Edgar Filing: NEW WORLD RESTAURANT GROUP INC

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 October 3, 2006

OR

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

Commission File Number 0-27148

New World Restaurant Group, Inc.

(Name of Registrant as Specified in its Charter)

Delaware		13-3690261
(State or other jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

1687 Cole Blvd., Golden, Colorado 80401

(Address of principal executive offices, including zip code)

(303) 568-8000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

None

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 or a non-accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).

Large accelerated filer o

Accelerated filer o

Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes o No x

As of November 8, 2006, 10,593,085 shares of Common Stock of the registrant were outstanding.

NEW WORLD RESTAURANT GROUP, INC.

October 3, 2006

TABLE OF CONTENTS

Part I. Financial Information

Item 1.	Financial Statements:

	Consolidated Balance Sheets (unaudited), October 3, 2006 and January 3, 2006

	Consolidated Statements of Operations (unaudited), for the third quarter and year to date periods ended October 3, 2006 and September 27, 2005

	Consolidated Statements of Cash Flows (unaudited), for the year to date periods ended October 3, 2006 and September 27, 2005

	Consolidated Statement of Changes in Stockholders’ Deficit (unaudited), for the year to date period ended October 3, 2006

	Notes to the Consolidated Financial Statements (unaudited)

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

Item 3.	Quantitative and Qualitative Disclosures about Market Risk

Item 4.	Controls and Procedures

Part II. Other Information

Item 1.	Legal Proceedings

Item 1A.	Risk Factors

Item 6.	Exhibits

NEW WORLD RESTAURANT GROUP, INC.

CONSOLIDATED BALANCE SHEETS

AS OF OCTOBER 3, 2006 AND JANUARY 3, 2006

(in thousands, except share information)

(unaudited)

	October 3,			January 3,
	2006			2006
ASSETS
Current assets:
Cash and cash equivalents	$	4,234		$	1,556
Restricted cash	2,202			2,554
Franchise and other receivables, net of allowance of $629 and $480, respectively	5,858			5,506
Inventories	4,943			5,072
Prepaid expenses and other current assets	4,809			4,506
Total current assets	22,046			19,194

Restricted cash long-term	579			595
Property, plant and equipment, net	33,285			33,359
Trademarks and other intangibles, net	63,806			67,717
Goodwill	4,875			4,875
Debt issuance costs and other assets, net	5,579			5,184

Total assets	$	130,170		$	130,924

LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$	5,188		$	5,848
Accrued expenses	27,303			24,789
Short term debt and current portion of long-term debt	3,130			280
Current portion of obligations under capital leases	66			19
Total current liabilities	35,687			30,936

Senior notes and other long-term debt, net of discount	167,290			160,560
Obligations under capital leases	115			29
Other liabilities	8,438			8,610
Mandatorily redeemable, Series Z Preferred Stock, $.001 par value, $1,000 per share liquidation value; 2,000,000 shares authorized; 57,000 shares issued and outstanding	57,000			57,000
Total liabilities	268,530			257,135

Commitments and contingencies

Stockholders’ deficit:
Common stock, $.001 par value; 25,000,000 shares authorized; 10,593,085 and 10,065,072 shares issued and outstanding	11			10
Additional paid-in capital	176,682			176,018
Unamortized stock compensation	—			(68		)
Accumulated deficit	(315,053		)	(302,171		)
Total stockholders’ deficit	(138,360		)	(126,211		)

Total liabilities and stockholders’ deficit	$	130,170		$	130,924

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

NEW WORLD RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THIRD QUARTER AND YEAR TO DATE PERIODS ENDED
OCTOBER 3, 2006 AND SEPTEMBER 27, 2005

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

(unaudited)

	Third quarter ended:						Year to date ended:
	October 3,			September 27,			October 3,			September 27,
	2006			2005			2006			2005
Revenues:
Restaurant sales	$	89,213		$	87,937		$	271,300		$	265,912
Manufacturing revenues	5,052			5,270			15,126			14,905
Franchise and license related revenues	1,487			1,575			4,358			4,373

Total revenues	95,752			94,782			290,784			285,190

Cost of sales:
Restaurant costs	72,187			73,941			219,677			219,141
Manufacturing costs	5,445			4,980			15,952			13,880

Total cost of sales	77,632			78,921			235,629			233,021

Gross profit	18,120			15,861			55,155			52,169

Operating expenses:
General and administrative expenses	9,750			8,868			30,038			26,857
Depreciation and amortization	2,640			5,798			14,238			19,583
Loss on sale, disposal or abandonment of assets, net	193			104			206			269
Charges of integration and reorganization cost	—			1			—			6
Impairment charges and other related costs	51			205			134			1,484

Income from operations	5,486			885			10,539			3,970
Other expense (income):
Interest expense, net	4,749			5,805			14,670			17,497
Prepayment penalty upon redemption of $160 Million Notes	—			—			4,800			—
Write-off of debt issuance costs upon redemption of $160 Million Notes	—			—			3,956			—
Other	(15		)	(106		)	(5		)	(232		)

Income (loss) before income taxes	752			(4,814		)	(12,882		)	(13,295		)

Provision for income taxes	—			—			—			—

Net income (loss)	$	752		$	(4,814	)	$	(12,882	)	$	(13,295	)

Net income (loss) per common share – Basic	$	0.07		$	(0.49	)	$	(1.25	)	$	(1.35	)
Net income (loss) per common share – Diluted	$	0.07		$	(0.49	)	$	(1.25	)	$	(1.35	)

Weighted average number of common shares outstanding:
Basic	10,593,085			9,868,623			10,276,464			9,859,407
Diluted	11,036,527			9,868,623			10,276,464			9,859,407

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

NEW WORLD RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEAR TO DATE PERIODS ENDED OCTOBER 3, 2006 AND SEPTEMBER 27, 2005

(in thousands)

(unaudited)

	October 3,			September 27,
	2006			2005
OPERATING ACTIVITIES:	(12,882		)	(13,295		)
Net loss
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	14,238			19,583
Stock based compensation expense	546			52
Loss, net of gains, on disposal of assets	206			269
Impairment charges and other related costs	134			1,484
Integration and reorganization costs	—			6
Provision for (recovery of) losses on accounts receivable, net	158			(78		)
Amortization of debt issuance and debt discount costs	620			1,386
Write-off of debt issuance costs	3,956			—
Accretion of paid-in-kind interest	1,113			—
Changes in operating assets and liabilities:
Franchise and other receivables	(509		)	938
Accounts payable and accrued expenses	1,832			(7,587		)
Other assets and liabilities	9			3

Net cash provided by operating activities	9,421			2,761

INVESTING ACTIVITIES:
Purchase of property and equipment	(10,570		)	(5,775		)
Proceeds from the sale of equipment	165			97

Net cash used in investing activities	(10,405		)	(5,678		)

FINANCING ACTIVITIES:
Proceeds from line of credit	24			5,445
Repayments of line of credit	(24		)	(5,460		)
Repayment of other borrowings	—			(14		)
Payments under capital lease obligations	(34		)	—
Repayment of notes payable	(160,000		)	—
Borrowings under First Lien	80,000			—
Repayments under First Lien	(950		)	—
Borrowing under Second Lien	65,000			—
Borrowings under Subordinated Note	24,375			—
Proceeds upon stock option and warrant exercises	187			21
Debt issuance costs	(4,916		)	—

Net cash provided by (used in) financing activities	3,662			(8		)

Net increase (decrease) in cash and cash equivalents	2,678			(2,925		)
Cash and cash equivalents, beginning of period	1,556			9,752
Cash and cash equivalents, end of period	$	4,234		$	6,827

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

NEW WORLD RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ DEFICIT

FOR THE YEAR TO DATE PERIOD ENDED OCTOBER 3, 2006

(in thousands, except share information)

(unaudited)

				Additional			Unamortized			Accumulated
	Common Stock			Paid In			Stock			Deficit
	Shares	Amount		Capital			Compensation			Amount			Total

Balance, January 3, 2006	10,065,072	$	10	$	176,018		$	(68	)	$	(302,171	)	$	(126,211	)
Net loss	—	—		—			—			(12,882		)	(12,882		)
Common stock issued upon stock option exercise	45,151	—		132			—						132
Common stock issued upon warrant exercise	482,862	1		54			—						55
Impact of adoption of SFAS 123R				(68		)	68						—
Stock based compensation expense	—	—		546			—			—			546

Balance, October 3, 2006	10,593,085	$	11	$	176,682		$	—		$	(315,053	)	$	(138,360	)

The accompanying notes are an integral part of this consolidated financial statement.

NEW WORLD RESTAURANT GROUP, INC.

Notes to Consolidated Financial Statements (Unaudited)

Quarter and Year to Date periods ended October 3, 2006 and September 27, 2005

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 October 3, 2006, 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”) and New World Coffee (“New World”). Our business is subject to seasonal trends. Generally, our revenues and results of operations in the first fiscal quarter are somewhat lower than in the other three fiscal quarters, while revenues in the fourth fiscal quarter tend to be the most significant.

The accompanying consolidated financial statements as of October 3, 2006 and for the quarter and year to date periods ended October 3, 2006 and September 27, 2005 have been prepared without audit. The balance sheet information as of January 3, 2006 has been 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 January 3, 2006. 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 our net loss or financial position as previously reported.

2. Stock Based Compensation

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 123R, Share-Based Payment. SFAS No. 123R is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees and its related implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires entities to recognize compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions).

Effective January 4, 2006, we adopted the provisions of SFAS No. 123R using the modified prospective transition method. Prior to the adoption of SFAS No. 123R, we applied the intrinsic value-based method of accounting prescribed by APB No. 25 and related interpretations, in accounting for our fixed award stock options to our employees. As such, compensation expense was 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 applied the fair value-basis of accounting as prescribed by SFAS No. 123 in accounting for our fixed award stock options to our consultants. Under SFAS No. 123, compensation expense was recognized based on the fair value of stock options granted.

Because we previously adopted only the pro forma disclosure provisions of SFAS No. 123, we will recognize compensation cost,over the requisite service period, relating to the unvested portion of awards granted prior to the date of adoption using the same estimate of the grant-date fair value and the same attribution method used to determine the pro forma disclosures under SFAS No. 123, except that forfeiture rates have been estimated for all options, as required by SFAS No. 123R.

Our stock-based compensation cost for the third quarter of 2006 and 2005 was $139,000 and $17,000, respectively and has been included in general and administrative expenses. For the year to date period ended October 3, 2006 and September 27, 2005, stock based compensation expense was $546,000 and $52,000, respectively. The impact of adoption of SFAS No. 123R had the effect of reducing our income per share by $0.01 and increasing our loss per share by $0.05 for third quarter and year to date period ended October 3, 2006, respectively. No tax benefits were recognized for these costs due to our recurring cumulative losses. Results for fiscal year 2005 have not been restated. 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):

	Quarter ended:			Year to date:
	Sept 27,			Sept 27,
	2005			2005
Net loss, as reported	$	(4,814	)	$	(13,295	)
Deduct: fair value based compensation expense	(199		)	(538		)
Pro forma net loss	$	(5,013	)	$	(13,833	)
Basic and diluted loss per common share:
As reported	$	(0.49	)	$	(1.35	)
Pro forma	$	(0.51	)	$	(1.40	)

The fair value of stock options is estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Third quarter ended:			Year to date ended:
	Oct 3,		Sept 27,	Oct 3,		Sept 27,
	2006		2005	2006		2005
Expected life of options from date of grant	4.0 years		*	4.0 years		4.0 years
Risk-free interest rate	4.8	%	*	4.4 - 4.8	%	3.6 - 3.9	%
Volatility	100.0	%	*	100.0	%	100.0	%
Assumed dividend yield	0.0	%	*	0.0	%	0.0	%

* There were no stock options granted during third quarter ended September 27, 2005.

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 US 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 new debt facility. We have not historically issued any dividends and are precluded from doing so under our debt covenants.

Stock Option Plans

1994 and 1995 Plans

Our 1994 Stock Plan (1994 Plan) provided for the granting to employees of incentive stock options and for the granting to employees and consultants of non-statutory stock options and stock purchase rights. On November 21, 2003, the board of directors terminated the authority to issue any additional options under the 1994 Plan. At October 3, 2006, options to purchase 17 shares of common stock at an exercise price of $210.71 per share and a remaining contractual life of 0.73 years remained outstanding under this plan.

Our 1995 Directors’ Stock Option Plan (Directors’ Option Plan) provided for the automatic grant of non-statutory stock options to non-employee directors of the Company. On December 19, 2003, our board of directors terminated the authority to issue any additional options under the Directors’ Option Plan. At October 3, 2006, options to purchase 2,324 shares of common stock at a weighted average exercise price of $32.43 per share and a weighted average remaining contractual life of 5.9 years remained outstanding under this plan.

2003 Executive Employee Incentive Plan

On November 21, 2003, our board of directors adopted the Executive Employee Incentive Plan, amended on December 19, 2003 (2003 Plan). The 2003 Plan provides for granting incentive stock options to employees and granting non-statutory stock options to employees and consultants. Unless terminated sooner, the 2003 Plan will terminate automatically in December 2013. The board of directors has the authority to amend, modify or terminate the 2003 Plan, subject to any required approval by our stockholders under applicable law or upon advice of counsel. No such action may affect any options previously granted under the 2003 Plan without the consent of the holders. There are 1,150,000 shares issuable pursuant to options granted under the 2003 Plan. Options are granted with an exercise price equal to the fair market value on the date of grant, have a contractual life of ten years and typically vest over a three-year service period. Generally, 50% of options granted vest based solely upon the passage of time. We recognize compensation costs for these awards using a graded vesting attribution method over the requisite service period. The remaining 50% of options granted vest based on service and performance conditions. Options that do not vest due to the failure to achieve specific financial performance criteria are forfeited. Options to purchase approximately 263,179 shares of our common stock, which are not yet exercisable, are subject to company performance conditions. We recognize compensation costs for performance based options over the requisite service period when conditions for achievement become probable. We expect that all of the non-vested awards at October 3, 2006 will vest based on company performance. As of October 3, 2006, there were 217,916 shares reserved for future issuance under the 2003 Plan.

2004 Stock Option Plan for Independent Directors

On December 19, 2003, our board of directors adopted the Stock Option Plan for Independent Directors, effective January 1, 2004, (2004 Directors’ Plan). Our board of directors may amend, suspend, or terminate the 2004 Directors’ Plan at any time, provided, however, that no such action may adversely affect any outstanding option without the option holders consent. A total of 200,000 shares of common stock have been reserved for issuance under the 2004 Directors’ Plan. The 2004 Directors’ Plan provides for the automatic grant of non-statutory stock options to independent directors on January 1 of each year and a prorated grant of options for any director elected during the year. Options are granted with an exercise price equal to the fair market value on the date of grant, become exercisable six months after the grant date and are exercisable for 5 years from the date of grant unless earlier terminated. As of October 3, 2006, there were 64,192 shares reserved for future issuance under the 2004 Directors’ Plan.

Transactions during the year to date period ending October 3, 2006 were as follows:

			Weighted		Weighted
	Number		Average		Average	Aggregate
	of		Exercise		Remaining	Intrinsic
	Options		Price		Life (Years)	Value
Outstanding, January 4, 2006	997,152		$	3.31
Granted	152,500		$	4.50
Exercised	(45,151	)	$	2.92
Forfeited	(79,419	)	$	2.64
Outstanding, October 3, 2006	1,025,082		$	3.58	7.39	$	5,045,260
Exercisable and Vested, October 3, 2006	498,705		$	3.61	6.30	$	2,438,354

			Weighted
	Number		Average
	of		Grant Date
	Options		Fair Value
Non-vested shares, January 4, 2006	643,915		$	2.13
Granted	152,500		$	4.50
Vested	(190,619	)	$	2.12
Forfeited	(79,419	)	$	2.64
Non-vested shares, October 3, 2006	526,377		$	2.50

At October 3, 2006, we have approximately $0.4 million of total unrecognized compensation cost related to non-vested awards granted under our option plans, which we expect to recognize over a weighted average period of ten months. Total compensation costs related to the options outstanding as of October 3, 2006 will be fully recognized by first quarter of fiscal 2009.

Warrants

As of October 3, 2006, there were 332 warrants outstanding and exercisable to purchase shares of our common stock. These warrants have an exercise price of $316.67 and expire on October 25, 2006.

3. Supplemental Cash Flow Information

	Oct 3,		Sept 27,
	2006		2005
	(in thousands of dollars)
Cash paid during the year to date period ended:
Interest	$	11,820	$	21,411
Prepayment penalty upon redemption of $160 Million Notes	$	4,800	$	—

Non-cash investing activities:
Non-cash purchase of equipment through capital leasing	$	168	$	—

4. 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:

	October 3,		January 3,
	2006		2006
	(in thousands of dollars)
Finished goods	$	3,847	$	3,883
Raw materials	1,096		1,189

Total inventories	$	4,943	$	5,072

5. 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. Other intangibles consist mainly of trademarks, trade secrets and patents.

Goodwill and other intangible assets with indefinite lives are not subject to amortization but are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. SFAS No. 142, Goodwill and Other Intangible Assets, requires a two-step approach for testing impairment of goodwill. For goodwill, the fair value of each reporting unit is compared to its carrying value to determine whether an indication of impairment exists. If impairment is indicated, the fair value of the reporting unit’s goodwill is determined by allocating the unit’s fair value to its assets and liabilities (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. For other indefinite lived intangibles, the fair value is compared to the carrying value. The amount of impairment for goodwill and other intangible assets is measured as the excess of its carrying amount over its fair value. Intangible assets not subject to amortization consist primarily of the Einstein Bros. and Manhattan trademarks.

Intangible assets with lives restricted by contractual, legal or other means are amortized over their useful lives and consist primarily of patents used in our manufacturing process. Amortization expense is calculated using the straight-line method over the estimated useful lives of approximately 5 years. Intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

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

	October 3,		January 3,
	2006		2006
Amortizing intangibles:
Trade secrets	$	5,385	$	5,385
Trademarks	—		1,082
Patents-manufacturing process	33,741		33,741
	39,126		40,208
Less accumulated amortization:
Trade secrets	5,385		4,847
Trademarks	—		1,082
Patents-manufacturing process	33,741		30,368
	39,126		36,297
Total amortizing intangibles, net	—		3,911

Non-amortizing intangibles:
Trademarks	63,806		63,806
Total trademarks and other intangibles, net	$	63,806	$	67,717

During the year to date period ended October 3, 2006, there were no events or changes in circumstances that indicated that our intangible assets might be impaired or may not be recoverable.

6. Senior Notes and Other Long-Term Debt

Senior notes and other long-term debt consist of the following (in thousands of dollars):

	October 3,		January 3,
	2006		2006

$80 Million First Lien Term Loan	$	79,050	$	—
$65 Million Second Lien Term Loan	65,000		—
$25 Million Subordinated Note	25,530		—
$160 Million Notes	—		160,000
New Jersey Economic Development
Authority Note Payable	840		840
	$	170,420	$	160,840
Less current portion of senior notes and other long-term debt	3,130		280
Senior notes and other long-term debt	$	167,290	$	160,560

Debt Redemption and Refinancing

On February 28, 2006, we completed the refinancing of the AmSouth Revolver and $160 Million Notes. Our new debt obligations consist of the following:

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

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

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

· $25 million subordinated note (Subordinated Note).

Proceeds from the new debt facility were used to repay the $160 Million Notes plus a 3% redemption premium of $4.8 million and accrued and unpaid interest to the redemption date.

Revolving Facility

The Revolving Facility has a maturity date of March 31, 2011 and provides for interest based upon the prime rate or LIBOR plus a margin. The margin may increase or decrease up to 0.25% based upon our consolidated leverage ratio as defined in the agreement. The initial margin is at prime plus 2.00% or LIBOR plus 3.00%. This facility may be used in whole or in part for letters of credit. As of October 3, 2006, the stated interest rate under the Revolving Facility was at prime plus 2.00%, or 10.25%.

In the event that we have not extended the maturity date of the Mandatorily Redeemable Series Z Preferred Stock (Series Z) to a date that is on or after July 26, 2012 or redeemed the Series Z by December 30, 2008, then the Revolving Facility will mature on December 30, 2008.

We are required to pay an unused credit line fee of 0.5% per annum on the average daily unused amount. The unused line fee is payable quarterly in arrears. Additionally, we are required to pay a letter of credit fee based on the ending daily undrawn face amount for each letter of credit issued, of an applicable margin being based on our consolidated leverage ratio with a minimum and maximum applicable margin of 2.75% and 3.25%, respectively, plus a 0.5% arranger fee payable quarterly. Letters of credit reduce our availability under the Revolving Facility. At October 3, 2006, we had $6.9 million in letters of credit outstanding. The letters of credit expire on various dates during 2007, 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 $8.1 million at October 3, 2006.

The Revolving Facility contains usual and customary covenants including consolidated leverage ratios, fixed charge coverage ratios, limitations on capital expenditures, etc. The ratio covenants are based on a Consolidated EBITDA calculation (as defined in our loan agreement) and are measured on a twelve month period ending on the last day of each fiscal quarter. The loan is guaranteed by our material subsidiaries. The Revolving Facility and the related guarantees are secured by a first priority security interest in all of our assets and our material subsidiaries, including a pledge of 100% of our interest in all shares of capital stock (or other ownership or equity interests) of each material subsidiary. As of October 3, 2006, we were in compliance with all our financial and operating covenants.

Approximately $0.4 million in debt issuance costs have been capitalized and are being amortized using the straight-line method over the term of the Revolving Facility.

First Lien Term Loan

The First Lien Term Loan has a maturity date of March 31, 2011 and provides for a floating interest rate based upon the prime rate or LIBOR plus a margin. The margin may increase or decrease 0.25% based upon our consolidated leverage ratio as defined in the agreement. The initial margin is at prime plus 2.00% and/or LIBOR plus 3.00% and is payable in arrears quarterly and/or at the LIBOR date, dependent upon the rate in effect. As of October 3, 2006, the stated interest rate under the First Lien Term Loan was 8.45%, which represents a weighted average of 6-Month LIBOR plus 3.00%, or 8.45%, 3-Month LIBOR plus 3.00%, or 8.37%, and prime plus 2.00%, or 10.25%. The effective interest rate since inception was 8.36%. The facility is fully amortizing with annual aggregate principal reductions payable in quarterly installments over the term of the loan as follows:

For the 2006 fiscal year ending January 2, 2007	$ 1.425 million
For the 2007 fiscal year ending January 1, 2008	$ 3.325 million
For the 2008 fiscal year ending December 30, 2008	$ 5.950 million
For the 2009 fiscal year ending December 29, 2009	$11.250 million
For the 2010 fiscal year ending December 28, 2010	$32.150 million
For the 2011 fiscal quarter ending March 29, 2011	$25.900 million

In addition to the repayment schedule discussed above, the First Lien Term Loan also requires additional principal reductions based upon a percentage of excess cash flow as defined in the loan agreement in any fiscal year. The First Lien Term Loan also provides us the opportunity to repay the Second Lien Term Loan or the Subordinated Note with the proceeds of a capital stock offering provided that certain consolidated leverage ratios are met.

In the event that we have not extended the maturity date of the Series Z to a date that is on or after July 26, 2012 or redeemed the Series Z by December 30, 2008, then the First Lien Term Loan will mature on December 30, 2008.

The First Lien Term Loan has usual and customary covenants including consolidated leverage ratios, fixed charge coverage ratios, limitations on capital expenditures, etc. The ratio covenants are based on a Consolidated EBITDA calculation (as defined in our loan agreement) and are measured on a twelve month period ending on the last day of each fiscal quarter. The loan is guaranteed by our material subsidiaries. The First Lien Term Loan and the related guarantees are secured by a first priority security interest in all of our assets and our material subsidiaries, including a pledge of 100% of our interest in all shares of capital stock (or other ownership or equity interests) of each material subsidiary. As of October 3, 2006, we were in compliance with all our financial and operating covenants.

Approximately $2.2 million in debt issuance costs have been capitalized and are being amortized using the effective interest method over the term of the First Lien Term Loan.

Second Lien Term Loan

The Second Lien Term Loan has a maturity date of February 28, 2012 and provides for a floating interest rate based upon the prime rate plus 5.75% or LIBOR plus 6.75%. Interest is payable in arrears on a quarterly basis. As of October 3, 2006, the stated interest rate under the Second Lien Term Loan was at LIBOR plus 6.75%, or 12.21% and the effective interest rate since inception was 11.82%. The Second Lien Term Loan has a prepayment penalty of 2.0% and 1.0% of the amount of any such optional prepayment that occurs prior to the first or second anniversary date, respectively. The Second Lien Term Loan requires principal reductions based upon a percentage of excess cash flow (as defined in the credit agreement) in any fiscal year and is also subject to certain mandatory prepayment provisions. In the event that we have not extended the maturity date of the Series Z to a date that is on or after July 26, 2012 or redeemed the Series Z by March 30, 2009, then the Second Lien Term Loan will mature on March 30, 2009.

The Second Lien Term Loan has usual and customary covenants including consolidated leverage ratios, fixed charge coverage ratios, limitations on capital expenditures, etc. The ratio covenants are based on a Consolidated EBITDA calculation (as defined in our loan agreement) and are measured on a twelve month period ending on the last day of each fiscal quarter. The loan is guaranteed by our material subsidiaries. The Second Lien Term Loan and the related guarantees are secured by a second priority security interest in all our assets and our material subsidiaries, including a pledge of 100% of our interest in all shares of capital stock (or other ownership or equity interests) of each material subsidiary. As of October 3, 2006, we were in compliance with all our financial and operating covenants.

Approximately $1.7 million in debt issuance costs have been capitalized and are being amortized using the effective interest method over the term of the Second Lien Term Loan.

Subordinated Note

The Subordinated Note has a maturity date of February 28, 2013, carries a fixed interest rate of 13.75% per annum and requires a quarterly cash interest payment in arrears at 6.5% and quarterly paid-in kind interest that is added to the principal balance outstanding at 7.25%. As of October 3, 2006, the effective interest rate since inception was 14.13%. The Subordinated Note is held by Greenlight Capital and its affiliates (collectively referred to as Greenlight). Based on an original issue discount of 2.5%, proceeds of approximately $24.4 million were loaned to the Company. The Subordinated Note is subject to certain mandatory prepayment provisions. In the event that we have not extended the maturity date of the Series Z to a date that is on or after July 26, 2013 or redeemed the Series Z by June 29, 2009, then the Subordinated Note will mature on June 29, 2009.

The Subordinated Note has usual and customary covenants including consolidated leverage ratios, fixed charge coverage ratios, limitations on capital expenditures, etc. The loan is guaranteed by our material subsidiaries. The Subordinated Note is unsecured. As of October 3, 2006, we were in compliance with all our financial and operating covenants.

Approximately $0.7 million in debt issuance costs have been capitalized and are being amortized using the effective interest method over the term of the Subordinated Note. The debt discount of $625,000 is accretive to the Subordinated Note and is amortized to interest expense using the effective interest method over the term of the Subordinated Note.

$160 Million Notes

On July 8, 2003, we issued $160 million of 13% senior secured notes maturing on July 1, 2008 (“$160 Million Notes”). On February 28, 2006, the $160 Million Notes were replaced with $170 million in new term loans as discussed above. Debt issuance costs were capitalized and amortized using the effective interest method over the term of the $160 Million Notes. During the first quarter ended April 4, 2006, debt issuance costs were written off in the amount of $3.8 million.

AmSouth Revolver

On July 8, 2003, we entered into a three-year, $15 million senior secured revolving credit facility with AmSouth Bank (“AmSouth Revolver”). On February 28, 2006, the AmSouth Revolver was replaced with a new $15 million revolving credit facility as discussed above.. Debt issuance costs were capitalized and amortized using the effective interest method over the term of the AmSouth Revolver. During the first quarter ended April 4, 2006, debt issuance costs were written off to interest expense in the amount of $0.2 million.

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.

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 October 3, 2006 and January 3, 2006 consolidated balance sheets in accordance with the payment terms. This classification will continue until the note is fully paid from the escrow amount proceeds.

7. Net Income (Loss) Per Common Share

In accordance with SFAS No. 128, Earnings per Share, we compute basic net income (loss) per common share by dividing the net income (loss) for the period by the weighted average number of shares of common 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 (loss) per share when their effect is anti-dilutive.

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

	Quarter ended:					Year to date period ended:
	October 3,		September 27,			October 3,			September 27,
	2006		2005			2006			2005

Net income (loss) (a)	$	752	$	(4,814	)	$	(12,882	)	$	(13,295	)

Basic weighted average shares outstanding (b)	10,593,085		9,868,623			10,276,464			9,859,407
Dilutive effect of stock options	443,442		—			—			—
Diluted weighted average shares outstanding (c)	11,036,527		9,868,623			10,276,464			9,859,407
Basic earnings (loss) per share (a)/(b)	$	0.07	$	(0.49	)	$	(1.25	)	$	(1.35	)
Diluted earnings (loss) per share (a)/(c)	$	0.07	$	(0.49	)	$	(1.25	)	$	(1.35	)

Antidilutive stock options and warrants	2,673		1,841,062			1,025,414			1,841,062

8. 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 in effect for the year differences are expected to be taxable or refunded. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period. Future tax benefits are subject to a valuation allowance when we conclude that our deferred income tax assets may not be realized from the results of operations. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.

Cumulative net operating losses generated in the current year from continuing operations resulted in no federal and state income tax liability for the third quarter and year to date periods ended 2006 and 2005. Due to the uncertainty of future taxable income, deferred tax assets resulting from these net operating losses have been fully reserved. To date we have incurred substantial net losses that have created significant net operating loss carryforwards (NOL’s) for tax purposes. Our NOL’s are one of our deferred income tax assets. Over the past two years, we have reduced our net losses substantially from prior years. Due to improved operations, reduction in our depreciation and amortization expense, and a savings from the reduction in the interest rate on our debt facility, we achieved net income for the third quarter ended October 3, 2006.

In accordance with SFAS 109, Accounting for Income Taxes, we will assess the continuing need for a valuation allowance that results from uncertainty regarding our ability to realize the benefits of our deferred tax assets. The ultimate realization of deferred income tax assets is dependent upon generation of future taxable income during the periods in which those temporary differences become deductible. During the third quarter ended October 3, 2006, we achieved net income. As we continue to move closer toward achieving net income on an annual basis, we will review various qualitative and quantitative data, including events within the restaurant industry, the cyclical nature of our business, our future forecasts and historical trending. 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

· Achievement of approximately two years of net income before tax, with a carryback and carryforward review of our performance over the same period of time in which profits have been sustained.

The amount of the deferred tax asset considered realizable, however, could be reduced if estimates of future taxable income during the carryforward periods are reduced. As of October 3, 2006, net operating loss carryforwards of $158 million were available to be utilized against future taxable income for years through fiscal 2026, subject to annual limitations.

9. Impairment Charges

In accordance with SFAS 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 restaurants. We determine whether a restaurant is impaired based on expected undiscounted future cash flows, considering location, local competition, current restaurant 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.

During the third quarter and year to date period ended October 3, 2006, we recorded $51,000 and $134,000, respectively in impairment charges related to company-owned stores. During the third quarter and year to date period ended September 27, 2005, we recorded $100,000 and $200,000, respectively in impairment charges related to company-owned restaurants. In addition, during the third quarter and year to date period ended September 27, 2005 we recorded $100,000 and $1.3 million, respectively in impairment charges related to our Chesapeake trademarks.

10. Litigation and Contingencies

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 that an adverse outcome in any currently pending or threatened matter would have a material adverse effect on our business, results of operations or financial condition.

On September 14, 2004, Atlantic Mutual Insurance Company brought an action in the Superior Court of New Jersey Law Division: Morris County, against the Company, certain of its former officers and directors and insurers seeking declaratory judgment on insurance coverage issues in previously resolved litigation against Jerold Novack and Ramin Kamfar, former officers. This lawsuit was settled in February 2006. The Company filed a claim against National Union, the Company’s officer and directors liability insurer for the applicable time period, asserting that certain settled claims were an insured loss under the Company’s policy with National Union. The Company and National Union recently settled the issue.

Guarantees

Prior to 2001, we would occasionally guarantee leases for the benefit of certain of our franchisees. None of the guarantees have been modified since their inception and we have since discontinued this practice. Current franchisees are the primary lessees under the vast majority of these leases. Under the lease guarantees, we may be required by the lessor to make all of 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 restaurants 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. Historically, we have not been required to make such payments in significant amounts. We record a liability for our exposure under the guarantees in accordance with SFAS No. 5, “Accounting for Contingencies,” following a probability related approach. Minimum future rental payments remaining under these leases were approximately $0.9 million as of October 3, 2006. We believe the ultimate disposition of these matters will not have a material adverse effect on our financial position or results of operations.

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 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 liability is included in accrued expenses in our consolidated balance sheets.

11. Recent Accounting Pronouncements

On October 6, 2005, the FASB released FASB Staff Position (“FSP”) 13-1, Accounting for Rental Costs Incurred during a Construction Period. FSP 13-1 is effective for the first reporting period beginning after December 15, 2005 and requires that rental costs associated with ground or building operating leases incurred during a construction period be recognized as rental expense allocated on a straight-line basis over the lease term. This accounting is consistent with our historical and current practice.

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 is an interpretation of FASB Statement No. 109, “Accounting for Income Taxes,” and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. FIN 48 prescribes a recognition threshold and measurement criterion for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return, among other items. In addition, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition with respect to uncertainty in income taxes. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact, if any, that FIN 48 will have on our financial statements.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (SAB 108). Due to diversity in practice among registrants, SAB 108 expresses SEC staff views regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether financial statement restatement is necessary. SAB 108 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. We do not believe SAB 108 will have a material impact on our results from operations or financial position.

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

12. Related Party Transactions

E. Nelson Heumann is the chairman of our board of directors and is a current employee of Greenlight Capital, Inc. Greenlight and its affiliates beneficially own approximately 94 percent of our common stock on a fully diluted basis. 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 approve actions by written consent without the approval of any other stockholders, to elect all of our board of directors, and among other things, to determine whether a change in control of our company occurs.

Greenlight owned $35.0 million of our $160 Million Notes when we called the Notes for redemption in January 2006. The Notes were redeemed from the proceeds of our refinancing in February 2006 as further described in Note 6.

We entered into the Subordinated Note with Greenlight as further described in Note 6. The Subordinated Note has a maturity date of February 28, 2013, carries a fixed interest rate of 13.75% per annum and requires a quarterly cash interest payment in arrears at 6.5% and quarterly paid-in kind interest that is added to the principal balance outstanding at 7.25%.

During the year to date period ended October 3, 2006, we issued 429,645 shares of our common stock to Greenlight in connection with cashless exercises of certain warrants previously granted by us. Greenlight surrendered 56,953 shares of common stock to us in connection with such cashless exercises. We issued these warrants in private financing transactions that occurred between 2000 and 2003.

Leonard Tannenbaum, a director, is a limited partner and 10% owner in BET. BET purchased $7.5 million of our $160 Million Notes and Mr. Tannenbaum purchased an additional $0.5 million of our $160 Million Notes in the market. In January 2006, Mr. Tannenbaum and BET’s Notes were called for redemption and were redeemed from the proceeds of our refinancing in February 2006 as further described in Note 6.

During the year to date period ended October 3, 2006, we received consideration of $6,183 and issued 6,057 shares of our common stock in connection with the exercises of certain warrants previously granted by us to Mr. Tannenbaum and BET. We issued these warrants in private financing transactions that occurred between 2000 and 2003.

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 January 3, 2006 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.

Critical Accounting Policies and Estimates

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 123R, Share-Based Payment. SFAS No. 123R is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees and its related implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires entities to recognize compensation expense for awards of equity instruments to employees based on the fair value of those awards on the date of grant (with limited exceptions).

Effective January 4, 2006, we adopted the provisions of SFAS No. 123R using the modified prospective transition method. Prior to the adoption of SFAS No. 123R, we applied the intrinsic value-based method of accounting prescribed by APB No. 25 and related interpretations, in accounting for our fixed award stock options to our employees. As such, compensation expense was 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 applied the fair value basis of accounting as prescribed by SFAS No. 123 in accounting for our fixed award stock options to our consultants. Under SFAS No. 123, compensation expense was recognized based on the fair value of stock options granted.

Historically, we adopted only the pro forma disclosure provisions of SFAS No. 123. Upon adoption of SFAS No. 123R, we will recognize compensation costs relating to the unvested portion of awards granted prior to the date of adoption using the same estimates and attributions used to determine the pro forma disclosures under SFAS No. 123, except that forfeiture rates will be estimated for all options, as required by SFAS No. 123R.

We use the Black-Scholes model to estimate the fair value of our option awards. The Black-Scholes model requires estimates of the expected term of the option, as well as future volatility and the risk-free interest rate. Our stock options generally vest over a period of 6 months to 3 years and have contractual terms to exercise of 5 to 10 years. 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 US 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 new debt facility. We have not historically issued any dividends and are precluded from doing so under our debt covenants.

Option pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions, are fully transferable and do not cause dilution. Because our share-based payments have characteristics significantly different from those of freely traded options, and because changes in the subjective input assumptions can materially affect our estimates of fair values, in our opinion, existing valuation models, including the Black-Scholes model, may not provide reliable measures of the fair values of our share-based compensation. Consequently, there is a risk that our estimates of the fair values of our share-based compensation awards on the grant dates may differ from the actual values realized upon the exercise, expiration, early termination or forfeiture of those share-based payments in the future. Certain share-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that is significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements. Although the fair value of our share-based awards is determined in accordance with SFAS 123R and the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107 (SAB 107) using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

Estimates of share-based compensation expenses do have an impact on our financial statements, but these expenses are based on the aforementioned option valuation model and will never result in the payment of cash by us. For this reason, and because we do not view share-based compensation as related to our operational performance, we exclude estimated share-based compensation expense when evaluating our performance.

There were no other material changes in our critical accounting policies since the filing of our 2005 Form 10-K. As discussed in our 2005 Form 10-K, 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.

Company Overview

We believe 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 October 3, 2006, we own, operate, franchise or license 604 restaurants primarily under the Einstein Bros., Noah’s and Manhattan brands. Einstein Bros. is a national fast-casual restaurant chain, and Noah’s and Manhattan are regional fast-casual restaurant chains operated on the West Coast and in the Northeast, respectively.

Our product offerings include fresh-baked 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 consistent, high-quality ingredients and we deliver them to our restaurants through our network of independent distributors. While the primary purpose of these operations is to support our restaurants, we also have sales to other third parties.

Significant Events, Trends or Uncertainties Expected to Impact 2006 Results

The following factors represent current trends or uncertainties that may impact operating performance or could cause reported financial information not to be indicative of future operating results or future financial condition.

Restaurant Base

Since 2003, as part of our efforts to improve financial performance, we completed a thorough evaluation of our restaurant base. At the end of 2003, we had 736 restaurants across 33 states and the District of Columbia. Since that time, we have closed 51 company-owned restaurants and 140 franchised and licensed restaurants. The majority of the closed company-owned restaurants were either located in inferior real estate locations, had average annual unit volumes (AUVs) below $600,000 or were unprofitable or marginally profitable. Substantially all of the franchises that closed either:

· Involved the failure of the franchisee to conform with the requirements of the franchise agreement;

· Were geographically located outside Manhattan’s core Northeast market; or

· Were restaurants operating under our non-core brands, Chesapeake Bagel Bakery and New World Coffee.

We have identified approximately 30 company-owned restaurants that we anticipate closing over the next three years as their leases expire. Generally, these restaurants have an annual AUV below $550,000 and contribute negligible cash flow.

We intend to open five restaurants in 2006. For the year to date period ended October 3, 2006, we have opened 2 restaurants, including an Einstein Bros. in Boca Raton, FL and a Noah’s in Mercer Island, WA. Additionally, on October 14, 2006 we opened an Einstein Bros. restaurant in Chicago. We anticipate opening an Einstein Bros. restaurant in Phoenix and a Noah’s restaurant in Portland, which are projected to open during the fourth quarter of fiscal 2006. In addition to these openings, we are in the process of identifying several other potential locations for restaurant openings in 2007 and 2008. We are focusing our efforts on key markets that include Portland, Seattle, Atlanta, Chicago, Las Vegas, Phoenix, Washington, D.C. and the state of Florida.

The following table details the number of restaurants opened and closed during the third quarter and year-to-date periods, total restaurants open at the end of the third quarter, and total restaurants projected to open and close during the fourth quarter of Fiscal 2006:

	Third Quarter				Year-to-Date				Projected
	Activity				Activity				Activity
	Fiscal		Fiscal		Fiscal		Fiscal		Fourth Quarter
	2006		2005		2006		2005		2006
Einstein Bros Bagels
Company-owned beginning balance	353		365		360		371
Opened restaurants	—		—		1		3		2
Closed restaurants	(9	)	(4	)	(17	)	(13	)	(4	)
Company-owned ending balance	344		361		344		361

Licensed beginning balance	70		57		67		54
Opened restaurants	13		10		18		14		12
Closed restaurants	—		(2	)	(2	)	(3	)	—
Licensed ending balance	83		65		83		65

Noah’s
Company-owned beginning balance	72		75		73		78
Opened restaurants	1		—		1		—		1
Closed restaurants	—		(1	)	(1	)	(4	)	(1	)
Company-owned ending balance	73		74		73		74

Licensed beginning balance	3		3		3		3
Opened restaurants	1		—		1		—		—
Closed restaurants	(1	)	—		(1	)	—		—
Licensed ending balance	3		3		3		3

Manhattan
Franchised beginning balance	105		127		109		145
Opened restaurants	—		—		2		—		—
Closed restaurants	(13	)	(9	)	(19	)	(27	)	(11	)
Franchised ending balance	92		118		92		118

Chesapeake
Franchised beginning balance	5		24		8		27
Opened restaurants	—		—		—		—		—
Closed restaurants	—		(12	)	(3	)	(15	)	—
Franchised ending balance	5		12		5		12

New World Coffee/Willoughby’s
Company-owned beginning balance	2		2		2		4
Opened restaurants	—		—		—		—		—
Closed restaurants	—		—		—		(2	)	—
Company-owned ending balance	2		2		2		2

Franchised beginning balance	3		5		4		7
Opened restaurants	—		—		—		—		—
Closed restaurants	(1	)	(1	)	(2	)	(3	)	—
Franchised ending balance	2		4		2		4

Consolidated Total
Total beginning balance	613		658		626		689
Opened restaurants	15		10		23		17		15
Closed restaurants	(24	)	(29	)	(45	)	(67	)	(16	)
Total ending balance	604		639		604		639

Revenue

Over 93% of our revenue is generated by restaurant sales at our Einstein Bros. and Noah’s company-owned restaurants. Restaurant sales also include catering sales where the food is prepared at the restaurant and either delivered to or held for pick-up by the guest. The key factors that affect our restaurant sales in the aggregate are the number of restaurants in operation for the period, the AUV of the restaurant, and the change in comparable store sales. In addition to AUV, we measure the change in comparable store sales on a weekly basis.

The majority of our growth in comparable store sales has been through an increase in our average check. This increase has been achieved through a combination of multiple initiatives including: system-wide price increases, regional price increases in markets with a higher cost of living and suggestive selling by our restaurant personnel to add-on higher priced items.

We will continue to focus on our core strengths in bagels, the breakfast daypart, and on quality, speed of service, order accuracy and guest interaction. Prospectively, our focus towards sales growth will include continued improvements in our service system, local store marketing, and the introduction of new menu items. For example, during the third quarter of 2006, we introduced frozen beverages and fresh baked pretzels. We also intend to expand our existing catering programs, increase customer awareness of our retail products, emphasize bundling products such as “Sweeten the Deal,” (adding on a beverage and a bakery product, such as a cookie) and highlight favorite items such as our egg sandwiches. These initiatives are aimed at increasing average check and transaction counts in our restaurants.

We are also in the process of refining our restaurant layout, ordering system and order fulfillment process. These changes will be customized to best utilize the unique layouts in our existing restaurant base. On a prospective basis, we intend to standardize our restaurant design to ensure a consistent guest experience that embodies our heritage of guest and associate interaction without compromising speed and efficiency.

Our manufacturing revenue is primarily derived from the sale of frozen bagel dough to our franchisees, licensees and third party accounts such as Costco. We also generate manufacturing revenue from the sale of cream cheese to our franchisees, and the sale of all food products distributed through our commissaries to our licensees. In late 2005, we entered into agreements to commence selling salad kits and other deli products to the conventional grocery channel through our commissary network. The principal factors affecting manufacturing and commissary revenue are: the number of franchised and licensed restaurants that purchase frozen bagel dough and commissary products from us; sales of our products in existing franchised and licensed restaurants; and sales to third parties, including conventional grocery chains and warehouse clubs.

Franchise and license revenue consists of a license or franchise fee at the inception of the agreement and ongoing royalty payments based on a percentage of the restaurant’s sales. The principal factors affecting franchise and license revenue are the number of franchised and licensed restaurants as well as the level of sales at those restaurants.

Expenses

Food, beverage and packaging costs represent one of the largest elements of cost at our company-owned restaurants. The most important factor that affects the cost of these products is the underlying cost of the agricultural commodities such as flour, cheese, coffee, turkey and other products. In order to mitigate the impact of rising commodity costs, we enter agreements with our suppliers to fix the cost of these products for a specified period of time that is generally one year or less. We do not engage in the practice of buying futures contracts and therefore we do not have derivative accounting. Packaging and distribution costs are primarily affected by the cost of oil because petroleum based material is often used to package products for distribution. Although we have generally been able to increase our retail prices at our company-owned restaurants to offset the increased costs of these items, we may not be able to do this in the future.

Compared to 2005, dairy and coffee prices in 2006 have slightly decreased. We expect the costs to remain relatively stable for the remainder of 2006. Commodity costs for flour continue to rise during 2006 as compared to 2005. Flour represents the most significant raw ingredient we purchase and world-wide wheat production for 2006 has been below projections due to poor crop yields. We expect to see continued pressure throughout the end of this year and continuing into 2007. We have experienced increases in the cost of other ingredients such as corn syrup due to the ethanol production demand on corn.

Compensation costs reflect the hourly wages, salary, bonus, taxes and insurance that we pay our associates at each restaurant. Compensation costs tend to vary by geographic region based upon the labor market, local minimum wages, and the supply and demand of workers. Also, compensation costs tend to be semi-variable in nature and increase or decrease somewhat based upon the volume of products sold. Due to competition for personnel, limited availability in the labor pool, and changes in the federal overtime regulations, we anticipate that we may experience an increase in hourly wages during the remainder of 2006 contingent upon the number of overtime hours worked. Additionally, we are aware of increases in state minimum hourly wage rates in most of the states in which we operate that are effective beginning January 1, 2007. We continue to make improvements in labor efficiencies that may help to offset a portion of the increases in labor costs.

Other operating costs consist of utilities, restaurant and other supplies, repairs and maintenance, laundry and uniforms, bank charges and other costs related to the operation of the company-owned restaurant. Certain of these costs generally tend to be fixed in nature and are only modestly impacted by changes in the volume of products sold. Utilities, distribution costs and other expenses impacted by fuel price fluctuations are not fixed and are contingent upon contract rates negotiated by third parties outside of our control. Many of our contracts are re-priced quarterly based on the prior quarter’s market fluctuations resulting in a delayed effect upon on operating costs. During 2005 and part of 2006, we experienced increases in the cost for energy. Our distribution partners and common freight carriers passed on fuel surcharges to us during 2004, 2005 and part of 2006. During periods of uncertainty and significant market fluctuations, we cannot be certain of the impact on our future operating results. If we are unable to leverage cost increases with operating efficiencies or price increases, it may negatively impact our operating results. Conversely, decreases in fuel prices will positively impact our utilities, distribution costs and other related expenses.

Non-operating expenses include rent, common area costs, property taxes and insurance, liability insurance, delivery fees and allocated marketing expenses. We exclude depreciation and amortization expense from company-owned restaurant expenses. Changes in these costs are generally the result of changes in our rent and other related facility costs. Accordingly, these costs are predominantly fixed in nature and are modestly impacted by changes in the volume of products sold. Certain states and local governments have increased both the rate and nature of taxes on businesses in their regions. These increased taxes include real estate and property taxes, state and local income taxes, and various employment taxes.

Manufacturing costs are comprised of raw materials such as flour, dairy products and meats, compensation costs and the related taxes and employee benefits, rents, supplies and repairs and maintenance. These costs are directly related to the manufacturing revenue they produce. Operating results from our manufacturing operations represents third-party sales and can be significantly impacted by fixed overhead costs such as rent, utilities, property taxes and manager salaries and fluctuating commodity costs.

Changes in any of the aforementioned categories could directly impact the profitability of our company-owned restaurants, manufacturing operations or distribution channels. Increases in any of these expense trends in the near future may contribute to degradation in our profit margins until such time as we are able to pass on increased costs to our consumers.

Consumer Spending Habits and Impact of Inflation

Our results depend on consumer spending, which is influenced by consumer confidence and disposable income. In particular, the effects of higher gasoline prices, an increase in minimum balances payable on consumer debt and increasing interest rates 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 like interest rate speculation, unemployment rates, and real estate market conditions. Any material decline in the amount of discretionary spending could have a material adverse effect on our sales and income.

We have experienced only a modest impact from inflation as evidenced by a slight increase in the level of consumer prices. However, the impact of inflation on labor, food and occupancy costs could, in the future, significantly affect our operations. We pay many of our employees hourly rates slightly above the applicable federal, state or municipal “living wage” rates. Food costs as a percentage of sales have been somewhat stable due to procurement efficiencies and menu price adjustments, although no assurance can be made that our procurement will continue to be efficient or that we will be able to raise menu prices in the future. Costs for construction, taxes, repairs, maintenance and insurance all impact our occupancy costs. We believe that our current strategy, which is to seek to maintain operating margins through a combination of menu price increases, cost controls, efficient purchasing practices and careful evaluation of property and equipment needs, has been an effective tool for dealing with inflation.

Results of Operations

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.

	Third quarter ended:				Increase		Third quarter ended:				Year to date ended:				Increase		Year to date ended:
	(in thousands of dollars)				(Decrease)		(percent of total revenue)				(in thousands of dollars)				(Decrease)		(percent of total revenue)
	October 3,		September 27,		2006		October 3,		September 27,		October 3,		September 27,		2006		October 3,		September 27,
	2006		2005		vs. 2005		2006		2005		2006		2005		vs. 2005		2006		2005
Revenues:
Restaurant sales	89,213		87,937		1.5	%	93.2	%	92.8	%	271,300		265,912		2.0	%	93.3	%	93.2	%
Manufacturing revenues	5,052		5,270		(4.1	)%	5.3	%	5.6	%	15,126		14,905		1.5	%	5.2	%	5.2	%
Franchise and license related revenues	1,487		1,575		(5.6	)%	1.6	%	1.7	%	4,358		4,373		(0.3	)%	1.5	%	1.5	%
Total revenues	95,752		94,782		1.0	%	100.0	%	100.0	%	290,784		285,190		2.0	%	100.0	%	100.0	%

Cost of sales:
Restaurant costs	72,187		73,941		(2.4	)%	75.4	%	78.0	%	219,677		219,141		0.2	%	75.5	%	76.8	%
Manufacturing costs	5,445		4,980		9.3	%	5.7	%	5.3	%	15,952		13,880		14.9	%	5.5	%	4.9	%
Total cost of sales	77,632		78,921		(1.6	)%	81.1	%	83.3	%	235,629		233,021		1.1	%	81.0	%	81.7	%

Gross profit:
Retail	17,026		13,996		21.6	%	17.8	%	14.8	%	51,623		46,771		10.4	%	17.8	%	16.4	%
Manufacturing	(393	)	290		*		(0.4	)%	0.3	%	(826	)	1,025		*		(0.3	)%	0.4	%
Franchise and license	1,487		1,575		(5.6	)%	1.6	%	1.7	%	4,358		4,373		(0.3	)%	1.5	%	1.5	%
Total gross profit	18,120		15,861		14.2	%	18.9	%	16.7	%	55,155		52,169		5.7	%	19.0	%	18.3	%

Operating expenses:
General and administrative expenses	9,750		8,868		9.9	%	10.2	%	9.4	%	30,038		26,857		11.8	%	10.3	%	9.4	%
Depreciation and amortization	2,640		5,798		(54.5	)%	2.8	%	6.1	%	14,238		19,583		(27.3	)%	4.9	%	6.9	%
Loss on sale, disposal or abandonment of assets, net	193		104		85.6	%	0.2	%	0.1	%	206		269		(23.4	)%	0.1	%	0.1	%
Impairment charges and other related costs	51		206		(75.2	)%	0.1	%	0.2	%	134		1,490		(91.0	)%	0.0	%	0.5	%
Income from operations	5,486		885		519.9	%	5.7	%	0.9	%	10,539		3,970		165.5	%	3.6	%	1.4	%
Other expense (income):
Interest expense, net	4,749		5,805		(18.2	)%	5.0	%	6.1	%	14,670		17,497		(16.2	)%	5.0	%	6.1	%
Prepayment penalty upon redemption of $160 Million Notes	—		—		*		0.0	%	0.0	%	4,800		—		*		1.7	%	0.0	%
Write-off of debt issuance costs upon redemption of $160 Million Notes	—		—		*		0.0	%	0.0	%	3,956		—		*		1.4	%	0.0	%
Other, net	(15	)	(106	)	*		(0.0	)%	(0.1	)%	(5	)	(232	)	*		(0.0	)%	(0.1	)%
Net income (loss)	752		(4,814	)	(115.6	)%	0.8	%	(5.1	)%	(12,882	)	(13,295	)	(3.1	)%	(4.4	)%	(4.7	)%

* not meaningful

Restaurant Operations

While our comparable store sales for the third quarter ended 2006 were slightly better than the overall industry, our restaurant sales were below our expectations. Restaurant sales improved 1.5% and 2.0% when compared to the third quarter and year to date periods ended 2005, respectively. Our comparable store sales increase of 3.2% consisted of a 5.7% increase in average check partially offset by a 2.3% reduction in transactions during the third quarter ended October 3, 2006. We also experienced a 4.3% increase in comparable store sales for the year to date period ended October 3, 2006 that consisted of a 6.2% increase in average check partially offset by a 1.7% reduction in transactions. The increase in average check was related to a system-wide price increase, a slight shift in product mix to higher priced items, and suggestive selling techniques encouraging our “Sweeten the Deal” bundling offer and our “Hate to Wait” promotion (a pre-packaged baker’s dozen of bagels with cream cheese). Comparable store sales represent sales at restaurants open for one full year and 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 12th full month of operation. Comparable store sales are also referred to as “same-store” sales or as “comp sales” within the restaurant industry.

The following table summarizes the elements of comparable store sales for each quarter in fiscal 2005 and 2006:

	Comparable
Period	Store Sales
Third quarter, fiscal 2005	6.0	%
Fourth quarter, fiscal 2005	3.9	%
First quarter, fiscal 2006	6.2	%
Second quarter, fiscal 2006	3.6	%
Third quarter, fiscal 2006	3.2	%

We believe we can improve our transaction counts and bring further awareness to our brand by focusing on improvements in the operation of our restaurants including initiatives in customer service (accuracy, friendliness and speed of service), overall restaurant appearance and further development of catering programs in selected markets. In addition, we are introducing our new seasonal menu, enhancing our local store marketing and implementing employee level contests to promote suggestive selling during the fourth quarter of fiscal 2006.

Our restaurant gross profit increased 21.6% and 10.4% for the third quarter and year to date periods ended October 3, 2006, respectively, when compared to the comparable periods in 2005. Our restaurant margins are impacted by various store-level operating expenses such as the cost of products sold, salaries and benefits, insurance, supplies, repair and maintenance expenses, advertising, rent, utilities and property taxes. Because certain elements of cost of sales such as rent, utilities, property taxes and manager salaries are fixed in nature, incremental sales positively impact gross profit. Depreciation, amortization and income taxes do not impact our store contribution margins.

During the third quarter of 2006, the increase in restaurant sales over the comparable period contributed approximately $0.3 million of store contribution margin related to the increased sales. Our margins were also favorably impacted by a reduction in marketing expense of $2.1 million, $0.4 million in decreased workers’ compensation loss reserves and group insurance IBNR (incurred but not reported) estimates, $0.3 million for improvements in labor utilization, offset by $0.1 million in additional bonus wages payable due to improved operating performance.

During the year to date period ended October 3, 2006, the increase in restaurant sales over the comparable period contributed approximately $4.3 million of store contribution margin related to the increased sales. Our margins were also favorably impacted by approximately $1.0 million for improvements in labor utilization and $0.7 million savings in real estate taxes that included the settlement of a real estate tax dispute, $0.7 million reduction in marketing expense, $0.3 million due to the timing of repair and maintenance expenditures, offset by $0.9 million in increased workers’ compensation loss reserves, $0.8 million in increased energy and utility costs and $0.4 million in wages payable due to improved operating performance.

Manufacturing Operations

Our manufacturing operations predominately support our company-owned restaurants and generate revenue from the sale of food products to franchisees, licensees and third-party distributors. For the third quarter and year to date periods ended October 3, 2006 and September 27, 2005, our manufacturing margins represented less than 1.0% of total revenues. Our manufacturing margins are impacted by various manufacturing-level operating expenses such as the cost of products sold, salaries and benefits, insurance, supplies, repair and maintenance expenses, rent, utilities and property taxes. Margins from our manufacturing operations represent third-party sales and can be significantly impacted by fixed overhead costs such as rent, utilities, property taxes and manager salaries and fluctuating commodity costs. All inter-company transactions have been eliminated during consolidation.

During the third quarter and year to date period ended October 3, 2006, our manufacturing operations experienced negative margins primarily due to increases in raw materials and freight costs and incremental start-up costs associated with new products and customers. During the fourth quarter of 2006, we plan to increase prices to third party customers. Additionally, we plan to begin operating two new commissary locations which, we believe, will increase future capacity, enabling us to become more operationally efficient in the future. We believe these initiatives will positively impact our manufacturing operations.

Franchise and License Operations

Revenues for the franchised and licensed operations consist primarily of initial fees and royalty income earned as a result of operation of franchise and license restaurants. Overall, franchisee and licensee royalty income decreased approximately $0.1 million during the third quarter of 2006 as compared to the same quarter of 2005. The third quarter of 2006 included an improvement in revenue of approximately $0.2 million predominately due to improved comparable sales in the Manhattan and Einstein Bros. brands and an increase in number of Einstein Bros. licensee restaurants. During the third quarter of fiscal 2005, we recognized approximately $0.3 million in accelerated royalties due to an early termination of a franchise agreement.

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 franchise and license operations. These costs include employee wages, taxes and related benefits, travel costs, information systems, recruiting and training costs, corporate rent, and general insurance costs.

Our general and administrative expenses increased 9.9%, or $0.9 million, for the third quarter of 2006 when compared to the third quarter of 2005. Contributing to the increase was approximately $0.3 million in increased severance, salary, and other wage related expenses, $0.3 million in increased management training wages, an increase of $0.2 million in bonus wages payable to corporate office staff due to improved operating performance, $0.1 million in relocation expense for new management, and $0.1 million in stock based compensation expense. These increases are offset with a decrease of $0.2 million in group insurance IBNR estimates.

General and administrative expenses increased 11.8%, or $3.2 million, for the year to date period ended October 3, 2006 when compared to the year to date period ended September 27, 2005. Contributing to the increase was approximately $0.5 million in stock based compensation expense, $0.4 million in bonus wages payable to corporate office staff due to improved operating performance, $0.4 million in increased travel and management development expenses, $0.3 million in expenses related to the costs of transitioning to a new distributor, $0.4 million in management training wages, $0.2 million in relocation expense for new management, $0.1 million in increased salary related expenses and $0.2 million in additional consulting and contract labor fees. Additionally, we incurred approximately $0.7 million for our first annual leadership summits for our Einstein Bros. and Noah’s general managers and our Manhattan Bagel franchisees.

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. Depreciation and amortization expenses decreased 54.5%, or $3.2 million, for the third quarter of 2006 when compared to the third quarter of 2005. Depreciation and amortization expenses decreased 27.3%, or $5.3 million, for the year to date period ended October 3, 2006 when compared to the year to date period ended September 27, 2005. The decrease is primarily due to all of our amortizing intangible assets becoming fully amortized and a substantial portion of our other assets becoming fully depreciated within the second and third quarters of fiscal 2006. Depreciation and amortization expense is predominately related to the assets of Einstein/Noah Bagel Corp. that we acquired in bankruptcy proceedings in June 2001. Based on our current purchases of capital assets, our existing base of assets, and our projections for new purchases of fixed assets, we believe our annual rate of depreciation expense will approximate $12 million to $15 million in the near term.

Loss on the Disposal, Sale or Abandonment of Assets

Loss on the disposal, sale or abandonment of assets represents the excess of proceeds received, if any, over the net book value of an asset. We establish estimated useful lives for our assets, which range from 3 to 8 years, and depreciate using the straight-line method. Leasehold improvements are limited to the lesser of the useful life or the noncancelable 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.

Impairment Charges and other Related Costs

Impairment losses are non-cash charges recorded on long-lived assets, goodwill, trademarks and our other intangible assets. Generally, an indicator of impairment would include significant change in an asset’s ability to generate positive cash flow in the future or in the fair value of an asset. Whenever impairment indicators are determined to be present, the amount of impairment is measured as the excess of the carrying amount of the asset over its fair value. During the third quarter and year to date period ended October 3, 2006, we recorded $51,000 and $0.1 million, respectively in impairment charges related to company-owned restaurants. During the third quarter and year to date period ended September 27, 2005, we recorded $0.1 million and $0.2 million, respectively in impairment charges related to company-owned restaurants. In addition, during the third quarter and year to date period ended September 27, 2005 we recorded $0.1 million and $1.3 million, respectively in impairment charges related to our Chesapeake trademarks.

Interest Expense

On February 28, 2006, we completed a debt refinancing that redeemed our $160 Million Notes and retired our $15 million AmSouth Revolver. We replaced this debt with $170 million in new term loans and a $15 million revolving credit facility effectively reducing our effective interest rate from 13.9% to a weighted-average effective interest rate of 9.9% as of October 3, 2006. During the first quarter ended 2006, we wrote off $4.0 million of debt issuance costs and paid a 3% redemption premium on the $160 Million Notes in the amount of $4.8 million. During the third quarter and year to date period ended 2006, we incurred $4.7 million and $14.7 million, respectively, in net interest expense compared to $5.8 million and $17.5 million in the respective 2005 periods.

Net Income (Loss) and Income Taxes

Cumulative net operating losses generated in the current year from continuing operations resulted in no federal and state income tax liability for the third quarter and year to date periods ended 2006 and 2005. Due to the uncertainty of future taxable income, deferred tax assets resulting from these net operating losses have been fully reserved. To date we have incurred substantial net losses that have created significant net operating loss carryforwards (NOL’s) for tax purposes. Our NOL’s are one of our deferred income tax assets. Over the past two years, we have reduced our net losses substantially from prior years. Due to improved operations and as a result of a reduction in our depreciation and amortization expense, as well as a savings from the reduction in the interest rate on our debt facility, we achieved net income of $0.8 million for the third quarter ended October 3, 2006.

In accordance with SFAS 109, Accounting for Income Taxes, we will assess the continuing need for a valuation allowance that results from uncertainty regarding our ability to realize the benefits of our deferred tax assets. The ultimate realization of deferred income tax assets is dependent upon generation of future taxable income during the periods in which those temporary differences become deductible. As we move closer toward achieving net income, we will review various qualitative and quantitative data, including events within the restaurant industry, the cyclical nature of our business, our future forecasts and historical trending. 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

· Achievement of approximately two years of net income before tax, with a carryback and carryforward review of our performance over the same period of time in which profits have been sustained.

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 credit facility to fund operations, capital expenditures and required debt and interest payments. Our inventory turns frequently since 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 store performance compared with the same period in the prior year and our operating plan.

2006 Debt Redemption and Refinancing

On February 28, 2006, we completed the refinancing of the AmSouth Revolver and $160 Million Notes. Our new financing consists of a:

· $15 million revolving credit facility (Revolving Facility) maturing on March 31, 2011;

· $80 million first lien term loan (First Lien Term Loan) maturing on March 31, 2011;

· $65 million second lien term loan (Second Lien Term Loan) maturing on February 28, 2012; and

· $25 million subordinated note (Subordinated Note) maturing on February 28, 2013.

Each of the loans requires the payment of interest in arrears on a quarterly basis commencing on March 31, 2006. Additionally, the First Lien Term Loan requires quarterly scheduled minimum principal reductions commencing June 30, 2006. In the event that we have not extended the maturity date of the Mandatorily Redeemable Series Z Preferred Stock (Series Z) to a date that is on or after July 26, 2012 (July 26, 2013 for the Subordinated Note) or redeemed the Series Z by various dates in 2008 and 2009, then each of the loans have various accelerated maturity dates beginning in December 2008. For an additional discussion regarding our new debt facility, see Note 6 to our consolidated financial statements included in Part I of this report.

Working Capital Deficit and Cash Flows

As of October 3, 2006, we had unrestricted cash of $4.2 million, restricted cash of $2.8 million and no outstanding borrowings under the Revolving Facility. However, we have $6.9 million in letters of credit outstanding under our Revolving Facility at October 3, 2006. Our working capital deficit increased to $13.6 million at October 3, 2006 from $11.7 million at January 3, 2006, primarily due to the short-term classification of principal payments due under our First Lien Term Loan. Due to increased profitability at our company-owned restaurants and the timing of operational receipts and payments, net cash generated by operating activities was $9.4 million for the year to date period ended October 3, 2006 compared to $2.8 million for the year to date period ended September 27, 2005. Cash provided by operations for the year to date period ended October 3, 2006 includes a $4.8 million cash prepayment penalty incurred upon redemption of the $160 Million Notes.

Based upon our projections for 2006 and beyond, we believe that our various sources of capital, including availability under existing debt facilities, ability to raise additional financing, and cash flow from operating activities of continuing operations, are adequate to finance operations as well as the repayment of current debt obligations. If we are unable to generate sufficient cash flow to make payments on our debt, we may 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 or selling assets. 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.

During the year to date period ended October 3, 2006, we used approximately $10.6 million of cash to purchase additional property and equipment that included $1.2 million for new restaurants, $2.0 million for remodeling existing restaurants, $3.7 million for replacement and new equipment at our existing company-owned restaurants, $2.3 million for our manufacturing operations and $1.4 million for general corporate purposes. We anticipate that the majority of our capital expenditures for fiscal 2006 will be focused on our refresh and remodel strategy that includes updates of restaurant interiors and design flow. In addition, we plan to acquire additional equipment for new menu items and improvements in the speed of service, particularly during the morning day-part. We also plan to open 5 new company-owned restaurants during 2006 at an average capital investment of approximately $0.4 million to $0.5 million per restaurant. For the year to date period ended October 3, 2006, we have opened 2 restaurants, including an Einstein’s Bros. in Boca Raton, FL and a Noah’s in Mercer Island, WA Additionally, on October 14, 2006, we opened an Einstein Bros. restaurant in Chicago. We anticipate opening an Einstein Bros. restaurant in Phoenix and a Noah’s restaurant in Portland, which are projected to open during the fourth quarter of fiscal 2006.

As a result of our refinancing of our $160 Million Notes with $170 million in new term loans in February 2006, we borrowed $169.4 million in term loans and incurred approximately $5.0 million in debt issuance costs. Upon closing of our new debt facility, we began amortizing these costs and the debt issuance costs related to our $160 Million Notes and AmSouth Revolver were written-off.

Contractual Obligations

The following table summarizes the amounts of payments due under specified contractual obligations as of October 3, 2006:

	Payments Due by Period
	2006		2007 to 2009		2010 to 2011		2012 and thereafter		Total
	(in thousands of dollars)
Accounts payable and accrued expenses	$	32,491	$	—	$	—	$	—	$	32,491
Debt	755		21,085		58,050		105,795		$	185,685
Estimated interest expense on our Debt Facility	4,241		48,658		26,279		4,987		$	84,165
Manditorily Redeemable Series Z	—		57,000		—		—		$	57,000
Minimum lease payments under capital leases	66		115		—		—		$	181
Minimum lease payments under operating leases	6,654		44,585		12,482		2,391		$	66,112
Purchase obligations (a)	4,827		—		—		—		$	4,827
Other long-term obligations (b)	—		1,344		832		4,907		$	7,083
Total	$	49,034	$	172,787	$	97,643	$	118,080	$	437,544

(a) Purchase obligations consist of non-cancelable minimum purchases of frozen dough and certain other raw ingredients that are used in our products.

(b) 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

Off-Balance Sheet Arrangements

Guarantees

Letters of Credit

We have $6.9 million in letters of credit outstanding under our Revolving Facility at October 3, 2006. The letters of credit expire on various dates during 2007, are automatically renewable for one additional year and are payable upon demand in the event that we fail to pay the underlying obligation.

Item 3. Qualitative and Quantitative Disclosures About Market Risk

During the third quarter and year to date periods ended October 3, 2006 and September 27, 2005, 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 debt as of October 3, 2006 was principally comprised of the Revolving Facility, First Lien Term Loan, Second Lien Term Loan, and Subordinated Note as further discussed in Note 6 to the consolidated financial statements included in Part I of this document. 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, First Lien Term Loan and Second 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 net loss by approximately $1.5 million annually, assuming no change in the size or composition of debt at October 3, 2006. Currently, the interest rates on our First Lien Term Loan, Second Lien Term Loan and Revolving Facility are predominately 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.

We purchase certain commodities such as butter, cheese, coffee and flour. These commodities are generally purchased based upon market prices established with vendors. 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 because our purchase arrangements help control the ultimate cost paid and any commodity price aberrations are generally short-term in nature.

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.

Item 4. 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 October 3, 2006. 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.

During the quarter ended October 3, 2006, 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.

PART II - OTHER INFORMATION

NEW WORLD RESTAURANT GROUP, INC.

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

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, estimates, predicts, expects, and similar expressions that convey the uncertainty of future events or outcomes. An expanded discussion of some of these risk factors follows.

Risk Factors Relating to Our Business and Our Industry

Failure to protect food supplies and adhere to food safety standards could result in food-borne illnesses and/or injuries to our customers.

Food safety is the most significant risk to any company that operates in the restaurant industry. It is the focus of increased government regulatory initiatives at the local, state and federal levels. To limit our exposure to the risk of food contamination, we vigorously emphasize and enforce food safety policies in all of our restaurants and at our commissaries and manufacturing plant. These policies are designed to work cooperatively with programs established by health agencies at all levels of government authority, including the federal Hazard Analysis of Critical Control Points (HACCP) program. In addition, we make use of ServSafe Training, a nationally recognized program developed by the National Restaurant Association. The ServSafe program provides accurate, up-to-date science-based information to all levels of restaurant workers on all aspects of food handling, from receiving and storing to preparing and serving. All restaurant managers are required to be certified in ServSafe Training and are required to be re-certified every three to five years.

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 customers. 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 customers 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 our manufacturing plant could have far-reaching effects, as the contamination would affect substantially all of our restaurants. In addition, product contamination or recalls, in general, such as the recent warning by the FDA and illnesses related to fresh spinach, may cause our customers to cease frequenting our restaurants based on fear of such illnesses.

Changes in consumer preferences and discretionary spending priorities could harm our financial results.

Numerous factors including changes in consumer tastes and discretionary spending priorities often affect restaurants. Shifts in consumer preferences away from our type of cuisine and/or the fast-casual style could have a material adverse 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 could also have a material adverse effect on our sales. A variety of factors could affect discretionary consumer spending, including national, regional and local economic conditions, inflation, consumer confidence and energy costs. Adverse changes in any of these factors could reduce consumers’ discretionary spending which in turn could reduce our guest traffic or average check. Adverse changes to consumer preferences or consumer discretionary spending, each of which could be affected by many different factors which are out of our control, could harm our business prospects, financial condition, operating results and cash flows. Our continued success will depend in part on our ability to anticipate, identify and respond to changing consumer preferences and economic conditions.

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 our guests’ needs. We believe successful deployment of our current business strategy will address guests’ needs and contribute to overall company growth. Our business strategy consists of several initiatives:

· expanding the menu offerings at our company-owned restaurants;

· increasing the profitability of our existing restaurants through our brand refresh strategy;

· growing our business through opening new company-owned, franchised and licensed restaurants; and

· continuing to develop our manufacturing and commissary operations to increase third-party sales.

Our ability to achieve any or all of these initiatives is uncertain. Our success in developing new menu offerings and refreshing our restaurants is dependent in part on our ability to predict and satisfy consumer preferences. 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, train appropriate staff and properly manage the new restaurant. Our success in increasing third-party sales is dependent on identifying new opportunities and negotiating profitable arrangements with third-party purchasers. 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 sales growth and will be a critical factor affecting profit growth. The profit margin driven by comparable store sales enables fixed costs to be spread over a higher sales base. Our ability to increase comparable store sales depends in part on our ability to successfully implement our initiatives to increase throughput, such as increasing the speed at which our employees serve each customer, and to build customer awareness of our menu offerings. Factors such as traffic patterns, local demographics and the type, number and location of competing restaurants 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. We expect quarterly comparable restaurant sales increases to decline throughout the year as sequential comparisons become more difficult.

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. 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 retain customers 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 for total terms of approximately 15 to 20 years. We believe that 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. Our obligation to continue making rental payments in respect of leases for closed 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 specialty 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.

Fluctuations in the cost, availability and quality of our raw ingredients and natural resources such as energy affect our results of operations.

The cost, availability and quality of the ingredients 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, weather and demand could adversely affect the cost of our ingredients. For example, flour represents the most significant raw ingredient we purchase and world-wide wheat production for 2006 has been below projections due to poor crop yields. We expect to see continued pressure throughout the end of this year and continuing into 2007. We have limited control over these changes in the price and quality of commodities, since we do not have any long-term pricing agreements for these ingredients. 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 frequent deliveries of fresh ingredients, thereby subjecting us to the risk of shortages or interruptions in supply. All of these factors could adversely affect our business, reputation and financial results.

Our operations may be negatively impacted by adverse weather conditions.

Adverse weather conditions could seriously affect regions in which our company-owned, franchised and licensed restaurants are located or regions that produce raw ingredients for our restaurants. If adverse weather conditions 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.

The effects of hurricanes 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 upon in the short-term. All of our remaining frozen bagel dough is produced at our dough manufacturing facility in Whittier, CA. Additionally, we purchase all of our cream cheese from a single source, and we have a single supplier for our coffee. 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.

Our contract with our supplier of frozen bagel dough expires at the end of 2006 and we are in the process of negotiating a new 5-year contract. If we are unable to reach a new agreement to supply frozen bagel dough on favorable terms, our frozen bagel dough costs could increase which would have a negative impact on our results from operations.

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 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.

During late 2005, we negotiated contract terms with a new distribution partner. We have experienced some transition issues at one new distribution center during 2006, but at this time we do not believe these issues will have a material adverse effect on our results of operations. We are currently working to resolve these issues.

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 an increase in the federal, state or municipal “living wage” rates. Numerous proposals have been made on federal, state and local levels to increase minimum wage levels. Although few, if any, of our associates are paid at the minimum wage level, an increase 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. We are aware of increases in state minimum hourly wage rates in most of the states in which we operate that are effective beginning January 1, 2007. 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 customers.

We may not be able to generate sufficient cash flow to make payments on our substantial amount of debt.

We have a high level of debt and are highly leveraged. As of October 3, 2006, we had $170 million in term loans 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; and

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

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

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

Our 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 on 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 may divert financial and management resources that would otherwise be used to benefit our future performance. We have been subject to 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 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 together 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 gathering places 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 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. As we move into offering franchises for our Einstein Bros. Bagel brand, our reliance on our franchisees is expected to increase in proportion to growth of the franchisee base. We are still in the planning stages with respect to franchising our Einstein Bros. brand, and have not yet made any formal offers of franchise area development agreements for this 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.

Government regulation could 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 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.

In addition, our franchising operations are subject to regulation by the Federal Trade Commission. Our franchisees and 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 our franchisees and 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 that 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 or to prevent others from claiming violations of their trademarks and proprietary rights by us. In addition, others may assert rights in our trademarks, service marks and other proprietary rights.

Risk Factors Relating to Our Common Stock

We have a majority stockholder.

Greenlight Capital, L.L.C. and its affiliates beneficially own approximately 94 percent 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 approve actions by written consent without the approval of any other stockholders, to elect all 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 is not involved in our day-to-day operations, but Greenlight has voted its shares to elect our current board of directors. The chairman of our board of directors is a current employee of Greenlight.

Our common stock is not currently listed on any stock exchange or Nasdaq. As a result, we are not subject to corporate governance rules adopted by the New York Stock Exchange, American Stock Exchange and Nasdaq requiring a majority of directors to be independent and requiring compensation and nominating committees that are composed solely of independent directors. However, we are subject to rules requiring that the audit committee consist entirely of independent directors. Under the rules of these stock exchanges and Nasdaq, if a single stockholder holds more that 50% of the voting power of a listed company, that company is considered a controlled company, and except for the rules relating to independence of the audit committee, is exempt from the above-mentioned independence rules. Since Greenlight beneficially owns approximately 94 percent of our common stock, we may take advantage of the controlled company exemption if our common stock becomes listed on an exchange or Nasdaq in the future. As a result, our stockholders currently do not have, and may never have, the protections that these rules are intended to provide.

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 94 percent 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. Additionally, holders of outstanding warrants may convert and sell the underlying shares in the public market. Sales of shares or a perception that there will be sales of the underlying shares could also cause a decrease in the market price of our common stock.

Holders may find it difficult to effect transactions in our common stock.

Our common stock is currently trading on the ‘‘pink sheets’’ under the symbol ‘‘NWRG.PK.’’ Since our common stock is not listed on Nasdaq, Amex or the New York Stock Exchange, holders of our common stock may find that the liquidity of our common stock is limited—not only in the number of securities that can be bought and sold, but also through delays in the timing of transactions, lack of security analysts’ and the news media’s coverage of us, and lower prices for our securities than might otherwise be attained.

Securities that are not listed on a stock exchange, the Nasdaq National Market or the Nasdaq SmallCap Market are subject to an SEC rule that imposes special requirements on broker-dealers who sell those securities to persons other than their established customers and accredited investors. The broker-dealer must determine that the security is suitable for the purchaser and must obtain the purchaser’s written consent prior to the sale. These requirements may make it more difficult for stockholders to sell our stock than the stock of some other companies. It may also affect our ability to raise more capital if and when necessary.

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

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.

		NEW WORLD RESTAURANT GROUP, INC.


Date:	November 10, 2006	By: /s/ PAUL J. B. MURPHY, III
		Paul J.B. Murphy, III
		Chief Executive Officer

Date:	November 10, 2006	By: /s/ RICHARD P. DUTKIEWICZ
		Richard P. Dutkiewicz
		Chief Financial Officer and Principal Accounting Officer