**UNITED STATES**

**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 October 2,  2007** |
|                                                                                                    |   |
|                                                                                                    | **OR** |
| ** **                                                                                              | ** ** |
| **o****TRANSITION REPORT UNDER  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**           |

 

**Commission File Number 0-27148**

 

**Einstein Noah Restaurant Group, Inc.**

(Exact name of registrant as specified in itscharter)

** **

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

** **

**(303) 568-8000**

(Registrant’s telephone number, includingarea code)

** **

 

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

 

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

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. 

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

 

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

 

As of November 6, 2007 there were 15,812,879 sharesof the registrant’s Common Stock, par value of $0.001 per share outstanding.

 

 

----

 

**EINSTEIN NOAH RESTAURANT GROUP, INC.**

 

October 2, 2007

 

TABLE OF CONTENTS

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

 

2

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

**CONSOLIDATED BALANCE SHEETS**

**AS OF JANUARY 2, 2007 AND OCTOBER 2, 2007**

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

**(unaudited)**

 
| ** **                                                                                                                                                              | ** ** | **January 2,  2007** | ** ** | **October 2,  2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| **ASSETS**                                                                                                                                                              | ** ** | ** **                | ** ** | ** **                | ** ** |
| Current assets:                                                                                                                                                         |       |                      |       |                      |       |
| Cash and cash equivalents                                                                                                                                               |       | $                         | 5,477      |                      | $          | 11,991 |   |
| Restricted cash                                                                                                                                                         |       | 2,403                     |       | 1,747                     |       |
| Franchise and other receivables, net of  allowance of $505 and $478, respectively                                                                                       |       | 6,393                     |       | 6,281                     |       |
| Inventories                                                                                                                                                             |       | 4,948                     |       | 5,210                     |       |
| Prepaid expenses and other current assets                                                                                                                               |       | 4,529                     |       | 5,029                     |       |
| Assets held for sale                                                                                                                                                    |       | 1,144                     |       | —                    |       |
| Total current assets                                                                                                                                                    |       | 24,894                    |       | 30,258                    |       |
|                                                                                                                                                                    |       |                      |       |                      |       |
| Restricted cash long-term                                                                                                                                               |       | 284                       |       | 278                       |       |
| Property, plant and equipment, net                                                                                                                                      |       | 33,889                    |       | 43,266                    |       |
| Trademarks and other intangibles, net                                                                                                                                   |       | 63,806                    |       | 63,806                    |       |
| Goodwill                                                                                                                                                                |       | 4,875                     |       | 4,875                     |       |
| Debt issuance costs and other assets, net                                                                                                                               |       | 5,406                     |       | 3,788                     |       |
|                                                                                                                                                                    |       |                      |       |                      |       |
| Total assets                                                                                                                                                            |       | $                         | 133,154    |                      | $          | 146,271 |   |
|                                                                                                                                                                    |       |                      |       |                      |       |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**                                                                                                                          | ** ** | ** **                | ** ** | ** **                | ** ** |
| Current liabilities:                                                                                                                                                    |       |                      |       |                      |       |
| Accounts payable                                                                                                                                                        |       | $                         | 3,347      |                      | $          | 6,555 |   |
| Accrued expenses                                                                                                                                                        |       | 25,855                    |       | 22,780                    |       |
| Short term debt and current portion of  long-term debt                                                                                                                  |       | 3,605                     |       | 1,180                     |       |
| Current portion of obligations under  capital leases                                                                                                                    |       | 76                        |       | 78                        |       |
| Total current liabilities                                                                                                                                               |       | 32,883                    |       | 30,593                    |       |
|                                                                                                                                                                    |       |                      |       |                      |       |
| Senior notes and other long-term debt, net  of discount                                                                                                                 |       | 166,556                   |       | 89,155                    |       |
| Obligations under capital leases                                                                                                                                        |       | 124                       |       | 64                        |       |
| Other liabilities                                                                                                                                                       |       | 8,822                     |       | 10,164                    |       |
| Mandatorily redeemable, Series Z Preferred  Stock, $.001 par value, $1,000 per share liquidation value; 57,000 shares authorized;  57,000 shares issued and outstanding |       | 57,000                    |       | 57,000                    |       |
|                                                                                                                                                                    |       |                      |       |                      |       |
| Total liabilities                                                                                                                                                       |       | 265,385                   |       | 186,976                   |       |
|                                                                                                                                                                    |       |                      |       |                      |       |
| Commitments and contingencies (see Note 10)                                                                                                                             |       |                      |       |                      |       |
|                                                                                                                                                                    |       |                      |       |                      |       |
| Stockholders’ deficit:                                                                                                                                             |       |                      |       |                      |       |
| Series A junior participating preferred  stock, 700,000 shares authorized; no shares issued and outstanding                                                             |       |                      |       |                      |       |
| Common stock, $.001 par value; 25,000,000  shares authorized; 10,596,419 and 15,812,879 shares issued and outstanding                                                   |       | 11                        |       | 16                        |       |
| Additional paid-in capital                                                                                                                                              |       | 176,797                   |       | 262,493                   |       |
| Accumulated deficit                                                                                                                                                     |       | (309,039                  | )          | (303,214                  | )          |
| Total stockholders’ deficit                                                                                                                                        |       | (132,231                  | )          | (40,705                   | )          |
|                                                                                                                                                                    |       |                      |       |                      |       |
| Total liabilities and stockholders’ deficit                                                                                                                        |       | $                         | 133,154    |                      | $          | 146,271 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

3

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**FOR THE THIRD QUARTER AND YEAR TO DATE PERIODS ENDED OCTOBER3, 2006 AND OCTOBER 2, 2007**

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

**(unaudited)**

 
| ** **                                                        | ** ** | **Third quarter ended:** | ** ** | **Year to date ended:** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------|------------|----------------------------------------|------------|
| ** **                                                        | ** ** | **October 3,  2006**          | ** ** | **October 2,  2007**              | ** ** | **October 3,  2006** | ** ** | **October 2,  2007** | ** ** |
| Revenues:                                                         |       |                               |       |                                   |       |   |   |   |   |
| Company-owned restaurant sales                                    |       | $                                  | 89,213     |                                   | $          | 93,026 |   | $ | 271,300 |   | $ | 276,283 |   |
| Manufacturing and commissary revenues                             |       | 5,257                              |       | 5,910                                  |       | 15,725 |   | 17,409 |   |
| Franchise and license related revenues                            |       | 1,282                              |       | 1,442                                  |       | 3,759 |   | 3,996 |   |
|                                                              |       |                               |       |                                   |       |   |   |   |   |
| Total revenues                                                    |       | 95,752                             |       | 100,378                                |       | 290,784 |   | 297,688 |   |
|                                                              |       |                               |       |                                   |       |   |   |   |   |
| Cost of sales:                                                    |       |                               |       |                                   |       |   |   |   |   |
| Company-owned restaurant costs                                    |       | 72,187                             |       | 74,527                                 |       | 219,677 |   | 221,116 |   |
| Manufacturing and commissary costs                                |       | 5,445                              |       | 6,330                                  |       | 15,952 |   | 17,132 |   |
|                                                              |       |                               |       |                                   |       |   |   |   |   |
| Total cost of sales                                               |       | 77,632                             |       | 80,857                                 |       | 235,629 |   | 238,248 |   |
|                                                              |       |                               |       |                                   |       |   |   |   |   |
| Gross profit                                                      |       | 18,120                             |       | 19,521                                 |       | 55,155 |   | 59,440 |   |
|                                                              |       |                               |       |                                   |       |   |   |   |   |
| Operating expenses:                                               |       |                               |       |                                   |       |   |   |   |   |
| General and administrative expenses                               |       | 9,750                              |       | 9,794                                  |       | 30,038 |   | 31,381 |   |
| Depreciation and amortization                                     |       | 2,640                              |       | 2,868                                  |       | 14,238 |   | 7,910 |   |
| Loss (gain) on sale, disposal or  abandonment of assets, net      |       | 193                                |       | 25                                     |       | 206 |   | 429 |   |
| Impairment charges and other related costs                        |       | 51                                 |       | 28                                     |       | 134 |   | 213 |   |
|                                                              |       |                               |       |                                   |       |   |   |   |   |
| Income from operations                                            |       | 5,486                              |       | 6,806                                  |       | 10,539 |   | 19,507 |   |
| Other expense:                                                    |       |                               |       |                                   |       |   |   | — |   |
| Interest expense, net                                             |       | 4,749                              |       | 1,752                                  |       | 14,670 |   | 10,685 |   |
| Write-off of debt discount upon redemption  of senior notes       |       | —                             |       | —                                 |       | — |   | 528 |   |
| Prepayment penalty upon redemption of  senior notes               |       | —                             |       | —                                 |       | 4,800 |   | 240 |   |
| Write-off of debt issuance costs upon  redemption of senior notes |       | —                             |       | —                                 |       | 3,956 |   | 2,071 |   |
| Other                                                             |       | (15                                | )          | —                                 |       | (5 | ) | — |   |
|                                                              |       |                               |       |                                   |       |   |   |   |   |
| Income (loss) before income taxes                                 |       | 752                                |       | 5,054                                  |       | (12,882 | ) | 5,983 |   |
| Provision for income taxes                                        |       | —                             |       | 111                                    |       | — |   | 158 |   |
|                                                              |       |                               |       |                                   |       |   |   |   |   |
| Net income (loss)                                                 |       | $                                  | 752        |                                   | $          | 4,943 |   | $ | (12,882 | ) | $ | 5,825 |   |
|                                                              |       |                               |       |                                   |       |   |   |   |   |
| Net income (loss) per common share – Basic                   |       | $                                  | 0.07       |                                   | $          | 0.31 |   | $ | (1.25 | ) | $ | 0.46 |   |
| Net income (loss) per common share –  Diluted                |       | $                                  | 0.07       |                                   | $          | 0.30 |   | $ | (1.25 | ) | $ | 0.43 |   |
|                                                              |       |                               |       |                                   |       |   |   |   |   |
| Weighted average number of common shares  outstanding:            |       |                               |       |                                   |       |   |   |   |   |
| Basic                                                             |       | 10,593,085                         |       | 15,772,931                             |       | 10,276,464 |   | 12,718,051 |   |
| Diluted                                                           |       | 11,036,527                         |       | 16,572,486                             |       | 10,276,464 |   | 13,436,884 |   |

 

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

 

4

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**EINSTEINNOAH RESTAURANT GROUP, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**FOR THE YEAR TO DATE PERIODS ENDED OCTOBER 3, 2006 ANDOCTOBER 2, 2007**

**(inthousands)**

**(unaudited)**

 
| ** **                                                                       | ** ** | **October 3,  2006** | ** ** | **October 2,  2007** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| OPERATING ACTIVITIES:                                                            |       |                      |       |                      |       |
| Net income (loss)                                                                |       | $                         | (12,882    | )                         | $          | 5,825 |   |
| Adjustments to reconcile net loss to net  cash provided by operating activities: |       |                      |       |                      |       |
| Depreciation and amortization                                                    |       | 14,238                    |       | 7,910                     |       |
| Stock based compensation expense                                                 |       | 546                       |       | 1,588                     |       |
| Loss, net of gains, on disposal of assets                                        |       | 206                       |       | 429                       |       |
| Impairment charges and other related costs                                       |       | 134                       |       | 213                       |       |
| Provision for losses on accounts  receivable, net                                |       | 158                       |       | 25                        |       |
| Amortization of debt issuance and debt  discount costs                           |       | 620                       |       | 545                       |       |
| Write-off of debt issuance costs                                                 |       | 3,956                     |       | 2,071                     |       |
| Write-off of debt discount                                                       |       | —                    |       | 528                       |       |
| Paid-in-kind interest                                                            |       | 1,113                     |       | 904                       |       |
| Changes in operating assets and  liabilities:                                    |       |                      |       |                      |       |
| Franchise and other receivables                                                  |       | (509                      | )          | 87                        |       |
| Accounts payable and accrued expenses                                            |       | 1,832                     |       | 1,973                     |       |
| Other assets and liabilities                                                     |       | 9                         |       | (2,829                    | )          |
|                                                                             |       |                      |       |                      |       |
| Net cash provided by operating activities                                        |       | 9,421                     |       | 19,269                    |       |
|                                                                             |       |                      |       |                      |       |
| INVESTING ACTIVITIES:                                                            |       |                      |       |                      |       |
| Purchase of property and equipment                                               |       | (10,570                   | )          | (18,255                   | )          |
| Proceeds from the sale of equipment                                              |       | 165                       |       | 1,166                     |       |
|                                                                             |       |                      |       |                      |       |
| Net cash used in investing activities                                            |       | (10,405                   | )          | (17,089                   | )          |
|                                                                             |       |                      |       |                      |       |
| FINANCING ACTIVITIES:                                                            |       |                      |       |                      |       |
| Proceeds from secondary common stock  offering                                   |       | —                    |       | 90,000                    |       |
| Costs incurred with offering of our common  stock                                |       | —                    |       | (6,666                    | )          |
| Proceeds from line of credit                                                     |       | 24                        |       | —                    |       |
| Repayments of line of credit                                                     |       | (24                       | )          | —                    |       |
| Payments under capital lease obligations                                         |       | (34                       | )          | (58                       | )          |
| Repayment of notes payable                                                       |       | (160,000                  | )          | —                    |       |
| Borrowings under First Lien                                                      |       | 80,000                    |       | 11,900                    |       |
| Repayments under First Lien                                                      |       | (950                      | )          | (700                      | )          |
| Borrowing under Second Lien                                                      |       | 65,000                    |       | —                    |       |
| Repayments under Second Lien                                                     |       | —                    |       | (65,000                   | )          |
| Borrowings under Subordinated Note                                               |       | 24,375                    |       | —                    |       |
| Repayments under Subordinated Note                                               |       | —                    |       | (25,000                   | )          |
| Debt issuance costs                                                              |       | (4,916                    | )          | (921                      | )          |
| Proceeds upon stock option and warrant  exercises                                |       | 187                       |       | 779                       |       |
|                                                                             |       |                      |       |                      |       |
| Net cash provided by financing activities                                        |       | 3,662                     |       | 4,334                     |       |
|                                                                             |       |                      |       |                      |       |
| Net increase in cash and cash equivalents                                        |       | 2,678                     |       | 6,514                     |       |
| Cash and cash equivalents, beginning of  period                                  |       | 1,556                     |       | 5,477                     |       |
| Cash and cash equivalents, end of period                                         |       | $                         | 4,234      |                      | $          | 11,991 |   |

 

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

 

5

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**EINSTEIN NOAH RESTAURANT GROUP, INC.**

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

**FOR THE YEAR TO DATE PERIOD ENDED OCTOBER 2, 2007**

(inthousands, except share information)

(unaudited)

 
| ** **                                      | ** ** | ** **            | ** ** | ** **       | ** ** | **Additional** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|-----------------|------------|------------|------------|
| ** **                                      | ** ** | **Common Stock** | ** ** | **Paid In** | ** ** | **Deficit**    | ** ** | ** **      | ** ** |
| ** **                                      | ** ** | **Shares**            | ** ** | **Amount**       | ** ** | **Capital**    | ** ** | **Amount**      | ** ** | **Total**  | ** ** |
|                                            |       |                  |       |             |       |           |       |            |       |       |       |
| Balance, January 2, 2007                        |       | 10,596,419            |       | $                | 11         |           | $          | 176,797         |       | $          | (309,039   | ) | $ | (132,231 | ) |
| Net income                                      |       | —                |       | —           |       | —         |       | 5,825           |       | 5,825      |       |
| Common stock issued upon stock option  exercise |       | 216,460               |       | —           |       | 779            |       | —          |       | 779        |       |
| Common stock issued in secondary offering       |       | 5,000,000             |       | 5                |       | 89,995         |       | —          |       | 90,000     |       |
| Costs to issue common stock                     |       | —                |       | —           |       | (6,666         | )          | —          |       | (6,666     | )          |
| Stock based compensation expense                |       | —                |       | —           |       | 1,588          |       | —          |       | 1,588      |       |
|                                            |       |                  |       |             |       |           |       |            |       |       |       |
| Balance, October 2, 2007                        |       | 15,812,879            |       | $                | 16         |           | $          | 262,493         |       | $          | (303,214   | ) | $ | (40,705 | ) |

 

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

 

6

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**EINSTEINNOAH RESTAURANT GROUP, INC.**

 

Notes to Consolidated Financial Statements (Unaudited)

 

For the Third Quarters andYear to Date Periods ended October 3, 2006 and October 2, 2007

 

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

 

The consolidated financialstatements of Einstein Noah Restaurant Group, Inc. (formerly New WorldRestaurant Group, Inc.) and its wholly-owned subsidiaries (collectively, the “Company”)have been prepared pursuant to the rules and regulations of the Securities andExchange Commission (“SEC”). As of October 2, 2007, the Company owned,franchised or licensed various restaurant concepts under the brand names ofEinstein Bros. Bagels (“Einstein Bros.”), Noah’s New York Bagels (“Noah’s”),Manhattan Bagel Company (“Manhattan Bagel”), Chesapeake Bagel Bakery (“Chesapeake”)and New World Coffee (“New World”). Our business is subject toseasonal trends. Generally, our revenues and results of operations in thefourth fiscal quarter tend to be the most significant.

 

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

 

Certain immaterial reclassifications have been made to conformpreviously reported data to the current presentation. These reclassificationshave no effect on our net loss or financial position as previously reported.

 

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

 

In December 2004, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standard (“SFAS”) No. 123R, *Share-Based Payment*(“SFAS No. 123R”). SFAS No. 123R is arevision of SFAS No. 123, *Accounting for Stock-BasedCompensation*, and supersedes Accounting Principles Board Opinion (“APB”)No. 25, *Accounting for Stock Issued to Employees*and its related implementation guidance. SFAS No. 123R focuses primarily onaccounting for transactions in which an entity obtains employee services inshare-based payment transactions. The Statement requires entities to recognizecompensation expense for awards of equity instruments to employees based on thegrant-date fair value of those awards (with limited exceptions). EffectiveJanuary 4, 2006, we adopted the provisions of SFAS No. 123R using the modifiedprospective transition method.

 

7

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Our stock-based compensation cost for the third quarters ended October3, 2006 and October 2, 2007 was $139,000 and $338,000, respectively, and $0.5million and $1.6 million for the year to date periods ended October 3, 2006 andOctober 2, 2007, respectively, and has been included in general andadministrative expenses. The fair value of stock options and stock appreciationrights (“SARs”) are estimated using the Black-Scholes option-pricing model withthe following weighted average assumptions:

 
| ** **                                            | ** ** | **Third quarter ended:** | ** ** | **Year to date ended:** | ** ** |
|-------------------------------------------------------|------------|------------------------------------|------------|----------------------------------------|------------|
| ** **                                            | ** ** | **October 3,**                | ** ** | **October 2,**                    | ** ** | **October 3,** | ** ** | **October 2,** | ** ** |
| ** **                                            | ** ** | **2006**                           | ** ** | **2007**                               | ** ** | **2006** | ** ** | **2007** | ** ** |
| Expected  life of options and SARs from date of grant |       | 4.0 years                          |       | 4.0 years                              |       | 4.0 years |   | 4.0 years |   |
| Risk-free  interest rate                              |       | 4.8%                               |       | 4.13 - 4.85%                           |       | 4.4 - 4.8% |   | 4.13 - 5.02% |   |
| Volatility                                            |       | 100.0%                             |       | 29.0%                                  |       | 100.0% |   | 28 - 97% |   |
| Assumed  dividend yield                               |       | 0.0%                               |       | 0.0%                                   |       | 0.0% |   | 0.0% |   |

 

The expected term of options and SARs is based upon evaluations ofhistorical and expected future exercise behavior. The risk-free interest rateis based on the U.S. Treasury rates at the date of grant with maturity datesapproximately equal to the expected life at the grant date. During the quarterended October 2, 2007, we updated the assumptions of our implied volatilitybased on the mean reverting average of our stock’s historical volatility, andour industry peer group of competitors whose shares are traded on the publicmarkets, adjusted to reflect anticipated behavior specific to the Company. Theuse of mean reversion is supported by evidence of a correlation between stockprice volatility and a company’s leverage combined with the effects mandatoryprincipal payments will have on our capital structure, as defined under ourdebt facility. The use of our competitors’ historical data to calculate thevolatility is directly related to our recent listing on the NASDAQ and nothaving enough history to refine our estimate. We have not historically paid anydividends and are currently precluded from doing so under our debt covenants.

 

As of October 2, 2007, we had approximately $1.5 million of totalunrecognized compensation cost related to non-vested awards granted under ourstock option and stock appreciation rights plans, which we expect to recognizeover a weighted average period of 3.1 years. Total compensation costs relatedto the non-vested awards outstanding as of October 2, 2007 will be fullyrecognized by second quarter of fiscal 2010, which represents the end of therequisite service period.

 

**Stock Plans**

 

*1994 and 1995 Plans*

 

Our 1994 Stock Plan (“1994 Plan”) providedfor the granting to employees of incentive stock options and for the grantingto employees and consultants of non-statutory stock options and stock purchaserights. On November 21, 2003, the board of directors terminated theauthority to issue any additional options under the 1994 Plan. As of October 2,2007, all options under the 1994 Plan had expired.

 

Our 1995 Directors’ Stock Option Plan (“Directors’ Option Plan”)provided for the automatic grant of non-statutory stock options to non-employeedirectors of the Company. On December 19, 2003, our board of directorsterminated the authority to issue any additional options under the Directors’Option Plan. As of October 2, 2007, options to purchase 1,826 shares of commonstock at a weighted average exercise price of $38.16 per share and a weightedaverage remaining contractual life of 3.68 years remained outstanding underthis plan.

 

8

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*2003 Executive Employee Incentive Plan*

 

On November 21, 2003, our board of directors adopted the ExecutiveEmployee Incentive Plan, as amended on December 19, 2003, March 1, 2005,February 28, 2007 and April 24, 2007 (“2003 Plan”). The 2003 Plan provides forgranting incentive stock options to employees and granting non-statutory stockoptions to employees and consultants. Unless terminated sooner, the 2003 Planwill terminate automatically in December 2013. The board of directors has theauthority to amend, modify or terminate the 2003 Plan, subject to any requiredapproval by our stockholders under applicable law or upon advice of counsel. Nosuch action may affect any options previously granted under the 2003 Planwithout the consent of the holders. There are 2,000,000 shares reserved forissuance pursuant to options granted under the 2003 Plan. Options generally aregranted with an exercise price equal to the fair market value on the date ofgrant, have a contractual life of ten years and typically vest over a three-yearservice period. Generally, 50% of options granted vest upon service. Werecognize compensation costs for these awards using a graded vestingattribution method over the requisite service period. The remaining 50% ofoptions granted vest based on service and financial performance. Options thatdo not vest due to the failure to achieve specific financial performancecriteria are forfeited. Options to purchase approximately 165,077 shares of ourcommon stock, which are not yet exercisable, are subject to financialperformance conditions. We recognize compensation costs for performance basedoptions over the requisite service period when conditions for achievementbecome probable. As of October 2, 2007, there were 683,703 shares reserved forfuture issuance under the 2003 Plan.

 

In February 2007, we granted options to purchase 124,250 shares of ourcommon stock relating to the secondary public offering as further described inNote 6. The option awards vested upon closing of the offering and we recognizedapproximately $470,000 in stock-based compensation expense.

 

*2004 Stock Option Plan for IndependentDirectors*

 

On December 19, 2003, our board of directors adopted the Stock OptionPlan for Independent Directors, effective January 1, 2004, as amended on March1, 2005 and February 28, 2007 (“2004 Directors’ Plan”). Our board of directorsmay amend, suspend, or terminate the 2004 Directors’ Plan at any time,provided, however, that no such action may adversely affect any outstandingoption without the option holders consent. A total of 300,000 shares of commonstock have been reserved for issuance under the 2004 Directors’ Plan. The 2004Directors’ Plan provides for the automatic grant of non-statutory stock optionsto independent directors on January 1 of each year and a prorated grant ofoptions for any director elected during the year. Options are granted with anexercise price equal to the fair market value on the date of grant, becomeexercisable six months after the grant date and are exercisable for 5 yearsfrom the date of grant unless earlier terminated. As of October 2, 2007, therewere 114,192 shares reserved for future issuance under the 2004 Directors’Plan.

 

9

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*Stock Appreciation Rights Plan*

 

On February 17, 2007, our board of directors adopted the StockAppreciation Rights Plan (“SAR Plan”). The SAR Plan provides for granting stockappreciation rights to employees. Unless terminated sooner, the SAR Plan willterminate automatically on March 31, 2012. The board of directors has theauthority to amend, modify or terminate the SAR Plan, subject to any requiredapproval by our stockholders under applicable law or upon advice of counsel,provided that, with limited exception, no modification will adversely affectoutstanding rights. There are 150,000 shares issuable pursuant to stockappreciation rights under the SAR Plan.

 

The value of a share from which appreciation is determined is 100% ofthe fair market value of a share on the date of grant. The rights expire uponthe earlier of termination date of the SAR Plan or termination of employmentand typically vest over a two-year service period. Generally, 50% of rightsgranted vest based solely upon the passage of time. We recognize compensationcosts for these awards using a graded vesting attribution method over therequisite service period. The remaining 50% of rights granted vest based onfinancial performance. Rights to approximately 52,975 shares of our commonstock, which are not yet exercisable, are subject to financial performanceconditions. We will recognize compensation costs for performance based stockappreciation rights over the requisite service period when conditions forachievement become probable. Rights that do not vest are forfeited. As ofOctober 2, 2007, there were 44,050 shares reserved for future issuance underthe SAR Plan.

 

*James W. Hood Stock Award Agreement*

 

On May 3, 2007, our board of directors adopted the James W. Hood StockAward Agreement (the “Stock Award Plan”). The Stock Award Plan provides for theissuance of 22,000 shares of our common stock to Mr. Hood as inducement foraccepting employment with us as our Chief Marketing Officer. The common stockaward includes 7,333 shares that have no restrictions, 7,333 shares that becomeunrestricted on the first anniversary and 7,334 shares that become unrestrictedon the second anniversary of the date of grant, provided that Mr. Hood iscontinuously employed by us on those dates. We recognize compensation costs forthese awards using a graded vesting attribution method over the requisiteservice period. Included in our total stock based compensation expense of $1.6million for the year to date period ended October 2, 2007 was $219,000 relatedto this agreement.

 

10

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**Stock Option Plan Activity**

 

Transactions during the year to date period ended October 2, 2007 wereas follows:

 
| ** **                              | ** ** | ** **  | ** ** | **Weighted** | ** ** | **Weighted** | ** ** | ** **    | ** ** | **Weighted**          | ** ** |
|-----------------------------------------|------------|-------------|------------|--------------|------------|--------------|------------|---------------|------------|-----------------------|------------|
| ** **                              | ** ** | **Number**  | ** ** | **Average**  | ** ** | **Average**  | ** ** | **Aggregate** | ** ** | **Average**           | ** ** |
| ** **                              | ** ** | **of**      | ** ** | **Exercise** | ** ** | **Fair**     | ** ** | **Intrinsic** | ** ** | **Remaining**         | ** ** |
| ** **                              | ** ** | **Options** | ** ** | **Price**    | ** ** | **Value**    | ** ** | **Value**     | ** ** | **Life (Years)** | ** ** |
| Outstanding, January 2, 2007            |       | 993,707     |       | $            | 3.79       |         |       |          |       |                  |       |   |
| Granted                                 |       | 488,958     |       | $            | 12.68      |         |       |          |       |                  |       |   |
| Exercised                               |       | (194,460    | )          | $            | 4.01       |         |       |          |       |                  |       |   |
| Forfeited                               |       | (26,721     | )          | $            | 4.63       |         |       |          |       |                  |       |   |
| Outstanding, October 2, 2007            |       | 1,261,484   |       | $            | 7.18       |         | $          | 3.72          |       | $                     | 14,464,322 |   | 7.54 |   |
| Exercisable and vested, October 2, 2007 |       | 694,342     |       | $            | 4.48       |         | $          | 3.15          |       | $                     | 9,837,124  |   | 6.32 |   |

 
| ** **                         | ** ** | ** **  | ** ** | **Weighted**        | ** ** |
|------------------------------------|------------|-------------|------------|---------------------|------------|
| ** **                         | ** ** | **Number**  | ** ** | **Average**         | ** ** |
| ** **                         | ** ** | **of**      | ** ** | **Grant Date** | ** ** |
| ** **                         | ** ** | **Options** | ** ** | **Fair Value** | ** ** |
| Non-vested shares, January 2, 2007 |       | 370,045     |       | $                   | 2.81       |   |
| Granted                            |       | 488,958     |       | $                   | 5.46       |   |
| Vested                             |       | (318,565    | )          | $                   | 4.06       |   |
| Forfeited                          |       | 26,704      |       | $                   | 3.15       |   |
| Non-vested shares, October 2, 2007 |       | 567,142     |       | $                   | 4.41       |   |

 

11

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**Stock Appreciation Rights Plan Activity**

 

Transactions during the year to date period ended October 2, 2007 wereas follows:

 
| ** **                              | ** ** | ** ** | ** ** | **Weighted**        | ** ** | **Weighted** | ** ** | ** **    | ** ** | **Weighted**          | ** ** |
|-----------------------------------------|------------|------------|------------|---------------------|------------|--------------|------------|---------------|------------|-----------------------|------------|
| ** **                              | ** ** | **Number** | ** ** | **Average**         | ** ** | **Average**  | ** ** | **Aggregate** | ** ** | **Average**           | ** ** |
| ** **                              | ** ** | **of**     | ** ** | **Exercise**        | ** ** | **Fair**     | ** ** | **Intrinsic** | ** ** | **Remaining**         | ** ** |
| ** **                              | ** ** | **SARs**   | ** ** | **Price**           | ** ** | **Value**    | ** ** | **Value**     | ** ** | **Life (Years)** | ** ** |
| Outstanding, January 2, 2007            |       | —     |       | $                   | —     |         |       |          |       |                  |       |   |
| Granted                                 |       | 115,300    |       | $                   | 11.08      |         |       |          |       |                  |       |   |
| Exercised                               |       | —     |       | $                   | —     |         |       |          |       |                  |       |   |
| Forfeited                               |       | (9,350     | )          | $                   | 8.34       |         |       |          |       |                  |       |   |
| Outstanding, October 2, 2007            |       | 105,950    |       | $                   | 11.32      |         | $          | 5.55          |       | $                     | 776,099    |   | 4.50 |   |
| Exercisable and vested, October 2, 2007 |       | —     |       | $                   | —     |         | $          | —        |       | $                     | —     |   | — |   |
|                                    |       |       |       |                |       |         |       |          |       |                  |       |
| ** **                              | ** ** | ** ** | ** ** | **Weighted**        | ** ** |         |       |          |       |                  |       |
| ** **                              | ** ** | **Number** | ** ** | **Average**         | ** ** |         |       |          |       |                  |       |
| ** **                              | ** ** | **of**     | ** ** | **Grant Date** | ** ** |         |       |          |       |                  |       |
| ** **                              | ** ** | **SARs**   | ** ** | **Fair Value** | ** ** |         |       |          |       |                  |       |
| Non-vested shares, January 2, 2007      |       | —     |       | $                   | —     |         |       |          |       |                  |       |   |
| Granted                                 |       | 115,300    |       | $                   | 5.55       |         |       |          |       |                  |       |   |
| Vested                                  |       | —     |       | $                   | —     |         |       |          |       |                  |       |   |
| Forfeited                               |       | (9,350     | )          | $                   | 5.59       |         |       |          |       |                  |       |   |
| Non-vested shares, October 2, 2007      |       | 105,950    |       | $                   | 5.55       |         |       |          |       |                  |       |   |

 

12

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

 
| ** **                                                          | ** ** | **October 3, 2006**                | ** ** | **October 2, 2007** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------------|------------|-------------------------------|------------|
| ** **                                                          | ** ** | **2006**                                     | ** ** | **2007**                      | ** ** |
| ** **                                                          | ** ** | **(in thousands of dollars)** | ** ** |
| Cash paid during the year to date period  ended:                    |       |                                         |       |                          |       |
| Interest related to:                                                |       |                                         |       |                          |       |
| $160 Million Notes                                                  |       | $                                            | 3,293      |                          | $          | — |   |
| Term Loans                                                          |       | 7,137                                        |       | 9,401                         |       |
| $25 Million Subordinated Note                                       |       | 979                                          |       | 825                           |       |
| Other                                                               |       | 411                                          |       | 231                           |       |
|                                                                |       |                                         |       |                          |       |
| Prepayment penalty upon redemption of debt                          |       | $                                            | 4,800      |                          | $          | 240 |   |
|                                                                |       |                                         |       |                          |       |
| Non-cash investing activities:                                      |       |                                         |       |                          |       |
|                                                                |       |                                         |       |                          |       |
| Non-cash purchase of equipment through  capital leasing             |       | $                                            | 168        |                          | $          | — |   |
|                                                                |       |                                         |       |                          |       |
| Non-cash addition of leasehold improvements  provided by lessor     |       | $                                            | —     |                          | $          | 1,672 |   |
|                                                                |       |                                         |       |                          |       |
| Change in accrued expenses for purchases of  property and equipment |       | $                                            | 970        |                          | $          | (2,170 | ) |

 

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

 

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

 
| ** **        | ** ** | **January 2,**                          | ** ** | **October 2,** | ** ** |
|-------------------|------------|----------------------------------------------|------------|---------------------|------------|
| ** **        | ** ** | **2007**                                     | ** ** | **2007**            | ** ** |
| ** **        | ** ** | **(in thousands of dollars)** | ** ** |
| Finished goods    |       | $                                            | 3,835      |                | $          | 3,827 |   |
| Raw materials     |       | 1,113                                        |       | 1,383               |       |
| Total inventories |       | $                                            | 4,948      |                | $          | 5,210 |   |

 

13

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

 

Intangible assets includeboth goodwill and identifiable intangibles arising from the allocation of thepurchase prices of assets acquired. Goodwill represents the excess of cost overfair value of net assets acquired in the acquisition of Manhattan Bagel. As ofOctober 2, 2007, intangible assets of $63.8 million were not subject toamortization and consisted primarily of the Einstein Bros. and Manhattan Bageltrademarks.

 

During the year to dateperiods ended October 3, 2006 and October 2, 2007, there were no events orchanges in circumstances that indicated that our intangible assets might beimpaired or may not be recoverable.

 

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

 

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

 
| ** **                                                     | ** ** | **January 2,**                          | ** ** | **October 2,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------|------------|---------------------|------------|
| ** **                                                     | ** ** | **2007**                                     | ** ** | **2007**            | ** ** |
| ** **                                                     | ** ** | **(in thousands of dollars)** | ** ** |
| $90 Million Amended First Lien Term Loan                       |       | $                                            | 78,575     |                | $          | 89,775 |   |
| $65 Million Second Lien Term Loan                              |       | 65,000                                       |       | —              |       |
| $25 Million Subordinated Note                                  |       | 26,026                                       |       | —              |       |
| New Jersey Economic Development Authority  Note Payable        |       | 560                                          |       | 560                 |       |
|                                                           |       | $                                            | 170,161    |                | $          | 90,335 |   |
| Less current portion of senior notes and  other long-term debt |       | 3,605                                        |       | 1,180               |       |
| Senior notes and other long-term debt                          |       | $                                            | 166,556    |                | $          | 89,155 |   |

 

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

 

OnJune 13, 2007, we completed a $90 million secondary public offering of 5million shares of our common stock. After stock issuance costs of $6.7 millionrelated to the offering, we received net proceeds of $83.3 million. The netproceeds were used to repay our $65.0 million Second Lien Term Loan, repay aportion of our $25 million Subordinated Note held by Greenlight Capital, L.L.C. (“Greenlight”) and to pay for the offering costs. Additionally,on June 28, 2007, we repaid the remaining portion of the $25 millionsubordinated note held by Greenlight by using a portion of the incremental debtproceeds under the amended debt facility, as described below.

 

14

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OnJune 28, 2007, we amended our debt facility to increase it to $110 million,comprised of a $20 million revolving credit facility and a modified term loan witha principal amount of $90 million. The revolving credit facility remainsavailable, subject to certain conditions, to finance our ongoing workingcapital, capital expenditure and general corporate needs. In addition, all ofthe revolving credit facility is available for letters of credit. We arerequired to pay an unused credit line fee of 0.5% per annum on the averagedaily unused amount. The unused line fee is payable quarterly in arrears.Additionally, we are required to pay a letter of credit fee based on the endingdaily undrawn face amount for each letter of credit issued, of an applicablemargin being based on our consolidated leverage ratio with an applicable marginof 2.00% plus a 0.5% arranger fee payable quarterly. Letters of credit reduce ouravailability under the Revolving Facility. At October 2, 2007, we had $6.7million in letters of credit outstanding. The letters of credit expire onvarious dates during 2008, are automatically renewable for one additional yearand are payable upon demand in the event that we fail to pay the underlyingobligation. Our availability under the revolving facility was $13.3 million atOctober 2, 2007.

 

Both the revolving creditfacility and the term loan facility have a five-year term and are secured bysubstantially all of our assets and guaranteed by our subsidiaries. Borrowingsunder this senior secured credit facility bear interest at a rate equal to anapplicable margin plus, at our option, either a variable base rate or aEurodollar rate. The applicable margin for LIBOR loans ranges from 1.75% to2.25% and for base rate loans ranges from 0.75% to 1.25%, depending on thelevel of our consolidated leverage ratio (defined as in our current creditfacilities). Upon the occurrence of a payment event of default which iscontinuing, all amounts due under the senior secured credit facility bearinterest at 2.0% above the interest rate otherwise applicable. The outstandingamount of the term loan is amortizable on a quarterly basis by an amount equalto 0.25% of the original principal amount of the term loan. Any amountsremaining unpaid will be due and payable on the maturity date. At October 2,2007 the stated interest rate under the First Lien Term Loan was 7.40%.

 

The term loan requiresmandatory prepayments of

 

•       50% of excess cash flow (as defined in the senior secured creditfacility) subject to the ability to retain at least $5,000,000 in cash and cashequivalents;

•       100% of net cash proceeds of asset sales by us above a threshold andsubject to the ability to reinvest under certain circumstances;

•       100% of net cash proceeds of any debt issued by us, subject to certainexceptions; and

•       50% of the net cash proceeds of any equity issued by us, subject tocertain exceptions.

 

The revolving facility and the first lienterm loan contain usual and customary covenants including consolidated leverageratios, fixed charge coverage ratios, limitations on capital expenditures, etc.The ratio covenants are based on a Consolidated Earnings BeforeInterest, Taxes, Depreciation and Amortization (“EBITDA”) calculation (asdefined in our loan agreement) and are measured on a twelve month period endingon the last day of each fiscal quarter. The loan is guaranteed by our material subsidiaries. The revolvingfacility, the first lien term loan and the related guarantees are secured by afirst priority security interest in all of our assets and our materialsubsidiaries, including a pledge of 100% of our interest in all shares ofcapital stock (or other ownership or equity interests) of each materialsubsidiary. As of October 2, 2007, we were in compliance with all ourfinancial and operating covenants.

 

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

 

•       a minimum consolidated fixed charge coverage ratio; and

•       a maximum consolidated leverage ratio of 2.75x.

 

15

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

 

The facility is fullyamortizing with annual aggregate principal reductions payable in quarterlyinstallments over the term of the loan as follows:

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

 

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

 

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

 

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

 

For the revolving facility, the capitalized debt issuance costs arebeing amortized on a straight-line basis while the capitalized debt issuancecosts for the first lien term loan are being amortized on the effectiveinterest rate method.

 

**February 2006 Debt Redemption and Refinancing**

 

On February 28, 2006, we completed therefinancing of the AmSouth Revolver and $160 Million Notes. While our June 13, 2007 offeringof common stock, debt redemption and refinancing changed our capital structureas described above, our previous debt obligations consisted of the following:

 

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

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

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

•       $25 million subordinated note (Subordinated Note).

 

Proceeds from this debt facility were used to repay the $160 MillionNotes plus a 3% redemption premium of $4.8 million and accrued and unpaidinterest to the redemption date.

 

16

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**New Jersey Economic Development AuthorityNote Payable**

 

In December 1998, Manhattan Bagelentered into a note payable in the principal amount of $2,800,000 with the NewJersey Economic Development Authority (“NJEDA”) at an interest rate of 9% perannum. Principal is paid annually and interest is paid quarterly. The notematures on December 1, 2008 and is secured by the assets of Manhattan Bagel.

 

On July 3, 2003, we placed an advancedfunding of the note in escrow to enact a debt defeasance as allowed for in theagreement. This advanced funding is shown as restricted cash and the note isincluded in both current portion and long-term portion of debt in the January2, 2007 and October 2, 2007 consolidated balance sheets in accordance with thepayment terms. This classification will continue until the note is fully paidfrom the escrow amount proceeds.

 

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

 

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

 

Diluted net income per share is computed by dividing the net income forthe period by the weighted average number of shares of common stock andpotential common stock equivalents outstanding during the period using thetreasury stock method. Potential common stock equivalents include incrementalshares of common stock issuable upon the exercise of stock options andwarrants. Potential common stock equivalents are excluded from the computationof diluted net income (loss) per share when their effect is anti-dilutive.

 

The following table summarizes the weighted average number of commonshares outstanding, and the computation of basic and diluted net income (loss)per common share for the periods indicated:

 
| ** **                                       | ** ** | **Quarter ended:** | ** ** | **Year to date period ended:** | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|----------------------------------------------------|------------|
| ** **                                       | ** ** | **October 3,**     | ** ** | **October 2,**                                | ** ** | **October 3,** | ** ** | **October 2,** | ** ** |
| ** **                                       | ** ** | **2006**                | ** ** | **2007**                                           | ** ** | **2006** | ** ** | **2007** | ** ** |
|                                             |       |                    |       |                                               |       |   |   |   |   |
| Net income (loss) (a)                            |       | $                       | 752        |                                               | $          | 4,943 |   | $ | (12,882 | ) | $ | 5,825 |   |
|                                             |       |                    |       |                                               |       |   |   |   |   |
| Basic weighted average shares outstanding  (b)   |       | 10,593,085              |       | 15,772,931                                         |       | 10,276,464 |   | 12,718,051 |   |
| Dilutive effect of stock options and SARs        |       | 443,442                 |       | 799,555                                            |       | — |   | 718,833 |   |
| Diluted weighted average shares outstanding  (c) |       | 11,036,527              |       | 16,572,486                                         |       | 10,276,464 |   | 13,436,884 |   |
| Basic earnings (loss) per share (a)/(b)          |       | $                       | 0.07       |                                               | $          | 0.31 |   | $ | (1.25 | ) | $ | 0.46 |   |
| Diluted earnings (loss) per share (a)/(c)        |       | $                       | 0.07       |                                               | $          | 0.30 |   | $ | (1.25 | ) | $ | 0.43 |   |
|                                             |       |                    |       |                                               |       |   |   |   |   |
| Antidilutive stock options, SARs and  warrants   |       | 2,673                   |       | 213,064                                            |       | 1,025,414 |   | 261,914 |   |

 

17

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**8.     Income Taxes**

 

As of October 2, 2007, netoperating loss carryforwards of $151.9 million were available to be utilizedagainst future taxable income for years through fiscal 2026, subject in part toannual limitations. Our ability to utilize our net operating losses, includingthose that are not currently subject to limitation, could be limited or furtherlimited in the event that we undergo an “ownership change” as that term isdefined for purposes of Section 382 of the Internal Revenue Code.

 

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

 

In accordance with SFASNo. 109, *Accounting for Income Taxes*, (“SFAS No. 109”) we will assessthe continuing need for a valuation allowance that results from uncertaintyregarding our ability to realize the benefits of our deferred tax assets. As wemove closer toward achieving net income for a full year, we will review variousqualitative and quantitative data, including events within the restaurantindustry, the cyclical nature of our business, our future forecasts andhistorical trending. If we conclude that our prospects for the realization ofour deferred tax assets are more likely than not, we will then reduce ourvaluation allowance as appropriate and credit income tax expense afterconsidering the following factors:

 

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

 

•  Accumulation of net incomebefore tax utilizing a look-back period of three years.

 

The amount of the deferredtax asset considered realizable, however, could be reduced if estimates offuture taxable income during the carryforward periods are reduced.

 

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

 

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

 

We are subject to income taxes in the U.S. federal jurisdiction, and various states and local jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. We remain subject to examination by U.S. federal, state and local tax authorities for tax years 2004 through 2007. With a few exceptions, we are no longer subject to U.S. federal, state or local examinations by tax authorities for the tax year 2003 and prior.

 

18

 

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

 

In accordance with SFASNo. 144, *Accounting for the Impairment or Disposal of LongLived Assets*, impairment losses are recorded on long-lived assets ona restaurant-by-restaurant basis whenever impairment indicators are determinedto be present. We consider a history of cash flow losses to be the primaryindicator of potential impairment for individual restaurants. We determinewhether a restaurant is impaired based on expected undiscounted future cashflows, considering location, local competition, current restaurant managementperformance, existing pricing structure and alternatives available for thesite. If impairment exists, the amount of impairment is measured as the excessof the carrying amount of the asset over its fair value as determined utilizingthe estimated discounted future cash flows or the expected proceeds, net ofcosts to sell, upon sale of the asset.

 

During the quarters endedOctober 3, 2006 and October 2, 2007, we recorded $29,000 and $0, respectively,and for the year to date periods ended October 3, 2006 and October 2, 2007, werecorded $112,000 and $19,000, respectively in impairment charges. Additionally,the Company incurred other related costs to close company-owned restaurants of$22,000 and $28,000 for the quarter ended October 3, 2006 and October 2, 2007,respectively, and $22,000 and $194,000 for the year to date periods endedOctober 3, 2006 and October 2, 2007, respectively.

 

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

 

We are subject to claims and legal actions in the ordinary course ofour business, including claims by or against our franchisees, licensees andemployees or former employees and/or contract disputes. We do not believe thatan adverse outcome in any currently pending or threatened matter, other thandescribed below, would have a material adverse effect on our business, resultsof operations or financial condition.

 

On August 31, 2007, the Company was served in an action brought byFiera Foods Company in Ontario Canada Superior Court of Justice. Plaintiffclaims that the Company failed to negotiate in good faith towards a frozenbagel dough supply agreement, which was not concluded, and mademisrepresentations in the negotiations. Fiera is seeking damages of $17.0million (Canadian dollars), including detrimental reliance onmisrepresentations, lost profits, interest and costs. The Company believes thatthese claims are not valid and has filed its Defense.

 

On September 18, 2007, Eric Mathistad, a former store manager, filed apunitive class action against the Company in the Superior Court of Californiafor the State of California, County of San Diego. The plaintiff alleges thatdefendants failed to pay overtime wages to “salaried restaurant employees” ofits California stores who were improperly designated as exempt employees, andthat these employees were deprived of mandated meal periods and rest breaks. Plaintiffalleges that these actions were in violation of the California Labor CodeSections 1194, et seq., 500, et seq., California Business and Professions CodeSection 17200, et seq., and applicable wage order(s) issued by the IndustrialWelfare Commission. Plaintiff seeks injunctive relief, declaratory relief,attorney’s fees, restitution and an unspecified amount of damages for unpaidovertime and for missed meal and/or rest periods. The Company filed a Demurreron October 18, 2007 claiming that, inter alia, plaintiff fails to state a claimagainst the Company; plaintiff does not state a claim for a joint venturepartnership, common enterprise, or aiding and abetting; plaintiff’s definitionof the class is deficient and plaintiff’s claims for declaratory judgmentregarding Labor Code violations should be dismissed. A Hearing on the Demurreris scheduled for February 1, 2008. Because this litigation has only recentlybeen filed and discovery has not commenced, we can not predict the outcome ofthis matter.

 

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*Guarantees*

 

Prior to 2001, we would occasionally guarantee leases for the benefitof certain of our franchisees. None of the guarantees have been modified sincetheir inception and we have since discontinued this practice. Currentfranchisees are the primary lessees under the vast majority of these leases.Under the lease guarantees, we may be required by the lessor to make all of theremaining monthly rental payments or property tax and common area maintenancepayments if the franchisee does not make the required payments in a timelymanner. However, we believe that most, if not all, of the franchisedrestaurants could be subleased to third parties minimizing our potentialexposure. Additionally, we have indemnification agreements with our franchiseesunder which the franchisees would be obligated to reimburse us for any amountspaid under such guarantees. Historically, we have not been required to make suchpayments in significant amounts. As of October 2, 2007, we have not recorded aliability for our exposure under the guarantees in accordance with SFAS No. 5following a probability related approach. Minimum future rental payments forall remaining guaranteed leases that expire on various dates through July 2012were approximately $1.3 million as of October 2, 2007. We believe the ultimatedisposition of these matters will not have a material adverse effect on ourfinancial position or results of operations.

 

*Insurance*

 

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

 

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

 

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

 

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

 

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities — Including an Amendment of SFAS No.115* (“SFAS No. 159), which becomes effective for fiscal periodsbeginning after November 15, 2007. Under SFAS No. 159, companies may elect tomeasure specified financial instruments and warranty and insurance contracts atfair value on a contract-by-contract basis, with changes in fair valuerecognized in earnings each reporting period. This election, called the “fairvalue option”, will enable some companies to reduce volatility in reportedearnings caused by measuring related assets and liabilities differently. We donot expect the impact of adoption to have a material impact on our consolidatedfinancial statements.

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS No. 157”), which defines fair value, establishes a framework formeasuring fair value and expands disclosures about fair value measurements. Thestatement is effective for fiscal years beginning after November 15, 2007. Weare still in the process of evaluating SFAS No. 157 and are not able toestimate the impact of adoption to our consolidated financial statements.

 

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We have considered all other recently issued accounting pronouncementsand do not believe that the adoption of such pronouncements will have a materialimpact on our consolidated financial statements.

 

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

 

E. Nelson Heumann is theChairman of our board of directors and is a current employee of Greenlight. Greenlightand its affiliates beneficially own approximately 67.9% of our common stock ona fully diluted basis. As a result, Greenlight has sufficient voting powerwithout the vote of any other stockholders to determine what matters will besubmitted for approval by our stockholders, to approve actions by writtenconsent without the approval of any other stockholders, to elect all of ourboard of directors, and among other things, to determine whether a change incontrol of our Company occurs.

 

Greenlight owned $35million of our $160 Million Notes when we called the Notes for redemption inJanuary 2006. The Notes were redeemed from the proceeds of our refinancing inFebruary 2006 as further described in Note 6. We entered into the SubordinatedNote with Greenlight in February 2006 as further described in Note 6, and paidit in full during the second quarter of 2007. Total interest expense related tothe Subordinated Note with Greenlight was $0.9 million for the third quarterended October 3, 2006, and $2.1 million and $1.7 million for year to dateperiods ended October 3, 2006 and October 2, 2007, respectively.

 

During the quarter endedJuly 4, 2006, we issued 429,645 shares of our common stock to Greenlight inconnection with cashless exercises of certain warrants previously granted byus. Greenlight surrendered 56,953 shares of common stock to us in connectionwith such cashless exercises. We issued these warrants in private financingtransactions that occurred between 2000 and 2003.

 

Leonard Tannenbaum, aformer director, is a limited partner and 10% owner in BET. BET purchased $7.5million of our $160 Million Notes and Mr. Tannenbaum purchased an additional$0.5 million of our $160 Million Notes in the market. In January 2006, Mr.Tannenbaum and BET’s Notes were called for redemption and were redeemed fromthe proceeds of our refinancing in February 2006 as further described in Note6.

 

During the quarter endedJuly 4, 2006, we received consideration of $6,183 and issued 6,057 shares ofour common stock in connection with the exercises of certain warrantspreviously granted by us to Mr. Tannenbaum and BET. We issued these warrants inprivate financing transactions that occurred between 2000 and 2003.

 

On September 1, 2007,Leonard M. Tannenbaum resigned as a director of the Company effectiveimmediately.  The resignation was not the result of any disagreement onany matter relating to the Company’s operations, policies or practices.

 

On December 8, 2003, we entered into a consulting agreement with Jill B.W. Sisson to provide legal, consulting and advisory services to us and to serve as our General Counsel and Secretary. Pursuant to the agreement, Ms. Sisson is eligible to receive stock options to purchase shares of our common stock. Ms. Sisson also receives an annual compensation based upon company performance and personal performance, subject to an annual adjustment, and is reimbursed for reasonable and necessary out-of-pocket expenses. The agreement provides for non-solicitation of company employees for a year after termination of the agreement, and can be terminated by either party upon 30 days’ notice.

 

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

 

Thefollowing discussion and analysis supplements the management’s discussion andanalysis in our Annual Report on Form 10-K for the year ended January 2, 2007and presumes that readers have read or have access to the discussion andanalysis in our Annual Report. The following discussion and analysis includeshistorical and certain forward-looking information that should be read togetherwith the accompanying consolidated financial statements, related footnotes andthe discussion below of certain risks and uncertainties that could cause futureoperating results to differ materially from historical results or from theexpected results indicated by forward looking statements.

 

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

### * *

OnJanuary 3, 2007, we adopted the provisions of the Financial AccountingStandards Board (“FASB”) Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes* (“FIN 48”). FIN 48 is aninterpretation of Statement of Financial Accounting Standard (“SFAS”) No. 109, *Accounting for Income Taxes,* (“SFAS 109”) and it seeks to reduce thediversity in practice associated with certain aspects of measurement andrecognition in accounting for income taxes. FIN 48 prescribes a recognitionthreshold and measurement criterion for the financial statement recognition andmeasurement of tax positions taken or expected to be taken in a tax return. Forthose benefits to be recognized, a tax position must be more-likely-than-not tobe sustained upon examination by taxing authorities. The amount recognized ismeasured as the largest amount of benefit that is greater than 50% likely ofbeing realized upon ultimate settlement. As a result of the implementation ofFIN 48, we recorded a reduction of approximately $1.8 million of the grossdeferred tax asset. There was no effect to the financial statements due to theexistence of a full valuation allowance.

 

Therewere no other material changes in our critical accounting policies since thefiling of our 2006 Form 10-K. As discussed in our 2006 Form 10-K, thepreparation of the consolidated financial statements in conformity withaccounting principles generally accepted in the United States requiresmanagement to make certain estimates and assumptions that affect the amount ofreported assets and liabilities and disclosure of contingent assets andliabilities at the date of the consolidated financial statements and revenuesand expenses during the periods reported. Actual results may differ from thoseestimates.

 

**Company Overview**

 

We are the largest owner/operator, franchisor and licensor of bagelspecialty restaurants in the United States. We have approximately 600restaurants in 36 states and in the District of Columbia, primarily under theEinstein Bros. Bagels (“Einstein Bros.”), Noah’s New York Bagels (“Noah’s”) andManhattan Bagel brands (“Manhattan Bagel”). As a leading fast-casual restaurantchain, our restaurants specialize in high quality foods for breakfast, lunchand afternoon snacks in a café atmosphere with a neighborhood emphasis.Collectively, our concepts span the nation with Einstein Bros. restaurants in33 states and in the District of Columbia, Noah’s restaurants in three stateson the West Coast and Manhattan Bagel restaurants concentrated in theNortheast. Currently, our Einstein Bros. and Noah’s restaurants arecompany-owned or licensed, while Manhattan Bagel restaurants are all franchised.

 

Our product offerings include fresh bagels and other bakery items bakedon-site, made-to-order breakfast and lunch sandwiches on a variety of bagelsand breads, gourmet soups and salads, decadent desserts, premium coffees and anassortment of snacks. Our manufacturing and commissary operations prepare andassemble consistent, high quality ingredients that are delivered fresh to ourrestaurants through our network of independent distributors.

 

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

 

**Secondary Public Offering of Our Common Stock**

 

On June 13, 2007, we completed a secondary public offering of 5 millionshares of common stock resulting in gross proceeds of $90 million. After stockissuance costs of $6.7 million related to the offering, we received netproceeds

 

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of $83.3 million. Our common stock is nowlisted on the NASDAQ Global Market under the symbol “BAGL.”  We used the net proceeds from the offering topay down our existing indebtedness.

 

**Current Restaurant Base**

 

As of October 2, 2007, we owned and operated, franchised or licensed598 restaurants. Our base of company-owned restaurants under our core brandsincludes 337 Einstein Bros. restaurants and 74 Noah’s restaurants. Also, wefranchise 71 Manhattan Bagel restaurants and license/franchise 108 EinsteinBros. restaurants and three Noah’s restaurants. In addition, we have fiverestaurants which we operate/franchise under our non-core brands.

 

Our company-owned restaurants vary in their unit volume, profitabilityand recent comparable store sales performance. As of October 2, 2007, we had112 restaurants that generated an average annual unit volume (“AUV”) in excessof $1.0 million in sales. These restaurants have an AUV of approximately $1.2million and an average gross profit of $334,000. In the aggregate, theserestaurants contribute approximately 36.6% of total restaurant sales and 48.6%of total restaurant operating profit. Since 2003, as part of our efforts toimprove financial performance, we completed a thorough evaluation of ourrestaurant base. At the end of 2003, we had 735 restaurants across 33 statesand the District of Columbia. Since that time through October 2, 2007, we haveclosed 70 company-owned restaurants and 168 licensed and franchisedrestaurants. Most of our closed company-owned restaurants were either locatedin inferior real estate locations, had an AUV below $550,000 or were eitherunprofitable or marginally profitable. Substantially all of the franchisedrestaurants that were closed either:

 

•                  involvedthe failure of the franchisee to conform with the requirements of the franchiseagreement;

•                  weregeographically located outside Manhattan Bagel’s core market; or

•                  wererestaurants operating under our non-core brands, Chesapeake Bagel Bakery andNew World Coffee.

 

As of October 2, 2007, we have identified 15 to 20 company-ownedrestaurants that we anticipate closing over the next three years as their leasesexpire. Generally, these restaurants have an AUV of approximately $550,000 orless and contribute negligible cash flow.

 

We have implemented a number of initiatives in an effort to drive salesand improve profitability, including quality service checklists, secret shopperinspections, improved ordering systems, extension of store operating hours andenhanced training programs. These initiatives and others have led to positivecomparable store sales over the past twelve quarters. In addition, we have upgradedrestaurants where we had the opportunity to improve sales, and are continuingto upgrade locations based on this strategy. The upgrades provide superiormerchandising, enhance our guests’ experience and increase the speed of servicewhile maintaining the neighborhood feel of the restaurants. We are upgradingour Einstein Bros. restaurants based on sales volume, demographic traits andthe related cost of the upgrade. Only those restaurants that offer thepotential for a superior return on investment are considered for an upgrade.The upgrades that have been completed ranged from $70,000 to $118,000 perrestaurant. We anticipate the costs of upgrades in the near future to average$100,000 per restaurant.

 

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**New Restaurant Openings**

 

Using the knowledge gained from our upgrade program, we plan to pursuea measured approach to new company-owned restaurant openings. During 2004, 2005and 2006, we opened four, four and five new company-owned restaurants, respectively.Our ability to open new restaurants during those years was limited by thecapital expenditure restrictions of the debt agreements in place at that timeand, with the amendment of our debt facility in June 2007, these limitationshave become less restrictive. Our current plan is to open new company-ownedrestaurants in existing markets where we have an established brand name. Oursite selection process focuses on identifying markets, trade areas and specificsites based on several factors, including visibility, ready accessibility(particularly for morning and lunch time traffic), parking, signage andadaptability of any current structures.

 

For Einstein Bros., we have targeted Atlanta, Chicago, Las Vegas,Phoenix, the Baltimore/Washington D.C. area and various cities inFlorida and Texas for development. For Noah’s, we intend to focus ourdevelopment efforts on a relocation in Portland and various cities inCalifornia. In 2007, we plan to open 12 new company-owned restaurants. Asof October 2, 2007, we have opened one Einstein Bros. located in Naples,Florida, one in Atlanta, Georgia, and two in Las Vegas, Nevada, and one newNoah’s located in Portland, Oregon.  Currently we are in theprocess of identifying new restaurant sites for 2008 as well as 2009 to ensurethat we achieve our development goals.

 

As of October 2, 2007, we have opened 17 new licensed locations underthe Einstein Bros. brand and closed 2 locations during the year.

 

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The following table details our restaurant openings and closings foreach respective period:

 
| ** **                      | ** ** | **Third Quarter** | ** ** | **Year-to-Date** | ** ** |
|---------------------------------|------------|------------------------|------------|------------------|------------|
| ** **                      | ** ** | **Activity**           | ** ** | **Activity**     | ** ** |
| ** **                      | ** ** | **Fiscal**             | ** ** | **Fiscal**       | ** ** | **Fiscal** | ** ** | **Fiscal** | ** ** |
| ** **                      | ** ** | **2006**               | ** ** | **2007**         | ** ** | **2006** | ** ** | **2007** | ** ** |
| **Einstein Bros.**              |       |                   |       |             |       |   |   |   |   |
| Company-owned beginning balance |       | 353                    |       | 336              |       | 360 |   | 341 |   |
| Opened restaurants              |       | —                 |       | 3                |       | 1 |   | 4 |   |
| Closed restaurants              |       | (9                     | )          | (2               | )          | (17 | ) | (8 | ) |
| Company-owned ending balance    |       | 344                    |       | 337              |       | 344 |   | 337 |   |
|                            |       |                   |       |             |       |   |   |   |   |
| Licensed beginning balance      |       | 70                     |       | 103              |       | 67 |   | 93 |   |
| Opened restaurants              |       | 13                     |       | 7                |       | 18 |   | 17 |   |
| Closed restaurants              |       | —                 |       | (2               | )          | (2 | ) | (2 | ) |
| Licensed ending balance         |       | 83                     |       | 108              |       | 83 |   | 108 |   |
|                            |       |                   |       |             |       |   |   |   |   |
| **Noah’s**                 |       |                   |       |             |       |   |   |   |   |
| Company-owned beginning balance |       | 72                     |       | 74               |       | 73 |   | 73 |   |
| Opened restaurants              |       | 1                      |       | —           |       | 1 |   | 1 |   |
| Closed restaurants              |       | —                 |       | —           |       | (1 | ) | — |   |
| Company-owned ending balance    |       | 73                     |       | 74               |       | 73 |   | 74 |   |
|                            |       |                   |       |             |       |   |   |   |   |
| Licensed beginning balance      |       | 3                      |       | 3                |       | 3 |   | 3 |   |
| Opened restaurants              |       | 1                      |       | —           |       | 1 |   | — |   |
| Closed restaurants              |       | (1                     | )          | —           |       | (1 | ) | — |   |
| Licensed ending balance         |       | 3                      |       | 3                |       | 3 |   | 3 |   |
|                            |       |                   |       |             |       |   |   |   |   |
| **Manhattan Bagel**             |       |                   |       |             |       |   |   |   |   |
| Franchised beginning balance    |       | 105                    |       | 76               |       | 109 |   | 80 |   |
| Opened restaurants              |       | —                 |       | 1                |       | 2 |   | 1 |   |
| Closed restaurants              |       | (13                    | )          | (6               | )          | (19 | ) | (10 | ) |
| Franchised ending balance       |       | 92                     |       | 71               |       | 92 |   | 71 |   |
|                            |       |                   |       |             |       |   |   |   |   |
| **Non-Core Brands**             |       |                   |       |             |       |   |   |   |   |
| Company-owned beginning balance |       | 2                      |       | 1                |       | 2 |   | 2 |   |
| Opened restaurants              |       | —                 |       | —           |       | — |   | — |   |
| Closed restaurants              |       | —                 |       | —           |       | — |   | (1 | ) |
| Company-owned ending balance    |       | 2                      |       | 1                |       | 2 |   | 1 |   |
|                            |       |                   |       |             |       |   |   |   |   |
| Franchised beginning balance    |       | 8                      |       | 4                |       | 12 |   | 6 |   |
| Opened restaurants              |       | —                 |       | —           |       | — |   | — |   |
| Closed restaurants              |       | (1                     | )          | —           |       | (5 | ) | (2 | ) |
| Franchised ending balance       |       | 7                      |       | 4                |       | 7 |   | 4 |   |
|                            |       |                   |       |             |       |   |   |   |   |
| **Consolidated Total**          |       |                   |       |             |       |   |   |   |   |
| Total beginning balance         |       | 613                    |       | 597              |       | 626 |   | 598 |   |
| Opened restaurants              |       | 15                     |       | 11               |       | 23 |   | 23 |   |
| Closed restaurants              |       | (24                    | )          | (10              | )          | (45 | ) | (23 | ) |
| Total ending balance            |       | 604                    |       | 598              |       | 604 |   | 598 |   |

 

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**OurSources of Revenue**

 

*Company-OwnedRestaurant Sales*

 

Approximately93% of our revenue is generated by restaurant sales at our Einstein Bros. andNoah’s company-owned restaurants, including catering sales where the food isprepared at the restaurant and either delivered to or held for pick-up by theguest. The principal factors that affect our restaurant sales in the aggregateare:

 

•                  thenumber of restaurants in operation for the period,

•                  theAUV of the restaurants and

•                  thechange in comparable store sales.

 

For the yearto date period ended October 2, 2007, approximately 63% of our revenues weregenerated from restaurant sales during the breakfast hours, 28% were generatedduring the lunch hours and 9% were generated during the late afternoon hours.

 

*Manufacturingand Commissary Revenue*

 

Approximately6% of our total revenue is generated by our manufacturing and commissaryoperations. Our manufacturing revenue is primarily derived from the sale offrozen bagel dough to our franchisees, licensees and third party accounts. Ourcommissaries generate revenue from the sale of sliced meats (turkey, ham andbeef), dairy products (cheese), and pre-portioned salad kits to our licensees.Additionally, our commissaries sell bagels, cream cheese, salad toppers andsalads through various supplier relationships, typically with conventionalgrocery stores as the customer. These products are sold either through aprivate label program or under the Einstein Bros. or Noah’s brand.

 

The principalfactors affecting manufacturing and commissary revenue are:

 

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

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

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

 

*Franchiseand License Related Revenue*

 

Franchise andlicense related revenue consists of a license or franchise fee at the executionof the agreement and ongoing royalty payments based on a percentage of therestaurant’s gross sales. Our costs associated with licensing and franchisingare minimal compared with the costs associated with company-owned restaurants.Approximately 1% of our total revenue is generated from these fees. Theprincipal factors affecting franchise and license revenue are the number oflicensed and franchised restaurants as well as the level of sales at thoserestaurants.

 

**Our Primary Costs**

 

***Company-Owned Restaurant Costs***

 

*Food, Beverage and Packaging Costs.*Food, beverage and packaging costs are the largest expense elements at ourcompany-owned restaurants. The most important factor that affects the cost of theseproducts is the underlying cost of agricultural commodities such as wheat,butter, cheese, coffee, turkey and other products. In order to mitigate theimpact of rising commodity costs, our suppliers enter into agreements to fixthe cost of these products for a specified period of time that is generally oneyear or less. We do contract with our suppliers for future delivery of our foodingredients under established terms. We do not engage in the practice ofdirectly buying futures contracts and therefore we do not use derivativeaccounting. Packaging and distribution costs are primarily affected by the costof oil because petroleum-based material is often used to manufacture certainpackaged products and the cost of diesel fuel affects distribution costs.Although we have generally been able to increase our retail prices at our

 

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company-owned restaurants to offset the increased costs of these items,we may not be able to do so in the future.

 

On an annual basis, we purchase a substantial amount of agriculturalproducts that are subject to fluctuations in price based upon market conditions.Wheat is our largest agricultural commodity, which is ultimately milled intoflour and included in our total cost of sales. Cost of sales consist of cost of goods sold which is made up of food andproduct costs, compensation costs, and operating costs. Our other majoragricultural products are butter, cheese, coffee and turkey.

 

In September 2007, the agricultural commodity markets experienced anunprecedented rise in the price of wheat due to a combination of economic andenvironmental conditions. This economic uncertainty has continued in the fourthquarter of 2007. It is anticipated that prices for a bushel of wheat willremain at unprecedented levels for the remainder of 2007 as well as the firsthalf of 2008. To manage this economic risk, we have recently contracted with asubsidiary of Cargill Incorporated to manage our wheat purchases for ourcompany-owned production facility. To date, we have contracted for 100% of ourwheat requirements for the remainder of 2007 and for the first half of 2008. Inaddition, we have contracted for 90% of our butter requirements for 2008, 100%of our cheese requirements for 2008, and 80% of our coffee requirements for2008. We just entered into a contract that covers our turkey requirements fromNovember 1, 2007 through October 31, 2008.

 

Most of the fresh produce that we purchase, such as lettuce andtomatoes, is subject to normal market fluctuations. We purchase substantiallyall of our orange juice from a single supplier that has production in Arizona,California and Florida. In 2006, we locked in our prices for orange juice for2007 and 2008 with this supplier. Accordingly, while the cost of oranges andorange related products has increased and stabilized since this contract wassigned, we locked in prices that are currently lower than market.

 

*Compensation Costs.*Compensation costs reflect the hourly wages, salary, bonus, taxes, benefits andinsurance for our associates at each restaurant. Compensation costs tend tovary by geographic region based upon the labor market, local minimum wages, andthe supply and demand of workers. Also, compensation costs tend to besemi-variable in nature and increase or decrease somewhat based upon unitsproduced.

 

There is significant competition for personnel and limited availabilityin the labor pool. In most of the states in which we operate, increases instate minimum hourly wage rates became effective January 1, 2007, and thefederal government has recently enacted federal wage increases. Accordingly, wehave seen increases in hourly wages in 2007 and this trend may continue into2008. We continue to focus on labor efficiencies that may help to offset aportion of the increases in labor costs.

 

*Other Operating Costs.*Other operating costs consist of utilities, restaurant and other supplies,repairs and maintenance, laundry and uniforms, bank charges and other costsrelated to the operation of company-owned restaurants. Certain of these costsgenerally tend to be fixed in nature and are only modestly impacted by changesin the volume of products sold. Utilities, distribution costs and otherexpenses impacted by fuel price fluctuations are not fixed and are contingentupon contract rates negotiated by third parties outside of our control. Many ofour contracts are re-priced quarterly based on the prior quarter’s marketfluctuations resulting in a delayed effect upon our operating costs. Duringperiods of uncertainty and significant market fluctuations, we cannot becertain of the impact on our future operating results. If we are unable toleverage cost increases with operating efficiencies or price increases, it maynegatively impact our operating results.

 

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

 

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***Manufacturing and Commissary Costs***

 

Manufacturing costs are comprised of raw materials such as flour, dairyproducts and meats, compensation costs and the related taxes and employeebenefits, rents, supplies and repairs and maintenance. These costs are directlyrelated to the manufacturing revenue they produce. Some of the raw materialsused are commodity-based products and are subject to the same market fluctuationspreviously mentioned. We purchase certain raw materials under volume-basedpricing agreements and, as manufacturing production increases, we experiencemore favorable pricing arrangements. Fixed overhead costs, such as rent,utilities, property taxes and manager salaries, are proportionately allocatedbased on total units produced. Operating results from our manufacturingoperations consist of third party sales whose profitability can besignificantly impacted by the allocation of fixed overhead costs. Results canalso be negatively impacted by rapidly increasing variable costs until suchtime as we are able to pass on increased costs to our customers.

 

***General and Administrative Expenses***

 

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

 

***Depreciation and Amortization***

 

Depreciation and amortization are periodic non-cash charges thatrepresent the reduction in usefulness and value of our tangible and intangibleassets. The majority of our depreciation and amortization relates to equipmentand leasehold improvements located in our company-owned restaurants. Based onour current purchases of capital assets, our existing base of assets, and ourprojections for new purchases of fixed assets, we believe depreciation andamortization expense for 2007 will be approximately $10.9 million.

 

**Consumer Spending Habits and Impact ofInflation**

 

Our results depend on consumer spending, which is influenced byconsumer confidence and disposable income. In particular, the effects of higherenergy costs, an increase in minimum balances payable on consumer debt andincreasing interest rates, among other things, may impact discretionaryconsumer spending in restaurants. Accordingly, we believe we experience declinesin comparable store sales during economic downturns or during periods ofeconomic uncertainty. Any material decline in the amount of discretionaryspending could have a material adverse effect on our sales and income.

 

In the past, we have been able to recover inflationary cost andcommodity price increases through increased menu prices. However, the continuedinflation and its impact on labor, food and occupancy costs could, in thefuture, significantly affect our operations. We pay many of our employeeshourly rates slightly above the applicable federal, state or municipal “livingwage” rates. Recent changes in minimum wage laws may create ongoing pressure toincrease the pay scale for our associates, which would increase our laborcosts. Recently, food costs as a percentage of sales have increased due to theimpact of rising agricultural commodities. To date, we have been able tomaintain our gross margin dollars, but have recently seen a degradation in costof sales as a percentage of sales. We anticipate continued increases in thecost of wheat through the first half of 2008. Costs for construction, taxes,repairs, maintenance and insurance all impact our occupancy costs. We believeour current strategy, which is to seek to maintain operating margins through acombination of menu price increases, cost controls, efficient purchasingpractices and careful evaluation of property and equipment needs, has been aneffective tool for dealing with inflation.

 

28

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**Seasonality and Quarterly Results**

 

Our business is subject to seasonal fluctuations. Significant portionsof our net revenues and results of operations are realized during the fourthquarter of the fiscal year, which includes the December holiday season. Becauseof the seasonality of the business and the industry, results for any quarterare not necessarily indicative of the results that may be achieved for anyother quarter or the full fiscal year.

 

29

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**Results of Operations**

 

This table sets forth, for the periods indicated, certain amountsincluded in our consolidated statements of operations, the relative percentagethat those amounts represent to total revenue(unless otherwise indicated), and the percentage change in those amounts fromperiod to period. All percentages are calculatedusing actual amounts rounded to the nearest thousand.

 
| ** **                                                        | ** ** | **Third quarter ended:**           | ** ** | **Increase/**       | ** ** | **Third quarter ended:**            | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------|------------|---------------------|------------|-----------------------------------------------|------------|
| ** **                                                        | ** ** | **(in thousands of dollars)** | ** ** | **(Decrease)**      | ** ** | **(percent of total revenue)** | ** ** |
| ** **                                                        | ** ** | **October 3,**                          | ** ** | **October 2,** | ** ** | **2006**                                      | ** ** | **October 3,** | ** ** | **October 2,** | ** ** |
| ** **                                                        | ** ** | **2006**                                     | ** ** | **2007**            | ** ** | **vs. 2007**                             | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenues:                                                         |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Company-owned restaurant sales                                    |       | $                                            | 89,213     |                | $          | 93,026                                        |       | 4.3 | % | 93.2 | % | 92.7 | % |
| Manufacturing and commissary revenues                             |       | 5,257                                        |       | 5,910               |       | 12.4                                          | %          | 5.5 | % | 5.9 | % |
| Franchise and license related revenues                            |       | 1,282                                        |       | 1,442               |       | 12.5                                          | %          | 1.3 | % | 1.4 | % |
| Total revenues                                                    |       | 95,752                                       |       | 100,378             |       | 4.8                                           | %          | 100.0 | % | 100.0 | % |
|                                                              |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Cost of sales:                                                    |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Company-owned restaurant costs                                    |       | 72,187                                       |       | 74,527              |       | 3.2                                           | %          | 75.4 | % | 74.20 | % |
| Manufacturing and commissary costs                                |       | 5,445                                        |       | 6,330               |       | 16.3                                          | %          | 5.7 | % | 6.30 | % |
| Total cost of sales                                               |       | 77,632                                       |       | 80,857              |       | 4.2                                           | %          | 81.1 | % | 80.5 | % |
|                                                              |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Gross profit:                                                     |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Company-owned restaurant                                          |       | 17,026                                       |       | 18,499              |       | 8.7                                           | %          | 17.8 | % | 18.4 | % |
| Manufacturing and commissary                                      |       | (188                                         | )          | (420                | )          | (123.4                                        | )%         | (0.2 | )% | (0.4 | )% |
| Franchise and license                                             |       | 1,282                                        |       | 1,442               |       | 12.5                                          | %          | 1.3 | % | 1.4 | % |
| Total gross profit                                                |       | 18,120                                       |       | 19,521              |       | 7.7                                           | %          | 18.9 | % | 19.4 | % |
|                                                              |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Operating expenses:                                               |       |                                         |       |                |       |                                          |       |   |   |   |   |
| General and administrative expenses                               |       | 9,750                                        |       | 9,794               |       | 0.5                                           | %          | 10.2 | % | 9.8 | % |
| Depreciation and amortization                                     |       | 2,640                                        |       | 2,868               |       | 8.6                                           | %          | 2.8 | % | 2.9 | % |
| Loss on sale, disposal or abandonment of  assets, net             |       | 193                                          |       | 25                  |       | (87.0                                         | )%         | 0.2 | % | 0.0 | % |
| Impairment charges and other related costs                        |       | 51                                           |       | 28                  |       | (45.1                                         | )%         | 0.1 | % | 0.0 | % |
| Income from operations                                            |       | 5,486                                        |       | 6,806               |       | 24.1                                          | %          | 5.7 | % | 6.8 | % |
| Other expense:                                                    |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Interest expense, net                                             |       | 4,749                                        |       | 1,752               |       | (63.1                                         | )%         | 5.0 | % | 1.7 | % |
| Write-off of debt discount upon redemption  of senior notes       |       | —                                       |       | —              |       |                                          | *          | 0.0 | % | 0.0 | % |
| Prepayment penalty upon redemption of  senior notes               |       | —                                       |       | —              |       |                                          | *          | 0.0 | % | 0.0 | % |
| Write-off of debt issuance costs upon redemption  of senior notes |       | —                                       |       | —              |       |                                          | *          | 0.0 | % | 0.0 | % |
| Other, net                                                        |       | (15                                          | )          | —              |       |                                          | *          | (0.0 | )% | 0.0 | % |
| Income (loss) before taxes                                        |       | 752                                          |       | 5,054               |       | 572.1                                         | %          | 0.8 | % | 5.0 | % |
| Provision for income taxes                                        |       | —                                       |       | 111                 |       |                                          | *          | 0.0 | % | 0.1 | % |
| Net income (loss)                                                 |       | $                                            | 752        |                | $          | 4,943                                         |       | 557.3 | % | 0.8 | % | 4.9 | % |

 

----

*not meaningful

 

30

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| ** **                             | ** ** | **Year to date ended:**       | ** ** | **Increase/**       | ** ** | **Year to date ended:**        | ** ** |
|----------------------------------------|------------|----------------------------------------------|------------|---------------------|------------|-----------------------------------------------|------------|
| ** **                             | ** ** | **(in thousands of dollars)** | ** ** | **(Decrease)**      | ** ** | **(percent of total revenue)** | ** ** |
| ** **                             | ** ** | **October 3,**                          | ** ** | **October 2,** | ** ** | **2006**                                      | ** ** | **October 3,** | ** ** | **October 2,** | ** ** |
| ** **                             | ** ** | **2006**                                     | ** ** | **2007**            | ** ** | **vs. 2007**                             | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenues:                              |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Company-owned restaurant sales         |       | $                                            | 271,300    |                | $          | 276,283                                       |       | 1.8 | % | 93.3 | % | 92.8 | % |
| Manufacturing and commissary revenues  |       | 15,725                                       |       | 17,409              |       | 10.7                                          | %          | 5.4 | % | 5.9 | % |
| Franchise and license related revenues |       | 3,759                                        |       | 3,996               |       | 6.3                                           | %          | 1.3 | % | 1.3 | % |
| Total revenues                         |       | 290,784                                      |       | 297,688             |       | 2.4                                           | %          | 100.0 | % | 100.0 | % |
|                                   |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Cost of sales:                         |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Company-owned restaurant costs         |       | 219,677                                      |       | 221,116             |       | 0.7                                           | %          | 75.5 | % | 74.3 | % |
| Manufacturing and commissary costs     |       | 15,952                                       |       | 17,132              |       | 7.4                                           | %          | 5.5 | % | 5.8 | % |
| Total cost of sales                    |       | 235,629                                      |       | 238,248             |       | 1.1                                           | %          | 81.0 | % | 80.1 | % |
|                                   |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Gross profit:                          |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Company-owned restaurant               |       | 51,623                                       |       | 55,167              |       | 6.9                                           | %          | 17.8 | % | 18.5 | % |
| Manufacturing and commissary           |       | (227                                         | )          | 277                 |       |                                          | *          | (0.1 | )% | 0.1 | % |
| Franchise and license                  |       | 3,759                                        |       | 3,996               |       | 6.3                                           | %          | 1.3 | % | 1.3 | % |
| Total gross profit                     |       | 55,155                                       |       | 59,440              |       | 7.8                                           | %          | 19.0 | % | 19.9 | % |
|                                   |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Operating expenses:                    |       |                                         |       |                |       |                                          |       |   |   |   |   |
| General and administrative expenses    |       | 30,038                                       |       | 31,381              |       | 4.5                                           | %          | 10.3 | % | 10.5 | % |
| Depreciation and amortization          |       | 14,238                                       |       | 7,910               |       | (44.4                                         | )%         | 4.9 | % | 2.7 | % |
| Loss on sale, disposal or abandonment  |       | 206                                          |       | 429                 |       | 108.3                                         | %          | 0.1 | % | 0.1 | % |
| Impairment charges and other related   |       | 134                                          |       | 213                 |       | 59.0                                          | %          | 0.0 | % | 0.1 | % |
| Income from operations                 |       | 10,539                                       |       | 19,507              |       | 85.1                                          | %          | 3.6 | % | 6.6 | % |
| Other expense:                         |       |                                         |       |                |       |                                          |       |   |   |   |   |
| Interest expense, net                  |       | 14,670                                       |       | 10,685              |       | (27.2                                         | )%         | 5.0 | % | 3.6 | % |
| Write-off of debt discount upon        |       | —                                       |       | 528                 |       |                                          | *          | 0.0 | % | 0.2 | % |
| Prepayment penalty upon redemption     |       | 4,800                                        |       | 240                 |       | (95.0                                         | )%         | 1.7 | % | 0.1 | % |
| Write-off of debt issuance costs upon  |       | 3,956                                        |       | 2,071               |       | (47.6                                         | )%         | 1.4 | % | 0.7 | % |
| Other, net                             |       | (5                                           | )          | —              |       | (100.0                                        | )%         | (0.0 | )% | 0.0 | % |
| Income (loss) before taxes             |       | (12,882                                      | )          | 5,983               |       | (146.4                                        | )%         | (4.4 | )% | 2.0 | % |
| Provision for income taxes             |       | —                                       |       | 158                 |       |                                          | *          | 0.0 | % | 0.0 | % |
| Net income (loss)                      |       | $                                            | (12,882    | )                   | $          | 5,825                                         |       |   | * | (4.4 | )% | 2.0 | % |

 

----

*not meaningful

 

31

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*Company-Owned Restaurant Operations*

 

**We have a 52/53-week fiscal year ending on the Tuesday closest toDecember 31. The third quarters in fiscal years 2006 and 2007 ended on October3, 2006 and October 2, 2007, respectively, and each contained 13 weeks.**

** **

**Comparable store sales is a key performance indicator widely usedthroughout the restaurant industry. Comparable store sales is calculated bydividing aggregate sales for stores open for each full week in the current yearby aggregate sales for the same stores open for the corresponding full week inthe prior year. Stores must be open for 52/53 weeks before they are included inthe calculation. Comparable store sales adjusted for like store weeks includecompany-owned restaurants only and represent the change in period-over-periodsales for the comparable store base.**

** **

For the third quarter and year to date period ended October 2, 2007,our comparable store sales increased 5.2% and 3.8%, respectively. Theimprovement was primarily due to system wide price increases and a shift inproduct mix to slightly higher priced products, slightly offset by a modestreduction in units sold. We continue to see accelerated comparable store salesperformances in our 23 restaurants that were upgraded in late 2006. Theserestaurants generated comparable store sales increases of 16.3% and 11.4% forthe third quarter and year to date periods ended October 2, 2007. Partiallyoffsetting the increase in revenue for the quarter and year to date periodsended October 2, 2007 was a net decrease in the number of company-ownedrestaurants. The decrease was a result of planned closures of underperformingrestaurants and positively contributes to our restaurant gross profitpercentage.

 

For the third quarter ended October 2, 2007, our restaurant grossprofit increased $1.5 million, or 8.7%, when compared to the same period of2006. Our gross profit percentage increased to 18.4% from 17.8% for the quarterended October 2, 2007 when compared to the same period in 2006. The increase inour comparative gross profit percentage is due to the implementation of priceincreases and menu changes since the quarter ended October 3, 2006. Thesechanges offset inflationary pressures on cost of sales and wage rates.Additionally, our net restaurant operating expenses were slightly down in forthe quarter ended October 2, 2007 compared to the same quarter in 2006.

 

For the year to date period ended October 2, 2007, our restaurant grossprofit increased $3.5 million, or 6.9%, when compared to the same period in2006. Our gross profit percentage increased to 18.5% from 17.8% for the year todate period ended October 2, 2007 when compared to the same period in 2006. Theincrease in our gross profit percentage is due to the implementation of priceincreases and menu changes, sales from new restaurants, and the closure ofunderperforming stores since the quarter ended October 3, 2006. These changesoffset inflationary pressures on cost of sales and wage rates. Additionally,our net restaurant operating expenses had decreased significantly for the yearto date period October 2, 2007 compared to the same period in 2006, primarilyrelated to a decrease in marketing expense and compensation related costs.

 

*Manufacturingand Commissary Operations*

 

Our manufacturingoperations, which include our United States Department of Agriculture (“USDA”)inspected commissaries, predominantly support our company-owned restaurants andgenerate revenue from the sale of food products to franchisees, licensees,third-party distributors and other third parties. All intercompany transactionshave been eliminated during consolidation.

 

During thelatter half of the 2006 fiscal year, we studied ways to gain efficiencieswithin our manufacturing and commissary operations. We also engaged a thirdparty consulting firm to assist us in developing manufacturing cost models. Asa result of our efforts, we implemented the following initiatives:

 

•                  implementedprice increases to some of our product resellers;

•                  openedtwo new commissary locations, aggregating our commissary system to fivelocations; and

•                  increasedour current production capacity, thereby allowing us to provide new products tonew and existing customers.

 

32

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During thethird quarter and year to date periods ended October 2, 2007, manufacturing andcommissary revenues improved $0.7 million and $1.7 million, or 12.4% and 10.7%,respectively, as compared to the same periods in 2006. This increase waspredominantly driven by price increases and an increase in volume of units soldto our more significant customers. For the third quarter of 2007, higher costsof wheat more than offset our increased revenue and lead to a decrease in grossprofit of approximately $0.2 million for the third quarter. For the year todate period ended October 2, 2007, our increased revenue more than offset therising commodity costs and lead to an improvement of $0.5 million.

 

*Franchiseand License Operations*

 

Revenues for the franchise and license operations consist primarily ofinitial fees and royalty income earned as a result of sales within licensed andfranchised restaurants. Overall, licensee and franchisee revenue increased $0.2million, or 12.5% and $0.2 million, or 6.3% for the quarter and year to dateperiods ended October 2, 2007, respectively, as compared to the same periods in2006. The increases were predominantly due to improved comparablefranchisee/licensee sales in the Manhattan Bagel and Einstein Bros. brands anda net increase of 25 licensed restaurants, slightly offset by a net decrease of24 franchised restaurants from October 3, 2006 to October 2, 2007.

 

*General and Administrative Expenses*

 

For the thirdquarter of 2007, our general and administrative expenses marginally increasedby $44,000, or 0.5%, as compared to the third quarter in 2006. Contributing tothis was a net increase of $0.4 million in miscellaneous overhead expensesoffset by a decrease of $0.3 million in compensation related costs.

 

For the yearto date period ended October 2, 2007, our general and administrative expensesincreased $1.3 million, or 4.5% as compared to the same period in 2006. Contributingto this was a $0.3 million increase in compensation related costs and a netincrease of $1.0 million in travel costs, management development, and costsrelated to relocating our corporate office.

 

33

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*Depreciation and Amortization*

 

Depreciation and amortization expenses increased $0.2 million for thethird quarter of 2007 when compared to the third quarter of 2006 and decreased$6.3 million for the year to date period ended October 2, 2007, compared to thesame period in 2006. The third quarter 2007 increase over 2006 is due to thedepreciation expense on our new corporate headquarters, including $1.7 millionin leasehold improvements that were provided by the landlord. The year to datedecrease over 2006 is primarily due to all of our amortizable intangibleassets becoming fully amortized and a substantial portion of our capitalizedassets becoming fully depreciated within the second and third quarters offiscal 2006. Depreciationand amortization expense is predominantly related to the assets ofEinstein/Noah Bagel Corp. that we acquired in bankruptcy proceedings in June2001. The sale of manufacturing equipment located at the plant of HarlanBakeries, Inc., our frozen bagel dough supplier, during the first quarter of2007 also contributed to the year to date decrease in depreciation expense. Theassets were classified as held for sale on the consolidated balance sheet as ofJanuary 2, 2007. Proceeds from the sale were received in the second quarter of2007.

 

*Losses andGains on the Sale, Disposal, or Abandonment of Assets*

 

Gains andlosses on the disposal, sale or abandonment of assets represent the differenceof proceeds received, if any, and the net book value of an asset. We establishestimated useful lives for our assets, which range from three to eight years,and depreciate using the straight-line method. Leasehold improvements arelimited to the lesser of the useful life or the noncancelable lease term. Theuseful lives of the assets are based upon our expectations of the period oftime that the asset will be used to generate revenue. We periodically reviewthe assets for changes in circumstances, which may impact their useful lives. During the third quarter and yearto date period ended October 2, 2007, we recorded $25 and $429, respectively inlosses on the disposal, sales or abandonment of assets. During the thirdquarter and year to date period ended October 3, 2006, we recorded a $193 and$206 loss, respectively on the disposal, sale or abandonment of assets.

 

*ImpairmentCharges and Other Related Costs*

 

Impairmentlosses are non-cash charges recorded on long-lived assets, goodwill, trademarksand our other intangible assets. Generally, an indicator of impairment wouldinclude significant change in an asset’s ability to generate positive cash flowin the future or in the fair value of an asset. Whenever impairment indicatorsare determined to be present, the amount of impairment is measured as theexcess of the carrying amount of the asset over its fair value. During the third quarter and yearto date period ended October 2, 2007, we recorded impairment charges of $0 and$19,000, respectively. During the third quarter and year to date endedOctober 3, 2006, we recorded $29,000 and $112,000, respectively in impairmentcharges related to company-owned restaurants. Additionally, we incurred other related costs to close company-ownedrestaurants of $28,000 and $194,000 for the quarter and year to date periodsended October 2, 2007, respectively, and $22,000 for both the quarter and yearto date periods ended October 3, 2006, respectively.

 

*OtherExpense*

 

During thefirst quarter ended April 4, 2006, we wrote off $4.0 million of debt issuancecosts and paid a 3% redemption premium on the $160 Million Notes in the amountof $4.8 million.

 

During thesecond quarter ended July 3, 2007, we wrote off $2.1 million of debt issuancecosts and paid a $0.2 million redemption premium related to the $65 MillionSecond Lien Term Loan, and wrote off a $0.5 million discount related to the $25Million Subordinated Note.

 

For thequarter ended October 2, 2007, there was a 63.1% decrease in net interestexpense of $3.0 million compared to the same quarter ended October 3, 2006. Forthe year to date period ended October 2, 2007, there was a 27.2% decrease innet interest expense of $4.0 million. Both the quarter and year to datedecreases are directly related to our pay down of $90 million of existingindebtedness that occurred in June 2007.

 

34

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*Net Income (Loss) and Income Taxes*

 

Under GAAP, we reported net income for the third quarter of 2007 of$4.9 million as compared to net income of $0.8 million for the third quarter of2006. We reported net income of $5.8 million for the year to date period endedOctober 2, 2007 as compared to the net loss of $12.9 million for the sameperiod in 2006. For tax purposes, our net operating loss carryforward reducedour federal and state income tax liability incurred for the third quarter andyear to date period ended October 2, 2007. We have recorded a provision forincome taxes in the amount of $0.1 million and $0.2 million for the thirdquarter and year to date period ended October 2, 2007 as a result of ourestimate of state income tax.

 

As of October 2, 2007, our net operating loss carryforwards for U.S.federal income tax purposes were $151.9 million, $90.6 million of which aresubject to an annual usage limitation of $4.7 million. These net operating losscarryforwards are subject to the following expiration schedule:

 

| **Net Operating Loss Carryforwards** | ** ** |
|-----------------------------------------------------|------------|
| **Expiration Date**                            | ** ** | **Amount** | ** ** |
| ** **                                          | ** ** | **(in thousands of dollars)** | ** ** |
| 12/31/2011                                          |       | $ | 1,431 |   |
| 12/31/2012                                          |       | 9,589 |   |
| 12/31/2018                                          |       | 14,553 |   |
| 12/31/2019                                          |       | 6,862 |   |
| 12/31/2020                                          |       | 10,424 |   |
| 12/31/2021                                          |       | 10,515 |   |
| 12/31/2022                                          |       | 35,688 |   |
| 12/31/2023                                          |       | 40,649 |   |
| 12/31/2024                                          |       | 11,938 |   |
| 12/31/2025                                          |       | 5,391 |   |
| 12/31/2026                                          |       | 4,900 |   |
|                                                | ** ** | $ | 151,940 | ** ** |

 

Our ability to utilize theapproximately $61.3 million of our net operating losses that are not currentlysubject to limitation could become limited, and our ability to utilize ourremaining net operating losses could be limited further, in the event that weundergo an “ownership change” as that term is defined for purposes of Section382 of the Internal Revenue Code.

 

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

 

**Financial Condition, Liquidityand Capital Resources**

 

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

 

35

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The primarydriver of our operating cash flow is our restaurant operations, specificallythe gross margin from our company-owned restaurants. Therefore, we focus on theelements of those operations including comparable store sales and cash flows toensure a steady stream of operating profits that enable us to meet our cashobligations. On a weekly basis, we review our company-owned restaurantperformance compared with the same period in the prior year and our operatingplan.

 

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

 

*Secondary Public Offering of Our Common Stock*

 

On June 13, 2007, we completed a $90 millionsecondary public offering of our common stock. After stock issuance costs of$6.7 million related to the offering, we received net proceeds of $83.3 million.The net proceeds were used to repay our $65.0 million Second Lien Term Loan,repay a portion of our $25 million Subordinated Note held by Greenlight Capital, L.L.C. (“Greenlight”) and to pay for the offering costs. Additionally,on June 28, 2007, we repaid the remaining portion of the $25 millionSubordinated Note held by Greenlight by using a portion of the incremental debtproceeds under the amended debt facility.

 

*June 2007 Debt Redemption and Amended First LienTerm Loan*

 

InJune 2007, we amended our debt facility from $95.0 million to $110.0 million.As part of this amendment we increased the amount of our existing revolvingcredit facility from $15.0 million to $20.0 million and modified our term loanfrom a principal amount of $80.0 million to $90.0 million and repaid theremaining amount of the $25 Million Subordinated Note as noted above. Therevolving credit facility remains available, subject to certain conditions, tofinance our ongoing working capital, capital expenditure and general corporateneeds. In addition, all of the revolving credit facility is available forletters of credit. We are required to pay an unused credit line fee of0.5% per annum on the average daily unused amount. The unused line fee ispayable quarterly in arrears. Additionally, we are required to pay a letter ofcredit fee based on the ending daily undrawn face amount for each letter ofcredit issued, being based on our consolidated leverage ratio with anapplicable margin of 2.00% plus a 0.5% arranger fee payable quarterly. Lettersof credit reduce our availability under the Revolving Facility. At October 2,2007, we had $6.7 million in letters of credit outstanding. The letters ofcredit expire on various dates during 2008, are automatically renewable for oneadditional year and are payable upon demand in the event that we fail to paythe underlying obligation. Our availability under the revolving facility was$13.3 million as of October 2, 2007.

 

In addition, we have obtained a commitment for an incremental term loanin an aggregate principal amount of up to $57.0 million which may be used ifneeded, solely for the purpose of redeeming the zero coupon Series Z preferredstock, which is not due until June 2009. Availability of the incremental term loan issubject to customary borrowing conditions, including absence of any default ormaterial adverse change, and to a requirement of successful syndication of thisincremental term loan.

 

We may prepay amounts outstanding under the senior secured creditfacility and may terminate commitments in whole at any time without penalty orpremium upon prior written notice.

 

*Working Capital Deficit*

 

At October 2, 2007, we had unrestricted cash of $12.0 million andrestricted cash of $2.0 million. Under our Revolving Facility, there were nooutstanding borrowings, $6.7 million in letters of credit outstanding andborrowing availability of $13.3 million. We reduced our working capital deficit$7.4 million to $0.3 million at October 2, 2007 compared to $8.0 million atJanuary 2, 2007.

 

36

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*Cash Provided by Operations*

 

Due to increased profitability at our company-owned restaurants and thetiming of operational receipts and payments, net cash generated by operatingactivities was $19.3 million through the third quarter of 2007 compared to $9.4million for the comparable period in 2006. Net income was $5.8 million for theyear to date period in 2007 and was adjusted for non-cash items of depreciationand amortization expense of $7.9 million, stock based compensation expense of$1.6 million and the write off of $2.1 million of debt issuance costs to arriveat cash provided by operating activities. Net loss for the same period in 2006was $12.9 million and was adjusted for non-cash items of depreciation andamortization expense of $14.2 million, stock based compensation expense of $0.5million and the write off of $4.0 million in debt issuance costs to arrive atcash provided by operating activities.

 

*Cash Used in Investing Activities*

 

During the year to date period ended October 2, 2007, we usedapproximately $18.3 million of cash to purchase additional property andequipment that included $2.9 million to open five new restaurants in 2007, $0.6million in payments for four restaurants that opened in 2006, and $0.9 milliontowards 13 restaurants that are currently under construction; $2.7 million forupgrading existing restaurants, $6.1 million for replacement of equipment atour existing company-owned restaurants, $1.1 million for our manufacturingoperations, $1.6 million for general corporate purposes, and $2.4 forleasehold improvements and build-out related to our new corporate headquarters.

 

During the year to date period ended October 3, 2006, we used approximately$10.6 million of cash to purchase additional property and equipment thatincluded $1.2 million for new restaurants, $2.0 million for upgrading existingrestaurants, $3.7 million for replacement of old equipment with new equipmentat our existing company-owned restaurants, $2.3 million for our manufacturingoperations and $1.4 million for general corporate purposes.

 

We anticipate that the majority of our capital expenditures for fiscal2007 will be focused on the addition of 12 new company-owned restaurants during2007 at an average gross capital investment of approximately $550,000 perrestaurant, which varies depending upon square footage, layout and location. Wealso intend to upgrade approximately 36 of our current restaurants to the frontof the house configuration of our prototype restaurant, during 2007, 26 ofwhich have been completed through the end of the third quarter 2007. Theupgrade includes new self-service coolers, an expanded coffee bar, and aseparate station for quick “to go” items. Finally, for many of our restaurants,we acquired additional equipment for new menu items and an improved orderingsystem that uses wireless technology to reduce the time our guests wait in linebefore they receive their food.

 

*Cash Used in Financing Activities*

 

As a result of our June 13, 2007 secondary public offering of commonstock, we received $90.0 million in cash, and incurred $6.7 million in stockissuance costs. Concurrent with our June 28, 2007 amendment to our First LienTerm Loan, we drew down an additional $11.9 million in debt and incurred anadditional $0.9 million in debt issuance costs. The funds from these twotransactions were used to pay off the $65.0 million Second Lien Term Loan andthe $25.0 Million Subordinated Note and $2.5 million of related paid-in-kindinterest on the Subordinated Note.

 

For the same period in 2006, and as a result of our refinancing of our$160 Million Notes with $170 million in new term loans in February 2006, weborrowed $169.4 million in term loans and incurred approximately $5.0 millionin debt issuance costs. Upon closing of our new debt facility, we beganamortizing these costs and the debt issuance costs related to our $160 MillionNotes and AmSouth revolver were written-off.

 

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*ContractualObligations*

 

The following table summarizes the amounts of payments due underspecified contractual obligations as of October 2, 2007:

 
| ** **                                           | ** ** | **Payments Due by Period**    | ** ** |
|------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                           | ** ** | ** **                                   | ** ** | **2008 to** | ** ** | **2011 to** | ** ** | **2013 and** | ** ** | ** ** | ** ** |
| ** **                                           | ** ** | **2007**                                     | ** ** | **2010** | ** ** | **2012** | ** ** | **thereafter** | ** ** | **Total** | ** ** |
| ** **                                           | ** ** | **(in thousands of dollars)** | ** ** |
| Accounts payable and accrued expenses                |       | $                                            | 29,335     |   | $ | — |   | $ | — |   | $ | — |   | $ | 29,335 |   |
| Debt                                                 |       | 505                                          |       | 2,755 |   | 87,075 |   | — |   | 90,335 |   |
| Estimated interest expense on our Debt  Facility (a) |       | 1,760                                        |       | 20,348 |   | 10,823 |   | — |   | 32,931 |   |
| Manditorily Redeemable Series Z                      |       | —                                       |       | 57,000 |   | — |   | — |   | 57,000 |   |
| Minimum lease payments under capital leases          |       | 22                                           |       | 136 |   | 2 |   | — |   | 160 |   |
| Minimum lease payments under operating  leases       |       | 6,111                                        |       | 56,810 |   | 14,340 |   | 7,608 |   | 84,869 |   |
| Purchase obligations (b)                             |       | 4,805                                        |       | 9,211 |   | — |   | — |   | 14,016 |   |
| Other long-term obligations (c)                      |       | —                                       |       | 834 |   | 506 |   | 5,848 |   | 7,188 |   |
| Total                                                |       | $                                            | 42,538     |   | $ | 147,094 |   | $ | 112,746 |   | $ | 13,456 |   | $ | 315,834 |   |

 

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(a)            Calculated as ofOctober 2, 2007 using the LIBOR and U.S. Prime rates, plus the applicablemargin in effect. Because the interest rates on the first lien term loanfacility and the revolving credit facility are variable, actual payments coulddiffer materially.

 

(b)           Purchase obligationsconsist of non-cancelable minimum purchases of frozen dough and certain otherraw ingredients that are used in our products.

 

(c)            Other long-termobligations primarily consist of the remaining liability related to minimumfuture purchase commitments with a supplier that advanced us $10.0 million in1996.

 

*Insurance*

 

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

 

**Off-Balance Sheet Arrangements**

 

*Guarantees*

 

Prior to 2001, we would occasionally guarantee leases for the benefitof certain of our franchisees. None of the guarantees have been modified sincetheir inception and we have since discontinued this practice. Current franchiseesare the primary lessees under the vast majority of these leases. Under thelease guarantees, we may be required by the lessor to make all of the remainingmonthly rental payments or property tax and common area maintenance payments ifthe franchisee does not make the required payments in a timely manner. However,we believe that most, if not all, of the franchised restaurants could besubleased to third parties minimizing our potential exposure. Additionally, wehave indemnification agreements with our franchisees under which thefranchisees would be obligated to reimburse us for any amounts paid under suchguarantees. Historically, we have not been required to make such payments insignificant amounts. As of October 2, 2007, we have not recorded a

 

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liability for our exposure under the guarantees in accordance with SFASNo. 5 following a probability related approach. Minimum future rental paymentsfor all remaining guaranteed leases were approximately $1.3 million as ofOctober 2, 2007. We believe the ultimate disposition of these matters will nothave a material adverse effect on our financial position or results ofoperations.

 

*Letters of Credit*

 

We have $6.7 million in letters of credit outstanding under ourRevolving Facility at October 2, 2007. The letters of credit expire on variousdates during 2007, are automatically renewable for one additional year and arepayable upon demand in the event that we fail to pay the underlying obligationrelated to certain workers compensation claims or distributor claims.

 

**Recent Accounting Pronouncements**

 

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities — Including an Amendment of SFAS No.115* (“SFAS No. 159), which becomes effective for fiscal periodsbeginning after November 15, 2007. Under SFAS No. 159, companies may elect tomeasure specified financial instruments and warranty and insurance contracts atfair value on a contract-by-contract basis, with changes in fair valuerecognized in earnings each reporting period. This election, called the “fairvalue option”, will enable some companies to reduce volatility in reportedearnings caused by measuring related assets and liabilities differently. We donot expect the impact of adoption to have a material impact on our consolidatedfinancial statements.

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS No. 157”), which defines fair value, establishes a framework for measuringfair value and expands disclosures about fair value measurements. The statementis effective for fiscal years beginning after November 15, 2007. We are stillin the process of evaluating SFAS No. 157 and are not able to estimate theimpact of adoption to our consolidated financial statements.

 

We have considered all other recently issued accounting pronouncementsand do not believe that the adoption of such pronouncements will have amaterial impact on our consolidated financial statements.

 

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

 

During the third quarters ended October 3, 2006 and October 2, 2007,our results of operations, financial position and cash flows have not beenmaterially affected by changes in the relative values of non-U.S. currencies tothe U.S. dollar. We do not use derivative financial instruments to limit ourforeign currency risk exposure since virtually all of our business is conductedin the United States.

 

Our manufacturing operations sell bagels to a wholesaler and adistributor who take possession in the United States and sell outside of theUnited States. As the product is shipped FOB domestic dock, there are nointernational risks of loss or foreign exchange currency issues. Sales shippedinternationally are included in manufacturing and commissary revenue.Approximately $0.5 million and $0.7 million for the third quarter in 2006 and2007, respectively, and $1.5 million and $2.3 million for the year to dateperiods in 2006 and 2007, respectively were recognized as revenue for theseinternational shipments.

 

Our debt as of October 2, 2007 was principally comprised of the amendedRevolving Facility and First Lien Term Loan. For fixed rate debt, interest ratechanges affect the fair market value of such debt but do not impact earnings orcash flows. Conversely for variable rate debt, including borrowings under ourRevolving Facility and First Lien Term Loan, interest rate changes generally donot affect the fair market value of such debt, but do impact future earningsand cash flows, assuming other factors are held constant. A 100 basis pointincrease in short-term effective interest rates would decrease our net incomeby approximately $0.9 million annually, assuming no change in the size orcomposition of debt at October 2, 2007. Currently, the interest rates on ourRevolving Facility and First Lien Term Loan are predominantly at LIBOR ratesplus an applicable margin through short-term fixed rate financing. Theestimated increase in interest expense incorporates the fixed interestfinancing into its assumptions.

 

On an annual basis, we purchase a substantial amount of agriculturalproducts that are subject to fluctuations in price based upon market conditions.Our purchase arrangements may contain contractual features that limit the pricepaid by establishing certain price floors or caps. We do not use financialinstruments to hedge commodity prices. We have recently contracted with asubsidiary of Cargill Incorporated to manage our wheat purchases for ourcompany-owned production facility. In addition to wheat, we have establishedcontracts and entered into commitments with our vendors for butter, cheese,coffee and turkey.

 

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

 

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**Item4.  Controls and Procedures**

 

An evaluation was carried out under the supervision and with theparticipation of company management, including our chief executive officer andchief financial officer, of the effectiveness of the design and operation of ourdisclosure controls and procedures (as defined in Rule 13a-15(e) under theSecurities Exchange Act of 1934, as amended) as of October 2, 2007. Based uponthat evaluation, our chief executive officer and our chief financial officerhave concluded that the design and operation of our disclosure controls andprocedures were effective in timely making known to them material informationrelating to the Company required to be disclosed in reports that we file orsubmit under the Exchange Act rules.

 

It should be noted that any system of controls, however well designedand operated, can provide only reasonable assurance regarding management’scontrol objectives. In addition, the design of any control system is based inpart upon certain assumptions about the likelihood of future events. Because ofthese and other inherent limitations of control systems, there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions, regardless of how remote.

 

During the year to date period ended October 2, 2007, there were nochanges to our internal controls over financial reporting that were identifiedin connection with the evaluation of our disclosure controls and proceduresrequired by the Exchange Act rules and that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

 

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**PART II - OTHER INFORMATION**

**EINSTEINNOAH RESTAURANT GROUP, INC.**

 

**Item 1. Legal Proceedings**

 

Informationregarding legal proceedings is incorporated by reference from Note 10 to ourConsolidated Financial Statements set forth in Part I of this report.

 

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

### * *

We wish to caution our readers that the following important factors,among others, could cause the actual results to differ materially from thoseindicated by forward-looking statements made in this report and from time totime in news releases, reports, proxy statements, registration statements andother written communications, as well as verbal forward-looking statements madefrom time to time by representatives of the Company. Such forward-lookingstatements involve risks and uncertainties that may cause our actual results,performance or achievements to be materially different from any futureperformance or achievements expressed or implied by these forward-lookingstatements. Factors that might cause actual events or results to differmaterially from those indicated by these forward-looking statements may includematters such as future economic performance, restaurant openings or closings,operating margins, the availability of acceptable real estate locations, thesufficiency of our cash balances and cash generated from operating andfinancing activities for our future liquidity and capital resource needs, thegranting of franchises and licenses and other matters, and are generallyaccompanied by words such as: believes, anticipates, estimates, predicts,expects, and similar expressions that convey the uncertainty of future eventsor outcomes. An expanded discussion of some of these risk factors follows.

 

**RiskFactors Relating to Our Business and Our Industry**

 

*Failure toprotect food supplies and adhere to food safety standards could result infood-borne illnesses and/or injuries to our guests.*

 

Food safetyand reputation for quality is the most significant risk to any company thatoperates in the restaurant industry. Food safety is the focus of increasedgovernment regulatory initiatives at the local, state and federal levels.

 

Failure toprotect our food supply or enforce food safety policies, such as proper foodtemperatures and adherence to shelf life dates, could result in food-borneillnesses and/or injuries to our guests. Also, our reputation of providing qualityfood is an important factor in choosing our restaurants. Instances of foodborneillness, including listeriosis, salmonella and e-coli, whether or not traced toour restaurants, could reduce demand for our menu offerings. If any of ourguests become ill from consuming our products, the affected restaurants may beforced to close. An instance of food contamination originating from one of ourrestaurants, our commissaries or suppliers, or our manufacturing plant couldhave far-reaching effects, as the contamination, or the perception ofcontamination could affect substantially all of our restaurants. In addition,publicity related to either product contamination or recalls may cause ourguests to cease frequenting our restaurants based on fear of such illnesses.

 

*Changes inconsumer preferences and discretionary spending priorities could harm ourfinancial results.*

 

Numerousfactors including changes in consumer tastes and discretionary spendingpriorities often affect restaurants. Shifts in consumer preferences away fromour type of cuisine and/or the fast-casual style could have a material adverseeffect on our results of operations. Dietary trends, such as the consumption offood low in carbohydrate content have, in the past, and may, in the future, negativelyimpact our sales.

 

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

 

*We may notbe successful in implementing any or all of the initiatives of our businessstrategy.*

 

Our successdepends in part on our ability to understand and satisfy the needs of ourguests, franchisees and licensees. Our business strategy consists of severalinitiatives:

 

• expand sales at our existingcompany-owned restaurants;

• open new company-owned restaurants;and

• open new licensed and franchisedrestaurants.

 

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

 

*Our salesand profit growth could be adversely affected if comparable store sales areless than we expect.*

 

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

 

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*Competitionin the restaurant industry is intense, and we may fall short of our revenue andprofitability targets if we are unable to compete successfully.*

 

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

 

*We occupyour company-owned restaurants under long-term non-cancelable leases, and we maybe unable to renew leases at the end of their lease periods or obtain newleases on acceptable terms.*

 

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

 

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

 

*The cost ofnatural resources, such as energy, together with the cost, availability andquality of our raw ingredients affect our results of operations.*

 

The cost,availability and quality of the ingredients that we use to prepare our food aresubject to a range of factors, many of which are beyond our control.Fluctuations in economic and political conditions, weather and demand couldadversely affect the cost of our ingredients. We have limited control overthese changes in the price and quality of commodities, since we typically donot enter into long-term pricing agreements for our ingredients. We may not beable to pass through any future cost increases by increasing menu prices, as wehave done in the past. We and our licensees and franchisees are dependent onfrequent deliveries of fresh ingredients, thereby subjecting us to the risk ofshortages or interruptions in supply. Additionally, in the event of massiveculling of specific animals such as chickens or turkeys to prevent the spreadof disease, the supply and availability of ingredients may become limited. Thiscould dramatically increase the price of certain menu items which coulddecrease sales of those items or could force us to eliminate those items fromour menus entirely. All of these factors could adversely affect our business,reputation and financial results.

 

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The cost ofenergy impacts our results of operations in several ways. We have seen our costof electricity gradually increase over time. Distribution costs related to fuelare included in our costs, including commodity purchases, and have impacted ouroperations negatively. Additionally, travel costs, primarily airline fares,have been steadily increasing nationwide. These costs impact our results ofoperation currently and could impact us negatively in the future.

 

*Ouroperations may be negatively impacted by adverse weather conditions and naturaldisasters.*

 

Adverseweather conditions and natural disasters could seriously affect regions inwhich our company-owned, licensed and franchised restaurants are located orregions that produce raw ingredients for our restaurants. If adverse weatherconditions or natural disasters such as fires affect our restaurants, we couldexperience closures, repair and restoration costs, food spoilage, and othersignificant reopening costs as well as increased food costs and delayed supplyshipments, any of which would adversely affect our business. Additionally,during periods of extreme temperatures (either hot or cold) or precipitation,many individuals choose to stay inside. This negatively impacts transactioncounts in our restaurants and over extended periods of time could adverselyaffect our business and results of operations.

 

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

 

*Increasingcommodity prices would adversely affect our gross profit.*

 

Recent globaldemand for commodities such as wheat has resulted in higher prices for flourand has increased our costs. The prices of our main ingredients are directlyassociated with the changing weather conditions as well as economic factorssuch as supply and demand of certain commodities within the United States andother countries. Our ability forecast and to manage our commodities couldsignificantly affect our gross margins.

 

Additionally,due to increased demand for ethanol the cost of corn has increasedsubstantially, which has increased the cost of corn-sourced ingredients as wellas other commodities such as wheat the primary ingredient in most of ourproducts. We expect that this demand and these commodity pressures to continuefor the remainder of 2007 and into 2008 as well. Any increase in the prices ofthe ingredients most critical to our products, such as wheat, could adverselyaffect our operating results.

 

*We havesingle suppliers for most of our key ingredients, and the failure of any ofthese suppliers to perform could harm our business.*

 

We currentlypurchase our raw materials from various suppliers; however, we have only onesupplier for each of our key ingredients. We purchase a majority of our frozenbagel dough from a single supplier, who utilizes our proprietary processes andon whom we are dependent in the short-term. All of our remaining frozen bageldough is produced at our dough manufacturing facility in Whittier, California.Additionally, we purchase all of our cream cheese from a single source under acontract that expires at the end of 2007. For coffee, we have a single suppliercurrently under contract for the remainder of 2007 with a second supplier undercontract for 2008. Although to date we have not experienced significantdifficulties with our suppliers, our reliance on a single supplier for each ofour key ingredients subjects us 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 ordegradation in the quality of the materials provided by our suppliers couldhave a material adverse effect on our business, operating results and financialcondition. In addition, any such disruptions in supply or degradations inquality could have a long-term detrimental impact on our efforts to maintain astrong brand identity and a loyal consumer base.

 

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

 

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

 

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

 

*Increasinglabor costs could adversely affect our results of operations and cash flows.*

 

We aredependent upon an available labor pool of associates, many of whom are hourlyemployees whose wages may be affected by increases in the federal, state ormunicipal “living wage” rates. Numerous proposals have been made on federal,state and local levels to increase minimum wage levels. Increases in stateminimum hourly wage rates in most of the states in which we operate becameeffective January 1, 2007, and the federal government has recently enactedminimum wage increases. Increases in the minimum wage may create pressure toincrease the pay scale for our associates, which would increase our labor costsand those of our franchisees and licensees.

 

A shortage inthe labor pool or other general inflationary pressures or changes could alsoincrease labor costs. In addition, changes in labor laws or reclassificationsof associates from management to hourly employees could affect our labor cost.An increase in labor costs could have a material adverse effect on our incomefrom operations and decrease our profitability and cash flows if we are unableto recover these increases by raising the prices we charge our guests.

 

*We may notbe able to generate sufficient cash flow to make payments on our substantialamount of debt.*

 

We have aconsiderable amount debt and are substantially leveraged. As of October 2,2007, we had $89.8 million in term loans outstanding. We also have $57.0million of mandatorily redeemable preferred stock due June 30, 2009. Inaddition, we may, subject to certain restrictions, incur substantial additionalindebtedness in the future. Our high level of debt, among other things, could:

 

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

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

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

• increase our vulnerability tovolatility in interest rates; and

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

 

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Economic,financial, competitive, legislative and other factors beyond our control mayaffect our ability to generate cash flow from operations to make payments onour indebtedness and to fund necessary working capital. A significant reductionin operating cash flow would likely increase the need for alternative sourcesof liquidity. If we are unable to generate sufficient cash flow to makepayments on our debt, we will have to pursue one or more alternatives, such asreducing or delaying capital expenditures, refinancing our debt on terms thatare not favorable to us, selling assets or issuing additional equitysecurities. We may not be able to accomplish any of these alternatives onsatisfactory terms, if at all, and even if accomplished, they may not yieldsufficient funds to service our debt.

 

*We mustcomply with certain covenants inherent in our debt agreements to avoiddefaulting under those agreements.*

 

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

 

*We face therisk of adverse publicity and litigation in connection with our operations.*

 

We are fromtime to time the subject of complaints or litigation from our consumersalleging illness, injury or other food quality, health or operational concerns.Adverse publicity resulting from these allegations may materially adverselyaffect us, regardless of whether the allegations are valid or whether we areliable. In addition, employee claims against us based on, among other things,discrimination, harassment or wrongful termination may divert financial andmanagement resources that would otherwise be used to benefit our futureperformance. There is also a risk of litigation from our franchisees withregard to the terms of our franchise arrangements. We have been subject to avariety of these and other claims from time to time, and although these claimshave not historically had a material impact on our operations, a significantincrease in the number of these claims or the number that are successful couldmaterially adversely affect our business, prospects, financial condition,operating results or cash flows.

 

*A regionalor global health pandemic could severely affect our business.*

 

A healthpandemic is a disease that spreads rapidly and widely by infection and affectsmany individuals in an area or population at the same time. In 2004, 2005 and2006, Asian and European countries experienced outbreaks of avian flu and it ispossible that it will continue to migrate to the United States where ourrestaurants are located. If a regional or global health pandemic were to occur,depending upon its duration and severity, our business could be severelyaffected. We have positioned ourselves as a “neighborhood atmosphere” betweenhome and work where people can gather for human connection and high qualityfood. Customers might avoid public gathering places in the event of a healthpandemic, and local, regional or national governments might limit or ban publicgatherings to halt or delay the spread of disease. A regional or globalpandemic might also adversely impact our business by disrupting or delayingproduction and delivery of products and materials in our supply chain andcausing staff shortages in our restaurants. The impact of a health pandemicmight be disproportionately greater on us than on other companies that dependless on the gathering of people in a neighborhood atmosphere.

 

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*Ourlicensees and franchisees may not help us develop our business as we expect, orcould actually harm our business.*

 

We rely inpart on our licensees and franchisees and the manner in which they operatetheir restaurants to develop and promote our business. Although we havedeveloped criteria to evaluate and screen prospective candidates, thecandidates may not have the business acumen or financial resources necessary tooperate successful restaurants in their respective areas. In addition,licensees and franchisees are subject to business risks similar to what we facesuch as competition, consumer acceptance, fluctuations in the cost,availability and quality of raw ingredients, and increasing labor costs. Thefailure of licensees and franchisees to operate successfully could have amaterial adverse effect on us, our reputation, our ability to collectroyalties, our brands and our ability to attract prospective candidates. As weoffer and grant franchises for our Einstein Bros. brand, our reliance on ourfranchisees is expected to increase in proportion to growth of the franchiseebase. With respect to franchising our Einstein Bros. brand, we may not be ableto identify franchisees that meet our criteria, or to enter into franchise areadevelopment agreements with prospective franchisee candidates that we identify.As a result, our franchise program for the Einstein Bros. brand may not grow atthe rate we currently expect, or at all.

 

*Ourrestaurants and products are subject to numerous and changing governmentregulations. Failure to comply could negatively affect our sales, increase ourcosts or result in fines or other penalties against us.*

 

Each of ourrestaurants is subject to licensing and regulation by the health, sanitation,safety, labor, building and fire agencies of the respective states, counties,cities and municipalities in which it is located. A failure to comply with oneor more regulations could result in the imposition of sanctions, including theclosing of facilities for an indeterminate period of time, or third partylitigation, any of which could have a material adverse effect on us and ourresults of operations.

 

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

 

Ourfranchising operations are subject to regulation by the Federal TradeCommission. We must also comply with state franchising laws and a wide range ofother state and local rules and regulations applicable to our business. Thefailure to comply with federal, state and local rules and regulations wouldhave an adverse effect on us.

 

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

 

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*We may notbe able to protect our trademarks, service marks and other proprietary rights.*

 

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

 

*Our abilityto use net operating loss carryforwards to offset future taxable income forU.S. federal income tax purposes is subject to limitation.*

 

In general,under Section 382 of the Internal Revenue Code, a corporation that undergoes an“ownership change” is subject to limitations on its ability to utilize itspre-change net operating losses, or NOLs, to offset future taxable income. Acorporation generally undergoes an “ownership change” when the stock ownershippercentage (by value) of its “5 percent stockholders” increases by more than 50percentage points over any three-year testing period.

 

As of October2, 2007, our net operating loss carryforwards for U.S. federal income taxpurposes were approximately $151.9 million. As a result of prior ownershipchanges, approximately $90.6 million of our NOL carryforwards are subject to anannual usage limitation of $4.7 million. Due to transactions involving the saleor other transfer of our stock from the date of our last ownership changethrough the date of the secondary public offering of our common stock, andchanges in the value of our stock during that period, such offering may resultin an additional ownership change for purposes of Section 382 or willsignificantly increase the likelihood that we will undergo an additionalownership change in the future (which could occur as a result of transactionsinvolving our stock that are outside of our control). In either event, theoccurrence of an additional ownership change would limit our ability to utilizethe approximately $61.3 million of our NOLs that are not currently subject to limitation,and could further limit our ability to utilize our remaining NOLs and possiblyother tax attributes. Limitations imposed on our ability to use NOLs and othertax attributes to offset future taxable income could cause us to pay U.S.federal income taxes earlier than we otherwise would if such limitations werenot in effect, and could cause such NOLs and other tax attributes to expireunused, in each case reducing or eliminating the benefit of such NOLs and othertax attributes to us and adversely affecting our future cash flow. There can beno assurance that we will realize any U.S. federal income tax benefit from anyof our net operating loss carryforwards. Similar rules and limitations mayapply for state income tax purposes as well.

 

**RiskFactors Relating to Our Common Stock**

 

*We have amajority stockholder.*

 

GreenlightCapital, L.L.C. and its affiliates beneficially own approximately 67.9% of ourcommon stock. As a result, Greenlight has sufficient voting power, without thevote of any other stockholders, to determine what matters will be submitted forapproval by our stockholders, to approve actions by written consent without theapproval of any other stockholders, to elect all of the members of our board ofdirectors, and to determine whether a change in control of our company occurs.Greenlight’s interests on matters submitted to stockholders may be differentfrom those of other stockholders. Greenlight is not involved in our day-to-dayoperations, but Greenlight has voted its shares to elect our current board ofdirectors. The chairman of our board of directors is a current employee ofGreenlight.

 

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

 

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

 

If asubstantial number of shares of our common stock are sold in the public market,the market price of our common stock could fall. The perception among investorsthat these sales will occur could also produce this effect. Our majoritystockholder, Greenlight, beneficially owns approximately 67.9% of our commonstock and sales by Greenlight or a perception that Greenlight will sell couldcause a decrease in the market price of our common stock.

 

*We have notyet completed our evaluation of our internal control over financial reportingin compliance with Section 404 of the Sarbanes-Oxley Act.*

 

We will berequired to comply with the internal control evaluation and certificationrequirements of Section 404 of the Sarbanes-Oxley Act by the end of our 2007fiscal year. We have not yet completed our evaluation of whether our currentinternal control over financial reporting is compliant with Section 404. We maynot be compliant and may not be able to meet the Section 404 requirements in atimely manner. If it is determined that we are not in compliance with Section404, we may be required to implement new internal control procedures andre-evaluate our financial reporting. We may experience higher than anticipatedoperating expenses as well as outside auditor fees during the implementation ofthese changes and thereafter. Further, we may need to hire additional qualifiedpersonnel in order for us to be compliant with Section 404. If we are unable toimplement these changes effectively or efficiently, it could harm ouroperations, financial reporting or financial results and could result in ourconclusion that our internal control over financial reporting is not effective.

 

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**Item 6.  Exhibits**

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

 

 

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**Signatures**

 

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

 

 
|        |              | EINSTEIN  NOAH RESTAURANT GROUP, INC. |
|--------|-------------------|---------------------------------------|
|   |              |                                  |
|   |              |                                  |
| Date:  | November 9,  2007 | By: /s/ PAUL  J. B. MURPHY, III       |
|   |              | Paul J.B.  Murphy, III                |
|   |              | Chief  Executive Officer              |
|   |              |                                  |
| Date:  | November 9,  2007 | By: /s/  RICHARD P. DUTKIEWICZ        |
|   |              | Richard P.  Dutkiewicz                |
|   |              | Chief  Financial Officer              |

 

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