NOODLES & Co annual report, FY2016

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Noodles & Company — FY2016 Form 10-K

Business context and reporting period. The filing covers the fiscal year ended January 3, 2017. FY2016 included 53 weeks versus 52 weeks in FY2015; the fourth quarter had 14 weeks. Noodles & Company operated 457 company-owned and 75 franchised restaurants at year-end. The company sells globally inspired fast-casual meals and reports one operating segment.

Financial performance

  • Revenue: $487.5 million, up 7.0% from $455.5 million. Company restaurant revenue rose 7.1% to $482.5 million; franchising royalties and fees were $4.9 million. The extra fiscal week contributed approximately $8.1 million of revenue.
  • Comparable sales and unit economics: Company-owned comparable restaurant sales fell 0.9%; system-wide comparable sales fell 0.8%. Average unit volume declined to $1.075 million from $1.103 million. Per-person spend was $8.68.
  • Profit and margins: Net loss widened to $71.7 million from $13.8 million; diluted loss per share was $2.58 versus $0.48. Operating loss was $67.5 million, equal to a 13.9% operating margin, compared with a $21.1 million operating loss and 4.6% negative margin in FY2015. Restaurant contribution was $61.8 million, or 12.8% of restaurant revenue, down from $73.0 million and 16.2%. Adjusted EBITDA, a non-GAAP measure, fell to $25.9 million from $38.0 million.
  • Costs and unusual charges: Restaurant impairments, closure costs and asset disposals totaled $47.3 million, including $41.6 million of restaurant impairment charges. General and administrative expense included $10.6 million for estimated payment-card claims, $3.0 million for an assistant-general-manager wage settlement, and $2.7 million of severance expense. A $27.4 million deferred-tax valuation allowance contributed to the FY2016 tax provision despite the pretax loss.
  • Cash flow and capital spending: Operating cash flow was $24.7 million, down from $44.5 million. Capital expenditures were $43.3 million; operating cash flow less capital expenditures was approximately negative $18.6 million. Investing cash use was $42.8 million and financing cash provided was $17.9 million. Year-end cash was $1.8 million.
  • Debt and liquidity: Year-end borrowings were $85.4 million under a $100 million revolving facility; $11.9 million was available after $2.7 million of letters of credit. Long-term debt on the balance sheet was $84.7 million. Current assets were $25.8 million versus current liabilities of $49.0 million. Total contractual obligations were $429.1 million, including $306.8 million of lease obligations. The company reported covenant compliance at year-end.

Material changes versus FY2015

  • Revenue growth reflected restaurant expansion and the extra fiscal week, while comparable sales and AUVs weakened. The company opened 38 company-owned restaurants in FY2016, compared with 51 in FY2015.
  • Restaurant contribution margin declined 3.4 percentage points, to 12.8%; labor, occupancy and other restaurant operating costs increased as percentages of restaurant revenue. Labor costs rose to 33.4% from 31.8%.
  • Impairments and closure-related charges increased substantially; 54 restaurants were identified as impaired in FY2016 versus 39 in FY2015. Total company-owned and franchised locations rose to 532 from 492.
  • Borrowings increased from $67.7 million to $84.7 million on the balance sheet, while operating cash flow declined by $19.8 million.

Outlook, management commentary and risks

  • Management said performance had underperformed expectations, particularly at newer-market restaurants, attributing weakness in part to rapid expansion without sufficient training and operational support. Initiatives include menu refinement, labor-efficiency tests, improved training and customer convenience measures.
  • The company closed 39 restaurants in Q1 2017 and planned to close another 18 by the end of Q2. These 57 locations generated approximately $0.7 million AUVs and a negative 22.0% aggregate restaurant contribution margin in FY2016. Management estimated $24 million–$29 million of future cash outlays and $17.5 million–$19.5 million of accounting charges related to closures.
  • FY2017 plans called for 12–15 company-owned openings, with eight already opened by the filing date, and no entry into new markets. Planned capital expenditures were $21 million–$25 million. Refranchising selected locations was planned but could take multiple years.
  • Management reported guest-satisfaction scores rising from 66% to 71% between August 2016 and January 2017, and expected a completed corporate restructuring to generate approximately $2.5 million of annual cash savings. These are management expectations, not guaranteed outcomes.
  • After year-end, the company received $18.5 million gross ($17.4 million net) from issuing convertible preferred stock and warrants to L Catterton. The preferred stock is convertible into 4.25 million Class A shares and carries an 8% annual dividend rate, increasing after six months up to 18%; warrants cover 1.91 million shares at $4.35. The company also amended its credit agreement, including suspending scheduled quarterly amortization until the end of Q2 2018. A further equity offering was contemplated, and a Form S-1 was filed February 9, 2017.
  • Key risks include execution of restaurant closures and refranchising, lease-exit costs exceeding estimates, weak comparable sales, labor and food-cost inflation, constrained liquidity and covenant compliance, and dilution from financing. The 2016 payment-card breach resulted in a $10.6 million recorded charge; the company noted potential additional card-related liabilities of up to $5.5 million and unresolved litigation whose loss range could not be estimated. The Delaware gift-card case and other claims also remain relevant contingencies.
  • The CEO and head of operations departed in 2016; the CFO was serving as interim CEO while the board searched for a permanent CEO.

Important facts for investors to verify

  • Whether comparable sales, AUVs and restaurant contribution margins stabilize after the operational changes and closures.
  • Actual closure costs and cash payments versus the $24 million–$29 million estimate, and whether the expected contribution improvement materializes.
  • Cash availability, covenant headroom, borrowing costs and compliance under the amended credit agreement; the filing’s liquidity outlook is subject to execution and operating assumptions.
  • Final payment-card breach assessments, insurance recoveries, litigation outcomes and any additional claims beyond recorded amounts.
  • Terms and dilution implications of the preferred stock, warrants and any subsequent equity issuance, including whether the $45 million equity-issuance condition is met.
  • Whether planned openings, capital spending, refranchising and corporate savings are achieved without disrupting restaurant operations or liquidity.