Noodles & Company (NASDAQ:NDLS) Q3 2019 Earnings Conference Call November 7, 2019 4:30 PM ET
Ken Kuick - Chief Financial Officer
Dave Boennighausen - Chief Executive Officer
Conference Call Participants
Spencer Hanus - Citi
Jake Bartlett - Suntrust
Andy Barish - Jefferies
Andrew Strelzik - BMO Capital Markets
Good afternoon and welcome to today's Noodles & Company’s Third 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 third quarter 2019 earnings call. Here with me this afternoon is Dave Boennighausen, our Chief Executive Officer. I’d 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 in 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 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 third quarter 2019 earnings release and our supplemental information.
Now, I would like to turn it over to Dave Boennighausen, our Chief Executive Officer.
Thanks, Ken, and good afternoon, everyone. We continue to be pleased with the trajectory of the company, evidence by strong third quarter results. Highlights for the quarter include a 2.1% system-wide comparable restaurant sales increase, 7.6% two year comparable growth, margin expansion of 70 basis points and 118% increase in adjusted net income, both relative to prior year.
The third quarter of 2019 also mark our sixth consecutive quarter of positive comparable sales as the company continues to capitalize on the inherent strengths of the brand, including our ability to provide choice for today's consumer with favorites from kids to adults, healthy to indulgent and comfortable to adventurous.
Additionally, we continue to benefit from the brand's unique capability to meet the consumer need for convenience, as digital sales increased 47% versus last year, and overall off-premise increased 490 basis points to 54% of sales. While we are pleased with the results in the third quarter, we are particularly excited with recent initiatives they've launched in just the past few weeks. We believe these initiatives will position the brand to finish 2019 strong and set a solid foundation for further growth in 2020 and beyond.
I’d like to start from a culinary perspective. During the last week of Q3, we launched a cauliflower infused rigatoni dish system-wide. Choice has always been a great strength of the brand, and we continue to innovate in ways that allow guests to enjoy the world flavors they know and love, as well as discover new ones with all the benefits of healthier options.
Building off of the success of the zucchini noodles launch in 2018, our cauliflower infused rigatoni provides a full serving of vegetables and has tremendous versatility as a substitute and all of our dishes. Well early we're very pleased with the initial performance of the cauliflower rigatoni, which is held a mix on par with the zucchini launch from last year, and currently is the highest guests rated item for taste on our entire menu.
We believe this reinforces the fact that you don't ever have to sacrifice flavor for health when dining noodles and company. In addition to providing a more healthful alternative for adults, we're also excited about our ability to offer parents the opportunity to invest into their kids have comes without sacrificing the taste that the pickiest of kids have come to love fried noodles.
The second reason was that we are particularly excited about her just three weeks ago with the introduction of a new and improved meals rewards program. As we increase the variety of our core menu, we also continue to provide multiple avenues for our TXTY, broadcast access to brand, building our off premise business to meet the increasing need for convenience from today's consumer. Our new rewards program moves from a surprise and delight only program to one that also incorporates points as well as cheering, providing guests with an easier to use more engaging program.
It also improves the targeting capabilities of our marketing communications. Concurrent with the launch of our new rewards program, we implemented a new digital ordering experience which makes it easier for guests to navigate our menu as well as customize their orders. Both the rewards program and the new digital ordering experiences significantly reduce friction for our guests, and create a foundation for raising our brand visibility and improving our guest engagement now and in the years to come. Noodles and companies guests tend to be younger over indexing in both millennials as well as generation Z. By building our digital capabilities, we have a clear opportunity to transform the business to better engage our guests and increase the visibility of the brand.
Given the timing of the cauliflower launch, as well as our improvements to the rewards program and digital experience, we delayed certain traffic driving marketing tactics until the last half of the fourth quarter. Comparable sales have remained positive during the first weeks of the fourth quarter. We anticipate that they will accelerate during the balance of the quarter as we activate our cauliflower and rewards program.
Shifting to our overall economic model, we remain pleased with our continued margin expansion, which in the third quarter increase 70 basis points versus the prior year, despite a significant increasing delivery fees, which increase the 140 basis points from Q3 of 2018.
While we've made significant strides in improving our economic model over the past several quarters, we see additional opportunities for expansion, particularly in our labor model. Although we do anticipate legislation to continue to impact the industry over the next several years, we are optimizing our kitchen equipment package and our operating processes to improve labor efficiency in our restaurants, while also improving throughput, food quality, off-premises of pickup, and importantly, flexibility for future innovation in our menu.
As we discussed last quarter, this initiative requires changes to many of our operating procedures, and as such we anticipate rigorous testing before it gets rolled out system wide. Currently, the new kitchen design has been retrofitted into three existing locations. And while too early to speculate on its ultimate impact on unit level economics, we're very pleased with the initial results we are seeing from these best restaurants, which indicate meaningful opportunity for saving and labor costs.
Improving the labor model will also be a meaningful contributor to executing our strategy surrounding Linear growth. We expect that new restaurants will begin incorporating the kitchen design in early 2020.
And switching to development, we open four company restaurants during the third quarter, including one restaurant that had a temporary closure for the last 15 months. Were very pleased with the performance of these openings. While the sample sizes small the four restaurants opened in the last than least three months are performing better than any class has an over 15 years.
Subsequent to the end of the quarter, we opened one company on restaurant during October, and one franchise location open just yesterday with one of our highest opening sales days in history.
Of our five company restaurants open thus far in 2019. Three incorporate pickup windows, which we continue to see as a strong avenue to meet the need for convenience with today's guests.
Moreover, we continue to execute our smaller square footage design engineer to increase efficiency, reduce costs, and deliver on the increased importance of off premise. As we communicated, we are targeting 5% unit growth system-wide beginning of 2021 with potential acceleration to at least 7% unit growth in the years beyond.
We're also focusing on meaningful expansion of our franchise network. Our approach to growth 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.
Given the strong results of our recent openings, we are excited by the opportunity to resume more meaningful unit growth and we feel we are laying a strong foundation for the success of our new restaurants.
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.
I'm extremely proud of our 10,000 team members nationwide who continue to provide outstanding guest experiences day-in and day-out, and will help us deliver another quarter of strong financial performance.
I will now turn it over to Ken to provide more details on our Q3 results.
Thanks Dave. For the third quarter ended October 1st, 2019, we reported net income of $4.2 million or $0.09 per diluted share compared to net income of $1.1 million or $0.02 per diluted share during the third quarter of 2018.
During the third quarter, the company recorded revenue of $118.3 million. System-wide comparable sales increased 2.1% comprised of a 2.2% increase at company-owned restaurants and a 1.6% increase at franchise locations. As Dave mentioned, the third quarter marker sixth consecutive quarter of positive comparable sales growth and our two-year system-wide comparable restaurant sales growth remains strong at 7.6%.
With a strong two-year growth, company LTM average unit volume has increased $95,000 from two years ago and was $1.157 million after Q3 of 2019.
Company-owned comparable restaurant sales included an increase of approximately 5% of average check, partially offset by an approximate 1% decline in discounting and a 1.8% decline in core 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 premium priced signature items. Additionally, we saw a benefit from the higher check associated with our zucchini noodles, which continues to grow and mix.
Turning to profit profitability, overall, restaurant margins in the third quarter improved 70 basis points versus the prior year to 17.1%, driven by leverage on higher average unit volume, supply chain 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 120 basis points to 25.3% during the quarter, reflecting successful implementation of certain supply chain and pricing initiatives.
We anticipate COGS between 25.5% and 26% in the fourth quarter of this year as we expect our cost savings initiatives to be partially offset by higher costs associated with the launch of the new guests engagement program that Dave referenced earlier.
Labor during the quarter decreased 20 basis points compared to last year as our labor efficiency initiatives and sales leverage offset continued wage inflation of between 4% and 5%.
We expect to achieve modest year-over-your leverage in labor during the balance of 2019, as a result of comparable sales growth and earlier labor initiatives.
Other operating expense increased 70 basis points from the prior year to 14.7% of sales. Other operating expenses were negatively impacted by 140 basis points increase in third party delivery fees, which increased to 1.7% of sales, partially offset by a benefit from leverage on AUV growth.
Delivery accounted for 7.6% of sales in the third quarter. And as a reminder, we begin lapping the national rollout of delivery during the back half of this current fourth quarter. In order to mitigate the impact that delivery has in margins.
In late October, we implemented a 10% delivery pricing premium system wide and while still early, we are pleased with the results. Additionally, we are continuing to test direct delivery, executed by third parties but ordered through our native digital channels to enhance delivery margins.
General and administrative expenses decrease 10 basis points to 8.8% of sales. During the third quarter, we generated a 6.4% increase in adjusted EBITDA to $11 million, while our adjusted diluted earnings per share increased 125% from $0.04 to $0.09. Long term debt at the end of the third quarter was $44.4 million, a $1.7 million decrease from the end of the previous quarter.
Cash on hand at the end of Q3 was $3.1 million. Our balance sheet remain strong and we anticipate we'll be able to meaningfully pay down debt over the remainder of 2019. Our anticipated effective tax rate for the full year is between 1% and 4%, and we anticipate continuing to pay only minimal cash tax in the near future.
Moving the guidance for the remainder of 2019, I'll start with our development expectations. As Dave discussed, in the fourth quarter, we already opened one additional company restaurant, bringing our 2019 openings to five. And we anticipate one franchise opening during the balance of the year.
Turning to our expected operating results, we are updating for full year guidance as follows. We now expect the adjusted net income per diluted share of $0.14 to $0.18, an increase from our prior guidance of $0.08 to $0.16.
Comparable sales are expected increased 3% to 4% compared to previous guidance of 3% to 5%, which takes into consideration actual third quarter results and the timing of the new initiative launches and our associated delay in marketing spend.
We expect total revenue of $466 million to $470 million from $466 million to $474 million prior. We expect restaurant contribution of approximately 16% compared to a prior range of 15.5% to 16.5%.
We now expect adjusted EBITDA of $38 million to $40 million from prior guidance of $37 million to $41 million. And we expect capital expenditures of $17 million to $19 million from our prior range of $14.5 to $19 million.
And with that, I would now like to turn it over to Dave for final remarks.
Thanks, Ken. Again, we're pleased with our Q3 2019 results as the company continues to grow profit, building the foundation for meaningful unit and revenue growth in the years to come. Our recent launch of both cauliflower noodles and our new rewards program continues to invigorate the brand and redefine how guests viewed and interact with noodles and company.
I'm proud of the results the team has delivered thus far in 2019. And look forward to the bounce of the year and continued growth and 2020 and beyond.
With that I would now like to turn it over to Sydney to open the lines for Q&A.
[Operator Instructions] And our first question comes from Greg Badishkanian
with Citi. Please proceed with your question.
Q – Spencer Hanus
Hi, guys, this is actually Spencer Hanus on for Greg. My first question is just on comps that you are seeing quarter today, can you quantify the level of comp that you have so far? And then in terms of the cauliflower noodle, have you seen any cannibalization of the zucchini noodles sales post the launch of cauliflower noodle. I know it's too early but what have you seen so far?
Yeah, absolutely. Appreciate that Spencer. From the comp side, as we said still positive. It's literally and we do expected comps to accelerate as we go through the balance of Q4 and we’re still positive early here in the quarter.
In terms of the cauliflower noodle, you know, we think it's a bit unfair to absolutely compare it to this zucchini noodle, which had the ability of bringing in lapsed users that really haven't thought through the brand in a while because of the perceived -- the perception of lack of health from the menu.
Cauliflower on the other hand is extremely versatile noodle. We see that much more as a frequency driver, very encouraged, as we said with the initial mix of the cauliflower noodle, as well as with how can we substitute into other dishes.
It ultimately Spencer, when we look at that healthy side of our menu, we believe that it has the ability to have menu mix in the 20%, 25% range. We continue to grow it well. But there's still significant runway in zucchini, cauliflower, the overall healthy side of our menu.
Makes sense. And I think you'd also mentioned in your prepared remarks that you're seeing, you guys are rolling up premium pricing on delivery. Have you seen any pushback from consumers on that? What's been the response there?
Yeah, hey, it's Ken Kuick, Spencer. We're pleased with the results we've seen so far. It's really early though, so just implemented in the last couple of weeks. So happy so far, respected things, but too early to really tell.
It is something that we have tested Spencer over the past several months. And again, we felt comfortable that there was very little cannibalization, if any, or reduction in sales.
Perfect, all right, thanks guys.
Thank you. And our next question comes from Jake Bartlett with Suntrust. Please proceed with your question.
Great, thanks for taking the question. Dave, there was a deceleration on a sequential basis from the second quarter. And then also on a two year basis, I'm also seeing it looks like delivery should have been an increasing impact.
So if you could just talk about what the moving pieces are. Were there any changes in marketing in the quarter? I'm just trying to understand what might be causing a deceleration kind of the underlying business aside from delivery?
Yeah, absolutely, we're very comfortable with the underlying business performance. Jake, as you looked at the marketing spend for the year, we did take a delay in a pause and most of our marketing tactics.
As you have the cauliflower launched on September 25th, ultimately, the rewards program launched on October 16, so from a detailed starting discount perspective, really 30% to 40% less than what we would typically spend in a given quarter.
As well as from the media side, the little that we did was even significantly less than we had in prior quarter someone we would typically run. From the delivery side of the business, I think, as you've seen, throughout the industry, it's starting to normalize a bit. So our delivery as a percentage of sales in Q3 was 7.6%.
I think, it was 6.6% during the second quarter. So it continues to increase continues to increase, continues to grow. But not at the rate that it was growing at earlier in the year.
Got it and then, just kind of getting deeper into the comments about your labor initiatives in the time study, in the kitchen that you've done in the equipment package.
What should we expect from that I understand that you're putting into the new stores? Is that something that that you anticipate kind of retrofitting the system with? How should some of those learning's are be applied to the system and not just the new source?
Yeah, I mean, we talked about the digital aspect and what we want to start October 15th and how over time that will absolutely transform the business from an AUV side. This labor savings initiatives Jake we really think it's going to transform the economic model.
So as we've talked in the past, our equipment package and our processes and the restaurants are pretty similar to what they were even 10 years ago. So, this has been a long process almost a year, culminating in us now starting to retrofit restaurants with design that has a few new pieces of equipment as well as a few changes in the processes and the flow within the restaurant.
It's very early, we retrofitted 3 restaurants. We have 3 main kitchen designs. So we retrofitted 1 of each of those earlier in the quarter, very comfortable, very happy with what we're seeing from a labor savings perspective.
Why we don't want to quantify it quite yet? Is, this is an important -- this is such an important project with such a big upside that we want to make sure we do it right. And that will entail that we will ultimately be going into all of our restaurants, retrofitting the equipment, so where it can execute on this process.
It's not just labor savings, its speed, its flexibility, temperature of food. We're seeing good movement in all those items in those existing restaurants that have been retrofitted. From the new restaurant perspective, that new layout, new design with the new equipment will start coming into play early in 2020.
Got it? And then last question, can - just if you could go through the composition of the comp again, I guess I wasn't quite clear. Maybe if you could share what the menu pricing was? What the mix was? And then -- and then what the traffic was, that will be helpful?
So many price in the third quarter 3.6%. Mix was 1.3%. And then as Dave alluded to earlier, with the pullback -- the strategic pullback and marketing a little bit in the third quarter with a discounted impact of 1% and then overall core traffic decline of about 1.7%.
Right, but with interest of core traffic -- should I just think of that is what we typically think of sort of traffic…
Yeah. Absolutely, that's how we look at it.
Got it. Thank you very much. Appreciate it.
Thank you. And our next question comes from Andy Barish with Jefferies. Please proceed with your question.
Hey, guys, just can you give us a little more color on the marketing spend in sort of 3Q and 4Q, just kind of the change there?
3Q to 4Q, so how we look at it is from a discount perspective from a sales driving side, we typically spend about 2.5% to 3% of sales on that figure, Andy. And in Q3, we only spent about 1.5%. So pretty significant decline in what we would normally invest in those activities. But you are seeing Q4 is actually probably pretty similar. It'll be balanced much more towards the back half of the quarter, but it will come back ups kind of that 2.5% range that we're more accustomed to. So pretty meaningful, decreasing spend. Additionally from the actual Restaurant Marketing spend which as you think of it -- from a media perspective that was also significantly less. We've spend about $1.8 million in more traditional digital type media during the first 3 quarters of 2018, that number was cut nearly in half during the first 3 quarters of 2019, which was much of that in Q3.
Okay, yeah, that's kind of the number I was looking for. And then how are you thinking about the 20? Same store sales, you know, layers -- obviously the recent digital upgrades and cauliflower, but then what else should we be thinking about in terms of looking at the next year?
Yeah, we were very excited with the levers that we have for next year. I think the three that I would focus on the most first would be on the digital front, and that will transform the way that we interact with our guests and sit will be significantly stronger and better than what we've done in the past will be able to be much more targeted with how we communicate, whether it be through the online on the app or through the rewards program.
Second one would still be the runway that we have a zucchini and cauliflower. Those continue to grow in Max. We still think there's a lot of opportunity for us increase awareness and trial for those items. And so you'll continue to see us push that.
The third thing is catering. So we talked about that in the past is an area where we currently are less than 2% of sales. We think there's significant upside there. And for a brand that really choices, one of the absolute strengths of the brand, we absolutely are great fit for catering and so that we haven't really invested much in the past. So that would be the third lever that I would say is going to be a significant driver for 2020.
Thank you very much.
Thank you. [Operator Instructions] And our next question comes from Andrew Strelzik with BMO Capital Markets. Please proceed with your question.
Hey, good afternoon. My first question is just on the guidance with the comps and revenue number coming down to the lower half of the range in keeping the restaurant margins and even kind of at the midpoint the same? Just can you help us out with the bridges at all the Delta on the marketing side? Are there any other changes in your assumptions on the costs?
No, really, Andrew, it's just the strategic pause that we took from, from the marketing and cost perspective, when it came to the initiatives that were just rolled out in the last several weeks otherwise feel very comfortable with what we're seeing kind of throughout the P&L and throughout the fundamentals of the organization.
Okay, and I'm curious on the frequency of your digital customers versus your non digital customers with digital growing as quickly as it is just trying to kind of frame up how powerful that could be as the mix continues to shift. And maybe even if you could talk about beyond frequency, just the spend difference more broadly?
Yeah, so what I will say is that we're still a bit early on and so one of the things that we wanted to do with this project and to put a bit more color into our overall initiative here on digital, we're transforming the way that we engage with our guests through digital. And so, it also includes the capabilities for us to have much better insight into our guests from a longitudinal basis. So during our prior programs, it was really limited with our ability to understand the actual frequency of those digital users versus a typical guest.
What this new platform allows us to do is have a greater understanding of how check changes over time the overall consumer lifecycle, how we can bring many more people into the funnel, and how we then convert them into frequent noodle users. So the answer is that since it's only in its infancy and only been around a couple of weeks, we actually don't have great data yet, Andrew on what that frequency is, but that's absolutely one of the intense of the -- intentions of this process. And this project is for us to have that type of data where we can easily activate and better engage with those guests.
That's helpful. Thank you. If I could squeeze one more in. Once you start to reaccelerate further the pace of the unit openings in 2021 and beyond, how are you thinking about the markets that you're going to target initially. Is it more the existing markets, is it newer markets, is it a blend? How are you thinking about that? Thank you.
Yeah, certainly we think over the next couple of years, it will be primarily infill of existing markets. We have several I believe in 30 states we have several markets where we see significant opportunities still, whether it be Chicago or even in the heartland or in our home market of Colorado, areas like Phoenix et cetera. So continue to expect a lot of infill low risk sites that we absolutely understand and have the people pipeline to execute. As we go into new markets from a company perspective, we will be focused a bit more on contiguous to our markets that we already have to brand awareness and we know we can execute from an operational supply chain perspective as well as activate the brand.
Additionally, we talked a bit about in the remarks about franchising, which we absolutely believe will be a larger part of our growth. We've been relatively conservative in terms of our approach to growing that franchise network over the past couple years, because we knew we had such tremendous upside with our prototype with those labor initiatives. Now that those are coming to pass, we're seeing such great momentum on the margin side as well as the sales side. You will see us be more aggressive on the franchise side, where a lot of the new market growth will occur.
Great. Thank you.
Thank you. And I'm not showing any further questions at this time. I will now turn the call over to Dave Boennighausen for any further remarks.
Thanks, Sydney. Again, as we discussed, this is an exciting time for Noodles & Company with the recent launch of the cauliflower noodle, as well as with our new guests engagement platform. We feel the company is positioned better than ever to really reach its enormous potential. Excited with what we're seeing from a margin perspective from a top line perspective, as well as with that new unit growth. So look forward to the balance of 2019 as well as the years to come. I appreciate your time today and everybody stay safe.
Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.