** **

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **(Mark One)**                                                                                                 |
|----------------------------------------------------------------------------------------------------------------|
| **ý****  QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                           |
| **For the quarterly period ended July 1, 2003**                                                                |
|                                                                                                           |
| **OR**                                                                                                         |
|                                                                                                           |
| **o****  TRANSITION REPORT UNDER SECTION 13 OR 15  (d) OF THE SECURITIES EXCHANGE ACT OF 1934**           |
|                                                                                                           |
| **Commission File Number 0-27148**                                                                             |

 

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

 

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

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Securities Exchange Act of 1934). Yes o  No ý

 

As of July 31,2003, 51,016,857 shares of Common Stock of the registrant were outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

None.

 

 

----

 

**NEW WORLD RESTAURANT GROUP, INC.**

** **

**July 1, 2003**

** **

**FORM 10-Q**

** **

**INDEX**

 
| PART  I. | FINANCIAL INFORMATION                                                                                                                                                |   |
|----------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|     |                                                                                                                                                                 |   |
| Item  1. | Financial  Statements                                                                                                                                                |   |
|     |                                                                                                                                                                 |   |
|     | Consolidated  Balance Sheets as of July 1, 2003  and December 31, 2002                                                                                               | 3      |
|     |                                                                                                                                                                 |   |
|     | Consolidated Statements of Operations for the three-months and  six-months  ended July 1, 2003 and July 2, 2002                                                      | 4      |
|     |                                                                                                                                                                 |   |
|     | Consolidated Statements of Cash Flows for  the six-months  ended July 1, 2003 and July 2, 2002                                                                       | 5      |
|     |                                                                                                                                                                 |   |
|     | Notes to Consolidated Financial Statements                                                                                                                           | 6      |
|     |                                                                                                                                                                 |   |
| Item 2.  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations for the three-months and  six-months ended July 1, 2003 and July 2, 2002 | 19     |
|     |                                                                                                                                                                 |   |
| Item 3.  | Quantitative and Qualitative Disclosures  About Market Risk                                                                                                          | 29     |
|     |                                                                                                                                                                 |   |
| Item 4.  | Controls and Procedures                                                                                                                                              | 29     |
|     |                                                                                                                                                                 |   |
| PART II: | OTHER INFORMATION                                                                                                                                                    |   |
|     |                                                                                                                                                                 |   |
| Item 1.  | Legal Proceedings                                                                                                                                                    | 29     |
|     |                                                                                                                                                                 |   |
| Item 2.  | Changes in Securities and Use of Proceeds                                                                                                                            | 30     |
|     |                                                                                                                                                                 |   |
| Item 3.  | Defaults upon Senior Securities                                                                                                                                      | 31     |
|     |                                                                                                                                                                 |   |
| Item  4. | Submission  of Matters to a Vote of Security Holders                                                                                                                 | 31     |
|     |                                                                                                                                                                 |   |
| Item 5.  | Other Information                                                                                                                                                    | 31     |
|     |                                                                                                                                                                 |   |
| Item 6.  | Exhibits and Reports on Form 8-K                                                                                                                                     | 31     |
|     |                                                                                                                                                                 |   |
|     | SIGNATURES                                                                                                                                                           | 32     |
|     |                                                                                                                                                                 |   |
|     |                                                                                                                                                                 |   |

 

2

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# **NEW WORLD RESTAURANT GROUP, INC.CONSOLIDATED BALANCE SHEETS**

# **AS OF JULY 1, 2003 AND DECEMBER 31,2002**

(in thousands, except share information)

 
|                                                                                                                   |   | **July 1,  2003** |    | **December  31, 2002** |   |
|------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|------------------------|--------|
|                                                                                                                   |   | **(Unaudited)**   |    |                   |   |
| ASSETS                                                                                                                 |   |              |    |                   |   |
| Current Assets:                                                                                                        |   |              |    |                   |   |
| Cash and cash equivalents                                                                                              |   | $                 | 9,367   |                   | $      | 10,705 |   |
| Franchise and other receivables, net of  allowance of $2,214 and $1,955                                                |   | 5,310             |    | 5,775                  |   |
| Current maturities of notes receivables                                                                                |   | 86                |    | 194                    |   |
| Inventories                                                                                                            |   | 4,871             |    | 5,005                  |   |
| Prepaid expenses and other current assets                                                                              |   | 9,526             |    | 3,180                  |   |
| Total current  assets                                                                                                  |   | 29,160            |    | 24,859                 |   |
|                                                                                                                   |   |              |    |                   |   |
| Property, plant and equipment, net                                                                                     |   | 74,364            |    | 81,254                 |   |
| Trademarks and other intangibles, net                                                                                  |   | 94,221            |    | 98,134                 |   |
| Goodwill, net                                                                                                          |   | 4,875             |    | 4,875                  |   |
| Debt issuance costs and other assets                                                                                   |   | 2,184             |    | 1,526                  |   |
| Total Assets                                                                                                           |   | $                 | 204,804 |                   | $      | 210,648 |   |
|                                                                                                                   |   |              |    |                   |   |
| LIABILITIES AND STOCKHOLDERS’ DEFICIT                                                                             |   |              |    |                   |   |
| Current Liabilities:                                                                                                   |   |              |    |                   |   |
| Accounts payable                                                                                                       |   | $                 | 9,886   |                   | $      | 7,650 |   |
| Accrued expenses                                                                                                       |   | 38,084            |    | 30,988                 |   |
| Short term debt and current portion of  long-term debt                                                                 |   | 154,246           |    | 150,872                |   |
| Current portion of obligations under  capital leases                                                                   |   | 101               |    | 100                    |   |
| Total current liabilities                                                                                              |   | 202,317           |    | 189,610                |   |
|                                                                                                                   |   |              |    |                   |   |
| Senior notes and other long-term debt                                                                                  |   | 10,998            |    | 11,011                 |   |
| Obligations under capital leases                                                                                       |   | 157               |    | 360                    |   |
| Derivative liability                                                                                                   |   | 2,026             |    | 2,847                  |   |
| Other liabilities                                                                                                      |   | 10,535            |    | 10,560                 |   |
| Total liabilities                                                                                                      |   | 226,033           |    | 214,388                |   |
|                                                                                                                   |   |              |    |                   |   |
| Series F Preferred Stock, $.001 par value;  116,000 shares authorized; 99,356 and 89,698 shares issued and outstanding |   | 99,356            |    | 84,932                 |   |
| Stockholders’ deficit:                                                                                            |   |              |    |                   |   |
| Common stock, $.001 par value; 150,000,000  shares authorized; 51,016,857 and 51,016,857 shares issued and outstanding |   | 51                |    | 51                     |   |
| Additional Paid-In capital                                                                                             |   | 89,975            |    | 86,607                 |   |
| Accumulated deficit                                                                                                    |   | (210,611          | )       | (175,330               | )      |
| Total stockholders’ deficit                                                                                       |   | (120,585          | )       | (88,672                | )      |
| Total Liabilities and Stockholders’ Deficit                                                                       |   | $                 | 204,804 |                   | $      | 210,648 |   |

 

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

 

3

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**NEW WORLD RESTAURANTGROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONSFOR THE THREE-MONTH PERIOD ENDED JULY 1, 2003 AND JULY 2, 2002 AND SIX-MONTH PERIODS ENDED JULY 1, 2003 AND JULY 2, 2002 (UNAUDITED)**(in thousands, except earnings per share and relatedshare information)

 
|                                                                           |   | **Three-month  Period Ended** |    | **Six-month  Period Ended** |   |
|--------------------------------------------------------------------------------|--------|-------------------------------|---------|-----------------------------|--------|
|                                                                           |   | **July 1,  2003**             |    | **July 2,  2002**           |   | **July 1,  2003** |   | **July 2,  2002** |   |
| Revenues:                                                                      |   |                          |    |                        |   |   |   |   |   |
| Retail sales                                                                   |   | $                             | 90,878  |                        | $      | 94,384 |   | $ | 179,328 |   | $ | 184,568 |   |
| Manufacturing  revenues                                                        |   | 5,754                         |    | 5,870                       |   | 11,178 |   | 12,010 |   |
| Franchise related revenues                                                     |   | 1,117                         |    | 1,324                       |   | 2,454 |   | 2,647 |   |
| Total revenues                                                                 |   | 97,749                        |    | 101,578                     |   | 192,960 |   | 199,225 |   |
| Cost of sales                                                                  |   | 83,639                        |    | 81,461                      |   | 162,676 |   | 161,131 |   |
| General and administrative expenses                                            |   | 9,432                         |    | 9,354                       |   | 18,644 |   | 22,645 |   |
| Depreciation and amortization                                                  |   | 7,092                         |    | 8,907                       |   | 14,297 |   | 14,995 |   |
| Provision (income) for integration and  reorganization cost                    |   | —                        |    | (656                        | )      | — |   | (552 | ) |
| Income (loss) from operations                                                  |   | (2,414                        | )       | 2,512                       |   | (2,657 | ) | 1,006 |   |
| Interest expense, net                                                          |   | (9,975                        | )       | (12,274                     | )      | (18,271 | ) | (24,604 | ) |
| Cumulative change in the fair value of derivatives  (expense)                  |   | (727                          | )       | 9,777                       |   | (70 | ) | (3,858 | ) |
| Other income                                                                   |   | 321                           |    | 53                          |   | 571 |   | 104 |   |
| Income (loss) before income taxes                                              |   | (12,795                       | )       | 68                          |   | (20,427 | ) | (27,352 | ) |
| Provision for income taxes                                                     |   | 320                           |    | 152                         |   | 430 |   | 152 |   |
| Net loss.                                                                      |   | (13,115                       | )       | (84                         | )      | (20,857 | ) | (27,504 | ) |
| Dividends and accretion on preferred stock                                     |   | (9,821                        | )       | (6,817                      | )      | (14,424 | ) | (13,529 | ) |
| Net loss available to common stockholders                                      |   | $                             | (22,936 | )                           | $      | (6,901 | ) | $ | (35,281 | ) | $ | (41,033 | ) |
| Net loss per common share – Basic and  Diluted                            |   | $                             | (0.21   | )                           | $      | (0.09 | ) | $ | (0.34 | ) | $ | (0.53 | ) |
| Weighted average number of common shares  outstanding:  Basic and Diluted |   | 107,842,599                   |    | 79,202,076                  |   | 104,304,782 |   | 77,560,135 |   |

 

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

 

4

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**NEW WORLD RESTAURANTGROUP, INC.CONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE YEAR TO DATE PERIOD ENDED JULY 1, 2003 AND JULY 2, 2002(UNAUDITED)**

**(in thousands)**

 
|                                                                                       |   | **July 1,  2003** |    | **July 2,  2002** |   |
|--------------------------------------------------------------------------------------------|--------|-------------------|---------|-------------------|--------|
|                                                                                       |   |              |    |              |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                      |   |              |    |              |   |
| Net loss                                                                                   |   | $                 | (20,857 | )                 | $      | (27,504 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |   |              |    |              |   |
| Depreciation and amortization                                                              |   | 14,297            |    | 14,995            |   |
| Provision for integration and  reorganization                                              |   | —            |    | (552              | )      |
| Cumulative change in fair value of  derivatives                                            |   | 70                |    | 3,858             |   |
| Amortization of debt issuance costs                                                        |   | 296               |    | 1,317             |   |
| Amortization of debt discount                                                              |   | 1,916             |    | 7,660             |   |
| Notes issued as paid in kind for interest  on Bridge Loan                                  |   | 510               |    | 2,545             |   |
| Standstill Warrants                                                                        |   | 1,238             |    | —            |   |
| Greenlight interest                                                                        |   | 1,025             |    | 842               |   |
| Stock issued for compensation and  consulting                                              |   | —            |    | 235               |   |
| Changes in operating assets and  liabilities:                                              |   |              |    |              |   |
| Receivables and notes receivable                                                           |   | 573               |    | 4,754             |   |
| Accounts payable and accrued expenses                                                      |   | 8,307             |    | (4,647            | )      |
| Other assets and liabilities                                                               |   | (6,156            | )       | (7,322            | )      |
| Net cash provided by (used in) operating  activities                                       |   | 1,219             |    | (3,819            | )      |
|                                                                                       |   |              |    |              |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                      |   |              |    |              |   |
| Purchase of property and equipment                                                         |   | (3,494            | )       | (2,653            | )      |
| Proceeds from the sale of assets held for  resale                                          |   | —            |    | 1,325             |   |
| Proceeds from the sale of debt securities                                                  |   | —            |    | 24,186            |   |
| Net cash provided by (used in) investing  activities                                       |   | (3,494            | )       | 22,858            |   |
|                                                                                       |   |              |    |              |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                      |   |              |    |              |   |
| Proceeds from issuance of debt                                                             |   | 1,500             |    | —            |   |
| Repayment of notes payable                                                                 |   | (563              | )       | (24,694           | )      |
| Net cash provided by (used in) financing  activities                                       |   | 937               |    | (24,694           | )      |
|                                                                                       |   |              |    |              |   |
| Net decrease in cash                                                                       |   | (1,338            | )       | (5,655            | )      |
| Cash and cash equivalents, beginning of  period                                            |   | 10,705            |    | 15,478            |   |
| Cash and cash equivalents, end of period                                                   |   | $                 | 9,367   |              | $      | 9,823 |   |

 

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

 

5

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**NEW WORLDRESTAURANT GROUP, INC.**

**Notes****to ConsolidatedFinancial Statements**

**(Unaudited)**

 

**1. Basis of Presentation**

 

The accompanying unaudited consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America and the instructions to Form 10-Q and Article 10 ofRegulation S-X.  Accordingly, they donot include all of the information and notes required by accounting principlesgenerally accepted in the United States of America for complete financialstatements. In the opinion of management, the unaudited interim consolidatedfinancial statements furnished herein include all adjustments necessary for afair presentation of the Company’s financial position at July 1, 2003 and theresults of its operations and its cash flows for the three-month and six-monthperiods ended July 1, 2003 and July 2, 2002. All such adjustments are of a normal recurring nature.  Interim financial statements are prepared ona basis consistent with the Company’s annual financial statements. Results ofoperations for the three-month and six-month periods ended July 1, 2003 are notnecessarily indicative of the operating results that may be expected for futureperiods.  The consolidated balance sheetas of December 31, 2002 has been derived from the audited consolidatedfinancial statements at that date but does not include all of the informationand notes required by accounting principles generally accepted in the UnitedStates of America for complete financial statements.  For further information, refer to the consolidated financialstatements and notes thereto included in the Company’s annual report on Form10-K for the fiscal year ended December 31, 2002.

 

Certain reclassifications have been made to conform previously reporteddata to the current presentation.

 

**2. Liquidity**

 

The accompanying consolidated financial statements have been preparedin conformity with accounting principles generally accepted in the UnitedStates of America, which contemplate continuation of the Company as a goingconcern.  However, the Company hassustained substantial losses in recent years, and such losses have continuedthrough unaudited periods in 2003.  The Company also has adeficit in stockholders’ equity of approximately $120,585,000 as of July 1,2003, and, as of that date, the Company’s current liabilities exceeded itscurrent assets by approximately $173,157,000. During the years ended January 1, 2002 and December 31, 2002, andcontinuing into 2003, the Company was in violation of certain covenants on theindenture for the Company’s $140 million aggregate principal amount of notesdue June 15, 2003 (the “$140 Million Facility”).  On July 8, 2003, the Company issued $160,000,000, 13% seniorsecured notes (the “$160 Million Facility”). The Company used the proceeds from these notes, among other things, torefinance the $140 Million Facility (Note 13 and 14).  Concurrently with the debt refinancing, the Company entered intoa $15 million senior secured revolving credit facility (the “Senior CreditFacility”) (Note 8).  On June 27, 2003the Company also entered into an Equity Recapitalization Agreement (Note 15).

 

In view of the matters described in the preceding paragraph,recoverability of a major portion of the recorded asset amounts shown in theaccompanying balance sheets is dependent upon continued operations of theCompany, which in turn is dependent upon the Company’s ability to meet itsfinancing requirements on a continuing basis, to obtain new financing, and tosucceed in its future operations.  Theconsolidated financial statements do not include any adjustments relating tothe recoverability and classification of recorded asset amounts or amounts andclassification of liabilities that might be necessary should the Company beunable to continue in existence.

 

6

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The Company has also initiated cost reduction programs that stemprimarily from the integration of Einstein Noah Bagel Corp. and itsmajority-owned subsidiary, Einstein/Noah Bagel Partners, L.P. (collectively,“Einstein”) into the Company, including supply chain efficiencies andreductions in overhead as a result of the elimination of duplicative functionsand the streamlining of various functional areas.  While most of these initiatives commenced in fiscal 2002, thefull year effect is not expected to be realized until 2003 and beyond.  The Company believes that its currentbusiness plan will improve its operating results and cash flow in the future.

 

**3. Earnings Per Share**

 

In accordance with SFAS No. 128, Earnings Per Share, basic earnings percommon share amounts (basic EPS) are computed by dividing net earnings by theweighted average number of common shares outstanding (which include warrantsexercisable for a nominal price of $0.01 per share) and exclude any potentialdilution. The Company has included both issued and obligations to issue $0.01warrants in the calculation described above. Diluted earnings per common share amounts assuming dilution (dilutedEPS) are computed by reflecting potential dilution of the Company’s commonstock equivalents.  Common stockequivalents are not reflected in diluted EPS if their effect would beanti-dilutive.  The following tablesummarizes the weighted average shares used in the basic and diluted EPScomputations:

 
|                                             |   | **For the Three-month  Period  Ended** |   | **For the  Six-month Period  Ended** |   |
|--------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                             |   | **July 1,  2003**                      |   | **July 2,  2002**                    |   | **July 1,  2003** |   | **July 2,  2002** |   |
| Weighted average shares outstanding              |   | 51,016,857                             |   | 17,481,394                           |   | 51,016,857 |   | 17,481,394 |   |
| Weighted average warrants exercisable for  $0.01 |   | 56,825,742                             |   | 61,720,682                           |   | 53,287,925 |   | 60,078,741 |   |
|                                             |   | 107,842,599                            |   | 79,202,076                           |   | 104,304,782 |   | 77,560,135 |   |

 

All stock options and warrants outstanding (excluding those exercisablefor $0.01) during the three- and six-month periods ended July 1, 2003 and July2, 2002 were excluded from the computation because of their anti-dilutiveeffect.  The excluded options andwarrants for the three-month and six-month periods ended July 1, 2003 and July2, 2002 were 6,103,595 and 6,101,095, respectively.

 

 

7

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**4. Recent Pronouncements**

 

In, April 2003, the FASB issuedStatement of Financial Accounting Standards No. 149 (SFAS 149), Amendment ofStatement 133 on Derivative Instruments and Hedging Activities.  SFAS 149 amends and clarifies financialaccounting and reporting for derivative instruments, including certainderivative instruments embedded in other contracts (collectively referred to asderivatives) and for hedging activities. The accounting and reporting requirements will be effective forcontracts entered into or modified after June 30, 2003 and for hedgingrelationships designated after June 30, 2003. SFAS 149 is not expected to have a significant impact to the Company'sfinancial statements.

 

In May 2003, the FASB issuedSFAS No. 150, Accounting for Certain Financial Instruments with Characteristicsof both Liabilities and Equity.  SFAS150 changes the classification in the statement of financial position ofcertain common financial instruments from either equity or mezzaninepresentation to liabilities and requires an issuer of those financialstatements to recognize changes in fair value or redemption amount asapplication in earnings.  This statementis effective at the beginning of the first interim period beginning after June15, 2003.  The adoption of this newstandard will result in the Company’s Series F Preferred Stock being presentedas a liability rather than the current mezzanine presentation, beginning in thethird quarter 2003.  After adoption alldividends and accretion of discount or amortization of premiums will berecognized as interest expense. Additionally, the Series Z Preferred Stock which will be issued when andif the Equity Recapitalization (Note 15) occurs will also be presented as a liability.

 

The Company has considered all other recently issued accountingpronouncements and does not believe that the adoption of such pronouncementswill have a material impact on its financial statements.

 

**5. Stock-Based Compensation**

 

The Company currently follows the intrinsic value method of APB 25 toaccount for its employee stock compensation, and has no intention to change tothe fair value method to account for employee stock-based compensation.

 

Had compensation cost for theCompany’s two stock option plans (the 1994 Stock Plan and 1995 Directors’ Plan)been recognized under the fair value method specified in SFAS 123, theCompany’s net loss and loss per share would have been increased to thefollowing pro forma amounts:

 
|                                                                                                             |   | **For the  Three-month Period Ended** |    | **For the  Six-month Period  Ended** |   |
|------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|---------|--------------------------------------|--------|
|                                                                                                             |   | **July 1,  2003**                     |    | **July 2,  2002**                    |   | **July 1,  2003** |   | **July 2,  2002** |   |
| As reported                                                                                                      |   | $                                     | (22,936 | )                                    | $      | (6,901 | ) | $ | (35,281 | ) | $ | (41,033 | ) |
| Deduct: total stock-based employee  compensation expense determined under fair value based method for all awards |   | (45                                   | )       | (49                                  | )      | (90 | ) | (98 | ) |
| Pro forma                                                                                                        |   | $                                     | (22,981 | )                                    | $      | (6,950 | ) | $ | (35,371 | ) | $ | (41,131 | ) |
|                                                                                                             |   |                                  |    |                                 |   |   |   |   |   |
| Basic and diluted net loss available to  common stockholders per common share:                                   |   |                                  |    |                                 |   |   |   |   |   |
| As reported                                                                                                      |   | $                                     | (.21    | )                                    | $      | (.09 | ) | $ | (.34 | ) | $ | (.53 | ) |
| Pro forma                                                                                                        |   | $                                     | (.21    | )                                    | $      | (.09 | ) | $ | (.34 | ) | $ | (.53 | ) |

 

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

 

Goodwill represents the excess of cost over fair value of net assetsacquired in the acquisition of Manhattan Bagel Company.

 

The Company uses a two-step approach to assess its goodwillimpairment.  This requires that theCompany first compare the estimated fair value of each reporting unit thathouses goodwill to the carrying amount of the unit’s assets and liabilities,including its goodwill and intangible assets. If the fair value of thereporting unit is below its carrying amount, then the second step of theimpairment test is performed, in which the current fair value of the unit’sassets and liabilities will determine the current implied fair value of theunit’s goodwill.  The annual impairmenttests relating to goodwill and trademarks are performed as of year-end, unlessevents and circumstances indicate a potential impairment, which would requirean interim impairment test.

 

8

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The Company’s management has determined that no impairment indicatorswere present during the three-month and six-month periods ended July 1, 2003,and accordingly no interim tests for impairment of goodwill, trademarks oramortizing intangibles were performed.

 

In 2002 and forward, in accordance with SFAS 142, goodwill andindefinite-lived trademarks are not amortized and other intangibles are beingamortized on a straight-line basis consistent with the associated estimatedfuture cash flows.

 
|                                   |   | **Unaudited  July 1, 2003** |   | **December  31, 2002** |   |
|----------------------------------------|--------|-----------------------------|--------|------------------------|--------|
|                                   |   | **(amounts  in thousands)** |   |
| Non-amortizing intangibles:            |   |                        |   |                   |   |
| Trademarks                             |   | $                           | 70,746 |                   | $      | 70,746 |   |
| Amortizing intangibles (5 year lives): |   |                        |   |                   |   |
| Trade Secrets                          |   | 5,385                       |   | 5,385                  |   |
| Patents-manufacturing process          |   | 33,741                      |   | 33,741                 |   |
|                                   |   | 39,126                      |   | 39,126                 |   |
| Less accumulated amortization          |   | (15,651                     | )      | (11,738                | )      |
| Total amortizing intangibles           |   | 23,475                      |   | 27,388                 |   |
| Total intangibles                      |   | $                           | 94,221 |                   | $      | 98,134 |   |

 

**7. Accrued Expenses**

 

Accrued expenses consist of the following:

 
|                         |   | **Unaudited  July 1, 2003** |   | **December 31, 2002** |   |
|------------------------------|--------|-----------------------------|--------|-----------------------|--------|
|                         |   | **(amounts in thousands)**  |   |
|                         |   |                        |   |                  |   |
| Accrued payroll and  related |   | $                           | 14,213 |                  | $      | 13,949 |   |
| Accrued reorganization       |   | 2,373                       |   | 2,768                 |   |
| Accrued taxes                |   | 2,472                       |   | 2,310                 |   |
| Accrued interest             |   | 11,017                      |   | 4,342                 |   |
| Accrued utilities            |   | 1,182                       |   | 1,789                 |   |
| Gift certificates  liability |   | 1,703                       |   | 1,115                 |   |
| Other                        |   | 5,124                       |   | 4,715                 |   |
|                         |   | $                           | 38,084 |                  | $      | 30,988 |   |

 

9

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**8. Debt and Equity Instruments:**

 

The major components of the Company’s short-term and long-term debt areincluded in the accompanying balance sheets as follows:

 
|                                   |   | **Unaudited  July 1, 2003** |   | **December  31, 2002** |   |
|----------------------------------------|--------|-----------------------------|--------|------------------------|--------|
|                                   |   | **(amounts  in thousands)** |   |
|                                   |   |                        |   |                   |   |
| Greenlight obligation                  |   | $                           | 10,000 |                   | $      | 10,000 |   |
| Bridge Loan                            |   | 4,952                       |   | 4,443                  |   |
| $140 Million Facility (Note 13 and 14) |   | 140,000                     |   | 138,084                |   |
| BET Revolver                           |   | 7,500                       |   | 6,000                  |   |
| All other debt                         |   | 2,792                       |   | 3,356                  |   |
|                                   |   | 165,244                     |   | 161,883                |   |
| Less current portion                   |   | (154,246                    | )      | (150,872               | )      |
| Long-term debt                         |   | $                           | 10,998 |                   | $      | 11,011 |   |

 

The components of Series F Preferred Stock, Greenlight obligation, the$35 million assets-backed loan to the Company’s non-restricted subsidiary, NewWorld EnbcDeb Corp. (the “Bridge Loan”), and $140 Million Facility are includedin the accompanying balance sheets as follows:

 

**SeriesF Preferred Stock (Note 15)**

 
|                                                                                                           |   | **Unaudited  July 1, 2003** |   | **December  31, 2002** |   |
|----------------------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|------------------------|--------|
|                                                                                                           |   | **(amounts  in thousands)** |   |
|                                                                                                           |   |                        |   |                   |   |
| Proceeds from issuance of Series F  preferred stock, $16,398 of which was the value of the Series D conversion |   | $                           | 66,398 |                   | $      | 66,398 |   |
| Discount attributable to fees and  commissions                                                                 |   | (3,254                      | )      | (3,254                 | )      |
| Discount attributable to initial and future  warrants                                                          |   | (33,027                     | )      | (33,027                | )      |
| Accreted PIK preferred stock                                                                                   |   | 32,958                      |   | 23,330                 |   |
| Extinguishment of discount                                                                                     |   | 8,271                       |   | 8,271                  |   |
| Effective dividend amortization of discount                                                                    |   | 28,010                      |   | 23,214                 |   |
|                                                                                                           |   | $                           | 99,356 |                   | $      | 84,932 |   |

 

**GreenlightObligation**

 
|                                                  |   | **Unaudited  July 1, 2003** |   | **December  31, 2002** |   |
|-------------------------------------------------------|--------|-----------------------------|--------|------------------------|--------|
|                                                  |   | **(amounts  in thousands)** |   |
|                                                  |   |                        |   |                   |   |
| Proceeds from issuance of Greenlight  obligation      |   | $                           | 10,000 |                   | $      | 10,000 |   |
| Discount attributable to initial and future  warrants |   | (4,316                      | )      | (4,316                 | )      |
| Extinguishment of discount                            |   | 4,195                       |   | 4,195                  |   |
| Effective interest amortization of discount           |   | 121                         |   | 121                    |   |
|                                                  |   | $                           | 10,000 |                   | $      | 10,000 |   |

 

10

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**BridgeLoan**

 
|                                        |   | **Unaudited  July 1, 2003** |   | **December  31, 2002** |   |
|---------------------------------------------|--------|-----------------------------|--------|------------------------|--------|
|                                        |   | **(amounts  in thousands)** |   |
|                                        |   |                        |   |                   |   |
| Original face value of Bridge Loan          |   | $                           | 35,000 |                   | $      | 35,000 |   |
| Issuance discount from face value           |   | (1,750                      | )      | (1,750                 | )      |
| Discount attributable to future warrants    |   | (5,365                      | )      | (5,365                 | )      |
| Accreted PIK interest                       |   | 6,662                       |   | 6,153                  |   |
| Effective interest amortization of discount |   | 7,116                       |   | 7,116                  |   |
| Reductions in Principal                     |   | (36,711                     | )      | (36,711                | )      |
|                                        |   | $                           | 4,952  |                   | $      | 4,443 |   |

 

**$140Million Facility (Note 13 and 14)**

 
|                                                  |   | **Unaudited  July 1, 2003** |    | **December  31, 2002** |   |
|-------------------------------------------------------|--------|-----------------------------|---------|------------------------|--------|
|                                                  |   | **(amounts  in thousands)** |    |
|                                                  |   |                        |    |                   |   |
| Original face value of $140 Million  Facility         |   | $                           | 140,000 |                   | $      | 140,000 |   |
| Issuance discount from face value                     |   | (11,550                     | )       | (11,550                | )      |
| Discount attributable to initial and future  warrants |   | (17,312                     | )       | (17,312                | )      |
| Effective interest amortization of discount           |   | 28,862                      |    | 26,946                 |   |
|                                                  |   | $                           | 140,000 |                   | $      | 138,084 |   |

 

**Revolving Line of Credit**

 

On May 30, 2002, the Company entered into a Loan and Security Agreementwith one of the Company’s principal stockholders, BET Associates, L.P. (“BET”),which provides for a $7,500,000 revolving loan facility.  The facility is secured by substantially allof the Company’s assets.  At the timethe Company entered into this facility, the Company terminated its priorrevolving loan facility.  Borrowingsunder the facility bore interest at the rate of 11% per annum until February2003.  The facility originally expiredon March 31, 2003.  In February of 2003,the Company extended the maturity of the revolving loan facility to June 1,2003.  From February 1, 2003 to June 1,2003, the facility will bear interest at the rate of 13%.  After June 1, 2003 the interest rate forborrowings under the facility is 15%. This facility was repaid with proceeds from the $160 Million Facility(Note 14) on July 8, 2003.

 

Concurrently on July 8, 2003, the Company entered into a three-year,$15 million senior secured revolving credit facility with AmSouth Bank.  Initially, the Senior Credit Facility bearsinterest at the AmSouth “prime rate” plus 1.00%.  After the receipt of the Company's audited fiscal year endedDecember 30, 2003 financial statements, the Senior Credit Facility will besubject to an interest pricing grid based on the Company's Fixed ChargeCoverage (as defined by the Indenture).

 

**9. Contingencies**

 

The Company is subject toclaims and legal actions in the ordinary course of business, including claimsby  franchisees.  The Company does not believe that an adverseoutcome in any currently pending or threatened matter, other than describedbelow, would have a material adverse effect on its business, results ofoperations or financial condition.

 

On April 3, 2002, the Companywas notified by the Securities and Exchange Commission that the Commission isconducting an investigation into the resignation of the former Chairman, R.Ramin Kamfar, and the termination for cause of the former Chief FinancialOfficer, Jerold Novack, and the delay in filing the Form 10-K for 2001.  The Company is cooperating fully with theinvestigation.  The Company is alsocooperating fully with a recent Department of Justice inquiry relating to theseissues.  Further, several of the formerand present officers and directors have requested that the Company advancereasonable legal expense on their respective behalf to the extent any of themis or has been requested to provide information to the Commission in connectionwith its investigation.  The Company isfulfilling its obligations as required by applicable law and the Company’sBy-Laws.

 

On July 31, 2002, TristanGoldstein, a former store manager, and Valerie Bankhordar, a current storemanager, filed a purported class action complaint against Einstein in theSuperior Court for the State of California, County of San Francisco.  The plaintiffs allege that Noah’s failed topay overtime wages to managers and assistant managers of its California stores,whom it is alleged were improperly designated as exempt employees in violationof California and Business Profession Code Section 17200.  As a result of subsequent communicationsregarding the circumstances under which the Company purchased Einstein out ofbankruptcy, the plaintiffs filed a first amended complaint

 

11

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disclaiming back wages for theperiod prior to June 19, 2001.  However,the first amended complaint added as defendants certain former directors andofficers of Einstein.  The first amendedcomplaint also added a second cause of action seeking to invalidate releasesobtained from Noah’s assistant managers pursuant to the settlement of aDepartment of Labor investigation.  TheCompany filed a demurrer to the first amended complaint, which the plaintiffsopposed.  Subsequent to the filing ofthat demurrer, the Company procured a dismissal without prejudice of the claimsbrought against Paul Murphy, the only individual defendant the Company employedsubsequent to its acquisition of Einstein. The plaintiffs subsequently stipulated to the severance of the claimsagainst the Company and those against the remaining individual defendants.  The stipulation provides that the plaintiffswill file separate second amended complaints against the Company and againstthe remaining individual defendants.  Asa result, the Company’s demurrer will be taken off calendar.  The Company will have thirty days from thedate of the filing of the second amended complaint to refile the Company’sdemurrer.

 

On March 31, 2003, Jerold E.Novack, the former Chief Financial Officer, Secretary, and shareholder of theCompany, filed a complaint in the United States District Court for the Districtof New Jersey against the Company, Anthony D. Wedo, Chairman and ChiefExecutive Officer of the Company, and William J. Nimmo, a member of the Boardof Directors.  The complaint purports tostate claims for breach of plaintiff’s employment contract with the Company,breach of the Company’s fiduciary duties to plaintiff, defamation, andviolation of the New Jersey Conscientious Employee Protection Act, and inaddition seeks a declaration that the termination of plaintiff “for cause” wasinvalid.  As a basis for his purportedclaims, the plaintiff alleges that the Company wrongfully contended certainbonuses he received were unauthorized and that he was wrongfully terminated forcause in order to deny him certain other benefits allegedly owed under hisemployment agreement.  Furthermore, theplaintiff asserts that he was defamed by certain of defendants’ publicstatements regarding his dismissal and also that his termination was inretaliation for certain actions he believes were protected by the New JerseyConscientious Employee Protection Act. The Company intends to vigorously oppose the plaintiff’s purportedclaims.  The Company was served with thecomplaint on May 2, 2003.  On June 23,2003, the Company filed its answer and counterclaims as well as a motion to dismisscertain of the claims against it.  Thatmotion is pending with the court.

 

On June 4, 2003, Ramin Kamfar,our former Chairmen of the Board and Chief Executive Office, filed an action inthe United States District Court for the Southern District of New York Againstus and Anthony Wedo, our current Chief Executive Officer, alleging causes ofaction for breach of contract, defamation, declaratory relief and punitivedamages.  In this action, Mr., Kamfaralleges that we breached confidentiality and non-disparagement provisions inhis separation agreement with us by disclosing certain financial and otherterms contained therein.  Mr. Kamfar isseeking damages of at least $7.0 million. As of the data of this filing, we have not yet been served with the complaintrelating to this action.  We believethat the claims of Mr. Kamfar are without merit, and we intend to vigorouslydefend ourself and Mr. Wedo in this matter.

 

In July 2002, the New JerseyDivision of Taxation entered judgment in the amount of $5,744,902, plus costs,against Manhattan Bagel Construction Company, a wholly owned subsidiary ofManhattan Bagel Company.  This judgmentrepresents amounts for corporate income taxes for the period from 1996 to 2000,and sales and use taxes for the period from 1995 to 1997.  At that same time, the Division of Taxationprovided Manhattan Bagel Construction Company with a Notice and Demand forPayment of Tax in the additional amount of $130,200, for corporate income taxesand sales and use taxes for the period from October 2001 through June2002.  Manhattan Bagel ConstructionCompany ceased operations in or about early 1997 and has existed since thattime only as a non-operating entity with no assets.  Therefore, the Company is currently working with the New JerseyDivision of Taxation to have all tax assessments for the period after ManhattanBagel Construction Company ceased operations removed, and that portion of thejudgment deemed satisfied.  With regardto taxes imposed for the period prior to early 1997, the Company believes thoseamounts are barred from being asserted against Manhattan Bagel Company, to theextent they otherwise could have been, because they were not asserted inManhattan Bagel Company’s November 1997 bankruptcy proceeding.

 

On February 23, 2000, New WorldCoffee of Forest Hills, Inc., a franchisee, filed a demand for arbitration withthe American Arbitration Association (*American Arbitration Association, New York, New York,Case No. 13-114-237-00*) against the Company alleging fraudulentinducement and violations of New York General Business Law Article 33.  The franchisee seeks damages in the amountof $750,000.  New World has asserted acounterclaim in the arbitration seeking amounts owed under the franchisee’sfranchise agreement and monies owed for goods purchased

 

12

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by the franchisee in the amountof $200,000.  An arbitrator has beenselected and document exchange is complete. Hearings were scheduled for June 2002 but have been postponed by orderof the arbitrator.

 

On October 28, 2002, SansimPatel, Inc., a subfranchisee of Manhattan Bagel Company, filed suit againstManhattan Bagel Company, the master franchisee, and others in Orange County(Orlando, Florida).  The plaintiff allegesclaims of civil conspiracy and unjust enrichment against Manhattan BagelCompany and seeks rescission of its franchise agreement with Manhattan BagelCompany.  The plaintiff also seeksdamages in an unspecified amount.  InDecember 2002, the Company filed a motion to dismiss all of the claims assertedagainst it by the plaintiff, based in part on a general release the plaintiffhad previously executed in favor of Manhattan Bagel Company.  That motion remains pending with theCourt.  However, on March 18, 2003, defaultjudgments were obtained against the other named defendants.

 

On March 17, 2003, Jason andAndrew Gennusa, former employees of the Company and founders of Manhattan BagelCompany, filed suit against the Company in the Superior Court of New Jersey, MonmouthCounty.  As the founders of ManhattanBagel Company, the plaintiffs claim to be reproducing the “original formula”Manhattan Bagel dough, and selling it to franchisees at a competitive price.  Their complaint seeks a judgment declaringthat their production and sale of this bagel dough to franchisees does notviolate various non-competition covenants and confidentiality agreements theypreviously entered into with the Company. Furthermore, the plaintiffs seek a declaration that the “originalrecipe” bagel dough they manufacture is not a trade secret of the Company andthat their manufacture and sale of the dough is not in violation ofintellectual property law.  The Companyhas not yet answered or otherwise responded to plaintiffs’ complaint.  We answered plaintiff's complaint on May 14,2003, and filed counterclaims and a motion for the preliminary injunction onJune 2, 2003.  On July 22, 2003, weannounced that this lawsuit had been settled. As part of the settlement, the plaintiffs acknowledged that ManhattanBagel franchisees are obligated under their franchisee agreements to purchasefrozen bagel dough only from suppliers approved by Manhattan Bagel Corp. andNew World and withdrew their request for an injunction that would have allowedsuch franchisees to purchase frozen dough from unapproved outside suppliers.

 

On June 2, 2003, a group offour Manhattan Bagel franchisees filed a lawsuit captioned Kaufman et al. v.New World Restaurant Group, Inc. in the Superior Court of New Jersey, ChanceryDivision, Monmouth County.  In theircomplaint, plaintiffs allege that since we closed our Eatontown, New Jerseybaking facility and began contracting with Harlan Bakeries, the quality of itsbagels has suffered.  As a result ofthis alleged decline in bagel quality, plaintiffs claim that they will losebagel sales and customer goodwill if they continue to purchase their bagelsfrom Harlan Bakeries in accordance with the terms of their franchiseagreements.  Alleging claims for breachof contract, consumer fraud, constructive termination of the franchiseagreements, and violation of the New Jersey Franchise Practices Act, plaintiffsseek a judgment permitting their purchase of “New York style” bagels from anythird-party supplier, enjoining our termination of their franchise agreementsbecause of their purchase of such non-approved bagels, and awarding toplaintiffs damages in an unspecified amount. The Company’s time to answer or otherwise respond to the complaint has notyet elapsed.  We intend to defend thismatter vigorously.

 

13

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Given the early stage of theproceeding matters, the Company cannot predict their outcome.  However, there can be no assurance that theCompany will not be subject to regulatory sanctions, civil penalties and/orclaims for monetary damages or other relief.

 

Special Situations Fund, L.P.,Special Situations Cayman Fund, L.P. and Special Situations Private EquityFund, L.P. (collectively, “Special Situations”), holders of Series F preferredstock, had notified the Company that they believe that materialmisrepresentations were made to them in June 2001 in connection with theirpurchase of the  stock.  Special Situations filed a complaint in theUnited States District Court for the Southern District of New York regardingthis claim.  Special Situations allegedvarious contractual and tort claims against the Company, as well as RaminKamfar, the former Chairman of the Board of Directors, Jerold Novack, theformer Chief Financial Officer, and Greenlight Capital, L.P., GreenlightCapital Qualified, L.P. and Greenlight Capital Offshore, Ltd. (collectively,“Greenlight”), another holder of the Series F preferred stock.  Special Situations sought, among otherrelief, damages in the amount of at least $5,166,000 and the equitable remedyof rescission of its purchase of stock. Prior to responding to Special Situations’ complaint, the Company andSpecial Situations entered into a settlement agreement and release on April 29,2003, pursuant to which the Company agreed to settle Special Situations’ claimsagainst the Company and its present and former officers, directors, agents andother representatives, and Special Situations agreed to release those entitiesand individuals, in exchange for payment to Special Situations of $176,000. ANotice of Voluntary Withdrawal was filed by Special Situations with the UnitedStates District Court for the Southern District of New York on May 5, 2003.

 

On February 28, 2003, theCompany’s former insurance broker of record filed suit in Superior Court of theState of California, County of Orange, against the Company and itssubsidiaries, alleging wrongful termination of the Company’s brokerage contractwith plaintiff, Pension & Benefit Insurance Services, Inc. (“PBIS”), whichdeprived PBIS of brokerage commissions. PBIS’s complaint asserts claims for breach of contract, reasonable valueof services, intentional interference with prospective advantage and negligentinterference with prospective advantages. Plaintiff seeks $500,000 in consequential damages and $20 million inpunitive damages.  Prior to respondingto PBIS’s complaint, the Company entered into a settlement agreement with PBISon April 2, 2003.  As consideration forPBIS’s agreement to settle and dismiss this matter, the Company agreed to listPBIS as its insurance broker of record until at least the end of 2003.  A Request for Dismissal of the suit wasfiled by PBIS with the Superior Court of the State of California, County ofOrange on April 9, 2003.

 

On April 7, 2003, GeneralElectric Capital Corp. filed an action in the Supreme Court for the State ofNew York, County of New York, against the Company and its franchisee, captioned*General Electric Capital Corp. v. New WorldCoffee/Manhattan Bagels, Inc. et al*.  In its complaint, plaintiff asserts that it entered into certainequipment lease agreements with the Company on April 18, 2001, and with thefranchisee on February 26, 2001, upon which the Company and its franchiseesubsequently defaulted.  As a result ofthose alleged defaults, plaintiff purports to state claims against defendantsfor breach of contract, conversion, unjust enrichment, foreclosure of securityinterest, and replevin, and demands damages from defendants, jointly andseverally, in the total specified amount of $118,555.49, plus late charges,taxes, interest, costs and attorneys’ fees. The Company served an answer to plaintiff’s complaint on May 14,2003.  The plaintiff has dismissed itsclaim against the Company with prejudice.

 

On December 28, 2001, RobertHiggs, a franchisee, filed a complaint against the Company and its officers andagents in New Jersey (*Superior Court of New Jersey, Case No. OCN-L-2153-99*)alleging breach of contract, breach of fiduciary duties and tortuousinterference with contract and business opportunities.  The complaint was subsequently withdrawn bythe franchisee without prejudice.  InFebruary 2002, the franchisee filed a new complaint against the Company and itsofficers and agents alleging breach of contract, breach of fiduciary duties,tortuous interference with contract and business opportunities, and violationsof New Jersey’s franchise law.  Thefranchisee seeks damages in an unspecified amount, punitive damages, costs andattorneys’ fees.  The Company moved todismiss all of the claims in the new complaint.  The court dismissed the breach of fiduciary duty claims and oneof the breach of contract claims. Discovery requests have been served by the Company.  This matter has been settled for animmaterial amount.

 

**10.****      ****DerivativeInstruments**

 

Effective January 1, 2000, theCompany adopted SFAS No. 133, Accounting for Derivative Instruments and HedgingActivities.  SFAS 133 requires that allderivatives be recognized in the balance sheet at their fair value.  Changes in the fair values of derivativesthat do not qualify for hedge accounting under SFAS 133 are recognized throughearnings.  In conjunction with certaindebt and preferred stock issuances in 2000 and 2001, the Company issuedfreestanding warrants and rights to receive additional warrants based either onthe passage of time or upon the occurrence (or non-occurrence) of certaincontingent future events (contingently-issuable warrants).  In June 2001, certain of the Series Fpreferred stock holders agreed not to exercise their warrants if, in doing so,the authorized number of shares remaining after exercise by the holders of theSeries F preferred stock was not sufficient to permit warrants associated withthe $140 Million Facility to be exercised. The Company determined the contingently-issuable warrants cannot beclassified within stockholders’ equity based on the application of the criteriain EITF Issue 00-19, Accounting for Derivative Financial Instruments Indexedto, and Potentially Settled in, a Company’s Own Stock, and accordingly haveclassified those warrants as a liability in the balance sheet.  To the extent that the number offreestanding warrants and the maximum number of additional warrants that couldpotentially be issued in the future exceed the maximum number of authorizedshares (the Share Cap) at the time the debt or preferred stock instrument isissued, the Company determines the classification of, and accounting for, thefreestanding and additional warrants as follows: (1) freestanding warrants(those that are immediately exercisable) are considered first for equitytreatment, to the extent of the maximum number of authorized shares; (2) amongvarious outstanding instruments, those with the earlier issuance dates areconsidered first for equity treatment; and (3) contractual priorities areconsidered where applicable.

 

Issued $0.01 warrantsclassified as liabilities, if any, are recognized in the balance sheet at theirfair value, as determined periodically based on quoted market prices of theunderlying Common Stock.  As of July 1,2003 and

 

14

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December 31, 2002, there wereno issued warrants classified as liabilities. Contingently-issuable $0.01 warrants classified as liabilities are alsorecorded at fair value based on quoted market prices of the underlying commonstock and considering the probability of issuance, the Company’s assessments ofthe probability of refinancing its debt, and other pertinent factors.  Changes in the fair value of derivativeliabilities are recorded within the statement of operations.  If reclassification from liability topermanent equity is required under EITF 00-19, prior to reclassification theliability is adjusted to fair value, with the change recorded in cumulativechange in derivative fair value within the statement of operations.  In the event of reclassification frompermanent equity to liability, the related warrants are adjusted to fair value,with the change recorded in additional paid-in-capital.

 

From January 1, 2003 through July 31, 2003, the Company issued anadditional 27,539,258 warrants to certain Series F holders and to the holdersof the $140 Million Facility, all of which were exercisable.  These warrants have an exercise price of$0.01 per share, and have terms that expires on June 20, 2006.  Since January 1, 2003, warrants to purchase50,000 shares of common stock have expired. In addition, existing agreements require us to issue (i) $0.01 warrantssemi-annually to the holders of our Series F preferred stock until such SeriesF preferred stock has been redeemed (this obligation will cease if and when theEquity Recap (Note 15) is consummated) and (ii) $0.01 warrants to Greenlight atthe rate of 1.125% of our fully diluted common stock for each $1.0 million ofdeficiency if Greenlight does not receive a return on its investment in GNWequal to its Guaranteed Return (this obligation will cease on June 30, 2003 andno additional warrants will be accrued after that date, if and when the EquityRecapitalization (Note 15) is consumated.)

 

**11.****      ****Additional Paid-InCapital**

 

Additional paid-in capital increased from $86.6 million as of December31, 2002, to $90.0 million as of July 1, 2003 due to the issuance of additionalwarrants under the terms of the Series F preferred stock and the $140 MillionFacility agreements, that had previously been classified as derivativeliabilities in accordance with the policy outlined in Note 10.

 

**12.  Reorganization and Integration**

 

The following table displays the activity for the quarter ended July 1,2003 and July 2, 2002, respectively and balances of the restructuring accrualaccounts.

 
| **2002 Restructuring Accrual  (amounts in thousands)** |   |
|--------------------------------------------------------|--------|
| **2003 Activity**                                      |   | **Balance  at  Beginning  of Period** |   | **Initial  Accrual** |   | **Application  of Costs  Against  Accrual** |   | **Net Accrual  Adjustments** |   | **Balance at  End of Period** |   |
|                                                   |   |   |   |   |   |   |   |   |   |   |   |
| Quarter ended July 1,  2003                            |   | $ | 1,513 |   | — |   | (52 | ) | — |   | $ | 1,461 |   |
| Year to Date Period  Ended July 1, 2003                |   | $ | 1,704 |   | — |   | (243 | ) | — |   | $ | 1,461 |   |

 

15

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| **2001 Restructuring Accrual  (amounts in thousands)** |   |
|--------------------------------------------------------|--------|
| **2003 Activity**                                      |   | **Balance  at  Beginning  of Period** |   | **Initial  Accrual** |   | **Application  of Costs  Against  Accrual** |   | **Net Accrual  Adjustments** |   | **Balance at  End of Period** |   |
|                                                   |   |   |   |   |   |   |   |   |   |   |   |
| Quarter ended July 1, 2003                             |   | $ | 979 |   | — |   | (67) |   | — |   | $ | 912 |   |
| Year to Date Period Ended July 1, 2003                 |   | $ | 1,064 |   | — |   | (152) |   | — |   | $ | 912 |   |

 
| **2001 Restructuring  Accrual  (amounts in thousands)** |   |
|---------------------------------------------------------|--------|
| **2002 Activity**                                       |   | **Balance  at  Beginning  of Period** |   | **Initial  Accrual** |   | **Application  of Costs  Against  Accrual** |   | **Net Accrual  Adjustments** |   | **Balance at  End of Period** |   |
|                                                    |   |   |   |   |   |   |   |   |   |   |   |
| Quarter ended July 2, 2002                              |   | $ | 2,820 |   | — |   | (463) |   | (656) |   | $ | 1,701 |   |
| Year to Date Period Ended July 2, 2002                  |   | $ | 2,936 |   | — |   | (683) |   | (552) |   | $ | 1,701 |   |

 

**13.****      ****$140 MillionFacility Refinancing**

 

At July 1, 2003, Company had outstanding $140 Million of SeniorIncreasing Rate Notes (the “$140 Million Facility”), which matured on June 15,2003.  The Company called the$140 Million Facility for redemption on June 10, 2003.  On June 18, 2003, the Company announced thatit had entered into a 30-day standstill agreement with the holder ofapproximately $113.0 million, or 80.7% of the $140 Million Facility, whilecontinuing to actively pursue the refinancing of its debt as well as the rationalizationof its capital structure.  Under thisinitial accord, holders of those notes agreed not to take any action to enforceany of their rights and remedies against the Company until July 15, 2003, as aresult of the Company’s failure to repay the notes.  The interest rate and terms under the standstill agreement stayedthe same as the original agreement. Concurrently, the Company entered into a 30-day standstill agreementwith its senior lender with respect to the BET revolving line of credit.  The interest rate on the revolving line ofcredit increased from 13% to 15% starting June 1, 2003.  In consideration of the agreements by theholder of the $140 Million Facility, the Company agreed to issue to the holdersof the $140 Million Facility and additional $0.01 warrants to purchase anaggregate of up to 11,309,994 shares of its Common Stock.  The Company is recognizing a charge tointerest expense related to the warrants, over the 30-day standstill period andhas recognized $1.2 million of this charge in the three-month andsix-month periods ended July 1, 2003. This charge was based on the fair value of the Company’s stock at June18, 2003 less $0.01.  The $140 MillionFacility and related accrued interest was repaid with the proceeds from the$160 Million Facility (Note 14).

** **

**14.****      ****$160 MillionFacility**

 

On June 27, 2003, the Companyentered into an agreement with Jefferies & Company, Inc. (InitialPurchaser) whereby the Company agreed to issue, and the Initial Purchaseragreed to purchase, $160,000,000 aggregate principal amount of notes.  On July 8, 2003, the Company issued$160,000,000 of 13% senior secured notes due 2008 to replace its $140.0 MillionFacility. The $160 Million Facility was offered by the Company and guaranteed,jointly and severally, by all present and all future subsidiaries of theCompany other than the Non-Restricted Subsidiaries (as defined in the Indenturegoverning the notes). The Company is a holding company that conductssubstantially all of its business operations through its subsidiaries. TheCompany is dependent upon distributions or other inter-company transfers fromits subsidiaries to make payments on the notes and service its otherobligations. There are no significant restrictions on the Company's ability toobtain funds from its subsidiaries by dividend or loan.  The Company used the net proceeds of theoffering, among other things, to refinance the $140.0 Million Facility.

 

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**15.****      ****EquityRecapitalization**

 

On June 27, 2003, Halpern Denny, Greenlight and the Company enteredinto an equity recapitalization agreement pursuant to which the parties agreedto a recapitalization of our equity structure (the “Equity Recap”).  The Board of Directors has approved theEquity Recap.  In the Equity Recap, (a)Halpern Denny will exchange all of its equity interests in the Company for$57.0 million face amount of a new Series Z Preferred Stock and (b) all otheroutstanding preferred stock, including the Series F Preferred Stock to beissued in full payment of the outstanding EnbcDeb Notes, will be converted intocommon stock.  The Equity Recap issubject to stockholder approval, which will be voted on at the annualstockholders meeting in September 2003, and other customary conditions.  The Agreement among the parties includes anundertaking by the parties thereto to vote in favor of the Equity Recap.  Assuming that such stockholder approval isreceived, following the closing of the Equity Recap, the Stockholder Agreementwill terminate and Greenlight will beneficially own approximately 92% of theCompany’s outstanding common stock and the warrants issued to the holders ofthe $140 Million Facility will represent approximately 4.3% of our commonstock in the aggregated.

 

The followingtable sets forth (I) our historical cash and cash equivalents andcapitalization as of July 1, 2003, (II) our pro forma cash and cash equivalentsand capitalization as of July 1, 2003, as adjusted to reflect the issuance ofthe $160 Million Facility and the application of the net proceeds therefrom and(III) our pro forma cash and cash equivalents and capitalization as of July 1,2003 adjusted to reflect the issuance of the $160 Million Facility and theapplication of the net proceeds therefrom, as well as the closing of the EquityRecap.  This table should be read inconjunction with our historical financial statement and the related notes.

 
|                                      |   | **As of July  1, 2003** |   |                                               |
|-------------------------------------------|--------|-------------------------|--------|----------------------------------------------------|
|                                      |   |                    |   |                                               |   |   |   | Pro Forma |   |
|                                      |   |                    |   |  

Pro Forma 

for the

$160 Million Facility |   |   |   | for the |   |
|                                      |   | Actual                  |   |                                               |   |   | $160 Million Facility

and Equity Recap |   |
|                                      |   |                    |   | (amounts in thousands)                             |   |   |   |   |   |
|                                      |   |                    |   |                                               |   |   |   |   |   |
|                                      |   |                    |   |                                               |   |   |   |   |   |
| Cash and cash equivalents                 |   | 9,367                   |   | 5,165                                              |   | (1 | ) | 5,165 | (1)  |
|                                      |   |                    |   |                                               |   |   |   |   |   |
| Existing revolving credit facility (BET)  |   | 7,500                   |   | —                                             |   |   |   | — |   |
| New revolving credit facility (AmSouth)   |   | —                  |   | —                                             |   |   |   | — |   |
| Bridge Loan                               |   | 4,952                   |   | 4,952                                              |   |   |   | — |   |
| Greenlight Obligation                     |   | 10,000                  |   | 10,000                                             |   |   |   | — |   |
| $140 Million Facility                     |   | 140,000                 |   | —                                             |   |   |   | — |   |
| $160 Million Facility                     |   | —                  |   | 160,000                                            |   |   |   | 160,000 |   |
| Capital Leases and other debt             |   | 3,050                   |   | 1,370                                              |   |   |   | 1,370 |   |
|                                      |   |                    |   |                                               |   |   |   |   |   |
| Total Debt                                |   | 165,502                 |   | 176,322                                            |   |   |   | 161,370 |   |
|                                      |   |                    |   |                                               |   |   |   |   |   |
| Series F and Series Z preferred stock (2) |   | 99,356                  |   | 99,356                                             |   |   |   | 33,831 |   |
| Stockholders’ deficit                |   | (120,585                | )      | (120,585                                           | ) |   |   | (35,312 | ) |
|                                      |   |                    |   |                                               |   |   |   |   |   |
| Total Capitalization                      |   | 144,273                 |   | 155,093                                            |   |   |   | 159,889 |   |
|                                           |        |                         |        |                                                    |  |  |  |  |  |  |  |

 

(1) Does notreflect cash used in operations since July 1, 2003

 

(2) Net ofallocation of discount attributable to fees and initial and futurewarrants.  Does not include the4,337,481 shares of Series F preferred stock issued by us to the holder of theEnbcDeb Notes upon the consummation of the offering of the $140 MillionFacility.  Effective with the thirdquarter of 2003, the balance of the Company’s outstanding preferred stock willmove from the mezzanine section of our balance sheet to the long-term liabilitysection due to the implementation of SFAS No. 150, Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity (Note4).

 

**16.****      ****Subsequent Events**

 

On July 16, 2003, Eve Trkla resigned from the Company’s Board ofDirectors.  Josh Clark was appointed tofill a vacancy on the board of directors. In addition, Len Tannenbaum, as chairman of the AuditCommittee and Compensation Committee will receive a fee of $25,000 per monthfrom August 2003 through October 2003 for service in such capacities.

 

On August 5, 2003, we enteredinto a consulting agreement with Herbert Buchwald, P.A., a Florida ProfessionalAssociation, effective as of July 16, 2003. The agreement expires on August 5, 2006, but is subject to earliertermination as provided in the agreement. Pursuant to the agreement, the consultant shall provide legal,consulting and advisory services, including: serving as Chairman of theAdvisory Committee of the board of directors; conducting a comprehensiveanalysis and evaluation of our financial condition; and developing a businessplan for approval by the board of directors covering a strategic plan for ourstability and future growth, a compensation plan, an audit plan and a legalplan.  The consultant is required tospend a minimum of 160 hours per calendar month on average during the term ofthe agreement providing us with consulting services.  The consultant is subject to a confidentiality clause in the agreement.  The agreement provides that we will pay theconsultant a consulting fee as follows: $100,000 within two days of the execution of the agreement; $100,000 onor before August 16, 2003; $100,000 on or before September 16, 2003; $50,000 onor before October 16, 2003; $50,000 on or before November 16, 2003; $50,000 onor before December 16, 2003; and $25,000 on or before the sixteenth of eachmonth thereafter until the expiration or termination of the agreement.  Additionally, if we conclude a transactionthat results in the sale of 51% or more of our aggregate outstanding securitiesor of substantially all our assets, the consultant will be entitled to atransaction fee equal to the sum of (A) 3.75% of the first $65 million of grossproceeds received by the holders of our common stock from the transaction and(B) 1% of the gross proceeds received by holders of our common stock from thetransaction.  Under certaincircumstances, the transaction fee shall be reduced by the amount of previouslypaid consulting fees.  In the event thatwe terminate the agreement with the consultant for any reason, the consultantwill not be entitled to a transaction fee unless the sale of 51% or more of ouraggregate outstanding securities or of substantially all our assets wasconsidered by the board of directors during the consultant’s tenure and isconsummated within six-months of the termination of the agreement.

 

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After serving six months as aconsultant, the consultant is entitled to receive a ten-year option to purchase5% of our common stock for a strike price initially based on a valuation of ourcommon stock at $65 million and increasing at a rate of LIBOR plus 2%compounded monthly.  The option is notexercisable so long as entities affiliated with Greenlight hold 10% of more ofour outstanding equity securities.  Theconsultant is also entitled to the reimbursement of reasonable and necessaryout-of-pocket expenses incurred at our request or with our approval, includingthe reimbursement for the consultant’s use of the consultant’s aircraft forcompany-related travel at a rate of $650 per flight hour.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Certain statements in this Form 10-Q under Management’sDiscussion and Analysis of Financial Condition and Results of Operationsconstitute forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995 with respect to the Company’sfinancial condition and business.  Thewords estimate, plan, intend, believe, expect and similar expressions areintended to identify forward-looking statements.  Such forward-looking statements involve and are subject to knownand unknown risks, uncertainties and other factors, which could cause theCompany’s actual results, performance and achievements to be materiallydifferent from any future results, performance (financial or operating), or achievements expressed or implied by suchforward-looking statements.  Suchfactors include, among others, the following: success of the integration of New World and acquired businesses; successof cost-saving strategies; competition; success of operating, franchising andlicensing initiatives; development schedules; advertising and promotionalefforts; adverse publicity; acceptance of new product offerings; availabilityof new locations, and terms of sites for store development; changes in businessstrategy or development plans; availability and terms of capital; food, labor,and employee benefit costs; changes in government regulations; regional weatherconditions; and other factors referenced in this Form  10-Q or in the Company’s Form 10-K.

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

**Overview**

 

The Company is a leader in the quick casual segment of therestaurant industry and the largest operator of bagel bakeries in the UnitedStates.  With 739 locations in 33states, the Company operates and licenses locations primarily under theEinstein Bros. and Noah’s brand names and franchise locations primarily underthe Manhattan and Chesapeake brand names. The Company’s locations specialize in high-quality foods for breakfastand lunch, including fresh baked goods, made-to-order sandwiches on a varietyof breads and bagels, soups, salads, desserts, premium coffees and other cafebeverages, and offer a cafe experience with a neighborhood emphasis.  As of July 1, 2003, the Company’s retailsystem consisted of 462 company-operated locations and 249 franchised and 28licensed locations.  The Company alsooperates dough production and coffee roasting facilities.

 

On June 19, 2001, the Company purchased (the “EinsteinAcquisition”) substantially all of the assets of Einstein. Einstein was thelargest bagel bakery chain in the United States, with 458 stores, nearly all ofwhich were company-operated.  TheEinstein Acquisition was made pursuant to an asset purchase agreement enteredinto by us as the successful bidder at an auction conducted by the UnitedStates Bankruptcy Court, District of Arizona, on June 1, 2001, in the Einsteinbankruptcy case.  The purchase price was$160 million in cash plus the assumption of certain liabilities, subject toadjustment in the event that Assumed Current Liabilities (as defined under theasset purchase agreement) exceed $30 million. The acquisition was accounted for using the purchase method ofaccounting.

 

In January and March 2001, the Company issued Series Fpreferred stock and warrants to purchase its Common Stock and equity in a newlyformed affiliate, Greenlight New World, L.L.C (“GNW”).  The aggregate net proceeds of thosefinancings of approximately $23.7 million were used to purchase Einstein bondsand pay related costs.  In June 2001,the Company issued additional Series F preferred stock and warrants to purchaseits Common Stock for aggregate net proceeds of $22.7 million, which were usedto fund a portion of the purchase price of the Einstein Acquisition.  In January 2001, the Company entered into aBond Purchase Agreement with Greenlight. Pursuant to the agreement, Greenlightformed a limited liability company and contributed $10.0 million to be utilizedfor the purchase of Einstein bonds.  TheCompany consolidated the limited liability company as debt given the terms ofthe agreement.  In June 2001, theCompany issued $140 million of Senior Increasing Rate Notes due 2003 (the “$140Million Facility”) and warrants to purchase its Common Stock.  The net proceeds of approximately $122.4million were used to fund a portion of the purchase price of the EinsteinAcquisition, to repay then-outstanding bank debt and for general workingcapital purposes.  Also in June 2001,the Company obtained a $35 million asset-backed loan to a non-restrictedsubsidiary, New World EnbcDeb Corp., for net proceeds of $32.2 million, whichwere used to fund a portion of the purchase price of the Einstein Acquisition.

 

At July 1, 2003,Company had outstanding $140.0 million of Senior Increasing Rate Notes (the“$140 Million Facility”), which matured on June 15, 2003.  The Company called the Existing Notes forredemption on June 10, 2003.  On June18, 2003, the Company announced that it had entered into a 30-day standstillagreement with the holder of approximately $113.0 million, or 80.7% of theExisting Notes, while continuing to actively pursue the refinancing of its debtas well as the rationalization of its capital structure.  Under this initial accord, holders of thosenotes agreed not to take any action to enforce any of their rights and remediesagainst the Company until July 15, 2003, as a result of the Company’s failureto repay the notes.  The interest rateand terms under the standstill agreement stayed the same as the originalagreement.  Concurrently, the Companyentered into a 30-day standstill agreement with its senior lender with respectto the BET revolving line of credit. The interest rate on the revolving line of credit increased from 13% to15% from June 1, 2003 forward.  Inconsideration of the agreements by the holder of the $140 Million Facility, theCompany agreed to issue to the holders of the Existing Notes and additionalwarrants to purchase an aggregate of up to 11,309,994 shares of its CommonStock.  The Company is recognizing acharge to interest expense related to the warrants, over the 30-day standstillperiod and has recognized $1.2 million of this charge in the three-monthperiod ended July 1, 2003.  This chargewas based on the fair value of the Company’s stock at June 18, 2003 less$0.01.  The $140 Million Facility andrelated accrued interest was paid-off with the proceeds from the $160 MillionFacility.

 

On June 27, 2003,the Company entered into an agreement with Jefferies & Company, Inc.(Initial Purchaser) whereby the Company agreed to issue, and the InitialPurchaser agreed to purchase, $160,000,000 aggregate principal amount ofnotes.  On July 8, 2003, the Companyissued $160,000,000 of 13% senior secured notes due 2008 to replace its $140Million Facility. The $160 Million Facility was offered by the Company andguaranteed, jointly and severally, by all present and all future subsidiariesof the Company other than the Non-Restricted Subsidiaries (as defined in theIndenture governing the notes). The Company is a holding company that conductssubstantially all of its business operations through its subsidiaries. TheCompany is dependent upon distributions or other inter-company transfers fromits subsidiaries to make payments on the notes and service its otherobligations. There are no significant restrictions on the Company's ability toobtain funds from its subsidiaries by dividend or loan.  The Company used the net proceeds of theoffering, among other things, to refinance the $140 Million Facility.

 

Halpern Denny, Greenlight and the Company entered into an equityrecapitalization agreement pursuant to which the parties agreed to arecapitalization of our equity structure (the “Equity Recap”).  The Board of Directors has approved the EquityRecap.  In the Equity Recap, (a) HalpernDenny will exchange all of its equity interests in the Company for $57.0million face amount of a new Series Z Preferred Stock and (b) all otheroutstanding preferred stock, including the Series F Preferred Stock to beissued in full payment of the outstanding EnbcDeb Notes, will be converted intocommon stock.  The Equity Recap issubject to stockholder approval and other customary conditions.  The Agreement among the parties includes anundertaking by the parties thereto to vote in favor of the Equity Recap.  Assuming that such stockholder approval isreceived, following the closing of the Equity Recap, the Stockholder Agreementwill terminate and Greenlight will beneficially own approximately 92% of theCompany’s outstanding common stock and the warrants issued to the holders ofthe Existing Notes will represent approximately 4.3% of our common stock in theaggregated.

 

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**Critical Accounting Policies and Estimates**

 

The Consolidated Financial Statementsand Notes to the Consolidated Financial Statements contain information that ispertinent to management’s discussion and analysis.  The preparation of financial statements in conformity withgenerally accepted accounting principles requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosures of contingent assets and liabilities.

 

The Company believes thefollowing critical accounting policies involve additional management judgmentdue to the sensitivity of the methods, assumptions, and estimates necessary indetermining the related asset and liability amounts.

 

Revenue Recognition

 

Manufacturing revenues arerecognized upon shipment to customers. Retail sales are recognized when payment is tendered at the point ofsale.  Pursuant to the franchiseagreements, franchisees are generally required to pay an initial franchise feeand a monthly royalty payment equal to a percentage of the franchisees’ grosssales.  Initial franchise fees are recognizedas revenue when the Company performs substantially all of its initial servicesas required by the franchise agreement. Royalty fees from franchisees are accrued each month pursuant to thefranchise agreements.  Royalty incomeand initial franchise fees are included in franchise revenues.

 

# **Accounts Receivable**

 

The majority of the Company’saccounts receivable are due from the Company’s franchisees.  Accounts receivable are due within 15 to 30days and are stated at amounts due from customers net of an allowance fordoubtful accounts.  Accounts outstandinglonger than the contractual payment terms are considered past due.  The Company determines its allowance byconsidering a number of factors, including the length of time trade accountsreceivable are past due, previous loss history, the customer’s current abilityto pay its obligation to us, and the condition of the general economy and theindustry as a whole.  The Company writesoff accounts receivable when they become uncollectible, and paymentssubsequently received on such receivables are credited to the allowance fordoubtful accounts.

 

# **Deferred Tax Assets**

 

The Company has recorded a fullvaluation allowance to eliminate its deferred tax assets related to netoperating loss carryforwards and other deductible temporary differences.  The Company limited the amount of taxbenefits recognizable based on an evaluation of the benefits that are expectedto be ultimately realized.  Anadjustment to income could be required if the Company determined it couldrealize these deferred tax assets in excess of the net recorded amount.

# ** **

# **Goodwill, Trademarks and Other Intangibles**

 

The Company adopted SFAS No.142, Goodwill and Other Intangible Assets, effective January 2, 2002.  SFAS 142 provides that goodwill and otherindefinite-lived intangibles should not be amortized, but be subject to anannual assessment for impairment, or more frequently if circumstances indicatepotential impairment, through a comparison of fair value to its carryingamount.  The two-step approach to assessits goodwill impairment requires that the Company first compare the estimatedfair value of each reporting unit that houses goodwill to the carrying amountof the unit’s assets and liabilities, including its goodwill and intangible assets.  If the fair value of the reporting unit isbelow its carrying amount, then the second step of the impairment test isperformed, in which the current fair value of the unit’s assets and liabilitieswill determine the current implied fair value of the unit’s goodwill.

 

In conducting its annualimpairment analyses, the Company utilizes independent valuation experts toperform the analyses and tests of the Company’s indefinite lived assets withrespect to its reporting units.  The testmethods employed involved assumptions concerning useful lives of intangibleassets, interest and discount rates growth projections and other assumptions offuture business conditions.  Theassumptions employed were based on management’s judgment

 

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using internal and externaldata.  The Company also utilizesindependent valuation experts to assist it in determining useful lives for itsintangibles other than goodwill including the assessment that its Einstein trademarkshave  indefinite useful lives.  Its determination that this trademark, aswell as its other trademarks have indefinite useful lives, is based on the factthat there are no legal, regulatory, competitive or other factors, which limittheir useful lives.

 

The Company’s management has determined that no impairment indicatorswere present during the three-month and six-month periods ended July 1, 2003,and accordingly no interim tests for impairment of goodwill, trademarks orintangibles were performed.

 

Derivative Instruments

 

See Note 9 – DerivativeInstruments

 

Interest and Dividends

 

Interest expense and dividendson the $140 Million Facility and Series F preferred stock, respectively, isdetermined, in part, by assumptions related to expected maturity of such instruments.  These assumptions are reviewed and adjustedas the Company’s circumstances change.

 

**Results ofOperations**

 

**Fiscal QuarterEnded July 1, 2003 Compared to Fiscal Quarter Ended July 2, 2002**

 

Revenues

 

Total revenues decreased 3.8%to $97.8 million for the fiscal quarter ended July 1, 2003 from $101.6 millionfor the comparable 2002 period. The overall $3.8 million decrease in revenuesconsists of decreases of approximately $3.7 million in retail (i.e.,company-operated store sales) and $0.1 million manufacturing sales (i.e., foodand beverage sales to third-party customers, franchisees and licensees),respectively. The retail sales decline was primarily due to a 3.6% comparablestore sales decrease at Einstein Bros. and Noah’s company-owned units for thefiscal quarter ended July 1, 2003.

 

Costs and Expenses

 

Cost of sales increased 2.7% to$83.6 million for the fiscal quarter ended July 1, 2003 from $81.4 million forthe comparable 2002 period. The overall $2.2 million increase was primarilycomprised of a $2.3 million increase in retail-related and a $0.1 milliondecrease in manufacturing-related costs. The overall increase was primarily dueto cost associated with a transition in menu item mix and controllable expensesin the Einstein Bros. and Noah’s company-owned units in 2003. Cost of sales,expressed as a percentage of the related retail and manufacturing sales,increased to 86.5% for the fiscal quarter ended July 1, 2003 from 81.3% for thecomparable 2002 period.  The percentageincrease was primarily attributable to the retail related costs noted above, adecline in manufacturing margins due to a price decline, as well as a declinein operating leverage due to the sales decrease.

 

General and administrativeexpenses stayed consistent at $9.4 million for the fiscal quarter ended July 1,2003 compared to $9.4 million for the comparable 2002 period. As a percentageof total revenues, general and

 

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administrative expensesincreased to 9.6% in the second quarter of fiscal 2003 from 9.2% in the secondquarter of  fiscal 2002.  This increase is the result of a decline inoperating leverage due to a sales decline.

 

Depreciation and amortization expenses decreased by $1.8million to $7.1 million for the fiscal quarter ended July 1, 2003 from $8.9million for the comparable 2002 period. The 2002 comparable period included depreciation expense related torecording the final asset valuation for the Einstein acquisition beingallocated to the individual assets within the Company’s asset managementsystem.

 

Operatingincome decreased $4.9 million to a $2.4 million loss for thefiscal quarter ended July 1, 2003 from a $2.5 million income for the comparable2002 period. The decrease was due to the reasons cited in the precedingparagraphs.

 

Interest expense, net for the fiscal quarter ended July 1, 2003decreased to $10.0 million from $12.3 million for the comparable 2002period.  The decrease was primarily theresult of assumptions regarding the expected maturity of the $140 MillionFacility.  The Company anticipated arefinancing would occur during 2002, which compressed the time period overwhich the related effective interest was recognized.

 

The cumulative change in the fair value of derivatives was a $0.7 millionexpense for the quarter ended July 1, 2003 compared to a $9.8 million gain forthe quarter ended July 2, 2002.  Thechange is due to the change in the fair value of warrants classified as aderivative liability based on the underlying fair value of Common Stock towhich they are indexed and, for contingently-issuable warrants classified as aderivative liability, the estimated probability of issuance and other pertinentfactors.

 

Provision for income taxes was $0.3 million for the fiscal quarterended July 1, 2003 compared to $0.2 million for the comparable 2002 period.

 

Net loss for the fiscal quarter ended July 1, 2003 was $13.1 millioncompared to a net loss of $0.1 million for the comparable 2002 period.  The increase in net loss is the result of thereasons cited in the preceding paragraphs.

 

**Year-to-Date Period Ended July 1, 2003Compared to the Year-to-Date Period Ended July 2, 2002**

 

Revenues

 

Total revenues decreased to $193.0 million for theyear-to-date period ended July 1, 2003 from $199.2 million for the comparable2002 period.  Retail sales decreased to$179.3 million or 92.9% of total revenues for the 2003 period from $184.6million or 92.6% of total revenues for the comparable 2002 period. The decreasein revenues was primarily attributable to a 2.2% decrease in same store salesin Einstein Bros. and Noah’s company-owned units.  Manufacturing revenues decreased to $11.2 million or 5.8% oftotal revenues for the year-to-date period ended July 1, 2003 from $12.0million or 6.0% of total revenues for the comparable 2002 period. The decreasein manufacturing revenues results primarily from the decline in manufacturingvolume and the decline in average price per unit.  Franchise related revenues decreased 7.3% to $2.5 million or 1.3%of total revenues for year to date period ended July 1, 2003 from $2.6 millionor 1.3% of total revenues for the comparable 2002 period.

 

Costs and Expenses

 

Total  cost of salesincreased $1.5 million to $162.7 for the year-to-date period ended July 1, 2003from $161.1 million for the comparable 2002 period.  Cost of sales as a percentage of related manufacturing and retailsales increased to 85.4% for the fiscal year-to-date period ended July 1, 2003from 82.0% for the comparable 2002 period. The increase primarily resulted from a decline in operating leverage dueto a sales decrease in addition to an increase in costs associated with atransition in menu item mix and controllable expenses from the retail businessand declines in margins due to a price decrease for the manufacturing business.

 

General and administrative expenses decreased to $18.6million or 9.7% of total revenues for the year-to-date period ended July 1,2003 from $22.6 million or 11.4% of total revenues, for the comparable 2002period.  General and administrativeexpenses in the 2002 period included approximately $2.5 million (inclusive ofrelated payroll tax expenses) in connection with the unauthorized

 

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bonus payments to former officers and employees of theCompany.  Such unauthorized bonuses wereoffset against payments to be made in connection with the separation of certainofficers and employees of the Company. General and administrative expenses in the 2002 period also includeslegal expenses of approximately $1.7 million incurred in connection with theCompany’s voluntary internal investigation of the unauthorized bonus payments.

 

Depreciation and amortization expenses decreased to $14.3 million or7.4% of total revenues for the 2003 period from $14.9 million or 7.5% of totalrevenues for the comparable 2002 period. The 2002 comparableperiod included depreciation expense related to recording the final assetvaluation for the Einstein acquisition being allocated to the individual assetswithin the Company's asset management system.

 

Interest expense, net for the year-to-date period ended July1, 2003 decreased to $18.3 million from $24.6 million for the comparable 2002period.  The decrease was primarily theresult of assumptions regarding the expected maturity of the $140 MillionFacility.  The Company originallyanticipated a refinancing would occur during 2002, which compressed the timeperiod over which the related effective interest was recognized.

 

The cumulative change in the fair value of derivatives was a charge of$0.07 million for 2003 compared to a charge of $3.9 million in 2002.  The change is due to the change in the fairvalue of warrants classified as a derivative liability based on the underlyingfair value of Common Stock to which they are indexed and, forcontingently-issuable warrants classified as a derivative liability, theestimated probability of issuance and other pertinent factors.

 

Provision for income taxes increased to $0.4 million for the2003 period from $0.2 million for the 2002 period.

 

Net loss for the year-to-date period ended July 1, 2003 was$20.9 million compared to a net loss of $27.5 million for the comparable 2002period.  The lower loss in 2003 resultedfrom the reasons cited in the preceding paragraphs.

 

**Liquidity and Capital Resources**

 

At July 1, 2003, the Company had a working capital deficitof $173.2 million compared to a working capital deficit at December 31, 2002 of$164.8 million.  The working capitaldeficit is due primarily to the classification of the $140 Million Facility asa current liability.  The $140 MillionFacility matured on June 15, 2003 and was repaid with the proceeds of the $160Million Facility as previously discussed.

 

The increase in the working capital deficit of $8.8 millionis primarily due to cash used in operating activities and the increase incertain current liabilities during the quarter ended July 1, 2003.

 

The Company had net cash provided by operating activities of$1.2 million for the year to date period ended July 1, 2003 compared with netcash used in operating activities of $3.8 million for the year to date periodended July 2, 2002.  The increase incash provided by operating activities was primarily attributable to the increasein accrued interest related to the final interest payment on the increasingrate notes which was paid in the third quarter of 2003.

 

The Company had net cash used in investing activities of$3.5 million for the year to date period ended July 1, 2003 compared with netcash provided by investing activities of $22.8 million for the year to dateperiod ended July 2, 2002.   The cashused in investing activities represented the purchase of property, plant andequipment.

 

The Company had $0.9 million net cash provided by financingactivities for the year to date period ended July 1, 2003 compared with netcash used in financing activities of $24.7 million for the fiscal quarter endedJuly 2, 2002.   The cash provided byfinancing activities was due to a draw on its revolving loan facility offset byrepayments of debt.

 

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On May 30, 2002, the Company entered into a Loan andSecurity Agreement with BET, one of the Company’s principal stockholders, whichprovides for a $7.5 million revolving loan facility. The facility is secured bysubstantially all of the Company’s assets. Borrowings under the facility bear interest at the rate of 11% perannum.  The facility was to expire onMarch 31, 2003. In February 2003, the Company and BET executed an amendment to thefacility to extend the maturity of the facility to June 1, 2003.  From February 1, 2003 to June 1, 2003, thefacility will bear interest at the rate of 13% per annum.  After June 1, 2003 the interest ratefor borrowings under the facility is 15.0%. BET will receive an extension fee of $187,500 in connection with theamendment, payable at maturity, and an additional fee of $112,500 if thefacility is not paid in full by June 2, 2003. This facility was repaid with the proceeds of the $160 Million Facilityas previously discussed.

 

Concurrently on July 8, 2003, the Company entered into a three-year,$15 million senior secured revolving credit facility with AmSouth Bank.  Initially, the Senior Credit Facility bearsinterest at the AmSouth “prime rate” plus 1.00%.  After the receipt of the Company's audited fiscal year endedDecember 30, 2003 financial statements, the Senior Credit Facility will besubject to an interest pricing grid based on the Company's Fixed ChargeCoverage (as defined by the Indenture).

 

On June 27, 2003, Halpern Denny, Greenlight and the Company enteredinto an equity recapitalization agreement pursuant to which the parties agreedto a recapitalization of our equity structure (the “Equity Recap”).  The Board of Directors has approved theEquity Recap.  In the Equity Recap, (a)Halpern Denny will exchange all of its equity interests in the Company for$57.0 million face amount of a new Series Z Preferred Stock and (b) all otheroutstanding preferred stock, including the Series F Preferred Stock to beissued in full payment of the outstanding EnbcDeb Notes, will be converted intocommon stock.  The Equity Recap issubject to stockholder approval, which will be voted on at the annualstockholders meeting in September 2003, and other customary conditions.  The Agreement among the parties includes anundertaking by the parties thereto to vote in favor of the Equity Recap.  Assuming that such stockholder approval is received,following the closing of the Equity Recap, the Stockholder Agreement willterminate and Greenlight will beneficially own approximately 92% of theCompany’s outstanding common stock and the warrants issued to the holders ofthe $140 Million Facility will represent approximately 4.3% of our commonstock in the aggregated.

 

On June 19, 2001, the Company consummated a privateplacement of 140,000 units consisting of $140 million of Senior Increasing RateNotes due 2003 with detachable warrants for the purchase of 13.7 million sharesof the Company’s Common Stock, exercisable at $.01 per share (the “$140 MillionFacility”).  The proceeds, net ofdiscount and related offering expenses, were $122.4 million.  The proceeds were utilized to fund a portionof the purchase price for the Einstein Acquisition, to repay the Company’sthen-existing bank debt and for general working capital purposes.  The $140 Million Facility initially boreinterest at 13.00% per annum increasing by 100 basis points each quartercommencing September 15, 2001 to a maximum of 18.00%.  In addition, since the Company has not completed a registeredexchange offer for the $140 Million Facility, the Company began payingadditional interest on the $140 Million Facility on November 17, 2001 at therate of 0.25% per annum increasing by 0.25% each 90 days that such defaultcontinues up to a maximum rate of additional interest of 1% per annum.  As of July 1, 2003, the $140 MillionFacility bore interest at a rate of 19%. This facility was repaid with the proceeds of the $160 Million Facilityas previously discussed.

 

On June 19, 2001, the Company obtained a $35.0 millionasset-backed secured loan to its wholly owned non-restricted subsidiary,EnbcDeb Corp. The proceeds, net of discount and related offering expenses, were$32.2 million.  The proceeds wereutilized to fund a portion of the purchase price for the EinsteinAcquisition.  The asset-backed loan, forwhich EnbcDeb Corp. issued increasing rate notes (the “EnbcDeb Notes”), issecured by Einstein bonds owned by EnbcDeb Corp.  The EnbcDeb Notes matured on June 15, 2002.  Because EnbcDeb Corp. is a non-restrictedsubsidiary, a default on the EnbcDeb Notes does not result in a default underthe Notes or the Company’s revolving loan facility.  Interest on the EnbcDeb Notes initially accrues at the rate of14.0% per annum, increasing by 0.35% on the fifteenth day of each monthfollowing issuance, plus 2.0% per annum penalty on overdue amounts.  As previously mentioned, since the EnbcDebNotes matured on June 15, 2002, the additional 2.0% penalty is effective as aresult of the default. Interest is payable on the fifteenth day of every monthand may be paid in kind at the Company’s option.  As of July 1, 2003, the EnbcDeb Notes had a carrying value of$4.7 million and bore interest at 23.0%. The Company must apply all proceeds relating to the Einstein bonds tothe repayment of the EnbcDeb Notes.  Tothe extent that the proceeds received are insufficient to repay the EnbcDebNotes in full, the holders of the EnbcDeb Notes will have the option to requirethe Company to issue them preferred stock having a redemption value equal tothe deficiency.  If the amount of suchdeficiency is less than $5.0 million, then the preferred stock will be entitledto an annual cash dividend equal to 17.0% per annum, increasing 100 basispoints per month until the preferred stock is redeemed, and the Company will berequired to issue warrants to purchase 5% of its fully diluted CommonStock.  If the amount of the deficiencyis $5.0 million or greater, then the preferred stock will be entitled to an annualcash dividend equal to 18% per annum, increasing 100 basis points per monthuntil the preferred stock is redeemed, and the Company will be required toissue warrants to purchase 10% of its fully diluted Common Stock.  The Company has classified thesecontingently issued warrants as a derivative liability within its consolidatedbalance sheet.

 

On January 17, 2001, the Company entered into a BondPurchase Agreement with Greenlight. Pursuant to the agreement, Greenlight formed a limited liability company,Greenlight New World, L.L.C.  (“GNW”),and contributed $10 million to GNW to purchase Einstein bonds. The Company isthe exclusive manager of GNW.  Theagreement provided Greenlight with a secure interest in GNW and a right toreceive the return of its original contribution plus a guaranteed accretion of15% per year, increasing to 17% on January 17, 2002 and by an additional 2%each six months thereafter  (the  “Guaranteed   Return”).  As of July 1,2003 the interest rate was 19%.  Inconnection with the agreement, the Company issued Greenlight warrants topurchase an aggregate of 4,242,056 shares of its Common Stock at $0.01 pershare. On June 19, 2001, GNW, Greenlight, and the Company entered into a letteragreement, pursuant to which, among other things, Greenlight consented to thepledge of the Einstein bonds owned by GNW to secure the EnbcDeb Notes.  The Company is required to apply allproceeds

 

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received with respect to the Einstein bonds to repay theEnbcDeb Notes.  To the extent that thereare any excess proceeds, the Company is required to pay them toGreenlight.  If Greenlight does notreceive a return equal to its Guaranteed Return, the Company is obligated toissue Greenlight Capital Series F preferred stock with a face amount equal tothe deficiency and warrant coverage equal to 1.125% of its fully diluted CommonStock for each $1 million of deficiency (this obligation will cease on June 30,2003 and no additional warrants will be accrued after that date, if and whenthe Equity Recapitalization is consumated). The Company has classified these contingently issuable warrants as aderivative liability within its consolidated balance sheet.

 

The Company plans to satisfy its capital requirements forthe balance of fiscal 2003 through cash flow from operations and borrowingsunder its revolving loan facility.

 

**Seasonality and General Economic Trends**

 

The Company anticipates that its business will be affectedby general economic trends that affect retailers in general.  While the Company has not operated during aperiod of high inflation, management believes based on industry experience thatthe Company would generally be able to pass on increased costs resulting frominflation to its customers.  TheCompany’s business may be affected by other factors, including increases in thecommodity prices of green coffee and/or flour, acquisitions by the Company ofexisting stores, existing and additional competition, marketing programs,weather, and variations in the number of store openings.  Although few, if any, of the Company’semployees are paid at the minimum wage level, an increase in the minimum wagemay create pressure to increase the pay scale for its employees, which wouldincrease its labor costs and those of the Company’s franchisees and licensees.

### * *

### ***Risk Factors***

####  

#### *RiskFactors Relating to the Company’s Financial Condition*

 

*The Company has and expects to continue to have asubstantial amount of debt.*

 

TheCompany has a high level of debt and is highly leveraged.  In addition, the Company may, subject tocertain restrictions, incur substantial additional indebtedness in thefuture.  The Company’s high level ofdebt could:

 

•                                          makeit difficult for the Company to satisfy its obligations under its indebtedness;

 

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•                                          limitthe Company’s ability to obtain additional financing for working capital,capital expenditures, acquisitions and general corporate purposes;

 

•                                          increasethe Company’s vulnerability to downturns in its business or the economygenerally;

 

•                                          limitthe Company’s ability to withstand competitive pressures from its lessleveraged competitors; and

 

•                                          harmthe Company if it fails to comply with the covenants in the instruments andagreements governing its indebtedness, because a failure could result in anevent of default that, if not cured or waived, could result in all of theCompany’s indebtedness becoming immediately due and payable, which could renderthe Company insolvent.

#### * *

#### *TheCompany may not be able to generate sufficient cash flow to make payments underits indebtedness due to events that are beyond the Company’s control*.

####  

#### Economic,financial, competitive, legislative and other factors beyond the Company’scontrol may affect its ability to generate cash flow from operations to makepayments on its indebtedness and to fund necessary working capital.  A significant reduction in operating cashflow would likely increase the need for alternative sources of liquidity.  If the Company is unable to generatesufficient cash flow to make payments on its debt, the Company will have topursue one or more alternatives, such as reducing or delaying capitalexpenditures, refinancing its debt, selling assets or raising equity.  The Company cannot assure you that any ofthese alternatives could be accomplished on satisfactory terms, if at all, orthat they would yield sufficient funds to service the Company’s debt.

#### * *

#### *RiskFactors Relating to the Company’s Business*

#### * *

#### *TheCompany faces potential regulatory sanctions and civil and criminal penaltiesand claims for monetary damages and other relief.*

 

TheSecurities and Exchange Commission has initiated an investigation relating tothe reasons for the Company’s delay in filing its Form 10-K for fiscal 2001 andthe resignation of the Company’s former Chairman, R. Ramin Kamfar, and thetermination for cause of its former Chief Financial Officer, Jerold E.Novack.  The Company is cooperatingfully with the Commission’s investigation. The Company is also cooperating fully with a Department of Justiceinquiry relating to the above-referenced issues.  Given the early stage of these matters, the Company cannotpredict the outcome, and it cannot assure you that the Company will not be subjectto regulatory sanctions, civil penalties and/or claims for monetary damages andother relief that may have a material adverse effect on its business, prospectsand financial condition.

####  

#### *TheCompany is vulnerable to fluctuations in the cost, availability and quality ofits ingredients.*

 

Thecost, availability and quality of the ingredients the Company uses to prepareits food is subject to a range of factors, many of which are beyond theCompany’s control.  Fluctuations ineconomic and political conditions, weather and demand could adversely affectthe cost of the Company’s ingredients. The Company has no control over fluctuations in the price ofcommodities, and no assurance can be given that the Company will be able topass through any cost increases to its customers.  The Company is dependent on frequent deliveries of freshingredients, thereby subjecting the Company to the risk of shortages orinterruptions in supply.  All of thesefactors could adversely affect the Company’s business and financial results.

####  

#### *TheCompany heavily depends on its suppliers and distributors.*

 

TheCompany currently purchases its raw materials from various suppliers.  Though to date the Company has notexperienced any difficulties with its suppliers, the Company’s reliance on itssuppliers subjects the Company to a number of risks, including possible delaysor interruption in supplies, diminished control over quality and a potentiallack of adequate raw material capacity. Any disruption in the supply of or degradation in the quality of the rawmaterials provided by the Company’s suppliers could have a material adverseeffect on the Company’s business, operating results and financialcondition.  In addition, suchdisruptions in supply or degradations in quality could

 

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havea long-term detrimental impact on the Company’s efforts to develop a strongbrand identity and a loyal consumer base.

 

TheCompany depends on its distributors to distribute frozen dough and othermaterials to the Company’s locations. The Company recently replaced a single national distributor with sixregional custom distributors.  If anyone or more of such distributors fails to perform as anticipated, or if thereis any disruption in any of the Company’s distribution relationships for anyreason, it could have a material adverse effect on the Company’s business,financial condition and results of operations.

####  

#### *TheCompany faces the risk of increasing labor costs that could adversely affectthe Company’s continued profitability.*

 

TheCompany is dependent upon an available labor pool of unskilled employees, manyof whom are hourly employees whose wages may be impacted by an increase in thefederal or state minimum wage.  Numerousproposals have been made on state and federal levels to increase minimum wagelevels.  Although few, if any, of theCompany’s employees are paid at the minimum wage level, an increase in theminimum wage may create pressure to increase the pay scale for the Company’semployees, which would increase its labor costs and those of the Company’sfranchisees and licensees.  A shortagein the labor pool or other general inflationary pressures or changes could alsoincrease labor costs.  An increase in laborcosts could have a material adverse effect on the Company’s income from operationsand decrease the Company’s profitability and cash available to service its debtobligations if the Company is unable to recover these increases by raising theprices the Company charges its consumers.

####  

#### *TheCompany is vulnerable to changes in consumer preferences and economicconditions that could harm its financial results.*

 

Foodservice businesses are often affected by changes in consumer tastes, national,regional and local economic conditions and demographic trends.  Factors such as traffic patterns, localdemographics and the type, number and location of competing restaurants mayadversely affect the performance of individual locations.  In addition, inflation and increased foodand energy costs may harm the restaurant industry in general and the Company’slocations in particular.  Adversechanges in any of these factors could reduce consumer traffic or imposepractical limits on pricing, which could harm the Company’s business,prospects, financial condition, operating results or cash flow.  The Company’s continued success will dependin part on its ability to anticipate, identify and respond to changing consumerpreferences and economic conditions.

####  

#### *Thereis intense competition in the restaurant industry.*

 

TheCompany’s industry is intensely competitive and there are many well establishedcompetitors with substantially greater financial and other resources.  In addition to current competitors, one ormore new major competitors with substantially greater financial, marketing andoperating resources could enter the market at any time and compete directlyagainst the Company.  In addition, invirtually every major metropolitan area in which the Company operates or expectto enter, local or regional competitors already exist.

####  

#### *TheCompany faces the risk of adverse publicity and litigation in connection withits operations.*

 

TheCompany is from time to time the subject of complaints or litigation from itsconsumers alleging illness, injury or other food quality, health or operationalconcerns.  Adverse publicity resultingfrom these allegations may materially adversely affect the Company, regardlessof whether the allegations are valid or whether the Company is liable.  In addition, employee claims against theCompany based on, among other things, discrimination, harassment or wrongfultermination may divert the Company’s financial and management resources thatwould otherwise be used to benefit the future performance of the Company’soperations.  The Company has beensubject to claims from time to time, and although these claims have nothistorically had a material impact on the Company’s operations, a

 

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significantincrease in the number of these claims or an increase in the number ofsuccessful claims could materially adversely affect the Company’s business,prospects, financial condition, operating results or cash flows.

####  

#### *TheCompany relies in part on its franchisees.*

 

TheCompany relies in part on its franchisees and the manner in which they operatetheir locations to develop and promote the Company’s business.  Although the Company has developed criteriato evaluate and screen prospective franchisees, there can be no assurance thatfranchisees will have the business acumen or financial resources necessary tooperate successful franchises in their franchise areas.  The failure of franchisees to operatefranchises successfully could have a material adverse effect on the Company,its reputation, its brands and the Company’s ability to attract prospective franchisees.

####  

#### *TheCompany faces risks associated with government regulation.*

 

Eachof the Company’s locations is subject to licensing and regulation by thehealth, sanitation, safety, building and fire agencies of the respective statesand municipalities in which they are located. A failure to comply with one or more regulations could result in theimposition of sanctions, including the closing of facilities for anindeterminate period of time, or third-party litigation, any of which couldhave a material adverse effect on the Company and the results of ouroperations.

 

Inaddition, the Company’s franchise operations are subject to regulation by theFederal Trade Commission.  The Company’sfranchisees and the Company must also comply with state franchising laws and awide range of other state and local rules and regulations applicable to theCompany’s business.  The failure tocomply with federal, state and local rules and regulations would have anadverse effect on the Company’s franchisees and the Company

 

Undervarious federal, state and local laws, an owner or operator of real estate maybe liable for the costs of removal or remediation of certain hazardous or toxicsubstances on or in such property.  Suchliability may be imposed without regard to whether the owner or operator knewof, or was responsible for, the presence of such hazardous or toxicsubstances.  Although the Company is notaware of any environmental conditions that require remediation by the Company underfederal, state or local law at the Company’s properties, the Company has notconducted a comprehensive environmental review of its properties or operationsand no assurance can be given that the Company has identified all of thepotential environmental liabilities at its properties or that such liabilitieswould not have a material adverse effect on the Company’s financial condition.

####  

*We may need additional financing in the future.*

 

We may seek additionalfinancing in the future to expand our business. If we are unable to obtainsufficient financing on satisfactory terms and conditions, we may not be ableto expand our business. Our ability to obtain additional financing will dependupon a number of factors, many of which are beyond our control. For example, wemay not be able to obtain additional financing because we already havesubstantial debt and because we may not have sufficient cash flow to service orrepay our existing or additional debt. In addition, any additional equityfinancing may not be available on satisfactory terms or at all.

 

#### *TheCompany may not be able to protect its trademarks and other proprietary rights*.

 

TheCompany believes that its trademarks and other proprietary rights are importantto its success and the Company’s competitive position.  Accordingly, the Company devotes substantialresources to the establishment and protection of its trademarks and proprietaryrights.  However, the actions taken bythe Company may be inadequate to prevent imitation of the Company’s products andconcepts by others or to prevent others from claiming violations of theirtrademarks and proprietary rights by the Company.  In addition, others may assert rights in the Company’s trademarksand other proprietary rights.

####  

#### *Theholders of our Series F Preferred Stock control the Company.*

 

HalpernDenny III, L.P. (“Halpern Denny”), one of the holders of Series F preferredstock, currently beneficially owns 50.1% of the Company’s Common Stock.  The other holders of the Company’s Series Fpreferred stock currently beneficially own an aggregate of an additional 39.5%of the Company’s Common Stock.  Inaddition, because the Series F preferred stock has remained outstanding formore than one year, the holders of Series F preferred stock are entitled toreceive additional warrants.  Inaddition, the holders of Series F preferred stock currently have the right todesignate up to four members of the Company’s board of directors and, in theevent that any dividends on the Series F preferred stock are in arrears, or ifthe Series F preferred stock is not redeemed in

 

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accordancewith its terms, the holders of the Series F preferred stock will be entitled todesignate at least 50% of the members of the Company’s board of directors.  Pursuant to applicable law, we have beenunable to pay the Series F preferred stock dividends that were due to them onJune 30, 2002, September 30, 2002, December 31, 2002 and March 31, 2003 andJune 30, 2003.  Such dividends are beingaccrued.  This concentration of votingpower could allow Halpern Denny and/or the other holders of the Series Fpreferred stock to direct the Company’s affairs, and may also have the effectof delaying or preventing a change of control.

 

Ifthe Equity Recap is consummated, Greenlight will beneficially own approximately92% of our outstanding common stock, which would allow Greenlight to direct ouraffairs and which may also have the effect of delaying or preventing a changeof control.

 

*There can be no assurance that the Equity Recapitalizationwill be consummated.*

 

HalpernDenny, Greenlight and we have entered into an equity recapitalization agreementpursuant to which the parties agreed to a recapitalization of our equitystructure. Our Board of Directors has approved the Equity Recap. In the EquityRecap, (a) Halpern Denny will exchange all of its equity interests in thecompany for $57.0 million face amount of a new Series Z preferred stock and (b)all other outstanding preferred stock, including the Series F preferred stockto be issued in full payment of the outstanding EnbcDeb Notes, will beconverted into common stock. See "Description of Capital Stock—EquityRecapitalization." The Equity Recap is subject to stockholder approval andother customary conditions. Although the agreement among the parties includesan undertaking by the parties thereto to vote in favor of the Equity Recap,there can be no assurance that such stockholder approval will be obtained. Ifthe Equity Recap is not consummated, for any reason, we will continue to becontrolled by the holders of our Series F preferred stock and be bound by theterms and conditions contained in a stockholders agreement (the"Stockholders Agreement"), dated January 18, 2001, as amended March29, 2001, June 19, 2001 and July 9, 2001, among the Company, BET Associates,L.P. ("BET"), Brookwood New World Investors, LLC("Brookwood"), Halpern Denny, Greenlight and certain of itsaffiliates. See "Management—Certain Relationships and RelatedTransactions." 

 

**Item 3. **** Quantitativeand Quantitative Disclosures About Market Risk**

 

ThroughJuly 1, 2003, our results of operations, financial position and cash flows havenot been materially affected by changes in the relative values of non-U.S.currencies to the U.S. dollar.  We donot use derivative financial instruments to limit our foreign currency riskexposure.

 

Ouraccounts receivable are subject, in the normal courses of business, tocollection risks.  We regularly assessthese risks and have established policies and business practices to protectagainst the adverse effects of collection risks.

 

Ourdebt at July 1, 2003 is principally comprised of the Senior Increasing RateNotes due 2003, the revolving loan facility and the EnbcDeb Notes.  A 100 basis point increase in marketinterest rates would have no effect on our borrowing costs, as interest is paidat rates defined under the respective agreements.  However, an increase in prevailing market interest rates couldnegatively affect the market value of our outstanding notes.

 

**Item 4.****  Controlsand Procedures**

 

Our management, including ourChief Executive Officer (who also serves as the Company’s principal financialofficer), evaluated the effectiveness of the Company’s “disclosure controls andprocedures,” as that term is defined in Rule 13a-15(e) promulgated under theSecurities and Exchange Act of 1934, as amended (the “Exchange Act”), as ofJune 30, 2003.  Based on thatevaluation, the Chief Executive Officer concluded that the disclosure controlsand procedures are effective to ensure that information required to bedisclosed by the Company in the reports that we file or submit under theExchange Act is recorded, processed, summarized and reported, within the timeperiods specified in the SEC’s rules and forms, and to ensure that suchinformation is accumulated and communicated to the Company’s management,including the Chief Executive Officer, as appropriate to allow timely decisionsregarding required disclosure.

 

There were no changes in theCompany’s internal control over financial reporting during the quarter endedJune 30, 2003 identified in connection with the evaluation thereof by ourmanagement, including the Chief Executive Officer, that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

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**PART II****- OTHERINFORMATION**

**NEW WORLD RESTAURANT GROUP, INC.**

**APRIL 1, 2002**

 

**Item 1.    Legal Proceedings.**

 

On April 3,2002, the Company was notified by the Securities and Exchange Commission thatthe Commission is conducting an investigation into the resignation of theformer Chairman, R. Ramin Kamfar, and the termination for cause of the formerChief Financial Officer, Jerold Novack, and the delay in filing the Form 10-Kfor 2001.  The Company is cooperatingfully with the investigation.  TheCompany is also cooperating fully with a recent Department of Justice inquiryrelating to these issues.  Further,several of the former and present officers and directors have requested thatthe Company advance reasonable legal expense on their respective behalf to theextent any of them is or has been requested to provide information to theCommission in connection with its investigation.  The Company is fulfilling its obligations as required byapplicable law and the Company’s By-Laws.

 

On July 31,2002, Tristan Goldstein, a former store manager, and Valerie Bankhordar, acurrent store manager, filed a purported class action complaint againstEinstein in the Superior Court for the State of California, County of San Francisco.  The plaintiffs allege that Noah’s failed topay overtime wages to managers and assistant managers of its California stores,whom it is alleged were improperly designated as exempt employees in violationof California and Business Profession Code Section 17200.  As a result of subsequent communicationsregarding the circumstances under which the Company purchased Einstein out ofbankruptcy, the plaintiffs filed a first amended complaint disclaiming backwages for the period prior to June 19, 2001.  However, the first amended complaint added as defendants certainformer directors and officers of Einstein. The first amended complaint also added a second cause of action seekingto invalidate releases obtained from Noah’s assistant managers pursuant to thesettlement of a Department of Labor investigation.  The Company filed a demurrer to the first amended complaint,which the plaintiffs opposed. Subsequent to the filing of that demurrer, the Company procured adismissal without prejudice of the claims brought against Paul Murphy, the onlyindividual defendant the Company employed subsequent to its acquisition ofEinstein.  The plaintiffs subsequentlystipulated to the severance of the claims against the Company and those againstthe remaining individual defendants. The stipulation provides that the plaintiffs will file separate secondamended complaints against the Company and against the remaining individualdefendants.  As a result, the Company’sdemurrer will be taken off calendar. The Company will have thirty days from the date of the filing of thesecond amended complaint to refile the Company’s demurrer.

 

On March 31,2003, Jerold E. Novack, the former Chief Financial Officer, Secretary, andshareholder of the Company, filed a complaint in the United States DistrictCourt for the District of New Jersey against the Company, Anthony D. Wedo,Chairman and Chief Executive Officer of the Company, and William J. Nimmo, amember of the Board of Directors.  Thecomplaint purports to state claims for breach of plaintiff’s employmentcontract with the Company, breach of the Company’s fiduciary duties toplaintiff, defamation, and violation of the New Jersey Conscientious EmployeeProtection Act, and in addition seeks a declaration that the termination of plaintiff“for cause” was invalid.  As a basis forhis purported claims, the plaintiff alleges that the Company wrongfullycontended certain bonuses he received were unauthorized and that he waswrongfully terminated for cause in order to deny him certain other benefitsallegedly owed under his employment agreement. Furthermore, the plaintiff asserts that he was defamed by certain ofdefendants’ public statements regarding his dismissal and also that histermination was in retaliation for certain actions he believes were protectedby the New Jersey Conscientious Employee Protection Act.  The Company intends to vigorously oppose theplaintiff’s purported claims.  TheCompany was served with the complaint on May 2, 2003.  On June 23, 2003, the Company filed its answer and counterclaimsas well as a motion to dismiss certain of the claims against it.  That motion is pending with the court.

 

On June 4,2003, Ramin Kamfar, our former Chairmen of the Board and Chief ExecutiveOffice, filed an action in the United States District Court for the SouthernDistrict of New York Against us and Anthony Wedo, our current Chief ExecutiveOfficer, alleging causes of action for breach of contract, defamation,declaratory relief and punitive damages. In this action, Mr., Kamfar alleges that we breached confidentiality andnon-disparagement provisions in his separation agreement with us by disclosingcertain financial and other terms contained therein.  Mr. Kamfar is seeking damages of at least $7.0 million.  As of the data of this filing, we have notyet been served with the complaint relating to this action.  We believe that the claims of Mr. Kamfar arewithout merit, and we intend to vigorously defend ourself and Mr. Wedo in thismatter.

 

In July 2002,the New Jersey Division of Taxation entered judgment in the amount of$5,744,902, plus costs, against Manhattan Bagel Construction Company, a whollyowned subsidiary of Manhattan Bagel Company. This judgment represents amounts for corporate income taxes for theperiod from 1996 to 2000, and sales and use taxes for the period from 1995 to1997.  At that same time, the Divisionof Taxation provided Manhattan Bagel Construction Company with a Notice andDemand for Payment of Tax in the additional amount of $130,200, for corporateincome taxes and sales and use taxes for the period from October 2001 throughJune 2002.  Manhattan Bagel ConstructionCompany ceased operations in or about early 1997 and has existed since thattime only as a non-operating entity with no assets.  Therefore, the Company is currently working with the New JerseyDivision of Taxation to have all tax assessments for the period after ManhattanBagel Construction Company ceased operations removed, and that portion of thejudgment deemed satisfied.  With regardto taxes imposed for the period prior to early 1997, the Company believes thoseamounts are barred from being asserted against Manhattan Bagel Company, to theextent they otherwise could have been, because they were not asserted inManhattan Bagel Company’s November 1997 bankruptcy proceeding.

 

On February23, 2000, New World Coffee of Forest Hills, Inc., a franchisee, filed a demandfor arbitration with the American Arbitration Association (*American Arbitration Association, NewYork, New York, Case No. 13-114-237-00*) against the Company allegingfraudulent inducement and violations of New York General Business Law Article33.  The franchisee seeks damages in theamount of $750,000.  New World hasasserted a counterclaim in the arbitration seeking amounts owed under thefranchisee’s franchise agreement and monies owed for goods purchased by thefranchisee in the amount of $200,000. An arbitrator has been selected and document exchange is complete.  Hearings were scheduled for June 2002 buthave been postponed by order of the arbitrator.

 

On October 28,2002, Sansim Patel, Inc., a subfranchisee of Manhattan Bagel Company, filedsuit against Manhattan Bagel Company, the master franchisee, and others inOrange County (Orlando, Florida).  Theplaintiff alleges claims of civil conspiracy and unjust enrichment againstManhattan Bagel Company and seeks rescission of its franchise agreement withManhattan Bagel Company.  The plaintiffalso seeks damages in an unspecified amount. In December 2002, the Company filed a motion to dismiss all of theclaims asserted against it by the plaintiff, based in part on a general releasethe plaintiff had previously executed in favor of Manhattan Bagel Company.  That motion remains pending with the Court.  However, on March 18, 2003, defaultjudgments were obtained against the other named defendants.

 

On March 17,2003, Jason and Andrew Gennusa, former employees of the Company and founders ofManhattan Bagel Company, filed suit against the Company in the Superior Courtof New Jersey, Monmouth County.  As thefounders of Manhattan Bagel Company, the plaintiffs claim to be reproducing the“original formula” Manhattan Bagel dough, and selling it to franchisees at acompetitive price.  Their complaintseeks a judgment declaring that their production and sale of this bagel doughto franchisees does not violate various non-competition covenants andconfidentiality agreements they previously entered into with the Company.  Furthermore, the plaintiffs seek a declarationthat the “original recipe” bagel dough they manufacture is not a trade secretof the Company and that their manufacture and sale of the dough is not inviolation of intellectual property law. The Company has not yet answered or otherwise responded to plaintiffs’complaint.  We answered plaintiff'scomplaint on May 14, 2003, and filed counterclaims and a motion for thepreliminary injunction on June 2, 2003. On July 22,2003, we announced that this lawsuit had been settled.  As part of the settlement, the plaintiffsacknowledged that Manhattan Bagel franchises are obligated under theirfranchise agreements to purchase frozen bagel dough only from suppliersapproved by Manhattan Bagel Corp. and New World and withdrew their request foran injunction that would have allowed such franchises to purchase frozen doughfrom unapproved outside suppliers.

 

On June 2, 2003, a group of four ManhattanBagel franchisees filed a lawsuit captioned Kaufman et al. v. New WorldRestaurant Group, Inc. in the Superior Court of New Jersey, Chancery Division,Monmouth County.  In their complaint,plaintiffs allege that since we closed our Eatontown, New Jersey bakingfacility and began contracting with Harlan Bakeries, the quality of its bagelshas suffered.  As a result of thisalleged decline in bagel quality, plaintiffs claim that they will lose bagelsales and customer goodwill if they continue to purchase their bagels fromHarlan Bakeries in accordance with the terms of their franchiseagreements.  Alleging claims for breachof contract, consumer fraud, constructive termination of the franchiseagreements, and violation of the New Jersey Franchise Practices Act, plaintiffsseek a judgment permitting their purchase of “New York style” bagels from anythird-party supplier, enjoining our termination of their franchise agreementsbecause of their purchase of such non-approved bagels, and awarding toplaintiffs damages in an unspecified amount. The Company’s time to answer or otherwise respond to the complaint hasnot yet elapsed.  We intend to defendthis matter vigorously.

 

SpecialSituations Fund, L.P., Special Situations Cayman Fund, L.P. and SpecialSituations Private Equity Fund, L.P. (collectively, “Special Situations”),holders of Series F preferred stock, had notified the Company that they believethat material misrepresentations were made to them in June 2001 in connectionwith their purchase of the  stock.  Special Situations filed a complaint in theUnited States District Court for the Southern District of New York regardingthis claim.  Special Situations allegedvarious contractual and tort claims against the Company, as well as RaminKamfar, the former Chairman of the Board of Directors, Jerold Novack, theformer Chief Financial Officer, and Greenlight Capital, L.P., GreenlightCapital Qualified, L.P. and Greenlight Capital Offshore, Ltd. (collectively,“Greenlight”), another holder of the Series F preferred stock.  Special Situations sought, among otherrelief, damages in the amount of at least $5,166,000 and the equitable remedyof rescission of its purchase of stock. Prior to responding to Special Situations’ complaint, the Company andSpecial Situations entered into a settlement agreement and release on April 29,2003, pursuant to which the Company agreed to settle Special Situations’ claimsagainst the Company and its present and former officers, directors, agents andother representatives, and Special Situations agreed to release those entitiesand individuals, in exchange for payment to Special Situations of $176,000. ANotice of Voluntary Withdrawal was filed by Special Situations with the UnitedStates District Court for the Southern District of New York on May 5, 2003.

 

On February28, 2003, the Company’s former insurance broker of record filed suit inSuperior Court of the State of California, County of Orange, against theCompany and its subsidiaries, alleging wrongful termination of the Company’sbrokerage contract with plaintiff, Pension & Benefit Insurance Services,Inc. (“PBIS”), which deprived PBIS of brokerage commissions.  PBIS’s complaint asserts claims for breachof contract, reasonable value of services, intentional interference withprospective advantage and negligent interference with prospectiveadvantages.  Plaintiff seeks $500,000 inconsequential damages and $20 million in punitive damages.  Prior to responding to PBIS’s complaint, theCompany entered into a settlement agreement with PBIS on April 2, 2003.  As consideration for PBIS’s agreement tosettle and dismiss this matter, the Company agreed to list PBIS as itsinsurance broker of record until at least the end of 2003.  A Request for Dismissal of the suit wasfiled by PBIS with the Superior Court of the State of California, County ofOrange on April 9, 2003.

 

On April 7,2003, General Electric Capital Corp. filed an action in the Supreme Court forthe State of New York, County of New York, against the Company and itsfranchisee, captioned *General ElectricCapital Corp. v. New World Coffee/Manhattan Bagels, Inc. et al*.  In its complaint, plaintiff asserts that itentered into certain equipment lease agreements with the Company on April 18,2001, and with the franchisee on February 26, 2001, upon which the Company andits franchisee subsequently defaulted. As a result of those alleged defaults, plaintiff purports to stateclaims against defendants for breach of contract, conversion, unjustenrichment, foreclosure of security interest, and replevin, and demands damagesfrom defendants, jointly and severally, in the total specified amount of$118,555.49, plus late charges, taxes, interest, costs and attorneys’fees.  The plaintiff has dismissed itsclaim against the Company with prejudice.

 

On December28, 2001, Robert Higgs, a franchisee, filed a complaint against the Company andits officers and agents in New Jersey (*Superior Court of New Jersey, Case No. OCN-L-2153-99*)alleging breach of contract, breach of fiduciary duties and tortuousinterference with contract and business opportunities.  The complaint was subsequently withdrawn bythe franchisee without prejudice.  InFebruary 2002, the franchisee filed a new complaint against the Company and itsofficers and agents alleging breach of contract, breach of fiduciary duties,tortuous interference with contract and business opportunities, and violationsof New Jersey’s franchise law.  Thefranchisee seeks damages in an unspecified amount, punitive damages, costs andattorneys’ fees.  The Company moved todismiss all of the claims in the new complaint.  The court dismissed the breach of fiduciary duty claims and oneof the breach of contract claims. Discovery requests have been served by the Company.  This matter has been settled.

 

 

**Item 2.    Changes in Securities and Use of Proceeds.**

 

Not applicable

 

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**Item 3.  Defaultsupon Senior Securities.**

 

Notapplicable.

 

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

 

Not applicable

 

**Item 5.  OtherInformation.**

 

Not applicable

 

**Item 6.  Exhibitsand Reports on Form 8-K.**

 

(a)          Exhibits

 

10.61       Buchwald ConsultingAgreement (Chairman of recently created Advisory committee to the Board ofDirectors)

31.1         Certification byChief Executive Officer (who also serves as the Company’s principal accountingofficer) pursuant to Exchange Act Rule 13a-15(e), as adopted pursuant toSection 302 of the Sarbanes-Oxley Act of 2002

32.1         Certification by Chief Executive Officer (who also serves asthe Company’s principal accounting officer) pursuant to 18 U.S.C. Section 1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(b)         Reports on Form 8-K filedduring the quarter ended July 1, 2003

 

5/15/03 New World Reports Results for 2002 and Restated Results for2001, 2000. 

5/16/03 Company intends to offer approximately $160 Million of seniorsecured notes due 2008. 

6/18/03 New World Announces Standstill Agreements; Continues toactively pursue refinancing of existing debt. 

6/27/03 New World Announces EquityRestructuring Agreement.

 

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**Signatures**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|   |            |                                  | NEW WORLD RESTAURANT GROUP,  INC. |
|--------|-----------------|---------------------------------------|-----------------------------------|
|   |            |                                  |
|   |            |                                  |
| Date:  | August 15, 2003 | By:  /s/ ANTHONY D. WEDO         |                              |
|   |            | Anthony D. Wedo                       |
|   |            | Chairman and Chief Executive  Officer |
|        |                 |                                       |                                   |  |

 

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