |       |                                                |       |   |
| Exercised                            |       | —                  |       | $                                      | —     |                               |       |                            |       |                                                |       |   |
| Forfeited                            |       | (4,800                  | )          | $                                      | 8.00       |                               |       |                            |       |                                                |       |   |
| Outstanding, July 3,  2007           |       | 109,150                 |       | $                                      | 11.15      |                               | $          | 5.56                            |       | $                                                   | 720,863    |   | 4.70 |   |
| Exercisable and vested, July 3, 2007 |       | —                  |       | $                                      | —     |                               | $          | —                          |       | $                                                   | —     |   | — |   |

 

|                                     | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|-------------------------------------|------------|-------------------------|------------|---------------------------------------------------------|------------|
| Non-vested shares,  January 2, 2007 |       | —                  |       | $                                                       | —     |   |
| Granted                             |       | 113,950                 |       | $                                                       | 5.56       |   |
| Vested                              |       | —                  |       | $                                                       | —     |   |
| Forfeited                           |       | (4,800                  | )          | $                                                       | 5.59       |   |
| Non-vested shares, July 3, 2007     |       | 109,150                 |       | $                                                       | 5.56       |   |

** **

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**3.     Supplemental Cash Flow Information**
| ** **                                                          | ** ** | **July 4,  2006**                       | ** ** | **July 3,  2007** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------|------------|
| ** **                                                          | ** ** | **(in thousands of dollars)** | ** ** |
| Cash paid during the  year to date period ended:                    |       |                                         |       |                   |       |
| Interest related  to:                                               |       |                                         |       |                   |       |
| $160 Million  Notes                                                 |       | $                                            | 3,293      |                   | $          | — |   |
| Term Loans                                                          |       | 3,593                                        |       | 8,185                  |       |
| $25 Million  Subordinated Note                                      |       | 553                                          |       | 825                    |       |
| Other                                                               |       | 279                                          |       | 172                    |       |
| Prepayment  penalty upon redemption of debt                         |       | $                                            | 4,800      |                   | $          | 240 |   |
|                                                                |       |                                         |       |                   |       |
| Non-cash investing  activities:                                     |       |                                         |       |                   |       |
| Non-cash  purchase of equipment through capital leasing             |       | $                                            | 141        |                   | $          | — |   |
| Change in accrued  expenses for purchases of property and equipment |       | $                                            | 712        |                   | $          | 2,076 |   |

 

**4.     Inventories**

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

|                   | ** ** | **January 2,  2007**                    | ** ** | **July 3,  2007** | ** ** |
|-------------------|------------|----------------------------------------------|------------|------------------------|------------|
| ** **        | ** ** | **(in thousands of dollars)** | ** ** |
| Finished goods    |       | $                                            | 3,835      |                   | $          | 3,681 |   |
| Raw materials     |       | 1,113                                        |       | 1,284                  |       |
| Total inventories |       | $                                            | 4,948      |                   | $          | 4,966 |   |

 

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

Intangible assets include both goodwill and identifiable intangiblesarising from the allocation of the purchase prices of assets acquired. Goodwillrepresents the excess of cost over fair value of net assets acquired in theacquisition of Manhattan Bagel. As of July 3, 2007, intangible assets of $63.8million were not subject to amortization and consisted primarily of theEinstein Bros. and Manhattan Bagel trademarks.

During the year todate periods ended July 4, 2006 and July 3, 2007, there were no events orchanges in circumstances that indicated that our intangible assets might beimpaired or may not be recoverable.

**6.     Senior Notes and Other Long-Term Debt**

Senior notes and other long-term debt consist of the following:
| ** **                                                     | ** ** | **January 2,    2007**        | ** ** | **July 3,    2007** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------|------------|
| ** **                                                     | ** ** | **(in thousands of dollars)** | ** ** |
| $90 Million Amended  First Lien Term Loan                      |       | $                                            | 78,575     |                               | $          | 90,000 |   |
| $65 Million Second Lien  Term Loan                             |       | 65,000                                       |       | —                             |       |
| $25 Million  Subordinated Note                                 |       | 26,026                                       |       | —                             |       |
| New Jersey Economic  Development Authority Note Payable        |       | 560                                          |       | 560                                |       |
|                                                           |       | $                                            | 170,161    |                               | $          | 90,560 |   |
| Less current  portion of senior notes and other long-term debt |       | 3,605                                        |       | 1,180                              |       |
| Senior notes and other long-term debt                          |       | $                                            | 166,556    |                               | $          | 89,380 |   |

 

**June 2007Debt Redemption and Amended First Lien Term Loan**

OnJune 13, 2007, we completed a $90 million secondary public offering of 5million shares of our common stock. After underwriting discounts and commissions and other costs incurredrelated to the offering of $6.4 million, we received net proceeds of $83.6million.  The net proceeds were used torepay our $65.0 million Second Lien Term Loan, repay a portion of our $25million Subordinated Note heldby Greenlight Capital,L.L.C. (“Greenlight”) and to payfor the offering costs.  Additionally, onJune 28, 2007, we repaid the remaining portion of the $25 million subordinatednote held by Greenlight by using a portion of the incremental debt proceedsunder the amended debt facility, as described below.

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On June 28, 2007, we amended our debt facility to increase it to $110million, comprised of a $20 million revolving credit facility and a modifiedterm loan with a principal amount of $90 million. The revolving credit facilityremains available, subject to certain conditions, to finance our ongoingworking capital, capital expenditure and general corporate needs and a portionof the revolving credit facility remains available for letters of credit. Weare required to pay an unused credit line fee of 0.5% per annum on the averagedaily unused amount. The unused line fee is payable quarterly in arrears.Additionally, we are required to pay a letter of credit fee based on the endingdaily undrawn face amount for each letter of credit issued, of an applicable marginbeing based on our consolidated leverage ratio with an applicable margin of2.00% plus a 0.5% arranger fee payable quarterly. Letters of credit reduce ouravailability under the Revolving Facility. At July 3, 2007, we had $6.7 millionin letters of credit outstanding. The letters of credit expire on various datesduring 2008, are automatically renewable for one additional year and arepayable upon demand in the event that we fail to pay the underlying obligation.Our availability under the revolving facility was $13.3 million at July 3,2007.

Both the revolving creditfacility and the term loan facility have a five-year term and are secured bysubstantially all of our assets and guaranteed by our subsidiaries.  Borrowings under this senior secured creditfacility bear interest at a rate equal to an applicable margin plus, at ouroption, either a variable base rate or a Eurodollar rate. The applicable marginfor LIBOR loans ranges from 1.75% to 2.25% and for base rate loans ranges from0.75% to 1.25%, depending on the level of our consolidated leverage ratio(defined as in our current credit facilities). Upon the occurrence of a paymentevent of default which is continuing, all amounts due under the senior securedcredit facility bear interest at 2.0% above the interest rate otherwiseapplicable.  The outstanding amount ofthe term loan is amortizable on a quarterly basis by an amount equal to 0.25%of the original principal amount of the term loan. Any amounts remaining unpaidwill be due and payable on the maturity date. At July 3, 2007 the stated interest rate under the First Lien Term Loanwas 7.39%.

The term loan requiresmandatory prepayments of

·      50%of excess cash flow (as defined in the senior secured credit facility) subjectto the ability to retain at least $5,000,000 in cash and cash equivalents;

·      100% of net cash proceeds of assetsales by us above a threshold and subject to the ability to reinvest undercertain circumstances;

·      100%of net cash proceeds of any debt issued by us, subject to certain exceptions;and

·      50% of the net cash proceeds of any equityissued by us, subject to certain exceptions.

The revolvingfacility and the first lien term loan contain usual and customary covenantsincluding consolidated leverage ratios, fixed charge coverage ratios,limitations on capital expenditures, etc. The ratio covenants are based on a ConsolidatedEarnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”)calculation (as defined in our loan agreement) and are measured on a twelve monthperiod ending on the last day of each fiscal quarter. The loan is guaranteed by ourmaterial subsidiaries.  The revolvingfacility, the first lien term loan and the related guarantees are secured by afirst priority security interest in all of our assets and our materialsubsidiaries, including a pledge of 100% of our interest in all shares ofcapital stock (or other ownership or equity interests) of each materialsubsidiary.  As of July 3, 2007,we were in compliance with all our financial and operating covenants.

The senior secured creditfacility contains a number of negative covenants that limits us from takingcertain actions including issuing debt, paying dividends and makinginvestments. In addition, we are required to maintain:

·      aminimum consolidated fixed charge coverage ratio; and

·      amaximum consolidated leverage ratio of 2.75x.

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The senior secured creditfacility contains a limitation on annual capital expenditures, but allows forthe greater of either (i) unused capital expenditure amounts to be used in theimmediately following fiscal year up to a mutually agreed-upon amount or (ii)the capital expenditure limitation to be incrementally increased for theimmediately following fiscal year by up to 25% of the current fiscal yearexcess cash flow. The senior secured credit facility contains customary eventsof default.

The facility is fully amortizing with annual aggregate principalreductions payable in quarterly installments over the term of the loan asfollows:

| For the 2008 fiscal year ending  January 1, 2008  |   | $ 0.7 million  |
|---------------------------------------------------|--------|---------------------|
| For the 2009 fiscal year ending December 30, 2009 |   | $ 0.9 million  |
| For the 2010 fiscal year ending December 29, 2010 |   | $ 0.9 million  |
| For the 2011 fiscal year ending December 28, 2011 |   | $ 1.1 million  |
| For the 2012 fiscal year ending January 3, 2012   |   | $ 86.0 million |

 

In addition, we obtained acommitment for an incremental term loan in an aggregate principal amount of upto $57.0 million to be used by us, if needed, solely for the purpose ofredeeming the zero coupon Series Z preferred stock due in June 2009. If wechoose to draw down the incremental term loan, the outstanding amount of theincremental term loan will be amortized on a quarterly basis by an amount equalto 0.25% of the original principal amount of the incremental term loan.Borrowings under the incremental term loan, if any, bear interest at the samerate schedule as the new senior secured credit facility. Any amounts remainingunpaid are due and payable on the maturity date of the term loans. Availabilityof the incremental term loan is subject to customary borrowing conditions,including absence of any default or material adverse change, and to arequirement of successful syndication of such incremental term loan.

We may prepay amounts outstandingunder the senior secured credit facility and may terminate commitments in wholeat any time without penalty or premium upon prior written notice.

Approximately $2.3million and $0.5 million in debt issuance costs have been capitalized for the amended$90 Million First Lien Term Loan and the revolving facility, respectively.

For the revolvingfacility, the capitalized debt issuance costs are being amortized on astraight-line basis while the capitalized debt issuance costs for the firstlien term loan are being amortized on the effective interest rate method.

**February 2006 DebtRedemption and Refinancing**

On February 28,2006, we completed the refinancing of the AmSouth Revolver and $160Million Notes.  While our June 13, 2007 offering of common stock,debt redemption and refinancing changed our capital structure as describedabove, our previous debt obligations consisted of the following:

·      $15million revolving credit facility (Revolving Facility);

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

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

·      $25million subordinated note (Subordinated Note).

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

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**New Jersey Economic Development Authority NotePayable**

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

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

**7.     Net Income (Loss) Per Common Share**

In accordance withSFAS No. 128, *Earnings per Share*, we computebasic net income (loss) per common share by dividing the net income (loss) forthe period by the weighted average number of shares of common stock outstandingduring the period.

Diluted net incomeper share is computed by dividing the net income for the period by the weightedaverage number of shares of common stock and potential common stock equivalentsoutstanding during the period using the treasury stock method. Potential commonstock equivalents include incremental shares of common stock issuable upon theexercise of stock options and warrants. Potential common stock equivalents areexcluded from the computation of diluted net income (loss) per share when theireffect is anti-dilutive.

The followingtable summarizes the weighted average number of common shares outstanding, andthe computation of basic and diluted net income (loss) per common share for theperiods indicated:
| ** **                                       | ** ** | **Quarter ended:** | ** ** | **Year to date period ended:** | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|----------------------------------------------------|------------|
| ** **                                       | ** ** | **July 4,**        | ** ** | **July 3,**                                   | ** ** | **July 4,** | ** ** | **July 3,** | ** ** |
| ** **                                       | ** ** | **2006**                | ** ** | **2007**                                           | ** ** | **2006** | ** ** | **2007** | ** ** |
| Net income  (loss) (a)                           |       | $                       | (1,542     | )                                                  | $          | (250 | ) | $ | (13,634 | ) | $ | 881 |   |
|                                             |       |                    |       |                                               |       |   |   |   |   |
| Basic weighted  average shares outstanding (b)   |       | 10,171,236              |       | 11,775,597                                         |       | 10,118,154 |   | 11,190,612 |   |
| Dilutive effect  of stock options                |       | —                  |       | —                                             |       | — |   | 684,262 |   |
| Diluted weighted  average shares outstanding (c) |       | 10,171,236              |       | 11,775,597                                         |       | 10,118,154 |   | 11,874,874 |   |
| Basic earnings  (loss) per share (a)/(b)         |       | $                       | (0.15      | )                                                  | $          | (0.02 | ) | $ | (1.35 | ) | $ | 0.08 |   |
| Diluted earnings  (loss) per share (a)/(c)       |       | $                       | (0.15      | )                                                  | $          | (0.02 | ) | $ | (1.35 | ) | $ | 0.07 |   |
|                                             |       |                    |       |                                               |       |   |   |   |   |
| Antidilutive stock  options SARs and warrants    |       | 1,013,746               |       | 1,380,509                                          |       | 1,013,746 |   | 188,364 |   |

** **

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**8.     Income Taxes**

As of July 3, 2007, net operating loss carryforwards of $153.7million were available to be utilized against future taxable income for yearsthrough fiscal 2026, subject in part to annual limitations. Our ability toutilize our net operating losses, including those that are not currentlysubject to limitation, could be limited or further limited in the event that weundergo an “ownership change” as that term is defined for purposes of Section382 of the Internal Revenue Code.

Our net operating loss carryforwards are one of our deferredincome tax assets; however, the ultimate realization of these deferred incometax assets is dependent upon the generation of future taxable income. Due tothe uncertainty of future taxable income, deferred tax assets resulting fromthese net operating losses have been fully reserved.

In accordance with SFAS No. 109, *Accountingfor Income Taxes*, (“SFAS No. 109”) we will assess the continuingneed for a valuation allowance that results from uncertainty regarding ourability to realize the benefits of our deferred tax assets. As we move closertoward achieving net income for a full year, we will review various qualitativeand quantitative data, including events within the restaurant industry, thecyclical nature of our business, our future forecasts and historical trending.If we conclude that our prospects for the realization of our deferred taxassets are more likely than not, we will then reduce our valuation allowance asappropriate and credit income tax expense after considering the followingfactors:

·      Thelevel of historical taxable income and projections for future taxable incomeover periods in which thedeferred tax assets would be deductible, and

·      Accumulationof net income before tax utilizing a look-back period of three years.

The amount of the deferred tax asset considered realizable,however, could be reduced if estimates of future taxable income during thecarryforward periods are reduced.

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

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

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

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

In accordance with SFAS No. 144, *Accountingfor the Impairment or Disposal of Long Lived Assets*, impairmentlosses are recorded on long-lived assets on a restaurant-by-restaurant basiswhenever impairment indicators are determined to be present. We consider ahistory of cash flow losses to be the primary indicator of potential impairmentfor individual restaurants. We determine whether a restaurant is impaired basedon expected undiscounted future cash flows, considering location, localcompetition, current restaurant management performance, existing pricingstructure and alternatives available for the site. If impairment exists, theamount of impairment is measured as the excess of the carrying amount of theasset over its fair value as determined utilizing the estimated discountedfuture cash flows or the expected proceeds, net of costs to sell, upon sale ofthe asset.

During the quarters ended July 4, 2006 and July 3, 2007, we recorded$7,000 and $0, respectively, and for the year to date periods ended July 4,2006 and July 3, 2007, we recorded $83,000 and $19,000, respectively inimpairment charges.  Additionally, theCompany incurred other related costs to close company-owned restaurants of$166,000 for both year to date periods ended July 4, 2006 and July 3, 2007, andno costs were incurred for the quarters ended July 4, 2006 and July 3, 2007.

**10.  Litigation and Contingencies**

We are subject toclaims and legal actions in the ordinary course of our business, includingclaims by or against our franchisees, licensees and employees or formeremployees and/or contract disputes. We do not believe that any currentlypending or threatened matter would have a material adverse effect on ourbusiness, results of operations or financial condition.

The Company hasreceived a claim from a third party in connection with the unsuccessfulnegotiations for a supply contract in 2006. The Company is aware that the claim has been issued but it has not beenserved and no responses are yet required. If served, the Company intends tovigorously defend the litigation.

*Guarantees*

Prior to 2001, wewould occasionally guarantee leases for the benefit of certain of ourfranchisees. None of the guarantees have been modified since their inceptionand we have since discontinued this practice. Current franchisees are theprimary lessees under the vast majority of these leases. Under the leaseguarantees, we may be required by the lessor to make all of the remainingmonthly rental payments or property tax and common area maintenance payments ifthe franchisee does not make the required payments in a timely manner. However,we believe that most, if not all, of the franchised restaurants could besubleased to third parties minimizing our potential exposure. Additionally, wehave indemnification agreements with our franchisees under which thefranchisees would be obligated to reimburse us for any amounts paid under suchguarantees. Historically, we have not been required to make such payments insignificant amounts. As of July 3, 2007, we have $50,000 recorded as aliability for our exposure under the guarantees in accordance with SFAS No. 5following a probability related approach. Minimum future rental payments for allremaining guaranteed leases were approximately $1.4 million as of July 3, 2007.We believe the ultimate disposition of these matters will not have a materialadverse effect on our financial position or results of operations.

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*Insurance*

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

**11.  Assets Held for Sale**

As of January 2, 2007, certain manufacturing equipment was locatedat the plant of Harlan Bakeries, Inc. (Harlan), our frozen bagel doughsupplier. In late 2006, we were notified of Harlan’s intent, under the terms ofthe contract, to purchase the equipment and we agreed to sell the equipment toHarlan for $1.1 million. The assets were classified as held for sale on theconsolidated balance sheet as of January 2, 2007. The assets were sold toHarlan in the first quarter of 2007 and the note receivable from Harlan waspaid in the second quarter of 2007.

**12.  Recent Accounting Pronouncements**

In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities —Including an Amendment of SFAS No. 115* (“SFAS No. 159), whichbecomes effective for fiscal periods beginning after November 15, 2007.  Under SFAS No. 159, companies may elect tomeasure specified financial instruments and warranty and insurance contracts atfair value on a contract-by-contract basis, with changes in fair value recognizedin earnings each reporting period.  Thiselection, called the “fair value option”, will enable some companies to reducevolatility in reported earnings caused by measuring related assets andliabilities differently. We do not expect the impact of adoption to have amaterial impact on our consolidated financial statements.

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

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

**13.  Related Party Transactions**

E. Nelson Heumann is the Chairman of our board of directors and isa current employee of Greenlight. Greenlight and its affiliates beneficially own approximately 68.4% 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.

Greenlight owned $35 million of our $160 Million Notes when wecalled the Notes for redemption in January 2006. The Notes were redeemed fromthe proceeds of our refinancing in February 2006 as further described in Note6.

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We entered into the Subordinated Note with Greenlight in February2006 as further described in Note 6, and paid it in full during the secondquarter of 2007. Total interest expense related to the Subordinated Note withGreenlight was $0.9 million and $0.8 million and for the second quarter endedJuly 4, 2006 and July 3, 2007, respectively, and $1.2 million and $1.7 millionfor year to date periods ended July 4, 2006 and July 3, 2007, respectively.  The Subordinated Note was paid in full duringthe second quarter of 2007.

During the quarter ended July 4, 2006, we issued 429,645 shares ofour common stock to Greenlight in connection with cashless exercises of certainwarrants previously granted by us. Greenlight surrendered 56,953 shares ofcommon stock to us in connection with such cashless exercises. We issued thesewarrants in private financing transactions that occurred between 2000 and 2003.

Leonard Tannenbaum, a director, is a limited partner and 10% ownerin BET. BET purchased $7.5 million of our $160 Million Notes and Mr. Tannenbaumpurchased an additional $0.5 million of our $160 Million Notes in the market.In January 2006, Mr. Tannenbaum and BET’s Notes were called for redemption andwere redeemed from the proceeds of our refinancing in February 2006 as furtherdescribed in Note 6.

During the quarter ended July 4, 2006, we received considerationof $6,183 and issued 6057 shares of our common stock in connection with theexercises of certain warrants previously granted by us to Mr. Tannenbaum andBET.  We issued these warrants in privatefinancing transactions that occurred between 2000 and 2003.

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

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**ITEM 2.  MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

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

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

On January 3, 2007, we adopted the provisions of theFinancial Accounting Standards Board (“FASB”) Interpretation No. 48, *Accounting for Uncertainty in Income Taxes* (“FIN 48”). FIN48 is an interpretation of Statement of Financial Accounting Standard (“SFAS”)No. 109, *Accounting for Income Taxes,*(“SFAS 109”) and itseeks to reduce the diversity in practice associated with certain aspects ofmeasurement and recognition in accounting for income taxes. FIN 48 prescribes arecognition threshold and measurement criterion for the financial statementrecognition and measurement of tax positions taken or expected to be taken in atax return. For those benefits to be recognized, a tax position must bemore-likely-than-not to be sustained upon examination by taxing authorities.The amount recognized is measured as the largest amount of benefit that isgreater than 50% likely of being realized upon ultimate settlement. As a resultof the implementation of FIN 48, we recorded a reduction of approximately $1.8million of the gross deferred tax asset. There was no effect to the financial statements due to the existence ofa full valuation allowance.

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

**Company Overview**

We are the largest owner/operator, franchisor andlicensor of bagel specialty restaurants in the United States. We haveapproximately 600 restaurants in 36 states and the District of Columbia underthe Einstein Bros. Bagels (“Einstein Bros.”), Noah’s New York Bagels (“Noah’s”)and Manhattan Bagel brands (“Manhattan Bagel”). As a leading fast-casualrestaurant chain, our restaurants specialize in high quality foods forbreakfast, lunch and afternoon snacks in a café atmosphere with a neighborhoodemphasis. Collectively, our concepts span the nation with Einstein Bros.restaurants in 33 states and the District of Columbia, Noah’s restaurants inthree states on the West Coast and Manhattan Bagel restaurants concentrated inthe Northeast. Our Einstein Bros. and Noah’s restaurants are company-owned orlicensed, while Manhattan Bagel restaurants are all either franchised orlicensed.

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

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

**SecondaryPublic Offering of Our Common Stock**

On June 13, 2007,we completed a secondary public offering of 5 million shares of common stockresulting in gross proceeds of $90 million. After underwriting discounts and commissions and other costs of $6.4million incurred related to the offering, we received net proceeds of $83.6million. Our common stock is now listed on the 

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NASDAQ GlobalMarket under the symbol “BAGL.”  We usedthe net proceeds of the offering to pay down our existing indebtedness.

**Current Restaurant Base**

As of July 3, 2007, we owned and operated, franchisedor licensed 597 restaurants. Our current base of company-owned restaurantsunder our core brands includes 336 Einstein Bros. restaurants and 74 Noah’srestaurants. Also, we franchise 76 Manhattan Bagel restaurants and license/franchise103 Einstein Bros. restaurants and three Noah’s restaurants. In addition, wehave five restaurants which we operate/franchise under our non-core brands.

Our company-owned restaurants vary in their unitvolume, profitability and recent comparable store sales performance. As of July3, 2007, we had 107 restaurants that generated an average annual unit volume (“AUV”)in excess of $1.0 million. These restaurants have an AUV of approximately $1.2million and an average gross profit of $336,000. In the aggregate, theserestaurants contribute approximately 35.1% of total restaurant sales and 47.7%of total restaurant operating profit. Since 2003, as part of our efforts toimprove financial performance, we completed a thorough evaluation of our restaurantbase. At the end of 2003, we had 735 restaurants across 33 states and theDistrict of Columbia. Since that time through July 3, 2007, we have closed 68company-owned restaurants and 160 licensed and franchised restaurants. Most ofour closed company-owned restaurants were either located in inferior realestate locations, had an AUV below $550,000 or were either unprofitable ormarginally profitable. Substantially all of the franchised restaurants thatwere closed either:

·      involved the failure of the franchisee toconform with the requirements of the franchise agreement;

·      were geographically located outsideManhattan Bagel’s core market; or

·      were restaurants operating under ournon-core brands, Chesapeake Bagel Bakery and New World Coffee.

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

We have recently implemented a number of initiativesin an effort to drive sales and improve profitability, including qualityservice checklists, secret shopper inspections, improved ordering systems,extension of store operating hours and enhanced training programs. Theseinitiatives have led to positive comparable store sales over the past elevenquarters. In addition, we have started to upgrade restaurants where we have theopportunity to improve sales. The upgrades are intended to provide superiormerchandising, enhance our guests’ experience and increase the speed of servicewhile maintaining the neighborhood feel of the restaurants. We are upgradingour Einstein Bros. restaurants based on sales volume, demographic traits andthe related cost of the upgrade. Only those restaurants that offer thepotential for a superior return on investment are considered for an upgrade. Weanticipate the costs of upgrades in the near future to approximate $100,000 perrestaurant.

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**New Restaurant Openings**

Using the knowledge gained from our upgrade program,we plan to pursue a measured approach to new company-owned restaurant openings.During 2004, 2005 and 2006, we opened four, four and five new company-ownedrestaurants, respectively. Our ability to open new restaurants during thoseyears was limited by the capital expenditure restrictions of the debtagreements in place at that time, and with the amendment of our debt facilityin June 2007, these limitations have become less restrictive. Our current planis to open new company-owned restaurants in existing markets where we have anestablished brand name. Our site selection process focuses on identifyingmarkets, trade areas and specific sites based on several factors, includingvisibility, ready accessibility (particularly for morning and lunch timetraffic), parking, signage and adaptability of any current structures.

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

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The following table details our restaurant openingsand closings for each respective period:
| ** **                      | ** ** | **Second Quarter** | ** ** | **Year-to-Date** | ** ** |
|---------------------------------|------------|-------------------------|------------|------------------|------------|
| ** **                      | ** ** | **Activity**            | ** ** | **Activity**     | ** ** |
| ** **                      | ** ** | **Fiscal**              | ** ** | **Fiscal**       | ** ** | **Fiscal** | ** ** | **Fiscal** | ** ** |
| ** **                      | ** ** | **2006**                | ** ** | **2007**         | ** ** | **2006** | ** ** | **2007** | ** ** |
| **Einstein  Bros.**             | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Company-owned beginning balance |       | 358                     |       | 336              |       | 360 |   | 341 |   |
| Opened restaurants              |       | —                  |       | 1                |       | 1 |   | 1 |   |
| Closed restaurants              |       | (5                      | )          | (1               | )          | (8 | ) | (6 | ) |
| Company-owned ending balance    |       | 353                     |       | 336              |       | 353 |   | 336 |   |
|                            |       |                    |       |             |       |   |   |   |   |
| Licensed beginning balance      |       | 69                      |       | 97               |       | 67 |   | 93 |   |
| Opened restaurants              |       | 2                       |       | 6                |       | 5 |   | 10 |   |
| Closed restaurants              |       | (1                      | )          | —           |       | (2 | ) | — |   |
| Licensed ending balance         |       | 70                      |       | 103              |       | 70 |   | 103 |   |
|                            |       |                    |       |             |       |   |   |   |   |
| **Noah’s**                 | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Company-owned beginning balance |       | 72                      |       | 74               |       | 73 |   | 73 |   |
| Opened restaurants              |       | —                  |       | —           |       | — |   | 1 |   |
| Closed restaurants              |       | —                  |       | —           |       | (1 | ) | — |   |
| Company-owned ending balance    |       | 72                      |       | 74               |       | 72 |   | 74 |   |
|                            |       |                    |       |             |       |   |   |   |   |
| Licensed beginning balance      |       | 3                       |       | 3                |       | 3 |   | 3 |   |
| Opened restaurants              |       | —                  |       | —           |       | — |   | — |   |
| Closed restaurants              |       | —                  |       | —           |       | — |   | — |   |
| Licensed ending balance         |       | 3                       |       | 3                |       | 3 |   | 3 |   |
|                            |       |                    |       |             |       |   |   |   |   |
| **Manhattan  Bagels**           | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Franchised beginning balance    |       | 107                     |       | 79               |       | 109 |   | 80 |   |
| Opened restaurants              |       | —                  |       | —           |       | 2 |   | — |   |
| Closed restaurants              |       | (2                      | )          | (3               | )          | (6 | ) | (4 | ) |
| Franchised ending balance       |       | 105                     |       | 76               |       | 105 |   | 76 |   |
|                            |       |                    |       |             |       |   |   |   |   |
| **Non-Core  Brands**            | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Company-owned beginning balance |       | 2                       |       | 2                |       | 2 |   | 2 |   |
| Opened restaurants              |       | —                  |       | —           |       | — |   | — |   |
| Closed restaurants              |       | —                  |       | (1               | )          | — |   | (1 | ) |
| Company-owned ending balance    |       | 2                       |       | 1                |       | 2 |   | 1 |   |
|                            |       |                    |       |             |       |   |   |   |   |
| Franchised beginning balance    |       | 10                      |       | 6                |       | 12 |   | 6 |   |
| Opened restaurants              |       | —                  |       | —           |       | — |   | — |   |
| Closed restaurants              |       | (2                      | )          | (2               | )          | (4 | ) | (2 | ) |
| Franchised ending balance       |       | 8                       |       | 4                |       | 8 |   | 4 |   |
|                            |       |                    |       |             |       |   |   |   |   |
| **Consolidated  Total**         | ** ** | ** **              | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total beginning balance         |       | 621                     |       | 597              |       | 626 |   | 598 |   |
| Opened restaurants              |       | 2                       |       | 7                |       | 8 |   | 12 |   |
| Closed restaurants              |       | (10                     | )          | (7               | )          | (21 | ) | (13 | ) |
| Total ending  balance           |       | 613                     |       | 597              |       | 613 |   | 597 |   |

 

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**Our Sources of Revenue**

*Company-Owned Restaurant Sales*

Approximately 93% of ourrevenue is generated by restaurant sales at our Einstein Bros. and Noah’scompany-owned restaurants. Restaurant sales also include catering sales wherethe food is prepared at the restaurant and either delivered to or held forpick-up by the guest. The principal factors that affect our restaurant sales inthe aggregate are:

·      thenumber of restaurants in operation for the period,

·      theAUV of the restaurants and

·      thechange in comparable store sales.

For the year to dateperiod ended July 3, 2007, approximately 63% of our revenues were generatedfrom restaurant sales during the breakfast hours, 28% were generated during thelunch hours and 9% were generated during the late afternoon hours.

*Manufacturing and CommissaryRevenue*

Approximately 6% of ourtotal revenue is generated by our manufacturing and commissary operations. Ourmanufacturing revenue is primarily derived from the sale of frozen bagel doughto our franchisees, licensees and third party accounts. Our commissariesgenerate revenue from the sale of sliced meats (turkey, ham and beef), dairyproducts (cheese), and pre-portioned salad kits to our licensees. Additionally,our commissaries sell bagels, cream cheese, salad toppers and salads throughvarious supplier relationships, typically with conventional grocery stores asthe customer. These products are sold either through a private label program orunder the Einstein Bros. or Noah’s brand.

The principal factorsaffecting manufacturing and commissary revenue are:

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

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

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

*Franchise and License Revenue*

License and franchiserevenue consists of a license or franchise fee at the execution of theagreement and ongoing royalty payments based on a percentage of the restaurant’sgross sales. Our costs associated with licensing and franchising are minimalcompared with the costs associated with company-owned restaurants.Approximately 1% of our total revenue is generated from these fees. Theprincipal factors affecting license and franchise revenue are the number oflicensed and franchised restaurants as well as the level of sales at thoserestaurants.

**Our Primary Costs**

***Company-Owned Restaurant Costs***

*Food, Beverage and PackagingCosts.* Food, beverage and packaging costs are the largestexpense elements at our company-owned restaurants. The most important factorthat affects the cost of these products is the underlying cost of theagricultural commodities such as flour, butter, cheese, coffee, turkey andother products. In order to mitigate the impact of rising commodity costs, oursuppliers enter into agreements to fix the cost of these products for aspecified period of time that is generally one year or less. We do not engagein the practice of buying futures contracts and therefore we do not usederivative accounting. Packaging and distribution costs are primarily affectedby the cost of oil because petroleum-based material is often used tomanufacture certain packaged products and the cost of diesel fuel affects distributioncosts. Although we have generally been able to increase our retail prices at

 

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our company-ownedrestaurants to offset the increased costs of these items, we may not be able todo so in the future.

Commodity based food costs for the first two quartersof 2007 were higher than 2006 but below our forecasted amounts.  Wheat, butter, dairy and cheese represent ourlargest exposure to agriculture commodity costs.  We utilize an independent third partyconsulting firm to assist us in managing our exposure to fluctuations incommodity costs.

Based upon our existing purchase agreements already inplace as well as our best estimate of commodity costs for the remainder of2007, we believe that commodity costs will increase in the second half of 2007,but remain within our expectation for the full year.

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

In late 2006, we negotiated contract terms with twonew regional distributors. In early 2007, these new distributors begandelivering products to our company-owned, licensed and franchised restaurantsin the respective geographic regions. Currently, the new distributors areproviding a higher level of services at a lower cost for our company-ownedrestaurants. However, there is no assurance that the new distributors willcontinue to perform as we expect, or that their cost structure will continue toprovide for the cost savings that we anticipate.

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

There is significant competition for personnel andlimited availability in the labor pool. In most of the states in which weoperate, increases in state minimum hourly wage rates became effective January1, 2007, and the federal government has recently enacted federal wageincreases. Accordingly, we anticipate increases in hourly wages during 2007. Wecontinue to focus on labor efficiencies that may help to offset a portion ofthe increases in labor costs.

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

*Facility, Marketing and Other Costs.*Facility, marketing and other costs include rent, common area costs, propertytaxes and insurance, liability insurance, delivery fees and allocated marketingexpenses. We exclude depreciation and amortization expense from company-ownedrestaurant costs in determining gross profit. Changes in these costs aregenerally the result of changes in our rent and other related facility costs.Accordingly, these costs are predominantly fixed in nature and are modestlyimpacted by changes in the volume of products sold.

Certain states and local governments have increasedboth the rate and nature of taxes on businesses in their regions.

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These increased taxes include real estate and propertytaxes, state and local income taxes, and various employment taxes.

***Manufacturing and CommissaryCosts***

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

***General and AdministrativeExpenses***

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

***Depreciation and Amortization***

Depreciation and amortization are periodic non-cashcharges that represent the reduction in usefulness and value of our tangibleand intangible assets. The majority of our depreciation and amortizationrelates to equipment and leasehold improvements located in our company-ownedrestaurants. Based on our current purchases of capital assets, our existingbase of assets, and our projections for new purchases of fixed assets, we believedepreciation expense for 2007 will be approximately $11.0 million.

**Consumer Spending Habits and Impact of Inflation**

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

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

**Seasonality and Quarterly Results**

Our business is subject to seasonal fluctuations.Significant portions of our net revenues and results of operations

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are realized during the fourth quarter of the fiscalyear, which includes the December holiday season. Because of the seasonality ofthe business and the industry, results for any quarter are not necessarilyindicative of the results that may be achieved for any other quarter or thefull fiscal year.

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**Results of Operations**

This table 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.

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| ** **                                                        | ** ** | **Second quarter ended:  (in thousands of dollars)** | ** ** | **Increase/  (Decrease)** | ** ** | **Second quarter ended:  (percent of total revenue)** | ** ** | **Year to date ended:  (in thousands of dollars)** | ** ** | **Increase/  (Decrease)** | ** ** | **Year to date ended:  (percent of total revenues)** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|---------------------------|------------|--------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|---------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                                        | ** ** | **July 4,  2006**                                                        | ** ** | **July 3,  2007**    | ** ** | **2006  vs. 2007**                                                        | ** ** | **July 4,  2006**                                                           | ** ** | **July 3,  2007**    | ** ** | **July 4,  2006**                                                             | ** ** | **July 3,  2007** | ** ** | **2006  vs. 2007** | ** ** | **July 4,  2006** | ** ** | **July 3,  2007** | ** ** |
| Revenues:                                                         |       |                                                                          |       |                      |       |                                                                           |       |                                                                             |       |                      |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Company-owned restaurant sales                                    |       | $                                                                             | 91,507     |                      | $          | 94,141                                                                         |       | 2.9                                                                              | %          | 93.4                      | %          | 93.2                                                                               | %          | $ | 182,087 |   | $ | 183,256 |   | 0.6 | % | 93.4 | % | 92.9 | % |
| Manufacturing and commissary revenues                             |       | 5,196                                                                         |       | 5,682                     |       | 9.4                                                                            | %          | 5.3                                                                              | %          | 5.6                       | %          | 10,469                                                                             |       | 11,500 |   | 9.8 | % | 5.4 | % | 5.8 | % |
| Franchise and license related revenues                            |       | 1,253                                                                         |       | 1,232                     |       | (1.7                                                                           | %)         | 1.3                                                                              | %          | 1.2                       | %          | 2,476                                                                              |       | 2,554 |   | 3.2 | % | 1.3 | % | 1.3 | % |
| Total Revenues                                                    |       | 97,956                                                                        |       | 101,055                   |       | 3.2                                                                            | %          | 100.0                                                                            | %          | 100.0                     | %          | 195,032                                                                            |       | 197,310 |   | 1.2 | % | 100.0 | % | 100.0 | % |
|                                                              |       |                                                                          |       |                      |       |                                                                           |       |                                                                             |       |                      |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Cost of sles:                                                     |       |                                                                          |       |                      |       |                                                                           |       |                                                                             |       |                      |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Company-owned restaurant costs                                    |       | 73,964                                                                        |       | 75,257                    |       | 1.7                                                                            | %          | 75.5                                                                             | %          | 74.5                      | %          | 147,490                                                                            |       | 146,589 |   | (0.6 | %) | 75.6 | % | 74.3 | % |
| Manufacturing and commissary costs                                |       | 5,502                                                                         |       | 5,380                     |       | (2.2                                                                           | %)         | 5.6                                                                              | %          | 5.3                       | %          | 10,507                                                                             |       | 10,802 |   | 2.8 | % | 5.4 | % | 5.5 | % |
| Total cost of  sales                                              |       | 79,466                                                                        |       | 80,637                    |       | 1.5                                                                            | %          | 81.1                                                                             | %          | 79.8                      | %          | 157,997                                                                            |       | 157,391 |   | (0.4 | %) | 81.0 | % | 79.8 | % |
|                                                              |       |                                                                          |       |                      |       |                                                                           |       |                                                                             |       |                      |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Gross profit:                                                     |       |                                                                          |       |                      |       |                                                                           |       |                                                                             |       |                      |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Company-owned restaurant                                          |       | 17,543                                                                        |       | 18,884                    |       | 7.6                                                                            | %          | 17.9                                                                             | %          | 18.7                      | %          | 34,597                                                                             |       | 36,667 |   | 6.0 | % | 17.7 | % | 18.6 | % |
| Manufacturing and commissary                                      |       | (306                                                                          | )          | 302                       |       | *                                                                              |       | (0.3                                                                             | %)         | 0.3                       | %          | (38                                                                                | )          | 698 |   | * |   | (0.0 | %) | 0.4 | % |
| Franchise and license                                             |       | 1,253                                                                         |       | 1,232                     |       | (1.7                                                                           | %)         | 1.3                                                                              | %          | 1.2                       | %          | 2,476                                                                              |       | 2,554 |   | 3.2 | % | 1.3 | % | 1.3 | % |
| Total gross  profit                                               |       | 18,490                                                                        |       | 20,418                    |       | 10.4                                                                           | %          | 18.9                                                                             | %          | 20.2                      | %          | 37,035                                                                             |       | 39,919 |   | 7.8 | % | 19.0 | % | 20.2 | % |
|                                                              |       |                                                                          |       |                      |       |                                                                           |       |                                                                             |       |                      |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Operating  expenses:                                              |       |                                                                          |       |                      |       |                                                                           |       |                                                                             |       |                      |       |                                                                               |       |   |   |   |   |   |   |   |   |
| General and administrative expenses                               |       | 9,727                                                                         |       | 10,855                    |       | 11.6                                                                           | %          | 9.9                                                                              | %          | 10.7                      | %          | 20,288                                                                             |       | 21,587 |   | 6.4 | % | 10.4 | % | 10.9 | % |
| Depreciation and amortization                                     |       | 5,594                                                                         |       | 2,623                     |       | (53.1                                                                          | %)         | 5.7                                                                              | %          | 2.6                       | %          | 11,598                                                                             |       | 5,042 |   | (56.5 | %) | 5.9 | % | 2.6 | % |
| Loss on sale, disposal or abandonment of assets, net              |       | (8                                                                            | )          | 31                        |       | *                                                                              |       | (0.0                                                                             | %)         | 0.0                       | %          | 13                                                                                 |       | 405 |   | * |   | 0.0 | % | 0.2 | % |
| Impairment charges and other related costs                        |       | 7                                                                             |       | 166                       |       | 2271.4                                                                         | %          | 0.0                                                                              | %          | 0.2                       | %          | 83                                                                                 |       | 185 |   | 122.9 | % | 0.0 | % | 0.1 | % |
| Income from  operations                                           |       | 3,170                                                                         |       | 6,743                     |       | 112.7                                                                          | %          | 3.2                                                                              | %          | 6.7                       | %          | 5,053                                                                              |       | 12,700 |   | 151.3 | % | 2.6 | % | 6.4 | % |
| Other expense:                                                    |       |                                                                          |       |                      |       |                                                                           |       |                                                                             |       |                      |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Interest expense, net                                             |       | 4,712                                                                         |       | 4,144                     |       | (12.1                                                                          | %)         | 4.8                                                                              | %          | 4.1                       | %          | 9,921                                                                              |       | 8,933 |   | (10.0 | %) | 5.1 | % | 4.5 | % |
| Write-off of debt discount upon redemption of senior  notes       |       | —                                                                        |       | 528                       |       | *                                                                              |       | 0.0                                                                              | %          | 0.5                       | %          | —                                                                             |       | 528 |   | * |   | 0.0 | % | 0.3 | % |
| Prepayment penalty upon redemption of senior notes                |       | —                                                                        |       | 240                       |       | *                                                                              |       | 0.0                                                                              | %          | 0.2                       | %          | 4,800                                                                              |       | 240 |   | (95.0 | %) | 2.5 | % | 0.1 | % |
| Write-off of debt issuance costs upon redemption of  senior notes |       | —                                                                        |       | 2,071                     |       | *                                                                              |       | 0.0                                                                              | %          | 2.0                       | %          | 3,956                                                                              |       | 2,071 |   | (47.6 | %) | 2.0 | % | 1.0 | % |
| Other, net                                                        |       | —                                                                        |       | —                    |       | *                                                                              |       | 0.0                                                                              | %          | 0.0                       | %          | 10                                                                                 |       | — |   | (100.0 | %) | 0.0 | % | 0.0 | % |
| Income (loss)  before taxes                                       |       | $                                                                             | (1,542     | )                         | $          | (240                                                                           | )          | (84.4                                                                            | %)         | (1.6                      | %)         | (0.2                                                                               | %)         | $ | (13,634 | ) | $ | 928 |   | * |   | (7.0 | %) | 0.5 | % |
| Provision for income taxes                                        |       | —                                                                        |       | 10                        |       | *                                                                              |       | 0.0                                                                              | %          | 0.0                       | %          | —                                                                             |       | 47 |   | * |   | 0.0 | % | 0.0 | % |
| Net income (loss)                                                 |       | $                                                                             | (1,542     | )                         | $          | (250                                                                           | )          | (83.8                                                                            | %)         | (1.6                      | %)         | (0.2                                                                               | %)         | $ | (13,634 | ) | $ | 881 |   | * |   | (7.0 | %) | 0.4 | % |

----

* not meaningful

31

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*Company-Owned RestaurantOperations*

**Wehave a 52/53-week fiscal year ending on the Tuesday closest to December 31. Thesecond quarters in fiscal years 2006 and 2007 ended on July 4, 2006 and July 3,2007, respectively, and each contained 13 weeks.**

**Comparablestore sales is a key performance indicator widely used throughout therestaurant industry. Comparable store sales is calculated by dividing aggregatesales for stores open for each full week in the current year by aggregate salesfor the same stores open for the corresponding full week in the prioryear.  Stores must be open for 52/53weeks before they are included in the calculation. Comparable store salesinclude company-owned restaurants only and represent the change inperiod-over-period sales for the comparable store base.**

For the second quarter andyear to date period of 2007, our comparable store sales increased 5.2% and3.1%, respectively. The improvement was primarily due to system-wideprice increases, growth in total units sold and a slight shift in product mixto higher priced items. We have seen strong comparable store sales performancein all 26 of our upgraded restaurants. The performance of the upgradedrestaurants translated into a quarter-over-quarter and year-over-year increasein comparable sales of 12.9 % and 8.6%, respectively, and positively impactedthe second quarter and year to date periods of 2007 by 0.5% and 0.4%,respectively. Partially offsetting the increase in revenue for the quarter andyear to date periods ended July 3, 2007, was a net decrease in the number ofcompany-owned restaurants. The decrease was a result of planned closures ofunderperforming restaurants and positively contributes to our restaurant grossprofit.

For the second quarter ended July 3, 2007, our restaurantgross profit increased 7.6% when compared to the same period in 2006. Theimprovement of $1.3 million in our company-owned restaurant gross profit forthe quarter was partially driven by profit in comparable stores sales of $0.9million, a decrease in marketing expense of $0.6 million, and recognition ofthe gross profit portion of unredeemed gift cards issued prior to 2006 of $0.5million. These items were partially offset by an increase of approximately $0.3million due to the net impact of inflationary increases in cost of goods andwage rates, approximately $0.2 million in insurance costs, and approximately$0.2 million in increased common area maintenance expenses.

For the year todate period ended July 3, 2007, our restaurant gross profit increased 6.0% whencompared to the same period in 2006. The improvement of $2.1 million in ourcompany-owned restaurant gross profit was partially driven by profit fromcomparable restaurant sales of $0.4 million, a decrease in marketing expense of$1.3 million, the recognition of the gross profit portion of unredeemed giftcards issued prior to 2006 of $0.5 million, approximately $1.0 million indecreased workers’ compensation loss reserves and a reduction of $0.4 millionin quarterly bonus accruals. These items were partially offset by an increasein group insurance of approximately $0.4 million, $0.4 million in higher bankfees, property taxes and repair and maintenance expenses, $0.4 million due thenet impact of inflationary increases in cost of goods and wage rates andapproximately $0.3 million in increased common area maintenance expenses.

*Manufacturing and Commissary Operations*

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

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

·      implemented price increases to some of ourthird-party customers;

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

·      increased our current production capacity,thereby allowing us to provide new products to new and existing customers.

32

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During the second quarter and year to date periodsended July 3, 2007, manufacturing and commissary revenues improved $0.5 millionand $1.0 million, or 9.4% and 9.8%, respectively, as compared to the sameperiods in 2006.  This increase waspredominantly driven by price increases and an increase in volume of units soldto our more significant customers. The increase in revenue combined with anoverhead cost structure that is primarily fixed in nature translated to animprovement in gross profit of approximately $0.6 million and $0.7 million forthe second quarter and year to date periods ended July 3, 2007, respectively.

*Franchise and License Operations*

Revenues for the license and franchise operationsconsist primarily of initial fees and royalty income earned as a result ofsales within licensed and franchised restaurants. Overall, licensee andfranchisee revenue increased $78,000, or 3.2% for the year to date period endedJuly 3, 2007, as compared to the same period of 2006, and declined slightly by$21,000, or 1.7% in the second quarter of 2007, compared to the second quarterof 2006. The year to date increase was predominantly due to improved comparablefranchisee/licensee sales in the Manhattan Bagel and Einstein Bros. brands anda net increase of 33 licensed restaurants, slightly offset by a net decrease of33 franchised restaurants.

*General and Administrative Expenses*

For the second quarter of 2007, our general andadministrative expenses increased $1.1 million, or 11.6% as compared to thesecond quarter in 2006. Contributing to the increase was $0.8 million in salaryexpense and $0.7 million in additional stock based compensation expense, $0.2million in relocating our corporate office, and $0.2 in legal expenses to amendour debt facility, offset by $0.6 million savings in quarterly bonus accrualsand a $0.2 million savings in other general and administrative expenses.

For the year to date period ended July 3, 2007, ourgeneral and administrative expenses increased $1.3 million, or 6.4% as comparedto the same period in 2006. Contributing to the increase was $1.1 million insalary expense; $0.8 million in additional stock based compensation expense;$0.3 million in increased travel and management development expenses, $0.2 millionin relocating our corporate office, and $0.2 in legal expenses to amend ourdebt facility, and $0.4 million in recruiting and referral fees related to ouremployees, offset by a $1.3 million savings in quarterly bonus accruals and$0.4 savings in other general and administrative expenses.

*Depreciation and Amortization*

Depreciation and amortization expenses decreased $2.9million for the second quarter of 2007 when compared to the second quarter of2006 and decreased $6.6 million for the year to date period ended July 3, 2007,compared to the same period in 2006. The decrease is primarily due to all of our amortizing intangibleassets becoming fully amortized and a substantial portion of our capitalizedassets becoming fully depreciated within the second and third quarters offiscal 2006. Depreciationand amortization expense is predominantly related to the assets ofEinstein/Noah Bagel Corp. that we acquired in bankruptcy proceedings in June2001. The sale of certain manufacturing equipment located at the plant ofHarlan Bakeries, Inc., our frozen bagel dough supplier, during the firstquarter of 2007 also contributed to the decrease in depreciation expense. Theassets were classified as held for sale on the consolidated balance sheet as ofJanuary 2, 2007. Proceeds from the sale were received in the second quarter of2007.

*Losses and Gains on the Sale, Disposal, orAbandonment of Assets*

Gains and losses on the disposal, sale or abandonmentof assets represent the difference of proceeds received, if any, and the netbook value of an asset. We establish estimated useful lives for our assets,which range from three to eight years, and depreciate using the straight-linemethod. Leasehold improvements are limited to the lesser of the useful life orthe noncancelable lease term. The useful lives of the assets are based upon ourexpectations of the period of time that the asset will be used to generaterevenue. We periodically review the assets for changes in circumstances, whichmay impact their useful lives. During the second quarter and year to date period ended July 4,2006, we recorded an $8,000 gain and a $13,000 loss, respectively on thedisposal, sale or abandonment of assets. During the second quarter and year to date period ended July 3, 2007, werecorded $31,000 and $405,000,

33

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respectively inlosses on the disposal, sales or abandonment of assets.

*Impairment Charges and Other Related Costs*

Impairment losses are non-cash charges recorded onlong-lived assets, goodwill, trademarks and our other intangible assets.Generally, an indicator of impairment would include significant change in anasset’s ability to generate positive cash flow in the future or in the fairvalue of an asset. Whenever impairment indicators are determined to be present,the amount of impairment is measured as the excess of the carrying amount ofthe asset over its fair value. During the second quarter and year to date period ended July 3,2007, we recorded impairment charges of $0 and $19,000, respectively.During the second quarter and year to date ended July 4, 2006, we recorded$7,000 and $83,000, respectively in impairment charges related to company-ownedrestaurants. Additionally, weincurred other related costs to close company-owned restaurants of $0 and$166,000 for the quarter and year to date periods ended July 4, 2006 and July3, 2007, respectively.

*Other Expense*

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

On June 13, 2007, we completed a secondary publicoffering of 5 million shares of common stock resulting in gross proceeds of$90.0 million.  After underwritingdiscounts and commissions and other costs incurred related to the offering of$6.4 million, we received net proceeds of $83.6 million. We used theproceeds of the offering to pay down our existing indebtedness.  On June 28, 2007, we paid off our $65 MillionSecond Lien Term loan and a portion of our $25 Million Subordinated Note.  During the second quarter, we wrote off $2.1million of debt issuance costs and paid a $0.2 million redemption premiumrelated to the $65 Million Second Lien Term Loan, and wrote off a $0.5 milliondiscount related to the $25 Million Subordinated Note.

*NetIncome (Loss) and Income Taxes*

Under GAAP, wereported net loss for the second quarter of 2007 of $0.3 million as compared tonet loss of $1.5 million for the second quarter of 2006. We reported net incomeof $0.9 million for the year to date period ended July 3, 2007 as compared tothe net loss of $13.6 million for the same period in 2006. For tax purposes,our net operating loss carryforward reduced our federal and state income taxliability incurred for the second quarter of 2007. We have recorded a provisionfor income taxes in the amount of $10,000 for the second quarter 2007 and$47,000 for the year to date period ended July 3, 2007 as a result of ourestimate of alternative minimum income tax due on taxable earnings and ourestimate of state income tax.

34

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As of July 3,2007, our net operating loss carryforwards for U.S. federal income tax purposeswere $153.7 million, $95.7 million of which are subject to an annual usagelimitation of $4.7 million, and were subject to the following expirationschedule:

** **

| Net Operating Loss  Carryforwards | ** ** |
|-----------------------------------|------------|
| **Expiration Date**               | ** ** | **Amount** | ** ** |
| ** **                        | ** ** | **(in thousands of dollars)** | ** ** |
| 12/31/2010                        |       | $ | 1,660 |   |
| 12/31/2011                        |       | 4,862 |   |
| 12/31/2012                        |       | 9,589 |   |
| 12/31/2018                        |       | 14,553 |   |
| 12/31/2019                        |       | 6,862 |   |
| 12/31/2020                        |       | 10,424 |   |
| 12/31/2021                        |       | 10,515 |   |
| 12/31/2022                        |       | 35,688 |   |
| 12/31/2023                        |       | 40,649 |   |
| 12/31/2024                        |       | 11,938 |   |
| 12/31/2025                        |       | 5,391 |   |
| 12/31/2026                        |       | 1,552 |   |
|                              |       | $ | 153,683 |   |

 

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

Our net operating losscarryforwards are one of our deferred income tax assets; however, the ultimaterealization of these deferred income tax assets is dependent upon generation offuture taxable income. Due to the uncertainty of future taxable income,deferred tax assets resulting from these net operating losses have been fullyreserved. In accordance with SFAS 109 we will assess the continuing need for avaluation allowance that results from uncertainty regarding our ability torealize the benefits of our deferred tax assets.

**Financial Condition, Liquidityand Capital Resources**

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

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

Based upon ourprojections for the remainder of 2007 and throughout 2008, we believe ourvarious sources of capital, including availability under existing debtfacilities, and cash flow from operating activities of continuing operations,are adequate to finance operations as well as the repayment of current debt obligations.

35

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*Secondary Public Offering of Our Common Stock*

OnJune 13, 2007, we completed a $90 million secondary public offering of ourcommon stock.  After underwritingdiscounts and commissions of $6.4 million, we received net proceeds of $83.6million.  The net proceeds were used torepay our $65.0 million Second Lien Term Loan, repay a portion of our $25million Subordinated Note heldby Greenlight Capital,L.L.C. (“Greenlight”) and to payfor the offering costs.  Additionally, onJune 28, 2007, we repaid the remaining portion of the $25 million SubordinatedNote held by Greenlight by using a portion of the incremental debt proceedsunder the amended debt facility.

*June 2007 Debt Redemption and Amended First LienTerm Loan*

In June 2007, we amended our debt facility from $95.0 million to $110.0million. As part of this amendment we increased the amount of our existingrevolving credit facility from $15.0 million to $20.0 million and modified ourterm loan from a principal amount of $80.0 million to $90.0 million and repaidthe remaining amount of the $25 Million Subordinated Note as noted above. Therevolving credit facility remains available, subject to certain conditions, tofinance our ongoing working capital, capital expenditure and general corporateneeds and a portion of the revolving credit facility remains available forletters of credit. We are required to pay an unused credit line fee of0.5% per annum on the average daily unused amount. The unused line fee ispayable quarterly in arrears. Additionally, we are required to pay a letter ofcredit fee based on the ending daily undrawn face amount for each letter ofcredit issued, being based on our consolidated leverage ratio with anapplicable margin of 2.00% plus a 0.5% arranger fee payable quarterly. Lettersof credit reduce our availability under the Revolving Facility. At July 3,2007, we had $6.7 million in letters of credit outstanding. The letters ofcredit expire on various dates during 2008, are automatically renewable for oneadditional year and are payable upon demand in the event that we fail to paythe underlying obligation. Our availability under the revolving facility was$13.3 million at July 3, 2007.

In addition, wehave obtained a commitment for an incremental term loan in an aggregateprincipal amount of up to $57.0 million which may be used if needed, solely forthe purpose of redeeming the zero coupon Series Z preferred stock, which is notdue until June 2009.

We may prepayamounts outstanding under the senior secured credit facility and may terminatecommitments in whole at any time without penalty or premium upon prior writtennotice.

*Working Capital Deficit*

At July 3, 2007,we had unrestricted cash of $7.1 million and restricted cash of $2.0 million.Under our Revolving Facility, there were no outstanding borrowings, $6.7million in letters of credit outstanding and borrowing availability of $13.3million. Our working capital deficit improved $5.4 million to $2.6 million atJuly 3, 2007 compared to $8.0 million at January 2, 2007.

*CashProvided by Operations*

Due to increasedprofitability at our company-owned restaurants and the timing of operationalreceipts and payments, net cash generated by operating activities was $8.3million through the second quarter of 2007 compared to $4.3 million for thecomparable period in 2006. Net income was $0.9 million for the year to dateperiod in 2007 and was adjusted for non-cash items of depreciation andamortization expense of $5.0 million, stock based compensation expense of $1.3million and the write off of $2.1 million of debt issuance costs to arrive atcash provided by operating activities. Net loss for the same period in 2006 was$13.6 million and was adjusted for non-cash items of depreciation andamortization expense of $11.6 million, stock based compensation expense of $0.4million and the write off of $4.0 million in debt issuance costs to arrive atcash provided by operating activities.

*Cash Usedin Investing Activities*

During the year todate period ended July 3, 2007, we used approximately $12.4 million of cashused to purchase additional property and equipment that included $2.6 millionto open two new restaurants, $1.1 million for

36

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upgrading existingrestaurants, $4.5 million for replacement of old equipment with new equipment atour existing company-owned restaurants, $1.1 million for our manufacturingoperations, $1.3 million for general corporate purposes, and $1.8 for leaseholdimprovements and build-out related to our new corporate headquarters.  We estimate the total capital cost for ournew corporate headquarters will be $2.4 million.

During the year todate period ended July 4, 2006, we used approximately $5.4 million of cash topurchase additional property and equipment that included $0.7 million for newrestaurants, $1.4 million for upgrading existing restaurants, $2.0 million forreplacement of old equipment with new equipment at our existing company-ownedrestaurants, $0.4 million for our manufacturing operations and less than $0.9million for general corporate purposes.

We anticipate thatthe majority of our capital expenditures for fiscal 2007 will be focused on theaddition of 11 — 15 new company-owned restaurants during 2007 at an averagegross capital investment of approximately $550,000 per restaurant, which variesdepending upon square footage, layout and location. We also intend to upgradeapproximately 37 of our current restaurants to the front of the houseconfiguration of our prototype restaurant, during 2007. The upgrade includesnew self-service coolers, an expanded coffee bar, and a separate station forquick “to go” items. Finally, we plan to acquire additional equipment for newmenu items and an improved ordering system that uses wireless technology toreduce the time our guests wait in line before they receive their food.

*Cash Used in Financing Activities*

As a result of our June 13, 2007 secondary publicoffering of common stock, we received $90.0 million in cash, and incurred $6.4million in stock issuance costs. Concurrent with our June 28, 2007 amendment toour First Lien Term Loan, we drew down an additional $11.9 million in debt andincurred an additional $0.8 million in debt issuance costs.  The funds from these two transactions wereused to pay off the $65.0 million Second Lien Term Loan and the $25.0 MillionSubordinated Note and $2.5 million of related paid-in-kind interest on theSubordinated Note.

For the same period in 2006, and as a result of ourrefinancing of our $160 Million Notes with $170 million in new term loans inFebruary 2006, we borrowed $169.4 million in term loans and incurredapproximately $5.0 million in debt issuance costs. Upon closing of our new debtfacility, we began amortizing these costs and the debt issuance costs relatedto our $160 Million Notes and AmSouth revolver were written-off.

37

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*Contractual Obligations*

The following table summarizes the amounts of paymentsdue under specified contractual obligations as of July 3, 2007:
| ** **                                           | ** ** | **Payments Due by Fiscal Period** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                              | ** ** | **2008 to  2010** | ** ** | **2011 to  2012** | ** ** | **2013 and  thereafter** | ** ** | **Total** | ** ** |
| ** **                                           | ** ** | **(in thousands of dollars)**          | ** ** |
| Accounts payable  and accrued expenses               |       | $                                                     | 25,901     |   | $ | — |   | $ | — |   | $ | — |   | $ | 25,901 |   |
| Senior notes and  other long-term debt               |       | 730                                                   |       | 2,755 |   | 87,075 |   | — |   | 90,560 |   |
| Estimated  interest expense on our Debt Facility (a) |       | 3,017                                                 |       | 20,484 |   | 10,965 |   | — |   | 34,466 |   |
| Manditorily  Redeemable Series Z Preferred Stock     |       | —                                                |       | 57,000 |   | — |   | — |   | 57,000 |   |
| Minimum lease  payments under capital leases         |       | 45                                                    |       | 133 |   | 3 |   | — |   | 181 |   |
| Minimum lease  payments under operating leases       |       | 25,779                                                |       | 54,730 |   | 13,179 |   | 5,839 |   | 99,527 |   |
| Purchase  obligations (b)                            |       | 3,863                                                 |       | — |   | — |   | — |   | 3,863 |   |
| Other long-term  obligations (c)                     |       | —                                                |       | 683 |   | 506 |   | 5,833 |   | 7,022 |   |
| Total                                                |       | $                                                     | 59,335     |   | $ | 135,785 |   | $ | 111,728 |   | $ | 11,672 |   | $ | 318,520 |   |

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(a)    Calculatedas of July 3, 2007, using the LIBOR and U.S. Prime rates, plus the applicablemargin in effect. Because the interest rates on the first lien term loanfacility and the revolving credit facility are variable, actual payments coulddiffer materially.

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

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

*Insurance*

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

**Off-BalanceSheet Arrangements**

*Guarantees*

Prior to 2001, wewould occasionally guarantee leases for the benefit of certain of ourfranchisees. None of the guarantees have been modified since their inceptionand we have since discontinued this practice. Current franchisees are theprimary lessees under the vast majority of these leases. Under the leaseguarantees, we may be required by the lessor to make all of the remainingmonthly rental payments or property tax and common area maintenance payments ifthe franchisee does not make the required payments in a timely manner. However,we believe that most, if not all, of the franchised restaurants could besubleased to third parties minimizing our

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potentialexposure. Additionally, we have indemnification agreements with our franchiseesunder which the franchisees would be obligated to reimburse us for any amountspaid under such guarantees. Historically, we have not been required to makesuch payments in significant amounts.  We recorded a $50,000 liability for our exposure under the guarantees inaccordance with SFAS No. 5 following a probability related approach. Minimumfuture rental payments remaining under all remaining leases were approximately$1.4 million as of July 3, 2007. We believe the ultimate disposition of thesematters will not have a material adverse effect on our financial position orresults of operations.

*Letters of Credit*

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

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

During the first quarters ended July 4, 2006 and July3, 2007, our results of operations, financial position and cash flows have notbeen materially affected by changes in the relative values of non-U.S.currencies to the U.S. dollar. We do not use derivative financial instrumentsto limit our foreign currency risk exposure since virtually all of our businessis conducted in the United States.

Our manufacturing operations sell bagels to awholesaler and a distributor who take possession in the United States and selloutside of the United States. As the product is shipped FOB domestic dock,there are no international risks of loss or foreign exchange currency issues.Approximately $0.4 million and $0.9 million of sales shipped internationallyare included in manufacturing and commissary revenue for the second quarter in2006 and 2007, respectively.

Our debt as of July 3, 2007 was principally comprisedof the amended Revolving Facility and First Lien Term Loan. For fixed ratedebt, interest rate changes affect the fair market value of such debt but donot impact earnings or cash flows. Conversely for variable rate debt, includingborrowings under our Revolving Facility and First Lien Term Loan, interest ratechanges generally do not affect the fair market value of such debt, but doimpact future earnings and cash flows, assuming other factors are heldconstant. A 100 basis point increase in short-term effective interest rateswould decrease our net income by approximately $0.9 million annually, assumingno change in the size or composition of debt at July 3, 2007. Currently, theinterest rates on our First Lien Term Loan and Revolving Facility arepredominantly at LIBOR rates plus an applicable margin through short-term fixedrate financing. The estimated increase in interest expense incorporates thefixed interest financing into its assumptions.

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

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

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**Item4.  Controls and Procedures**

An evaluation was carried out under the supervisionand with the participation of company management, including our chief executiveofficer and chief financial officer, of the effectiveness of the design andoperation of our disclosure controls and procedures (as defined inRule 13a-15(e) under the Securities Exchange Act of 1934, as amended) asof July 3, 2007. Based upon that evaluation, our chief executive officer andour chief financial officer have concluded that the design and operation of ourdisclosure controls and procedures were effective in timely making known tothem material information relating to the Company required to be disclosed inreports that we file or submit under the Exchange Act rules.

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

During the year to date period ended July 3, 2007,there were no changes to our internal controls over financial reporting thatwere identified in connection with the evaluation of our disclosure controls andprocedures required by the Exchange Act rules and that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

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**PART II - OTHERINFORMATIONEINSTEIN NOAH RESTAURANT GROUP, INC.**

**Item 1.    Legal Proceedings**

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

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

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

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

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

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

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

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

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

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Changes in our guests’spending habits could also have a material adverse effect on our sales. Avariety of factors could affect discretionary consumer spending, includingnational, regional and local economic conditions, weather, inflation, consumerconfidence, effect of credit markets and energy costs. Adverse changes in anyof these factors could reduce consumers’ discretionary spending which in turncould reduce our guest traffic or average check. For example, traffic torestaurants industry-wide was adversely affected in 2006 and 2007 as a resultof reduced consumer spending due to rising fuel and energy costs. Adversechanges to consumer preferences or consumer discretionary spending, each ofwhich could be affected by many different factors which are out of our control,could harm our business prospects, financial condition, operating results andcash flows. Our continued success will depend in part on our ability toanticipate, identify and respond to changing consumer preferences and economicand other conditions.

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

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

·              expandsales at our existing company-owned restaurants;

·              opennew company-owned restaurants; and

·              opennew licensed and franchised restaurants.

Our ability to achieveany or all of these initiatives is uncertain. Our success in expanding sales atcompany-owned restaurants through various sub-initiatives including: developingnew menu offerings and broadening our offerings across multiple dayparts,improving our ordering and production systems, expanding our catering programand upgrading our restaurants is dependent in part on our ability to predictand satisfy consumer preferences. Our success in growing our business throughopening new company-owned restaurants is dependent on a number of factors,including our ability to: find suitable locations, reach acceptable leaseterms, have adequate capital, find available contractors, obtain licenses andpermits, locate and train appropriate staff and properly manage the newrestaurant. Our success in opening new licensed and franchised restaurants isdependent upon, among other factors, our ability to: attract quality businessesto invest in our core brands, maintain the effectiveness of our franchiseoffering circulars in target states, offer restaurant solutions for a varietyof location types and the ability of our licensees and franchisees to: findsuitable locations, reach acceptable lease terms, have adequate capital, findavailable contractors, obtain licenses and permits, locate and train staffappropriately and properly manage the new restaurants. Accordingly, we may notbe able to open or upgrade as many restaurants or grant as many franchises orlicenses as we project or otherwise execute on our strategy. If we are notsuccessful in implementing any or all of the initiatives of our businessstrategy, it could have a material adverse effect on our business, results ofoperations, and financial condition.

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

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

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

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

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

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

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

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

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

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The cost of energyimpacts our results of operations in several ways.  We have seen our cost of electricity graduallyincrease over time. Distribution costs related to fuel are included in ourcosts, including commodity purchases, and have impacted our operationsnegatively. Additionally, travel costs, primarily airline fares, have beensteadily increasing nationwide. These costs impact our results of operationcurrently and could impact us negatively in the future.

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

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

The effects ofhurricanes, freezes and other adverse weather conditions are likely to affectsupply of and costs for raw ingredients and natural resources, near-term constructioncosts for our new restaurants as well as sales in our restaurants goingforward. If we are not able to anticipate or react to changing costs of foodand other raw materials

by adjusting ourpurchasing practices or menu prices, our operating margins would likelydeteriorate.

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

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

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

We depend on our networkof independent regional distributors to distribute frozen bagel dough and otherproducts and materials to our company-owned, licensed and franchisedrestaurants. Any failure by one or more of our distributors to perform asanticipated, or any disruption in any of our distribution relationships for anyreason, would subject us to a number of risks, including inadequate productsdelivered to our restaurants, diminished control over quality of productsdelivered, and increased operating costs to prevent delays in deliveries. Anyof these events could harm our relationships with our franchisees or licensees,or diminish the reputation of our menu offerings or our brands in themarketplace. In addition, a negative change in the volume of products orderedfrom our distributors by our company-owned, franchised and/or licensedrestaurants could increase our distribution costs. These risks could have amaterial adverse effect on our business, financial condition and results ofoperations.

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

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

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

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

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

We have a considerableamount debt and are substantially leveraged. As of July 3, 2007, we had $90.0million in term loans outstanding.  Wealso have $57.0 million of mandatorily redeemable preferred stock due June 30,2009.  In addition, we may, subject tocertain restrictions, incur substantial additional indebtedness in the future.Our high level of debt, among other things, could:

·              make it difficult for us tosatisfy our obligations under our indebtedness;

·              limitour ability to obtain additional financing for working capital, capitalexpenditures, acquisitions and general corporate purposes;

·              increaseour vulnerability to downturns in our business or the economy generally;

·              increaseour vulnerability to volatility in interest rates; and

·              limitour ability to withstand competitive pressures from our less leveragedcompetitors.

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

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

Our current debtagreements contain certain covenants, which, among others, include certainfinancial covenants such as limitations on capital expenditures, maintenance ofthe business, use of proceeds from sales of assets and consolidated leverageand fixed charge coverage ratios as defined in the agreements. The covenantsalso preclude the declaration and payment of dividends or other distributionsto holders of our common stock. We are subject to multiple economic, financial,competitive, legal and other risks that are beyond our control and could harmour future financial results. Any adverse effect on our business or financialresults could affect our ability to maintain compliance with our debtcovenants, and any failure by us to comply with these covenants could result inan event of default. If we were to default under our covenants and such defaultwere not cured or waived, our indebtedness could become immediately due andpayable, which could render us insolvent.

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

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

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

A health pandemic is adisease that spreads rapidly and widely by infection and affects manyindividuals in an area or population at the same time. In 2004, 2005 and 2006,Asian and European countries experienced outbreaks of avian flu and it ispossible that it will continue to migrate to the United States where ourrestaurants are located. If a regional or global health pandemic were to occur,depending upon its duration and severity, our business could be severelyaffected. We have positioned ourselves as a “neighborhood atmosphere” betweenhome and work where people can gather for human connection and high qualityfood. Customers might avoid public gathering places in the event of a healthpandemic, and local, regional or national governments might limit or ban publicgatherings to halt or delay the spread of disease. A regional or globalpandemic might also adversely impact our business by disrupting or delayingproduction and delivery of products and materials in our supply chain andcausing staff shortages in our restaurants. The impact of a health pandemicmight be disproportionately greater on us than on other companies that dependless on the gathering of people in a neighborhood atmosphere.

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

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

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

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

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

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

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

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

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

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

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

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

**Risk Factors Relating to OurCommon Stock**

*We have a majority stockholder.*

Greenlight Capital,L.L.C. and its affiliates beneficially own approximately 68.2% of our commonstock. As a result, Greenlight has sufficient voting power, without the vote ofany other stockholders, to determine what matters will be submitted forapproval by our stockholders, to approve actions by written consent without theapproval of any other stockholders, to elect all of the members of our board ofdirectors, and to determine whether a change in control of our company occurs.Greenlight’s interests on matters submitted to stockholders may be differentfrom those of other stockholders. Greenlight is not involved in our day-to-dayoperations, but Greenlight has voted its shares to elect our current board ofdirectors. The chairman of our board of directors is a current employee ofGreenlight.

We have listed our commonstock on the NASDAQ Global Market. NASDAQ rules will require us to have anaudit committee consisting entirely of independent directors. However, underNASDAQ rules, if a single stockholder holds more that 50% of the voting powerof a listed company, that company is considered a controlled company, and isexempt from several other corporate governance rules, including the requirementthat companies have a majority of independent directors and independentdirector involvement in the selection of director nominees and in thedetermination of executive compensation. As a result, our stockholders will nothave, and may never have, the protections that these rules are intended toprovide.

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

If a substantial numberof shares of our common stock are sold in the public market, the market priceof our common stock could fall. The perception among investors that these saleswill occur could also produce this effect. Our majority stockholder,Greenlight, beneficially owns approximately 68.2% of our common stock and salesby Greenlight or a perception that Greenlight will sell could cause a decreasein the market price of our common stock.

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

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

**Item 4.Submission of Matters to a Vote of Security Holders**

(a)           The Annual Meeting of Shareholders ofthe Company was held on May 3, 2007. The Company’s Proxy Statement dated April3, 2007, as filed with the Securities Exchange Commission (“SEC”) on April 4,2007 and as amended on April 24, 2007, as filed with the SEC on April 26, 2007,is incorporated herein by reference.

(b)           Each of the nominees, as described inthe Proxy Statement referenced above, was re-elected as a director to holdoffice until the next Annual Meeting of Shareholders or until his successor iselected and qualified.

 

| Nominee Name           | ** ** | **Votes For** | ** ** | **Votes Against  or Withheld** | ** ** |
|-----------------------------|------------|--------------------|------------|------------------------------------------|------------|
| Michael W.  Arthur          |       | 10,372,818         |       | 11,031                                   |       |
| E. Nelson  Heumann          |       | 10,371,283         |       | 12,566                                   |       |
| James W. Hood               |       | 10,372,818         |       | 11,031                                   |       |
| Frank C. Meyer              |       | 10,372,818         |       | 11,031                                   |       |
| Paul J.B. Murphy  III       |       | 10,371,283         |       | 12,566                                   |       |
| S. Garrett  Stonehouse, Jr. |       | 10,372,818         |       | 11,031                                   |       |
| Leonard Tannenbaum          |       | 10,372,818         |       | 11,031                                   |       |

 

(c)           Thefollowing matters were also voted upon at the meeting and approved by theShareholders:

1.     Proposalto approve an amendment to the Restated Certificate of Incorporation to changethe Corporation’s name to Einstein Noah Restaurant Group, Inc.

 

| Votes For  | ** ** | **Votes Against** | ** ** | **Abstentions** |
|------------|------------|-------------------|------------|-----------------|
| 10,368,568 |       | 15,248            |       | 33              |

 

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2.     Proposalto approve an amendment to the Stock Option Plan for Independent Directors toincrease the number of authorized shares for issuance under the Plan.

| Votes For  | ** ** | **Votes Against** | ** ** | **Abstentions** |
|------------|------------|-------------------|------------|-----------------|
| 10,001,660 |       | 9,301             |       | 72              |

 

3.     Proposalto approve an amendment to the Executive Employee Incentive Plan to increasethe number of authorized shares for issuance under the Plan to 2,000,000.

| Votes For | ** ** | **Votes Against** | ** ** | **Abstentions** |
|-----------|------------|-------------------|------------|-----------------|
| 9,380,843 |       | —            |       | —          |

 

4.     Proposalto ratify the appointment of Grant Thornton LLP as independent auditors for thefiscal year ending January 1, 2008

| Votes For  | ** ** | **Votes Against** | ** ** | **Abstentions** |
|------------|------------|-------------------|------------|-----------------|
| 10,378,564 |       | 3,943             |       | 1,342           |

 

**Item6.  Exhibits**

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

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

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

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

 

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**Signatures**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.
|        |            |                                                     |
|--------|-----------------|----------------------------------------------------------|
|   |            | EINSTEIN NOAH RESTAURANT GROUP, INC.                     |
|   |            |                                                     |
|   |            |                                                     |
| Date:  | August 10, 2007 | By: /s/ PAUL J. B. MURPHY, III                           |
|   |            | Paul J.B. Murphy, III                                    |
|   |            | Chief Executive Officer                                  |
|   |            |                                                     |
| Date:  | August 10, 2007 | By: /s/ RICHARD P. DUTKIEWICZ                            |
|   |            | Richard P. Dutkiewicz                                    |
|   |            | Chief Financial Officer and Principal Accounting Officer |

 

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