Noodles & Company — Q2 2017 Form 10-Q
Reporting period: Fiscal quarter ended July 4, 2017; year-to-date figures cover the two fiscal quarters ended July 4, 2017. Comparisons are to the fiscal quarter and first two fiscal quarters ended June 28, 2016. Amounts are in U.S. dollars.
Business context and operating results
The company operates fast-casual restaurants and reports one segment. At July 4, 2017, it had 413 company-owned and 73 franchised restaurants. It closed 55 company-owned restaurants in Q1 2017, primarily underperforming locations, and opened 11 company-owned restaurants in the first half.
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Total revenue | $112.8m | $121.4m | $229.5m | $235.4m |
| Operating loss | $0.8m | $11.3m | $26.5m | $14.2m |
| Net loss | $1.8m | $14.1m | $28.7m | $16.5m |
| Net loss attributable to common stockholders | $8.8m | $14.1m | $36.6m | $16.5m |
| Adjusted EBITDA | $8.7m | $7.5m | $12.5m | $12.9m |
| Operating cash flow | Not presented by quarter | $(8.2)m | $12.3m |
Q2 company-owned comparable sales fell 3.9% and system-wide comparable sales fell 3.4%; first-half declines were 3.2% and 2.7%, respectively. Company-owned average unit volume was $1.065m, down 2.5% from $1.092m. Restaurant contribution, calculated as restaurant revenue less restaurant operating costs, was approximately $16.8m (15.0% of restaurant revenue) in Q2 versus $16.4m (13.7%) a year earlier; first-half contribution was approximately $29.5m (13.0%) versus $31.5m (13.5%).
Q2 cost of sales, labor, occupancy and other restaurant operating costs were 26.5%, 32.6%, 11.3% and 14.5% of restaurant revenue, respectively. First-half cost of sales and labor ratios worsened to 27.2% and 33.5%, while other restaurant operating costs improved to 14.7%. Management cited commodity inflation and menu-change waste for food-cost pressure, wage increases and lower sales volumes for labor deleverage, and reduced marketing expense for lower other operating costs.
Financial position, liquidity and capital
- Cash and cash equivalents were $3.2m at July 4, 2017, versus $1.8m at January 3, 2017. Total assets were $197.4m and total liabilities were $153.5m.
- Long-term debt, net, was $60.9m on the balance sheet. Management reported $62.1m borrowed under the revolving credit facility and $3.0m of letters of credit outstanding. The facility has a $100m commitment and matures in June 2020; availability is subject to covenants. The company was in compliance with covenants at quarter-end.
- First-half investing cash outflow was $12.2m, mainly capital expenditures, versus $24.0m in the prior-year period. Financing provided $21.8m, including net proceeds from equity transactions, partly offset by debt repayments. Cash increased $1.3m during the period.
- The company raised $50.0m gross in 2017 private placements: $18.5m gross from L Catterton and $31.5m gross from Mill Road. The preferred shares converted into 4.25m common shares in April; the Mill Road transaction issued 8.87m common shares. Preferred-stock accretion added $7.0m to Q2 loss attributable to common stockholders and $8.0m for the first half.
Material changes, outlook and management commentary
Revenue declined 7.1% in Q2, primarily reflecting the 55 restaurant closures and lower average unit volumes; first-half revenue declined 2.5%. Q2 operating loss improved substantially year over year, mainly because restaurant impairment and closure costs were lower. First-half operating loss worsened, reflecting $24.9m of impairment, closure and disposal costs, including costs related to the Q1 closures. Q2 adjusted EBITDA rose to $8.7m from $7.5m, while first-half adjusted EBITDA declined to $12.5m from $12.9m.
Management planned 13 company-owned openings for 2017, with 11 completed through the first half, and expected slower development to support focus on operations and profitability. Estimated 2017 capital expenditures were $19m–$23m, including $7m–$9m for new restaurant construction before landlord reimbursements. Management estimated restaurant-closing liabilities of $18m–$23m for 2017; approximately $8m had been paid, with $10m–$15m expected over the following nine to 15 months. It stated that cash, expected operating cash flow, placement proceeds and credit availability were expected to fund requirements for the next 12 months and the remainder of 2017. No specific revenue or earnings guidance was provided.
Risks, contingencies and unusual items
- Restaurant closures and impairments: A Q2 gain of $3.6m related to landlord liability adjustments on lease terminations partly offset closure costs. Thirteen restaurants were identified as impaired in the first half. Further impairments may arise.
- Data security incident: The company had recorded $10.6m for estimated payment-card claims and said actual liabilities could be up to $5.5m higher. It expected additional incident-related costs, some of which could exceed insurance coverage. The Selco litigation was dismissed in the company’s favor in July 2017, subject to appeal.
- Other litigation: Delaware gift-card litigation remained pending, with trial set for May 21, 2018; the company warned losses could exceed its existing accrual. An employment settlement reserve was reduced by $0.4m in Q2, recorded as a gain.
- Liquidity and operating risks: First-half operating cash flow was negative, and the company cited wage inflation, commodity costs, sales and traffic weakness, staffing, competition, and execution of restaurant and operational strategies as risks. A 1% change in the effective rate on variable-rate debt would change annualized pretax interest expense by approximately $0.6m.
- Accounting changes: The company expected Topic 606 adoption in fiscal 2018 to defer recognition of initial franchise fees over franchise agreement terms. It expected the new lease standard, effective for it in fiscal 2019, to significantly increase balance-sheet assets and liabilities.
Important facts for investors to verify
- Whether comparable sales, traffic and average unit volumes improve after the 55 closures.
- Actual closure liabilities, cash payments, future impairment charges and the realized benefit to restaurant margins.
- Remaining data-breach exposure, insurance recoveries, payment-card assessments and any appeal in the Selco case.
- Debt availability and covenant headroom, especially as closing costs and operating cash flow affect liquidity.
- Progress against the 2017 opening and capital-spending plans, and the impact of equity issuance and preferred conversion on share dilution.