SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 28, 2004

OR

Commission File Number 0-27148

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 ý  No o

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

As of November 8, 2004, 9,842,385 shares of Common Stock of the registrant were outstanding.

NEW WORLD RESTAURANT GROUP, INC.

September 28, 2004

TABLE OF CONTENTS

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NEW WORLD RESTAURANT GROUP, INC.
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 28, 2004 AND DECEMBER 30, 2003

(in thousands, except share information)

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

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NEW WORLD RESTAURANT GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THIRTEEN AND THIRTY-NINE WEEKS ENDED SEPTEMBER 28, 2004 AND SEPTEMBER 30, 2003

(UNAUDITED)

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

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

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NEW WORLD RESTAURANT GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THIRTY-NINE WEEKS ENDED SEPTEMBER 28, 2004 AND SEPTEMBER 30, 2003

(UNAUDITED)

(in thousands)

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

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NEW WORLD RESTAURANT GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)
FOR THE THIRTY-NINE WEEKS ENDED SEPTEMBER 28, 2004

(UNAUDITED)

(in thousands, except share information)

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

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NEW WORLD RESTAURANT GROUP, INC.

Notes to Consolidated Financial Statements (Unaudited)

Thirteen and thirty-nine weeks ended September 28, 2004 and September 30, 2003

1.             Basis of Presentation

The accompanying consolidated financial statements of New World 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 September 28, 2004, the Company owns, franchises or licenses various restaurant concepts under the brand names of Einstein Bros. Bagels (“Einstein Bros.”), Noah’s New York Bagels (“Noah’s”), Manhattan Bagel Company (“Manhattan”), Chesapeake Bagel Bakery (“Chesapeake”), New World Coffee (“New World”), and Willoughby’s Coffee and Tea (“Willoughby’s”). Our business is subject to seasonal trends. Generally, our revenues in the first fiscal quarter are somewhat lower than in the other three fiscal quarters.

The accompanying consolidated financial statements as of September 28, 2004 and December 30, 2003 and for the thirteen and thirty-nine weeks ended September 28, 2004 and September 30, 2003 have been prepared without audit (except for the balance sheet information as of December 30, 2003, which is derived from our audited 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 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 December 30, 2003. We believe that the disclosures are sufficient for interim financial reporting purposes.

Certain reclassifications have been made to conform previously reported data to the current presentation. These reclassifications have no effect on net income or financial position as previously reported.

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2.             Goodwill, Trademarks and Other Intangibles

Statement of Financial Accounting Standards (SFAS) No. 142 provides that goodwill and other indefinite-lived intangibles should not be amortized, but be subject to an annual assessment for impairment, or more frequently if circumstances indicate potential impairment, through a comparison of fair value to its carrying amount. The two-step approach to assess goodwill impairment requires that we first compare the estimated fair value of each reporting unit that houses goodwill to the carrying amount of the unit’s assets and liabilities, including its goodwill and intangible assets. If the fair value of the reporting unit is below its carrying amount, then the second step of the impairment test is performed, in which the current fair value of the unit’s assets and liabilities will determine the current implied fair value of the unit’s goodwill. The impairment tests relating to goodwill and indefinite-lived trademarks are performed as of year-end, unless events and circumstances indicate otherwise. During the thirteen weeks ended June 29, 2004, we began an evaluation of whether each of our brands should be a part of our overall strategic business plan. As a result of this evaluation, we determined that certain brands may no longer fit strategically. Accordingly, we performed an impairment analysis and determined that no impairment of these brands existed at June 29, 2004. We also performed a longevity analysis of certain brands and determined that certain trademarks had an estimated remaining useful life of 4 years. These trademarks were previously treated as a non-amortizing intangible and accordingly, were reclassified as an amortizing intangible at June 29, 2004. During the thirteen weeks ended September 28, 2004, no additional impairment indicators were present and accordingly no additional interim tests for impairment of goodwill, trademarks or amortizing intangibles were performed.

Goodwill represents the excess of cost over fair value of net assets acquired in the acquisition of Manhattan Bagel Company, Inc.

Trademarks and other intangibles consists of the following (in thousands of dollars):

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3.             Debt

Debt consists of the following (in thousands of dollars):

(a)   $160 Million Indenture

On July 8, 2003, we issued $160 million of 13% senior secured notes maturing on July 1, 2008 (“$160 Million Indenture”) in a private placement.

The $160 Million Indenture is guaranteed, fully and unconditionally, jointly and severally, by us and all present and future subsidiaries of ours and is collateralized by substantially all of our assets in which we have an interest. Pursuant to an Intercreditor Agreement, the $160 Million Indenture is subordinate to the AmSouth Revolver as described below.

The $160 Million Indenture contains certain covenants, which, among others, include certain financial covenants such as limitations on capital expenditures and minimum EBITDA as defined in the agreement. These covenants are measured on a rolling twelve-month period and fiscal quarter basis, respectively. This debt contains usual and customary default provisions. As of September 28, 2004, we were in compliance with all our financial and operating covenants.

Interest payments under the $160 Million Indenture are payable in arrears at the rate of 13% per year on July 1 and January 1, commencing January 1, 2004. The notes are redeemable, at our option, in whole or in part at any time after July 1, 2004 at the following redemption prices (as expressed in percentages of the principal amount):

Debt issuance costs are capitalized and amortized using the effective interest method over the term of the $160 Million Indenture.

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(b)   AmSouth Revolver

Also on July 8, 2003, we entered into a three-year, $15 million senior secured revolving credit facility with AmSouth Bank (“AmSouth Revolver”). The AmSouth Revolver has been subsequently amended to make technical corrections, clarify ambiguous terms and provide for increased limits with respect to letters of credit.

The AmSouth Revolver is collateralized by substantially all of our assets in which we have an interest and is senior to the $160 Million Indenture pursuant to an Intercreditor Agreement.

The AmSouth Revolver contains certain covenants, which, among others, include certain financial covenants such as limitations on capital expenditures, operating lease obligations, minimum EBITDA as defined in the agreement, operating cash flow coverage ratio and minimum net worth. These covenants are measured on a rolling twelve-month period at each fiscal quarter or annually at year-end. Additional covenant restrictions exist if the total borrowings, including outstanding letters of credit exceed $10.0 million. This debt also contains usual and customary default provisions. As of September 28, 2004, we are in compliance with all of our financial and operating covenants.

Interest payments under the AmSouth Revolver are payable in arrears on the first of each month. The net borrowings under the AmSouth Revolver bear an interest rate equal to the base rate plus an applicable margin with the base rate being the AmSouth Bank “prime rate” and the applicable margin being based on our fixed charge coverage ratio with a minimum and maximum applicable margin of 0.5% and 2.5% respectively. As of September 28, 2004, the prime interest rate under the AmSouth Revolver was 4.5%.

We are required to pay an unused credit line fee of 0.50% per annum on the average daily unused amount. The unused line fee is payable monthly in arrears. Additionally, we are required to pay a letter of credit fee based on the average daily undrawn face amount for each letter of credit issued, of an applicable margin being based on our fixed charge coverage ratio with a minimum and maximum applicable margin of 2.0% and 4.5% respectively. Letters of credit reduce our availability under the AmSouth Revolver. At September 28, 2004, we had $5.0 million of letters of credit outstanding. The letters of credit expire on various dates during 2005, are automatically renewable for one additional year and are payable upon demand in the event that we fail to pay certain workers compensation claims. Our availability under the AmSouth Revolver was $10.0 million at September 28, 2004.

Debt issuance costs are capitalized and amortized using the effective interest method over the term of the AmSouth Revolver.

(c)   Chesapeake Bagel Bakery Note Payable

As a part of the acquisition of the assets of Chesapeake Bagel Bakery, we entered into a note payable to the seller. The note provided for quarterly payments of interest only at 10%. The note was paid in full on August 31, 2004 according to its terms.

(d)   New Jersey Economic Development Authority Note Payable

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

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On July 3, 2003, we placed an advanced funding of the note in escrow to enact a debt defeasance as allowed for in the agreement. This advanced funding is shown as restricted cash and the note is included in both current portion and long-term portion of debt in the September 28, 2004 and December 30, 2003 consolidated balance sheets in accordance with the payment terms. This classification will continue until the note is fully paid from the escrow amount proceeds.

4.             Net Loss Per Common Share

We compute basic net loss per common share by dividing the net loss for the period by the weighted average number of shares of common stock outstanding (which includes shares contingently issuable for little or no consideration) during the period.

Diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of common stock and potential common stock equivalents outstanding during the period, if dilutive. Potential common stock equivalents include incremental shares of common stock issuable upon the exercise of stock options. The effects of potential common stock equivalents have not been included in the computation of diluted net loss per share as their effect is anti-dilutive.

The following table summarizes the weighted average number of common shares outstanding, as well as sets forth the computation of basic and diluted net loss per common share for the periods indicated (in thousands, except per share data):

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5.             Stock Based Compensation

We apply the intrinsic value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, in accounting for our fixed award stock options to our employees. As such, compensation expense is recorded only if the current market price of the underlying common stock exceeded the exercise price of the option on the date of grant. We apply the fair value-basis of accounting as prescribed by Statements of Financial Accounting Standards (SFAS) Nos. 123 and 148, Accounting for Stock-Based Compensation in accounting for our fixed award stock options to our consultants. Under SFAS Nos. 123 and 148, compensation expense is recognized based on the fair value of stock options granted.  Had compensation cost for stock options granted to employees been determined on the basis of fair value as computed using the assumptions herein, net loss and loss per share would have been increased to the following pro forma amounts (in thousands of dollars, except per share amounts):

Compensation cost of options granted for the SFAS No. 123 pro forma amounts disclosed above was estimated using the Black-Scholes option-pricing model with the following assumptions:

There were no options granted during the thirteen weeks ended September 28, 2004.

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6.             Income Taxes

We record deferred tax assets and liabilities based on the difference between the financial statement and income tax basis of assets and liabilities using the enacted statutory tax rate. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period. The recorded deferred tax assets are reviewed for impairment on a quarterly basis by reviewing our internal estimates for future net income. If we determine it to be more likely than not that the recovery of the asset is in question in the immediate, foreseeable future, we record a valuation allowance. On September 28, 2004 and September 30, 2003, we recorded a full valuation allowance against our net deferred tax asset. We will continue to record valuation allowances against additional deferred tax assets until such time that recoverability of such assets is demonstrated.

During the thirteen weeks ended September 28, 2004, we recorded a state income tax benefit of $147,000 as a result of finalization of our 2003 tax returns, representing the difference between our original estimates and actual taxes payable. The state income taxes recorded for the thirty-nine weeks ended September 28, 2004 represent our estimate of minimum state franchise taxes payable for 2004.

7.             Adjustment of Integration and Reorganization Cost

The adjustment of integration and reorganization cost primarily represents adjustments to previously recorded liabilities associated with the closing and corporate consolidation of our Eatontown facilities during 2002. During April 2004, we reached an agreement with the landlord of our Eatontown facility to settle outstanding litigation. Previously recorded integration and reorganization estimates associated with closing this facility were adjusted down by $700,000 during the thirteen weeks ended March 30, 2004 as a result of this settlement.

8.             Impairment Charges and Other Related Costs

In accordance with Statement of Financial Accounting Standard No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, impairment losses are recorded on long-lived assets on a restaurant-by-restaurant basis whenever impairment indicators are determined to be present. We consider a history of cash flow losses to be the primary indicator of potential impairment for individual restaurant locations. We determine whether a restaurant location is impaired based on expected undiscounted future cash flows, considering location, local competition, current store management performance, existing pricing structure and alternatives available for the site. If impairment exists, the amount of impairment is measured as the excess of the carrying amount of the asset over its fair value as determined utilizing the estimated discounted future cash flows or the expected proceeds, net of costs to sell, upon sale of the asset.

For the thirteen and thirty-nine weeks ended September 28, 2004, we recorded $402,000 in impairment charges for long-lived asset impairments and exit costs from the decision to close two restaurants and to write down the assets of four under-performing restaurants.

9.             Loss on Disposal or Abandonment of Assets

For the thirteen and thirty-nine weeks ended September 28, 2004, we recorded a loss on disposal or abandonment of assets of approximately $0.3 million and $2.0 million, respectively, primarily due to the disposal of menu boards as a result of our new menu offerings and due to the abandonment of leasehold improvements related to closed restaurants and our administrative facilities located in New Jersey.

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10.          Third Quarter 2003 Financings

Debt Financing – As further described in Note 3, on July 8, 2003, we issued $160 million in aggregate principal amount of 13% senior secured notes due in 2008 to replace our $140 million in aggregate principal amount of senior secured increasing rate notes due in 2003. On that same date, we also entered into a three-year, $15 million senior secured revolving credit facility with Am South Bank.

Equity Recapitalization – In September 2003, we completed an equity recapitalization with our preferred stockholders, who held a substantial portion of our common stock. Among other things, our Mandatorily Redeemable Series F Preferred Stock was eliminated. In exchange, we issued 57,000 shares of our Mandatorily Redeemable Series Z Preferred Stock to Halpern Denny Fund III, L.P. (“Halpern Denny”) and we issued 9,380,843 shares of our common stock to Greenlight Capital and affiliates (“Greenlight”).

The exchange of the Halpern Denny interest resulted in a reduction of our effective dividend rate and as a result of this and other factors, we accounted for this transaction as troubled debt restructuring. This exchange did not result in a gain from troubled debt restructuring. The exchange of the Greenlight interest into common shares was recorded at fair value, which resulted in a loss upon exchange of approximately $23.0 million. Refer to our annual report on Form 10-K for the fiscal year ended December 30, 2003 for more information regarding this transaction.

11.          Litigation, Commitments and Contingencies

Guarantees

In the past, we would sometimes guarantee leases for the benefit of certain of our franchisees. The lease guarantees extend through 2008. Under the guarantees, we may be required by the lessor to make all of the remaining monthly rental payments or property tax and common area maintenance payments if the franchisee does not make the required payments in a timely manner. However, we believe that most, if not all, of the franchised locations could be subleased to third parties minimizing our potential exposure. Additionally, we have indemnification agreements with our franchisees under which the franchisees would be obligated to reimburse us for any amounts paid under such guarantees. As of September 28, 2004, our maximum exposure under these contingent liabilities was approximately $1.7 million.

Employment Related

On July 31, 2002, Tristan Goldstein, a former store manager, and Valerie Bankhordar, a current store manager, filed a putative class action against Einstein and Noah Corp. (“ENC”) in the Superior Court for the State of California, County of San Francisco. The plaintiffs allege that ENC failed to pay overtime wages to managers and assistant managers of its California stores who were improperly designated as exempt employees in violation of California wage and hour laws and Business Profession Code Section 17200. During April 2004, we reached an agreement in principle for the settlement of litigation with the plaintiffs, subject to court approval. Amounts representing our estimate to settle this litigation were previously recorded during the quarter ended December 30, 2003.

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On March 31, 2003, Jerold E. Novack, our former Chief Financial Officer and Secretary, filed a complaint in the United States District Court for the District of New Jersey against us, Anthony D. Wedo, our former Chairman and Chief Executive Officer, and William J. Nimmo, a former member of our board of directors.  The plaintiff claims breach of employment contract, breach of Messrs. Wedo and Nimmo’s fiduciary duties to plaintiff, defamation, violation of the New Jersey Conscientious Employee Protection Act, and for a declaration that the termination of plaintiff “for cause” was invalid.  We have answered and asserted counterclaims against Mr. Novack. On January 20, 2004, the Court granted our motion to dismiss the breach of fiduciary duty claims. On October 4, 2004, the Court granted the motion for summary judgment dismissing the plaintiff’s defamation claims against Messrs. Nimmo and Wedo, and denied the plaintiff’s and defendant’s remaining motions for summary judgment. We have accrued an estimate of the loss, but do not believe the resolution of this issue will have a material adverse effect on our consolidated financial condition or results of operations.

On June 4, 2003, R. Ramin Kamfar, our former Chairman of the Board and Chief Executive Officer, filed an action in the United States District Court for the Southern District of New York against us and Anthony D. Wedo, our former Chairman and Chief Executive Officer, alleging causes of action for breach of contract, defamation, declaratory relief and punitive damages. We believe that the claims of Mr. Kamfar are without merit. We have answered and filed counterclaims against Mr. Kamfar, including claims for breach of fiduciary duty, fraud, and breach of contract.  Motions for summary judgment were filed on July 15, 2004. At this time, it is not possible to reasonably estimate the loss or range of loss, if any.

Investigations

On April 3, 2002, the Securities and Exchange Commission notified us that the Commission was conducting an investigation into the resignation of our former Chairman, R. Ramin Kamfar, and the termination for cause of our former Chief Financial Officer, Jerold Novack, and the delay in filing our Form 10-K for 2001. We have cooperated fully with the investigation as well as with a Department of Justice inquiry relating to these issues. Further, several of the former and present officers and directors have requested that, under applicable law and our by-laws, we advance reasonable legal expenses on their respective behalves to the extent any of them is or has been requested to provide information to the Commission in connection with its investigation. We have advanced certain expenses in connection with these requests. At this time, it is not possible to reasonably estimate the loss or range of loss, if any.

Financial Impact of Litigation

We are engaged in various other legal proceedings and have certain unresolved claims pending. The ultimate liability, if any, for the aggregate amounts claimed cannot be determined at this time. However, we believe based upon consultation with legal counsel that there are no other matters pending or threatened which are expected to have a material adverse effect, individually or in the aggregate, on our consolidated financial condition or results of operations.

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Insurance Programs

We are self-insured for a substantial portion of our current and prior years’ coverage including workers’ compensation, employment practices liability and general liability (collectively, “insurance losses”). To mitigate the potential cost of our exposures for certain of the insurance losses, we make annual decisions to self-fund the risks of loss up to defined maximum per occurrence retentions on a policy-by-policy basis. We then purchase insurance coverage, up to a certain limit, for losses that exceed the self-insurance per occurrence or aggregate retention. The insurers’ maximum aggregate loss limits are significantly above our actuarially determined probable losses; therefore, we believe the likelihood of losses exceeding the insurers’ maximum aggregated loss limits is remote. We are also self-insured for healthcare claims for eligible participating employees subject to certain deductibles and limitations. We have accounted for our liabilities related to the insurance losses and healthcare claims, including reported and incurred but not reported claims, based on information provided by actuaries.

We believe that we have recorded reserves adequate to cover our insurance losses based upon information we have today. Due to the inherent volatility of actuarially determined insurance loss estimates, it is reasonably possible that we could experience changes in estimated losses, which could be material to our consolidated financial position or results of operations.

12.          Recent Accounting Pronouncements

We have evaluated all recently issued but not yet effective accounting pronouncements and believe such pronouncements will not have a material effect on our financial statements.

13.          Subsequent Event - Sale of Assets of Willoughby’s Coffee & Tea

Effective October 6, 2004, we executed an Asset Purchase Agreement and sold the assets of Willoughby’s to the original founders.  The Willoughby’s business consisted of a coffee roasting plant, three retail locations and an office space. Components of the asset sale included, but were not limited to:

•          The “Willoughby’s Coffee & Tea” trade name, trademark and logo,

•          The “Serious Coffee” trademark,

•          The willoughbyscoffee.com domain name and existing website,

•          All property and equipment of Willoughby’s, and

•          Cash in drawer, accounts receivable, and inventory at all Willoughby’s locations.

Under the terms of agreement, we sold the assets for a total sales price of approximately $400,000, which was received in cash. In connection with the sale of Willoughby’s, we also executed a two-year supply agreement to purchase coffee from the buyer for our New World stores.

We have considered Statement of Financial Accounting Standard No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. We have determined that the revenues, cost of sales, other operating expenses and the net book value of the assets related to the sale of the coffee roasting plant and three retail locations included in the Willoughby’s business were immaterial in relation to our Einstein Bros., Noah, Chesapeake and Manhattan restaurants, as well as the financial statements taken as a whole. Accordingly, we have not presented discontinued operations in the accompanying consolidated statements of operations for the thirteen and thirty-nine weeks ended September 28, 2004 and September 30, 2003, respectively, nor have we reflected assets as held for sale in the accompanying consolidated balance sheet as of September 28, 2004.  We have determined that net book value of the assets is less than the sales price and accordingly, no impairment existed at September 28, 2004.

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

The following discussion and analysis supplements the management’s discussion and analysis in our Annual Report on Form 10-K for the year ended December 30, 2003 and presumes that readers have read or have access to the discussion and analysis in our Annual Report. 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.

Business Overview

We are a leader in the quick casual segment of the restaurant industry. With 707 locations in 33 states and in the District of Columbia as of September 28, 2004, we operate and license locations primarily under the Einstein Bros. and Noah’s brand names, and franchise locations primarily under the Manhattan and Chesapeake brand names. We also operate a dough production facility. We operate as a single business segment with a focus on our company-operated restaurants. Our manufacturing and franchise operations are either supportive or ancillary to our main business focus.

Our financial focus is on long term, sustainable growth in free cash flow. Free cash flow represents net cash provided by operations less purchases of fixed assets. In achieving free cash flow, we are more capable of paying down debt, saving cash for future use and building shareholder equity. We also believe free cash flow will allow us the opportunity to pursue new opportunities, acquire other businesses, or pay dividends. Increasing our operating profit and efficiently managing working capital and capital expenditures primarily drive free cash flow.

The restaurant industry, in which we compete, is intensely competitive with respect to food quality, price, service, convenience, location and concept. The industry is often affected by changes in consumer tastes, economic conditions, demographic trends, traffic patterns, the type, number and location of competing food retailers and products and disposable purchasing power.

In measuring our overall growth and progress, we focus on various key performance indicators. Such key performance indicators include: same-store sales growth, number of restaurant openings and closings, number of franchise and licensed locations opened, restaurant level and concept level margins, cash generated from operations and free cash flow. Our progress against some of these key performance indicators is discussed throughout the Management’s Discussion and Analysis.

Current Events

Effective October 6, 2004, we completed the sale of the Willoughby’s Coffee & Tea business in Connecticut. The business was sold to the original founders for a total sales price of approximately $400,000, which was received in cash. In connection with the transaction, we also executed a two-year supply agreement to purchase coffee from the buyer for our New World stores. The transaction allowed us to place a non-core asset in the hands of experienced operators and, concurrently, assure a quality source of supply for our New World Coffee shops.

On October 13, 2004, we announced that E. Nelson Heumann was named Chairman of the Board of Directors. Paul Murphy, Chief Executive Officer, who had been serving as Acting Chairman since October 2003, will continue on the Board as a Director. Additionally, Michael W. Arthur was elected as a Director to our Board expanding the panel to seven members. Mr. Arthur will also serve on the Audit Committee and has been designated as the “financial expert.” Other members of the Audit Committee are Directors Leonard Tannenbaum and Frank Meyer.

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Also on October 13, 2004, we announced that Susan Daggett, who had been Chief Operating Officer since October 2003, was named to the new position of Chief Strategy Officer.  Mike Mrlik, formerly the Executive Vice President of Operations, was promoted to Chief Operating Officer.

On October 14, 2004, we announced the introduction of our new test concept, Einstein Bros. Café. In addition to our core bagel offerings and expanded breakfast menu, the new concept offers a lunch and dinner menu with a culinary focus on innovative items using fresh and high quality ingredients. The first unit of the quick casual restaurant, located within Denver’s Stapleton neighborhood, opened on October 18, 2004.  On November 1, 2004, we retrofitted one additional Einstein Bros. restaurant in the Denver, Colorado market and by the end of fiscal year 2004, we intend to retrofit all three of our Einstein Bros. restaurants in the Colorado Springs, Colorado market.  Conversion of the remaining Einstein Bros. Bagel locations will be rolled out on a market-by-market basis.

Significant Known Events, Trends or Uncertainties Expected to Impact 2004 Results

The following factors impact comparability of operating performance or could impact comparisons for the remainder of 2004.

Economic Trends

We anticipate that our business will be affected by general economic trends that affect retailers in general. While we have not operated during a period of high inflation, we believe based on industry experience that we would generally be able to pass on increased costs resulting from inflation to our consumers. Our business may be affected by other factors, including increases in the commodity prices of flour, butter and/or fresh produce, energy costs, existing and additional competition, marketing programs, weather and variations in the number of company-owned or licensed location openings.

Although few, if any, employees are paid at the minimum wage, an increase in the minimum wage may create pressure to increase the pay scale for our employees, which would increase our labor costs and those of our franchisees and licensees.

Revenue Trends

Due to the increasing competitive pressure of the restaurant industry, we continued to experience lower retail sales during the thirteen weeks ended September 28, 2004. Additionally, recent dietary trends and negative publicity on products high in carbohydrate content may have had and may continue to have an adverse impact on our sales. We believe that we are addressing these trends with modifications to our menus via pricing increases, as well as limited time offerings of seasonal menu items. We anticipate that these planned price changes will have the effect of increasing our average check in future periods. We have also begun implementation of modifications to our customer service system of our company-operated restaurants. We believe that, as a result of these modifications, we have begun to experience little to no further deterioration in October 2004 comparable store sales as compared to the same period in the prior year.

As previously discussed, we opened our first Einstein Bros. Café on October 18, 2004 in the Denver, Colorado market. On November 1, 2004, we retrofitted one additional Einstein Bros. restaurant in the Denver, Colorado market and by the end of fiscal year 2004, we intend to retrofit all three of our Einstein Bros. restaurants in the Colorado Springs, Colorado market.

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We will operate the new concept restaurants for approximately 90 days after which we intend to study the financial and operating performance of the restaurants in order to determine modifications necessary, if any, to our menu offerings and/or the physical layout of our restaurants before commencing a staggered rollout to additional markets in 2005.

We believe that by retrofitting existing restaurants on a market-by-market basis, we can ensure minimal supply chain disruption and send a consistent marketing message within each market.

Expense Trends

Commodities - Currently, the restaurant industry is experiencing increases in the cost of dairy and other raw ingredients, as well as increases in fuel and energy costs. During the current fiscal quarter, we saw the impact of such increases in our food costs, packaging materials, utility bills and transportation charges and we believe this trend will continue through the remainder of the year. For the quarter and year-to-date period ended September 28, 2004, we experienced a negative impact of approximately $0.5 million and $1.8 million, respectively, in our margins due to increases in commodity costs.

These increases directly impact the profitability of company-owned locations, manufacturing operations and distribution channels. While we have purchase commitments for our dairy and other raw ingredients that mitigate immediate increases in food costs, our purchase commitments are not long-term in nature. Accordingly, in the near future we may experience degradation in our profit margins until such time as we are able to pass on increased costs to our consumers.

Weather  - Adverse weather experienced in the southeastern United States during September and October 2004 significantly destroyed crops already in the ground, as well as delayed fall plantings. The result of delayed plantings and expected lower yields/quality is anticipated to be increased costs and added pressure on suppliers from the desert regions and Mexico throughout the fall season, early winter and possibly beyond depending on the future weather. Additionally, hurricanes caused many of our restaurants in Florida to be closed for a short period of time due to evacuations and power shortages. During the quarter ended September 28, 2004, we estimate a loss of approximately $0.5 million in revenue due to the temporary closures. The loss of revenue resulted in a negative impact to our margins of approximately $0.3 million. We have filed a claim under our business interruption insurance coverage. At this time, we have not recorded any gain contingency associated with the estimated losses that we believe our covered under our business interruption insurance policy.

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Store Portfolio Strategy

From time to time, we close restaurants that are performing poorly, we relocate restaurants to a new site within the same trade area or we consolidate two or more of our existing units into a single unit. Generally, the closures coincide with the expiration of an existing lease and result in little or no impairment charges.

The following table details the total restaurants open at the end of the respective third quarter:

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We believe we have a strong platform for growth through store licensing of our Einstein and Noah’s brands. During the latter half of 2003, we began expansion of our licensed stores. During the thirty-nine weeks ended September 28, 2004, we added 15 new licensed stores. We anticipate opening an additional 1 - 3 licensed stores during the fourth quarter of 2004.

The licensing program is available to qualified foodservice operators and typically requires an upfront license fee that is fully earned at the time when we have substantially performed our required services in accordance with the license agreement, which generally coincides with the commencement of licensee operations. Stores are developed on college campuses, hospitals, airports, military installations and other locations. The licensed stores are generally opened during the third and fourth calendar quarters consistent with the timing of many government and higher education projects and federal funding. We typically receive continuing royalties on sales from each licensed store location. Our licensees are not required to buy all of their proprietary products directly from us, but rather their product sources must be approved by us.

Our Manhattan and Chesapeake brands primarily represent our franchise base. Our franchised locations generate a recurring revenue stream through royalty payments on sales from each franchised location and create a built-in customer base for our manufacturing operations.

We continually evaluate the rationale for each of our brands with a view toward determining whether the brand should be a part of our overall strategic business plan.

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Results of Operations