Noodles & Co. (NDLS) David James Boennighausen on Q2 2016 Results - Earnings Call Transcript

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Noodles & Co. (NASDAQ:NDLS)

Q2 2016 Earnings Call

August 04, 2016 4:30 pm ET

Executives

Paul Allen Strasen - Secretary, Executive VP & General Counsel

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Robert Hartnett - Chairman

Analysts

Nicole Miller Regan - Piper Jaffray & Co. (Broker)

Joseph Terrence Buckley - BofA Merrill Lynch

Andrew Strelzik - BMO Capital Markets (United States)

Mary L. McNellis - Robert W. Baird & Co., Inc. (Broker)

Operator

Good afternoon and welcome to today's Noodles & Company Second Quarter 2016 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 call is being recorded.

I will now introduce Noodles & Company's General Counsel, Paul Strasen.

Paul Allen Strasen - Secretary, Executive VP & General Counsel

Thank you. And good afternoon everyone and welcome to our second quarter 2016 earnings call. Here with me this afternoon is Dave Boennighausen, our CFO and Interim Chief Executive Officer; Bob Hartnett, our new Chairman of the board will also be with us for a portion of today's call.

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 2016 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 press release and the cautionary statement in the company's most recent Form 10-K are considered a part of this conference call.

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 2015 fiscal year. This document contains and identifies important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

Now, I'd like to turn it over to Dave.

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Thanks, Paul and good afternoon, everyone. I'd like to first discuss briefly the agenda for today's call. I'll review our recent announcements, the state of the business, as well as our second quarter financial results. I will then discuss our current priorities to increase shareholder value.

Before I begin those remarks though, I would like to introduce Bob Hartnett, our new Chairman of the Board. I'm incredibly excited to have Bob join the team as his broad array of skills and experience within the restaurant industry will be a tremendous asset for the board and for the company as a whole.

I look forward to working with Bob over the coming months as we implement our strategic plan. Bob can only join us for a portion of this call, but I would love to turn it over to him to say a few words.

Robert Hartnett - Chairman

Thank you, Dave. Hello all. My name is Bob Hartnett. Some of you may know me. And for those who don't, I've been in the industry for 45 years starting as a dishwasher, while I was in college, at Steak and Ale. I was fortunate to spend 19 years in Steak and Ale under the umbrella of Norman Brinker and also under the guidance of a lot of other industry veterans you probably all know.

The last thing I did there, I was President of Bennigan's in the late 1980's. I then became a Boston Market franchisee and an Einstein Bros. franchisee in the State of Florida. I opened and operated about 100 Boston Markets, and about the same number of Einsteins.

In 1998, I became Chairman, CEO and President of Einstein Bros. here in Denver. And for the last 15 years, I was CEO and President of Houlihan's Restaurants, where we operated three different brands Houlihan's, a polished casual brand, Devon's Seafood Grill, and J. Gilbert's, which was an upscale steakhouse. We sold and closed that transaction last December at which time I left.

I first experienced Noodles & Company restaurants 18 years ago, while I was living here in Denver and fell in love with the concept and the food. I followed the evolution of the concept and the menu and I'm still a fan today. So, I'm really excited to join the Noodles team.

After spending the last few days here in Denver, I can say there is a talented and passionate group of people who are committed to the brand. And I'm sure that talent and passion extends to the field organization as well. I look forward to working with Dave, the board, and the Noodles team to improve our overall performance, which I am confident we can do.

One other comment before I turn it back over to Dave. As we said on our July 25 press release, we have initiated a search for a permanent CEO and we will evaluate both internal and external candidates. This search is in its early progress and the company will be able to update you on that search as it progresses.

Thank you all. And I'll turn it back over to Dave.

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Thanks, Bob. I would first like to take the opportunity to discuss how I see the Noodles & Company brand and our path forward. I've been fortunate enough to work at Noodles for over 12 years now and I've seen the brand grow from 70 restaurants in 2004 to over 500 restaurants today.

I've seen the brand go through a few cycles over the years. I've seen the company go through rough patches and come out stronger than it was before. I've seen the company go through a tremendous run of continuous growth in comparable sales, margins, and earnings. I've seen the company make the necessary adjustments to our menu, people and operational strategies to succeed in an increasingly competitive environment.

And over the past couple of years, I've seen the company perform at a level that we aren't accustomed to, resulting in a decline in average unit volumes and in earnings. However, while I've seen a lot of change over the past 12 years, two things that have endured are the unique, differentiated and special way in which Noodles & Company resonates with our guests, as well as the foundation of caring, passionate individuals, who tirelessly work to create a dining experience that we can be proud of.

I know that some of the past decisions that we've made may not have come to fruition the way we envisioned. But I also believe the team knows both the strategic and tactical improvements that are needed for us to right the ship and return to sustainable profitable growth.

Earlier today, we reported an adjusted net loss of $0.03 per diluted share on the previously released comparable sales decline of 1% system-wide. The three main areas impacting recent results have been declining comparable restaurant sales, lower sales from our newer restaurants, and significant margin degradation.

In my current leadership role, I am working aggressively with our team to make the changes necessary to stimulate improved performance. And I will be speaking to our plan to address each of these three metrics during this call.

I'd first like to address the largest pressure on our margins and earnings, which has been under performance in newer classes. Our restaurants that are not in the comparable restaurant base currently are averaging about 80% of company average sales, compared with the range of 85% to 90% that we had typically seen in the past.

On top of that, we've had the additive efficiencies of often being in new markets without the economies of scale. We still feel confident in our real estate selection in these units and the brands ability to resonate in these trade areas. But I believe we have lost some of our consistency in execution during our last few years of high unit growth.

We will be aggressively working on taking our learnings from prior new unit success stories and incorporating them into these underperformers. Through a combination of superior operational execution in targeted marketing I'm confident that we can bring these restaurants back towards company average. However, in the short-term, these restaurants have led to increased levels of impairment as well as significant margin dilution.

As we focus on improvement in our underperforming restaurants, we will continue to slow our unit growth rate. After opening 49 company-owned units in 2015, we expect to open between 35 and 40 company opened restaurants this year. We plan on slowing down growth again in 2017 to approximately 10 to 15 company openings. These restaurants will be centered in markets where we continue to see strong new restaurant performance and can gain advantages in scale.

We have tightened our real estate streams considerably to target only eight plus locations with reasonable lease terms in order to mitigate risk in the portfolio. We have also signed an amendment to our credit facility that we will include with our 10-Q later this week. This amendment allows us the flexibility to continue to make the decisions necessary to execute our strategic plan.

As the company continues to slow down growth, we are also taking the appropriate steps to recalibrate our corporate overhead. This past week, we completed a restructuring, which better aligns our organizational structure with our unit growth as well as our ongoing operational strategy. This restructuring is essential in improving our business model and will reduce our G&A labor overhead by over $2 million annually. As part of this restructuring, Mark Mears, our former CMO, have left the company. And in the short-term, his duties will be absorbed by our strong and capable marketing team.

While we will be executing an aggressive plan to create best practices for our underperforming units. We also recognize the need to revisit our labor model system-wide; especially as increasing labor pressures affect our entire industry. For our second quarter, wage inflation remained at 5% and labor as a percentage of sales increased to 180 basis points from the prior-year.

We have prioritized three potential opportunities to improve our labor efficiency and execution. First, our preparation in cooking procedures, second our guest bussing model, and third a selective streamlining of the menu to reduce operational complexity. We believe these efforts can make our labor significantly more efficient, will also improve the consistency in our execution.

The unit charge on our efforts to deliver excellent operations will be Victor Heutz, who started as our Chief Operating Officer earlier this week. I'm excited at the skills, experience and passion that Victor will deploy and bring our operations initiatives to life.

While we execute these operational initiatives, we also are making the appropriate adjustments to our culinary and marketing strategies to help the brand better resonate with today's consumer. Noodles' World Kitchen positioning is unique in the restaurant space, yet too often consumers are unaware of the variety inherent in our concept and the strong global flavors that we offer.

For global variety and flavors, we will continue to innovate and build on the success of our recent menu introductions such as the Chicken Veracruz Salad and the Korean Beef Noodles. But we will also be taking a hard look at underperforming dishes to either improve their taste profile or to eliminate them from the menu. We will also become more clear and consistent in our communication of our brand promise, reducing the number and types of messages inside and outside of our four walls.

As we've discussed in the past, in the back half of 2015, we began initiating an intergraded marketing plan designed to build brand awareness and to increase traffic in our restaurants. Marketing spend during the second quarter was 2.1% of sales, a 130 basis point increase over the prior-year.

We will continue to invest in certain markets and channels that we have seen the most success in, but as we focus on our operational and culinary initiatives outlined earlier, we anticipate marketing spend to decline to approximately 1.5% to 1.75% of sales during the balance of the year.

Much of our marketing spend in the balance of the year will be centered around digital efforts, such as paid search and the promotion of our off-premise offerings. We feel strongly that we have gained important learnings from our marketing efforts during the past 12 months that we will be able to apply effectively and efficiently in these efforts.

As we continue to capitalize on the strengths of the brand, one aspect of our strategies that will remain is our initiatives to support the growth of the off-premise dining occasion. In particular, we are focused on offering a better experience for the 43% of guests already using the brand for off-premise occasions. While we will continue to make every dish to order, online ordering serves as a throughput equalizer for our teams and for our guests.

We will be testing various design elements to make the carry-out experience more seamless for our guests, as well as incorporating online ordering more into our marketing communications. We have also recently expanded our test and delivery through OLO, our online ordering provider and while early we still believe there is great potential in the delivery occasion.

We also believe that catering has significant opportunity for the brand, that's not yet been tapped. We would like our team's focus though to be on the initiatives discussed earlier in the near-term, and so we will be spending the next few months ensuring that we have the right offering and continuing to test more dedicated sales resources.

Finally, we will continue our effort to capturing more business with millennial families. This segment is one of the fastest growing in the restaurant industry and one that we have a natural strength in. Last fall, we introduced a Kids Meal as well as a partnership with No Kid Hungry to help fight childhood hunger in the United States. We are happy to have renewed that partnership and later this month we'll announce an exciting program to further that commitment.

Noodles & Company has been, is, and will continue to be a strong national brand. We are confident that the initiatives we are working on will return us to sales, margin, and earnings expansion in the quarters ahead. We also recognize that the macro environment is challenging and improvement will not happen overnight. This resulted in the revised guidance that we disclosed in our press release earlier today.

We have already taken important initial steps to address our near-term issues. And we are confident that we have the plans in place to support sustainable, profitable long-term growth.

Kaitlyn, will you please open the lines for Q&A?

Question-and-Answer Session

Operator

Your first question comes from the line of Nicole Miller from Piper Jaffray. Your line is open.

Nicole Miller Regan - Piper Jaffray & Co. (Broker)

Thank you. Good afternoon. I had two quick questions please. First, Bob just given your background on the opening statement was helpful. What is your perspective on the current consumer environment?

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Hi, Nicole. This is Dave. Unfortunately, Bob, did have to leave us...

Nicole Miller Regan - Piper Jaffray & Co. (Broker)

Oh, okay. I'll take your view.

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

My personal view of the consumer environment, clearly, when you look at the results that have been released as well as ours, it is a challenging consumer backdrop seemed like that started towards April and has been continuing onward.

What we're seeing thus far in Q3 is a similar type of trend, in terms of, it's just a competitive eating and drinking out environment and the consumers got some uncertainties, in the election and everything else that's been going on in the world. We don't expect that to change anytime soon. But we do still feel very confident that the brand itself can resonate in good times and bad, some of our best performance has been during challenging consumer environment. So, we feel good that we have the path to move forward.

Nicole Miller Regan - Piper Jaffray & Co. (Broker)

And then I did want to ask you, in the past, you talked about more marketing, now you're talking about less, maybe give us a little bit more color and you also talked historically about empowering the field level, team members, and how is the optimism in that, is that – and are they still a critical component to changing the trends?

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Sure. I'll say, we still believe, so the two questions are surrounding marketing and brand awareness and how we're approaching that in the spend level as well as how are we empowering our field level teams.

To start off with the marketing question, we did see a lot of success in several of the marketing initiatives that we had done, particularly in the D.C. Metro area. Some other markets where we had penetration, but didn't have high brand awareness. We know brand awareness remains a significant opportunity for our brand.

That said, the initiatives that we've talked about whether they'd be more execution of the World Kitchen positioning, streamlining some of the menu, working on some of the operations pieces. We need to focus on that in the call. So, that's what our focus is going to be over the next several months. I mean there'll be – there'll still be some markings we are seeing some good success in certain channels, certain markets. But we're going to take a little bit of a breather from that spend.

As it comes to empowering the field level, I think we have just an amazing team out in the field. And I think there's a team that as we've expanded the menu a bit, as we've had a high percentage of unit growth that we've had over the past few years, we've put some pressure on the teams and made a little bit more challenging to execute the concept. I feel very good. There was Victor's leadership with the things that we're outlining today, in today's call that we're going to be focused on that this team is just going to get on fire and get some amazing things in the upcoming quarters and in upcoming years.

Nicole Miller Regan - Piper Jaffray & Co. (Broker)

Thank you and good luck.

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Thank you.

Operator

Your next question comes from the line of Joe Buckley from Bank of America Merrill Lynch. Your line is open.

Joseph Terrence Buckley - BofA Merrill Lynch

Hi, Dave, a couple of questions as well. When you talked about changing the labor model for the dining business, will there be changes in terms of how you service the guests?

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

That's actually one of the things that we're testing Joe. So when you – those of us – those of you that may not be as familiar with the brand, what we do is we serve the food on real china to your table and then we currently also bus our guest table as well.

Over the past 20 years, as fast casual has evolved, what you're seeing is that most fast casual concepts have evolved more to a system where the guest has the opportunity to bus the tables themselves.

What we've seen is that as consumers have been trained, they're in our restaurants, even some of our more established markets, and looking for that opportunity when they're done to be able to bus their own table.

What's important for us though Joe is that, as we introduce kind of self-bussing into our restaurants and start testing that more expansively, it needs to be a (19:22) great opportunity for our team members to not just execute a cleaner dining experience, but also engage our guests better. If they have more time to be able to talk to our guests while they're out in the dining room versus being focused purely on bussing the table, I think that's actually a win-win for the labor model as well as a win-win for the guest experience.

Joseph Terrence Buckley - BofA Merrill Lynch

Dave, how will you communicate to the guests that they should bus themselves?

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Sure. So, that's something that we'll be working on as we test, it's still in early stages, Joe, a lot of it – they've been trained in most concepts in fast-casual, whether it'd be Panera or others. They've been trained in a way that that's a typical fast-casual experience.

Certainly, we'll require our team members, they're still going to be out there bussing tables, they're still going to be out there wiping, making sure that they're clean. But we do believe that with a station that has some clear signage and is designed well, it might take some time but we'll be able to evolve that and improve the cleanliness as well as that guest experience.

Joseph Terrence Buckley - BofA Merrill Lynch

Okay. And then, just wondered, so on the unit expansion, you slowed the unit expansion and obviously took some impairment charges. Is there a regional focus in terms of the markets where you're still open and was there a regional focus in terms of the stores where you took impairments?

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Not as much of a regional focus on the impairments, what they often had were – they were underperforming restaurants that often we didn't execute correctly on the operation side as we introduced the concept, often they have higher net book value for various reasons.

As we go forward and you look at the restaurants we will be opening, those will be primarily in markets where we continue to see great success, we feel very comfortable that the teams are executing our operations at an incredibly high level. And they're ones that we will gain more brand awareness, more economies of scale as we go in with additional restaurants. So, we feel that we've mitigated the risk as well as we can with the restaurants that we'll be opening in 2017.

Joseph Terrence Buckley - BofA Merrill Lynch

Okay. Thank you.

Operator

Your next question comes from the line of Andrew Strelzik from BMO Capital Markets. Your line is open.

Andrew Strelzik - BMO Capital Markets (United States)

Hey, good afternoon, everyone.

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Hi, Andrew.

Andrew Strelzik - BMO Capital Markets (United States)

Wanted to ask in the context, I think there's a couple of quarters now where you've taken some impairments on the new units. And a couple of quarters ago, you did close some units. Would you look more broadly or do you feel like there is a need to look more broadly at the unit base right now, potentially some closures in some markets, anything like that that would be on your radar?

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

It's certainly on our radar. As we take a fresh look at the portfolio, we will be evaluating if there are restaurants that are good candidates for closure, nothing has been determined necessarily as of today, Andrew.

Andrew Strelzik - BMO Capital Markets (United States)

Okay. And you went through a number of initiatives that are at the forefront here of the strategy. One that you didn't mention was the remodels. I know that that was something you guys were looking at in Colorado and potentially expanding. So, what's the thought process around that, is that still a component of the strategy?

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

One thing, we like about the remodels, Andrew, is we are actually seeing some nice results from the restaurants where we have done remodels. We're seeing some good results when we've put exterior signage into some of the trade areas that maybe we don't have good brand awareness or people don't know the brand as well. We've seen successes there. That said, a lot of the initiatives that we talked about on today's call, whether they are improving our communication of the World Kitchen positioning, changing the labor model up a bit, making the design more friendly for to go, we want to make sure that we've given those tests and those initiatives the opportunity to germinate a little bit. So, then when we do go in and remodel, we've learned from those initiatives as well as from the remodels that we've done over the past six months or seven months. So, I do still think remodels are an opportunity, you just won't see us be very aggressive with them over the balance of this year.

Andrew Strelzik - BMO Capital Markets (United States)

And then my last question. Obviously the focus on stepping up the marketing over the last couple of quarters and it seemed like there were some progress there. So number one, did those markets actually hold up better this quarter?

And number two, can you reflect back on that decision and now stepping down the marketing – reflecting back on that decision. And then also with the strategy that you're going with and the levels of marketing that you're going with going forward, what gives you the confidence that that will resonate at this stage?

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Sure. So, what we had seen is – the markets that we've seen the most success with marketing such as the D.C. Metro area, Indianapolis, where we started as well. We'll continue to do that. They held up very well during the second quarter, D.C. continues to run in that low to mid single-digit positive comparable restaurant sales.

What you'll be seeing is us shifting the resources that we had and bring towards marketing towards the channels and the markets that are like a D.C. or Indianapolis, where we believe we can have the best return on our capital. Where there is some reduction though, is that – and we did see struggles in Denver, that's a market that we talked about in the past very competitive from the black-box perspective, the industry has seen significant struggles here as well. So, we're certainly not alone. But that's one where the marketing has not necessarily able to cut through the quarter.

So, what you'll see is a shift more towards the markets that we see in the best performance and the channels that we see in the best performance and often that's in digital. I mean, I think you'll also see us put a little bit more emphasis on those underperforming newer restaurants where the trigger is good, the real estate is good, our operations improve and get stronger and then we can turn on marketing to help those restaurants get back on the maturity curve.

Andrew Strelzik - BMO Capital Markets (United States)

Great. I really appreciate it.

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Thank you, Andrew.

Operator

Your next question comes from the line of Mary McNellis from Robert W. Baird. Your line is open.

Mary L. McNellis - Robert W. Baird & Co., Inc. (Broker)

Good afternoon. You mentioned your focus going forward on streamlining the menu to – and some opportunities to reduce operational complexity. Can you elaborate on that? And how you might be approaching the opportunity there and how much opportunity is there?

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Sure. I think there's significant opportunity in a few different places, Mary. So, one is from the operational side, and we currently have a significant amount of menu items that our teams have learned, have to execute on a daily basis.

And I do believe in the 12 years that I've been here, we may be stretched the menu a bit too far. So that increased the complexity for those operations teams, and I think there's opportunity. I don't have a number on how many items that ends up being, but I do think there's good opportunity there.

And I also think there's opportunity from the guest experience. Often we find the guest get a little bit overwhelmed, got the variety and the breadth in the menu. And also, we're not able to execute the food as consistently as we would, if we had a little bit more of a streamline menu. So, I think that can be a great opportunity on several fronts from a labor execution, the consistency of operations, team member, engagement as well as the guest experience.

I do also think though – and this is important Mary that even as we streamline the menu I feel very confident that we'll be able to maintain our World Kitchen positioning and have those global flavors in the variety that really is the hallmark of this brand.

Mary L. McNellis - Robert W. Baird & Co., Inc. (Broker)

That's great. Thank you. It's very helpful. Thanks for the question.

David James Boennighausen - Interim Chief Executive Officer and Chief Financial Officer

Thank you, Mary.

Operator

I am showing no further questions at this time. Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.

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