Einstein Noah Restaurant (BAGL)

Einstein Noah Restaurant Group owns, and operates a chain of 617 fast-casual restaurants, specializing in a wide variety of bagels, muffins sandwiches and premium coffees for breakfast and lunch in a caf atmosphere. The chain spans 35 states and D.C., operating under three brands: Einstein Bros. Bagels (national), Noah's New York Bagels (West Coast), and Manhattan Bagel (predominately Northeast). Currently, 416 or 67% of its restaurants are company-owned (338 Einstein Bros., 76 Noah's, 1 Manhattan Bagel and 1 under non-core brands) 1 Einstein Bros. restaurant, 69 Manhattan Bagels restaurants, and 3 restaurants operated under non-core brands are franchised 125 Einstein Bros, and 3 Noah's restaurants are licensed. The company operates commissary operations, which prepare and assemble consistent, high-quality ingredients that are delivered to its restaurants and sold to third parties through its network of independent distributors.

History

A young, ex-investment banker with dreams of creating another Starbucks founded the company and began by opening New World Coffee caf in New York in 1993. Over the next couple of years, the company opened additional New World Coffee caf s in the Northeast. In February 1996, the company went public, albeit to very weak investor reception, selling $17.8 million in common and convertible preferred stock. It used the funds to continue growing rapidly, purchasing three Cooper's Coffee Bars in New York, and acquiring its coffee supplier, Willoughby's Coffee and Tea in 1996. The company became vertically integrated and a significant franchisor of bagel specialty restaurants by purchasing Manhattan Bagel in 1998, which included a bagel manufacturing facility. The nearly 300-unit Manhattan Bagel chain was purchased for just $21.8 million from creditors in bankruptcy court. The following year the company acquired Chesapeake Bagel Bakery. After completing these acquisitions, the company had roughly 340 restaurants, about 90% of which were franchises.

In 2001, the company more than doubled its size by acquiring Einstein/Noah Bagel Corp. (for $190 million), which included 461 company-owned restaurants operating under two brands Einstein Bros. and Noah's - as well as an additional bagel manufacturing facility. This series of acquisitions catapulted the company to the largest owner/operator/franchisor/licensor of bagel specialty restaurants in the United States.

Bagel Wars

During the mid-1990s, bagel cafes were a new concept to many towns and operated successfully as consumer appetite for bagels increased. Competition intensified quickly, as the concept was replicated and new bagel caf s opened. Local delis and corner stores also began to offer bagels, as did bakery caf s (Au Bon Pain, etc.) and coffee chains (Starbucks, etc.) and in late 1997, Dunkin Donuts rolled out bagels across its 2,000-store chain. As a result, Manhattan Bagel, once a favored Wall Street growth stock, filed for bankruptcy in 1997, followed by Einstein Noah in 2000.

Uncontrolled Growth, Financed by Debt

Ironically, the company followed the same ill-fated strategy that forced both Manhattan Bagel and Einstein Noah's previous owner, Boston Chicken, into bankruptcy it financed its torrid and unplanned growth with debt, even as many stores were underperforming in a fiercely competitive market. Before the company purchased Manhattan Bagel in 1998, it had fewer than 10 stores. Just three years later, after acquiring Einstein Noah in June 2001, it grew to 788. Both purchases were financed largely by debt (Einstein with short-term debt) and preferred equity. In 2002, interest expense soared to $28.5 million from $2.0 million the year before, while restaurant EBITDA was actually declining.

Is Anyone At the Wheel?

Turmoil ensued over the next couple of years. The company was delisted from the Nasdaq, primarily for failing to get proper stockholder approval for equity issuances. The SEC investigated accounting irregularities (related to its increasing rate notes, preferred stock, and warrants), 2001 financials were restated downwards, and the 2002 10-K delayed. Things came to a head when, strapped for cash, the company defaulted on a $35 million bridge loan due in June 2002. Not surprisingly, the company (then called New World Restaurant Group) replaced its CFO and forced out its founder and Chairman of the Board, Raman Kamfar. In their places, the company promoted the existing CEO, Anthony Wedo and recruited Max Craig from his post as CFO of Taco Bell (Mr. Craig died unexpectedly shortly thereafter).

Sinking under the weight of its staggering debt load, in September 2003, the company restructured its debt and equity, replacing its bridge loan with equity, extending for five years the maturity of most of the remaining debt, which was due within 12 months, and reducing its interest rates. As a result, Greenlight Capital, a private equity investor in the company, saw its stake in the company increase to 92% from 48%.

New Management Streamlines Restaurant Chain

After taking control, Greenlight appointed a new management team, which focused on closing under-performing restaurants, enhancing the company's core brands (Einstein Bros and Noah's Bagels), selling or exiting non-core concepts, such as Willoughby's and Chesapeake, improving its margins and expanding its menus. There were only two company-owned New World Coffee locations and four franchised Chesapeake locations remaining. Finally, in early 2006 as the company continued raising comps, culling unprofitable locations and expanding margins, the company refinanced its debt and in June of 2007, sold 5 million shares in a public offering.

Jettisoning a Huge Chunk of Underperforming Units

Since assuming control in September 2003, Einstein Noah's current management has closed nearly 41% of its current restaurant base because they were underperforming: 77 company-owned and 174 franchised restaurants have been closed, and management has identified roughly 15 more company-owned restaurants for closing over the next three years as their leases expire. After closing 3 underperforming company-owned restaurants in 1Q08, the company plans to close an additional 5 restaurants during the remaining year. Most of the company-owned restaurants that were closed had average unit volumes (AUVs) less than $650,000 and/or were unprofitable or marginally profitable. Some of the franchised restaurants were operating under non-core brands, Chesapeake Bagel and New World Coffee.

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