Noodles & Company — Q1 2017 Form 10-Q
Business context and period: The quarter ended April 4, 2017, compared with the quarter ended March 29, 2016. The company operated 409 company-owned and 73 franchise restaurants across 31 states and Washington, D.C. Results are unaudited; the quarters each comprised 13 operating weeks.
Financial results
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Total revenue | $116.7 million | $114.0 million |
| Operating loss | $25.6 million | $2.8 million |
| Net loss | $26.8 million | $2.4 million |
| Net loss attributable to common stockholders | $27.8 million | $2.4 million |
| Loss per share, basic and diluted | $0.99 | $0.09 |
| Adjusted EBITDA | $3.8 million | $5.4 million |
| Operating cash flow | $(8.1) million | $5.7 million |
| Capital expenditures | $6.6 million | $12.3 million |
Revenue increased 2.4%, but comparable sales fell 2.0% system-wide (company-owned: down 2.5%; franchise: up 1.1%). Company-owned average unit volumes were $1.067 million, down 3.1%. Restaurant contribution, calculated as restaurant revenue less restaurant operating costs, was approximately $12.7 million, or 11.0% of restaurant revenue, versus $15.0 million, or 13.3%, a year earlier.
Operating margin deteriorated sharply, largely due to $22.1 million of restaurant impairment, closure and disposal charges, including $19.9 million of closure costs. Cost of sales rose to 27.8% of restaurant revenue from 26.7%; labor rose to 34.3% from 33.2%; and occupancy rose to 12.1% from 11.8%. Adjusted EBITDA excludes specified items and is a non-GAAP measure.
Cash and equivalents were $3.2 million at April 4, versus $1.8 million at January 3, 2017. Long-term debt, net, was $52.8 million on the balance sheet; the company reported $54.1 million drawn on its $100 million revolving facility and $2.7 million of letters of credit. It reported covenant compliance. Financing cash flow was $16.1 million, including proceeds from equity transactions, partly offset by debt repayments.
Material changes and management outlook
- The company closed 55 company-owned restaurants in Q1, citing significant underperformance; four restaurants were identified as impaired. Restaurant closure and impairment charges drove most of the increase in losses. Management expects the closures to improve future restaurant-level performance, but benefits are not assured.
- Management planned 12–15 company-owned openings in 2017, with eight total system openings in Q1 (seven company-owned and one franchise). It anticipated slower unit growth and no entry into new markets in 2017, to focus on operations and profitability.
- Management estimated 2017 capital expenditures of $21–$25 million and restaurant-closing liabilities of $24–$29 million, including $23–$28 million for lease terminations and related costs, payable over the next 12–18 months. It stated that expected operating cash flow, equity proceeds and credit availability should cover anticipated needs for the remainder of 2017 and the next 12 months.
- Two Q1 equity transactions generated $50.0 million gross proceeds: L Catterton purchased convertible preferred stock and warrants for $18.5 million; Mill Road purchased common stock for $31.5 million. The preferred stock converted into 4,252,873 Class A shares on April 12, 2017. The Mill Road issuance added 8,873,240 Class A shares. The transactions provided liquidity but increased potential and actual dilution.
- Management cited rising wage rates and benefits, minimum-wage increases, commodity inflation, lower AUVs, and weaker company-owned comparable sales as operating pressures. The company maintained a full valuation allowance on U.S. and Canadian deferred tax assets and anticipated no material income tax expense or benefit for the rest of 2017.
Risks, contingencies and unusual items
- Data security incident: The 2016 payment-card breach led to a $10.6 million accrual for payment-card claims, with potential exposure up to $5.5 million above that estimate. A related class action remained at an early stage; potential losses were not estimable, and the company warned that some exposure could exceed insurance limits. Further fees and costs were expected.
- Delaware gift-card litigation: Certain claims survived a motion to dismiss; trial was scheduled for January 8, 2018. The company had recorded an accrual but could face greater losses.
- Credit facility: Borrowing availability depends on financial covenants. The company said it expected to remain compliant but cautioned that failure could require a waiver or amendment, with no assurance lenders would agree.
- Other unusual items: Q1 included $639,000 of costs related to a withdrawn registration statement and $203,000 of severance costs. The preferred-stock discount created a $1.0 million deemed dividend in Q1; the remaining $7.0 million discount was to be recognized at conversion in Q2.
- The company expected adoption of the new lease standard to significantly increase reported non-current assets and liabilities. Revenue-standard adoption was expected to change the timing of initial franchise-fee recognition, generally spreading it over the franchise agreement term.
Important facts for investors to verify
- Whether restaurant closures improve comparable sales, restaurant contribution margins and adjusted EBITDA, and whether further impairments or closures are needed.
- Cash generation and liquidity after funding the estimated closure liabilities, breach-related costs, capital expenditures and debt service.
- The ultimate cost of payment-card claims, the Selco litigation and related insurance recoveries, as well as the outcome of the Delaware gift-card case.
- Compliance with credit-facility covenants and remaining borrowing availability; reported debt and letters of credit are subject to covenant limits.
- The impact of the preferred conversion and common-stock issuance on share count, dilution and future earnings per share.