UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Einstein Noah Restaurant Group, Inc.

(Exact name of registrant as specified in its charter)

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.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

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

As of May 1, 2008, there were 15,923,227 shares of the registrant’s Common Stock, par value of $0.001 per share outstanding.

EINSTEIN NOAH RESTAURANT GROUP, INC.

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements

EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED BALANCE SHEETS
AS OF JANUARY 1, 2008 AND APRIL 1, 2008

(in thousands, except share information)

(Unaudited)

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

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EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE FIRST QUARTERS ENDED APRIL 3, 2007 AND APRIL 1, 2008

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

(unaudited)

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

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EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FIRST QUARTERS ENDED
APRIL 3, 2007 AND APRIL 1, 2008

(in thousands)

(Unaudited)

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

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EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ DEFICIT
FOR THE YEAR TO DATE PERIOD ENDED

APRIL 1, 2008

(in thousands, except share information)

(Unaudited)

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

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EINSTEIN NOAH RESTAURANT GROUP, INC.

Notes to Consolidated Financial Statements (Unaudited)

1.     Basis of Presentation

The consolidated financial statements of Einstein Noah Restaurant Group, Inc. and its wholly-owned subsidiaries (collectively, the “Company”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). As of April 1, 2008, the Company owned, franchised or licensed various restaurant concepts under the brand names of Einstein Bros. Bagels (“Einstein Bros.”), Noah’s New York Bagels (“Noah’s”), Manhattan Bagel Company (“Manhattan Bagel”), 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 fourth fiscal quarter tend to be the most significant.

The consolidated financial statements as of April 1, 2008 and for the first quarters ended April 3, 2007 and April 1, 2008 have been prepared without audit. The balance sheet information as of January 1, 2008 has been derived from our audited consolidated financial statements. The information furnished herein reflects all adjustments (consisting only of normal recurring accruals and adjustments), which are, in our opinion, necessary to fairly state the interim operating results for the respective periods.  However, these operating results are not necessarily indicative of the results expected for the full fiscal year.

Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States have been omitted pursuant to Security Exchange Commission (“SEC”) rules and regulations. The notes to the consolidated financial statements (unaudited) should be read in conjunction with the notes to the consolidated financial statements contained in our annual report on Form 10-K for the fiscal year ended January 1, 2008. We believe that the disclosures are sufficient for interim financial reporting purposes.

2.     Recent Accounting Pronouncements

Effective January 1, 2008, the Company adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for using fair value to measure assets and liabilities, and expands disclosure about fair value measurements. SFAS 157 applies whenever other statements require or permit assets or liabilities to be measured at fair value. The adoption of SFAS 157 did not have an impact on the Company’s consolidated financial statements.

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

In December 2007, the FASB issued SFAS 141 (revised 2007), Business Combinations, (“SFAS 141R”). SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, including goodwill, the liabilities assumed and any non-controlling interest in the acquiree. The Statement also establishes disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The impact of adopting SFAS 141R will be dependent on the future business combinations that the Company may pursue after its effective date.

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

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

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

3.     Stock Based Compensation

Our stock-based compensation cost for the first quarters ended April 3, 2007 and April 1, 2008 was $331,000 and $506,000, respectively and has been included in general and administrative expenses. The fair value of stock options and stock appreciation rights (“SARs”) are estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:

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

As of April 1, 2008, we had approximately $1.9 million of total unrecognized compensation cost related to non-vested awards granted under our stock option and stock appreciation rights plans, which we expect to recognize over a weighted average period of 2.2 years. Total compensation costs related to the non-vested awards outstanding as of April 1, 2008 will be fully recognized by the first quarter of fiscal 2011, which represents the end of the requisite service period.

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Stock Option Plan Activity

Transactions during the first quarter ended April 1, 2008 were as follows:

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Stock Appreciation Rights Plan Activity

Transactions during the first quarter ended April 1, 2008 were as follows:

4.     Supplemental Cash Flow Information

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5.     Inventories

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

6.     Goodwill, Trademarks and Other Intangibles

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

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

7.     Senior Notes and Other Long-Term Debt

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

First Lien Term Loan and Revolving Facility

Our debt is comprised of a modified term loan with a principal amount of $90 million and a $20 million revolving credit facility. We may prepay amounts outstanding under the senior secured credit facility and may terminate commitments in whole at any time without penalty or premium upon prior written notice.  Borrowings under this senior secured credit facility bear interest at a rate equal to an applicable margin plus, at our option, either a variable base rate or a Eurodollar rate. As of April 1, 2008 the stated interest rate under the $90 million First Lien Term Loan (“First Lien Term Loan”) was 5.55%. The revolving facility and the First Lien Term Loan contain usual and customary covenants including consolidated leverage ratios, fixed charge coverage ratios, limitations on capital expenditures, etc. As of January 1, 2008 and April 1, 2008 we were in compliance with all our financial and operating covenants

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The revolving credit facility remains available, subject to certain conditions, to finance our ongoing working capital, capital expenditure and general corporate needs.  In addition, all of the revolving credit facility is available for letters of credit. As of April 1, 2008, we had $7.3 million in letters of credit outstanding under this facility. The letters of credit expire on various dates during 2008, 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 $12.7 million at April 1, 2008.

For the revolving facility, the capitalized debt issuance costs are being amortized on a straight-line basis while the capitalized debt issuance costs for the First Lien Term Loan are being amortized on the effective interest rate method. As of April 1, 2008, approximately $0.4 million and $2.0 million in debt issuance costs have been capitalized for the revolving facility and the First Lien Term Loan, respectively, net of amortization.

8.     Net Income Per Common Share

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

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

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9.     Income Taxes

Utilization of our net operating loss (“NOL”) carryforwards reduced our federal and state income tax liability incurred for the first quarter of 2008. We have recorded a provision for income taxes in the amount of $142,000 related to our estimate of income taxes due on taxable earnings for the first quarter of 2008.

As of April 1, 2008, NOL carryforwards of $144.9 million were available to be utilized against future taxable income for years through fiscal 2026, subject in part to annual limitations. As a result of prior ownership changes, approximately $98.3 million of our NOL carryforwards are subject to an annual usage limitation of $4.7 million.  Our ability to utilize our NOL carryforwards, including those that are not currently subject to limitation, could be limited or further limited in the event that we undergo an “ownership change” as that term is defined for purposes of Section 382 of the Internal Revenue Code.  We are in the process of filing a request with the Internal Revenue Service to review our methodology for determining ownership changes in accordance with Internal Revenue Code Section 382. Upon acceptance of our request, we believe that our NOL carryforwards will be available for utilization. In the event that our request is not accepted, approximately $17.9 million of NOL carryforwards will be at risk to expire prior to utilization.

Our NOL carryforwards are included in our deferred income tax assets; however, the ultimate realization of these deferred income tax assets is dependent upon the generation of future taxable income. Due to the uncertainty of future taxable income, deferred tax assets resulting from these net operating losses have been fully reserved.  Additionally, we maintain a full valuation allowance against our total net deferred tax assets.

In accordance with SFAS No. 109, Accounting for Income Taxes, (“SFAS No. 109”) we 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.  Although we achieved $12.6 million of net income for 2007 and $3.8 million of net income for the quarter ended April 1, 2008, we will continue to 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

·  Accumulation of net income before tax utilizing a look-back period of three years.

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.

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

10.  Commitments and Contingencies

Letters of Credit and Line of Credit

As of April 1, 2008, we had $7.9 million in letters of credit outstanding. The letters of credit expire on various dates during 2008, are automatically renewable for one additional year and are payable upon demand in the event that we fail to pay the underlying obligation. Of the total letters of credit outstanding, $7.3 million reduce our availability under the Revolving Facility. Our availability under the revolving facility was $12.7 million at April 1, 2008.

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Litigation

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

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

On September 18, 2007, Eric Mathistad, a former store manager, filed a putative class action against the Company in the Superior Court of California for the State of California, County of San Diego.  The plaintiff alleges that we failed to pay overtime wages to “salaried restaurant employees” of our California stores who were improperly designated as exempt employees, and that these employees were deprived of mandated meal periods and rest breaks.  Plaintiff alleges that these actions were in violation of the California Labor Code Sections 1194, et seq., 500, et seq., California Business and Professions Code Section 17200, et seq., and applicable wage order(s) issued by the Industrial Welfare Commission.  Plaintiff seeks injunctive relief, declaratory relief, attorney’s fees, restitution and an unspecified amount of damages for unpaid overtime and for missed meal and/or rest periods.  The Company filed a Demurrer on October 18, 2007 claiming that, inter alia, plaintiff fails to state a claim against the Company; plaintiff does not state a claim for a joint venture, partnership, common enterprise, or aiding and abetting; plaintiff’s definition of the class is deficient and plaintiff’s claims for declaratory judgment regarding Labor Code violations should be dismissed.   On January 15, 2008, Plaintiffs filed a First Amended Complaint.  On November 14, 2007, Bernadette Mejia, another former store manager, filed a similar case.    On April 10, 2008, the Mathistad and Meija cases were consolidated into one case, and on May 6, 2008, Plaintiffs filed an Amended Consolidated Complaint.   Because limited discovery has been conducted and no class certification proceeding has occurred, we cannot predict the outcome of this matter.

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

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 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 most, if not all, of the franchised locations could be subleased to third parties reducing 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 Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. In the event that trends change in the future, our financial results could be impacted. As of April 1, 2008, we had outstanding guarantees of indebtedness under certain leases of approximately $1.2 million.  Approximately $14,000 is reflected in accrued expenses in our consolidated balance sheet at April 1, 2008 for the guarantee of a franchisee’s lease.

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11.  Subsequent Events

On May 7, 2008, we entered into an interest rate swap agreement relating to our $90 million First Lien Term Loan, effectively fixing our rate on $60 million of our debt to 3.52% plus an applicable margin for the next two years, effective starting August 2008.  Under this interest rate swap agreement, the Company will pay a fixed rate plus a margin every quarter on the notional amount of the debt and will receive the London InterBank Offered Rate (“LIBOR”).

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

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

Cautionary Note Regarding Forward-Looking Statements

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

General

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

Company Overview

We are a leading fast-casual restaurant chain, specializing in high-quality foods for breakfast and lunch in a café atmosphere with a neighborhood emphasis.  As of April 1, 2008, we owned and operated, franchised or licensed 617 restaurants in 35 states and in the District of Columbia, primarily under the Einstein Bros., Noah’s and Manhattan Bagel brands.  Einstein Bros. is a national fast-casual restaurant chain.  Noah’s is a regional fast-casual restaurant chain operated exclusively on the West Coast and Manhattan Bagel is a regional fast-casual restaurant chain operated predominantly in the Northeast.  Our product offerings include fresh bagels and other goods baked on-site, made-to-order sandwiches on a variety of bagels and breads, gourmet soups and salads, decadent desserts, premium coffees and other café beverages.  Our manufacturing and commissary operations prepare and assemble consistent, high-quality ingredients and we deliver them to our restaurants quickly and efficiently through our network of independent distributors.  Our manufacturing and commissary operations support our main business focus, restaurant operations, by exposing our brands to new product channels as well as enabling sales of our products to third parties.

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Current Restaurant Base

As of April 1, 2008, we owned and operated, franchised or licensed 617 restaurants. Our current base of company-owned restaurants under our core brands includes 338 Einstein Bros. restaurants, 76 Noah’s restaurants and one Manhattan Bagel restaurant. Also, we franchise one Einstein Bros. restaurant and 69 Manhattan Bagel restaurants, and license 125 Einstein Bros. restaurants and three Noah’s restaurants. In addition, we have four restaurants which we operate/franchise under our non-core brands.

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

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