Einstein Noah Restaurant (BAGL) 10-Q 2008 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2008

OR

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

Commission File Number 0-27148

Einstein Noah Restaurant Group, Inc.

(Exact name of registrant as specified in its charter)

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

(303) 568-8000

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal 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 the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter 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 x  No o

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

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

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

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

EINSTEIN NOAH RESTAURANT GROUP, INC.

TABLE OF CONTENTS

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

2

PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements

EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share information)

(Unaudited)

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

The accompanying notes are an integral part of these consolidated financial statements.

3

EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except earnings per share and related share information)

(unaudited)

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

The accompanying notes are an integral part of these consolidated financial statements.

4

EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

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

The accompanying notes are an integral part of these consolidated financial statements.

5

EINSTEIN NOAH RESTAURANT GROUP, INC.

Notes to the Consolidated Financial Statements (Unaudited)

1.Basis of Presentation

The accompanying consolidated balance sheet as of January 1, 2008, which has been derived from audited financial statements, and the unaudited consolidated financial statements of Einstein Noah Restaurant Group, Inc. and its wholly-owned subsidiaries (collectively, the “Company”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  The information furnished herein reflects all adjustments (consisting only of normal recurring accruals and adjustments), which are, in our opinion, necessary to fairly state the interim operating results for the respective periods.

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

Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States have been omitted pursuant to Security Exchange Commission (“SEC”) rules and regulations. The notes to the consolidated financial statements (unaudited) should be read in conjunction with the notes to the consolidated financial statements contained in our annual report on Form 10-K for the fiscal year ended January 1, 2008. We believe that the disclosures are sufficient for interim financial reporting purposes.  However, these operating results are not necessarily indicative of the results expected for the full fiscal year.  Additionally, our business is subject to seasonal trends. Generally, our revenues and results of operations in the fourth fiscal quarter tend to be the most significant.

2.Recent Accounting Pronouncements

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

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

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

In April 2008, the FASB issued FASB Staff Position No. FAS 142-3, Determination of the Useful Life of Intangible Assets (“FSP 142-3”).  FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions that are used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets and requires enhanced related disclosures.  FSP 142-3 must be applied prospectively to all intangible assets acquired as of and subsequent to fiscal years beginning after

6

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

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”). SFAS 162 identifies the sources of accounting principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (“GAAP”) in the United States (“the GAAP hierarchy”). This Statement will be effective November 15, 2008. The Company currently adheres to the hierarchy of GAAP as presented in SFAS 162 and does not expect its adoption will have a material impact on its consolidated results of operations and financial condition.

We have considered all other recently issued accounting pronouncements and do not believe the adoption of such pronouncements would have a material impact on our consolidated financial statements.

3.Stock Based Compensation

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

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

The expected term of options is based upon evaluations of historical and expected future exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life at the grant date. Implied volatility is based on the mean reverting average of our stock’s historical volatility and that of an industry peer group. The use of mean reversion is supported by evidence of a correlation between stock price volatility and a company’s leverage combined with the effects mandatory principal payments will have on our capital structure, as defined under our debt facility. We have not historically paid any dividends and are currently precluded from doing so under our debt covenants.

As of September 30, 2008, we had approximately $1.8 million of total unrecognized compensation cost related to non-vested awards granted under our stock option and stock appreciation rights plans, which we expect to recognize over a weighted average period of 2.3 years. Total compensation costs related to the non-vested awards outstanding as of September 30, 2008 will be fully recognized through the fourth quarter of fiscal 2011, which represents the end of the requisite service period.

7

Stock Option Plan Activity

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

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

Stock Appreciation Rights Plan Activity

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

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

8

4.Supplemental Cash Flow Information

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

5.Inventories

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

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

6.Senior Notes and Other Long-Term Debt

Senior notes and other long-term debt consist of the following:

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

9

First Lien Term Loan and Revolving Facility

Our debt is composed of a modified term loan with a principal amount of $90 million and a $20 million revolving credit facility. We may prepay amounts outstanding under the senior secured credit facility and may terminate commitments in whole at any time without penalty or premium upon prior written notice.  Borrowings under this senior secured credit facility bear interest at a rate equal to an applicable margin plus, at our option, either a variable base rate or a Eurodollar rate. As of September 30, 2008, the weighted average interest rate under the $90 million First Lien Term Loan (“First Lien Term Loan”) was 5.48%. The revolving facility and the First Lien Term Loan contain usual and customary covenants including consolidated leverage ratios, fixed charge coverage ratios, limitations on capital expenditures, etc. As of January 1, 2008 and September 30, 2008 we were in compliance with all our financial and operating covenants.

In addition to our quarterly payments of $225,000 due on our First Lien Term Loan and the $280,000 final installment of the New Jersey Economic Development Authority Note Payable, we are also required to make excess cash flow payments on our First Lien Term Loan as defined in our debt agreement.  We estimate that approximately $8.0 million will be due and payable in the first quarter of 2009.

The revolving credit facility remains available, subject to certain conditions, to finance our ongoing working capital, capital expenditure and general corporate needs.  In addition, all of the revolving credit facility is available for letters of credit. As of September 30, 2008, we had $7.0 million in letters of credit outstanding under this facility. The letters of credit expire on various dates during 2008 and 2009, are automatically renewable for one additional year and are payable upon demand in the event that we fail to pay the underlying obligation. Our availability under the revolving facility was $13.0 million at September 30, 2008.

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

7.Interest Rate Swap and Other Comprehensive Income

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

The Company’s interest rate swap agreement qualifies as a cash flow hedge, as defined by SFAS 133, Accounting for Derivative Instruments and Hedging Activities.  The fair value of the interest rate swap agreement, which will be adjusted regularly, will be recorded in the Company’s balance sheet as an asset or liability, as necessary, with a corresponding adjustment to accumulated other comprehensive loss within equity.

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

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

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

·Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

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

10

Comprehensive income consisted of the following:

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

The Company will reclassify any gain or loss from accumulated other comprehensive loss, net of tax, on the Company’s condensed consolidated balance sheet to other expense/income on the Company’s consolidated statements of operations when the interest rate swap expires or at the time the Company chooses to terminate the swap.

8.Net Income Per Common Share

In accordance with SFAS No. 128, Earnings per Share, we compute basic net income per common share by dividing the net income for the period by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted average number of shares of common stock and potential common stock equivalents outstanding during the period using the treasury stock method. Potential common stock equivalents include incremental shares of common stock issuable upon the exercise of stock options and warrants. Potential common stock equivalents are excluded from the computation of diluted net income per share when their effect is anti-dilutive.

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

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

9.Income Taxes

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

11

As of September 30, 2008, NOL carryforwards of $140.4 million were available to be utilized against future taxable income for years through fiscal 2026, subject in part to annual limitations. As a result of prior ownership changes, approximately $93.8 million of our NOL carryforwards are subject to an annual usage limitation of $4.7 million.  Our ability to utilize our NOL carryforwards, including those that are not currently subject to limitation, could be limited or further limited in the event that we undergo an “ownership change” as that term is defined for purposes of Section 382 of the Internal Revenue Code.  We are in the process of filing a request with the Internal Revenue Service to review our methodology for determining ownership changes in accordance with Internal Revenue Code Section 382. Upon acceptance of our request, we believe that our NOL carryforwards will be available for utilization. In the event that our request is not accepted, approximately $17.9 million of NOL carryforwards will be at risk to expire prior to utilization.

Our NOL carryforwards are included in our deferred income tax assets and have been fully reserved.  Additionally, we maintain a full valuation allowance against our total net deferred tax assets.  In accordance with SFAS No. 109, Accounting for Income Taxes, (“SFAS No. 109”) we assess the continuing need for a valuation allowance that results from uncertainty regarding our ability to realize the benefits of our deferred tax assets.

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

·The level of historical taxable income and projections for future taxable income over periods in which the deferred tax assets would be deductible, and

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

We will continue to review various qualitative and quantitative data in regards to the realization of our deferred tax assets, including:

·Events within the restaurant industry,

·The cyclical nature of our business,

·The health of the economy,

·Our future forecasts of taxable income and

·Historical trending.

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 2005 through 2008. With a few exceptions, we are no longer subject to U.S. federal, state or local examinations by tax authorities for the tax year 2004 and prior.

10.Commitments and Contingencies

Letters of Credit and Line of Credit

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

Litigation

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

12

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

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

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

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

13

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Note Regarding Forward-Looking Statements

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

General

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

Company Overview

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

Executive Summary

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

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

14

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

15

Current Restaurant Base

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

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

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

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

New Restaurant Openings

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

We have opened two franchise restaurants in 2008 and we will have three locations which are expected to be in various stages of development during the fourth quarter of 2008 with openings scheduled for the first half of 2009.

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

Results of Operations

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

16

Consolidated Results

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

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

For the thirty-nine weeks ended September 30, 2008 compared to the same period in 2007, total revenue increased $11.9 million, gross profit increased $0.9 million, income from operations improved $0.6 million, and our income before income taxes increased $10.0 million. This growth is primarily due to having six additional company-owned restaurants and 28 additional franchise and license locations from a year ago, which increased our sales and cost of sales.  Additionally, revenues have increased as a result of higher comparable store sales, partially offset by increased cost of sales which was primarily driven by rising commodity costs and labor costs for both the company-owned restaurants and our manufacturing and commissary operations.  Adding to this was a decrease in our general and administrative expenses related to decreased stock-based compensation expense and other cost savings, decreased interest expense related to the debt redemption in 2007, off-set by an increase in depreciation expense from the new restaurants that have been opened and upgrades that have been completed, as well as the $1.9 million related to the settlement of two class-action lawsuits in California.

Company-Owned Restaurant Operations

Revenues

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

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

17

primarily due to a decline in volume, offset by the aforementioned price increases coupled with a net increase in restaurants opened over the last twelve months.  On average, the restaurants opened since October 2, 2007 are higher volume restaurants relative to those that were closed over the same period, which positively contributed to our sales.

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

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

Cost of Sales

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

Cost of Goods Sold

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

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

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

Labor Expenses

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

18

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

For the thirty-nine weeks ended September 30, 2008 compared to the same period in 2007, labor costs increased from a combination of the growth of new restaurant openings that occurred throughout 2007 and the first thirty-nine weeks of 2008, and an increase in base pay year-over-year from a combination of merit and an overall inflationary shift in our compensation structure caused by a January 2008 increase in minimum wage rates at the federal level and in several states in which we operate, partially offset by a decrease in incentive compensation and insurance costs.

Other Operating Costs

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

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

Rent and related, and marketing costs

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

Rent and related, and marketing costs consist of restaurant-level rent expense, common area maintenance expense, property taxes and marketing expense.  For the thirteen and thirty-nine weeks ended September 30, 2008, rent and related and marketing costs increased $0.4 million and $0.8 million, respectively, compared to the same periods in 2007.  The increase is principally attributable to an increase in rent and related expense, partially offset by a decrease in marketing expense.

Manufacturing and Commissary Operations

Revenues

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

** not meaningful

19

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

Cost of Sales

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

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

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

·Manufacturing costs of goods sold are increased predominantly due to an increase in commodity costs and, to a lesser extent, a rise in volume of units sold.

·Labor expenses decreased for the thirteen weeks ended September 30, 2008 compared to the same period in 2007.  This was due to a decrease in incentive compensation and a decrease in personnel that occurred late in the second quarter of 2008, partially off-set by an increase in merit pay year-over-year coupled with increased minimum wage rates at the federal level and in some states in which we operate, and to a lesser extent an increase in the cost of employee benefits.

·The change in labor expenses for the thirty-nine weeks ended September 30, 2008 compared to the same period in 2007 was negligible.

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

Franchise and License Operations

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

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

20

General and Administrative Expenses

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

** not meaningful

Our general and administrative expenses decreased $2.1 million and $3.5 million for the thirteen and thirty-nine weeks ended September 30, 2008, respectively, compared to the same periods in 2007. The overall decrease was partially related to a decrease in stock-based compensation expense that was primarily due to the additional options that were granted and vested in the second quarter of 2007 related to the secondary public offering, which did not occur again in 2008. Additionally, in 2008 compared to 2007, the Company had decreases in travel expense, recruiting and referral fees, and relocation expense related to our corporate headquarters.

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

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

Depreciation and Amortization, Disposal and Impairment Charges

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

   ** not meaningful

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

21

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

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

Interest Expense, Net and Other Expenses

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

** not meaningful

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

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

The Company entered into an interest rate swap which became effective in August 2008 and will expire in two years.  The net effect of the swap fixed our interest rate on $60.0 million of our First Lien Term Loan at 3.52% plus an applicable margin. While 1-month LIBOR was lower than our fixed rate in the first month of the swap, it has increased during the second month. On a prospective basis, we cannot estimate the impact of LIBOR due to the uncertainties in the current credit market.

Income Taxes

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

22

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

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

Financial Condition, Liquidity and Capital Resources

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

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

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

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

Working Capital Deficit

On September 30, 2008, we had unrestricted cash of $22.2 million and restricted cash of $0.9 million. Under the Revolving Facility, there were no outstanding borrowings, $7.0 million in letters of credit outstanding and borrowing availability of $13.0 million. On June 30, 2008 we reclassified the $57 million Mandatorily Redeemable Series Z Preferred Stock as a short term liability which resulted in our working capital shifting to a deficit, which was $54.7 million on September 30, 2008 compared to a surplus of $3.7 million on January 1, 2008.  Adding to the deficit was a decrease in our non-cash current assets and an increase in current liabilities for the following primary reasons:

·accounts receivable has decreased due to improved collection efforts,

·other assets decreased as we were able to recover several deposits that were held by our vendors,

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

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

23

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

Covenants

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

Capital Expenditures

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

·$5.9 million to open nine new restaurants in 2008,

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

·$0.7 million towards eight restaurants that are currently under construction and are scheduled to open in 2008,

·$5.0 million for upgrading existing restaurants in 2008,

·$0.1 million for restaurants that were upgraded in 2007,

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

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

·$0.3 million for equipment at our manufacturing operations, and

·$2.1 million for general corporate purposes.

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

Off-Balance Sheet Arrangements

Except for our line of credit and letters of credit, we do not have any off-balance sheet arrangements.  For the thirteen and thirty-nine weeks ended September 30, 2008, there were no material changes outside the ordinary course of business to our contractual obligations.

Critical Accounting Policies and Estimates

Information regarding recent accounting pronouncements is incorporated by reference from Note 2 to our Consolidated Financial Statements set forth in Part I of this report.

In the first quarter of 2008, we reviewed the depreciable lives of our assets and determined that the economic useful life for leasehold improvements on new restaurants should be the shorter of 10 years or the life of the lease, which is typically 10 years.  We also determined that the economic useful lives of our restaurant upgrades should be the shorter of 5 years or the life of the lease. However, as we approve our restaurants to be upgraded, we simultaneously review the lease, and typically only upgrade those locations that have a renewal option and we are reasonably assured that the lease will be renewed.

In the first quarter of 2008, we reviewed the expected term of our options and SARs using the guidance under SFAS 123(R) and SAB 110.  Previously, all options had an expected term of 4 years, but subsequent to our secondary offering and listing back onto the NASDAQ Global Market exchange, we determined that each plan should be evaluated separately and we revised the expected term for newly issued options.  We estimated that the expected term for the 2003 Executive Employee Incentive Plan, the 2004 Stock Option Plan for Independent Directors, and the Stock Appreciation Rights Plan should be 6 years, 2.75 years and 3.25 years, respectively.

24

The effects of these two changes in estimates are recorded prospectively in accordance with SFAS 154 Accounting Changes and Error Corrections.  These changes, individually and in the aggregate, do not materially change the income from operations, net income or the net income per common share.

There were no other material changes in our critical accounting policies since the filing of our 2007 Form 10-K. As discussed in that filing, the preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the amount of reported assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the periods reported. Actual results may differ from those estimates.

25

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

During the thirteen and thirty-nine weeks ended September 30, 2008 and October 2, 2007, our results of operations, financial position and cash flows have not been materially affected by changes in the relative values of non-U.S. currencies to the U.S. dollar. We do not use derivative financial instruments to limit our foreign currency risk exposure since virtually all of our business is conducted in the United States.

Our manufacturing operation sells bagels to a wholesaler and a distributor who both take possession in the United States and sell outside of the United States. As the product is shipped FOB domestic dock, there are no international risks of loss or foreign exchange currency issues. Sales shipped internationally are included in manufacturing and commissary revenue. We continue to look for other international opportunities.

Our debt as of September 30, 2008 was principally composed of the amended Revolving Facility and First Lien Term Loan.  For fixed rate debt, interest rate changes affect the fair market value of such debt but do not impact earnings or cash flows. Conversely for variable rate debt, including borrowings under our revolving facility and first lien term loan, interest rate changes generally do not affect the fair market value of such debt, but do impact future earnings and cash flows, assuming other factors are held constant.

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

Assuming no change in the size or composition of debt as of September 30, 2008, and presuming the utilization of our accumulated net operating losses would minimize the tax implications for the next several years, a 100 basis point increase in short-term effective interest rates would increase our interest expense on our Revolving Facility and First Lien Term Loan, including the interest rate swap, by approximately $0.3 million annually.  Currently, the interest rates on our revolving facility and first lien term loan are predominantly at LIBOR rates plus an applicable margin through short-term fixed rate financing and the interest rate swap has fixed our rate on $60 million of our outstanding debt. The estimated increase in interest expense incorporates the fixed interest financing into its assumptions.

On an annual basis, we purchase a substantial amount of agricultural products that are subject to fluctuations in price based upon market conditions. Our purchase arrangements may contain contractual features that limit the price paid by establishing certain price floors or caps. We do not use financial instruments to hedge commodity prices.  We have utilized a subsidiary of Cargill, Incorporated to manage our wheat purchases for our company-owned production facility.  In addition to wheat, we have established contracts and entered into commitments with our vendors for butter, cheese, and coffee.

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

26

Item 4.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An evaluation was carried out under the supervision and with the participation of company management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of September 30, 2008. Based upon that evaluation, our chief executive officer and our chief financial officer have concluded that the design and operation of our disclosure controls and procedures were effective in timely making known to them material information relating to the Company required to be disclosed in reports that we file or submit under the Exchange Act rules.

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

Changes in Internal Control over Financial Reporting

During the thirty-nine weeks ended September 30, 2008, there were no changes to our internal controls over financial reporting that were identified in connection with the evaluation of our disclosure controls and procedures required by the Exchange Act rules and that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

27

PART II - OTHER INFORMATION

Item 1.    Legal Proceedings

Information regarding legal proceedings is incorporated by reference from Note 10 to our Consolidated Financial Statements set forth in Part I of this report.

Item 1A.  Risk Factors

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

Risk Factors Relating to Our Business and Our Industry

General economic conditions have affected, and could continue to affect, discretionary consumer spending, particularly spending for meals prepared away from home.

International, national and local economic conditions, including credit and mortgage markets, energy costs, lay-offs, foreclosure rates, bankruptcies, and similar adverse economic news and factors affect discretionary consumer spending. These factors could reduce consumers’ discretionary spending which in turn could reduce our guest traffic or average check.  In 2006, 2007 and currently through 2008, restaurants industry-wide were adversely affected as a result of reduced consumer spending due to rising fuel and energy costs.  The conditions experienced recently also include reduced consumer confidence, on-going concerns about the housing market, concerns over the stability of financial institutions, and increased health care and energy costs.  Adverse changes in consumer discretionary spending, which could be affected by many different factors which are out of our control, including those listed above, could harm our business prospects, financial condition, operating results and cash flows.  Our success will depend in part upon our ability to anticipate, identify and respond to changing economic and other conditions.

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

Failure to protect food supplies and adhere to food safety standards could result in food-borne illnesses and/or injuries to our guests. Damage to our reputation for serving high quality, safe food could adversely affect our results.

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

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

28

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

Changes in consumer preferences could harm our financial results.

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

Increasing commodity prices would adversely affect our gross profit.

Global demand for commodities such as wheat has resulted in higher prices for flour and has increased our costs.  The prices of our main ingredients are directly associated with the changing weather conditions as well as economic factors such as supply and demand of certain commodities within the United States and other countries.  Our ability to forecast and manage our commodities could significantly affect our gross margins.

Due to increased demand for ethanol, the cost of corn has increased substantially, which has increased the cost of corn-sourced ingredients as well as other commodities such as wheat, the primary ingredient in most of our products.  This demand and these commodity pressures could continue for 2008 and into 2009 as well. Any increase in the prices of the ingredients most critical to our products, such as wheat, could adversely affect our operating results.

Additionally, in the event of destruction of products such as tomatoes or peppers or massive culling of specific animals such as chickens or turkeys to prevent the spread of disease, the supply and availability of ingredients may become limited. This could dramatically increase the price of certain menu items which could decrease sales of those items or could force us to eliminate those items from our menus entirely. All of these factors could adversely affect our business, reputation and financial results.

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

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

·expand sales at our existing company-owned restaurants;

·open new company-owned restaurants; and

·open new franchised and licensed restaurants.

Our ability to achieve any or all of these initiatives is uncertain. Our success in expanding sales 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 program and upgrading our restaurants is dependent in part on our ability to predict and satisfy consumer preferences and as mentioned above, consumers ability to respond positively in a troublesome economic environment. Our success in growing our business through opening new company-owned restaurants is dependent on a number of factors, including our ability to: find suitable locations, reach acceptable lease terms, have adequate capital, find available contractors, obtain licenses and permits, locate and train appropriate staff and properly manage the new restaurant. Our success in opening new franchised and licensed restaurants is dependent upon, among other factors, our ability to: attract quality businesses to invest in our core brands, maintain the effectiveness of our franchise disclosure documents in target states, offer restaurant solutions for a variety of location types and the ability of our franchisees and licensees to: find suitable locations, reach acceptable lease terms, have adequate capital, secure reasonable

29

financing, find available contractors, obtain licenses and permits, locate and train staff appropriately and properly manage the new restaurants. Accordingly, we may not be able to open or upgrade as many restaurants or grant as many franchises or licenses as we project or otherwise execute on our strategy. If we are not successful in implementing any or all of the initiatives of our business strategy, it could have a material adverse effect on our business, results of operations, and financial condition.

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

The level of growth in comparable store sales significantly affects our overall sales growth and will be a critical factor affecting profit growth. Our ability to increase comparable store sales depends in part on our ability to offer hospitality and attractive menu items, and successfully implement our initiatives to increase throughput, such as increasing the speed at which our employees serve each guest. Factors such as traffic patterns, local demographics, the type, number and location of competing restaurants and economic climate may adversely affect the performance of individual restaurants. It is possible that we will not achieve our targeted comparable store sales growth or that the change in comparable store sales could be negative and could adversely impact our sales and profit growth.

Competition in the restaurant industry is intense, and we may fall short of our revenue and profitability targets if we are unable to compete successfully.

Our industry is highly competitive and there are many well-established competitors with substantially greater financial and other resources than we have. Although we operate in the fast-casual segment of the restaurant industry, we also consider restaurants in the fast-food and full-service segments to be our competitors. Several fast-casual and fast-food chains are focusing more on breakfast offerings and expanding their coffee offerings. This could further increase competition in the breakfast daypart. In addition to current competitors, one or more new major competitors with substantially greater financial, marketing and operating resources could enter the market at any time and compete directly against us. Also, in virtually every major metropolitan area in which we operate or expect to enter, local or regional competitors already exist. This may make it more difficult to obtain real estate and advertising space, and to attract and retain guests and personnel.

We occupy our company-owned restaurants under long-term non-cancelable leases, and we may be unable to renew leases at the end of their lease periods or obtain new leases on acceptable terms.

We do not own any real property, and all of our company-owned restaurants are located in leased premises. Many of our current leases are non-cancelable and typically have terms ranging from five to ten years with two three- to five-year renewal options. We believe leases that we enter into in the future likely will also be long-term and non-cancelable and have similar renewal options. Most of our leases 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 remain committed to perform our obligations under the applicable lease, which would include, among other things, payment of the base rent for the balance of the lease term. In some instances, we may be unable to close an underperforming restaurant due to continuous operation clauses in our lease agreements. Our obligation to continue making rental payments in respect of leases for closed or underperforming restaurants could have a material adverse effect on our business and results of operations.

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

30

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

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

The cost of energy impacts our results of operations in several ways.  We have seen our cost of electricity gradually increase over time. Distribution costs related to fuel have impacted our operations negatively. Additionally, travel costs, including gas prices and airline fares, have been increasing significantly nationwide. These costs impact our results of operation currently and could impact us negatively in the future.

Our operations may be negatively impacted by adverse weather conditions and natural disasters.

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

The effects of hurricanes, fires, freezes and other adverse weather conditions are likely to affect supply of and costs for raw ingredients and natural resources, near-term construction costs for our new restaurants as well as sales in our restaurants going forward. If we are not able to anticipate or react to changing costs of food and other raw materials by adjusting our purchasing practices or menu prices, our operating margins would likely deteriorate.

We have single suppliers for most of our key ingredients, and the failure of any of these suppliers to perform could harm our business.

We currently purchase our raw materials from various suppliers; however, we have only one supplier for each of our key ingredients. We purchase a majority of our frozen bagel dough from a single supplier, who utilizes our proprietary processes and on whom we are dependent in the short-term. All of our remaining frozen bagel dough is produced at our dough manufacturing facility in Whittier, California. Additionally, we purchase all of our cream cheese from a single source. Although to date we have not experienced significant difficulties with our suppliers, our reliance on a single supplier for each of our key ingredients subjects us to a number of risks, including possible delays or interruption in supplies, diminished control over quality and a potential lack of adequate raw material capacity. Any disruption in the supply or degradation in the quality of the materials provided by our suppliers could have a material adverse effect on our business, operating results and financial condition. In addition, any such disruptions in supply or degradations in quality could have a long-term detrimental impact on our efforts to maintain a strong brand identity and a loyal consumer base.

31

Failure of our distributors to perform adequately or any disruption in our distributor relationships could adversely affect our business and reputation.

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

Increasing labor costs could adversely affect our results of operations and cash flows.

We are dependent upon an available labor pool of associates, many of whom are hourly employees whose wages may be affected by increases in the federal, state or municipal “living wage” rates. Numerous increases have been made on federal, state and local levels to increase minimum wage levels. Increases in state minimum hourly wage rates in some of the states in which we operate became effective January 2008, and the federal minimum wage increased on July 24, 2008 and the minimum wage will be raised again in 2009. Increases in the minimum wage may create pressure to increase the pay scale for our associates, which would increase our labor costs and those of our franchisees and licensees.

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

We may not be able to generate sufficient cash flow to make payments on our substantial amount of debt and mandatorily redeemable preferred stock.

We have a considerable amount of debt and are substantially leveraged.  In addition, we may, subject to certain restrictions, incur substantial additional indebtedness in the future. Our high level of debt, among other things, could:

·make it difficult for us to satisfy our obligations under our indebtedness;

·limit our ability to obtain additional financing for working capital, capital expenditures, acquisitions and general corporate purposes;

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

·increase our vulnerability to volatility in interest rates; and

·limit our ability to withstand competitive pressures from our less leveraged competitors.

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

32

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

We must comply with certain covenants inherent in our debt agreements to avoid defaulting under those agreements.

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

We face the risk of adverse publicity and litigation in connection with our operations.

We are from time to time the subject of complaints or litigation from our consumers alleging illness, injury or other food quality, health or operational concerns. Adverse publicity resulting from these allegations may materially adversely affect us, regardless of whether the allegations are valid or whether we are liable. In addition, employee claims against us based on, among other things, discrimination, harassment or wrongful termination, or labor code violations may divert financial and management resources that would otherwise be used to benefit our future performance.  For example, we recently settled two class actions in California as described in Note 10 to our Consolidated Financial Statements set forth in Part I of this report. There is also a risk of litigation from our franchisees with regard to the terms of our franchise arrangements. We have been subject to a variety of these and other claims from time to time and a significant increase in the number of these claims or the number that are successful could materially adversely affect our business, prospects, financial condition, operating results or cash flows.

A regional or global health pandemic could severely affect our business.

A health pandemic is a disease that spreads rapidly and widely by infection and affects many individuals in an area or population at the same time. In 2004, 2005 and 2006, Asian and European countries experienced outbreaks of avian flu and it is possible that it will continue to migrate to the United States where our restaurants are located. If a regional or global health pandemic were to occur, depending upon its duration and severity, our business could be severely affected. We have positioned ourselves as a “neighborhood atmosphere” between home and work where people can gather for human connection and high quality food. Customers might avoid public gathering places in the event of a health pandemic, and local, regional or national governments might limit or ban public gatherings to halt or delay the spread of disease. A regional or global pandemic might also adversely impact our business by disrupting or delaying production and delivery of products and materials in our supply chain and causing staff shortages in our restaurants. The impact of a health pandemic might be disproportionately greater on us than on other companies that depend less on the gathering of people in a neighborhood atmosphere.

Our franchisees and licensees may not help us develop our business as we expect, or could actually harm our business.

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

33

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

Our restaurants and products are subject to numerous and changing government regulations. Failure to comply could negatively affect our sales, increase our costs or result in fines or other penalties against us.

Each of our restaurants 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 one or more regulations could result in the imposition of sanctions, including the closing of facilities for an indeterminate period of time, or third party litigation, any of which could have a material adverse effect on us and our results of operations.

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

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

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

We may not be able to protect our trademarks, service marks and other proprietary rights.

We believe our trademarks, service marks and other proprietary rights are important to our success and our competitive position. Accordingly, we devote substantial resources to the establishment and protection of our trademarks, service marks and proprietary rights. However, the actions we take may be inadequate to prevent imitation of our products and concepts by others, to prevent various challenges to our registrations or applications or denials of applications for the registration of trademarks, service marks and proprietary rights in the U.S. or other

34

countries, or to prevent others from claiming violations of their trademarks and proprietary marks. In addition, others may assert rights in our trademarks, service marks and other proprietary rights.

Our ability to use net operating loss carryforwards to offset future taxable income for U.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 its pre-change net operating loss (“NOL”) carryforwards to offset future taxable income. A corporation generally undergoes an “ownership change” when the stock ownership percentage (by value) of its “5 percent stockholders” increases by more than 50 percentage points over any three-year testing period.

As of September 30, 2008, our NOL carryforwards for U.S. federal income tax purposes were approximately $140.4 million. As a result of prior ownership changes, approximately $93.8 million of our NOL carryforwards are subject to an annual usage limitation of $4.7 million. Due to transactions involving the sale or other transfer of our stock from the date of our last ownership change through the date of the secondary public offering of our common stock, and changes in the value of our stock during that period, such offering may result in an additional ownership change for purposes of Section 382 or will significantly increase the likelihood that we will undergo an additional ownership change in the future (which could occur as a result of transactions involving our stock that are outside of our control).   In either event, the occurrence of an additional ownership change would limit our ability to utilize the approximately $46.6 million of our NOL carryforwards that are not currently subject to limitation, and could further limit our ability to utilize our remaining NOL carryforwards and possibly other tax attributes. Limitations imposed on our ability to use NOL carryforwards and other tax attributes to offset future taxable income could cause us to pay U.S. federal income taxes earlier than we otherwise would if such limitations were not in effect, and could cause such NOL carryforwards and other tax attributes to expire unused, in each case reducing or eliminating the benefit of such NOL carryforwards and other tax attributes to us and adversely affecting our future cash flow. We are in the process of filing a request with the Internal Revenue Service to review our methodology for determining ownership changes in accordance with Internal Revenue Code Section 382.  Upon acceptance of our request, we believe that our NOL carryforwards will be available for utilization.  In the event that our request is not accepted, approximately $17.9 million of NOL carryforwards will be at risk to expire prior to utilization.  Similar rules and limitations may apply for state income tax purposes as well.

Risk Factors Relating to Our Common Stock

We have a majority stockholder.

Greenlight Capital, L.L.C. and its affiliates beneficially own approximately 67.2% of our common stock. As a result, Greenlight has sufficient voting power, without the vote of any other stockholders, to determine what matters will be submitted for approval by our stockholders to elect all of the members of our board of directors, and to determine whether a change in control of our company occurs. Greenlight’s interests on matters submitted to stockholders may be different from those of other stockholders. Greenlight has voted its shares to elect our current board of directors, and the chairman of our board of directors is a current employee of Greenlight.

We have listed our common stock on the NASDAQ Global Market. NASDAQ rules require us to have an audit committee consisting entirely of independent directors. However, under NASDAQ rules, if a single stockholder holds more that 50% of the voting power of a listed company, that company is considered a controlled company, and is exempt from several other corporate governance rules, including the requirement that companies have a majority of independent directors and independent director involvement in the selection of director nominees and in the determination of executive compensation. As a result, our stockholders will not have, and may never have, the protections that these rules are intended to provide. The Company currently has a majority of independent directors on the board of directors.

35

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

If a substantial 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 investors that these sales will occur could also produce this effect. Our majority stockholder, Greenlight, beneficially owns approximately 67.2% of our common stock and sales by Greenlight or a perception that Greenlight will sell could cause a decrease in the market price of our common stock.

36

Item 6.  Exhibits

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

Signatures

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

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

37