Susan Daggett - Noodles & Co. David James Boennighausen - Noodles & Co..

David E. Tarantino - Robert W. Baird & Co., Inc. John Glass - Morgan Stanley & Co. LLC Jake Rowland Bartlett - SunTrust Robinson Humphrey, Inc. Joshua C. Long - Piper Jaffray & Co. Ryan Royce - BMO Capital Markets (United States).

Good afternoon and welcome to today's Noodles & Company First Quarter 2017 Earnings Conference Call. All participants are now on a listen-only mode. After the presenters' remarks, there will be a question-and-answer session. As a reminder, this call is being recorded.

I would now like to introduce Noodles & Company's Vice President of Finance, Sue Daggett..

Thank you and good afternoon, everyone. Just wanted to apologize quickly for the late start, (00:27) was having some technical difficulties, but I think we're on track now. Welcome to our first quarter 2017 earnings call. Here with me this afternoon is Dave Boennighausen, our CFO and Interim Chief Executive Officer.

Let me start by going over a few regulatory matters. I'd like to note that during our opening remarks and in response to your questions, we may make forward-looking statements regarding future events or the future financial performance of the company.

Any such items, including our guidance about our anticipated results in 2017 and details relating to our future performance, should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Such statements are only projections and actual events or results could differ materially from those projections due to a number of risks and uncertainties.

The Safe Harbor statement in this afternoon's news release and the cautionary statement in the company's most recent Form 10-K and subsequent filings with the SEC are considered a part of this conference call, including the portions of each that set forth the risks and uncertainties related to the company's forward-looking statements.

I refer you to the documents the company files from time to time with the Securities and Exchange Commission, specifically the company's Annual Report on Form 10-K for its 2016 fiscal year and subsequent filings we have made.

These documents contain and identify important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. Now, I would like to turn it over to Dave..

Thank you, Sue, and hello everyone. Earlier this afternoon, we reported Q1 2017 financial results including an adjusted net loss of $2.5 million and adjusted EBITDA of $3.8 million. Total revenue was $116.7 million, a modest increase over the prior year.

During the first quarter, we completed two important steps that will allow us to sharpen our focus on improving the performance and profitability of our go-forward portfolio. First, the company completed private placements with L Catterton and Mill Road Capital, resulting in $50 million of gross proceeds.

These investments are from firms with strong records in the consumer space and validate the potential of the brand and our strategic direction as we execute our transformation plan through the balance of 2017 and beyond.

Using a portion of these investments, we also completed our second important step, the closing of 55 underperforming restaurants that have been a persistent burden on the company's human and financial capital. 39 restaurants closed on the first day of March, while the remaining 16 closed as of the last day of Q1.

Consequently, our results are burdened by these underperforming restaurants for the vast majority of the quarter, negatively impacting restaurant-level contribution by $1.6 million and restaurant-level margin by approximately 210 basis points.

We also recorded $19.9 million in charges related to these closures during the quarter, primarily related to the anticipated cost of lease extinguishment, broker fees and severance paid to team members.

Returning to Q1's performance, comparable sales declined 2% system-wide comprised of 2.5% decline at company-owned restaurants, offset by a 1.1% increase at franchise locations. The comparable sales decline in company restaurants included a 3.6% decline in traffic, offset by a 1.1% increase in average check.

Although our traffic did decline relative to last year, it has been a challenging industry environment and the company continued to outperform the Black Box fast casual traffic index by over 200 basis points during the first quarter.

As for the cadence of comparable sales results, we did see some softness during the last portion of the first quarter and throughout the month of April, which coincided with the lapping of the prior year's modest price increase and a negative Easter shift.

As a result of the softness in April, we currently anticipate low-to-mid single-digit negative company-owned comparable restaurant sales for the second quarter. However, we have seen improvements in our comparable sales, thus far in May and anticipate full-year, low-single digit negative company comparable restaurant sales.

To build sales momentum, we're pursuing several key initiatives surrounding our menu, brand activation, operational execution and the off-premise dining occasion.

During the first week in May, we launched the return of our popular Pasta Fresca, which had been a guest favorite and was removed a couple of years ago creating a gap in our menu for a light Mediterranean dish. At the same time, we also implemented a revised pricing structure, which has been in test in recent months.

This structure, which incorporates about 2% of price increase makes it easier for our guest to understand our menu, better defines our pricing around proteins and specifically calls out our vegetarian, low-calorie, and gluten-free options.

Although very early, we are seeing nice preliminary improvements in our results since the launch of these menu initiatives.

We will continue to activate the Noodles brand through product launches around our core strengths, but at the same time, we also continue to believe there is great opportunity to better communicate our World Kitchen positioning to our guests.

We are in the early stages of this initiative, as we first needed to shore up our balance sheet and address under-performing restaurants.

With that now behind us, later this year we intend to improve communication inside the four walls supported by media in select markets to better develop the emotional connections necessary to compete in today's environment.

While we invest in better articulating our brand to guests, we also see continued opportunity to sharpen our operational execution. As you probably noticed, our franchise locations have consistently outperformed the company in comparable restaurant sales during recent quarters, including a 360-basis-point gap during this first quarter.

The franchise community has been able to move more quickly to execute on our initiatives and drive operational excellence in the restaurants. Moreover, the franchise teams have not encountered as many challenges with turnover during 2016 as we did on the company side.

Historically, we have seen a clear path from improved people metrics to operational improvements, which in turn have led to improved guest satisfaction and ultimately sales increases. Our turnover has continued to improve both at the manager and team level, and is now below industry averages.

We have also seen our guest satisfaction scores continue to rise well above our performance from 2016. Consequently, we believe the work over the past several months to streamline our menu and simplify operations has set a solid foundation.

However, to drive better performance long-term, we also feel it is important to allocate additional resources throughout our multi-unit management ranks. We believe the recent organizational restructuring will allow us to improve those spans of controls without any net increase in our G&A expenses.

The capital infusion that we completed during the first quarter, also allows us to execute on several initiatives that we feel will continue to drive operational excellence.

As an example, we will now be moving quickly to implement guest bussing stations in all of our restaurants, which we are confident will improve cleanliness, guest engagement and team member execution. We anticipate rolling guest bussing stations to all company-owned restaurants by the end of 2017.

Finally, we also see an opportunity to drive sales momentum by improving our off-premise sales platform. During the first quarter, our overall off-premise sales increased to 46% of total sales, an increase of 240 basis points from prior year and easily our highest mark ever.

The lion's share of this 240-basis-point increase came from online ordering, which increased 220 basis points to 8% of total sales.

We believe that our price point and menu, which is centered around Italian, American, and Asian flavor profiles, are particularly relevant to the off-premise occasion and we will begin investing more in technology and processes to allow us to capitalize on this opportunity.

This includes delivery, which continues to be in just over 10% of our locations. We are moving closer to finalizing additional partnerships with third-party providers to expand our delivery program to more areas of the country. Our efforts to make it easier to be a guest will be supported by our NoodlesREWARDS Program.

This program is in 50 restaurants currently and we have been very pleased by the impact that it is having on frequency as well as our ability to better use data to more effectively communicate with our guests. We anticipate that NoodlesREWARDS will be rolled out throughout much of the country by the fall of 2017.

While we are taking a multi-layered approach to building sales momentum, we also know there remains opportunity to improve labor efficiency. We believe there are several areas of inefficiencies in our menu execution that can be addressed by revisiting all of our processes, equipment and methodologies.

While it is much too early to assign an anticipated labor savings that can be accomplished by this transformation, we believe it can meaningfully improve our labor cost structure, improve the consistency of our execution and improve our throughput as well.

We anticipate the hiring of a third-party to assist us in this initiative to help us realize an attractive and swift return on investment. Let me also provide an update on development. We continue to anticipate 14 to 17 new restaurants system-wide in 2017, 11 of which have already opened.

While we do not anticipate any significant ramp-up in our development pipeline, encouragingly we have seen very strong performance from our restaurants that have thus far opened in 2017.

Year-to-date, their sales performance has been over 120% of the company average, well above where prior classes had been performing during their initial months of operations. We also continue to be in the process of refranchising certain company-owned markets.

These are specific markets in which we have begun building infrastructure and attained modest success in building brand awareness, but we feel they will be able to flourish and grow under franchise ownership that's able to provide greater focus on their success.

The Cypress Group is assisting us in these refranchising efforts and we will keep you updated as they progress. This afternoon we also revised our full year 2017 guidance, which reflects recent trends and the completion of the 55 restaurant closures.

This revised guidance includes total revenue of $458 million to $468 million, a company-owned comparable restaurant sales decline of low single digits, restaurant-level contribution margin of 13.5% to 14.5%, adjusted EBITDA of $31 million to $35 million, approximately flat adjusted net income and capital expenditures of $21 million to $25 million.

Before we open it up for questions, I'd like to reiterate my confidence in the brand and the direction that we are taking to meaningfully improve our performance.

The events of the first quarter, in particular, the closure of underperforming restaurants and the raising of significant capital were important and necessary steps to solidify the foundation of the company. We are now focused solely on executing on our initiatives, which we believe will drive increased shareholder value for years to come.

Thank you very much for your time today. And now, we'd like to turn it over to any questions you may have. Skylar, can you please open the lines for Q&A..

Yes, sir. And our first question comes from David Tarantino with Baird. Your line is now open..

Hi. Thank you. Good afternoon. Dave, to ask the first question on the recent trends you've been seeing, it seems like March and April combined have been fairly weak and I was just wondering if you could maybe elaborate on what your thoughts are and why you're seeing that weakness.

I guess we're not seeing that more broadly? And then I have a follow-up related to the outlook?.

Sure. So, on the first question, so specific to us, I think, some of the things that were unique in April. The way the timing worked out in terms of menu rollouts, we ultimately did not have price in our system in the back half of March as well as throughout the month of April. So, that was one factor that was a little bit more specific to us.

The second thing is we're still overlapping quite a bit of discount and promotional activity, which we should get through the end of that, as you get through Q2 we should start having the completion of the lap of kind of the heavy promotion that we'd done the prior year.

Taking away those two factors, ultimately traffic was actually pretty consistent between the first part of Q1 and then at the end of March and April..

Got it. That's helpful. And then, I guess on the outlook, Dave, I know, once you get past some of these issues you just mentioned, I guess there is line of sight to getting better related to that. But what's needed I guess in the second half of the year to get to your guidance? I know low-single-digits could be a pretty wide range of outcome.

So I guess how are you thinking about the second half of this year relative to the first half?.

We feel pretty comfortable as the comparisons start getting better and ultimately our same-store sales trends have been pretty consistent when you look at throughout 2016 and through the first part of 2017.

Despite the fact that we've been overlapping a significant amount of discounting media, from a marketing perspective, our market expense was 1% of sales in Q1 relative to 1.5% the year prior.

As I look forward, I think we'll be able to reap the benefits of all of the operational and people improvements that we've seen during the past six months, we will be doing some select media in some of our markets.

So, I feel actually pretty comfortable especially as you execute the loyalty rewards program that will continue to get an upswing that we've seen in this most recent week or two..

Got it.

And then Dave, did you mention how much pricing you'll have for the remainder of the year?.

So this particular quarter will be weighted average of around 1.5%, and then we should be at about 2% through the balance of the year..

Okay, great. And then last one is on the guest bussing initiative or the roll out of that, that seems like a pretty meaningful change especially in markets where you've done very well historically.

So, perhaps can you share some insights on what you've learned as you've tested that and sort of talk about the risks of going that route versus your current model?.

Yeah. Especially for those that maybe aren't as familiar with the brand, since our genesis, we have bussed our guest tables and since I started here at Noodles & Co.

about 13 years ago, even then the number one consumer complaint was un-bussed tables and the reality is even when we had good teams that were executing well, if you happen to have three or four tables leave at the same time, our restaurants would have the appearance of being dirty and what you also saw was our team members, when they buss tables having to take all of those steps to go from the front of the house, back to the dish area and back to the front of the house meant that it was more difficult to do a few things.

First, keep the restaurants clean and keep the tables clean. Second, they actually had more difficulty in actually engaging with the guests because they had to move so quickly back and forth and there were so many steps associated with it.

And when you look at the guest bussing stations that we've been testing, which has been in legacy markets as well as newer markets, what we see is a significant uptick almost immediately in the cleanliness scores because our teams are able to – they're still out there bussing the tables that are un-bussed, which you certainly see in some of the legacy markets.

But even in those situations, David, there're only walking handful of steps to the bus station to drop it off, versus having to go all the way to the back of the house.

So, it's not necessarily that we are eliminating bussing entirely but we're making it much more efficient and much easier for our team members to keep the restaurants clean as well as actually engage the guest..

Great. Thank you very much..

And our next question comes from John Glass of Morgan Stanley. Your line is now open..

Hi. Thank you. Dave, just first on the first quarter you just reported, I think you had said in the fourth quarter call, $4 million in EBITDA and you came in a little under $3 million, around $3 million and it looked like comps were kind of where they were running when you gave the guidance and I think your margins were kind of on target.

Just remind us or help us what was the difference then?.

I'm sorry. I misunderstood the question..

You guided to, I think, $4 million of EBITDA in the first quarter, and you reported $3 million, right?.

Yeah. I believe it was $3.8 million. So, it's right on the – really close towards it. Ultimately, we did see some more softness in March than we had anticipated. So, that was the major variable..

Got it. Okay. And then, can you just bridge the gap between your previous guidance and your current guidance. And I understand comps are weaker, maybe that influences margins. But you did get your store closures done earlier, so maybe that's a positive.

What are the puts and takes just to get you to the new EBITDA guidance and margin guidance versus the prior?.

Yeah. Absolutely. The major benefit would be the completion of the balance of the closures, which was not incorporated in our original guidance. What was changed was, as we looked at the softness that we had in March and throughout April, we did drop the same store sales guidance, which I believe was flat to slightly negative.

And so, that was probably the biggest negative, if you will, from guidance from last quarter to this quarter..

Okay.

And then, what do you owe the new store openings being so strong to, is it the location specifically, is there a new format? What are the factors you think that have driven the new store productivity up so much better than it's been in the past?.

Sure. So I think, we have executed World Kitchen signage better in newer restaurants, which I think has been a factor. Also, when you at look our growth in the past couple of years, John, obviously you know it's been at 40 and 50 restaurants.

What we did is we narrowed down the pipeline for 2017, is we culled it in a way that we made sure that we had just the highest amount of discipline that we could on the real estate selection. So I do think you have ultimately better criteria, better discipline of the restaurants that we are opening thus far in 2017 or have opened.

And then from a training perspective, all of the benefits that we have from streamlining the menu, probably play into the new restaurants more than they do to the existing restaurants.

Because what ultimately happened over time when we look back at the last several years is as we're adding incremental changes to the menu, incremental things for our operations teams, those 10-year teams were able to pick-up on them relatively quickly.

But as you got to newer restaurants just the sheer number of menu items that they had to learn relative to what they have to learn now, which is considerably more streamlined, I think we are seeing better execution in those restaurants, which we see in the results, not just from the sales perspective, but also in our guest satisfaction scores and the operational metrics.

So when all is said and done, I think it's a combination of improved real estate screens, some better execution of our signage as well as just better training in operations and execution..

And then just lastly, I know you didn't want to talk about maybe what you can save in labor, some of the new initiatives you were talking about.

But is there a way to frame in the intermediate term what your target might be for store level margins out the next couple of years assuming, let's assume comps are positive, right, so if we avoid the scenario where comps are negative, but slightly positive or low-single digit positive comps, is it a mid-teens margin or high-teen, do you have any sense now just directionally where you think you could be in say 18 months?.

So, I think, so as a remainder the guidance for this year is between 13.5% to 14.5% and only a few years ago, our concept was running contribution close to 20%. We certainly feel there is the opportunity to do so as we eliminate the underperforming restaurants and do some labor initiatives and start ultimately building average unit volumes.

That said, it is not something that's going to happen overnight. We do need to look at the labor processes across the board at our kitchen equipment, et cetera.

How we are approaching it from the labor perspective, is we do believe from our own internal team that we could pick up between three and five hours of labor per day starting in potentially Q3 and Q4, we've actually already got a couple in place here in May.

You can start doing the math from that, based on roughly $10 or $11 average hourly rate, but the real win and the real opportunity that we see is probably something that's farther out.

It's not going to be in the back half of 2017, but it's revisiting, doing the heavy engineering work, industrial engineering, the time and motion studies to re-imagine how we can approach just the labor profile.

I think that's something that we're just way too early in the process in order to identify what those savings could be, but we think it's probably some type of multiple off of what our initial targets are..

Got it. Okay. Thank you..

And our next question comes from Jake Bartlett with SunTrust. Your line is now open..

Great. Thanks for taking the question.

Building on the last question about margins, understand the impact of closing these underperforming units, but how much had the new unit growth been hurting, been pressuring margins, I imagine just that alone should enable you to expand your margins, maybe we can frame both of those two impacts and I understand maybe they overlap a little bit, given that these were – the ones you're closing are some of the newer units, but if you can go into that, that would be helpful..

Yeah. Yeah. It's a great question, Jake, it's not something we've quantified very recently because as you said there is significant amount of overlap there.

The traditional trajectory that we've seen in our restaurants has been that the first two years or so, the restaurants tend to run at 85% to 90% of company average and tend to have restaurant level margins in the low double digits and then you move from there.

And what that has typically done is negatively hurt our comparable restaurant sales by roughly – averaging of volumes by roughly 50 basis points and our margin is a little bit less than that. So in the neighborhood of 50 basis points, maybe a touch lower.

So there will be some benefit from that, but it's probably somewhat modest compared with the benefit of the closures as well as the labor efficiency opportunities that we see..

Okay.

And then just to clarify, it looks like – were there three franchise store closures in the quarter?.

There were three franchise locations that closed. They were in the Long Island area..

Is that something that we should expect to continue kind of in keeping with what the company is going through right now?.

I don't believe so. I think that overall we have a very strong franchise base as you've seen their momentum relative to ours. They have maintained and been pretty well above the industry average. So, I think you might see one or two, but I don't think you will see any wholesale changes..

Okay.

And then as you think about the prospect of refranchising some units, can you give us a sense, is there any way you can kind of give us a scale as to how extensive that would be, whether it's 20% of the system or more or less, just to kind of give us an idea of what this could look like?.

I don't want to assign necessarily a percentage to it because we're still having discussions on that and I will tell you that, we as a company see tremendous upside now as we focus more on executing on our initiatives and so, we want to make sure that we're able to realize a lot of those from the company-owned restaurants.

That said, we certainly still see markets where we believe there is a lot of tremendous potential and that they're going to do incredibly well, potentially another franchise ownership, expect that that process will be lengthy. And you'll probably not see much refranchising activity for us until Q3 and into Q4 and then throughout 2018.

Hard to peg a specific number on it, but if right now, you could think of maybe a ballpark of 10% of restaurants for the near- to medium-term shifting from company to franchise ownership..

Okay. Thank you very much. I appreciate it..

And our next question comes from Joshua Long with Piper Jaffray. Your line is now open..

Great. Thanks for taking my question. You touched on it a little bit, Dave, but I wanted to get a better sense of the timing around some of those labor initiatives. It seems like some of those – maybe hourly savings, that's three to five hours that you might be able to pull out could come in around 3Q, 4Q.

But just curious about some of the other moving pieces that either – the kind of impact, just the timing and the ability to roll some of those things out over the course of the year..

Sure. So, as a management team, we believe it's important that when you look at labor, you're able to quantify specifically to the teams, here is where those labor savings are coming from.

So, as an example, two items that we've changed as we went into this rollout this past week was introducing a chopper to help us, where we had been cutting everything by hand, we're still bringing produce in the same way we always had, but now, we are utilizing a chopper, which allows a much more consistent ultimate ingredient, but also makes it considerably more efficient for our teams when they're doing their prep procedures, also again to add processes around how we approach the rolling of silverware.

Those little things ultimately add up. And we feel very good that we've got two hours of savings a day coming into play here during the back half of Q2. And that as we get into Q3 and Q4, we believe we can get an additional hour to three hours depending on how some of the testing that we do ultimately plays out.

As you get beyond that, that's where we believe we need a third-party to come in and help us really do the heavy lifting to understand what are the different pieces of equipment that we can be looking at, the different flows and processes, which would have a more meaningful step change in our labor savings..

Okay. That's helpful. So, it sound like to get above that we need to do a little bit more heavy lifting, dig deeper, do some time and motion studies or things like that.

Have you identified the third-party or is that still something that's kind of in the works?.

In the works, we're pretty far along..

Understood. And then similarly, on the marketing side, it sounds like you're going to revamp or come up with a new approach to how you engage with the guest in the second half of the year.

Curious, what kind of research needs to be done or has already been done and kind of what the timing or rollout procedure of that might look like?.

Yeah, so something that we've talked about in prior quarters Josh, was we felt there was too much messaging, and that the guests ultimately were not receiving a coherent cohesive positioning of our brand. And so it was challenging for us to create the emotional connections that we needed with our guests.

And I think, ultimately when you look at our restaurants today, there's a lot of great stuff there. But at the same time we don't think it necessarily has the emotional resonance that it could.

So, we're trying to bring in a lot more of the fun and energy that has been a hallmark of this brand for so many years, and that's looking at merchandising, that's looking at all of our social media platforms and how we execute on those and as we approach media as well, I think, you'll see us have a lot more fun and energy.

Certainly, still surrounding the World Kitchen positioning, but we want to bring a little bit more excitement to that. How it will ultimately come to life, again, we'll have media in probably select markets towards the back half of this year.

I think our media spend will go up from about 1% in Q1 to probably 1.5% or so during the back half of the year, and then from a merchandising perspective, how we'll approach it is, is really test it in certain markets, make sure that we're getting the results we want to see and then expand it nationally.

More so as the kind of the normal course of business as we do menu refreshes and do merchandising refreshes..

Understood. And then more of a housekeeping item.

For 1Q, how much price did you have in place or maybe what the effective price was, it sounds like there was some mismatches year-over-year in terms of what you're promoting or how much menu price was there, but how should we think about that, the components of that average check piece for 1Q?.

So menu mix was roughly flat. So the 1.1% you saw was almost entirely price and then, most of that again was in the first half of Q1 where we were running closer to 2% before rolling off..

Understood. Thank you..

And our next question comes from Andrew Strelzik with BMO Capital Markets. Your line is now open..

Great. Thanks for taking the question. This is actually Ryan Royce on for Andrew. Just on the restaurant margin guidance, you took it down for the year. It looked like 1Q was within your expectations and now you have the additional closures that are now incorporated in the guide. I guess, what was the thought process behind lowering the guidance.

Is it really just a softer top line outlook and should we think about 1Q as the bottom for restaurant margins?.

Certainly, we would hope and expect that Q1 will be the bottom between the benefit of closures as well as the initiatives that we're working on, combine that with the fact that just seasonally Q1 is always our lowest volume and lowest margin quarter. So absolutely, we would expect that this would be the trough when it comes to margins.

And then for the change that we had in guidance, ultimately, yes, it is because of the drop that we have seen during April and just trying to make sure that we are conservative and appropriate with our sales during the balance of the year..

Great, thanks. And then you talked about the rolling out the loyalty a little broader.

I guess, can you just share some color on what you're seeing from the guests in terms of how they're responding to the loyalty program in the markets it's implemented so far?.

Sure. So, Ryan, we've been in test since about October of last year, currently in 50 restaurants. How we approach it was, first we wanted to make sure that the technology worked, that the way the programs function was how we expected, and then we wanted to make sure that we had done the right tests in terms of the different campaigns to be using.

It's a surprise and delight type program where you can specifically target users based on their purchase history as well as what their usage has been over any period of time.

So we want to see that and what we're very pleased with is very strong correlations between the restaurants that have it versus those that don't in terms of their sales performance. And within the restaurants that have the rewards program, the more guest sign-ins they're getting, the better their same store sales and overall performances as well.

I would say that these are two areas we've talked about significantly over time in terms of the opportunity in off-premise as well as the opportunity from a rewards program. Those are the ones I think we've been discussing for the last few quarters. We really wanted to get the capital raises behind us in order to execute on those items.

There is an investment that's incorporated into our guidance, that we had held off on for the loyalty program. So those are things that we're now able to execute on that we weren't necessarily able to execute on before, and that's where the consumer is going.

The consumer is certainly going towards convenience, towards speed, toward consistency, and a lot of our efforts are to make sure that we're capitalizing on our opportunities there..

Great. Thank you very much..

At this time, I'm showing no further questions. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone, have a great day..