Good afternoon and welcome to today's Noodles & Company’s Second Quarter 2019 Earnings Conference Call. All participants are now in a listen-only mode. After the presenters' remarks, there will be a question-and-answer session. As a reminder, this conference call is being recorded.

I will now introduce Noodles & Company's Chief Financial Officer, Ken Kuick..

Thank you, and good afternoon, everyone. Welcome to our second quarter 2019 earnings call. Here with me this afternoon are Paul Murphy, our Executive Chairman; and Dave Boennighausen, our Chief Executive Officer. I would like to start by going over a few regulatory matters.

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 2019 and details relating to our future performance should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act.

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 Annual Report on Form 10-K for its 2018 fiscal year 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 2018’s 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. During the call, we will discuss non-GAAP measures, which we believe can be useful in evaluating the company's operating performance.

These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measures is available in our second quarter 2019 earnings release and our supplemental information.

Now, I would like to turn it over to Paul Murphy, our Executive Chairman..

Thanks Ken and good afternoon everyone. Over the past several quarters, we have laid out the company's strategy to deliver top-tier sustainable growth at the top and bottom lines.

As we continue to make progress against our initiatives, we're extremely pleased with our Q2 results, which was our 5th consecutive quarter of positive same-store sales highlighted by 4.8% company-wide comparable sales growth, two-year growth of 9.8% and restaurant-level margin expansion of 160 basis points to 17.1%.

As we discussed in prior earnings calls, we firmly believe that Noodles & Company has the inherent strengths necessary to become one of the premier growth concepts in the restaurant industry.

Our unique noodle and pasta based menu delivers flavors from throughout the world and varieties spanning from our famous Mac & Cheese to our healthy zucchini dishes.

Additionally, the brand is uniquely positioned to meet the increasing consumer demand for convenience, as our food travels well and meets the variety, speed and price point necessary to compete favorably for the off-premise occasion.

As we transition to the next phase of our strategy, including the incorporation of meaningful unit growth, we're convinced that the brand is positioned well from a consumer, people and operating model perspective.

While we continue to remain focused on expanding top and bottom-line results at our existing restaurants, we also see significant potential to expand the brand in a disciplined manner that will provide sustainable long-term shareholder value creation.

I am proud of our 10,000 team members nation-wide who continue to provide outstanding guest experiences day-in and day-out. It has helped us deliver another quarter of strong financial performance. I will now turn it over to Dave to provide more details on our Q2 results and current initiatives. .

Thank you, Paul. We're very pleased with our second quarter financial performance as the company continues to deliver top-tier results, executing on the strategic initiatives that we have discussed over the past several quarters. As Paul noted, the second quarter was highlighted by strong top-line growth and margin expansion.

In fact, our 2Q results reflected our best two year stack comparable sales growth in six years and our strongest quarterly restaurant-level margin since the second quarter of 2015.

Our performance in the second quarter benefited from our continued culinary innovation, investment in the off-premise occasion, and further execution of our operational and people initiatives. From a culinary perspective, we continue to better define how guest can access Noodles & Company, regardless of their dietary preferences.

Choice has always been a great strength of the brand. And we continue to innovate ways that allow guest to enjoy the world flavors they know and love, as well as discover new ones with all the benefits of healthier noodle options.

As we discussed, the introduction of zucchini noodles last year removed the major obstacle to the brand, by providing a low-carb gluten-free noodle alternative to our guest. We continue to innovate around plant-based menu options, and we anticipate launching a cauliflower infused rigatoni dish system-wide in late September of this year.

Like the Zoodle, our cauliflower infused rigatoni has tremendous versatility as a substitute in all of our dishes.

In addition to a more healthful alternative for adults, we're also excited to offer parents the opportunity to bring vegetables into their kids’ diet without sacrificing the flavors for the pickiest of kids who have come to love from Noodles & Company.

As we increase the variety of our core menu, we also continue to provide multiple avenues for our guests to access the brand, building our off-premise business to meet the increasing need for convenience in today's consumer.

Off-premise sales again represented more than half of our total sales and increased 500 basis points over last year to 56% of sales. Growth was led by digital ordering which inclusive of delivery grew 47% year-over-year during the second quarter, and represented 22% of total sales.

While we are excited about our growth in digital sales to-date, we still believe there's a significant opportunity to simplify the digital experience, as well as better communicate the brand to existing and potential guests alike.

Concurrent with our launch of cauliflower infused noodles at the end of September, we will also be relaunching our entire digital platform, including our app, online ordering experience and our rewards program.

Both the app and online ordering improvements will significantly reduce friction for our guests, particularly surrounding their ability to customize their meal to meet their individual preferences.

Meanwhile, we'll be moving from our current surprise-and-delight rewards program to a new rewards program that will incorporate not just surprise-and-delight capabilities, but will also provide a point-and-share system to better reward our guests and allow for more customized customer engagement.

We believe our new rewards program and digital capabilities will transform our ability to communicate with guests from a marketing perspective in a more personalized, targeted and relationship driven manner. As our core off-premise continues to grow, we also still see significant runway in the delivery and catering opportunity.

Delivery grew to 6.6% of sales during the second quarter. And we will soon begin testing a third-party delivery direct from the Noodles & Company website and app, allowing us to better engage with guests, as well as mitigate the cost pressures that come with delivery.

Concerning catering, which still accounts for less than 2% of total sales, we remain on track to re-launch our program during 2020, which we believe will add to our ability to deliver long-term sustained growth.

As our initiatives continue to drive our best performance in years from a comparable sales and restaurant-level margin perspective, I would like to take a bit of time to discuss our increased confidence in the company's ability to successfully expand our unit count.

We are working diligently on our restaurant pipeline, anticipate six new restaurants to open system-wide during the back half of 2019, including five company and one franchise location. Two of the five company restaurants have opened thus far in Q3, with an additional opening occurring tomorrow.

As we were targeting the growth, I would like to discuss a few aspects of our strategy. Linear growth targets, our approach to the operating model, and finally, our thoughts on franchising.

From a growth target perspective, as we've mentioned in the past, we're targeting 5% unit growth system-wide beginning in 2021 with potential acceleration to roughly 7% unit growth at some point in the years beyond.

Our approach will be disciplined factoring in strict site and economic characteristics, as well as ensuring that our people pipeline is robust enough to support the unit expansion and provide operational fulfillment of the brand promise.

As to the operating model for new restaurants, we have already begun incorporating pickup windows into the majority of our new restaurants, and continue to target small square footage units to reflect the evolution of overall guest preference towards the off-premise occasion.

Additionally, we've completed the first stage of our efforts to optimize our equipment package and operating processes. We expect these changes will yield improvements to labor efficiency, throughput and food quality, while also putting the flexibility for future culinary innovation.

This initiative will require changes to many of our operating procedures. And as such, we anticipate rigorous testing before it gets incorporated into all of our restaurants.

While we will start testing the kitchen remodel during the fourth quarter of 2019 in existing locations, new restaurants are expected to begin seeing the new operating model in Q1 of 2020. We anticipate this project will meaningfully improve our restaurant efficiency.

But until we have thoroughly vetted each initiative in a live restaurant environment, we believe it's a bit premature to speculate as to the potential impact on unit level economics.

Additionally, we believe that utilizing a smaller square footage footprint with a more effective economic model will provide a greater opportunity for us to grow the franchising side of our business.

While we expect franchise growth to remain modest as we vet our new design, we are seeing increased appetite for growth from existing and new franchisees alike. In July, we refranchised five restaurants to a strong existing franchisee, expanding their territory and allowing the acceleration of the brand's growth in their respective market.

Additionally, we have recently finalized our first new area development agreement in several years, which calls for the construction of six new franchise restaurants in certain markets of South Carolina over the next few years.

While still early, we're extremely excited about our progress on the development front and look forward to sharing more with you over the coming quarters.

Meanwhile, Noodles & Company's performance in Q2 delivered against some of the most challenging comparisons in years as further evidenced with the strength of our brand, the power of our initiatives, and our ability to position the brand to capitalize on a significant growth opportunity ahead.

I'd now like to turn over to Ken to discuss in more depth our Q2 results and expectations for the balance of 2019. .

Thanks, Dave, and good afternoon, everyone. For the second quarter ended July 2, 2019, we reported net income of $400,000, or $0.01 per diluted share, compared to a net loss of $5.9 million or $0.14 per diluted share during the second quarter of 2018.

During the second quarter, the company recorded revenue of $120.2 million, a 2.4% increase over the prior year as we saw the benefit of strong comparable sales growth, including a 2.8% weighted price increase during the quarter partially offset by the impact of closed restaurants.

System-wide comparable sales increased 4.6% comprised of a 4.8% increase at company-owned restaurants and a 3.7% increase at franchise locations. Second quarter comparable sales were negatively impacted by approximately 50 basis points due to a fiscal shift in the Easter holiday. This impact offsets the 50 basis point tailwind we saw in Q1.

As we noted, despite the slight headwind, our two year comparable restaurant sales growth at company-owned restaurants of 9.8% was our best performance in six years.

Company-owned comparable restaurant sales included an increase of approximately 2.8% of menu price, and a mix shift increase of approximately 2.5% partially offset by 0.5 point decline of traffic.

From a menu mix perspective, we saw continued growth from delivery, as well as from the early second quarter launch of our new menu board that features higher priced signature items, as well as the opportunity for guests to making a meal by purchasing a drink and a side for one no price.

Additionally, we saw a continued benefit from the higher check associated with our zucchini noodles, which continues to grow in mix. Turning to profitability, overall restaurant margins improved 160 basis points to 17.1%, their highest level since the second quarter 2015.

This improvement was driven by leverage on higher AUV, lower marketing spend, supply chain savings initiatives and labor efficiencies, partially offset by an increase in third-party delivery fees and labor inflation.

Cost of goods sold as a percentage of restaurant sales decreased 110 basis points to 25.6% during the quarter, reflecting successful implementation of certain supply chain savings and pricing initiatives.

We anticipate COGS to remain between 25.5% and 26.5% during the last half of the year, as we expect our cost saving initiatives to be partially offset by promotion of the new guest engagement program as Dave referenced earlier. Labor during the quarter was flat compared to last year at 32.7% of sales.

While we did see leverage from our comparable sales growth and labor systems introduced in the first quarter, they were generally offset by wage inflation of approximately 5%. We continue to expect wage inflation of 4% to 5% for the remainder of 2019.

However, we expect to achieve modest year-over-year leverage in labor during the balance of 2019 as a result of comparable sales growth, and earlier labor initiatives.

Additionally, as Dave discussed, as we move into 2020 and beyond, we are encouraged by our work on the back-of-the-house design, which we anticipate will help us to better address wage inflation over the long-term.

Other operating expenses decreased 30 basis points from the prior year to 14.2% of sales, benefiting from leverage on AUV growth, as well as reduced marketing expense, which declined 40 basis points to 0.9% of sales. These benefits were offset by 130 basis point increase in third-party delivery fees, which increased to 1.5% of sales.

While delivery as a whole is incremental and accretive to earnings, we are continuing to test different approaches to deliver pricing and direct delivery to mitigate the impact that delivery has on margins. General and administrative expenses in the second quarter decreased 270 basis points to 9.9% of sales.

G&A in last year’s second quarter included charges totaling $3.7 million related to data breach liabilities and the settlement of gift card litigation. Excluding these charges G&A increased 50 basis points due primarily to higher compensation costs as we filled out the management team.

Adjusted EBITDA increased 20.5% in the second quarter to $10.9 million, while adjusted earnings per diluted share increased to $0.05 in this year’s second quarter from $0.01 last year.

Turning to the balance sheet, long-term debt at the end of the second quarter was $46.1 million, a $3.2 million decrease from the end of the first quarter due to the strong second quarter operating results. And cash on hand at the end of the second quarter was $3.3 million.

Our balance sheet remains strong and we anticipate that we will be able to continue to pay down debt over the remainder of 2019. Our anticipated effective tax rate for the full year is between 1% and 4%. Moving to guidance for the remainder of 2019, let me start with our development expectations.

As Dave discussed, we anticipate five company restaurants to open during 2019 complemented by one franchise opening. And outside of unit development, we're affirming our guidance from our prior call.

And this guidance includes comparable sales growth of 3% to 5%, total revenue of $466 million to 474 million, restaurant contribution margin of 15.5% just 16.5%, adjusted EBITDA of $37 million to $41 million, adjusted net income per diluted share of $0.08 to $0.16, and capital expenditures of $14.5 million to $19 million.

In closing, we're pleased with the performance as it continues to reinforce the substantial upside potential of the Noodles & Company operating model. And we look forward to sharing how our top and bottom-line initiatives continue to help drive sustainable, consistent long-term growth for the brand.

And with that, I would now like to pass Howard to open the lines for Q&A..

[Operator Instructions]. Our first question or comment was in the line of Jake Bartlett from SunTrust. Your line is open..

My first was, given the results in the second quarter, which were stronger than what we were expecting, I'm not sure, how they relate to what you were expecting. But I'm just curious as to why guidance wasn't raised. It seems like it was a very strong quarter.

And I'm wondering within that answer, does it have anything to do with the franchising of those 11 stores?.

No, really the re-franchising of those stores source Jake was somewhat de minimis to the overall impact on our financials. Ultimately, our guidance from the last quarter reflected our confidence in the balance of the year. And I think you saw it in the same-store sales targets as well as margin and EBITDA.

Second -- the second quarter performed as we expected it and we continue to expect a strong back half of the year, a lot of confidence in the initiatives that we have, whether it'd be the cauliflower introduction, or the rewards programs. So we still feel very strong about what we see for the balance of this 2019..

If you can just give us some -- maybe some detail on how the composition of the comp changed, as you rolled over the launch of Zoodles last year. And I'm just -- I think the traffic was stronger in the beginning of the quarter.

It ended up negative but you had that big check, my thought that kind of lapping the check would -- lapping the Zoodles would have the mix come down.

So maybe any commentary on how that's all kind of looking as you exit the quarter, including what's the impact of a menu change -- the pricing changes and the structure change as well on the menu?.

Sure, Jake. Yes, as Ken alluded to, we still are very excited with what we're seeing from a check perspective from both delivery, which is coming with a higher per person spend, as well as with the zucchini which does continue to grow in mix.

A lot of the growth what you see there does come from the new menu board, which includes making the meal, includes some other aspects that are helping move the needle there. We continue to be very happy with the trajectory of the business overall.

Exiting the quarter, and at the very beginning of Q3, there was some choppiness around the 4th of July holiday. Once we got passed that 4th of July holiday week, we're seeing the business come back to strong momentum..

Got it. And then last question just on the longer term development plan. I just want to make sure I am clear as to whether you expect that to be more franchise store led or company led, I might have missed it.

But just in the context of some of the new development agreements and re-franchising, what should we expect unit growth to look like in terms of the stores in 2021 and beyond?.

Yes, I would certainly like Paul to weigh in as well. But one way we look at franchising is our first goal is to improve the economic model of the organization.

And as we do the work on the back-of-the-house kitchen design, smaller square footage units, the pickup window, we feel it's imperative that we're able to prove those out in order to more aggressively pursue franchising as a part of the growth strategy. We certainly believe that there is a lot of optionality and opportunity there.

But I believe it's actually too early to really breakout what we expect will be company versus franchise growth. .

Jake, this is Paul. I anticipate early on being a bit more company-driven. We are very pleased with the results of the first phase of work on the back-of-the-house that has really met all of mock kitchen tests. We’re about to bring it in the fourth quarter in July in our three different types of back-of-the-houses that we have.

It was able to address the quality of the product. It was able to address basically the speed of service in reference to cook times and able to address the labor efficiency which Dave has called out in his remarks.

So as we get that put into the prototype, scale down the footprint, we think that the economic model will be very compelling from a franchise point of view. So we see that starting to layer in as we move through time, and then hopefully, becoming a real driver of our unit growth, our restaurant growth. .

Yes. And do you want to clarify, Jake, from your first question. In terms of the franchise activity that occurred over the last few weeks, there were two separate transactions. The first one was a re-franchising to an existing franchisee. That was five restaurants, relatively minimal impact on the overall projections to the company.

But feel very excited to be able to accelerate growth under a new territory agreement. The second thing that occurred was actually the signing of a new ADA. So that calls for six restaurants opening in South Carolina over the next few years.

Again, not going to have significant impact in terms of the overall growth profile of the organization, but really, I think bellwethers for the momentum we're seeing from the franchise community..

Our next question or comment comes from the line of Andrew Strelzik from BMO Capital. Your line is open. .

My first question is about the cauliflower rigatoni.

Can you talk about any testing that you did around the product? What was the impact? Is the price point going to be similar to the Zoodles? And I guess bigger picture, did you find it to be incremental from an mix perspective to Zoodles such that adding better for new products grows that pie within I guess the share of the better-for-you products? Or is it more kind of switching between the better-for-you?.

Absolutely, those are great questions Andrew. I mean from the initial tests what we're excited about is the overall acceptance as well as the repurchase intent of that rigatoni. And one reason we went with the cauliflower infused noodle is unlike the zucchini, it does have a bit of a different taste profile.

It doesn't have the texture that you see with zucchini. It has exactly what you want for somebody that wants to get more vegetables into their diet, have a more plant-based alternative, but doesn't necessarily have the bite of what you see with zucchini instead has a bit more of your traditional wheat pasta bite.

So we were able to see that it was able to attract the guests that zucchini was a little too much for them, but zucchini was a bit polarizing. What we also enjoyed seeing was the versatility of the cauliflower noodle.

Somebody who has an 8 year old and a 6 year old, getting vegetables into their diet is extremely difficult transitioning into a zucchini noodle, not necessarily in the cards. But when you try the cauliflower noodle on the spaghetti or Mac & Cheese or anything on those lines, you really can't tell the difference.

So we are seeing the opportunity to hit a different type of guests here. From the pricing perspective, it's not priced to the premium that zucchini is. So it is a little bit higher than the core menu, but not dollar out-charged that you see with zucchini noodle. .

And then can you talk a little bit or give us an update on the pricing strategies that you've been testing to mitigate some of the delivery margin headwinds? And I know now you're talking about potentially pushing people through the app.

But it feels like schematically one of the things we're hearing more is the ability to renegotiate those fee structures lower.

Is that an opportunity for the brand? Is there some limitation in your ability to do that?.

I don't want to speculate on where we’ll ultimately land with fees from our third-party providers which have been great partners with us as we've gotten this program off the ground, but certainly that is something we're looking at. From a pricing perspective, we are still in tests.

We want to see a few more kind of guest -- the guest rotations through the cycle to see what the impact could potentially be on traffic, as well as check. We will give a much more wholesome update on that during the next earnings call.

But we are still in test where no plans to necessarily roll out any pricing changes over the next several weeks nation-wide. .

And then if I could just squeeze one more, how much was the marketing down in the quarter? And what's the plan over the balance of year and beyond?.

Marketing as a percentage of sales, Ken, correct me if I'm wrong, down 40 basis points to 0.9% of sales. We would expect it to be in and around that 1% number for the balance of this year.

What you will see Andrew is from the COGS perspective, a bit more promotional dollars going towards engaging and energizing our guests around the new rewards program. We're excited with what the capabilities are with this particular program.

We talked about in the past that this is a brand that has no choice and we personalized menu and offerings to our guests liking. And unfortunately for us, we have not had quite the capabilities we would like from a marketing perspective to target folks.

So we've ended up with a brand providing great choice but being limited in how we engage existing guests as well as activate new guests into the brand. So you end up with Mac & Cheese and Zoodles going to the same audience even though they might be completely different guests and what their preferences are.

So you will see a bit more on the cost of goods sold line as we activate that program and become a bit more targeted on how we communicate. That's where you'll probably see more of the impact than you will in the actual marketing line. .

Thank you. [Operator Instructions]. Our next question or comment comes from the line of Andy Barish from Jefferies. Your line is open..

It's Alex on for Andy. Maybe digging in a little bit more to that rewards piece.

From the customer research that you’ve done and had ultimately led to the Zoodles launch and then the recent refresh, what are you learning from customers with respect to what they wanted out of the rewards program and maybe just beyond kind of that expression of customization?.

Yes, I think customization was probably the one that came most loud and clear in terms of just the weakness that we had. More or so on the online ordering experience than the rewards program itself.

On the rewards program, the one that we consistently hear is the fact that when we do provide offers or provide just communication in general, just how it might not be relevant to them.

So when you have a brand that has strength with families and kids, that has this Generation Z band, you then see us have a zucchini noodle and the cauliflower infused noodle, and then you are spreading it very thin in terms of across the entire platform, you just -- you get a lot of folks that would say, I get this offer for zucchini or I get offer for Mac & Cheese, that's not relevant for me.

So that was the biggest learning we had is to allow it to be a bit more customized to their preferences. At the same time, folks want some psychological productivity or predictability from the rewards program.

So surprise-and-delight, there was a bit of frustration we heard from the guests in terms of not really understanding if they were getting rewarded for their loyalty or not.

How we are approaching it is yes, there's points based aspects of it, but also cheering in terms of being able to provide guests the ability to access certain features or aspects of the brand, based on their loyalty to Noodles & Company.

So to put in a nutshell, it would be really the customization has been a challenge from the app execution perspective. And then our ability to effectively segment and target communications and promotions has been the second aspect..

And then maybe going back to the guidance, maybe I missed it. But if I look at it, the guidance was trended toward the lower end of the previous range.

And so would some of that ramp towards 5% in 2021 include some this year’s units slipping from ‘19 or ‘20 or what's in that change?.

Yes, there is an aspect there. So as we see the benefit, or the potential of this back-of-the-house kitchen design, there were a few locations that we strategically placed into beginning of 2020, which allows us to back out the learnings from that and make sure we have the proper execution of the new kitchen design when we go into those restaurants.

So you will see kind of a furthering of activity early in 2020 from some of the openings that were originally slated for 2019..

Thank you. Our next question or comment comes from the line of Dennis Geiger from UBS. Your line is open. .

Dave, specific to Zoodles you mentioned the sales mix trending higher. But curious if you could speak to kind of what you've seen over the last couple of quarters I guess from a guest perspective.

Is it new customers coming, is it an existing customers that are increasingly ordering Zoodles? And I guess just how you think about what you've seen from a customer perspective there with respect to future offerings, cauliflower and other plant-based items, new customers existing ordering it more? Thanks. .

We still think there's -- that was a good question, Dennis. So we still think there is a lot of upside in terms of gaining awareness for zucchini noodles. What we're seeing is in our rewards program as it is today, only about 20% of our rewards members have actually tried zucchini.

So being a bit more targeted and a bit more engaging and open with getting folks to try that zucchini noodle, particularly based on how versatile it is, you will not see us shy away from zucchini, even as we launched cauliflower noodles, it'll be part of an overall how do you eat a plant-based healthy way from Noodles & Company.

So the research, the data, the results we're seeing still shows that there's quite a bit of upside in terms of articulating that offering to guests..

Thank you. I'm showing no additional audio questions in the queue. I'd like to turn the conference back over to management for any closing remarks..

Thank you, Howard. We appreciate everyone's time today. Obviously very pleased with the trajectory of the business going against some of the most challenging comparisons we've had in years. Just very pleased to see where we're at from a two-year growth perspective, from a margin perspective, as well as the trajectory going into the balance of the year.

So thank you a lot. Have a wonderful evening..

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone have a wonderful day..