Executives: Paul Murphy - Chairman Dave Boennighausen - CEO Sue Daggett - Interim

CFO
Analysts: Nicole Miller - Piper Jaffrey David Palmer - RBC Capital Markets Andrew Strelzik - BMO Capital

Markets
Operator: Good afternoon, and welcome to today's Noodles & Company Fourth Quarter 2017 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 would now introduce Noodles & Company's Interim Chief Financial Officer, Sue Daggett.

Sue Daggett: Thank you, and good afternoon, everyone. Welcome to our fourth quarter 2017 earnings call. Here with me this afternoon are Paul Murphy, our Executive Chairman; and Dave Boennighausen, our Chief Executive Officer. Let me start by going over a few regulatory matters. I'd like to note that during our opening remarks and in response to your questions, we may make forward-looking statements regarding future events or the future financial performance of the company.

Any such items, including our guidance about our anticipated results in 2017 and details relating to our future performance, should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are only projections, and actual events or results could differ materially from those projections due to a number of risks and uncertainties. The Safe Harbor statement in this afternoon's news release and the cautionary statement in the company's most recent Form 10-K and subsequent filings with the SEC, are considered a part of this conference call, including the portions of each that set forth the risks and uncertainties related to the company's forward-looking statements. I refer you to the documents the company files from time to time with the Securities and Exchange Commission, specifically the company's Annual Report on Form 10-K for its 2016 fiscal year and subsequent filings we have made and will make. These documents contain and identify important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

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

Paul Murphy: Thank you, Sue, and good afternoon. Before Dave discusses some of the highlights from 2017 and the strategy we are currently implementing, I want to briefly take some time to give my perspective on the business. I am now in my second full quarter as part of the Noodles team, and continue to be excited about the tremendous opportunity ahead, as well as the progress that has already been made. During 2017, the team completed many steps to strengthen the company's foundation and position us to return to a leadership position in the fast casual space.

Dave will outline some of those steps taken and discuss the results that we've seen thus far. As discussed on the last earnings call, one of the first actions we took when I came on board and Dave was appointed permanent CEO, was the completion of research and discovery needed to clarify our transformation strategy. Our strategy is comprehensive, from the execution of a best practice quest within our restaurant operations, to the testing of new culinary offerings to address gaps in our menu, to expansion and development of initiatives to become a leader in the off-premise occasion. We are now effecting many elements of that strategy with several initiatives in test that will be introduced nationally either this year or as part of a larger effort in 2019, and are encouraged by our initial results. We believe that collectively, our efforts against the brand, our menu, our operational execution, and the off premise occasion, will provide the critical mass for us to make meaningful progress.

Our goal is to drive enduring growth in both our top and bottom line results for years to come. While there is still work to be done, the progress we have made is tangible, and I am confident in our ability to execute against the opportunities we have to grow the Noodles brand. I’ll now turn it over to Dave to discuss our 2017 results and our 2018 strategy in more detail.

Dave Boennighausen: Thank you, Paul. I would first like to give an overview of some of the highlights from the fourth quarter, as well as fiscal year 2017.

As Paul discussed, we took several steps to strengthen our foundation during 2017. Early in the year, we closed 55 underperforming restaurants which were causing a burden on our human resources and financial performance. Additionally, we raised capital, which strengthened our balance sheet and allowed us to pursue our transformation strategy. In 2017, we also enacted several initiatives in our restaurants to improve our performance, including streamlining our menu, improving operational processes and procedures, and launching our newest rewards loyalty program. Finally, we took several significant steps to strengthen our leadership team.

At the board level, we added Mary Egan and Drew Madsen, both of whom provide tremendous insight as we pursue our strategy and initiatives around off premise and activating the brand. Meanwhile, at the executive level, we added Paul Murphy as our full time Executive Chairman, Brad West as our EVP of Operations. And just last week, we announced the addition of Chas Hermann as our Chief Brand Officer. Chas will be responsible for developing and executing our marketing menu and culinary roadmap, and I'm excited to have him join the team. During the fourth quarter, we began to see the benefits of the actions that we took during 2017.

As announced earlier this afternoon, comparable restaurant sales declined 0.9% system wide in the fourth quarter. This represents a 260 basis point improvement over our comparable sales during the third quarter of 2017, and a 200 basis point improvement in two year growth relative to the third quarter. We attribute much of this improvement directly to the initiatives that we implemented earlier in the year. Our rewards program continues to gain traction, with steady increases in acquisition and activation of rewards members. We're seeing a direct correlation between activation of the program and traffic growth, and are excited about the opportunity the program presents over the next several years.

We're also seeing improvements in our guest satisfaction scores, indicating that the initiatives we have enacted to improve operations and strengthen the guest experience, are driving results. Finally, improvement in performance is always closely tied with employee engagement. During Q4, we continued to see improvement in our turnover metrics and employee satisfaction scores, resulting in a team that is highly motivated and committed to delivering a superior guest experience. As a result of the actions discussed, we're seeing bottom line improvements at our restaurants. Our restaurant level margin of 15.1% during the fourth quarter, represented a 320 basis point improvement over the prior year.

During the fourth quarter, we realized the benefit from the closures earlier in the year, while also modestly expanding margins at our core restaurants through our ongoing labor initiatives. This has driven improvement in our overall bottom line, with adjusted EBITDA increasing 26.4% compared to the prior year. While we're pleased with the progress that has been made, we're most excited that we've been able to narrow our focus on returning to comparable sales and AUV growth, while continuing to expand margins. I now want to discuss some of the initiatives that will be implemented in 2018 to help drive continued improvement in our top and bottom line results, while setting the stage for meaningful, enduring growth in 2019 and beyond. First, I'd like to address our initiatives around the off premise occasion and improving convenience for our guests.

We continued to see growth in the off premise occasion during the fourth quarter. Total off premise sales again were nearly 50%, 240 basis points above Q4 of 2016. This growth has continued into 2018, with overall off premise through our second fiscal period 330 basis points ahead of prior year. As in 2017, much of this growth has been led by online ordering, which has had nearly 13% of sales year to date. During the first quarter of 2018, we completed the installation of quick pick up shelving units in our restaurants, which makes it more convenient for guests to order ahead and pick up their orders.

Aside from reducing friction for our guests to utilize online ordering, these pickup units also reduce the line in our restaurant, taking some of the pressure off guests that are ordering at the counter. We’re also continuing to expand our delivery program through select third party providers. While currently only in just over 15$% of our restaurants, we anticipate that soon delivery may be available at nearly half of our system. In order to support digital activation of the brand, we continue to invest in and improve our Noodles Rewards loyalty program, which as we noted, launched during the third quarter of 2017. We continue to see it at a tremendous platform to drive transactions, as well as develop meaningful, emotional connections with our guests.

As we've noted in the past, while off premise has appropriately drawn considerable attention throughout the restaurant industry, we believe that the variety inherent in our menu, our resonance with millennials and families, and how well our food travels, provide a competitive advantage that we intend to capitalize on in 2018 and beyond. Overall, we believe that we are only in the early innings of implementing a strategy around off promise that can result in us being best in class in fast casual for that occasion. I'm extremely excited about the opportunity that off premise presents. From an operational perspective, in February we began a phased approach of implementing strategies borne out of our best practice quest, such as updates to our prep procedures, improvements in our employee recognition programs, and changes to our staffing model. Coinciding with this launch has been the installation of self-bussing units, which are now in all of our company restaurants, and have resulted in improved employee engagement with our guests, as well as improved cleanliness scores.

We will continue to execute on our initiatives from our best practice quest throughout 2018, as well as additional efforts to continually improve our operations. Finally, I would love to discuss the area that we are perhaps most excited about. As discussed during our prior earnings call, while our research has indicated tremendous strength from the brand, one area that we identified a gap in our menu was in health perception. We are in the final stages of testing zucchini noodles and continue to be encouraged by the taste and popularity of these dishes, as well as our ability to execute them. In May, we will launch Zoodles nationwide, including a signature zucchini romesco dish.

We're also excited that our guests will have the opportunity to substitute the zucchini noodle into any one of their favorite noodle entrees. Zucchini noodles have the opportunity to increase frequency, bring lapsed users back to the brand, and introduce the brand to new guests who may have avoided us in the past due to dietary preferences. In addition to the zucchini launch in May, we will also implement several additional changes that have been in test and that we feel will help activate the brand. As an example, we will be interesting a new look and feel to our in-restaurant merchandising, particularly our welcome wall and our menu panels. Last fall, we discussed that our research indicated that the brand had become too serious and too broad in our messaging.

And we believe the color scheme and design of the new merchandising, will allow the brand to become more approachable and endearing to our guests. We are entering what I believe will be an extremely exciting time in the history of Noodles & Company. The core foundation of the brand has strengthened and is reflected in improvements in both our top and bottom line results. Beginning with the initiatives that will be launched nationally in May of this year, we are now moving with the right balance of discipline and urgency to return to positive comparable sales growth during 2018, with the intent to begin driving sustainable revenue and earnings growth for years to come. I'd now like to turn it over to Sue to provide more details on our fourth quarter performance, as well as our outlook for 2018.

Sue Daggett: Thank you, Dave. Fourth quarter 2017 total revenue decreased 12.8% year over year to $112.8 million. The decrease was primarily due to be impact of closing 55 company owned restaurants in the first quarter of 2017, combined with the fourth quarter of 2016 including an extra operating week. As Dave noted, during the fourth quarter, comparable restaurant sales decreased 0. 9% system wide, with 0.9% decrease at both company owned and franchise locations.

Comparable company owned restaurant sales included a 2% price increase and a modest benefit from menu mix shift. We also anticipate running approximately 2% of price during the majority of 2018. From a cadence perspective, comparable restaurant sales improved throughout the fourth quarter, attributable to the initiatives that Dave outlined earlier, as well as beneficial weather in December relative to prior year. Restaurant contribution margin in the fourth quarter was 15.1%, a 320 basis point improvement over the prior year. We saw a significant benefit from the restaurant closures earlier in the year.

But similar to the third quarter, we additionally saw modest margin expansion in our core restaurant base. This expansion was related to the implementation of labor savings initiatives and lower marketing spend during the fourth quarter versus the prior year. With our improvements in restaurant level margin, adjusted EBITDA increased 26.4% to $8.6 million, versus $6.8 million earned last year. As Dave noted, the improvement in adjusted EBITDA that we have seen during our most recent quarter, reflects a solidified base that we feel positions us well to execute on the initiatives that were outlined earlier. During the fourth quarter, we opened one new company owned restaurant.

For the full year, we opened 15 new restaurants system wide, including 12 company owned and three franchise locations. Our class of 2017 continues to significantly outperform prior classes and gives us increased confidence in the ultimate growth potential of the brand. That said, we still anticipate limited unit growth in the near term, with only one to five anticipated openings system wide during 2018. This pause in unit growth is allowing us the opportunity to refine the brand and work on a new prototype in advance of future accelerated unit growth. We continue to believe there is opportunity to reduce costs in our new unit development through a smaller footprint that caters more to the off premise occasion.

With our improved earnings profile, as well the more moderate unit growth rate, we continue to see liquidity improvement, which was also bolstered by our capital raise in early 2017. Long term debt as of the end of Q4 2017, was $57.6 million, a $6.2 million decrease from Q3 2017, and a $27 million decrease versus prior year. Cash on hand at the end of Q4 was $3.4 million. I would now like to discuss our guidance for full year 2018 and some of the components. As a reminder, most of the closures that were affected during Q1 of 2017 occurred towards the end of the quarter.

So we do expect to see almost favorable margin expansion versus prior year during Q1 of 2018. From a revenue perspective, our full year guidance calls for total revenue of between $440 million and $450 million for 2018. Although we do not believe it is constructive to give quarterly guidance, we do anticipate that comparable sales during Q1 of 2018 will be modestly negative. While we believe the core business continues to gain momentum, the weather benefit that we saw in December of last year, reversed itself during February of 2018, resulting in a short term negative impact to our restaurants located in the upper Midwest and Mid-Atlantic regions. We do believe that with continued momentum in the core, and with our upcoming initiatives, comparable sales will improve throughout 2018, and our guidance reflects comparable sales that are modestly positive for the full year.

From an expense perspective, we believe that modest commodity inflation and continued wage inflation, will require us to continue to execute on cost savings initiatives in order to improve our restaurant level margin and earnings profile. Aside from the potential leverage that can be gained by building average unit volume through our initiatives, we also believe there’s opportunity to improve the effectiveness of our supply chain initiatives, as well as labor efficiency. These initiatives should allow us to offset anticipated inflation. And as a result, our guidance for 2018 calls for modest improvement in restaurant level margin, adjusted EBITDA and adjusted earnings per share relative to 2017. I would now like to turn it over to Dave for final remarks.

Dave Boennighausen: Thanks, Sue. We believe we're approaching a special time for Noodles & Company. 2017 was a solid year in terms of strengthening our foundation from a financial, operational and leadership team perspective. The work that has been done in recent quarters, has allowed us to increase our capabilities to drive meaningful progress in 2018 and beyond. The initiatives we outlined today surrounding activation of the brand, from a culinary and off premise perspective, coupled with our continued focus on operational execution, represents the company's transition towards an exciting phase in our transformation strategy.

Although we recognize there's still work to be done and recognize that these initiatives are still in the early part of our long term strategic growth map, we are confident in our strategy and excited for the balance of 2018 and the years to come. Brian, please open the lines for Q&A.

Operator: [Operator Instructions] And our first question will come from the line of Nicole Miller with Piper Jaffrey. Your line is now open.

Nicole Miller: Good afternoon.

Thank you for taking my question. Just a couple of quick ones here. How many have signed up for the royalty program or rewards membership right now and how is it growing?

Dave Boennighausen: Yes. It's not a number that we disclose, Nicole, but I think one of the things we're most excited about when it comes to the program, is when we look at the monthly users that we're gaining and acquiring just in the past recent weeks and the past recent month, they're equal to and sometimes above what we did actually during the first couple of months. So it's growing at a very rapid rate, so we're pretty excited about that.

Nicole Miller: Okay. Fair. And when you talk about off premise, I want to make sure I got this right, you said about 50%, up 240 basis points. I think you said year over year, but then there was another basis points figure you gave and I didn’t understand if that was sequential. Could you clarify that please?

Dave Boennighausen: Yes, absolutely.

So quarter to date through P2, so roughly through February, we're actually seeing the acceleration year over year improve. So we're now 330 basis points above where we were year to date during 2017.

Nicole Miller: Got it. Okay. Year to date, year over year.

Excellent. And then …

Dave Boennighausen: Yes, and the year - go ahead, Nicole. I’m sorry.

Nicole Miller: And then I think I just want to make sure I understand this kind of model Q1 comp negative. Can you somehow extract weather and tell us if you would still be a little negative or be positive and am I understanding that correctly?

Dave Boennighausen: Sure.

So when you look at February, I think you see certainly many others talk about it in the industry, significant amount of weather. For us, the geographic dispersion of our restaurants so much in the upper Midwest, that's where we started to see some impact. Now, when we exclude the weather impact thus far this quarter, we do see that we're running positive comparable sales thus far. One factor I would say and why we did talk about negative comparable sales for the full quarter, we do have an Easter shift that will ultimately negatively impact us by about 50 basis points and it goes from Q1 this year. It was in Q2 of 2017.

That’s a soft volume day for us. So one reason why we expect to be modestly negative in Q1.

Nicole Miller: You’re picking up the 50 basis points in 1Q or you’re picking it up in 2Q?

Dave Boennighausen: We pick it up in Q2. We lose it in Q1.

Nicole Miller: Okay.

And then last question, the price and traffic in down 0.9 comp for 4Q, please and thanks again.

Dave Boennighausen: Yes. It was just a modest improvement, a little bit on the positive side of the ledger from menu mix, but not terribly meaningful. So pretty negligible.

Nicole Miller: Thanks.

Operator: Thank you. And our next question will come from the line of David Palmer with RBC Capital Markets. Your line is now open.

David Palmer: Good evening guys. Just a question on your guidance for 2018.

There’s so many moving parts. I know you gave a general type of guidance with up low single digits for the year, and you're starting off slightly negative, albeit with some particularly noisy weather trends lately. But you've got so much noise also in the numbers when you think about all the stuff you're doing. You’ve got delivery ramping, the loyalty apps, zucchini noodles, that improved pickup experience. I guess you're lapping some menu rationalization from last year.

So how do you really think about those things and what would you point to as the biggest moving parts that we should be thinking about through the year?

Dave Boennighausen: From a pure guidance perspective, Sue noted that Q1 of last year towards the end of the quarter is when we enacted a lot of our closures. So we do expect, David that when you think purely about the guidance from a margin perspective and overall EBITDA growth perspective, we do think there'll be a little bit more benefit in Q1 than you see through the balance of the year. Ultimately, our strategy is to really, as we enact zucchini in May, which will also come with new menu look and feel, a little bit more emphasis on some of our digital marketing, a little bit more activation of the brand. We're already seeing nice momentum in the core business. We think that momentum will continue to move throughout the year.

Think ultimately will be positive for Q2 through Q4 of 2018.

David Palmer: More specifically, like so many things you're talking about, the new experience and the zucchini noodles, a lot of those things I think are ready just in time for the second half. Do you think that the second quarter will be a step change improvement aside from Easter timing noise from the first quarter? Or are you really looking at this as predominantly a first half, second half situation?

Dave Boennighausen: We do think that the core business will just continue to accelerate. So certainly we expect the second half of the year to be stronger from an underlying trend perspective than the first half of the year. We're pretty excited with what we're already seeing.

I will say from the Q2 perspective, again we’ll get about a 50 basis point benefit during the quarter from the Easter shift. So that will help prop up a little bit what Q2 will show up in terms of same store sales. Q4 on the other hand, as we expect to continue to see underlying momentum, we just want to be cognizant of the fact that as we discussed on the call, December weather was actually favorable. So we think it had an impact on our Q4 improvement. We’re going to be overlapping a much more difficult number in Q4 of this year than we will in other quarters.

So we think that the modest to positive comparable sales will be somewhat consistent throughout the year.

David Palmer: And then just one last one on mobile order - mobile online orders, I thought it was 9%. Was that from fourth quarter? Was - I mean from third quarter? Was that the right number and is that comparable to the 13 average you say on the call before?

Dave Boennighausen: Yes. I guess similar trajectory, and one reason why we’re so excited in that, the underlying line trends we’re pretty comfortable and confident with. And we were at 9% to your point, David in Q3 of ’17.

That accelerated to 11% of sales during the fourth quarter. And year to date we're sitting at 13%. So we just continue to make nice, steady progress in terms of activating that channel.

David Palmer: Thank you.

Operator: Thank you.

[Operator instructions]. And our next question will come from the line of Andrew Strelzik with BMO. Your line is now open.

Andrew Strelzik: Hey, good afternoon everyone. I wanted first to try to better understand, in terms of the cost savings, you had some that came through in the second half of last year.

It sounds like there's going to be more layering in, then you'll start to lap those from last year. So can you quantify how much benefit to the margins you're expecting the cost savings to be, number one? And number two, how should we think about the progression of that throughout the year?

Sue Daggett: Sure. And Dave just spoke with one of the more recent questions that we do expect to see modest expansion in our restaurant contribution margin. And as he had indicated, the majority of the expansion will be in Q1 as we lap our 2017 closures. Through the balance of the year though, while we do see upside in both supply chain and labor initiatives, we as well as the industry are experiencing headwinds with respect to both wage and commodity inflation.

Given that, we are still confident that our purchasing strategy will minimize the impact of commodity inflation and expect contribution margin in Q2 through Q4 to be relatively flat to 2017.

Dave Boennighausen: Yes. And to put a bit more texture on it, I think Sue and the team have done a nice job continuing to contract more and more of our ingredients. We expect commodity inflation, Andrew, to be about 1.5% and believe that the savings that they're implementing will allow us to offset that nearly completely.

Andrew Strelzik: Okay, great.

And then there was a comment made in some of the prepared remarks about you have initiatives coming in ‘18 and then a larger effort in 2019. So could you give a little more color on exactly what you mean by that? And how are you guys thinking about the staging of all of these initiatives? Because to an earlier point, you do have a lot of moving parts and a lot of things that you're flowing in here.

Paul Murphy: This is Paul. The - really we're looking to staging almost in terms of two buckets, we are - as Dave mentioned on the call, we have several initiatives that we’ll be hitting in May of this year 2018. The plan that we have in place and the strategy that we're executing, we also have a basket of initiatives that we’re working on to put in combination to roll out in 2019 that we think are even frankly more impactful than what we're doing this year.

we're just taking the time to put them in test and get the results and make sure that we have the right combination of initiatives to accelerate the business even further than it is accelerating right now, and really put us on a course for kind of sustained, not only topline, but bottom line growth. So we're taking the time right now to test a series of initiatives that we'll bring to bear kind of second quarter of 2019. We're trying to be very disciplined about the business process behind it, making sure that not only with the consumer out there, but operationally and through our financial metrics, has a green light in all three aspects. So we're excited about what we're doing in May of this year, and even more excited about the work that we're doing against the brand and the prototype and those type of things for 2019.

Andrew Strelzik: Great.

And then my last one. The numbers that you provided on delivery, 15% of the units going towards 50%, I think they're the same as last quarter. So it doesn't sound like there was much progress made this quarter. So I guess I'm just wondering, when do you expect to see that starting to accelerate towards that 50 and how quickly does that move?

Dave Boennighausen: Sure. So we’re certainly being disciplined in our delivery strategy.

I mean as everybody knows, there's quite a bit of incrementality in terms of opportunity from a sales perspective, but the economics are ones we certainly have to be laser focused on as well. Ultimately, we're working with third party providers. And I guess there has not been quite - there has not been a lot of movement in the number of restaurants that have added delivery during the last few months, we're just really in the process of testing and it's just the timeframe in terms of getting the integrations working right. and what's really critical for us, Andrew is that we make sure that it's integrated really cleanly in our POS system, and we'd much rather take our time, ensure that we get that right to ensure the guest experience is as strong as it can be. That’s taking us a bit longer than we’d originally anticipated, but we're well on our way now.

Andrew Strelzik: So is that another layer, kind of another second half layer? Is that the way that we should think about it?

Dave Boennighausen: Yes. I think that's a good way to think of it. I mean the good news about delivery, once you get the integration working, it's actually very seamless for our restaurant operations team. It actually doesn't show up anything differently than a typical online order. So it's a relatively simple one to execute from the operation side.

Andrew Strelzik: Great. Thanks for taking all the questions.

Operator: Thank you. [Operator instructions]. And I'm showing no further questions at this time.

So now it's my pleasure to hand the conference back over to Mr. Dave Boennighausen for closing comments and remarks. Sir.

Dave Boennighausen: Thank you, Brian. Well, we appreciate everybody joining us this afternoon.

Appreciate the time and the questions. Really excited about what 2018 has to bear and looking forward to it. Hope everybody has a wonderful afternoon and evening and we’ll talk to you soon.

Operator: Ladies and gentlemen, thank you for your participation in today's conference. This does conclude our program and we may all disconnect.

Everybody, have a wonderful day.