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EX-31.1 - CERTIFICATION OF CEO - EINSTEIN NOAH RESTAURANT GROUP INCdex311.htm
EX-21.1 - LIST OF SUBSIDIARIES - EINSTEIN NOAH RESTAURANT GROUP INCdex211.htm
EX-32.1 - CERTIFICATION OF CEO - EINSTEIN NOAH RESTAURANT GROUP INCdex321.htm
EX-32.3 - CERTIFICATION OF PRINCIPAL ACCOUNTING OFFICER - EINSTEIN NOAH RESTAURANT GROUP INCdex323.htm
EX-31.2 - CERTIFICATION OF CFO - EINSTEIN NOAH RESTAURANT GROUP INCdex312.htm
EX-23.1 - CONSENT OF GRANT THORNTON LLP - EINSTEIN NOAH RESTAURANT GROUP INCdex231.htm
EX-32.2 - CERTIFICATION OF CFO - EINSTEIN NOAH RESTAURANT GROUP INCdex322.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

(Mark One):

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

For the fiscal year ended December 29, 2009

OR

 

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

For the transition period from                      to                     

Commission File Number 001-33515

EINSTEIN NOAH RESTAURANT GROUP, INC.

(Exact Name of Registrant as Specified in its Charter)

 

Delaware   13-3690261

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

555 Zang Street, Suite 300, Lakewood, Colorado   80228
(Address of principal executive offices)   (Zip Code)
Registrant’s telephone number, including area code: (303) 568-8000

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

Title of each class:

 

Name of each exchange on which registered:

Common Stock, $.001 par value   The NASDAQ Global Market
Securities registered pursuant to Section 12(g) of the Act:   None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments of this Form 10-K.    ¨

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

 

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

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

The aggregate market value of the voting common equity held by non-affiliates of the registrant as of the last business day of the second fiscal quarter, June 30, 2009 was $44,714,203 (computed by reference to the closing sale price as reported on the NASDAQ Global Market). As of February 22, 2010 there were 16,466,142 shares of the registrant’s Common Stock, par value of $0.001 per share outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III is incorporated herein by reference from the registrant’s definitive proxy statement for the 2010 annual meeting of stockholders, which will be filed with the SEC within 120 days after the close of the 2009 fiscal year.

 

 

 


Table of Contents

EINSTEIN NOAH RESTAURANT GROUP, INC.

FORM 10-K

TABLE OF CONTENTS

 

PART I
ITEM 1.  

BUSINESS

   2
ITEM 1A.  

RISK FACTORS

   9
ITEM 1B.  

UNRESOLVED STAFF COMMENTS

   16
ITEM 2.  

PROPERTIES

   17
ITEM 3.  

LEGAL PROCEEDINGS

   19
ITEM 4.  

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

   19
PART II
ITEM 5.  

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

   20
ITEM 6.  

SELECTED FINANCIAL DATA

   22
ITEM 7.  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

   23
ITEM 7A.  

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   41
ITEM 8.  

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

   42
ITEM 9.  

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

   77
ITEM 9A.  

CONTROLS AND PROCEDURES

   77
ITEM 9B.  

OTHER INFORMATION

   78
PART III
ITEM 10.  

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

   79
ITEM 11.  

EXECUTIVE COMPENSATION

   79
ITEM 12.  

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

   79
ITEM 13.  

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

   79
ITEM 14.  

PRINCIPAL ACCOUNTANT FEES AND SERVICES

   79
PART IV
ITEM 15.  

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

   80

 

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Table of Contents

PART I

 

ITEM 1. BUSINESS

General development of our Company:

Einstein Noah Restaurant Group, Inc. (the “Company”) operates primarily under the Einstein Bros. Bagels (“Einstein Bros.”), Noah’s New York Bagels (“Noah’s”) and Manhattan Bagel Company (“Manhattan Bagel”) brands. We commenced operations as an operator and franchisor of coffee cafes in 1993. Substantial growth in our restaurant counts occurred through a series of acquisitions. Our largest acquisition was in 2001 when we acquired substantially all the assets of Einstein/Noah Bagel Corp. in an auction conducted by the bankruptcy court. Since then, we have grown organically by opening company-owned restaurants, working with franchisees on development agreements, and promoting the licensing of our brand.

Financial information about segments:

We operate three business segments plus a corporate support unit:

 

   

The company-owned restaurants segment includes our Einstein Bros. and Noah’s brands, which have similar investment criteria and economic and operating characteristics.

 

   

The franchise and license segment earns royalties and other fees from the use of trademarks and operating systems developed for the Manhattan Bagel, Einstein Bros. and Noah’s brands.

 

   

The manufacturing and commissary segment produces and distributes bagel dough and other products to our company-owned restaurants, licensees and franchisees and other third parties.

 

   

The corporate support unit consists of overhead and other activities related to the three key business segments, as well as interest on our debt and depreciation on our assets.

See Note 17 to the consolidated financial statements included in Item 8 of this 10-K for the financial results by segment for fiscal years 2007, 2008 and 2009.

Narrative description of business:

We are the largest owner/operator, franchisor and licensor of bagel specialty restaurants in the United States. As of December 29, 2009, we had 683 restaurants in 37 states and in the District of Columbia. As a leading fast-casual restaurant chain, our restaurants specialize in high-quality foods for breakfast, lunch and afternoon snacks in a bakery-café atmosphere with a neighborhood emphasis. Collectively, our concepts span the nation with Einstein Bros. restaurants in 36 states and in the District of Columbia, Noah’s restaurants in three states on the west coast and Manhattan Bagel restaurants concentrated in eight states in the Northeast. Currently, our Einstein Bros. and Noah’s restaurants are predominantly company-owned or licensed, while Manhattan Bagel restaurants are predominantly franchised, with one company-owned location.

Our product offerings include fresh bagels and other bakery items baked on-site, made-to-order breakfast and lunch sandwiches on a variety of bagels, breads or wraps, gourmet soups and salads, assorted pastries, premium coffees and an assortment of snacks. Our manufacturing and commissary operations prepare and assemble consistent, high-quality ingredients that are delivered fresh to our restaurants through our network of independent distributors.

We believe controlling the development, sourcing, manufacturing and distribution of our key products is an important element in ensuring both quality and profitability. To support this strategy, we have developed proprietary formulations, invested in processing technology and manufacturing capacity, and aligned ourselves with strategic suppliers.

 

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Licensing and franchising our brands allows us to increase our geographic footprint and brand recognition. We also generate additional revenues without incurring significant additional expense, capital commitments and avoid many of the other risks associated with opening new company-owned restaurants.

As of December 29, 2009, the Company had 7,054 associates, of whom 233 were corporate personnel, 147 were manufacturing and commissary personnel and 6,674 were restaurant personnel. Most restaurant personnel work part-time and are paid on an hourly basis. We have never experienced a work stoppage and our associates are not represented by a labor organization.

Company-owned restaurants

We generated approximately 91% of our 2009 total revenue from restaurant sales at our Einstein Bros. and Noah’s company-owned restaurants. For the year ended December 29, 2009, approximately 65% of our revenues were generated from restaurant sales during the breakfast hours.

 

   

Principal products and services sold: Einstein Bros. offers a menu that specializes in high-quality foods for breakfast and lunch, including fresh-baked bagels and hot breakfast sandwiches, freshly prepared lunch sandwiches, cream cheese and other spreads, specialty coffees and teas, soups, salads and other unique menu offerings. During fiscal years 2007, 2008 and 2009, Einstein Bros. company-owned restaurants generated approximately 80% of our total company-owned restaurant sales.

Noah’s is a neighborhood-based, New York City inspired bakery/deli restaurant that serves fresh-baked bagels, hot breakfast sandwiches, made-to-order deli-style sandwiches, cream cheese and other spreads, specialty coffees and teas, soups, salads and other unique menu offerings During fiscal years 2007, 2008 and 2009, Noah’s company-owned restaurants generated approximately 20% of our total company-owned restaurant sales.

Manhattan Bagel provides a traditional New York City style boil and baked bagel. Manhattan Bagel also serves a variety of grilled sandwiches, freshly made deli sandwiches, freshly prepared breakfast sandwiches, soups, and a variety of other fresh-baked sweets. Similar to Einstein Bros. and Noah’s, Manhattan Bagel also features a full line of fresh brewed coffees and specialty coffee/espresso beverages. In late 2007, we acquired a location from one of our franchisees, which made it our only company-owned Manhattan Bagel restaurant. We use this location for employee and manager training, and to test out new products and services before they are rolled out system-wide.

 

   

Status of products/services: We are planning to open new company-owned restaurants under the Einstein Bros. and Noah’s brands within existing markets. Our expansion plans are intended to increase penetration of our restaurants in our most attractive markets. In 2009, we opened seven new company-owned restaurants. In 2010, we plan to open 10 to 12 new company-owned restaurants and upgrade 10 to 20 of our existing restaurants.

Throughout most of our Einstein Bros. restaurants, we have implemented an improved kitchen display ordering system (“KDS”) that reduces the time our guests wait in line before they receive their food. We believe that this system improves production accuracy compared to the paper tickets process and helps to reduce waste. For 2010, we plan to implement the KDS in most of our Noah’s restaurants as well as some of our Einstein Bros. restaurants.

We believe catering is an effective and incremental way to leverage our existing restaurant infrastructure with little or no additional capital investment and to expose more people to our food and our brands. We recognize that an effective catering program requires different skills for effectively selling to businesses that frequently utilize catering. In the fourth quarter of 2009, we implemented a new software program and on-line ordering capabilities which helped us to establish a new process to generate, fulfill and deliver catering sales. This change should reduce the cost of our catering program considerably in 2010 while at the same time providing a more robust method of attracting new customers and increasing the order frequency of existing customers.

 

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Product Supply: Our purchasing programs provide our company-owned restaurants and our franchised and licensed restaurants with high quality ingredients at competitive prices from reliable sources. Consistent product specifications, as well as purchasing guidelines, help to ensure freshness and quality. Because we utilize fresh ingredients in most of our menu offerings, inventory at our distributors and company-owned restaurants is maintained at modest levels. We negotiate price agreements and contracts depending on supply and demand for our products and commodity trends. These agreements can range in duration from six months to five years.

 

   

Trademarks and service marks: Our rights in our trademarks and service marks are a significant part of all segments of our business. We are the owners of the federal registration rights to the “Einstein Bros.,” “Noah’s New York Bagels” and “Manhattan Bagel” marks, as well as several related word marks and word and design marks related to our core brands. We license the rights to use certain trademarks we own or license to our franchisees and licensees in connection with their operations. Many of our core brand trademarks are also registered in numerous foreign countries. We are party to a co-existence agreement with the Hebrew University of Jerusalem (“HUJ”), which sets forth the terms under which we can use the name Einstein Bros. and the terms and restrictions under which HUJ could license the name and likenesses associated with the Estate of Albert Einstein to a business that competes with the Company. We also own numerous other trademarks and service marks related to our other brands. We are aware of a number of companies that use various combinations of words in our marks, some of which may have senior rights to ours for such use, but we do not consider any of these uses, either individually or in the aggregate, to materially impair the use of our marks. It is our policy to defend our marks and their associated goodwill against encroachment by others.

 

   

Seasonality: Our business is subject to seasonal fluctuations. Because of the seasonality of the business and the industry, results for any quarter are not necessarily indicative of the results that may be achieved for any other quarter or the full fiscal year.

 

   

Government Regulation: Each of our restaurants is subject to licensing and regulation by a number of governmental authorities, which include health, safety, labor, sanitation, building and fire agencies in the state, county, or municipality in which the restaurant is located. A failure to comply with one or more regulations could result in the imposition of sanctions, including the closing of restaurants for an indeterminate period of time, fines or third party litigation.

 

   

Competition: The restaurant industry is intensely competitive. The industry is often affected by changes in demographics, consumers’ eating habits and preferences, local and national economic conditions affecting consumer spending habits, population trends, and local traffic patterns.

We experience competition from numerous sources in our trade areas. Our restaurants compete based on guests’ needs for breakfast, lunch and afternoon snacks. Our competitors are different for each daypart. The competitive factors include brand awareness, advertising effectiveness, location and attractiveness of facilities, hospitality, environment, quality and speed of guest service and the price/value of products offered. We compete in the fast-casual segment of the restaurant industry, but we also consider other restaurants in the fast-food, specialty food and full-service segments to be our competitors.

Manufacturing and Commissaries:

We generated approximately 7% of our 2009 total revenue from our manufacturing and commissary operations.

 

   

Manufacturing: We currently operate a bagel dough manufacturing facility in Whittier, California and have a supply contract with a two suppliers to produce bagel dough and sweets to our specifications. These facilities provide frozen dough and partially-baked frozen bagels and fully baked sweets for our company-owned restaurants, franchisees and licensees. We use excess capacity to produce bagels for sale to third party resellers. We also sell frozen dough in the U.S. to a third party foreign entity who sells that product under our Einstein Bros. brand in Asia.

 

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Commissaries: Currently we operate five commissaries geographically located to best serve our existing company-owned, franchised and licensed restaurants. These operations primarily provide our restaurants with critical food products such as sliced meats, cheeses, and pre-portioned kits that create our various salads. Our commissaries assure consistent quality, supply fresh products and improve efficiencies by reducing labor and inventory requirements at the restaurants. We distribute commissary products primarily through our regional distribution partners.

 

   

Product supply: We have developed or use proprietary recipes and production processes for our bagel dough, cream cheese and coffee to help ensure product consistency. We believe this system provides a variety of consistent, superior quality products at competitive market prices to our company-owned, franchised and licensed restaurants.

Frozen, or partially baked and frozen bagel dough is shipped to all of our company-owned, franchised and licensed restaurants and baked on-site. Our significant know-how and technical expertise for manufacturing and freezing mass quantities of raw dough produces a high-quality product more commonly associated with smaller bakeries.

Our cream cheese is manufactured to our specifications utilizing proprietary recipes. Our cream cheese and certain other cheese products are purchased from one supplier under a contract that has been extended through the end of 2013. We also have developed proprietary coffee blends for sale at our company-owned, franchised and licensed restaurants.

We purchase other ingredients used in our restaurants, such as meat, lettuce, tomatoes and condiments, from a select group of third party suppliers. Our chicken products come from naturally raised chickens that are cared for in strict accordance with established animal care guidelines and without the use of growth accelerators such as antibiotics, steroids or hormones. Our roast beef is United States Department of Agriculture (“USDA”) Choice, Grade A, and comes only from corn-fed, domestic cattle. Where available, we buy high quality fruits, vegetables and specialty produce from local farmers and shippers through distributors.

 

   

Government regulation: Our manufacturing and commissary facilities are licensed and subject to regulation by either federal, state or local health and fire codes. We are subject to the regulations of keeping our commissaries USDA compliant. Additionally, we are also subject to federal and state environmental regulations.

 

   

Competition: Our manufacturing and commissary operations are primarily ancillary and support our company-owned restaurant operations as well as our franchisees and licensees. Our competition is from several large bakeries and from local bakeries in the states in which we operate.

Franchise and Licensing

Approximately 2% of our 2009 total revenue was generated by our franchise and license operations.

 

   

Einstein Bros. franchising: We are offering Einstein Bros. franchises to qualified area developers. As of December 29, 2009, we were registered to offer Einstein Bros. franchises in 49 states. During 2009, we actively marketed the Einstein Bros. brand franchise rights and signed several multi-location deals. We currently have 14 development agreements in place for 63 total restaurants, six of which have already opened. We expect the existing 14 development agreements will result in 57 additional restaurants being opened through 2014.

We utilize a franchise area development model for the Einstein Bros. brand in which we assign exclusive rights to develop restaurants within a defined geographic region within a specified period of time. We are targeting franchise area developers who have the existing infrastructure, operational experience and financial strength to develop several restaurants in a designated market. The franchise agreement requires an up-front fee of $35,000 per restaurant and a 5% royalty based on net sales.

 

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Manhattan Bagel franchising: We currently have a franchise base in our Manhattan Bagel brand that generates a recurring revenue stream through royalty fee payments and revenue from the sale to our franchisees of products made from our proprietary recipes. The typical Manhattan Bagel franchise agreement requires an up-front fee of $25,000 per restaurant and a 5% royalty based on net sales. Our Manhattan Bagel franchise base provides us with the ability to grow this brand with minimal commitment of capital by us, and creates a built-in customer base for our manufacturing operations.

 

   

Licensing: We have license relationships that include Aramark, Sodexho, AAFES, HMS Host, Compass, and SSP. Our licensees are located primarily in colleges and universities, hospitals, airports and military bases. Our license agreements vary by venue, but typically have a five-year term and provide that the licensee pays us an up-front license fee of $12,500 and a weighted average royalty fee of 6.2%.

 

   

Status of development plans or expansion: We are planning to expand our presence through a significant expansion of franchise and license restaurants. We are continuously signing new franchise development agreements and there could be the potential to sell an existing company-owned restaurant to a prospective franchisee. This strategy allows us to generate additional revenues without incurring significant additional expense, capital commitments or many of the other risks associated with opening new company-owned restaurants. In 2009 we opened seven franchised locations and 31 licensed locations. We are currently planning to open 12 to 16 franchise restaurants and 35 to 45 license restaurants in 2010. In support of our strategy to only license the Einstein Bros. brand, we recently converted three of our Noah’s licensed restaurants to the Einstein Bros. brand.

 

   

Product supply: Our franchisees and licensees are required to purchase proprietary products through our designated suppliers or directly from us. Our Manhattan Bagel franchisees are not required to buy all of their non-proprietary products directly from us, but rather their product sources must be approved by us.

 

   

Seasonality: This segment is subject to the same seasonal fluctuations as our company-owned restaurant segment. Additionally, as many of our license locations are on college and university campuses, they are impacted by school schedules which typically include a summer break and the December holiday season. Because of the seasonality of the business and the industry, results for any quarter are not necessarily indicative of the results that may be achieved for any other quarter or the full fiscal year.

 

   

Government regulation: Our franchise operations are subject to Federal Trade Commission (the “FTC”) regulation and various state laws which regulate the offer and sale of franchises. Several state laws also regulate substantive aspects of the franchisor/franchisee relationship. The FTC requires us to furnish to prospective franchisees a franchise disclosure document containing prescribed information. A number of states in which we might consider franchising also regulate the sale of franchises and require registration of the disclosure document with state authorities. Our ability to sell franchises in those states is dependent upon obtaining approval of our disclosure document by those authorities.

 

   

Competition: We compete against similar fast-casual and quick-casual restaurants which franchise and license their brands in the states in which we operate.

Corporate Support

 

   

Principal products/services sold: The support center is not a profit center and is designed to manage and support all of our company-owned restaurants, the manufacturing facility and commissaries and support our franchisees and licensees as well as general corporate governance.

 

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Financial information about geographic areas:

Our manufacturing operations sell bagels to a wholesaler and a distributor who take possession in the United States and sell outside of the United States. As the product is shipped FOB domestic dock, and invoiced and paid in U.S. dollars, there are no international risks of loss or foreign exchange currency issues. Sales shipped internationally are included in manufacturing and commissary revenue, and were approximately $3.3 million, $4.8 million and $5.3 million for 2007, 2008 and 2009. All other revenues were from external customers domiciled in the United States of America.

Available Information:

We are subject to the informational requirements of the Securities Exchange Act of 1934. We therefore file periodic reports, proxy statements and other information with the Securities Exchange Commission (the “SEC”). Such reports may be obtained by visiting the Public Reference Room of the SEC at 100 F Street, N.E., Washington, D.C. 20549, or by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet site (www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically.

Additionally, copies of our reports on Forms 10-K, 10-Q and 8-K and any amendments to such reports are available for viewing and copying through our internet site (www.einsteinnoah.com), free of charge, as soon as reasonably practicable after filing such material with, or furnishing it to the SEC. We typically post information about the Company on our website under the Financials & Media tab.

We also make available on our website and in print to any stockholder who requests it, the Charters for our Audit and Compensation Committees, as well as the Code of Conduct that applies to all directors, officers, and associates of our company. Amendments to these documents or waivers related to the Code of Conduct will be made available on our website as soon as reasonably practicable after their execution.

Executive Officers:

 

Name

   Age    Position

Jeffery J. O’Neill

   53    President, Chief Executive Officer and Director

Daniel J. Dominguez

   64    Chief Operating Officer

Richard P. Dutkiewicz

   54    Chief Financial Officer

James P. O’Reilly

   43    Chief Concept Officer

Rhonda J. Parish

   53    Chief Legal Officer and Secretary

Jeffrey J. O’Neill. Mr. O’Neill joined us in December 2008 when he was appointed President and Chief Executive Officer. Previously, Mr. O’Neill worked for Priszm Income Fund from April 2005 to November 2008. Priszm is a publicly traded Canadian restaurant income trust with a portfolio of popular brands such as Pizza Hut and Taco Bell and is one of the largest independent KFC franchisees in the world. Mr. O’Neill joined the company as President and Chief Operating Officer and was promoted to Chief Executive Officer in January 2008. Mr. O’Neill began his career in Brand Marketing with The Quaker Oats Company. In April 1999, he joined PepsiCo as the President of Pepsi Cola Canada. In 2002, PepsiCo acquired the Quaker Oats Company and in January 2003 Mr. O’Neill returned to his old company in Chicago to help lead the integration of the Quaker Oats/Gatorade acquisition. Mr. O’Neill has an Honors Bachelor of Business degree from the University of Ottawa.

Daniel J. Dominguez. Mr. Dominguez was appointed Chief Operating Officer in December 2005. Mr. Dominguez joined us in November 1995 and served as Senior Vice President of Operations for Noah’s New York Bagels from April 1998 to December 2005. From 1995 to April 1998, Mr. Dominguez served as the Director of Operations for Einstein Bros. Midwest. Prior to joining us, Mr. Dominguez was Executive Vice President of JB Patt America, Beverly Hills, CA, dba Koo Koo Roo Restaurants, from July 1994 to

 

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October 1995. From May 1987 to July 1994, he was the Divisional Vice President of Food Services for Carter Hawley Hale in San Francisco, California. From November 1976 to May 1987 he was the Vice President of Operations for Bakers Square Restaurants in California.

Richard P. Dutkiewicz. Mr. Dutkiewicz joined us in October 2003 as Chief Financial Officer. From May 2003 to October 2003, Mr. Dutkiewicz was Vice President—Information Technology of Sirenza Microdevices, Inc. In May 2003, Sirenza Microdevices, Inc. acquired Vari-L Company, Inc. From January 2001 to May 2003, Mr. Dutkiewicz was Vice President—Finance, and Chief Financial Officer of Vari-L Company, Inc. From April 1995 to January 2001, Mr. Dutkiewicz was Vice President—Finance, Chief Financial Officer, Secretary and Treasurer of Coleman Natural Products, Inc., located in Denver, Colorado. Mr. Dutkiewicz’s previous experience includes senior financial management positions at Tetrad Corporation, MicroLithics Corporation and various divisions of United Technologies Corporation. Mr. Dutkiewicz began his career as an Audit Manager at KPMG LLP. Mr. Dutkiewicz received a B.B.A. degree from Loyola University of Chicago.

James P. O’Reilly. Mr. O’Reilly joined us in April 2009 as our Chief Concept Officer. Previously, Mr. O’Reilly worked at Yum! Brands, Inc. from November 1996 until January 2009. He joined Yum! as a Director of Marketing, worked internationally in Canada, Latin America and the United Kingdom before returning to the United States in June 2008 as Senior Vice President, U.S Marketing. Mr. O’Reilly received a B.S. degree from McMaster University and holds an MBA from York University.

Rhonda J. Parish. Ms. Parish joined us in January 2010 as Chief Legal Officer. Ms. Parish worked for Denny’s Corporation from January 1995 to July 2008. She joined the company as Senior Vice President and General Counsel and was promoted to Executive Vice President/Chief Legal Officer and Secretary of Denny’s Corporation in July 1998. Ms. Parish received a B.S. degree in Political Science from the University of Central Arkansas and her J.D. degree from the University of Arkansas School of Law.

 

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ITEM 1A. RISK FACTORS

Cautionary Note Regarding Forward-Looking Statements:

We wish to caution our readers that this report, including the Management’s Discussion and Analysis of Financial Conditions and Results of Operations (“MD&A”), contains forward-looking statements within the meaning of the federal securities laws. All such statements are qualified by this cautionary note, which is provided pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933 (“1933 Act”). 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. Our financial condition and results of operations are sensitive to, and may be adversely affected by, a number of factors, many of which are largely outside the Company’s control. 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. We do not undertake any obligation to update or revise any forward looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events, except as may be required under applicable law. An expanded discussion of some of these risk factors follows. The list of risk factors below is not exhaustive.

Risk Factors Relating to Our Business and Our Industry

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

International, national and local economic conditions, including credit and mortgage markets, energy costs, lay-offs, foreclosure rates, bankruptcies, and similar adverse economic news and factors affect discretionary consumer spending. These factors could reduce discretionary consumer spending which in turn could reduce our guest traffic or average check. In 2008 and 2009, restaurants industry-wide were adversely affected as a result of reduced consumer spending due to rising fuel and energy costs, lay-offs and general economic conditions. The conditions experienced recently also include reduced consumer confidence, on-going concerns about down-sizing and lay-offs, the housing market, concerns over the stability of financial institutions, and increased health care and energy costs. Adverse changes in consumer discretionary spending, which could be affected by many different factors that are out of our control, including those listed above, could harm our business prospects, financial condition, operating results and cash flows. Our success will depend in part upon our ability to anticipate, identify and respond to changing economic and other conditions.

The economic turmoil that has arisen in the credit markets and in the housing markets as well as job losses throughout various sectors of the economy during and following 2008 and 2009 may continue to suppress discretionary spending and other consumer purchasing habits and, as a result, adversely affect our results of operations.

Failure to protect food supplies and adhere to food safety standards could result in food-borne illnesses.

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

 

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

Volatile commodity prices would adversely affect our gross profit.

Global demand for commodities such as wheat, coffee and dairy products has resulted, and could in the future result, in higher prices which would increase our costs. The prices of our main ingredients are directly associated with the changing weather conditions as well as economic factors such as supply and demand of certain commodities within the United States and other countries. Our ability to forecast and manage our commodities could significantly affect our gross margins. Any increase in the prices of the ingredients most critical to our products could adversely affect our operating results.

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

Any material failure, inadequacy, interruption or security failure of information technology could harm our ability to effectively operate our business.

We rely on information technology systems across our operations, including for management of supply chain, point-of-sale processing in our stores, and various other processes and transactions. Our ability to effectively manage our business and coordinate the production, distribution and sale of products depends on the reliability and capacity of these systems. The failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, or a breach in security of these systems could cause delays in product sales and reduced efficiency of the Company’s operations, and significant capital investments could be required to remediate the problem.

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

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

 

   

expand sales at our existing company-owned restaurants;

 

   

achieving the cost reduction and profitability improvements we have based our plan upon;

 

   

open new company-owned restaurants;

 

   

open new franchise and license restaurants; and

 

   

expand our franchise base through the sale of existing company-owned restaurants to qualified franchisees in exchange for a development agreement obligating the franchisees to build additional new units.

 

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Our ability to achieve any or all of these initiatives is uncertain. Our success in expanding sales at company-owned restaurants through various sub-initiatives including: promoting and offering value to our customers through marketing, discounts, coupons and new menu offerings and broadening our offerings across multiple dayparts, improving our ordering and production systems, expanding our catering program and upgrading our restaurants is dependent in part on our ability to offer value to consumers, attract new customers, predict and satisfy consumer preferences and as mentioned above, consumers’ ability to respond positively in a troublesome economic environment. Our success in growing our business through opening new company-owned restaurants is dependent on a number of factors, including our ability to: find suitable locations, reach acceptable lease terms, have adequate capital, find acceptable contractors, obtain licenses and permits, recruit and train appropriate staff and properly manage the new restaurant. Our success in opening new franchise and license restaurants is dependent upon, among other factors, our ability to: attract quality businesses to invest in our core brands, maintain the effectiveness of our franchise disclosure documents in target states, offer restaurant solutions for a variety of location types and the ability of our franchisees and licensees to: find suitable locations, reach acceptable lease terms, have adequate capital, secure reasonable financing, find available contractors, obtain licenses and permits, locate and train staff appropriately and properly manage the new restaurants. Our success in expanding our franchise business is dependent upon signing additional development agreements along with the refranchising our company-owned restaurants. 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.

Competition in the restaurant industry is intense.

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

Numerous factors including changes in consumer tastes and preferences often affect restaurants. Shifts in consumer preferences away from our type of cuisine and/or the fast-casual style could have a material effect on our results of operations. Dietary trends, such as the consumption of food low in carbohydrate content have, in the past, and may, in the future, negatively impact our sales. Changes in our guests’ spending habits and preferences could have a material adverse effect on our sales. Our results will depend on our ability to respond to changing consumer preferences and tastes. In addition, recent local and state regulations mandating prominent disclosure of nutritional and calorie information may result in reduced demand for some of our products which could be viewed as containing too much fat or too many calories.

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

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

 

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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 prior location. We also face competition from both restaurants and other retailers for suitable sites for new restaurants.

Our operations may be negatively impacted by adverse weather conditions, natural disasters or acts of terror.

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

The effects of hurricanes, fires, snowstorms, freezes and other adverse weather conditions are likely to affect supply of and costs for raw ingredients and natural resources, near-term construction costs for our new restaurants as well as sales in our restaurants going forward. If we do not 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.

The impact on our business from terrorism (including cyber-terrorism) could have an adverse impact on our brand and results of operations.

We have single suppliers for one of our key products, 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 some of our key products. We purchase all of our cream cheese from a single source. Also, we purchase a majority of our frozen bagel dough from one supplier, who uses our proprietary processes and on whom we are dependent in the short-term. All of our remaining frozen bagel dough is produced at our dough manufacturing facility in Whittier, California or by a second supplier. Although to date we have not experienced significant difficulties with our suppliers, our reliance on a single supplier for most 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.

Disruptions or distribution issues could adversely affect our business and reputation.

We depend on our network of independent regional distributors to distribute frozen bagel dough and other products and materials to our company-owned, franchised and licensed restaurants. Any failure by one or more of our distributors to perform as anticipated, or any disruption in any of our distribution relationships for any reason, would subject us to a number of risks, including inadequate products delivered to our restaurants, diminished control over quality of products delivered, and increased operating costs to prevent delays in deliveries. Any of these events could harm our relationships with our franchisees or licensees, or diminish the

 

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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 licensed restaurants could increase our distribution costs. These risks could have a material adverse effect on our business, financial condition and results of operations.

Additionally, increased costs and distribution issues related to fuel and utilities could also materially impact our business and results of operations.

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

We depend upon an available labor pool of associates, many of whom are hourly employees whose wages may be affected by increases in the federal, state or municipal “living wage” rates. Numerous increases have been made on federal, state and local levels to increase minimum wage levels. Increases in the federal and state minimum hourly wage rates in some of the states in which we operate became effective throughout 2009, and we are aware that additional increases have been approved and will become effective in few of the states in which we operate in 2010. Increases in the minimum wage may create pressure to increase the pay scale for our associates, which would increase our labor costs and those of our franchisees and licensees.

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

We may not be able to comply with certain debt covenants or generate sufficient cash flow to make payments on our substantial amount of debt or redeem our mandatorily redeemable preferred stock when due.

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

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

 

   

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

 

   

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

 

   

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

 

   

increase our vulnerability to volatility in interest rates; and

 

   

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

Economic, financial, competitive, legislative and other factors beyond our control may affect our ability to generate cash flow from operations to make payments on our indebtedness and to fund necessary working capital. A significant reduction in operating cash flow would likely increase the need for alternative sources of

 

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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 currently estimate that $10.0 to $15.0 million of mandatorily redeemable Series Z preferred stock will remain unredeemed on June 30, 2010. Given the current state of the credit markets as well as the financial condition of some of our lenders, our ability to borrow additional funds on our existing credit facility could be unlikely. Failure to redeem all of the preferred stock on June 30, 2010 will result in us continuing to pay additional redemption price to redeem the remaining shares in the future. In addition, the holder of the preferred stock may seek to enforce the mandatory redemption provisions of the preferred stock.

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 and our brand, regardless of whether the allegations are valid or whether we are liable. In addition, employee claims against us based on, among other things, discrimination, harassment or wrongful termination, or labor code violations may divert financial and management resources that would otherwise be used to benefit our future performance. For example, in 2008 we settled two class actions in California and made payments of $1.9 million during 2009 in connection with such settlements. There is also a risk of litigation from our franchisees and licensees. We have been subject to a variety of these and other claims from time to time and a significant increase in the number of these claims or the number that are successful could materially adversely affect our business, prospects, financial condition, operating results or cash flows.

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

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

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

We rely in part on our franchisees and licensees and the manner in which they operate their restaurants to develop and promote our business. Although we have developed criteria to evaluate and screen prospective candidates, the candidates may not have the business acumen or financial resources necessary to operate successful restaurants in their respective areas. In addition, franchisees and licensees are subject to business risks similar to what we face 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 meet their development obligations or to operate successfully could have a material adverse effect on us, our reputation, our ability to collect royalties, our brands and our ability to attract prospective candidates. Potential franchisees and licensees may have difficulty obtaining proper financing as a result of the downturn in the credit markets. As we offer and grant franchises for our Einstein Bros. and Manhattan Bagel brands, our reliance on our franchisees is expected to increase in proportion to growth of the franchisee base. With respect to franchising our Einstein

 

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Bros. brand, we may not be able to identify franchisees that meet our criteria, or to enter into franchise area development agreements with prospective franchisee candidates that we identify. As a result, our franchise program for the Einstein Bros. brand may not grow at the rate we currently expect, or at all.

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

Each of our restaurants is subject to licensing and regulation by the health, sanitation, safety, labor, building and fire agencies of the respective states, counties, cities and municipalities in which it is located. A failure to comply with one or more regulations could result in the imposition of sanctions, including the closing of facilities for an indeterminate period of time, or third party litigation, any of which could have a material adverse effect on us and our results of operations.

Recently, many government bodies have begun to legislate or regulate high-fat and high sodium foods and disclosure of nutritional information as a way of combating concerns about obesity and health. In addition to the phase-out of artificial trans-fats, public interest groups have focused attention on the marketing of high-fat and high-sodium foods to children in a stated effort to combat childhood obesity. Some cities and states have recently adopted or are considering regulations requiring disclosure of nutritional facts, including calorie information, on menus and/or menu boards. Additional cities or states may propose or adopt similar regulations. The cost of complying with these regulations could increase our expenses and the possible negative publicity arising from such legislative initiatives could reduce our future sales.

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

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

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

Our brands, which include 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 brands. However, the actions we take may be inadequate to prevent imitation of our products and concepts by others, to prevent various challenges to our registrations or applications or denials of applications for the registration of trademarks, service marks and proprietary rights in the U.S. or other countries, or to prevent others from claiming violations of their trademarks and proprietary marks. In addition, others may assert rights in our trademarks, service marks and other proprietary rights.

The loss of key personnel or difficulties recruiting and retaining qualified personnel could jeopardize the Company’s ability to meet its financial targets.

Our success depends substantially on the contributions and abilities of key executives and other employees, and on our ability to recruit and retain high quality employees to work in and manage our restaurants. We must continue to recruit, retain and motivate management and other employees sufficient to maintain our current business and support our projected growth. A loss of key employees or a significant shortage of high quality restaurant employees could jeopardize our ability to meet our financial targets.

 

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Our ability to use net operating loss carryforwards to offset future taxable income for U.S. federal income tax purposes is subject to limitation.

In general, under Section 382 of the Internal Revenue Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its pre-change net operating loss (“NOL”) carryforwards to offset future taxable income. A corporation generally undergoes an “ownership change” when the stock ownership percentage (by value) of its “5 percent stockholders” increases by more than 50 percentage points over any three-year testing period.

Due to transactions involving the sale or other transfer of our stock from the date of our last ownership change through the date of the secondary public offering of our common stock, and changes in the value of our stock during that period, any new offerings may result in an additional ownership change for purposes of Section 382 or will significantly increase the likelihood that we will undergo an additional ownership change in the future (which could occur as a result of transactions involving our stock that are outside of our control). In either event, the occurrence of an additional ownership change would limit our ability to utilize a portion of our NOL carryforwards that are not currently subject to limitation, and could further limit our ability to utilize our remaining NOL carryforwards and possibly other tax attributes. Limitations imposed on our ability to use NOL carryforwards and other tax attributes to offset future taxable income could cause us to pay U.S. federal income taxes earlier than we otherwise would if such limitations were not in effect, and could cause such NOL carryforwards and other tax attributes to expire unused, in each case reducing or eliminating the benefit of such NOL carryforwards and other tax attributes to us and adversely affecting our future cash flow. Similar rules and limitations may apply for state income tax purposes as well.

Risk Factors Relating to Our Common Stock

We have a majority stockholder.

Greenlight Capital, L.L.C. and its affiliates (“Greenlight”) beneficially own approximately 65% of our common stock as of December 29, 2009. As a result, Greenlight has sufficient voting power, without the vote of any other stockholders, to determine what matters will be submitted for approval by our stockholders to elect all of the members of our board of directors, and to determine whether a change in control of the Company occurs. Greenlight’s interests on matters submitted to stockholders may be different from those of other stockholders. Greenlight has voted its shares to elect our current board of directors, and the chairman of our board of directors is a current employee of Greenlight.

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

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. Sales of our common stock by our majority stockholder, Greenlight, or a perception that Greenlight will sell their shares could cause a decrease in the market price of our common stock.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None

 

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ITEM 2. PROPERTIES

Our Properties

Our headquarters, manufacturing and commissary facilities and all of our restaurants are located on leased premises. Lease terms are usually five to 10 years, with two or three five year renewal option periods, for total lease terms that average approximately 11 to 20 years. The average company-owned restaurant is approximately 1,800 to 2,500 square feet in size with approximately 30—40 seats and is generally located in a neighborhood or regional shopping center.

Information with respect to our headquarters, production and commissary facilities is presented below:

 

Location

   Facility    Square
Feet
   Lease
Expiration

Lakewood, Colorado

   Headquarters, Support Center, Test Kitchen    44,574    5/31/2017

Whittier, California

   Manufacturing Facility and USDA Approved Commissary    54,640    11/30/2013

Walnut Creek, California

   Administration Office-Noah’s    1,672    3/31/2013

Carrolton, Texas

   USDA Approved Commissary    26,820    7/31/2011

Orlando, Florida

   USDA Approved Commissary    7,422    10/31/2010

Denver, Colorado

   USDA Approved Commissary    9,200    10/14/2013

Grove City, Ohio

   USDA Approved Commissary    20,644    8/31/2012

Our Current Restaurants

As of December 29, 2009, we owned and operated, franchised or licensed 683 restaurants. Our current base of company-owned restaurants under our core brands includes 350 Einstein Bros. restaurants, 76 Noah’s restaurants and one Manhattan Bagel restaurant. Also, we franchise 71 Manhattan Bagel restaurants and six Einstein Bros. restaurants, and license 176 Einstein Bros. restaurants and two Noah’s restaurants. In support of our strategy to only license the Einstein Bros. brand, we recently converted three of our Noah’s licensed restaurants to the Einstein Bros. brand. We anticipate converting the remaining two Noah’s licensed restaurants to Einstein Bros. by the end of the first quarter of 2010. In addition, we had one company-owned restaurant which we owned and operated under a non-core brand, which we closed during the first quarter of 2010.

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

 

     52 weeks ended December 30, 2008     52 weeks ended December 29, 2009  
     Company
Owned
    Franchised     Licensed     Total     Company
Owned
    Franchised     Licensed     Total  

Consolidated Total

                

Total beginning balance

   416      72      124      612      426      71      152      649   

Opened restaurants

   17      2      32      51      7      7      31      45   

Closed restaurants

   (7   (3   (4   (14   (5   (1   (5   (11
                                                

Total ending balance

   426      71      152      649      428      77      178      683   
                                                

 

We use franchise agreements to contract with qualified disadvantaged business enterprises, non-profit and other entities, either as licensees, fractional franchisees, or franchisees under a traditional franchise agreement, who do not meet the fractional franchise exemption to open restaurants in our traditional licensee venues. As of both December 30, 2008 and December 29, 2009, we had six franchisees operating Einstein Bros. restaurants in such license locations which operationally fall under our licensing group.

 

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As of December 29, 2009, our company-owned facilities, franchisees and licensees operated in various states and in the District of Columbia as follows:

 

Location

   Company
Operated
   Franchised
or Licensed
   Total

Alabama

   —      3    3

Arkansas

   —      1    1

Arizona

   26    5    31

California

   79    18    97

Colorado

   32    8    40

Connecticut

   1    1    2

District of Columbia

   1    4    5

Delaware

   1    1    2

Florida

   53    19    72

Georgia

   17    15    32

Illinois

   31    6    37

Indiana

   10    1    11

Kansas

   6    1    7

Kentucky

   —      6    6

Louisiana

   —      3    3

Maryland

   12    5    17

Massachusetts

   2    3    5

Michigan

   15    7    22

Minnesota

   5    3    8

Missouri

   12    6    18

Mississippi

   —      3    3

North Carolina

   2    7    9

New Hampshire

   1    —      1

New Jersey

   5    29    34

New Mexico

   5    —      5

Nevada

   14    —      14

New York

   1    7    8

Ohio

   9    12    21

Oklahoma

   —      1    1

Oregon

   8    1    9

Pennsylvania

   9    29    38

South Carolina

   —      6    6

Tennessee

   —      10    10

Texas

   27    19    46

Utah

   18    —      18

Virginia

   10    11    21

Washington

   6    2    8

Wisconsin

   10    2    12
              

Total

   428    255    683
              

 

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ITEM 3. LEGAL PROCEEDINGS

We are subject to claims and legal actions in the ordinary course of 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 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 (“Fiera”) in the Superior Court of Justice of Ontario, Canada. Fiera claimed 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 sought damages of $17.0 million (Canadian) as well as interest and costs. The Company and Fiera executed and filed Minutes of Settlement with the Ontario Court to dismiss the lawsuit and through the execution of a new supply agreement have resolved their differences with regard to this matter.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No items were submitted to a vote of security holders in the fourth quarter of the fiscal year ended December 29, 2009.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on the NASDAQ Global Market under the symbol “BAGL”. The following table sets forth the high and low sale prices for our common stock for each fiscal quarter during the periods indicated.

 

     High    Low

Year ended December 29, 2009 (fiscal 2009):

     

First Quarter

   $ 7.56    $ 4.24

Second Quarter

   $ 11.37    $ 5.74

Third Quarter

   $ 14.24    $ 8.70

Fourth Quarter

   $ 13.31    $ 8.69
     High    Low

Year ended December 30, 2008 (fiscal 2008):

     

First Quarter

   $ 19.17    $ 8.35

Second Quarter

   $ 15.46    $ 9.30

Third Quarter

   $ 15.04    $ 9.07

Fourth Quarter

   $ 10.59    $ 2.50

As of February 22, 2010, there were 316 holders of record of our common stock. This number does not include individual stockholders who own common stock registered in the name of a nominee under nominee security listings.

We have not declared or paid any cash dividends on our common stock since our inception. We do not intend to pay any cash dividends in the foreseeable future, and we are precluded from paying cash dividends on our common stock under our financing agreements.

 

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Performance Graph

The included performance graph covers the fiscal five-year period from December 28, 2004 through December 29, 2009. The graph compares the total return of our common stock (BAGL) to our current peer group of companies (PGI) and the NASDAQ Composite Index. The PGI was selected representing our competitive peer group, comprised of multi-concept companies and/or companies with a similar organizational structure. The companies selected are participants of the restaurant industry with a sufficient period of operating history for continuous inclusion in the Index.

LOGO

 

     Measurement period - five years (1) (2)
     Fiscal
2004
   Fiscal
2005
   Fiscal
2006
   Fiscal
2007
   Fiscal
2008
   Fiscal
2009

BAGL

   $ 100.00    $ 191.49    $ 319.15    $ 772.34    $ 227.23    $ 415.32

PGI (3)

   $ 100.00    $ 109.70    $ 124.98    $ 93.52    $ 75.96    $ 96.59

NASDAQ

   $ 100.00    $ 103.06    $ 110.94    $ 121.82    $ 71.22    $ 105.11

 

(1) Assumes all distributions to stockholders are reinvested on the payment dates.
(2) Assumes $100 initial investment on December 28, 2004 in BAGL, the PGI, and the NASDAQ Composite Index.
(3) The PGI is a price-weighted index. The index includes:
   

Panera Bread Company

   

Starbucks Corporation

   

Sonic Corporation

   

Jack in the Box Incorporated

   

CKE Restaurants Incorporated (Hardee’s, Carl’s Jr., La Salsa, and Green Burrito restaurant chains)

   

AFC Enterprises Incorporated (Popeyes Chicken and Biscuits restaurant chain)

   

YUM! Brands, Incorporated (A&W, KFC, Long John Silver’s, Pizza Hut and Taco Bell restaurant chains)

   

Wendy’s

 

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Table of Contents
ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data for each fiscal year was extracted or derived from our consolidated financial statements which have been audited by Grant Thornton LLP, our independent registered public accounting firm.

 

     Fiscal years ended (1):  
     2005
(53 weeks)
    2006
(52 weeks)
    2007
(52 weeks)
    2008
(52 weeks)
    2009
(52 weeks)
 
     (in thousands of dollars, except per share data and as otherwise
indicated)
 

Selected Statements of Operations Data:

          

Revenues

   $ 389,093      $ 389,962      $ 402,902      $ 413,450      $ 408,562   

Gross profit

     73,702        78,632        80,930        81,768        77,732   

Gross profit percentage

     18.9     20.2     20.1     19.8     19.0

General and administrative expenses

     36,096        37,484        40,635        36,356        35,463   

California wage and hour settlements

     —          —          —          1,900        —     

Senior management transition costs

     —          —          —          1,335        —     

Income from operations

     9,368        21,438        28,266        27,616        24,917   

Interest expense, net (2)

     23,698        19,555        12,387        5,439        6,114   

Write-off of debt discount upon redemption of senior notes

     —          —          528        —          —     

Prepayment penalty upon redemption of senior notes

     —          4,800        240        —          —     

Write-off of debt issuance costs upon redemption of senior notes

     —          3,956        2,071        —          —     

(Loss) income before income taxes

     (14,018     (6,868     13,040        22,177        18,803   

Provision (benefit) for income taxes

     —          —          454        1,100        (53,192
                                        

Net (loss) income

   $ (14,018   $ (6,868   $ 12,586      $ 21,077      $ 71,995   
                                        

Per share data:

          

Weighted average number of common shares outstanding -

          

Basic

     9,878,665        10,356,415        13,497,841        15,934,796        16,175,391   

Diluted

     9,878,665        10,356,415        14,235,625        16,378,965        16,526,869   

Net (loss) income available to common stockholders per share -

          

Basic

   $ (1.42   $ (0.66   $ 0.93      $ 1.32      $ 4.45   

Diluted

   $ (1.42   $ (0.66   $ 0.88      $ 1.29      $ 4.36   

Cash dividends declared

   $ —        $ —        $ —        $ —        $ —     

Other Data:

          

Capital expenditures (3)

   $ 10,264      $ 13,172      $ 25,869      $ 26,690      $ 16,898   

Percent increase (decrease) in system-wide comparable store sales (4)

     na        4.7     4.0     1.4     (2.4 %) 

Percent increase (decrease) in company owned restaurant comparable store sales (4)

     5.2     4.5     3.7     (0.1 %)      (3.4 %) 
     As of fiscal year ended (1):  
     2005     2006     2007     2008     2009  
     (in thousands of dollars, except per share data and as otherwise
indicated)
 

Selected Balance Sheet Data:

          

Cash and cash equivalents

   $ 1,556      $ 5,477      $ 9,436      $ 24,216      $ 9,885   

Property, plant and equipment, net

     33,359        33,889        47,714        59,747        58,682   

Total assets

     130,924        133,154        148,562        172,929        211,221   

Short-term debt, capital leases and current portion of long-term debt

     299        3,681        1,035        8,149        5,256   

Mandatorily redeemable Series Z preferred stock, $.001 par value, $1,000 per share liquidation value

     57,000        57,000        57,000        57,000        32,194   

Senior notes, capital leases and other long-term debt, net of discount

     160,589        166,680        88,942        79,825        74,572   

Total stockholders’ (deficit) equity

     (126,211     (132,231     (33,607     (13,651     62,286   

Other Data:

          

Number of locations at end of period

     626        598        612        649        683   

Franchised and licensed

     191        182        196        223        255   

Company-owned and operated

     435        416        416        426        428   

 

(1) We have a 52/53-week fiscal year ending on the Tuesday closest to December 31. Fiscal years 2006, 2007, 2008 and 2009, which ended on January 2, 2007, January 1, 2008, December 30, 2008, and December 29, 2009, respectively, contained 52 weeks, while fiscal year 2005, which ended on January 3, 2006, contained 53 weeks.
(2) Net interest expense is comprised of interest paid or payable in cash, Series Z Additional Redemption amounts, and non-cash interest expense resulting from the amortization of debt discount, notes paid-in-kind, debt issuance costs and the amortization of warrants issued in connection with debt financings, and interest income from our money market cash accounts.
(3) Excludes fixed asset purchases for which payment had not occurred as of each year end.
(4)

Comparable store sales represent sales at restaurants open for one full year that have not been relocated or closed during the current year. Comparable store sales include company-owned restaurants only and represent the change in period-over-period sales for the comparable restaurant base. A restaurant becomes comparable in its 13th full month of operation.

 

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Table of Contents
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

General

We have a 52/53-week fiscal year ending on the Tuesday closest to December 31. Fiscal years 2007, 2008 and 2009 ended on January 1, 2008, December 30, 2008 and December 29, 2009, respectively, and each contained 52 weeks.

Overview

In spite of the economic challenges of 2009 and an increasingly competitive restaurant industry, we made progress on a number of key initiatives. Our consumers remain under a significant economic strain, which, in turn, put strain on our revenues, comparable store sales, gross profit margins and operating income throughout 2009. We responded by becoming a nimbler and more focused organization, and early in 2009 we began multiple marketing and operational initiatives designed to increase transactions, rekindle the positioning of our brands, improve our margins through a more disciplined execution of operations at our company-owned restaurants and manufacturing segments, and lower and rationalize the cost structure of our support organization. Additionally, we established a redemption schedule with the holder of our Series Z mandatorily redeemable preferred stock (“Series Z”) and recognized the value embedded in our deferred tax assets. We delivered on these initiatives while maintaining an exceptional experience for our restaurant guests.

Our primary goal in 2009 was to regain momentum in re-building comparable store sales and transaction growth. We targeted our marketing investments at our core breakfast daypart and have been creating a pipeline of new products. In the second quarter we launched a new 400 calorie breakfast menu and introduced a premium Frozen Strawberry Lemonade, in the third quarter we introduced the $1.99 Chicken Bagel wrap and re-introduced the Bagel Poppers, and in the fourth quarter we introduced the Saladwich Sandwich. As a result of these initiatives, we saw a marked improvement in our comparable store sales and transactions throughout the year, especially in our breakfast daypart.

From an operational standpoint, we developed and executed several initiatives aimed at reducing our cost structure in 2009. These targeted initiatives focused on efficient labor utilization and scheduling, consistency in our product standards and portion control, and other programs aimed at restoring margins in outlier restaurants. We also utilized our supplier network to reduce our costs of agricultural commodities in 2009. Finally, we engaged a consultant and consummated a process of negotiating more favorable lease rates for many of our restaurants. These initiatives will also continue into 2010.

We established a redemption schedule with Halpern Denny III, L.P., (the “Holder”) the holder of the Series Z. We redeemed $20.0 million of Series Z shares on June 30, 2009, and another $5.0 million on December 29, 2009, which was $2.0 million higher than what was agreed to in the redemption schedule. We currently accrue an additional redemption price on outstanding shares of Series Z at a rate of 8.02%, which is 250 bps higher than the highest rate paid on the Company’s funded indebtedness.

Due to the softer economy in 2009 we were more cautious with our capital expenditures, and we developed a new approach to our company-owned restaurant development process. The process change resulted in fewer new restaurants for 2009 and the creation of a pipeline of potential new restaurants in our more developed markets.

Lastly, we reversed $61.0 million of our valuation allowance in the third quarter and increased our net deferred tax assets by the same amount as a result of our conclusion that it is more likely than not that we will realize the benefits of substantially all of our deferred tax assets.

 

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Table of Contents

2010 Outlook

During 2010, we plan to increase our marketing initiatives, concentrating primarily on the breakfast daypart, with increased efforts aimed at the lunch daypart. We have a strong line-up of new product offerings and limited time offers that will be introduced throughout the year to drive new traffic and repeat visits.

We intend to continue to expand our company-owned restaurants in 2010 with the addition of 10 to 12 new units. The new units will be in our more developed markets, such as Denver, Phoenix, Chicago, Baltimore, and Washington D.C.

As we move into 2010, we have a robust pipeline of existing franchise development agreements and new license locations. We will continue to host discovery days for potential franchises as well as expand our license footprint. We plan to open 12 to 16 franchise locations in 2010 in markets that have already been established and have shown a strong following. We plan to open 35 to 45 license restaurants in 2010 primarily in colleges and universities, hospitals, airports and military bases.

Finally, we intend to continue to focus on generating free cash flow that will allow us to redeem a significant portion of the remaining outstanding shares of the Series Z on June 30, 2010. We believe that approximately $10.0 million to $15.0 million of the Series Z will remain unredeemed on June 30, 2010. Similar to the approach we used in 2009, we intend to negotiate with the holder of the Series Z to either revise the letter agreement that will extend the redemption of the Series Z out one more year to June 30, 2011, or work with the holder to find an alternative means to settling this obligation. In addition, we also continue to monitor the state of the credit and capital markets and could satisfy any unredeemed portion with additional indebtedness, new capital or a combination of both.

Results of Operations for 2009 as compared to 2008

Financial Highlights

 

   

Earnings per share (“EPS”) increased substantially to $4.36 per share on a dilutive basis in 2009 compared to $1.29 per share on a dilutive basis in 2008. This increase was primarily due to the benefit from income taxes that we incurred related to the reversal of substantially all of our valuation allowance on our deferred tax assets, which had an impact of $3.23 per share on a dilutive basis.

 

   

Consolidated earnings before interest, taxes, depreciation, amortization, and other operating expenses (“Adjusted EBITDA”), which is calculated starting with net income, was relatively flat in 2009 compared to 2008. While total revenues decreased $4.9 million, we effectively reduced costs at both the restaurant level and the corporate support level while expanding the gross margins in our manufacturing and commissaries segment.

Use of Non-GAAP Financial Information

In addition to the results reported in accordance with accounting principles generally accepted in the United States of America (“GAAP”) included in this filing, the Company has provided certain non-GAAP financial information, Adjusted EBITDA and free cash flow. Management believes that the presentation of this non-GAAP financial information provides useful information to investors because this information may allow investors to better evaluate ongoing business performance and certain components of the Company’s results. This information should be considered in addition to the results presented in accordance with GAAP, and should not be considered a substitute for the GAAP results. The Company has reconciled the non-GAAP financial information included in this release to the nearest GAAP measure in context.

 

24


Table of Contents

Consolidated Results

 

     52 weeks ended  
     (dollars in thousands)     Increase/
(Decrease)
    Percentage of
total revenues
 
     December 30,
2008
   December 29,
2009
    2009
vs. 2008
    December 30,
2008
    December 29,
2009
 

Revenues

   $ 413,450    $ 408,562      (1.2 %)     

Cost of sales

     331,682      330,830      (0.3 %)    80.2   81.0
                     

Total gross profit

     81,768      77,732      (4.9 %)    19.8   19.0

Operating expenses

     54,152      52,815      (2.5 %)    13.1   12.9
                     

Income from operations

     27,616      24,917      (9.8 %)    6.7   6.1

Interest expense

     5,439      6,114      12.4   1.3   1.5
                     

Income before income taxes

     22,177      18,803      (15.2 %)    5.4   4.6

Total provision (benefit) for income tax

     1,100      (53,192   *   0.3   -13.0
                     

Net income

   $ 21,077    $ 71,995      241.6   5.1   17.6

Adjustments to net income:

           

Interest expense, net

     5,439      6,114      12.4    

Provision (benefit) for income taxes

     1,100      (53,192   *    

Depreciation and amortization

     14,100      16,627      17.9    

Other operating expenses

     461      725      57.3    
                     

Earnings before interest, taxes, deprecation, amortizationand other operating expenses (adjusted EBITDA)

   $ 42,177    $ 42,269      0.2   10.2   10.3
                     

 

** not meaningful

System-wide comparable store sales decreased 2.4% in 2009. When the year began, we had negative 3.4% system-wide comparable store sales comprised of negative 8.1% in transactions and positive 5.2% for the average check related to a prior year price increase. By December of 2009 our system-wide comparable store sales were virtually flat at a negative 0.4% and negative 0.2% in both transactions and average check. We achieved this through our increased marketing initiatives, focused around our core breakfast product offerings as well as other value-oriented initiatives aimed at increasing transactions and the frequency of guest visits. We believe that the difficult economic climate also put pressure on our catering sales as demand from our business customers has declined.

Our gross profit margins have been pressured due primarily to the unfavorable deleveraging of certain operating expenses, higher health care benefit costs and the impact of increased investments in marketing initiatives. During periods of lower sales, we typically experience deleveraging in those cost elements that are not fully variable to changes in sales. These costs include other operating expenses, rent and related costs, and to a lesser extent, labor costs. Our health care benefit costs increased $1.9 million in 2009. We also continued to support our focus around our core breakfast offerings and other value-oriented initiatives by increasing our investments in marketing by $2.3 million in 2009.

While our revenues declined in 2009 and our cost of sales reflected a $1.9 million increase in health care benefit costs, our focus on our cost initiatives resulted in our Adjusted EBITDA being virtually flat in 2009 compared to 2008.

 

25


Table of Contents

Company-Owned Restaurant Operations

Our company-owned restaurants vary in their unit volume, profitability and recent comparable store sales performance. As of December 29, 2009, we had 110 restaurants that generated an average unit volume in excess of $1 million. These 110 restaurants had an average unit volume of approximately $1.2 million and an average gross profit of $0.3 million. In the aggregate, these restaurants contribute approximately 36% of total restaurant sales and 51% of total restaurant gross profit.

Company-owned restaurant sales for 2009 decreased, which was primarily related to the decline in our 2009 company-owned restaurant comparable store sales to a negative 3.4%. This was due to a decrease in the number of transactions, and a slight decrease in our average check mostly due to greater coupon redemptions associated with our initiatives and a slightly unfavorable change in the mix of products sold. This was partially offset by the modest price increases in 2009 at our Einstein Bros. and Noah’s company-owned restaurants, compared to the price increases taken during 2008 and, on average, the company-owned restaurants that were opened since late in 2008 until the end of 2009 had higher volumes than those that were closed over the same period, which positively contributed to our sales.

 

     52 weeks ended  
     (dollars in thousands)     Increase/
(Decrease)
    Percentage of company-
owned restaurant sales
 
     December 30,
2008
    December 29,
2009
    2009
vs. 2008
    December 30,
2008
    December 29,
2009
 

Company-owned restaurant sales

   $ 376,664      $ 370,412      (1.7 %)     

Percent of total revenues

     91.1     90.7      

Cost of sales:

          

Cost of goods sold

   $ 112,675      $ 108,052      (4.1 %)    29.9   29.2

Labor costs

     112,007        113,665      1.5   29.7   30.7

Other operating costs

     37,781        37,426      (0.9 %)    10.0   10.1

Rent and related, and marketing costs

     40,653        45,114      11.0   10.8   12.2
                      

Total company-owned restaurant cost of sales

   $ 303,116      $ 304,257      0.4   80.5   82.1
                      

Total company-owned restaurant gross profit

   $ 73,548      $ 66,155      (10.1 %)    19.5   17.9
                      

Comparable store sales for our restaurants for each quarter in 2008 and 2009 were as follows:

 

     Fiscal 2008     Fiscal 2009  

First Quarter

   3.6   -5.7

Second Quarter

   1.0   -3.2

Third Quarter

   -1.7   -3.1

Fourth Quarter

   -3.3   -1.7

Our gross profit percentage decreased 1.6% in 2009 primarily due to fixed costs that do not vary with changes in sales volume, an increase in health benefit costs, an increase in marketing initiatives, and an increase in rent expense for new restaurants. Although we had a 1.7% decrease in company-owned revenues, we were able to control and lower our variable cost of goods sold by 4.1% to cause our cost of goods sold to decline from 29.9% to 29.2% as a percent of company-owned restaurant revenues. We expect to renegotiate a supply agreement with one of our suppliers in early 2010 that will further decrease our costs for certain products over the next several years.

Most of our commodity-based food costs decreased in 2009. Flour represents the most significant raw ingredient we purchase. To mitigate the risk of increasing market prices, we have utilized a third party advisor to

 

26


Table of Contents

manage our wheat purchases for our company-owned manufacturing facility. As a result of this relationship, our wheat costs have declined throughout 2009. We will continue to work with our third party advisor to strategically source our wheat purchases. However, there can be no assurance that we will benefit from a decline in the cost of any of the commodity-based products that we purchase.

Although our staffing costs declined in response to decreased traffic, our health care benefit costs increased and we added new catering personnel throughout 2009. In the fourth quarter of 2009 we implemented a new on-line ordering system which allowed us to reduce our catering sales force at the end of the year. Total labor costs increased 1.0% as a percentage of company-owned restaurant sales in 2009.

During 2009, we doubled our investment in marketing to $4.6 million from $2.3 million in 2008. The increase was principally attributable to an investment in our marketing initiatives that we started early in 2009, which were aimed at increasing transactions and launching of our new products. We intend to continue this trend as we believe the increased marketing creates awareness of our brand which will help facilitate trial, increase loyalty and frequency of our guest’s visits.

In 2009 we had additional rent expense associated with the net opening of two restaurants over the last twelve months and the eight new restaurants that opened towards the end of 2008. During the year, we negotiated more favorable lease terms with many of our landlords. These lease modifications will result in lower future rent expense compared to the prior terms.

Manufacturing and Commissary Operations

 

     52 weeks ended  
     (dollars in thousands)     Increase/
(Decrease)
    Percentage of manufacturing
and commissary revenues
 
     December 30,
2008
    December 29,
2009
    2009
vs. 2008
    December 30,
2008
    December 29,
2009
 

Manufacturing and commissary revenues

   $ 30,369      $ 30,638      0.9    

Percent of total revenues

     7.3     7.5      

Manufacturing and commissary costs

   $ 28,566      $ 26,573      (7.0 %)    94.1   86.7
                      

Total manufacturing and commissary gross profit

   $ 1,803      $ 4,065      125.5   5.9   13.3
                      

Manufacturing and commissary revenues for 2009 were relatively flat compared to 2008. Manufacturing gross profit increased substantially in 2009 as a result of substantial productivity improvements in 2009 at our bagel manufacturing facility. In addition, we experienced lower prices of our raw ingredient costs as a result of the decrease of most of our commodity-based food costs.

Franchise and License Operations

 

     52 weeks ended  
     (dollars in thousands)     Increase/
(Decrease)
 
     December 30,
2008
    December 29,
2009
    2009 vs.
2008
 

Franchise and license related revenues

   $ 6,417      $ 7,512      17.1

Percent of total revenues

     1.6     1.8  

Franchise and license gross margin

     100.0     100.0  

Number of franchise and license restaurants

     223        255     

 

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Table of Contents

Overall, franchise and license revenue improvement was driven by strong royalty streams resulting from the net opening of 26 license locations and six franchise locations over the last twelve months. Comparable store sales for the franchisees and licensees of the Manhattan Bagel and Einstein Bros. brands increased 1.1% in 2009.

During 2009 we revised a development agreement with one of our franchisees to modify the number of franchise stores to be built under the development agreement from 21 to four.

Corporate Support

 

     52 weeks ended  
     (dollars in thousands)     Increase/
(Decrease)
    Percentage of
total revenues
 
     December 30,
2008
   December 29,
2009
    2009
vs. 2008
    December 30,
2008
    December 29,
2009
 

General and administrative expenses

   $ 36,356    $ 35,463      (2.5 %)    8.8   8.7

California wage and hour settlements

     1,900      —        (100.0 %)    0.5   0.0

Senior management transition costs

     1,335      —        (100.0 %)    0.3   0.0

Depreciation and amortization

     14,100      16,627      17.9   3.4   4.1

Other operating expenses

     461      725      57.3   0.1   0.2
                     

Total operating expenses

   $ 54,152    $ 52,815      (2.5 %)    13.1   12.9

Interest expense, net

     5,439      6,114      12.4   1.3   1.5

Provision (benefit) for income tax

     1,100      (53,192   *   0.3   (13.0 %) 

 

** not meaningful

Our general and administrative expenses decreased $0.9 million in 2009 compared to 2008 as a result of our cost reduction initiatives that were put into place throughout the year.

In 2008, we recorded $1.9 million in operating expenses to satisfy two California wage and hour settlements. These were fully paid in the second quarter of 2009. Late in 2008 we also experienced turnover at the senior management level, and hired our new CEO, which resulted in $0.9 million in severance charges and $0.4 million in recruiting and other costs.

Depreciation and amortization expenses increased 17.9% in 2009 compared to 2008 due to the additional assets invested in the company-owned restaurants that were added or upgraded in late 2008 and in 2009. We expect depreciation expense for 2010 to be approximately $20 million.

Interest expense, net increased in 2009 primarily due to the additional redemption amounts on our Series Z included in interest expense for the period of July 1 through December 29, 2009, partially offset by lower interest rates on our credit facility, inclusive of our interest rate swap.

We have recorded current income tax expense of $1.1 million and $0.2 million in 2008 and 2009, respectively. Utilization of our net operating loss carryforwards reduced our federal and state income tax liability incurred in 2008 and 2009. Additionally, we are completing several studies related to the timing and deductibility of property and equipment costs. The new estimates of the timing and deductibility of our property and equipment costs have reduced the expected current expense and the related liability. In 2009, we have recorded a net deferred tax benefit of $53.4 million, comprised of a $61.0 million reversal of substantially all of our valuation allowance, partially offset by deferred tax expense of $7.6 million. In the third quarter of 2009, we reduced our $65.9 million valuation allowance by $61.0 million to $4.9 million after concluding the likelihood for realization of the benefits of our deferred tax assets is more likely than not.

 

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Table of Contents

Results of Operations for 2008 as compared to 2007

Consolidated Results

 

     52 weeks ended  
     (dollars in thousands)    Increase/
(Decrease)
    Percentage of
total revenues
 
     January 1,
2008
   December 30,
2008
   2008
vs. 2007
    January 1,
2008
    December 30,
2008
 

Revenue

     402,902      413,450    2.6    

Cost of sales

     321,972      331,682    3.0   79.9   80.2
                    

Total gross profit

     80,930      81,768    1.0   20.1   19.8

Operating expenses

     52,664      54,152    2.8   13.1   13.1
                    

Income from operations

     28,266      27,616    (2.3 %)    7.0   6.7

Other expenses

     15,226      5,439    (64.3 %)    3.8   1.3
                    

Income before income taxes

     13,040      22,177    70.1   3.2   5.4

Income taxes

     454      1,100    142.3   0.1   0.3

Net income

   $ 12,586    $ 21,077    67.5   3.1   5.1

Adjustments to net income:

            

Interest expense, net

     12,387      5,439    (56.1 %)     

Provision (benefit) for income taxes

     454      1,100    142.3    

Depreciation and amortization

     11,192      14,100    26.0    

Other operating expenses

     837      461    (44.9 %)     
                    

Earnings before interest, taxes, deprecation, amortizationand other operating expenses (adjusted EBITDA)

   $ 37,456    $ 42,177    12.6   9.3   10.2
                    

For 2008, total revenues increased $10.5 million, gross profit increased $0.8 million, income from operations declined $0.7 million, and our income before income taxes increased $9.1 million. This growth is primarily due to having 10 additional company-owned restaurants and 27 additional franchise and license locations from the previous year, which increased our sales and cost of sales. System-wide comparable store sales increased 1.4% in 2008. Additionally, revenues have increased as a result of increased locations, offset by increased cost of sales which was primarily driven by volatile commodity costs and labor costs for both the company-owned restaurants and our manufacturing and commissary operations. Adding to this was a decrease in our general and administrative expenses related to decreased stock-based compensation expense and other cost savings, decreased interest expense related to the debt redemption in 2007, offset by an increase in depreciation expense from the new restaurants that have been opened and upgrades that have been completed. Additionally, our operating expenses included $1.9 million related to the settlement of two class-action lawsuits in California and the $1.3 million from the senior management transition costs.

 

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Company-Owned Restaurant Operations

Our company-owned restaurants vary in their unit volume, profitability and recent comparable store sales performance. As of December 30, 2008, we had 123 restaurants that generate an average unit volume in excess of $1 million. These 123 restaurants had an average unit volume of approximately $1.2 million and an average gross profit of $322,000. In the aggregate, these restaurants contributed approximately 39.5% of total restaurant sales and 53.8% of total restaurant operating profit.

 

     52 weeks ended  
     (dollars in thousands)     Increase/
(Decrease)
    Percentage of
restaurant sales
 
     January 1,
2008
    December 30,
2008
    2008
vs. 2007
    January 1,
2008
    December 30,
2008
 

Company-owned restaurant sales

   $ 372,997      $ 376,664      1.0    

Percent of total revenue

     92.6     91.1      

Cost of sales:

          

Cost of goods sold

   $ 110,397      $ 112,675      2.1   29.6   29.9

Labor costs

     111,453        112,007      0.5   29.9   29.7

Other operating costs

     35,786        37,781      5.6   9.6   10.0

Rent and related, and marketing costs

     39,544        40,653      2.8   10.6   10.8
                      

Total company-owned restaurant cost of sales

   $ 297,180      $ 303,116      2.0   79.7   80.5
                      

Total company-owned restaurant gross profit

   $ 75,817      $ 73,548      (3.0 %)    20.3   19.5
                      

Comparable store sales for our restaurants for each quarter in 2007 and 2008, compared to the same periods in the previous year were as follows:

 

     Fiscal 2007     Fiscal 2008  

First Quarter

   1.0   3.6

Second Quarter

   5.2   1.0

Third Quarter

   5.2   -1.7

Fourth Quarter

   3.2   -3.3

Company-owned restaurant sales for 2008 increased $3.7 million, when compared to 2007. These results were primarily due to price increases at Einstein Bros. and Noah’s coupled with a net increase in the number of restaurants opened over the previous twelve months, partially offset by a decline in volume. On average, the restaurants opened since January 1, 2008 had higher volumes relative to those that were closed over the same period, which positively contributed to our sales.

For 2008, our restaurant comparable store sales were relatively flat with a decrease of 0.1%. This was due to a decrease in the number of units sold, which we believe was mostly related to both the economic climate and its negative impact on consumer discretionary spending and from a decrease in our hours of operation. This was offset by system-wide price increases since January 1, 2008 and a shift in product mix to higher priced items.

Our gross profit decreased 3.0% in 2008 primarily due to the increase in our commodity-based food costs and a rise in labor costs due to changes in base pay from minimum wage rate increases.

Most of our commodity-based food costs increased in 2008. Flour represented the most significant raw ingredient we purchase. The market cost of wheat and in turn the cost to produce flour increased substantially in the last half of 2007 but stabilized by the end of the second quarter of 2008 and stayed at these levels through the remainder of 2008. To mitigate the risk of increasing market prices, we used a third party advisor to manage our wheat purchases for our company-owned production facility. As a result of this relationship, our wheat costs remained relatively constant throughout 2008.

 

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For 2008, labor costs increased $0.5 million from a combination of the growth of new restaurant openings that occurred throughout 2007 and 2008, an increase in base pay year-over-year from a combination of merit and an overall inflationary shift in our compensation structure caused by a July 2008 increase in minimum wage rates at the federal level and in several states in which we operate and an increase in workers’ compensation, partially offset by a decrease in incentive compensation and insurance costs.

For 2008, other operating costs increased $2.0 million, primarily attributable to an increase in utilities due to escalating energy costs, an increase in credit card fees due to a shift in consumer payment practices from using cash to using credit cards, and an increase in maintenance on our restaurants.

For 2008, rent and related and marketing costs increased $1.1 million, principally attributable to an increase in rent and related expense due to new restaurants as well as increases in the cost of rent on renewed leases, partially offset by a decrease in marketing expense from $3.3 million in 2007 to $2.3 million in 2008.

Manufacturing and Commissary Operations

Revenues

 

     52 weeks ended  
     (dollars in thousands)     Increase/
(Decrease)
    Percentage of manufacturing
and commissary revenues
 
     January 1,
2008
    December 30,
2008
    2008
vs. 2007
    January 1,
2008
    December 30,
2008
 

Manufacturing and commissary revenues

   $ 24,204      $ 30,369      25.5    

Percent of total revenue

     6.0     7.3      

Manufacturing and commissary costs

   $ 24,792      $ 28,566      15.2   102.4   94.1
                      

Total manufacturing and commissary gross profit

   $ (588   $ 1,803      *   (2.4 %)    5.9
                      

 

** not meaningful

Manufacturing and commissary revenues increased $6.2 million in 2008. The increase to revenue and gross profit was attributed to price increases and our expanded role within the distribution chain for sales to our franchise and license locations. In 2008, we saw a moderate rise in volume of units sold to our more significant third-party customers.

Franchise and License Operations

 

     (dollars in
thousands)
    Increase/
(Decrease)
 
     Fiscal
2007
    Fiscal
2008
    2008
vs. 2007
 

Franchise and license related revenues

   $ 5,701      $ 6,417      12.6

Percent of total revenue

     1.4     1.6  

Franchise and license gross margin

     100.0     100.0   0.0

Number of franchise and license restaurants

     196        223     

Overall, licensee and franchisee revenue improved predominantly due to improved comparable sales by franchisees and licensees of the Manhattan Bagel and Einstein Bros. brands of 8.6% in 2008 and a net increase of 28 license restaurants, partially offset by a net decrease of one franchise restaurant since January 1, 2008.

 

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Corporate Support

 

     52 weeks ended  
     (dollars in thousands)    Increase/
(Decrease)
    Percentage of
total revenues
 
     January 1,
2008
   December 30,
2008
   2008 vs.
2007
    January 1,
2008
    December 30,
2008
 

General and administrative expenses

   $ 40,635    $ 36,356    (10.5 %)    10.1   8.8

California wage and hour settlements

     —        1,900    *   0.0   0.5

Senior management transition costs

     —        1,335    *   0.0   0.3

Depreciation and amortization

     11,192      14,100    26.0   2.8   3.4

Other operating expenses

     837      461    (44.9 %)    0.2   0.1
                    

Total operating expenses

   $ 52,664    $ 54,152    2.8   13.1   13.1

Interest expense, net

     12,387      5,439    (56.1 %)    3.1   1.3

Provision for income tax

     454      1,100    142.3   0.1   0.3

 

** not meaningful

Our general and administrative expenses decreased $4.3 million in 2008. The overall decrease was partially related to a decrease in stock-based compensation expense that was primarily due to the additional options that were granted and vested in the second quarter of 2007 related to the secondary public offering, which did not occur again in 2008. Additionally, in 2008 compared to 2007, the Company had decreases in travel expense, recruiting and referral fees, sales and use tax expense and relocation expense related to our corporate headquarters, partially offset by an increase in our professional service fees. In addition, the Company experienced a decrease in compensation and related benefits as a result of a reduction in administrative positions that occurred in the latter half of 2008, decreased insurance costs, partially offset by an increase in incentive compensation expense.

The Company recorded $1.9 million in operating expenses during 2008 to satisfy the two California wage and hour settlements. This accrual represented the Company’s estimate of the aggregate amount that is probable to be paid pursuant to these settlements.

In late 2008 we experienced turnover at the senior management level. In November, our Chief Marketing Officer left the Company, and in December we transitioned to a new Chief Executive Officer. These events resulted in $0.9 million in severance charges and $0.4 million in recruiting and other costs.

Depreciation and amortization expenses increased $2.9 million in 2008 due to the additional depreciation expense on our new corporate headquarters that we occupied in May 2007 and the additional assets invested in the company-owned restaurants that were added or upgraded since the end of 2007.

In June 2007, we amended our credit facility and reduced our debt outstanding to $90 million, substantially decreasing our interest expense. The outstanding senior notes and other long-term debt as of December 30, 2008 was $87.9 million compared to $89.6 million as of January 1, 2008. Borrowings under this credit facility bore interest at either a Eurodollar rate or a variable base rate plus an applicable margin, as defined by our amended and restated credit agreement. We used LIBOR as our base rate.

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

The Company entered into an interest rate swap which became effective in August 2008 and will expire in August 2010. The net effect of the swap fixed our interest rate on $60.0 million of our First Lien Term Loan at 3.52% plus an applicable margin. The one-month LIBOR rate has been lower than our fixed rate for all but one

 

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month since we entered into the swap. The fair market value of the interest rate swap as of December 30, 2008 was a liability of $2.5 million, which is recorded in other liabilities on the Company’s consolidated balance sheet. As of December 30, 2008, the unrealized loss associated with this cash flow hedging instrument is recorded in accumulated other comprehensive loss within stockholders’ deficit.

For tax purposes, utilization of our fully reserved net operating loss (“NOL”) carryforwards reduced our effective tax rate and our federal and state income tax liability incurred for 2008. Although we have substantial NOL carryforwards available to offset federal taxable income, we are still required to pay income taxes at the state level and required to pay alternative minimum tax at the federal level. For 2008, the provision for income taxes increased $0.6 million. The increase was primarily driven by the considerable improvement in income before income taxes since the second quarter of 2007 when the Company paid down a substantial portion of its outstanding debt, thereby reducing interest expense.

Due to the uncertainty of future taxable income, deferred tax assets resulting from these net operating losses had been fully reserved as of the end of 2008.

Contractual Obligations

The following table summarizes the amounts of payments due under specified contractual obligations as of December 29, 2009:

 

     Payments Due by Fiscal Period
     2010    2011 to 2012    2013 to 2014    2015 and
thereafter
   Total
     (in thousands of dollars)

Accounts payable and accrued expenses

   $ 24,780    $ —      $ —      $ —      $ 24,780

Debt

     5,234      74,553      —        —        79,787

Estimated interest expense on our credit facility (a)

     2,985      3,246      —        —        6,231

Mandatorily Redeemable Series Z Preferred Stock

     32,194      —        —        —        32,194

Series Z additional redemption payments

     1,186      —        —        —        1,186

Minimum lease payments under capital leases

     25      17      3      —        45

Minimum lease payments under operating leases

     28,188      46,126      25,455      23,958      123,727

Purchase obligations (b)

     7,047      3,072      —        —        10,119

Other long-term obligations (c)

     —        778      600      5,596      6,974
                                  

Total

   $ 101,639    $ 127,792    $ 26,058    $ 29,554    $ 285,043
                                  

 

(a) Calculated as of December 29, 2009, using the fixed rate from the debt associated with the interest rate swap, and the variable LIBOR and U.S. Prime rates, plus the applicable margin in effect for the remainder. Because the interest rates on the first lien term loan facility and the revolving credit facility are variable, actual payments could differ materially.
(b) Purchase obligations consist of non-cancelable minimum purchases of frozen dough and certain other raw ingredients that are used in our products.
(c) Other long-term obligations primarily consist of the remaining liability related to minimum future purchase commitments with a supplier that advanced us $10.0 million in 1996.

Financial Condition, Liquidity and Capital Resources

The restaurant industry is predominantly a cash business where cash is received at the time of the transaction. Our inventory turns frequently and 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.

 

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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.

Excluding tenant improvement allowances that we typically receive from the landlord, the average cost of a new restaurant was approximately $540,000 in 2009, depending on square footage, layout and location. The cost includes equipment, leasehold improvements, furniture and fixtures, and other related capital. For 2010, we have reduced the size of our restaurants and have renegotiated other costs that should result in a $40,000 decrease in the average cost of each restaurant. We anticipate that our tenant improvement allowances will average approximately $40,000 per restaurant which also reduces the cash cost of our restaurants. However, the amount of the allowance can vary widely depending on the location of the restaurant and other terms of the lease. We also intend to upgrade at least 10 to 20 of our current restaurants during 2010, which will include approximately $80,000 in capital costs and approximately $50,000 in deferred maintenance costs, for a total cost of approximately $130,000 per restaurant. Finally for 2010, we intend to install the kitchen display ordering system (“KDS”) at most of our Noah’s restaurants and some of our Einstein Bros. restaurants. The KDS is currently in place at most of our Einstein Bros. locations, and we believe that this system improves production accuracy compared to the paper tickets process and helps to reduce waste.

We anticipate that the majority of our capital expenditures for 2010 will be focused on the addition of 10 to 12 new company-owned restaurants and 10 to 20 upgrades of our existing restaurants. Based on our current purchases of capital assets, our existing base of assets, and our projections for new purchases of fixed assets, we believe depreciation expense for 2010 will be approximately $20.0 million.

Mandatorily redeemable Series Z Preferred Stock (“Series Z”)

On May 28, 2009, we entered into an agreement with Halpern Denny to redeem shares as follows:

 

  1. $20 million to redeem 20,000 shares of Series Z on June 30, 2009 at a redemption price of $1,000 per share;

 

  2. $3 million to redeem shares of Series Z on December 31, 2009; and

 

  3. $5 million to redeem shares of Series Z on March 31, 2010.

The first payment was made on June 30, 2009, which reduced the outstanding Series Z to $37.0 million. The second and third redemption payments include additional redemption (“Additional Redemption”) price per share based on a rate that is 250 bps higher than the highest rate paid on our funded indebtedness, as provided in the Certificate of Designations (“Certificate”) for the Series Z.

In addition, we have agreed to redeem the remaining outstanding shares of Series Z on June 30, 2010. At any time we may also increase the amount and frequency of the redemption payments. Shares shall be redeemed subject to the legal availability of funds. The parties have also agreed that, if we complete an equity offering, we shall pay any proceeds of the offering, in excess of amounts payable under the credit facility, to Halpern Denny to redeem any outstanding Series Z. In addition, in the event of a merger or change of control, the outstanding Series Z shall be immediately mandatorily redeemable and the provisions of the Certificate shall control. In the event of bankruptcy, the provisions of the Certificate shall control. In exchange, Halpern Denny has agreed not to enforce certain mandatory redemption provisions of the Certificate.

On December 29, 2009, we redeemed $5.0 million of Series Z, which included the $3.0 million redemption payment that was due on December 31, 2009 plus an incremental redemption of $2.0 million. This reduced the outstanding Series Z by $4.8 million with $0.2 million being paid towards the accrued Additional Redemption price. As of December 29, 2009, $1.3 million of Additional Redemption price was included in accrued expenses

 

34


Table of Contents

and other liabilities on the balance sheet and included within interest expense, net on the statements of operations.

Our credit facility contains a commitment for an incremental term loan in the aggregate amount of up to $57.0 million to be used by us, if needed, solely for the purpose of redeeming the Series Z. Availability of the incremental term loan is subject to customary borrowing conditions, including absence of any default or material adverse change, and to a requirement of successful syndication of such incremental term loan. We have had discussions with Wells Fargo Foothill, the administrative agent for the credit facility, regarding the status of the current credit market and the likelihood of a successful syndication under the same terms as our existing credit facility. Given the current state of the credit market we do not believe that the incremental term loan could be syndicated at the same price and under the same terms as our existing credit facility. While it still remains an option for us to consider, due to the current state of the credit market, it is not likely that we will pursue this strategy at this time.

As of December 29, 2009, we have $9.9 million of unrestricted cash and $12.8 million of borrowing capacity under the revolver portion of our credit facility. During 2009 we generated $16.8 million of free cash flow (the sum of net cash provided by operating activities and net cash used in investing activities). As a result of this, we will make a $4.3 million excess cash flow payment on the credit facility in 2010 which will reduce our unrestricted cash balance.

Finally, we intend to continue to focus on generating free cash flow that will allow us to redeem a significant portion of the remaining outstanding shares of the Series Z on June 30, 2010. We believe that approximately $10.0 million to $15.0 million of the Series Z will remain unredeemed on June 30, 2010. Similar to the approach we used in 2009, we intend to negotiate with the holder of the Series Z to either revise the letter agreement that will extend the redemption of the Series Z out one more year to June 30, 2011, or work with the holder to find an alternative means to settling this obligation. In addition, to satisfy any unredeemed portion of the Series Z, we will also consider other alternatives such as issuing new capital, take on additional indebtedness, or a combination of both.

Amended credit facility

In June 2007, we amended our credit facility from $95.0 million to $110.0 million. Our amended credit facility consisted of a:

 

   

$20.0 million revolving credit facility maturing on June 28, 2012 (“revolver”; and

 

   

$90.0 million first lien term loan maturing in June 28, 2012.

As part of this amendment we increased the amount of the revolver from $15.0 million to $20.0 million and modified our term loan from a principal amount of $80.0 million to $90.0 million and repaid the remaining amount of our $25 Million Subordinated Note. The revolver remains available, subject to certain conditions, to finance our ongoing working capital, capital expenditure and general corporate needs. In addition, all of the revolver is available for letters of credit, which reduce the availability on the line. 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, being based on our consolidated leverage ratio with an applicable margin of 2.00% plus a 0.5% arranger fee payable quarterly. As of December 29, 2009, our availability under the revolver was $12.8 million.

We may prepay amounts outstanding under the credit facility and may terminate commitments in whole at any time without penalty or premium upon prior written notice.

 

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Table of Contents

In order to increase flexibility for raising funds to redeem the Series Z, we amended our existing credit facility on May 28, 2009 to permit (i) the incurrence of subordinated debt and replacement equity in the form of another issue of mandatorily redeemable preferred stock, provided that the replacement subordinated debt and preferred stock is not payable or redeemable prior to December 31, 2012 and December 28, 2012, respectively (which is approximately six months after the due date of the credit facility), and (ii) payment of an increased additional redemption amount at a rate up to 450 bps higher than the highest rate on the our funded indebtedness for any unredeemed shares of Series Z after June 30, 2010. In addition, the amendment to the credit agreement permits commodity forward purchasing contracts in the ordinary course of business.

In connection with the credit facility maturing June 28, 2012, the Company intends to refinance, renegotiate or replace the credit agreement when it matures.

Working Capital Deficit

Our working capital deficits were $51.2 million and $27.8 million as of the end of 2008 and 2009, respectively.

Our working capital deficit position improved in 2009 by $23.4 million due primarily to the generation of $16.8 million in free cash flow, or net cash provided by operating activities less net cash used in investing activities, and the recognition of $7.2 million in current deferred tax assets. We began 2009 with $24.2 million of unrestricted cash and generated $33.7 million in cash from operating activities and received $1.8 million from the exercise of stock options. We used a portion of this aggregate $59.7 million in cash to invest $16.9 million in property and equipment, to redeem $24.8 million of our Series Z, to repay $8.1 million of debt and to pay $3.2 million for the two California wage and hour settlements and the payment of senior management transition costs. As of December 29, 2009, we had unrestricted cash of $9.9 million, representing a decline in unrestricted cash of $14.3 million during 2009. In addition to changes in unrestricted cash, current deferred tax assets, current maturities of our Series Z and our debt, and the payment of $3.2 million of certain accrued liabilities, other elements of working capital fluctuated in the normal course of business.

Our working capital declined by $54.9 million to a deficit position in 2008 due primarily to $57 million of Series Z becoming a current liability on June 30, 2008. We began 2008 with $9.4 million of unrestricted cash and generated $43.1 million from operating activities and received $0.4 million for the exercise of stock options. We used a portion of this aggregate $52.9 million to invest $26.7 million in property and equipment and to repay $1.7 million of debt. As of December 30, 2008, we had unrestricted cash of $24.2 million, representing an increase in unrestricted cash of $14.8 million during 2008. In addition to changes in unrestricted cash and the current maturities of our Series Z and debt, other elements of working capital changed as follows:

 

   

accounts receivable decreased due to improved collection efforts;

 

   

accrued expenses increased primarily due to the two California wage and hour settlements and the accrual for senior management transition costs; and

 

   

short-term debt and the current portion of long-term debt increased by $8.1 million.

Based upon our projections for 2010, including the aforementioned approach on the Series Z, we believe our various sources of capital, including availability under our existing credit facility, and cash flow from operating activities of continuing operations, are adequate to finance operations as well as the repayment of current debt obligations.

 

36


Table of Contents
     52 weeks ended  
     December 30,
2008
    December 29,
2009
 
     (dollars in thousands)  

Net cash provided by operating activities

   $ 43,095      $ 33,700   

Net cash used in investing activities

     (26,680     (16,896
                

Free cash flow

     16,415        16,804   

Net cash used in financing activities

     (1,635     (31,135
                

Net increase (decrease) in cash and cash equivalents

     14,780        (14,331

Cash and cash equivalents, beginning of period

     9,436        24,216   
                

Cash and cash equivalents, end of period

   $ 24,216      $ 9,885   
                

Cash Provided by Operations

While we experienced increased profitability at our company-owned restaurants in recent years, our sales decreased in 2009 compared to 2008, interest expense increased due to the Series Z Additional Redemption amounts and we made several large payments related to the two California wage and hour settlements and the senior management transition. Net cash generated by operating activities was $33.7 million for 2009 compared to $43.1 million for 2008.

Cash Used in Investing Activities

During 2009, we used approximately $16.9 million of cash to purchase additional property and equipment as follows:

 

   

$9.5 million to open new restaurants and upgrade existing restaurants in 2008 and 2009;

 

   

$5.9 million for replacement of equipment at our existing company-owned restaurants and at our manufacturing operations; and

 

   

$1.5 million for general corporate purposes.

During 2008, we used approximately $26.7 million of cash to purchase additional property and equipment as follows:

 

   

$18.9 million to open new restaurants and upgrade existing restaurants in 2007 and 2008;

 

   

$5.4 million for replacement of equipment at our existing company-owned restaurants and at our manufacturing operations; and

 

   

$2.4 million for general corporate purposes.

Cash Used in Financing Activities

During 2009, we made payments on our debt totaling $8.1 million and redeemed $24.8 million of our Series Z. We received $1.8 million in proceeds from stock option exercises primarily from former employees.

During 2008, we made payments on our debt totaling $2.0 million and received $0.4 million in proceeds from stock option exercises.

 

37


Table of Contents

Off-Balance Sheet Arrangements

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. As of December 29, 2009, we do not have a liability recorded for our exposure following a probability related approach. Minimum future rental payments for all remaining guaranteed leases that expire on various dates through July 2012 were approximately $0.5 million as of December 29, 2009. We believe the ultimate disposition of these matters will not have a material adverse effect on our financial position or results of operations.

Letters of Credit

We have $7.2 million in letters of credit outstanding under our credit facility as of December 29, 2009. The letters of credit expire on various dates during 2010, are generally automatically renewable for one additional year and are payable upon demand in the event that we fail to pay the underlying obligation.

Economic Environment and Commodity Volatility

Economic Environment

Our results depend on discretionary consumer spending, which is influenced by consumer confidence and disposable income. In particular, the effects of changing energy and food costs, 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. 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. However, the impact of inflation on labor, food and occupancy costs could, in the future, significantly affect our operations. We pay many of our associates based on hourly rates slightly above the applicable minimum federal, state or municipal “living wage” rates. Recent changes in minimum wage laws may create pressure to increase the pay scale for our associates, which would increase our labor costs. Costs for construction, taxes, repairs, maintenance and insurance all impact our occupancy costs. We believe our current strategy, which is to seek to maintain operating margins through a combination of menu price increases, cost controls, efficient purchasing practices and careful evaluation of property and equipment needs, has been an effective tool for dealing with inflation.

Impact of Agricultural Commodities

Our cost of sales consist of cost of goods sold, which is made up of food and product costs, compensation costs and other operating costs. Wheat, butter and cheese are our primary agricultural commodities and in addition, coffee, chicken and turkey are the other major agricultural commodities which are included in our cost of goods sold. For the last few years, cost increases in one or more of our agricultural commodities were generally modest in relation to our total cost of sales. Because of the increasing commodity costs in 2007 and 2008, we raised our prices once at both Einstein Bros. and Noah’s during 2008 and during 2009.

 

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Recent Accounting Pronouncements

In April 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 165, Subsequent Events (“SFAS No. 165”) codified as FASB Accounting Standards Codification Topic 855 (“ASC 855”). ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. We adopted SFAS No. 165 for the quarter ending June 30, 2009. Adoption did not have a material impact on our consolidated financial statements.

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 168”), which identifies the FASB Accounting Standards Codification as the authoritative source of generally accepted accounting principles in the United States. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under federal securities laws are also sources of authoritative generally accepted accounting principles for SEC registrants. SFAS No. 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. Adoption did not have a material impact on our consolidated financial statements.

Critical Accounting Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate our estimates based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Additionally, any estimates for contingent liabilities that arise as result of any legal proceedings are discussed in Item 3 of this report.

Our significant accounting policies are discussed in Note 2 to our consolidated financial statements set forth in Item 8 of this report.

Impairment of Long-Lived Assets

We review property and equipment and amortizing intangible assets for impairment when events or circumstances indicate that the carrying amount of a restaurant’s assets may not be recoverable. We test for impairment using historical cash flows and other relevant facts and circumstances as the primary basis for our estimate of future cash flows. Relevant facts and circumstances may include, but are not limited to, local competition in the area, the ability of existing restaurant management, the necessity of tiered pricing structures and the impact that upgrading our restaurants may have on our estimates. Recoverability of a restaurant’s assets is measured by a comparison of the carrying amount of the assets to the estimated undiscounted future cash flows expected to be generated by the restaurant. This process requires the use of estimates and assumptions, which are subject to a high degree of judgment. If the carrying amount of a restaurant’s assets exceeds its estimated undiscounted future cash flows, an impairment charge is recognized as the amount by which the carrying amount of the assets exceeds its fair value. Absent other available information, we use discounted future cash flows as an estimate of fair value. During 2009, we recorded an impairment of $0.8 million related to seven of our company-owned restaurants.

At least annually, we assess the recoverability of goodwill and other intangible assets not subject to amortization related to our restaurant concepts. These impairment tests require us to estimate the fair values of our restaurant concepts by making assumptions regarding future profits and cash flows, expected growth rates, terminal values, discount rates and other factors. As of December 29, 2009, the fair value of goodwill and other intangible assets not subject to amortization sufficiently exceeded the carrying values. The assumptions used in

 

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the estimate of fair value are generally consistent with the past performance of each reporting unit and other intangible assets and are also consistent with the projections and assumptions that are used in current operating plans. These assumptions are subject to change as a result of changing economic and competitive conditions. In the event that these assumptions change in the future, we may be required to record impairment charges for these assets.

Insurance Liabilities

The Company uses a combination of insurance and self-insurance mechanisms to provide for the potential liabilities for workers’ compensation, general liability and healthcare benefits. The insurance liabilities represent an estimate of the ultimate cost of claims incurred and unpaid as of the balance sheet date. The estimated liabilities are established and are not discounted, with the exception of the workers’ compensation, which is discounted at 10% based upon analysis of historical data and actuarial estimates, and they are reviewed on a quarterly basis to ensure that the liabilities are appropriate. If actual trends, including the severity or frequency of claims differ from our estimates, our financial results could be favorably or unfavorably impacted.

Stock-Based Compensation

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

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 are 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 GAAP and the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107 using an option-pricing model, the value calculated 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 being related to our operational performance, we exclude estimated share-based compensation expense when evaluating our performance.

Gift Card Breakage

Proceeds from the sale of gift cards are recorded as deferred revenue and recognized as income when redeemed by the holder. While we will continue to honor all gift cards presented for payment, we may determine the likelihood of redemption to be remote for certain gift card balances due to the age of the unredeemed balance. In these circumstances, to the extent we determine there is no requirement for remitting balances to government agencies under unclaimed property laws, gift card balances may be recognized as gift card breakage and recorded as a reduction to deferred revenue and an increase to company-owned restaurant revenues. For 2009, we recognized $0.2 million in gift card breakage.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

During 2008 and 2009, our results of operations, financial position and cash flows have not been materially affected by changes in the relative values of non-U.S. currencies to the U.S. dollar. We do not use derivative financial instruments to limit our foreign currency risk exposure since virtually all of our business is conducted in the United States. Our manufacturing operations sell bagels to a wholesaler and a distributor who take possession in the United States and sell outside of the United States. As the product is shipped FOB domestic dock, and invoiced and paid in U.S. dollars, there are no international risks of loss or foreign exchange currency issues.

Our debt as of December 29, 2009 was principally composed of the credit facility. 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 credit facility, interest rate changes generally do not affect the fair market value of such debt, but do impact future earnings and cash flows, assuming other factors are held constant.

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

Assuming no change in the size or composition of debt as of December 29, 2009, and presuming the utilization of our accumulated net operating losses would minimize the tax implications for the next several years, a 100 basis point increase in short-term effective interest rates would increase our interest expense on our credit facility, including the interest rate swap, by approximately $0.2 million annually. Currently, the interest rates on our credit facility are predominantly at LIBOR rates plus an applicable margin through short-term fixed rate financing, and the interest rate swap has fixed our rate on $60 million of our outstanding debt. The estimated increase in interest expense incorporates the fixed interest financing into its assumptions.

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

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

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

     Page

Audited Annual Financial Statements

  

Reports of Independent Registered Public Accounting Firm

   43

Consolidated Balance Sheets as of December 30, 2008 and December 29, 2009

   45

Consolidated Statements of Operations for the 52 Weeks Ended January 1, 2008, December  30, 2008 and December 29, 2009

   46

Consolidated Statements of Changes in Stockholders’ (Deficit) Equity for the 52 Weeks Ended January 1, 2008, December 30, 2008 and December 29, 2009

   47

Consolidated Statements of Cash Flows for the 52 Weeks Ended January 1, 2008, December  30, 2008 and December 29, 2009

   48

Notes to Consolidated Financial Statements

   49

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Einstein Noah Restaurant Group, Inc.

We have audited the accompanying consolidated balance sheets of Einstein Noah Restaurant Group, Inc. and subsidiaries (collectively, “Einstein Noah”) (a Delaware corporation) as of December 29, 2009 and December 30, 2008, and the related consolidated statements of operations, stockholders’ (deficit) equity, and cash flows for each of the three years in the period ended December 29, 2009. Our audits of the basic financial statements include the financial statement schedule listed in the index appearing under Item 15(2). These financial statements and financial statement schedule are the responsibility of Einstein Noah’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Einstein Noah Restaurant Group, Inc. and subsidiaries’ as of December 29, 2009 and December 30, 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 29, 2009 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Einstein Noah Restaurant Group, Inc. and subsidiaries’ internal control over financial reporting as of December 29, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 25, 2010 expressed an unqualified opinion.

/s/ GRANT THORNTON LLP

Denver, Colorado

February 25, 2010

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Einstein Noah Restaurant Group, Inc.

We have audited Einstein Noah Restaurant Group, Inc. and subsidiaries (collectively, “Einstein Noah”) (a Delaware Corporation) internal control over financial reporting as of December 29, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Einstein Noah’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express an opinion on Einstein Noah’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Einstein Noah Restaurant Group, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 29, 2009, based on criteria established in Internal Control—Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Einstein Noah Restaurant Group, Inc. and subsidiaries as of December 29, 2009 and December 30, 2008, and the related consolidated statements of operations, stockholders’ (deficit) equity, and cash flows for each of the three years in the period ended December 29, 2009 and our report dated February 25, 2010 expressed an unqualified opinion.

/s/ GRANT THORNTON LLP

Denver, Colorado

February 25, 2010

 

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EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share information)

 

     December 30,
2008
    December 29,
2009
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 24,216      $ 9,885   

Restricted cash

     526        508   

Accounts receivable

     6,459        5,629   

Inventories

     5,290        5,513   

Current deferred income tax assets, net

     —          7,184   

Prepaid expenses

     4,175        5,682   

Other current assets

     599        73   
                

Total current assets

     41,265        34,474   

Property, plant and equipment, net

     59,747        58,682   

Trademarks and other intangibles, net

     63,831        63,831   

Goodwill

     4,981        4,981   

Long-term deferred income tax assets, net

     —          46,206   

Debt issuance costs and other assets, net

     3,105        3,047   
                

Total assets

   $ 172,929      $ 211,221   
                

LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY

    

Current liabilities:

    

Accounts payable

   $ 5,123      $ 4,147   

Accrued expenses and other current liabilities

     22,160        20,633   

Current portion of long-term debt

     8,088        5,234   

Current portion of obligations under capital leases

     61        22   

Mandatorily redeemable, Series Z Preferred Stock, $.001 par value, $1,000 per share liquidation value; 57,000 shares authorized; 57,000 and 32,194 shares outstanding

     57,000        32,194   
                

Total current liabilities

     92,432        62,230   

Long-term debt

     79,787        74,553   

Long-term obligations under capital leases

     38        19   

Other liabilities

     14,323        12,133   
                

Total liabilities

     186,580        148,935   
                

Commitments and contingencies

    

Stockholders’ (deficit) equity:

    

Series A junior participating preferred stock, 700,000 shares authorized; no shares issued and outstanding

    

Common stock, $.001 par value; 25,000,000 shares authorized; 15,969,167 and 16,461,123 shares issued and outstanding

     16        16   

Additional paid-in capital

     264,179        266,928   

Accumulated other comprehensive loss, net of income tax

     (2,470     (1,277

Accumulated deficit

     (275,376     (203,381
                

Total stockholders’ (deficit) equity

     (13,651     62,286   
                

Total liabilities and stockholders’ (deficit) equity

   $ 172,929      $ 211,221   
                

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

 

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EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

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

 

     52 weeks ended  
     January 1,
2008
   December 30,
2008
   December 29,
2009
 

Revenues:

        

Company-owned restaurant sales

   $ 372,997    $ 376,664    $ 370,412   

Manufacturing and commissary revenues

     24,204      30,369      30,638   

Franchise and license related revenues

     5,701      6,417      7,512   
                      

Total revenues

     402,902      413,450      408,562   

Cost of sales:

        

Company-owned restaurant costs

     297,180      303,116      304,257   

Manufacturing and commissary costs

     24,792      28,566      26,573   
                      

Total cost of sales

     321,972      331,682      330,830   
                      

Gross profit

     80,930      81,768      77,732   

Operating expenses:

        

General and administrative expenses

     40,635      36,356      35,463   

California wage and hour settlements

     —        1,900      —     

Senior management transition costs

     —        1,335      —     

Depreciation and amortization

     11,192      14,100      16,627   

Other operating expenses

     837      461      725   
                      

Income from operations

     28,266      27,616      24,917   

Other expense:

        

Interest expense, net

     12,387      5,439      6,114   

Write-off of debt discount upon redemption of senior notes

     528      —        —     

Prepayment penalty upon redemption of senior notes

     240      —        —     

Write-off of debt issuance costs upon redemption of senior notes

     2,071      —        —     
                      

Income before income taxes

     13,040      22,177      18,803   

Provision (benefit) for income tax

     454      1,100      (53,192
                      

Net income

   $ 12,586    $ 21,077    $ 71,995   
                      

Net income per common share – Basic

   $ 0.93    $ 1.32    $ 4.45   
                      

Net income per common share – Diluted

   $ 0.88    $ 1.29    $ 4.36   
                      

Weighted average number of common shares outstanding:

        

Basic

     13,497,841      15,934,796      16,175,391   
                      

Diluted

     14,235,625      16,378,965      16,526,869   
                      

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) EQUITY

(in thousands, except share information)

 

     Common Stock    Additional
Paid In
Capital
    Accumulated
Other
Comprehensive
Loss
    Accumulated
Deficit
    Total  
     Shares     Amount         

Balance, January 2, 2007

   10,596,419      $ 11    $ 176,797      $ —        $ (309,039   $ (132,231

Net income

   —          —        —          —          12,586        12,586   

Common stock issued upon stock option exercise and restricted stock awards

   282,392        —        1,017        —          —          1,017   

Common stock issued in secondary offering

   5,000,000        5      89,995        —          —          90,000   

Costs to issue common stock

   —          —        (6,667     —          —          (6,667

Stock based compensation expense

   —          —        1,688        —          —          1,688   
                                             

Balance, January 1, 2008

   15,878,811      $ 16    $ 262,830      $ —        $ (296,453   $ (33,607

Net income

   —          —        —          —          21,077        21,077   

Common stock issued upon stock option exercise

   97,526        —        404        —          —          404   

Restricted stock forfeited

   (7,334     —        —          —          —          —     

Common stock issued upon stock appreciation right exercise

   164        —        —          —          —          —     

Stock based compensation expense

   —          —        945        —          —          945   

Unrealized loss on derivative securities, net of taxes

   —          —        —          (2,470     —          (2,470
                                             

Balance, December 30, 2008

   15,969,167      $ 16    $ 264,179      $ (2,470   $ (275,376   $ (13,651

Net income

   —          —        —          —          71,995        71,995   

Common stock issued upon restricted stock awards

   63,776        —        —          —          —          —     

Common stock issued upon stock option exercise

   427,777        —        1,808        —          —          1,808   

Common stock issued upon stock appreciation right exercise

   403        —        —          —          —          —     

Stock based compensation expense

   —          —        941        —          —          941   

Net change in unrealized loss on derivative securities, net of taxes

   —          —        —          1,193        —          1,193   
                                             

Balance, December 29, 2009

   16,461,123      $ 16    $ 266,928      $ (1,277   $ (203,381   $ 62,286   
                                             

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

 

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EINSTEIN NOAH RESTAURANT GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     52 weeks ended  
     January 1,
2008
    December 30,
2008
    December 29,
2009
 

OPERATING ACTIVITIES:

      

Net income

   $ 12,586      $ 21,077      $ 71,995   

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

     11,192        14,100        16,627   

Deferred income tax benefit

     —          —          (53,390

Stock-based compensation expense

     1,688        945        941   

Loss on disposal of assets

     601        198        212   

Impairment charges and other related costs

     236        263        818   

Provision for losses on accounts receivable

     101        157        206   

Amortization of debt issuance and debt discount costs

     651        487        574   

Write-off of debt issuance costs

     2,071        —          —     

Write-off of debt discount

     528        —          —     

Paid-in kind interest

     904        —          —     

Changes in operating assets and liabilities:

      

Restricted cash

     1,484        677        18   

Accounts receivable

     (1,515     1,191        624   

Accounts payable and accrued expenses

     (2,387     3,297        (2,300

Accrued Series Z additional redemption

     —          —          1,285   

Other assets and liabilities

     (3,254     703        (3,910
                        

Net cash provided by operating activities

     24,886        43,095        33,700   

INVESTING ACTIVITIES:

      

Purchase of property and equipment

     (25,869     (26,690     (16,898

Proceeds from the sale of equipment

     1,168        17        2   

Acquisition of restaurant assets

     (375     (7     —     
                        

Net cash used in investing activities

     (25,076     (26,680     (16,896

FINANCING ACTIVITIES:

      

Proceeds from secondary common stock offering

     90,000        —          —     

Costs incurred with offering of our common stock

     (6,667     —          —     

Payments under capital lease obligations

     (53     (84     (49

Repayments of other borrowings

     (280     (280     —     

Borrowings under the term loan

     11,900        —          —     

Repayments under the term loan

     (925     (1,675     (8,088

Repayments under Second Lien Term Loan

     (65,000     —          —     

Repayments under Subordinated Note

     (25,000     —          —     

Redemptions under mandatorily redeemable Series Z Preferred Stock

     —          —          (24,806

Debt issuance costs

     (843     —          —     

Proceeds upon stock option exercises

     1,017        404        1,808   
                        

Net cash provided by (used in) financing activities

     4,149        (1,635     (31,135

Net increase (decrease) in cash and cash equivalents

     3,959        14,780        (14,331

Cash and cash equivalents, beginning of period

     5,477        9,436        24,216   
                        

Cash and cash equivalents, end of period

   $ 9,436      $ 24,216      $ 9,885   
                        

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

 

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EINSTEIN NOAH RESTAURANT GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

The consolidated financial statements of Einstein Noah Restaurant Group, Inc. and its wholly-owned subsidiaries (collectively, the “Company”) have been prepared in conformity with accounting principles generally accepted in the United States of America. All inter-company accounts and transactions have been eliminated in consolidation. As of December 29, 2009, 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”), and Manhattan Bagel Company (“Manhattan Bagel”).

We have a 52/53-week fiscal year ending on the Tuesday closest to December 31. Fiscal years 2007, 2008 and 2009 which ended on January 1, 2008, December 30, 2008 and December 29, 2009 respectively, contained 52 weeks.

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

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires us to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues, costs and expenses during the reporting period. Actual results could differ from the estimates.

Revenue Recognition

Company-owned restaurant sales – We record revenue from the sale of food, beverage and retail items as products are sold. Sales tax amounts collected from customers that are remitted to governmental authorities are excluded from our net revenue.

Manufacturing and commissary revenues – Our manufacturing revenues are recorded at the time of shipment to customers. Our manufacturing operations sell bagels to a wholesaler and a distributor who take possession in the United States and sells outside of the United States. As the product is shipped FOB domestic dock, and invoiced and paid in U.S. dollars, there are no international risks of loss or foreign exchange currency issues. Approximately $3.3 million, $4.8 million and $5.3 million of sales shipped internationally are included in manufacturing revenues for fiscal years ended 2007, 2008 and 2009, respectively.

Franchise and license related revenues – Initial fees received from a franchisee or licensee to establish a new location are recognized as income when we have performed our obligations required to assist the franchisee or licensee in opening a new location, which is generally at the time the franchisee or licensee commences operations. Continuing royalties, which are a percentage of the net sales of franchised and licensed locations, are accrued as income each month.

Gift Cards – Proceeds from the sale of gift cards are recorded as deferred revenue within accrued expenses, and recognized as income when redeemed by the holder. The deferred revenue balance represents the Company’s liability for gift cards that have been sold, but not yet redeemed. There are no expiration dates on the Company’s gift cards, nor do we charge any service fees that decrease customer balances.

 

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While we will continue to honor all gift cards presented for payment, we may determine the likelihood to be remote for certain gift card balances due to the age of the unredeemed balance. In these circumstances, to the extent we determine there is no requirement for remitting balances to government agencies under unclaimed property laws, gift card balances may be recognized as gift card breakage in revenue. Gift card breakage is included in revenue within company-owned restaurant sales in our consolidated statements of operations.

For the fiscal years ended December 30, 2008 and December 29, 2009, income from gift card breakage was $0.3 and $0.2 million, respectively. For the fiscal year ended January 1, 2008, income recognized from gift card breakage was $1.3 million, which relates to unredeemed balances from 2003 through 2006 and resulted from the Company entering into an agreement in December 2007, with an unrelated third party that assumed the unredeemed liability for gift cards that had not yet reached the statutory term for unclaimed property. As a result of the agreement, certain third-party claims on unredeemed gift cards for certain jurisdictions had been removed. Our estimate of gift card breakage is based upon reasonable and reliable company-specific historical information that the Company believes is predictive of the future and relates to a large pool of homogenous gift card transactions over a sufficient time frame.

Allowance for doubtful accounts – The majority of our receivables are due from our licensees, franchisees, distributors and trade customers. We determine our allowance by considering a number of factors, including the length of time trade accounts receivable are past due, our previous loss and payment history, the customer’s current ability to pay its obligation to us and the condition of the general economy and the industry as a whole. We write off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.

Cash and Cash Equivalents, and Restricted Cash

Cash and cash equivalents consist of cash on hand and highly liquid instruments with original maturities of three months or less when purchased. Amounts in-transit from credit card processors are also considered cash equivalents because they are both short-term and highly liquid in nature and are typically converted to cash within three days of the sales transaction. Restricted cash consists of funds paid by our franchisees that are earmarked as advertising fund contributions, monies set aside for the lease on our corporate office and restricted cash accounts for the benefit of taxing and other government authorities. The Company maintains cash and cash equivalent balances with financial institutions that exceed federally insured limits. The Company has not experienced any losses related to these balances and management believes its credit risk to be minimal.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Furniture and equipment are depreciated using the straight-line method over the estimated useful life of the asset, which ranges from 3 to 12 years. Leasehold improvements are amortized using the straight-line method. The depreciable lives for our leasehold improvements are limited to the lesser of the useful life or the non-cancelable lease term. In circumstances where we would incur an economic penalty by not exercising one or more option periods, we include one or more option periods when determining the depreciation period. In either circumstance, our policy requires consistency when calculating the depreciation period, in classifying the lease and in computing straight-line rent expense. Costs incurred to repair and maintain our facilities and equipment are expensed as incurred.

In the first quarter of 2008, we reviewed the depreciable lives of our assets and determined that the economic useful life for leasehold improvements on new restaurants should be the shorter of 10 years or the life of the lease, which is typically 10 years. We also determined that the economic useful lives of our restaurant upgrades should be the shorter of 5 years or the life of the lease. However, as we approve our restaurants to be

 

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upgraded, we simultaneously review the lease, and typically only upgrade those locations that have a renewal option and we are reasonably assured that the lease will be renewed. For 2008, the effect on both income from operations and net income was a reduction of $0.9 million in depreciation expenses, which increased both basic and diluted earnings per share by $0.05.

In accordance with GAAP, impairment losses are recorded on long-lived assets on a restaurant-by-restaurant basis whenever impairment indicators are determined to be present. We consider a history of cash flow losses to be the primary indicator of potential impairment for individual restaurant locations. We determine whether a restaurant location is impaired based on expected undiscounted future cash flows, considering location, local competition, current 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 fiscal years ended 2007, 2008 and 2009, we recorded approximately $0.2 million, $0.3 million, and $0.8 million, respectively, in impairment charges related to underperforming restaurants.

Leases and Deferred Rent Payable

We lease all of our restaurant properties. Leases are evaluated and classified as operating or capital leases for financial reporting purposes.

For a lease that contains rent escalations, we record the total rent payable during the lease term on a straight-line basis over the term of the lease and record the difference between rent paid and the straight-line rent expense as deferred rent payable. Incentive payments received from landlords are recorded as landlord incentives and are amortized on a straight-line basis over the lease term as a reduction of rent.

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. 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. In accordance with GAAP, we follow a two-step approach for testing impairment. 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 intangibles with indefinite lives, 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 Bagel trademarks.

As of January 1, 2008, December 30, 2008 and December 29, 2009, we performed an impairment analysis of the goodwill and indefinite lived intangible assets related to our Einstein Bros. and Manhattan Bagel brands. For the fiscal years ended 2007, 2008, and 2009 there was no indication of impairment in our goodwill and indefinite lived intangible assets.

 

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Insurance Reserves

The Company uses a combination of insurance and self-insurance mechanisms to provide for the potential liabilities for workers’ compensation, general liability and healthcare benefits. We maintain coverage with third party insurers which limit our total exposure from medical, workers’ compensation and general liability claims. The self-insurance medical liability and insured workers’ compensation and general liability represent an estimate of the ultimate cost of claims incurred and unpaid as of the balance sheet date. The estimated liabilities are established based upon analysis of historical data to ensure that the liability is appropriate. If actual claims differ from our estimates, our financial results could be impacted. The estimated workers’ compensation liability is established based on actuarial estimates, is discounted at 10% based upon a discrete analysis of actual claims and historical data and is reviewed on a quarterly basis to ensure that the liability is appropriate. These estimated liabilities are included in accrued expenses in our consolidated balance sheets.

Guarantees

Prior to 2001, we would occasionally guarantee leases for the benefit of certain 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 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 GAAP. In the event that trends change in the future, our financial results could be impacted. As of December 29, 2009, we had outstanding guarantees of indebtedness under certain leases of approximately $0.5 million and no liability has been recorded.

Fair Value of Financial Instruments

As of December 30, 2008 and December 29, 2009, our financial instruments consist of cash equivalents, accounts receivable, accounts payable and debt. The fair value of accounts receivable and accounts payable approximate their carrying value, due to their short-term maturities. As of December 30, 2008 and December 29, 2009, our total debt under the senior secured credit facility was $87.9 million and $79.8 million, respectively and had a fair value of $69.6 million and $64.6 million, respectively due to the changing credit markets. The fair value of the Company’s debt was estimated based on the current rates found in the market place for debt with the same remaining maturities.

The Mandatorily Redeemable Series Z Preferred Stock (“Series Z”) is recorded in the accompanying consolidated balance sheets at its full face value of $57.0 million and $32.2 million as of December 30, 2008 and December 29, 2009, respectively. This balance represents the total required future cash payment. The current fair value of the Series Z, which was determined by using the remaining term of the Series Z and the effective dividend rate from the Certificate of Designation, is estimated to be $54.7 million and $31.0 million as of December 30, 2008 and December 29, 2009, respectively.

Concentrations of Risk

We purchase a majority of our frozen bagel dough from a single supplier who utilizes our proprietary processes and on whom we are dependent in the short-term. Additionally, we purchase all of our cream cheese

 

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from a single source. Historically, we have not experienced significant difficulties with our suppliers but our reliance on a limited number of suppliers subject 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 develop a strong brand identity and a loyal consumer base.

Advertising Costs

We expense advertising costs as incurred. Advertising costs were $3.3 million, $2.3 million, and $4.6 million for the fiscal years ended 2007, 2008 and 2009, respectively, and are included in restaurant costs of sales in the consolidated statements of operations.

Company Operations and Segments

We operate three business segments: company-owned restaurants, manufacturing and commissaries and franchising and licensing. Our corporate support unit facilitates all of our company-owned restaurants, the manufacturing facility and commissaries, supports our franchisees and licensees and handles general corporate governance. The company-owned restaurants segment includes our Einstein Bros. and Noah’s brands, which have similar investment criteria and economic and operating characteristics. The manufacturing segment produces and distributes bagel dough and other products to our restaurants, licensees, franchisees and other third parties. Inter-company sales to our company-owned restaurants have been eliminated during consolidation. The franchise and license segment earns royalties and other fees from the use of trademarks and operating systems developed for the Manhattan Bagel, Einstein Bros. and Noah’s brands.

Information regarding revenue and costs of sales for each of our business segments has been reported in the consolidated statements of operations for the years ended January 1, 2008, December 30, 2008 and December 29, 2009. Our president and the senior management team manages our business and allocates resources via a combination of restaurant sales reports and gross profit information related to our three sources of revenue, which are presented in their entirety within the consolidated statements of operations. While we do review balance sheet and other asset information on a consolidated basis, we do not review it on a business segment basis as we base our resource allocation decisions on sales and gross profit information. Due to the immateriality of all other financial information in relation to the restaurant segment, including but not limited to assets, capital expenditures, depreciation and amortization and general and administrative expenses, our senior management does not regularly review any additional information for purposes of making decisions about allocating resources and assessing performance for each business segment.

Our manufacturing operations, which includes our bagel dough manufacturing facility and our United States Department of Agriculture inspected commissaries, are ancillary and support our restaurant operations through the production and distribution of bagel dough and other products to our restaurants, licensees, franchisees and other third parties. These operations reduce costs via vertical integration, enable us to control the quality and consistency of ingredients delivered to our restaurants, manage inventory levels and expose our brands to new product channels. Although the primary focus of our manufacturing and commissary operations is to produce and distribute products to our restaurants, our third party revenues have increased over time. The overall results of operations of our manufacturing operations historically have not and currently do not have a material impact on our operating profit. We report the results of our manufacturing segment associated with third party sales separately on our consolidated statements of operations. The product costs associated with internal “sales” to our restaurants are included in restaurant costs.

 

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Our franchise and license operations complement our restaurant operations by expanding the awareness of our brands. We report royalties and other fees earned from the use of trademarks and operating systems developed for the Manhattan Bagel, Einstein Bros. and Noah’s brands separately on our consolidated statements of operations. The overall results of operations of our franchise and license operations historically have not and currently do not have a material impact on our operating profit.

Net Income per Common 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 summarizes the weighted-average number of common shares outstanding, as well as sets forth the computation of basic and diluted net income per common share for the periods:

 

     52 weeks ended
     January 1,
2008
   December 30,
2008
   December 29,
2009
     (in thousands, except earnings per share and related
share information)

Net income (a)

   $ 12,586    $ 21,077    $ 71,995
                    

Basic weighted average shares outstanding (b)

     13,497,841      15,934,796      16,175,391

Dilutive effect of stock options and SARs

     737,784      444,169      351,478
                    

Diluted weighted average shares outstanding (c)

     14,235,625      16,378,965      16,526,869
                    

Basic earnings per share (a)/(b)

   $ 0.93    $ 1.32    $ 4.45
                    

Diluted earnings per share (a)/(c)

   $ 0.88    $ 1.29    $ 4.36
                    

Anti-dilutive stock options and SARs

     293,898      262,414      407,539
                    

Stock-Based Compensation

Our stock-based compensation cost for the years ended January 1, 2008, December 30, 2008 and December 29, 2009 was $1.7 million, $0.9 million and $0.9 million, respectively, and has been included in general and administrative expenses. No tax benefits were recognized for these costs due to our cumulative losses. Included in the cost for the year ended January 1, 2008 was approximately $0.7 million of expense from the options granted related to the secondary public offering as further described in Note 11.

 

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

 

     January 1,
2008
   December 30,
2008
   December 29,
2009

Expected life of options and SARs from date of grant

   4.0 years    3.25 - 6.0 years    2.75 - 6.0 years

Risk-free interest rate

   3.31 - 5.02%    1.30 - 2.92%    1.13 - 2.80%

Volatility

   29.0% - 97.0%    31.0% - 38.0%    40.0% - 42.0%

Assumed dividend yield

   0.0%    0.0%    0.0%

The expected term of options is based upon evaluations of historical and expected future exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life at the grant date. Prior to the secondary offering that was completed in June of 2007, our implied volatility was based on the mean reverting average of our stock’s historical volatility. Our implied volatility is now 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 paid any dividends and are precluded from doing so under our debt covenants.

As of December 29, 2009, we have approximately $0.8 million of total unrecognized compensation cost related to non-vested awards granted under our option and SARs plans, which we expect to recognize over a weighted-average period of 1.45 years. As of December 29, 2009, we have approximately $0.2 million of total unrecognized compensation cost related to our restricted stock plan, which we expect to recognize over a weighted-average period of 1.56 years.

Recent Accounting Pronouncements

In April 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 165, Subsequent Events (“SFAS No. 165”) codified as FASB Accounting Standards Codification Topic 855 (“ASC 855”). ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. We adopted SFAS No. 165 for the quarter ending June 30, 2009. Adoption did not have a material impact on our consolidated financial statements.

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 168”), which identifies the FASB Accounting Standards Codification as the authoritative source of generally accepted accounting principles in the United States. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under federal securities laws are also sources of authoritative generally accepted accounting principles for SEC registrants. SFAS No. 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. Adoption did not have a material impact on our consolidated financial statements.

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.

 

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3. 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 as of:

 

     December 30,
2008
   December 29,
2009
     (in thousands of dollars)

Finished goods

   $ 4,067    $ 4,100

Raw materials

     1,223      1,413
             

Total inventories

   $ 5,290    $ 5,513
             

 

4. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of the following as of:

 

     December 30,
2008
   December 29,
2009
     (in thousands of dollars)

Leasehold improvements

   $ 90,723    $ 98,112

Store and manufacturing equipment

     77,045      82,143

Furniture and fixtures

     1,493      1,323

Office and computer equipment

     16,523      17,998

Vehicles

     41      41
             

Property, plant and equipment

     185,825      199,617

Less accumulated depreciation

     126,078      140,935
             

Property, plant and equipment, net

   $ 59,747    $ 58,682
             

Included in our operating expenses is depreciation expense, which was $11.2 million, $14.1 million and $16.6 million for the fiscal years ended 2007, 2008 and 2009, respectively. There is no depreciation expense included in our cost of sales.

 

5. GOODWILL, TRADEMARKS AND OTHER INTANGIBLES

Our goodwill was $5.0 million for both fiscal years 2008 and 2009. Our trademarks and other intangibles consist of amortizing intangibles that have been fully amortized, and non-amortizing intangibles. Our non-amortizing intangibles were $63.8 million for both fiscal years 2008 and 2009.

 

6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities consist of the following as of:

 

     December 30,
2008
   December 29,
2009
     (in thousands of dollars)

Other accrued expenses and current liabilities

   $ 10,647    $ 9,531

Payroll and related expense

     9,913      9,488

Deferred gift card revenue

     1,415      1,377

Deferred franchise and license revenue

     185      237
             

Total accrued expenses and other current liabilities

   $ 22,160    $ 20,633
             

 

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Long-term deferred franchise and license revenue is included in other liabilities on the balance sheet and was $250,000 and $465,000 as of December 30, 2008 and December 29, 2009, respectively.

 

7. LONG-TERM DEBT

Our debt is composed of a credit facility that had an original principal amount of $90 million term loan and a $20 million revolver. We may prepay amounts outstanding under the credit facility and may terminate commitments in whole at any time without penalty or premium upon prior written notice. The credit facility has a five-year term and is secured by substantially all of our assets and guaranteed by our subsidiaries. Borrowings under this 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 December 30, 2008 and December 29, 2009, the weighted-average interest rate under the credit facility was 2.65% and 2.24%, respectively. The credit facility contains usual and customary covenants including consolidated leverage ratios, fixed charge coverage ratios, limitations on capital expenditures, etc. As of December 30, 2008 and December 29, 2009 we were in compliance with all our financial and operating covenants.

Letters of credit reduce our availability under our revolver. As of December 29, 2009, we had $7.2 million in letters of credit outstanding under this facility. The letters of credit expire on various dates during 2010, are generally 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 revolver was $12.8 million as of December 29, 2009.

The credit facility requires mandatory prepayments of:

 

   

50% of excess cash flow (as defined in the debt agreement) subject to the ability to retain at least $5 million in cash and cash equivalents;

 

   

100% of net cash proceeds of asset sales by us above a threshold and subject to the ability to reinvest under certain circumstances;

 

   

100% of net cash proceeds of any debt issued by us, subject to certain exceptions; and

 

   

50% of the net cash proceeds of any equity issued by us, subject to certain exceptions.

The credit facility contains a commitment for an incremental term loan in the aggregate amount of up to $57.0 million to be used by us, if needed, solely for the purpose of redeeming the mandatorily redeemable Series Z Preferred Stock. Availability of the incremental term loan is subject to customary borrowing conditions, including absence of any default or material adverse change, and to a requirement of successful syndication of such incremental term loan.

Debt issuance costs were capitalized as part of our credit agreement and are being amortized over a period of 5 years on a straight-line basis for the revolver and on the effective interest rate method for the term loan. In the event that the debt is retired prior to the maturity date, debt issuance costs will be expensed in the period that the debt is retired.

As of December 30, 2008 and December 29, 2009, debt issuance costs, net of amortization of approximately $2.1 million and $1.5 million, respectively, have been capitalized in other assets for the credit facility. The amortization of debt issuance costs of $0.6 million, $0.5 million and $0.6 million for the fiscal years ended 2007, 2008, and 2009, respectively, is included in interest expense in the consolidated statements of operations.

 

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In 2010, we will make a $4.3 million prepayment related to the excess cash flow provision in our debt agreement. For all subsequent years we have included the minimum contractual amounts as these future pre-payments cannot be estimated. Our obligations on our term loan for the five years following December 29, 2009 are as follows:

 

Fiscal year (in thousands of dollars):

2010

   $ 5,234

2011

   $ 1,125

2012

   $ 73,428

Thereafter

     —  
      
   $ 79,787
      

Through fiscal year 2011, payments of $225,000 are due on calendar quarter ends. However, due to the difference between our fiscal quarter ends and calendar quarter ends, there were only three payments in fiscal year ended December 30, 2008, and there are five payments scheduled for fiscal year ending 2011.

 

8. INTEREST RATE SWAP AND OTHER COMPREHENSIVE INCOME

On May 7, 2008, we entered into an interest rate swap agreement relating to our term loan for the next two years, effective August 2008. We are required to make payments based on a fixed interest rate of 3.52% calculated on an initial notional amount of $60 million. In exchange we receive interest on $60 million of notional amount at a variable rate. The variable rate interest we receive is based on the one-month London InterBank Offered Rate (“LIBOR”). The net effect of the swap is to fix the interest rate on $60 million of our First Lien Term Loan at 3.52% plus an applicable margin. As of December 30, 2008 and December 29, 2009 the weighted-average interest rate under the term loan including this swap was 4.74 and 4.71%, respectively.

The interest rate swap agreement qualifies as a cash flow hedge. The fair value of the interest rate swap agreement, which will be adjusted regularly, will be recorded in the Company’s balance sheet as an asset or liability, as necessary, with a corresponding adjustment to accumulated other comprehensive loss within stockholders’ (deficit) equity.

GAAP requires fair value measurement to be classified and disclosed in one of the following three categories:

 

   

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

 

   

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

 

   

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

The interest rate swap discussed above falls into the Level 2 category. The fair market value of the interest rate swap as of December 29, 2009 was a liability of $1.3 million, which is recorded in accrued expenses and other current liabilities on the consolidated balance sheet. As of December 30, 2008 and December 29, 2009, the unrealized (loss) gain associated with this cash flow hedging instrument is recorded in accumulated other comprehensive (loss) gain within stockholders’ (deficit) equity.

 

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Comprehensive income consisted of the following as of:

 

     52 weeks ended
     January 1,
2008
   December 30,
2008
    December 29,
2009
     (in thousands of dollars)

Net income

   $ 12,586    $ 21,077      $ 71,995

Unrealized (loss) gain on cash flow hedge

     —        (2,470     1,193
                     

Total comprehensive income

   $ 12,586    $ 18,607      $ 73,188
                     

We will reclassify any gain or loss from accumulated other comprehensive (loss) gain, net of tax, on the consolidated balance sheet to other expense/income on the consolidated statements of operations when the interest rate swap expires or at the time the we choose to terminate the swap.

 

9. MANDATORILY REDEEMABLE SERIES Z PREFERRED STOCK

In September 2003, we completed an equity recapitalization with our preferred stockholders, who held a substantial portion of our common stock. Among other things, the Halpern Denny Fund III, L.P. (“Halpern Denny”) interest in our Mandatorily Redeemable Series F Preferred Stock (“Series F”) was converted into 57,000 shares of Series Z Mandatorily Redeemable Preferred Stock (“Series Z”). The major provisions of our Series Z were as follows:

 

   

2,000,000 shares authorized;

 

   

par value of $0.001 per share;

 

   

mandatory redemption upon the earlier of (i) a merger or change of control or (ii) June 30, 2009;

 

   

shares are non-voting (except for certain limited voting rights with respect to specified events);

 

   

liquidation value is $1,000 per share;

 

   

an annual dividend rate equal to 250 basis points higher than the highest rate paid on our funded indebtedness is payable if the shares are not redeemed by the redemption date. The dividend is accrued prospectively based on the outstanding balance and is payable quarterly;

 

   

shares may be redeemed in whole or in part at an earlier date at our discretion; and

 

   

unpaid dividends accrue and must be paid as additional redemption price at the time the shares are redeemed.

The exchange of the Halpern Denny interest for Series Z resulted in a reduction of our effective dividend rate relative to that required by the Series F, and, as a result of this and other factors, we accounted for this transaction as a troubled debt restructuring. Since a portion of this exchange included the receipt of our common stock and warrants previously held by Halpern Denny, we did not recognize a gain from troubled debt restructuring. The Series Z is recorded in the accompanying consolidated balance sheets at its full face value of $57.0 million as of December 30, 2008 and $32.2 million as of December 29, 2009, which represents the total cash payable upon redemption.

 

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Notes to Consolidated Financial Statements

 

On May 28, 2009, the Company and Halpern Denny agreed that the Company will redeem shares as follows:

 

  1. $20 million to redeem 20,000 shares of Series Z on June 30, 2009 at a redemption price of $1,000 per share;

 

  2. $3 million to redeem shares of Series Z on December 31, 2009; and

 

  3. $5 million to redeem shares of Series Z on March 31, 2010.

The first payment was made on June 30, 2009, which reduced the outstanding Series Z to $37.0 million. The second and third redemption payments include additional redemption price per share based on a rate that is 250 bps higher than the highest rate paid on the Company’s funded indebtedness, as provided in the Certificate of Designations (“Certificate) for the Series Z.

In addition, the Company has agreed to redeem the remaining outstanding shares of Series Z on June 30, 2010. The Company may also increase the amount and frequency of the redemption payments at any time. Shares shall be redeemed subject to the legal availability of funds. The parties have also agreed that, if the Company completes an equity offering, the Company shall pay any proceeds of the offering, in excess of amounts payable under the credit facility, to Halpern Denny to redeem any outstanding Series Z. In addition, in the event of a merger or change of control, the outstanding Series Z shall be immediately mandatorily redeemable and the provisions of the Certificate shall control. In the event of bankruptcy, the provisions of the Certificate shall control. In exchange, Halpern Denny has agreed not to enforce certain mandatory redemption provisions of the Certificate.

On December 29, 2009, we redeemed $5.0 million of Series Z, which included the $3.0 million redemption payment that was due on December 31, 2009 plus an incremental redemption of $2.0 million. This reduced the outstanding Series Z by $4.8 million and $0.2 million was paid towards the accrued additional redemption price. As of December 29, 2009, $1.3 million of additional redemption price was included in accrued expenses and other liabilities on the balance sheet and included within interest expense on the statements of operations.

We plan to continue focusing on generating free cash flow through June 30, 2010 that would continue to build our balance of unrestricted cash. On or before June 30, 2010 we intend to either revise the letter agreement that will extend the final Series Z payment out one more year to June 30, 2011, or work with the Halpern Denny to find an alternative means to settling this obligation. In addition, to satisfy any unredeemed portion of the Series Z, we will also consider other alternatives such as issuing new capital, take on additional indebtedness, or a combination of both.

In order to increase flexibility for raising funds to redeem the Series Z, we amended our existing credit facility on May 28, 2009 to permit (i) the incurrence of subordinated debt and replacement equity in the form of another issue of mandatorily redeemable preferred stock, provided that the replacement subordinated debt and preferred stock is not payable or redeemable prior to December 31, 2012 and December 28, 2012, respectively (which is approximately six months after the due date of the credit facility), and (ii) payment of an increased additional redemption amount at a rate up to 450 bps higher than the highest rate on the our funded indebtedness for any unredeemed shares of Series Z after June 30, 2010. In addition, the amendment to the credit agreement permits commodity forward purchasing contracts in the ordinary course of business.

 

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Notes to Consolidated Financial Statements

 

10. STOCKHOLDERS’ (DEFICIT) EQUITY

Common Stock

We are authorized to issue up to 25 million shares of common stock, par value $0.001 per share. As of December 30, 2008 and December 29, 2009, there were 15,969,167 and 16,461,123 shares outstanding, respectively.

On June 13, 2007, we completed a secondary public offering of 5 million shares of common stock resulting in gross proceeds of $90 million. After stock issuance costs of $6.7 million related to the offering, we received net proceeds of $83.3 million. Our common stock is now listed on the NASDAQ Global Market under the symbol “BAGL”. We used the net proceeds from the offering to pay down our existing indebtedness.

Series A Junior Participating Preferred Stock

In June 1999, our Board of Directors (“BOD”) authorized the issuance of a Series A junior participating preferred stock in the amount of 700,000 shares. This authorization was made in accordance with the Stockholder Protection Rights Plan discussed below. There are currently no issued shares.

Stockholder Protection Rights Plan

Prior to June 2009, we maintained a Stockholder Protection Rights Plan (the “Plan”). Upon implementation of the Plan in June 1999, our BOD declared a dividend distribution of one right on each outstanding share of common stock, as well as on each share later issued. Each right would allow stockholders to buy Series A junior participating preferred stock. The rights would have become exercisable or convertible if a group or individual acquired, or announced a tender offer, of 15% or more of our common stock. If we were acquired in a merger or other business combination transaction, each right would entitle its holder to purchase a number of the acquiring company’s common shares. This Plan expired in June 2009.

 

11. STOCK OPTION AND WARRANT PLANS

1995 Directors’ Stock Option Plan

Our 1995 Directors’ Stock Option Plan (the “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 BOD terminated the authority to issue any additional options under the Directors’ Option Plan. As of December 29, 2009, options to purchase 996 shares of common stock at a weighted-average exercise price of $10.23 per share and a weighted-average remaining contractual life of 3.74 years remained outstanding under this plan.

2003 Executive Employee Incentive Plan

On November 21, 2003, our BOD adopted the Executive Employee Incentive Plan, as amended on December 19, 2003, March 1, 2005, February 28, 2007 and April 24, 2007 (the “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 BOD 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 2,000,000 shares reserved for issuance pursuant to options granted under the 2003 Plan. Options generally 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

 

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Notes to Consolidated Financial Statements

 

service period. Generally, 50% of options granted vest upon service. 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 financial performance. Options that do not vest due to the failure to achieve specific financial performance criteria are canceled. As of December 29, 2009, options to purchase approximately 71,971 shares of our common stock, which are not yet exercisable, are subject to future financial performance conditions. We recognize compensation costs for performance based options over the requisite service period when conditions for achievement become probable. For fiscal years 2008 and 2009, 73,967 and 71,901 shares, respectively, were canceled as we did not meet certain financial goals and the related compensation expense that had been recorded during the year was reversed. As of December 29, 2009, there were 503,267 shares reserved for future issuance under the 2003 Plan.

2004 Stock Option Plan for Independent Directors

On December 19, 2003, our BOD adopted the Stock Option Plan for Independent Directors, effective January 1, 2004, as amended on March 1, 2005, February 28, 2007 and May 5, 2009 (the “2004 Directors’ Plan”). Our BOD 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 holder’s consent. A total of 500,000 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 five years from the date of grant unless earlier terminated. As of December 29, 2009, there were 253,836 shares reserved for future issuance under the 2004 Directors’ Plan.

Stock Appreciation Rights Plan

On February 17, 2007, our BOD adopted the Stock Appreciation Rights Plan (the “SAR Plan”). The SAR Plan provides for granting stock appreciation rights to employees. Unless terminated sooner, the SAR Plan will terminate automatically on March 31, 2012. The BOD has the authority to amend, modify or terminate the SAR Plan, subject to any required approval by our stockholders under applicable law or upon advice of counsel, provided that, with limited exception, no modification will adversely affect outstanding rights. There are 150,000 shares issuable pursuant to stock appreciation rights under the SAR Plan.

The value of a share from which appreciation is determined is 100% of the fair market value of a share on the date of grant and will be paid in stock when they are exercised by the employee. The rights expire upon the earlier of termination date of the SAR Plan or termination of employment, and typically vest over a two-year service period, and have a contractual life of five years. Generally, 50% of rights 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 rights granted vest based on financial performance. As of December 29, 2009, rights to approximately 250 shares of our common stock, which are not yet exercisable, are subject to financial performance conditions. We will recognize compensation costs for performance based stock appreciation rights over the requisite service period when conditions for achievement become probable. For fiscal year 2008 and 2009, 21,841 and 1,561 shares, respectively, were canceled as we did not meet certain financial goals and the related compensation expense that had been recorded during the year was reversed. Rights that do not vest are forfeited and are entered back into the pool of shares to be distributed. As of December 29, 2009, there were 79,735 shares reserved for future issuance under the SAR Plan.

 

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Notes to Consolidated Financial Statements

 

Restricted Stock Plans

On May 3, 2007, the Company’s Compensation Committee had granted 7,333 shares of our common stock and 14,667 shares of restricted stock to Mr. Hood in connection with Mr. Hood’s employment as Chief Marketing Officer. The 7,333 shares of common stock awarded had no restrictions, 7,333 shares became unrestricted on the first anniversary of the grant and 7,334 shares that would have become unrestricted on the second anniversary of the date of grant, provided that Mr. Hood remained employed by the Company. On November 25, 2008, Mr. Hood was no longer employed by the Company and the remaining 7,334 shares of restricted stock were forfeited. We recognized compensation costs for these awards using a graded vesting attribution method over the requisite service period. Included in our total stock-based compensation expense for fiscal years ended 2007 and 2008, was $0.3 million and $0, respectively, related to this agreement.

On January 9, 2009, the Company’s Compensation Committee had granted 63,776 shares of restricted stock with a value of $375,000 in connection with Mr. O’Neill’s appointment as President and Chief Executive Officer. The forfeiture restrictions on 21,259 shares will lapse on the first and second anniversaries of the grant, and the forfeiture restriction on 21,258 shares will lapse on the third anniversary of the grant provided that Mr. O’Neill remains employed by the Company. We recognized compensation costs for these awards using a graded vesting attribution method over the requisite service period. Included in our total stock-based compensation expense for fiscal year ended 2009 was $0.2 million related to this agreement.

Stock Option Activity

Transactions for the 1995 Directors’ Stock Option Plan, the 2003 Plan, the 2004 Directors’ Plan and the Stock Award Plan during fiscal years ended 2007, 2008 and 2009 were as follows:

 

     Number of Options     Weighted-Average Exercise Price
     2007     2008     2009         2007            2008            2009    

Outstanding, beginning of year

   993,707      1,108,361      1,201,442      $ 3.79    $ 8.06    $ 8.04

Granted

   554,314      391,738      287,000        13.24      10.55      5.27

Exercised

   (260,392   (97,526   (427,777     3.91      4.14      4.23

Forfeited

   (179,268   (201,131   (130,288     6.48      14.92      10.98

Cancelled

   —        —        (20,000     —        —        3.40
                                      

Outstanding, ending of year

   1,108,361      1,201,442      910,377      $ 8.06    $ 8.04    $ 8.63
                                      

Exercisable and vested, end of year

   637,993      730,033      447,017      $ 4.57    $ 6.37    $ 9.35
                                      

The aggregate intrinsic value of options exercised during 2007, 2008 and 2009 was $3.4 million, $0.8 million and $3.0 million, respectively.

 

     Number
of Options
    Weighted-
Average
Grant Date
Fair Value

Non-vested shares, December 30, 2008

   471,409      $ 4.06

Granted

   287,000        2.11

Vested

   (165,480     3.31

Forfeited

   (129,569     3.16
            

Non-vested shares, December 29, 2009

   463,360      $ 2.83
            

 

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The weighted-average fair value of options granted during the years ended January 1, 2008 and December 30, 2008 was $5.39 and $3.86, respectively.

As of December 30, 2008, the weighted-average remaining life of total outstanding options, and exercisable and vested options was 5.84 years and 3.67 years, respectively, and the aggregate intrinsic value of outstanding options, and exercisable and vested options was $0.9 million and $0.8 million, respectively.

As of December 29, 2009, the weighted-average remaining life of total outstanding options, and exercisable and vested options was 7.1 years and 5.3 years, respectively, and the aggregate intrinsic value of outstanding options, and exercisable and vested options was $2.6 million and $1.2 million, respectively.

The following table summarizes information about stock options outstanding at December 29, 2009:

 

     Options Outstanding    Options Exercisable

Range of Exercise Prices

   Number of
Options
   Wt.Avg.
Exercise
Price
   Wt.Avg.
Remaining
Life (Years)
   Number
of Options
   Wt.Avg.
Exercise
Price

$0.00 - $4.00

   85,271    $ 3.68    4.18    85,271    $ 3.68

$4.01 - $8.00

   510,496      5.60    7.60    206,078      6.30

$8.01 - $15.00

   115,572      10.88    8.61    24,086      10.96

$15.01 - $20.00

   199,038      17.22    6.07    131,582      17.50
                            
   910,377    $ 8.63    7.07    447,017    $ 9.35
                            

Stock Appreciation Rights Plan Activity

Transactions for fiscal years ended 2007, 2008 and 2009 were as follows:

 

     Number of SARs     Weighted-average Exercise price
     2007     2008     2009         2007            2008            2009    

Outstanding, beginning of year

   —        76,913      46,377      $ —      $ 11.69    $ 11.78

Granted

   117,300      7,452      31,000        11.30      12.51      10.37

Exercised

   —        (388   (1,224     —        8.00      8.00

Forfeited

   (40,387   (37,600   (8,600     10.54      11.65      13.17
                                      

Outstanding, ending of year

   76,913      46,377      67,553      $ 11.69    $ 11.89    $ 11.05
                                      

Exercisable and vested, end of year

   —        19,563      34,741      $ —      $ 11.52    $ 11.53
                                      

The aggregate intrinsic value of SARs exercised during 2009 was negligible.

 

     Number
of SARs
    Weighted-
Average
Grant Date
Fair Value

Non-vested SARs, December 30, 2008

   26,814      $ 5.10

Granted

   31,000        3.25

Vested

   (19,926     5.39

Forfeited

   (5,076     3.13
            

Non-vested SARs, December 29, 2009

   32,812      $ 3.25
            

 

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The weighted-average fair value of SARs granted during the years ended January 1, 2008 and December 30, 2008 was $5.57 and $3.22, respectively.

As of December 30, 2008, the weighted-average remaining life of total outstanding SARs, and exercisable and vested SARs was 3.41 years and 3.25 years, respectively, and the aggregate intrinsic value for both the outstanding SARs, and exercisable and vested SARs was negligible.

As of December 29, 2009, the weighted-average remaining life of total outstanding SARs, and exercisable and vested SARs was 3.4 years and 2.3 years, respectively, and the aggregate intrinsic value for both the outstanding SARs, and exercisable and vested SARs was negligible.

The following table summarizes information about stock SARs outstanding at December 29, 2009:

 

     SARs Outstanding    SARs Exercisable

Range of Exercise Prices

   Number
of SARs
   Wt.Avg.
Exercise
Price
   Wt.Avg.
Remaining
Life (Years)
   Number
of SARs
   Wt.Avg.
Exercise
Price

$0.00 - $10.00

   33,101    $ 8.02    2.88    22,601    $ 7.98

$10.01 - $20.00

   33,827      13.78    3.87    11,827      17.97

$20.01 - $30.00

   625      23.70    2.86    313      23.70
                            
   67,553    $ 11.05    3.38    34,741    $ 11.53
                            

 

12. SAVINGS PLAN

We sponsor a qualified defined contribution retirement plan covering eligible employees of Einstein Noah Restaurant Group (the “401(k) Plan”). Employees, excluding officers, are eligible to participate in the 401(k) Plan if they meet certain eligibility requirements. The 401(k) Plan allows participating employees to defer the receipt of a portion of their compensation and contribute such amount to one or more investment options. We did not accrue a discretionary match for fiscal years ended 2007, 2008 or 2009. Employer contributions vest at the rate of 100% after three years of service.

We established the Einstein Noah Restaurant Group, Inc. Nonqualified Deferred Compensation Plan (the “DC Plan”) in June of 2007 for key employees, generally officers of the Company. The DC Plan allows an eligible employee to defer up to 80% of the participant’s base salary and bonus. In lieu of payments of the deferred amounts to the participant, the payments are to be invested with The Charles Schwab Trust Company under investment criteria directed by the participant.

 

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Notes to Consolidated Financial Statements

 

13. INCOME TAXES

Utilization of our net operating loss (“NOL”) carryforwards reduced our federal and state income tax liability incurred. As of December 29, 2009, we had $1.0 million of our federal and state income tax overpayments within prepaid expenses on our balance sheet. The provision for income taxes consists of the following:

 

     January 1,
2008
    December 30,
2008
    December 29,
2009
 
     (in thousands)  

Current

      

Federal

   $ 232      $ 359      $ —     

State

     222        741        198   
                        

Total current income tax provision

     454        1,100        198   
                        

Deferred

      

Federal

     4,957        9,194        808   

State

     1,132        971        6,755   
                        

Total deferred income tax benefit

     6,089        10,165        7,563   

Change in valuation allowance

     (6,089     (10,165     (60,953
                        

Total deferred income tax benefit

     —          —          (53,390
                        

Total income tax provision (benefit)

   $ 454      $ 1,100      $ (53,192
                        

We continuously assess the likelihood of realization of the benefits of our deferred tax assets. We consider many qualitative and quantitative factors, including:

 

   

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

 

   

accumulation of our income (loss) before taxes utilizing a look-back period of at least three fiscal years;

 

   

events within the restaurant industry;

 

   

the cyclical nature of our business;

 

   

the health of the economy;

 

   

our future forecasts of taxable income; and

 

   

historical trending.

In the fourth quarter of 2008, after consideration of this qualitative and quantitative data, we concluded not to reduce our valuation allowance because of the existing recessionary macroeconomic climate and the uncertainty around credit markets and consumer behavior.

In the third quarter of 2009, after again assessing the existing qualitative and quantitative data, including the wide-spread consensus that the economic climate was beginning to improve, we reduced our $65.9 million valuation allowance by $61 million to $4.9 million after consideration the following factors:

 

   

Our continued profitability through September 29, 2009 resulting in nine consecutive quarters of pretax profitability;

 

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our cumulative income before taxes of $41.5 million over the last fifteen quarters through September 29, 2009;

 

   

our cumulative income from operations of $94.7 million over the last fifteen quarters through September 29, 2009; and

 

   

the favorable ruling received from the IRS on September 24, 2009 regarding our methodology for determining ownership changes in accordance with Internal Revenue Code Section 382.

As of December 29, 2009, NOL carryforwards of $131.9 million were available to be utilized against future taxable income for years through fiscal 2029, subject in part to annual limitations and excluding approximately $12.2 million of NOL carryforwards that will expire prior to utilization. Accordingly, we have provided a full valuation allowance of $4.9 million related to this portion of our deferred tax assets. Our ability to utilize our NOLs could be further limited if we experience an “ownership change” as defined by Section 382 of the Internal Revenue Code. The occurrence of an additional ownership change would limit our ability to utilize approximately $113.4 million of our NOL carryforwards that are not currently subject to limitation, and could further limit our ability to utilize our remaining NOL carryforwards and possibly other tax attributes. Approximately $18.5 million of our NOLs are currently subject to limitation. On December 30, 2008, we filed a request with the Internal Revenue Service to review our methodology for determining ownership changes in accordance with Internal Revenue Code Section 382. On September 24, 2009, we received a favorable ruling from the IRS agreeing with our methodology.

We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority. In 2007 we reviewed our uncertain tax positions and recorded a reduction of approximately $1.8 million of the gross deferred tax asset and a corresponding reduction of the valuation allowance. There was no net effect to the financial statements and none of the unrecognized tax benefits will impact our effective tax rate in 2007. Subsequently, we completed and filed Forms 3115, Application for Change in Accounting Method. Due to this, we are highly certain that approximately $1.5 million of the unrecognized tax benefits will be realized. Additionally, we have refined our estimate of the unrecognized tax benefits related to the remaining $0.3 million.

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 2006 through 2008 and with certain state and local authorities for tax years 2005 through 2008. With a few exceptions, we are no longer subject to U.S. federal, state or local examinations by tax authorities for the tax year 2004 and prior.

 

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The amount of the deferred tax asset considered realizable could be reduced if estimates of future taxable income during the carryforward periods are reduced. As of December 29, 2009, our net operating loss carryforwards for U.S. federal income tax purposes that we expect to be utilized were subject to the following expiration schedule:

 

Net Operating Loss Carryforwards

Expiration Date

   Amount
     (in thousands of dollars)

December 31, 2012

   $ 7,528

December 31, 2018

     863

December 31, 2020

     6,810

December 31, 2021

     9,271

December 31, 2022

     35,668

December 31, 2023

     42,362

December 31, 2024

     12,023

December 31, 2025

     5,413

December 31, 2026

     4,900

December 31, 2029

     7,097
      
   $ 131,935
      

The reconciliation of income taxes calculated at the U.S. federal tax statutory rate to our effective tax rate is set forth below:

 

     January 1,
2007
    December 30,
2008
    December 29,
2009
 
     (in thousands)  

U.S. Federal statutory rate

   35.0   35.0   35.0

State income tax rate, net of Federal tax (benefit)

   8.9   6.2   4.2

Series Z additional redemption

   0.0   0.0   2.8

Other, net

   3.2   4.2   0.2

Deferred taxes related to change in tax accounting method

   18.6   0.0   0.0

Expired tax carryforwards

   8.7   0.0   0.0

Effect of change in tax rate

   -24.2   5.4   -0.9
                  
   50.2   50.8   41.3

Change in valuation allowance

   -46.7   -45.8   -324.2
                  

Effective income tax rate

   3.5   5.0   -282.9
                  

Excess tax benefits related to stock option exercises were not recorded for each of the three years ended December 29, 2009, due to our NOL carryforward position. The following represents a reconciliation of our unrecognized tax benefits for the year ended December 29, 2009:

 

     Unrecognized
tax benefits
     (in thousands)

Balance - December 30, 2008

   $ 3,384

Additions based on 2009 stock option exercises

     1,692
      

Balance - December 29, 2009

   $ 5,076
      

 

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If the $5.1 million of unrecognized tax benefits currently not recognized on our balance sheet is recognized in the future, the entire balance will impact our effective tax rate.

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.

The Company’s total deferred tax assets and liabilities are as follows:

     December 30,
2008
    December 29,
2009
 
     (in thousands)  

Deferred tax assets

   $ 67,381      $ 58,712   

Deferred tax liabilities

     (1,433     (413
                
     65,948        58,299   

Valuation allowance

     (65,948     (4,909
                

Total deferred tax assets, net

   $ —        $ 53,390   
                

Approximately $3.4 million and $5.1 million in 2008 and 2009, respectively, of the gross federal net operating losses are not included in the deferred tax asset due to the limitation regarding recognition of this tax benefit. The income tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are as follows:

 

     December 30,
2008
    December 29,
2009
 
     (in thousands)  

Current deferred tax assets and liabilities, net

    

Operating loss carryforwards

   $ —        $ 7,644   

California wage and hour settlements

     743        —     

Senior management transition costs

     326        72   

Allowances for doubtful accounts

     85        57   

Deferred revenue

     —          29   

Accrued expenses

     (404     43   
                

Total gross current deferred tax assets, net of liabilities

     750        7,845   

Valuation allowance

     (750     (661
                

Total current deferred tax assets, net

     —          7,184   

Long-term deferred tax assets and liabilities, net

    

Operating loss carryforwards, net of unrecognized tax benefits

     51,633        46,554   

§481(a) tax accounting method change

     (1,029     (413

Property, plant and equipment

     11,449        1,841   

Deferred rent

     809        498   

Stock-based compensation

     831        1,010   

Alternative minimum tax

     539        464   

Interest rate swap

     966        500   
                

Total gross long-term deferred tax assets, net of liabilities

     65,198        50,454   

Valuation allowance

     (65,198     (4,248
                

Total long-term deferred tax assets, net

     —          46,206   
                

Total deferred tax assets, net

   $ —        $ 53,390   
                

 

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EINSTEIN NOAH RESTAURANT GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

14. SUPPLEMENTAL CASH FLOW INFORMATION

 

     52 weeks ended  
     January 1,
2008
    December 30,
2008
    December 29,
2009
 
     (in thousands)  

Cash paid during the year to date period ended:

      

Interest related to:

      

Term Loans

   $ 11,111      $ 5,477      $ 3,910   

$25 Million Subordinated Note

     825        —          —     

Other

     319        226        250   

Prepayment penalty upon redemption of debt

   $ 240      $ —        $ —     

Income taxes

   $ 274      $ 1,092      $ 1,225   

Non-cash investing activities:

      

Non-cash purchase of equipment through capital leasing

   $ 24      $ 36      $ 14   

Non-cash addition of leasehold improvements provided by lessor

   $ 1,672      $ —        $ —     

Change in accrued expenses for purchases of property and equipment

   $ (2,125   $ (115   $ (295

 

15. RELATED PARTY TRANSACTIONS

E. Nelson Heumann is the chairman of our BOD and is a current employee of Greenlight. Greenlight and its affiliates beneficially own approximately 65 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 elect all of our BOD, and among other things, to determine whether a change in control of our company occurs.

We entered into the Subordinated Note with Greenlight in February 2006 and paid it in full during fiscal year 2007. The Subordinated Note had a maturity date of February 28, 2013, carried a fixed interest rate of 13.75% per annum, required 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%. Total interest expense related to the Subordinated Note with Greenlight was $1.7 million for the year ended January 1, 2008. The Note was repaid from the proceeds of our secondary offering and amended debt facility in June 2007 as further described in Note 13.

 

16. COMMITMENTS AND CONTINGENCIES

Letters of Credit and Line of Credit

As of December 29, 2009, we had $7.2 million in letters of credit outstanding. The letters of credit expire on various dates during 2010, are generally automatically renewable for one additional year and are payable upon demand in the event that we fail to pay the underlying obligation. Letters of credit reduce our availability under our revolver, which was $12.8 million as of December 29, 2009.

Capital Leases

We lease certain equipment under capital leases. Included in property, plant and equipment are the asset values of $265,000 and $98,000 and the related accumulated amortization of $194,000 and $66,000 as of December 30, 2008 and December 29, 2009, respectively. Amortization of assets under capital leases is included in depreciation and amortization expense.

 

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EINSTEIN NOAH RESTAURANT GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

Operating Leases

We lease office space, restaurant space and certain equipment under operating leases having terms that expire at various dates through the fiscal year ended 2021. Our restaurant leases have renewal clauses of 1 to 20 years at our option and, in some cases, have provisions for contingent rent based upon a percentage of gross sales, as defined in the leases. Rent expense for fiscal years ended 2007, 2008 and 2009 was $27.5 million, $29.3 million and $31.0 million, respectively. Contingent rent included in rent expense for fiscal years ended 2007, 2008 and 2009 was approximately $0.1 million, $0.1 million and $0.2 million, respectively. We sublease out a portion of our restaurant space on leases where we did not need the entire space for our operations. Our sublease income was $0.5 million for both of the fiscal years ended 2007 and 2008, and was $0.4 million for fiscal year ended 2009.

Future Minimum Lease Payments

As of December 29, 2009, future minimum lease payments under capital and operating leases were as follows:

 

Fiscal year:

   Capital
Leases
   Operating
Leases
     (in thousands of dollars)

2010

   $ 25    $ 31,283

2011

     14      26,888

2012

     3      19,238

2013

     3      14,194

2014

     —        11,261

2015 and thereafter

     —        23,958
             

Total minimum lease payments

     45    $ 126,822
         

Less imputed interest (average rate of 4.75%)

     4   
         

Present value of minimum lease payments

     41   

Less current portion of obligations under capital leases

     22   
         

Obligations under capital leases, long-term

   $ 19   
         

In addition, the total of minimum sublease rentals to be received in the future under non-cancelable subleases as of December 29, 2009 was $1.1 million.

Purchase Commitments

We have obligations with certain of our major suppliers of raw materials (primarily frozen bagel dough) for minimum purchases both in terms of quantity and pricing on an annual basis. Furthermore, from time to time, we will commit to the purchase price of certain commodities that are related to the ingredients used for the production of our bagels. On a periodic basis, we review the relationship of these purchase commitments to our business plan, general market trends and our assumptions in our operating plans. If these commitments are deemed to be in excess of the market, we will expense the excess purchase commitment to cost of sales in the period in which the shortfall is determined. The total of our future purchase obligations as of December 29, 2009 was approximately $10.1 million.

 

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EINSTEIN NOAH RESTAURANT GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

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 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 (“Fiera”) in the Superior Court of Justice of Ontario, Canada. Fiera claimed 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 sought damages of $17.0 million (Canadian) as well as interest and costs. The Company and Fiera executed and filed Minutes of Settlement with the Ontario Court to dismiss the lawsuit and through the execution of a new supply agreement have resolved their differences with regard to this matter.

 

17. SEGMENTS

Financial results for fiscal years 2007, 2008 and 2009 are as follows:

 

     Segments           
Fiscal 2007:    Company-owned
restaurants
   Manufacturing
and commissary
    Franchise
and license
   Corporate
support
    Consolidated
     (in thousands of dollars)

Revenues:

            

Company-owned restaurant sales

   $ 372,997    $ —        $ —      $ —        $ 372,997

Manufacturing and commissary revenues

     —        24,204        —        —          24,204

Franchise and license related revenues

     —        —          5,701      —          5,701
                                    

Total revenues

     372,997      24,204        5,701        402,902

Cost of sales:

            

Company-owned restaurant costs

     297,180      —          —        —          297,180

Manufacturing and commissary costs

     —        24,792        —        —          24,792

Franchise and license related costs

     —        —          —        —          —  
                                    

Total cost of sales

     297,180      24,792        —        —          321,972
                                    

Gross profit

     75,817      (588     5,701      —          80,930

Operating expenses

     —        —          —        52,664        52,664

Other expenses

     —        —          —        15,226        15,226

Provision for income taxes

     —        —          —        454        454
                                    

Net income (loss)

   $ 75,817    $ (588   $ 5,701    $ (68,344   $ 12,586
                                    

 

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EINSTEIN NOAH RESTAURANT GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

     Segments           
Fiscal 2008:    Company-owned
restaurants
   Manufacturing
and commissary
   Franchise
and license
   Corporate
support
    Consolidated
     (in thousands of dollars)

Revenues:

             

Company-owned restaurant sales

   $ 376,664    $ —      $ —      $ —        $ 376,664

Manufacturing and commissary revenues

     —        30,369      —        —          30,369

Franchise and license related revenues

     —        —        6,417      —          6,417
                                   

Total revenues

     376,664      30,369      6,417      —          413,450

Cost of sales:

             

Company-owned restaurant costs

     303,116      —        —        —          303,116

Manufacturing and commissary costs

     —        28,566      —        —          28,566

Franchise and license related costs

     —        —        —        —          —  
                                   

Total cost of sales

     303,116      28,566      —        —          331,682
                                   

Gross profit

     73,548      1,803      6,417      —          81,768

Operating expenses

     —        —        —        54,152        54,152

Other expenses

     —        —        —        5,439        5,439

Provision for income taxes

     —        —        —        1,100        1,100
                                   

Net income (loss)

   $ 73,548    $ 1,803    $ 6,417    $ (60,691   $ 21,077
                                   

 

     Segments             
Fiscal 2009:    Company-owned
restaurants
   Manufacturing
and commissary
   Franchise
and license
   Corporate
support
    Consolidated  
     (in thousands of dollars)  

Revenues:

             

Company-owned restaurant sales

   $ 370,412    $ —      $ —      $ —        $ 370,412   

Manufacturing and commissary revenues

     —        30,638      —        —          30,638   

Franchise and license related revenues

     —        —        7,512      —          7,512   
                                     

Total revenues

     370,412      30,638      7,512      —          408,562   

Cost of sales:

             

Company-owned restaurant costs

     304,257      —        —        —          304,257   

Manufacturing and commissary costs

     —        26,573      —        —          26,573   

Franchise and license related costs

     —        —        —        —          —     
                                     

Total cost of sales

     304,257      26,573      —        —          330,830   
                                     

Gross profit

     66,155      4,065      7,512      —          77,732   

Operating expenses

     —        —        —        52,815        52,815   

Other expenses

     —        —        —        6,114        6,114   

Provision (benefit) for income taxes

     —        —        —        (53,192     (53,192
                                     

Net income (loss)

   $ 66,155    $ 4,065    $ 7,512    $ (5,737   $ 71,995   
                                     

 

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EINSTEIN NOAH RESTAURANT GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

18. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following table summarizes the unaudited consolidated quarterly results of operations for fiscal years ended 2007, 2008 and 2009:

 

     Fiscal year 2007:
     1st Quarter
(13 wks)
   2nd Quarter
(13 wks)
    3rd Quarter
(13 wks)
   4th Quarter
(13 wks)
    

(in thousands, except earnings per share and

related share information)

Revenue

   $ 96,255    $ 101,055      $ 100,378    $ 105,214

Gross profit

     19,501      20,418        19,521      21,490

Income from operations

     5,958      6,743        6,806      8,759

Net income (loss) (a)

     1,132      (250     4,943      6,761

Net income (loss) per common share – Basic

   $ 0.11    $ (0.02   $ 0.31    $ 0.43

Net income (loss) per common share – Diluted

   $ 0.10    $ (0.02   $ 0.30    $ 0.41

Weighted average number of common shares outstanding:

          

Basic

     10,605,626      11,775,597        15,772,931      15,837,211
                            

Diluted

     11,136,669      11,775,597        16,572,486      16,623,629
                            

 

     Fiscal year 2008:
     1st Quarter
(13 wks)
   2nd Quarter
(13 wks)
   3rd Quarter
(13 wks)
   4th Quarter
(13 wks)
    

(in thousands, except earnings per share and

related share information)

Revenue

   $ 103,264    $ 105,414    $ 100,895    $ 103,877

Gross profit

     19,579      21,542      19,183      21,464

Income from operations

     5,563      8,540      5,997      7,516

Net income

     3,842      6,914      4,537      5,784

Net income per common share – Basic

   $ 0.24    $ 0.43    $ 0.28    $ 0.36

Net income per common share – Diluted

   $ 0.23    $ 0.42    $ 0.28    $ 0.36

Weighted average number of common shares outstanding:

           

Basic

     15,890,879      15,925,876      15,948,180      15,974,248
                           

Diluted

     16,451,556      16,398,822      16,412,748      16,179,269
                           

 

     Fiscal year 2009:
     1st Quarter
(13 wks)
   2nd Quarter
(13 wks)
   3rd Quarter
(13 wks)
   4th Quarter
(13 wks)
    

(in thousands, except earnings per share and

related share information)

Revenue

   $ 100,423    $ 104,358    $ 100,046    $ 103,735

Gross profit

   $ 16,429    $ 20,879    $ 18,627    $ 21,797

Income from operations

   $ 3,117    $ 8,015    $ 6,213    $ 7,572

Net income (b)

   $ 1,850    $ 6,466    $ 60,861    $ 2,818

Net income per common share – Basic

   $ 0.12    $ 0.40    $ 3.75    $ 0.17

Net income per common share – Diluted

   $ 0.11    $ 0.39    $ 3.65    $ 0.17

Weighted average number of common shares outstanding:

           

Basic

     16,025,935      16,047,305      16,236,271      16,392,052
                           

Diluted

     16,216,152      16,412,363      16,693,843      16,730,940
                           

 

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EINSTEIN NOAH RESTAURANT GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

 

(a) In connection with the debt redemption and our amended credit facility, we wrote off $2.1 million of debt issuance costs and $0.5 million of debt discount, and paid a redemption premium in the amount of $0.2 million during the second quarter ended 2007.
(b) In the third quarter of 2009, we reduced our $65.9 million valuation allowance by $61.0 million to $4.9 million and recorded a $56.8 deferred income tax benefit.

 

19. SUBSEQUENT EVENTS

As of January 26, 2010, the Company and Fiera resolved their differences with regard to the matter described in Note 16 by executing Minutes of Settlement that provide for dismissal of Fiera’s lawsuit in the Ontario Court, a supply agreement, and a mutual full and final release.

 

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EINSTEIN NOAH RESTAURANT GROUP, INC.

Schedule II—Valuation and Qualifying Accounts

 

     Balance at
beginning
of period
   Additions (a)    Deductions (b)     Balance
at end
of period
     (In thousands of dollars)

For the fiscal year ended January 1, 2008:

          

Allowance for doubtful accounts

   $ 505    502    (401   $ 606

Valuation allowance for deferred taxes

   $ 81,150    —      (6,089   $ 75,061

For the fiscal year ended December 30, 2008:

          

Allowance for doubtful accounts

   $ 606    157    (547   $ 216

Valuation allowance for deferred taxes

   $ 75,061    —      (9,199   $ 65,862

For the fiscal year ended December 29, 2009:

          

Allowance for doubtful accounts

   $ 216    206    (281   $ 141

Valuation allowance for deferred taxes

   $ 65,862       (60,953   $ 4,909

 

Notes:

(a) Amounts charged to costs and expenses.
(b) Bad debt write-offs and charges to reserves.

 

 

See accompanying report of independent registered public accounting firm

 

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES

None

 

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 29, 2009 pursuant to Securities Exchange Act Rule 13a-15. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded, as of December 29, 2009, that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure information required to be disclosed by us in the reports we file under the Securities Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Management’s Annual Report on Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.

As of December 29, 2009, management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 29, 2009, is effective.

Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America; receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on our financial statements.

The effectiveness of the Company’s internal control over financial reporting as of December 29, 2009 has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report dated February 25, 2010, appearing under the heading “Report of Independent Registered Public Accounting Firm,” in Part II , Item 8 of this report.

 

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Changes in Internal Control Over Financial Reporting

During the fourth quarter of 2009 no change in the Company’s internal control over financial reporting was identified in connection with this evaluation that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

None

 

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PART III

 

ITEM 10. DIRECTORS EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information relating to Directors required by Item 10 will be included in our 2010 Proxy Statement, which will be filed within 120 days after the close of the 2009 fiscal year, and is hereby incorporated by reference.

Information relating to compliance with Section 16(a) required by Item 10 will included in our 2010 Proxy Statement, which will be filed within 120 days after the close of the 2009 fiscal year, and is hereby incorporated by reference.

Information regarding executive officers is included in Part I of this Form 10-K, as permitted by General Instruction G(3).

The Company adopted a Code of Conduct applicable to its chief executive officer, chief financial officer, controller and other finance leaders, which is a “code of ethics” as defined by applicable rules of the SEC. This code is publicly available on the Company’s website. If the Company makes any amendments to this code other than technical, administrative or other non-substantive amendments, or grants any waivers, including implicit waivers, from a provision of this code to the Company’s chief executive officer, chief financial officer or controller, the Company will disclose the nature of the amendment or waiver, its effective date and to whom it applies on its website or in a report on Form 8-K filed with the SEC.

 

ITEM 11. EXECUTIVE COMPENSATION

This information will be included in our 2010 Proxy Statement, which will be filed within 120 days after the close of the 2009 fiscal year, and is hereby incorporated by reference.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

This information will be included in our 2010 Proxy Statement, which will be filed within 120 days after the close of the 2009 fiscal year, and is hereby incorporated by reference.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

This information will be included in our 2010 Proxy Statement, which will be filed within 120 days after the close of the 2009 fiscal year, and is hereby incorporated by reference.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

This information will be included in our 2010 Proxy Statement, which will be filed within 120 days after the close of the 2009 fiscal year, and is hereby incorporated by reference.

 

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PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(1) Financial Statements

See the Index to Consolidated Financial Statements included in Part II, Item 8 for a list of the financial statements included in this Form 10-K.

 

(2) Financial Statement Schedules

See the end of Part II, Item 8 for Schedule II—Valuation and Qualifying Accounts. All other financial statement schedules are omitted because they are not required or are not applicable.

 

(3) Exhibits

 

Exhibit
No.

  

Description

3.1    Restated Certificate of Incorporation (16)
3.2    Third Amended By-laws (1)
3.3    Amendments to By-laws (2)
4.2    New World Restaurant Group, Inc. Certificate of Designation, Preferences and Rights of Series Z Preferred Stock (3)
10.1    1994 Stock Plan (1)+
10.2    Directors’ Option Plan (1)+
10.3    Executive Employee Incentive Plan (4)+
10.4    Second Amendment to Executive Employee Incentive Plan (5)+
10.5    Third Amendment to the New World Restaurant Group, Inc. 2004 Executive Employee Incentive Plan (11)+
10.6    Stock Option Plan for Independent Directors (6)+
10.7    Amendment to Stock Option Plan for Independent Directors (7)+
10.8    Second Amendment to the New World Restaurant Group Inc. Stock Option Plan for (Non-Employee) Independent Directors (10)+
10.9    Approved Supplier Agreement dated as of November 30, 2006, by and among New World Restaurant Group, Inc., Einstein and Noah Corp., Manhattan Bagel Company, Inc., and Harlan Bagel Supply Company, LLC, and Harlan Bakeries, Inc. (Certain information contained in this exhibit has been omitted and filed separately with the Commission pursuant to a confidential treatment request under Rule 24b-2) (9)
10.10    Amended and Restated Credit Agreement dated June 28, 2007, among the Registrant, Bear, Stearns & Co. Inc. (“Bear Stearns”), as sole lead arranger, Wells Fargo Foothill, Inc., as administrative agent and the other lenders from time to time parties thereto (12)
10.11    New World Restaurant Group, Inc. Stock Appreciation Rights Plan (8)+
10.12    Einstein Noah Restaurant Group, Inc. Nonqualified Deferred Compensation Plan (13)+
10.13    Paul J.B. Murphy, III Executive Separation Agreement dated December 3, 2008 (14)+
10.14    Jeffrey J. O’Neill Offer of Employment dated December 3, 2008 (14)+

 

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Exhibit
No.

  

Description

10.15    James Hood Employee Separation Agreement dated February 2, 2009 (15)
10.16    James O’Reilly Offer of Employment dated March 24, 2009 (15)
10.17    Amendment No. 1 to Amended and Restated Credit Agreement (15)
10.18    Letter Agreement with Halpern Denny III L.P. regarding the Redemption of Series Z preferred stock (16)
10.19    Amendment No. 2 of Amended and Restated Credit Agreement (16)
21.1    List of Subsidiaries*
23.1    Consent of Grant Thornton LLP*
31.1    Certification of Chief Executive Officer of the Registrant pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, with respect to the Registrant’s Annual Report on Form 10-K for the year ended December 29, 2009*
31.2    Certification of Chief Financial Officer of the Registrant pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, with respect to the Registrant’s Annual Report on Form 10-K for the year ended December 29, 2009*
32.1    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act**
32.2    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act**
32.3    Certification of Principal Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act**

 

* Filed herewith.
** Furnished herewith.
+ Management contract.
(1) Incorporated by reference from Registrant’s Registration Statement on Form SB-2 (33-95764).
(2) Incorporated by reference from Registrant’s Annual Report on Form 10-K for the Fiscal Year Ended December 31, 2002, filed on May 14, 2003.
(3) Incorporated by reference from Registrant’s Schedule 14A, filed on September 10, 2003 included as schedule 1 to annex B.
(4) Incorporated by reference from Registrant’s Schedule 14A, filed on April 29, 2005 included as annex A.
(5) Incorporated by reference from Registrant’s Schedule 14A, filed on April 29, 2005 included as annex B.
(6) Incorporated by reference from Registrant’s Schedule 14A, filed on April 29, 2005 included as annex C.
(7) Incorporated by reference from Registrant’s Schedule 14A, filed on April 29, 2005 included as annex D.
(8) Incorporated by reference from Registrant’s Registration Statement on Form S-8, filed on February 20, 2007.
(9) Incorporated by reference from Registrant’s Annual Report on Form 10-K, filed on March 7, 2007.
(10) Incorporated by reference from Registrant’s Schedule 14A, filed on April 4, 2007 included as Annex B.
(11) Incorporated by reference from Registrant’s Schedule 14A, filed on April 4, 2007 included as Annex D.
(12) Incorporated by reference from Registrant’s Current Report on Form 8-K, filed on July 5, 2007.
(13) Incorporated by reference from Registrant’s Annual Report on Form 10-K for the Fiscal Year Ended January 1, 2008, filed on March 3, 2008.
(14) Incorporated by reference from Registrant’s Annual Report on Form 10-K for the Fiscal Year Ended December 30, 2008, filed on March 2, 2009.
(15) Incorporated by reference from Registrant’s Quarterly Report on Form 10-Q for the Quarterly Period Ended March 31, 2009, filed on May 7, 2009.
(16) Incorporated by reference from Registrant’s Current Report on Form 8-K dated June 2, 2009.

 

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Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    EINSTEIN NOAH RESTAURANT GROUP, INC.
Date: February 25, 2010     By:   /S/    JEFFREY J. O’NEILL         
     

Jeffrey J. O’Neill

Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on February 25, 2010.

 

Signature

  

Title

/S/    JEFFREY J. O’NEILL        

Jeffrey J. O’Neill

   President, Chief Executive Officer and Director (Principal Executive Officer)

/S/    RICHARD P. DUTKIEWICZ        

Richard P. Dutkiewicz

  

Chief Financial Officer

(Principal Financial Officer)

/S/    ROBERT E. GOWDY, JR.        

Robert E. Gowdy, Jr.

  

Controller and Chief Accounting Officer

(Principal Accounting Officer)

/S/    MICHAEL W. ARTHUR        

Michael W. Arthur

   Director

/S/    E. NELSON HEUMANN        

E. Nelson Heumann

   Director

/S/    FRANK C. MEYER        

Frank C. Meyer

   Director

/S/    S. GARRETT STONEHOUSE, JR.        

S. Garrett Stonehouse, Jr.

   Director

/S/    THOMAS J. MUELLER        

Thomas J. Mueller

   Director

 

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