10-Q

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 July 1, 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, an 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. (Check one):

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

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 August 1, 2008, there were 15,932,856 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
	Consolidated Statement of Changes in Stockholders’ Deficit	6
	Notes to the Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	32
Item 4.	Controls and Procedures	33
Part II. Other Information
Item 1.	Legal Proceedings	34
Item 1A.	Risk Factors	34
Item 4.	Submission of Matters to a Vote of Security Holders	43
Item 6.	Exhibits	44

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PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements

EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share information)

(Unaudited)

	January 1,			July 1,
	2008			2008
ASSETS
Current assets:
Cash and cash equivalents	$	9,436		$	18,416
Restricted cash	1,203			876
Franchise and other receivables, net ofallowance of $606 and $278, respectively	7,807			6,498
Inventories	5,313			4,917
Prepaid expenses and other current assets	5,281			5,036
Total current assets	29,040			35,743
Property, plant and equipment, net	47,714			52,532
Trademarks and other intangibles, net	63,831			63,831
Goodwill	4,981			4,981
Debt issuance costs and other assets, net	2,996			2,881
Total assets	$	148,562		$	159,968
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$	5,072		$	5,472
Accrued expenses and other current liabilities	19,279			19,795
Short-term debt and current portion of long-term debt	955			1,180
Current portion of obligations under capital leases	80			79
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			83,526
Senior notes and other long-term debt	88,875			87,200
Long-term obligations under capital leases	67			29
Other liabilities	10,841			11,034
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			181,789
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 15,932,856 shares issued and outstanding	16			16
Additional paid-in capital	262,830			263,860
Accumulated deficit	(296,453		)	(285,697		)
Total stockholders’ deficit	(33,607		)	(21,821		)
Total liabilities and stockholders’ deficit	$	148,562		$	159,968

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

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EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

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

(unaudited)

	13 weeks ended					26 weeks ended
	July 3,			July 1,		July 3,		July 1,
	2007			2008		2007		2008
Revenues:
Company-owned restaurant sales	$	94,141		$	96,321	$	183,256	$	189,931
Manufacturing and commissary revenues	5,682			7,640		11,500		15,728
Franchise and license related revenues	1,232			1,453		2,554		3,019
Total revenues	101,055			105,414		197,310		208,678
Cost of sales:
Company-owned restaurant costs	75,257			76,648		146,589		152,473
Manufacturing and commissary costs	5,380			7,224		10,802		15,084
Total cost of sales	80,637			83,872		157,391		167,557
Gross profit	20,418			21,542		39,919		41,121
Operating expenses:
General and administrative expenses	10,855			9,540		21,587		20,283
Depreciation and amortization	2,623			3,345		5,042		6,549
Loss on sale, disposal or abandonmentof assets, net	31			63		405		132
Impairment charges and other related costs	166			54		185		54
Income from operations	6,743			8,540		12,700		14,103
Other expense:
Interest expense, net	4,144			1,328		8,933		2,907
Write-off of debt discount upon redemption ofsenior notes	528			—		528		—
Prepayment penalty upon redemption of senior notes	240			—		240		—
Write-off of debt issuance costs upon redemptionof senior notes	2,071			—		2,071		—
Income (loss) before income taxes	(240		)	7,212		928		11,196
Provision for income taxes	10			298		47		440
Net income (loss)	$	(250	)	$	6,914	$	881	$	10,756
Net income (loss) per common share — Basic	$	(0.02	)	$	0.43	$	0.08	$	0.68
Net income (loss) per common share — Diluted	$	(0.02	)	$	0.42	$	0.07	$	0.65
Weighted average number of common shares outstanding:
Basic	11,775,597			15,925,876		11,190,612		15,908,377
Diluted	11,775,597			16,398,822		11,874,874		16,431,921

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

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EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	26 weeks ended
	July 3,			July 1,
	2007			2008
OPERATING ACTIVITIES:
Net income	$	881		$	10,756
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	5,042			6,549
Stock based compensation expense	1,250			810
Loss, net of gains, on disposal of assets	405			132
Impairment charges and other related costs	185			54
Provision for losses on accounts receivable	25			81
Amortization of debt issuance and debt discount costs	392			241
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	694			327
Franchise and other receivables	358			1,228
Accounts payable and accrued expenses	(1,225		)	2,027
Other assets and liabilities	(3,194		)	522
Net cash provided by operating activities	8,316			22,727
INVESTING ACTIVITIES:
Purchase of property and equipment	(12,404		)	(12,475		)
Proceeds from the sale of equipment	1,164			4
Acquisition of restaurant assets	—			(7		)
Net cash used in investing activities	(11,240		)	(12,478		)
FINANCING ACTIVITIES:
Proceeds from secondary common stock offering	90,000			—
Costs incurred with offering of our common stock	(6,417		)	—
Payments under capital lease obligations	(39		)	(39		)
Borrowings under First Lien Term Loan	11,900			—
Repayments under First Lien Term Loan	(475		)	(1,450		)
Repayments under Second Lien Term Loan	(65,000		)	—
Repayments under Subordinated Note	(25,000		)	—
Debt issuance costs	(842		)	—
Proceeds upon stock option exercises	430			220
Net cash provided by (used in) financing activities	4,557			(1,269		)
Net increase in cash and cash equivalents	1,633			8,980
Cash and cash equivalents, beginning of period	5,477			9,436
Cash and cash equivalents, end of period	$	7,110		$	18,416

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

5

EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ DEFICIT

(in thousands, except share information)

(Unaudited)

				Additional		Accumulated
	Common Stock			Paid In		Deficit
	Shares	Amount		Capital		Amount			Total
Balance, January 1, 2008	15,878,811	$	16	$	262,830	$	(296,453	)	$	(33,607	)
Net income	—	—		—		10,756			10,756
Common stock issued uponstock option exercise	54,020	—		220		—			220
Common stock issued uponstock appreciation right exercise	25	—		—		—			—
Stock based compensationexpense	—	—		810		—			810
Balance, July 1, 2008	15,932,856	$	16	$	263,860	$	(285,697	)	$	(21,821	)

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

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EINSTEIN NOAH RESTAURANT GROUP, INC.

Notes to the Consolidated Financial Statements (Unaudited)

1.Basis of Presentation

The 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”). As of July 1, 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”). 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.

The consolidated financial statements as of July 1, 2008 and for the thirteen and twenty-six weeks ended July 3, 2007 and July 1, 2008 have been prepared without audit. The balance sheet information as of January 1, 2008 has been derived from our audited consolidated financial statements. 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.  However, these operating results are not necessarily indicative of the results expected for the full fiscal year.

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.

2.Recent Accounting Pronouncements

Effective January 1, 2008, the Company adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, (“SFAS 157”). 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 December 2007, the FASB issued SFAS 141 (revised 2007), Business Combinations, (“SFAS 141R”). SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, including goodwill, the liabilities assumed and any non-controlling interest in the acquiree. The Statement also establishes disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The impact of adopting SFAS 141R will be dependent on the future business combinations that the Company may pursue after its effective date.

In December 2007, the SEC issued Staff Accounting Bulletin (“SAB”) 110 Share-Based Payment (“SAB 110”).  SAB 110 amends and replaces Question 6 of Section D.2 of Topic 14, Share-Based Payment, of the Staff Accounting Bulletin series. Question 6 of Section D.2 of Topic 14 expresses the views of the staff regarding the use of the “simplified” method in developing an estimate of the expected term of “plain vanilla” share options and allows usage of the “simplified” method for share option grants prior to December 31, 2007. SAB 110 allows public companies which do not have historically sufficient experience to provide a reasonable estimate to continue

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use of the “simplified” method for estimating the expected term of “plain vanilla” share option grants after December 31, 2007. SAB 110 is effective January 1, 2008. We currently use the “simplified” method to estimate the expected term for share option grants as we do not have enough historical experience to provide a reasonable estimate. We will continue to use the “simplified” method until we have enough historical experience to provide a reasonable estimate of expected term in accordance with SAB 110.

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

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 July 3, 2007 and July 1, 2008 was $919,000 and $303,000, respectively, and for the twenty-six weeks ended July 3, 2007 and July 1, 2008 was $1,250,000 and $810,000, 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		26 weeks ended
	July 3,	July 1,	July 3,	July 1,
	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	4.60 - 5.02%	2.92%	4.60 - 5.02%	2.49 - 2.92%
Volatility	28% - 97%	31.0%	28% - 97%	31.0%
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 July 1, 2008, we had approximately $1.5 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 1.95 years. Total compensation costs related to the non-vested awards outstanding as of July 1, 2008 will be fully recognized by the first quarter of fiscal 2011, which represents the end of the requisite service period.

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Stock Option Plan Activity

Transactions during the twenty-six weeks ended July 1, 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	116,738		15.61
Exercised	(54,020	)	4.09
Forfeited	—		—
Outstanding, July 1, 2008	1,171,079		$	9.00	$	4.09	$	4,552,983	7.13
Exercisable and vested, July 1, 2008	718,972		$	5.85	$	3.41	$	4,007,300	5.98

			Weighted
	Number		Average
	of		Grant Date
	Options		Fair Value
Non-vested shares, January 1, 2008	470,368		$	4.80
Granted	116,738		5.46
Vested	(134,999	)	4.16
Forfeited	—		—
Non-vested shares, July 1, 2008	452,107		$	5.16

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Stock Appreciation Rights Plan Activity

Transactions during the twenty-six weeks ended July 1, 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	(75	)	8.00
Forfeited	(11,487	)	11.46
Outstanding, July 1, 2008	70,353		$	11.92	$	5.45	$	113,685	3.83
Exercisable and vested, July 1, 2008	21,200		$	11.42	$	5.55	$	37,763	3.75

			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	(8,550	)	5.54
Non-vested shares, July 1, 2008	49,153		$	5.40

4.Supplemental Cash Flow Information

	26 weeks ended
	July 3,		July 1,
	2007		2008
	(in thousands)
Cash paid during the year to date period ended:
Interest related to:
Term Loans	$	8,185	$	2,858
$25 Million Subordinated Note	825		—
Other	172		140
Prepayment penalty upon redemption of debt	$	240	$	—
Income taxes	$	222	$	575
Non-cash investing activities:
Change in accrued expenses for purchases of property and equipment	$	2,076	$	(918	)

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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,		July 1,
	2008		2008
	(in thousands of dollars)
Finished goods	$	4,056	$	3,825
Raw materials	1,257		1,092
Total inventories	$	5,313	$	4,917

6.Goodwill, Trademarks and Other Intangibles

Intangible assets include both goodwill and identifiable intangibles arising from the allocation of the purchase prices of assets acquired. Goodwill represents the excess of cost over fair value of net assets acquired in the acquisition of Manhattan Bagel. As of July 1, 2008, intangible assets of $63.8 million were not subject to amortization and consisted primarily of the Einstein Bros., Noah’s and Manhattan Bagel trademarks.

We performed an impairment analysis of the goodwill and indefinite-lived intangible assets related to our Einstein Bros., Noah’s and Manhattan Bagel brands as of January 1, 2008 as to which there was no indication of impairment.  During the thirteen and twenty-six weeks ended July 3, 2007 and July 1, 2008, respectively there were no events or changes in circumstances that indicated that our goodwill or intangible assets might be impaired or may not be recoverable.

7.Senior Notes and Other Long-Term Debt

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

	January 1,		July 1,
	2008		2008
	(in thousands of dollars)
$90 Million First Lien Term Loan	$	89,550	$	88,100
New Jersey Economic Development Authority Note Payable	280		280
Total senior notes and other debt	$	89,830	$	88,380
Less short-term debt and current portion of long-term debt	955		1,180
Senior notes and other long-term debt	$	88,875	$	87,200

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 July 1, 2008 the weighted average interest rate under the $90 million First Lien Term Loan (“First Lien Term Loan”) was 5.07%. 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 July 1, 2008 we were in compliance with all our financial and operating covenants.

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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 July 1, 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 July 1, 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 July 1, 2008, approximately $0.4 million and $1.9 million in debt issuance costs have been capitalized for the revolving facility and the First Lien Term Loan, respectively, net of amortization.

On May 7, 2008, we entered into an interest rate swap agreement relating to our $90 million 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.

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 other comprehensive income within equity.

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					26 weeks ended
	July 3,			July 1,		July 3,		July 1,
	2007			2008		2007		2008
	(in thousands, except earnings per share and related share information)
Net income (loss) (a)	$	(250	)	$	6,914	$	881	$	10,756
Basic weighted average shares outstanding (b)	11,775,597			15,925,876		11,190,612		15,908,377
Dilutive effect of stock options and SARs	—			472,946		684,262		523,544
Diluted weighted average shares outstanding (c)	11,775,597			16,398,822		11,874,874		16,431,921
Basic earnings per share (a)/(b)	$	(0.02	)	$	0.43	$	0.08	$	0.68
Diluted earnings per share (a)/(c)	$	(0.02	)	$	0.42	$	0.07	$	0.65
Antidilutive stock options, SARs and warrants	1,380,509			410,224		188,364		410,224

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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 July 3, 2007 and July 1, 2008 of $10,000 and $298,000, respectively, and for the twenty-six weeks ended July 3, 2007 and July 1, 2008 of $47,000 and $440,000, respectively.

As of July 1, 2008, NOL carryforwards of $138.3 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 $91.7 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 2004 through 2007. With a few exceptions, we are no longer subject to U.S. federal, state or local examinations by tax authorities for the tax year 2003 and prior.

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10.Commitments and Contingencies

Letters of Credit and Line of Credit

As of July 1, 2008, we had $7.3 million in letters of credit outstanding. 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. Of the total letters of credit outstanding, $7.0 million reduce our availability under the Revolving Facility. Our availability under the Revolving Facility was $13.0 million at July 1, 2008.

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.

On August 31, 2007, the Company was served in an action brought by Fiera Foods Company in the Superior Court of Justice of Ontario, Canada.  Fiera claims that the Company failed to negotiate in good faith for a frozen bagel dough supply agreement, which was not concluded, and made misrepresentations in the negotiations.  Fiera is seeking damages of $17.0 million (Canadian) as well as interest and costs. The Company believes that these claims are not valid, is defending this action and has not recorded a liability.

On September 18, 2007, Eric Mathistad, a former store manager, 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 alleges that we failed to pay overtime wages to “salaried restaurant employees” of our California stores who were improperly designated as exempt employees, and that these employees were deprived of mandated meal periods and rest breaks.  Plaintiff alleges that these actions were in violation of the California Labor Code Sections 1194, et seq., 500, et seq., California Business and Professions Code Section 17200, et seq., and applicable wage order(s) issued by the Industrial Welfare Commission.  Plaintiff seeks injunctive relief, declaratory relief, attorney’s fees, restitution and an unspecified amount of damages for unpaid overtime and for missed meal and/or rest periods. On November 14, 2007, Bernadette Mejia, another former store manager, filed a similar case.    On April 10, 2008, the Mathistad and Meija cases were consolidated into one case and, on May 6, 2008, Plaintiffs filed an Amended Consolidated Complaint.   The Company filed a Demurrer on June  20,  2008,  claiming that, among other things, plaintiff fails to state a claim against the Company; plaintiff does not state a claim for a joint venture, partnership, common enterprise, or aiding and abetting; plaintiff’s definition of the class is deficient and plaintiff’s claims for declaratory judgment regarding Labor Code violations should be dismissed.   Because limited discovery has been conducted and no class certification proceeding has occurred, we cannot predict the outcome of this matter.

On February 8, 2008, Gloria Webber and Hakan Mikado, non-exempt employees, brought a putative class action against the Company in the Superior Court of California for the State of California, County of San Diego, claiming failure to pay minimum wages, failure to pay overtime and failure to provide rest periods and meal breaks, among other charges.  The parties have agreed to stay formal discovery and a formal response to the complaint pending exchange of information and pending settlement discussions.   We cannot predict the outcome of this matter.

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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 July 1, 2008, we owned and operated, franchised or licensed 623 restaurants in 35 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.

Current Restaurant Base

As of July 1, 2008, we owned and operated, franchised or licensed 623 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 one Einstein Bros. restaurant and 69 Manhattan Bagel restaurants, and license 132 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.

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The following tables detail our restaurant openings and closings for each respective period:

	13 weeks ended July 3, 2007							13 weeks ended July 1, 2008
	Company							Company
	Owned		Franchised		Licensed	Total		Owned		Franchised		Licensed		Total
Einstein Bros.
Beginning balance	336		—		97	433		338		1		125		464
Opened restaurants	1		—		6	7		2		—		8		10
Closed restaurants	(1	)	—		—	(1	)	(1	)	—		(1	)	(2	)
Ending balance	336		—		103	439		339		1		132		472
Noah’s
Beginning balance	74		—		3	77		76		—		3		79
Opened restaurants	—		—		—	—		1		—		—		1
Closed restaurants	—		—		—	—		—		—		—		—
Ending balance	74		—		3	77		77		—		3		80
Manhattan Bagel
Beginning balance	—		79		—	79		1		69		—		70
Opened restaurants	—		—		—	—		—		—		—		—
Closed restaurants	—		(3	)	—	(3	)	—		—		—		—
Ending balance	—		76		—	76		1		69		—		70
Non-Core Brands
Beginning balance	2		6		—	8		1		3		—		4
Opened restaurants	—		—		—	—		—		—		—		—
Closed restaurants	(1	)	(2	)	—	(3	)	—		(3	)	—		(3	)
Ending balance	1		4		—	5		1		—		—		1
Consolidated Total
Total beginning balance	412		85		100	597		416		73		128		617
Opened restaurants	1		—		6	7		3		—		8		11
Closed restaurants	(2	)	(5	)	—	(7	)	(1	)	(3	)	(1	)	(5	)
Total ending balance	411		80		106	597		418		70		135		623

	26 weeks ended July 3, 2007							26 weeks ended July 1, 2008
	Company							Company
	Owned		Franchised		Licensed	Total		Owned		Franchised		Licensed		Total
Einstein Bros.
Beginning balance	341		—		93	434		337		—		121		458
Opened restaurants	1		—		10	11		5		1		12		18
Closed restaurants	(6	)	—		—	(6	)	(3	)	—		(1	)	(4	)
Ending balance	336		—		103	439		339		1		132		472
Noah’s
Beginning balance	73		—		3	76		77		—		3		80
Opened restaurants	1		—		—	1		1		—		—		1
Closed restaurants	—		—		—	—		(1	)	—		—		(1	)
Ending balance	74		—		3	77		77		—		3		80
Manhattan Bagel
Beginning balance	—		80		—	80		1		69		—		70
Opened restaurants	—		—		—	—		—		—		—		—
Closed restaurants	—		(4	)	—	(4	)	—		—		—		—
Ending balance	—		76		—	76		1		69		—		70
Non-Core Brands
Beginning balance	2		6		—	8		1		3		—		4
Opened restaurants	—		—		—	—		—		—		—		—
Closed restaurants	(1	)	(2	)	—	(3	)	—		(3	)	—		(3	)
Ending balance	1		4		—	5		1		—		—		1
Consolidated Total
Total beginning balance	416		86		96	598		416		72		124		612
Opened restaurants	2		—		10	12		6		1		12		19
Closed restaurants	(7	)	(6	)	—	(13	)	(4	)	(3	)	(1	)	(8	)
Total ending balance	411		80		106	597		418		70		135		623

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

	Trailing 12 Months Activity
	Company
	Owned		Franchised		Licensed		Total
Einstein Bros.
Beginning balance July 3, 2007	336		—		103		439
Opened restaurants	12		1		33		46
Closed restaurants	(9	)	—		(4	)	(13	)
Ending balance July 1, 2008	339		1		132		472
Noah’s
Beginning balance July 3, 2007	74		—		3		77
Opened restaurants	4		—		—		4
Closed restaurants	(1	)	—		—		(1	)
Ending balance July 1, 2008	77		—		3		80
Manhattan Bagel
Beginning balance July 3, 2007	—		76		—		76
Opened restaurants	1		2		—		3
Closed restaurants	—		(9	)	—		(9	)
Ending balance July 1, 2008	1		69		—		70
Non-Core Brands
Beginning balance July 3, 2007	1		4		—		5
Opened restaurants	—		—		—		—
Closed restaurants	—		(4	)	—		(4	)
Ending balance July 1, 2008	1		—		—		1
Consolidated Total
Beginning balance July 3, 2007	411		80		106		597
Opened restaurants	17		3		33		53
Closed restaurants	(10	)	(13	)	(4	)	(27	)
Ending balance July 1, 2008	418		70		135		623

New Restaurant Openings

In 2008, we plan to open at least 18 new company-owned restaurants.  Through the twenty-six weeks ended July 1, 2008 we opened 5 company-owned Einstein Bros. restaurants.  Through the twenty-six weeks ended July 1, 2008 we opened one company-owned Noah’s restaurant.

We plan to open at least 5 franchise restaurants and at least 35 license restaurants in 2008.  The license restaurants will be located primarily in airports, colleges and universities, office buildings, hospitals and military bases and on turnpikes.  Through the twenty-six weeks ended July 1, 2008 we opened one Einstein Bros. franchise restaurant and twelve license restaurants.

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Results of Operations

We have a 52/53-week fiscal year ending on the Tuesday closest to December 31. The second quarters in fiscal years 2007 and 2008 ended on July 3, 2007 and July 1, 2008, respectively, and each contained thirteen weeks, and the year to date periods each contained twenty-six weeks.

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

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	13 weeks ended							Increase/		13 weeks ended
	(dollars in thousands)							(Decrease)		(percent of total revenue)
	July 3,				July 1,			2008		July 3,		July 1,
	2007				2008			vs. 2007		2007		2008
Revenues:
Company-owned restaurant sales	$	94,141			$	96,321		2.3	%	93.2	%	91.4	%
Manufacturing and commissary revenues	5,682				7,640			34.5	%	5.6	%	7.2	%
Franchise and license related revenues	1,232				1,453			17.9	%	1.2	%	1.4	%
Total revenues	101,055				105,414			4.3	%	100.0	%	100.0	%
Cost of sales:
Company-owned restaurant costs
Cost of goods sold	27,876				28,933			3.8	%	27.6	%	27.4	%
Labor costs	28,566				28,201			(1.3	)%	28.3	%	26.8	%
Other operating costs	8,728				9,300			6.6	%	8.6	%	8.8	%
Rent and related, and marketing costs	10,087				10,214			1.3	%	10.0	%	9.7	%
Total company-owned restaurant costs	75,257				76,648			1.8	%	74.5	%	72.7	%
Manufacturing and commissary costs	5,380				7,224			34.3	%	5.3	%	6.9	%
Total cost of sales	80,637				83,872			4.0	%	79.8	%	79.6	%
Gross profit:
Company-owned restaurant	18,884				19,673			4.2	%	18.7	%	18.7	%
Manufacturing and commissary	302				416			37.7	%	0.3	%	0.4	%
Franchise and license	1,232				1,453			17.9	%	1.2	%	1.4	%
Total gross profit	20,418				21,542			5.5	%	20.2	%	20.5	%
Gross profit percentages:
Company-owned restaurant	20.1			%	20.4		%	1.5	%		*		*
Manufacturing and commissary	5.3			%	5.4		%	1.9	%		*		*
Franchise and license	100.0			%	100.0		%	0.0	%		*		*
Operating expenses:
General and administrative expenses	10,855				9,540			(12.1	)%	10.7	%	9.1	%
Depreciation and amortization	2,623				3,345			27.5	%	2.6	%	3.2	%
Loss on sale, disposal or abandonmentof assets, net	31				63			103.2	%	0.0	%	0.1	%
Impairment charges and other relatedcosts	166				54			(67.5	)%	0.2	%	0.1	%
Income from operations	6,743				8,540			26.6	%	6.7	%	8.1	%
Other expense:
Interest expense, net	4,144				1,328			(68.0	)%	4.1	%	1.3	%
Write-off of debt discount uponredemption of senior notes	528				—			(100.0	)%	0.5	%	0.0	%
Prepayment penalty upon redemptionof senior notes	240				—			(100.0	)%	0.2	%	0.0	%
Write-off of debt issuance costs uponredemption of senior notes	2,071				—			(100.0	)%	2.0	%	0.0	%
Income (loss) before income taxes	(240			)	7,212				**	(0.2	)%	6.8	%
Provision for income taxes	10				298			2880.0	%	0.0	%	0.3	%
Net income (loss)	$		(250	)	$	6,914			**	(0.2	)%	6.6	%

*	not applicable
**	not meaningful

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	26 weeks ended								Increase/		26 weeks ended
	(dollars in thousands)								(Decrease)		(percent of total revenue)
	July 3,				July 1,				2008		July 3,		July 1,
	2007				2008				vs. 2007		2007		2008
Revenues:
Company-owned restaurant sales	$	183,256			$		189,931		3.6	%	92.9	%	91.0	%
Manufacturing and commissary revenues	11,500				15,728				36.8	%	5.8	%	7.6	%
Franchise and license related revenues	2,554				3,019				18.2	%	1.3	%	1.4	%
Total revenues	197,310				208,678				5.8	%	100.0	%	100.0	%
Cost of sales:
Company-owned restaurant costs
Cost of goods sold	54,149				56,918				5.1	%	27.4	%	27.3	%
Labor costs	55,173				57,151				3.6	%	28.0	%	27.4	%
Other operating costs	17,499				18,178				3.9	%	8.9	%	8.7	%
Rent and related, and marketing costs	19,768				20,226				2.3	%	10.0	%	9.7	%
Total company-owned restaurant costs	146,589				152,473				4.0	%	74.3	%	73.1	%
Manufacturing and commissary costs	10,802				15,084				39.6	%	5.5	%	7.2	%
Total cost of sales	157,391				167,557				6.5	%	79.8	%	80.3	%
Gross profit:
Company-owned restaurant	36,667				37,458				2.2	%	18.6	%	18.0	%
Manufacturing and commissary	698				644				(7.7	)%	0.4	%	0.3	%
Franchise and license	2,554				3,019				18.2	%	1.3	%	1.4	%
Total gross profit	39,919				41,121				3.0	%	20.2	%	19.7	%
Gross profit percentages:
Company-owned restaurant	20.0			%	19.7			%	(1.5	)%		*		*
Manufacturing and commissary	6.1			%	4.1			%	(32.8	)%		*		*
Franchise and license	100.0			%	100.0			%	0.0	%		*		*
Operating expenses:
General and administrative expenses	21,587				20,283				(6.0	)%	10.9	%	9.7	%
Depreciation and amortization	5,042				6,549				29.9	%	2.6	%	3.1	%
Loss on sale, disposal or abandonmentof assets, net	405				132				(67.4	)%	0.2	%	0.1	%
Impairment charges and other relatedcosts	185				54				(70.8	)%	0.1	%	0.0	%
Income from operations	12,700				14,103				11.0	%	6.4	%	6.8	%
Other expense:
Interest expense, net	8,933				2,907				(67.5	)%	4.5	%	1.4	%
Write-off of debt discount uponredemption of senior notes	528				—				(100.0	)%	0.3	%	0.0	%
Prepayment penalty upon redemptionof senior notes	240				—				(100.0	)%	0.1	%	0.0	%
Write-off of debt issuance costs uponredemption of senior notes	2,071				—				(100.0	)%	1.0	%	0.0	%
Income before income taxes	928				11,196				1106.5	%	0.5	%	5.4	%
Provision for income taxes	47				440				836.2	%	0.0	%	0.2	%
Net income	$		881		$	10,756			1120.9	%	0.4	%	5.2	%

* not applicable

Consolidated Results

For the thirteen weeks ended July 1, 2008 compared to the same period in 2007, total revenue increased $4.4 million, or 4.3%, gross profit increased $1.1 million or 5.5%, income from operations improved $1.8 million or 26.6%, and our income before income taxes increased $7.5 million. This growth was a result of having more locations, increased comparable store sales and price increases at our company-owned restaurants, an increase in sales volume and price increases from our manufacturing and commissary operations and an increase of comparable store sales from our franchisees and licensees, partially offset by increased cost of sales which was

20

primarily driven by rising commodity costs and labor costs for both the company-owned restaurants and our manufacturing and commissary operations.  Adding to the increase in gross profit was a decrease in our general and administrative expenses related to decreased stock-based compensation expense and other cost savings, an increase in depreciation expense from the new restaurants that have been opened, decreased interest expense related to the debt redemption in 2007 as well as the $2.8 million in related one-time charges that occurred in 2007.

For the twenty-six weeks ended July 1, 2008 compared to the same period in 2007, total revenue increased $11.4 million, or 5.8%, gross profit increased $1.2 million or 3.0%, income from operations improved $1.4 million or 11.0%, and our income before income taxes increased $10.3 million. This growth is primarily due to having seven additional company-owned restaurants and 19 additional franchise and license locations, 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, an increase in depreciation expense from the new restaurants that have been opened, decreased interest expense related to the debt redemption in 2007 as well as the $2.8 million in related one-time charges that occurred in 2007.

Company-Owned Restaurant Operations

Revenues

Comparable store sales represent sales at restaurants open for one full year that have not been relocated or closed during the current year.  Comparable store sales include company-owned restaurants only and represent the change in period-over-period sales for the comparable restaurant base.  A restaurant becomes comparable in its thirteenth full month of operation.

For the thirteen weeks ended July 1, 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 6.8% since July 3, 2007 and a 3.5% shift in product mix to higher priced items, partially offset by an 8.5% decrease in the volume 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.

For the twenty-six weeks ended July 1, 2008, our comparable store sales increased 2.3% over the same periods in 2007.  This increase was primarily due to system-wide price increases of 6.3% since July 3, 2007 and a 3.1% shift in product mix to higher priced items, partially offset by a 6.5% decrease in the volume 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.

Company-owned restaurant sales for the thirteen weeks ended July 1, 2008 increased $2.2 million, or 2.3%, when compared to the same period in 2007.  This increase was primarily due to the aforementioned price increases coupled with a net increase in restaurants opened over the last twelve months.  On average, the restaurants opened since July 3, 2007 are higher volume restaurants relative to those that were closed over the same period, which also positively contributed to the increase in sales.

Company-owned restaurant sales for the twenty-six weeks ended July 1, 2008 increased $6.7 million, or 3.6%, when compared to the same period in 2007.  This increase was primarily due to the aforementioned price increases coupled with a net increase of two restaurants opened in 2008 compared to a net decrease of five restaurants closed in 2007.

Cost of Sales

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

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Cost of Goods Sold

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.  These costs increased $1.0 million to $28.9 million for the thirteen weeks ended July 1, 2008 from $27.9 million for the same period in 2007, 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 seven stores over the last twelve months, partially offset by a reduction in the volume of products sold.

For the twenty-six weeks ended July 1, 2008, these costs increased $2.8 million to $56.9 million from $54.1 million for the same period in 2007, 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 seven 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 cost of wheat and the cost of flour increased substantially in the last half of 2007 but stabilized by the end of the second quarter and are expected to stay at these levels through the remainder of 2008. To mitigate this risk of increasing 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

Labor expenses, which includes our general managers and restaurant-level labor costs, including taxes and associated employee benefits, decreased $0.4 million to $28.2 million for the thirteen weeks ended July 1, 2008 compared to $28.6 million for the same period in 2007.  The decrease was primarily related to a decrease in incentive compensation of $0.5 million and a decrease in our self-insurance costs of $0.3 million, partially offset by a $0.4 million increase in labor costs from a combination of the growth of new restaurant openings that occurred throughout 2007 and the first twenty-six 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.

Labor expenses increased $2.0 million to $57.2 million for the twenty-six weeks ended July 1, 2008 compared to $55.2 million for the same period in 2007. This increase was predominantly due to a $2.6 million increase in labor costs from a combination of the growth of new restaurant openings that occurred throughout 2007 and the first twenty-six weeks of 2008 which increased the number of employees, 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, along with an increase in workers’ compensation costs of $0.5 million, partially offset by a decrease in incentive compensation of $0.8 million and a decrease in our self-insurance costs of $0.3 million.

Other Operating Costs

Other operating costs consist of other restaurant-level occupancy expenses such as utilities, repairs and maintenance costs, credit card fees and supplies.  Other operating costs increased $0.6 million to $9.3 million for the thirteen weeks ended July 1, 2008 compared to $8.7 million for the same period in 2007.  This increase was attributable to an increase in credit card fees of $0.3 million from a shift in consumer payment practices, an increase in utilities of $0.1 million, and an increase in other overhead costs of $0.2 million.

Other operating costs increased $0.7 million to $18.2 million for the twenty-six weeks ended July 1, 2008 compared to $17.5 million for the same period in 2007.  This increase was attributable to an increase in credit card fees of $0.5 million from a shift in consumer payment practices, and an increase in utilities of $0.2 million.

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Rent and related, and marketing costs

Rent and related, and marketing costs consist of restaurant-level rent expense, common area maintenance expense, property taxes and marketing expense.  Rent and related and marketing costs increased $0.1 million to $10.2 million for the thirteen weeks ended July 1, 2008 compared to $10.1 million for the same period in 2007.  This increase was principally attributable to an increase in rent and related expense of $0.6 million, partially offset by a decrease in marketing expense of $0.5 million.

Rent and related and marketing costs increased $0.4 million to $20.2 million for the twenty-six weeks ended July 1, 2008 compared to $19.8 million for the same period in 2007.  This increase was principally attributable to an increase in rent and related expense of $0.9 million, an increase in other costs of $0.1 million, partially offset by a decrease in marketing expense of $0.6 million.

Manufacturing and Commissary Operations

Our manufacturing operations, which include our United States Department of Agriculture inspected commissaries, predominantly support our company-owned restaurants and generate revenue from the sale of food products to franchisees, licensees, third-party distributors and other third parties. All inter-company transactions have been eliminated during consolidation.

Revenues

Manufacturing and commissary revenues for the thirteen weeks ended July 1, 2008 increased $1.9 million or 34.5% to $7.6 million from $5.7 million in the same period in 2007.  $0.6 million of this increase was attributed to a rise in the volume of units sold to our more significant customers and $0.9 million was related to price increases.  An additional $0.4 million of the increase was attributed to our expanded role within the distribution chain for sales to our franchise and license locations, slightly off-set by a drop in the volume of units sold to these customers.

Manufacturing and commissary revenues for the twenty-six weeks ended July 1, 2008 increased $4.2 million or 36.8% to $15.7 million from $11.5 million in the same period in 2007.  $1.4 million of this increase was attributed to a rise in the volume of units sold to our more significant customers and $1.6 million was related to price increases.  An additional $1.2 million of the increase was attributed to our expanded role within the distribution chain for sales to our franchise and license locations, slightly off-set by a drop in the volume of units sold to these customers.

Cost of Sales

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

Cost of Goods Sold

Manufacturing costs are composed of raw materials such as flour, dairy products and meats.  These costs increased $1.7 million to $4.3 million for the thirteen weeks ended July 1, 2008 from $2.6 million in the same period in 2007, predominantly due to an increase in commodity costs and, to a lesser extent, an increase in volume of units sold.  Some of the raw materials used are commodity-based products and are subject to the same market fluctuations previously mentioned. We purchase certain raw materials under volume-based pricing agreements and, as manufacturing production increases we experience more favorable pricing arrangements.

Manufacturing costs are composed of raw materials such as flour, dairy products and meats.  For the twenty-six weeks ended July 1, 2008, these costs increased $3.9 million to $9.2 million from $5.3 million for the same period in 2007, predominantly due to an increase in commodity costs and to a lesser extent, an increase in volume of units sold.  Some of the raw materials used are commodity-based products and are subject to the same market fluctuations previously mentioned. We purchase certain raw materials under volume-based pricing agreements and, as manufacturing production increases, we experience more favorable pricing arrangements.

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Labor Expenses

Labor expenses, which include manufacturing-level labor costs, including taxes and associated employee benefits, increased $0.1 million to $1.7 million for the thirteen weeks ended July 1, 2008 compared to $1.6 million for the same period in 2007. This increase was due to an increase in units produced as well as an increase in merit pay year-over-year, and increased minimum wage rate increases at the federal level and in some states in which we operate that went into effect starting January 2008.

Labor expenses increased $0.4 million to $3.5 million for the twenty-six weeks ended July 1, 2008 compared to $3.1 million for the same period in 2007. The increase was due to an increase in units produced as well as an increase in merit pay year-over-year, and increased minimum wage rate increases at the federal level and in some states in which we operate that went into effect starting January 2008, and to a lesser extent an increase in the cost of employee benefits.

Other Operating Costs and Expenses

Other operating costs and expenses consist of occupancy expenses (rent, insurance, licenses, taxes and utilities) and other operating expenses (excluding food costs and labor expenses reported separately). The changes for the thirteen and twenty-six weeks ended July 1, 2008 compared to the same periods in 2007 were negligible.  These expenses totaled $1.2 million for both the thirteen weeks ended July 1, 2008 and the same period in 2007, and $2.4 million for both the twenty-six weeks ended July 1, 2008 and the same period in 2007.

Franchise and License Operations

Franchise and license revenue consists of ongoing royalty payments to us based on a percentage of the restaurant’s gross sales, and a license or franchise fee that is recorded in deferred revenue and recognized as income upon the fulfillment of certain start up support obligations, such as training. Overall, licensee and franchisee revenue improved $0.2 million, or 17.9%, for the thirteen weeks ended July 1, 2008 as compared to the same period in 2007. The percentage increase was predominantly due to improved comparable sales by franchisees and licensees of the Manhattan Bagel and Einstein Bros. brands and a net increase of 29 licensed restaurants, partially offset by a net decrease of 9 franchised restaurants since July 3, 2007.

Overall, licensee and franchisee revenue improved $0.5 million, or 18.2%, for the twenty-six weeks ended July 1 2008 as compared to the same period in 2007. The year-to-date percentage increase was predominantly due to improved comparable sales by franchisees and licensees of the Manhattan Bagel and Einstein Bros. brands and a net increase of 29 licensed restaurants, partially offset by a net decrease of 9 franchised restaurants since July 3, 2007.

General and Administrative Expenses

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

Our general and administrative expenses decreased $1.4 million to $9.5 million for the thirteen weeks ended July 1, 2008 compared to $10.9 million for the same period in 2007. As a percentage of total revenues, our general and administrative expenses were 9.1% for the thirteen weeks ended July 1, 2008 compared to 10.7% for the same period in 2007.  The overall decrease was predominately related to a $0.6 million 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, there were decreases of $0.2 million related to legal costs incurred in 2007 to amend our debt facility, net decreases of $0.1 million in compensation expense related to lower bonus expenses partially offset by increased manager training costs, a decrease of $0.2 million related to the relocation of our corporate offices, and other decreases of $0.3 million in our general and administrative expenses.

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Our general and administrative expenses decreased $1.3 million to $20.3 million for the twenty-six weeks ended July 1, 2008 compared to $21.6 million for the same period in 2007. As a percentage of total revenues, our general and administrative expenses were 9.7% for the twenty-six weeks ended July 1, 2008 compared to 10.9% for the same period in 2007. The overall decrease was predominately related to a $0.4 million decrease in stock based compensation 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, there were decreases of $0.5 million in management development expenses, $0.3 million in costs of transitioning to a new distributor, $0.2 million related to the relocation of our corporate offices, $0.4 million in recruiting, and referral fees related to senior level management positions and $0.2 million in other expenses, partially offset by increases of $0.7 million related to increased manager training costs and increased salary expenses.

Depreciation and Amortization

Depreciation and amortization are periodic non-cash charges that represent the reduction in usefulness and value of our tangible and intangible assets.  The majority of our depreciation and amortization relates to equipment and leasehold improvements located in our company-owned restaurants. 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.

Depreciation and amortization expenses increased $0.7 million for the thirteen weeks ended July 1, 2008 when compared to the same period in 2007. The increase is due to the additional depreciation expense on our new corporate headquarters that we occupied in May 2007 and the additional assets invested in the company-owned restaurants that were added or upgraded since the second quarter of 2007.

Depreciation and amortization expenses increased $1.5 million for the twenty-six weeks ended July 1, 2008 when compared to the same period in 2007. The increase is due to the additional depreciation expense on our new corporate headquarters that we occupied in May 2007 and the additional assets invested in the company-owned restaurants that were added or upgraded since the second quarter of 2007.

Loss on Sale, Disposal or Abandonment of Assets

Gains and losses on the sale, disposal or abandonment of assets represent the difference of proceeds received, if any, and the net book value of an asset. We establish estimated useful lives for our assets, which range from three to ten years, and depreciate using the straight-line method. Leasehold improvements are limited to the lesser of the useful life or the non-cancelable lease term. The useful lives of the assets are based upon our expectations of the period of time that the asset will be used to generate revenue. We periodically review the assets for changes in circumstances, which may impact their useful lives.  During the thirteen weeks ended July 1, 2008, we recorded $63,000 in losses on the disposal, sales or abandonment of assets, compared to $31,000 for the same period in 2007.  During the twenty-six weeks ended July 1, 2008, we recorded $132,000 in losses on the disposal, sales or abandonment of assets, compared to $405,000 for the same period in 2007.

Impairment Charges and Other Related

Impairment losses are non-cash charges recorded on long-lived assets, goodwill, trademarks and our other intangible assets. Impairment losses are recorded on long-lived assets on a restaurant-by-restaurant basis whenever impairment indicators are determined to be present. Other related expenses are those costs incurred to close company-owned restaurants.  During the thirteen weeks ended July 1, 2008, we recorded $54,000 in impairment charges and other related expenses, compared to $166,000 for the same period in 2007.  During the twenty-six weeks ended July 1, 2008, we recorded $54,000 in impairment charges and other related expenses, compared to $185,000 for the same period in 2007.

Interest Expense, Net

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 July 1, 2008 was $88.4 million compared to $90.6 million as of July 3, 2007.   Net interest expense for the thirteen weeks ended July

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1, 2008 was $1.3 million, compared to $4.1 million for the same period in 2007 and net interest expense for the twenty-six weeks ended July 1, 2008 was $2.9 million, compared to $8.9 million for the same period in 2007.

Other Expense

During the second quarter, we wrote off $2.1 million of debt issuance costs and paid a $0.2 million redemption premium related to the repayment of the $65 Million Second Lien Term Loan, and wrote off a $0.5 million discount related to the repayment of the $25 Million Subordinated Note.

Income Taxes

We reported net income for the twenty-six weeks ended July 1, 2008 of $10.8 million as compared to net income of $0.9 million for the same period in 2007. 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 twenty-six weeks of 2008. We have recorded a provision for income taxes in the amount of $298,000 and $440,000 related to our estimate of income taxes due on taxable earnings for the thirteen and twenty-six weeks ended July 1, 2008, respectively.

As of July 1, 2008, our NOL carryforwards for U.S. federal income tax purposes were $138.3 million, $91.7 million of which are subject to an annual usage limitation of $4.7 million, and were subject to the following expiration schedule:

Net Operating Loss Carryforwards
Expiration Date	Amount
	(in thousands of dollars)
December 31, 2018	10,086
December 31, 2019	6,862
December 31, 2020	10,424
December 31, 2021	10,515
December 31, 2022	35,688
December 31, 2023	42,362
December 31, 2024	12,003
December 31, 2025	5,413
December 31, 2026	4,900
	$	138,253

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.

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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.

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. On a weekly basis, we review our company-owned restaurant performance compared with the same period in the prior year and our operating plan.

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 of July 1, 2008 as the redemption is now within one year. As part of the amended First Lien Term Loan in June of 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. Due to the current state of the credit market, we also plan to discuss our financing options with other institutions.

Working Capital Deficit

On July 1, 2008, we had unrestricted cash of $18.4 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 decreasing $51.4 million to a deficit of $47.8 million on July 1, 2008 compared to a surplus of $3.6 million on January 1, 2008.  The reclassification was partially offset by $5.6 million that was primarily due to the increased cash flow stemming from an increase in profitability at our company-owned restaurants, and a decrease in our accounts receivable along with decreases in our other current assets and current liabilities.  Short-term debt and the current portion of long-term debt increased by $0.2 million related to the timing of when the payments are due compared to our fiscal year-end.

Cash Provided by Operations

This $14.4 million increase was due primarily to a $9.9 million increase in net income and $7.5 million of changes to our operating assets and liabilities such as accounts receivable, inventories, prepaid expenses, accounts payable and accrued expenses. Net cash generated by operating activities was $22.7 million for the twenty-six weeks ended July 1, 2008 compared to $8.3 million for the same period in 2007.

Cash Used in Investing Activities

During the twenty-six weeks ended July 1, 2008, we used approximately $12.5 million of cash to purchase additional property and equipment that included $3.7 million to open six new restaurants in 2008, $0.7 million in payments for restaurants that opened in 2007, and $0.3 million towards 12 restaurants that are currently under construction and are scheduled to open in 2008; $3.7 million for upgrading existing restaurants in 2008, $0.1 million for restaurants that were upgraded in 2007 and $0.2 million of upgrades that are in process and are scheduled to be completed in 2008; $2.5 million for replacement of equipment at our existing company-owned

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restaurants, $0.3 million for equipment at our manufacturing operations, and $1.0 million for general corporate purposes.

During the twenty-six weeks ended July 3, 2007, we used approximately $12.4 million of cash to purchase additional property and equipment that included $1.0 million to open two new restaurants in 2007, $0.6 million in payments for restaurants that opened in 2006, and $1.0 million towards 10 restaurants that are currently under construction and were opened in 2007 and 2008; $1.1 million for upgrading existing restaurants, $4.5 million for replacement of old equipment with new equipment at our existing company-owned restaurants, $1.1 million for our manufacturing operations, $1.3 million for general corporate purposes, and $1.8 for leasehold improvements and build-out related to our new corporate headquarters.

We anticipate that the majority of our capital expenditures for the remainder of fiscal 2008 will be focused on the addition of at least 18 new company-owned restaurants during 2008 at an average investment of approximately $600,000 per restaurant, which varies depending upon square footage, layout and location. We also upgraded 27 of our current restaurants during the twenty-six weeks ended July 1, 2008 and intend to upgrade at least 18 more during the remainder of 2008.

Cash Provided by (Used in) Financing Activities

For the twenty-six weeks ended July 1, 2008, $1.3 million in cash was used in financing activities compared to $4.6 million of cash provided by financing activities in the same period in 2007. The primary use of funds in 2008 was from principal payments on our debt.

For the twenty-six weeks ended July 3, 2007, we received $90.0 million in cash, and incurred $6.4 million in stock issuance costs as a result of our secondary public offering of common stock. Concurrent with our June 28, 2007 amendment to our First Lien Term Loan, we drew down an additional $11.9 million in debt and incurred an additional $0.8 million in debt issuance costs.  The funds from these two transactions were used to pay off the $65.0 million Second Lien Term Loan and the $25.0 Million Subordinated Note and $2.5 million of related paid-in-kind interest on the Subordinated Note.

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Contractual Obligations

The following table summarizes the amounts of payments due under specified contractual obligations as of July 1, 2008:

	Payments Due by Fiscal Period
	2008		2009 to 2011		2012 to 2013		2014 and thereafter		Total
	(in thousands of dollars)
Accounts payable and accrued expenses	$	25,267	$	—	$	—	$	—	$	25,267
Debt	505		2,925		84,950		—		88,380
Estimated interest expense on our debt facility (a)	2,352		14,120		2,622		—		19,094
Manditorily redeemable series Z	—		57,000		—		—		57,000
Minimum lease payments under capital leases	45		73		—		—		118
Minimum lease payments under operating leases	14,169		66,440		13,214		12,261		106,084
Purchase obligations (b)	15,799		10,786		—		—		26,585
Other long-term obligations (c)	—		750		500		5,524		6,774
Total	$	58,137	$	152,094	$	101,286	$	17,785	$	329,302

(a)	Calculated as of July 1, 2008, using the LIBOR and U.S. Prime rates, plus the applicable margin in effect. Because the interest rates on the first lien term loan facility and the revolving credit facility are variable, actual payments could differ materially.
(b)	Purchase obligations consist of non-cancelable minimum purchases of frozen dough and certain other raw ingredients that are used in our products.
(c)	Other long-term obligations primarily consist of the remaining liability related to minimum future purchase commitments with a supplier that advanced us $10.0 million in 1996.

Insurance

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

Consumer Spending Habits and Impact of Inflation

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, 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.

Impact of Agricultural Commodities

Our cost of sales consist of cost of goods sold, which is made up of food and product costs, compensation costs, and operating costs.  Wheat, butter, and cheese are our primary agricultural commodities and represent 10.9%,

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3.7% and 2.4% of our cost of goods sold, respectively. In addition, coffee, chicken and turkey are the other major agricultural commodities and represent 4.6% of our cost of goods sold.   For the last few years, cost increases in one or more of our agricultural commodities were generally modest in relation to our total cost of sales. In 2007, however, the price for a bushel of wheat began to rise at a rapid rate and reached new price levels that were unprecedented. The increase is related to substantially lower ending stock of wheat as well as fears related to lower harvests which is a result of lower plantings, unfavorable weather conditions, and lost acreage to other competing crops.

Towards the end of 2007, we utilized a subsidiary of Cargill, Incorporated to assist us in managing the price of our purchases of wheat. Through this relationship we have secured our wheat requirements as well as established the price for wheat for virtually all of our needs in fiscal 2008 and have begun to take positions for 2009. 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.

Impact of Inflation on Labor

We pay many of our employees hourly rates above the applicable federal, state or municipal “living wage” rates. Ongoing changes in minimum wage laws have created pressure to increase the pay scale for our associates, which would increase our labor costs.

Impact of Inflation on Other Elements of Cost

We have experienced only a modest impact from inflation.  However, the impact of inflation on distribution and occupancy costs could, in the future, significantly affect our operations. Costs for construction, taxes, repairs, maintenance and insurance all impact our occupancy costs. We believe our current strategy, which is to seek to maintain operating margins through a combination of menu price increases, menu mix, cost controls, hours of operations, efficient purchasing practices and careful evaluation of property and equipment needs, has been an effective tool for dealing with inflation.

Seasonality and Quarterly Results

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

Critical Accounting Policies and Estimates

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.

The effect 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.

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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.

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Item 3.  Quantitative and Qualitative Disclosures about Market Risk

During the thirteen and twenty-six weeks ended July 1, 2008 and July 3, 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 operations sell bagels to a wholesaler and a distributor who 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 recognized revenue for these international shipments within manufacturing and commissary revenues of approximately $0.9 million and $1.5 million the thirteen weeks ended July 3, 2007 and July 1, 2008, respectively and $1.6 million and $2.6 million for the twenty-six weeks ended July 3, 2007 and July 1, 2008, respectively.  We continue to look for other international opportunities.

Our debt as of July 1, 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. A 100 basis point increase in short-term effective interest rates would increase our interest expense by approximately $0.9 million annually, assuming no change in the size or composition of debt as of July 1, 2008, and presuming the utilization of our accumulated net operating losses would minimize the tax implications for the next several years.  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. The estimated increase in interest expense incorporates the fixed interest financing into its assumptions.  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.

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, coffee and turkey.

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.

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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 July 1, 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 twenty-six weeks ended July 1, 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.

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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, and similar adverse economic news and factors affect discretionary consumer spending. These factors could reduce consumers’ discretionary spending with in turn could reduce our guest traffic or average check.  In 2006 and 2007, 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.

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 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. For example, the recent outbreak of salmonella may affect the public’s perception of food safety at restaurants and,

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in particular, in restaurants that serve suspected products and this in turn, could cause consumers to cease frequenting our restaurants.

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.

Recent 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.  We expect that this demand and these commodity pressures to 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

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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.

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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.

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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 debt and are substantially leveraged. As of July 1, 2008, we had $88.4 million in term loans and notes outstanding.  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 were 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.

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We also have $57.0 million of mandatorily redeemable preferred stock due June 30, 2009.  Given the current credit climate 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, improper classification of management employees as exempt employees or other labor code violations may divert financial and management resources that would otherwise be used to benefit our future performance. 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 although these claims have not historically had a material impact on our operations, a significant increase in the number of these claims or the number that are successful, including the claims described in Note 10 to our Consolidated Financial Statements set forth in Part I of this report, 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

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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 are requiring 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. San Francisco and New York City have recently adopted 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

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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 July 1, 2008, our NOL carryforwards for U.S. federal income tax purposes were approximately $138.3 million. As a result of prior ownership changes, approximately $97.1 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.  We anticipate this filing will be completed no later than September 15, 2008. 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 67.4% 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 will 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.

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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 67.4% 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.

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

(a)The Annual Meeting of Shareholders of the Company was held on May 6, 2008   in connection with which it filed a Proxy Statement with the SEC on April 2, 2008.

(c)The following matters were voted upon at the meeting and approved by the Shareholders:

(1)Each of the nominees, as described in the Proxy Statement referenced above, was re-elected as a director to hold office until the next Annual Meeting of Shareholders or until his successor is elected and qualified.

Nominee Name	Votes For	Votes Against or Withheld
Michael W. Arthur	15,174,885	366,592
E. Nelson Heumann	13,496,690	2,044,787
Frank C. Meyer	15,173,669	367,808
Thomas J. Mueller	15,305,286	236,191
Paul J.B. Murphy III	13,496,714	2,044,763
S. Garrett Stonehouse, Jr.	15,174,886	366,591

(2)Proposal to ratify the appointment of Grant Thornton LLP, an independent registered public accounting firm,  as independent auditors for the fiscal year ending December 30, 2008.

Votes For	Votes Against	Abstentions
15,539,918	1,110	449

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Item 6.  Exhibits

31.1	Certification by Chief Executive Officer pursuant to Exchange Act Rule 13a-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification by Chief Financial Officer pursuant to Exchange Act Rule 13a-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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:	August 6, 2008	By: /s/ PAUL J. B. MURPHY, III
		Paul J.B. Murphy, III
		Chief Executive Officer
Date:	August 6, 2008	By: /s/ RICHARD P. DUTKIEWICZ
		Richard P. Dutkiewicz
		Chief Financial Officer

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EX-31.1

Exhibit 31.1

Certifications

I, Paul J.B. Murphy, III, certify that:

1.I have reviewed this quarterly report on Form 10-Q of Einstein Noah Restaurant Group, Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated: August 6, 2008	By: /s/ PAUL J. B. MURPHY, III
	Paul J.B. Murphy, III
	Chief Executive Officer

EX-31.2

Exhibit 31.2

Certifications

I, Richard P. Dutkiewicz, certify that:

1.I have reviewed this quarterly report on Form 10-Q of Einstein Noah Restaurant Group, Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated: August 6, 2008	By: /s/ RICHARD P. DUTKIEWICZ
	Richard P. Dutkiewicz
	Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Paul J.B, Murphy, III, as Chief Executive Officer of Einstein Noah Restaurant Group, Inc. (the “Company”), certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)the Quarterly Report of the Company on Form 10-Q for the quarter ended July 1, 2008, as filed with the Securities and Exchange Commission (the “Report”), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: August 6, 2008	By: /s/ PAUL J. B. MURPHY, III
	Paul J. B. Murphy, III
	Chief Executive Officer

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Richard P. Dutkiewicz, as Chief Financial Officer of Einstein Noah Restaurant Group, Inc. (the “Company”), certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)the Quarterly Report of the Company on Form 10-Q for the quarter ended July 1, 2008, as filed with the Securities and Exchange Commission (the “Report”), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: August 6, 2008	By: /s/ RICHARD P. DUTKIEWICZ
	Richard P. Dutkiewicz
	Chief Financial Officer

EX-32.3

Exhibit 32.3

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

                I, Robert E. Gowdy, Jr., as Principal Accounting Officer of Einstein Noah Restaurant Group, Inc. (the “Company”), certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(3)the Quarterly Report of the Company on Form 10-Q for the quarter ended July 1, 2008, as filed with the Securities and Exchange Commission (the “Report”), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(4)the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: August 6, 2008	By: /s/ ROBERT E. GOWDY, Jr.
	Robert E. Gowdy, Jr.
	Controller and Chief Accounting Officer