Noodles & Company — Q3 2016 Form 10-Q
Reporting period: Fiscal quarter ended September 27, 2016; comparisons are with the quarter ended September 29, 2015. Year-to-date figures cover the first three fiscal quarters. The company operates fast-casual restaurants and reported one operating segment. At quarter-end, it had 455 company-owned and 73 franchised restaurants.
Financial performance
| Metric | Q3 2016 | Q3 2015 | First three quarters 2016 | First three quarters 2015 |
|---|---|---|---|---|
| Total revenue | $122.7 million | $117.3 million | $358.1 million | $338.3 million |
| Operating loss | $9.1 million | $15.3 million | $23.2 million | $14.6 million |
| Net loss | $9.8 million | $9.8 million | $26.3 million | $9.5 million |
| Diluted loss per share | $0.35 | $0.35 | $0.95 | $0.32 |
| Adjusted EBITDA (non-GAAP) | $6.2 million | $8.7 million | $19.2 million | $30.2 million |
Q3 revenue rose 4.6%, principally from restaurant openings, despite a 0.7% system-wide comparable-sales decline. Company-owned comparable sales fell 0.9%; franchise comparables rose 0.6%. Company-owned average unit volume (AUV) declined 2.2% to $1.087 million. For the first three quarters, system-wide comparable sales declined 0.6%.
Q3 operating loss improved year over year largely because restaurant impairment and closure-related charges were much lower than in Q3 2015. Net loss was nearly unchanged, while year-to-date net loss increased substantially. Q3 costs included $2.5 million of severance and a $3.0 million estimated labor-litigation settlement. Adjusted EBITDA is a company-defined non-GAAP measure.
Restaurant cost pressures continued. As a percentage of restaurant revenue, Q3 cost of sales increased to 27.3% from 26.6%, labor to 33.7% from 32.4%, occupancy to 11.4% from 11.1%, and other restaurant operating costs to 15.2% from 14.6%. Management attributed increases to commodity inflation, higher wages and benefits, lower AUV deleverage, menu changes, and maintenance and marketing costs. Q3 G&A increased 62.5% to $15.3 million, including the severance and litigation charges.
Cash flow, balance sheet and debt
- Cash and cash equivalents were $2.0 million at September 27, 2016. Total assets were $239.6 million and stockholders’ equity was $70.8 million.
- Balance-sheet long-term debt, net, was $84.0 million, compared with $67.7 million at December 29, 2015. The company reported $84.5 million drawn on its $100 million revolving facility and $2.7 million of letters of credit outstanding.
- For the first three quarters, operating cash flow was $16.1 million, down from $37.9 million. Capital expenditures were $33.8 million; investing cash outflow was $33.3 million. Financing provided $17.2 million, mainly reflecting increased revolver borrowing. Cash increased just $54,000.
- Current assets of $27.1 million were below current liabilities of $35.5 million. The company described its operations as typically having negative working capital and said expected operating cash flows and borrowing capacity would cover needs for the next 12 months.
- At quarter-end, the company was in compliance with debt covenants, but reported lease-adjusted leverage of 5.22x against a 5.25x maximum and fixed-charge coverage of 1.57x against a 1.50x minimum. A 1% change in the variable interest rate would change annualized pretax interest expense by approximately $0.8 million.
Outlook, material changes and risks
- Management planned approximately 44 system-wide openings, including 38 company-owned, by fiscal year-end, and approximately 10–15 new company-owned restaurants in 2017. It expected slower unit growth, continued wage inflation, and reduced pre-opening costs; lower AUVs at newer restaurants could pressure restaurant-level margins.
- Estimated FY2016 capital expenditures were $35–$40 million, including $26–$31 million for new restaurant construction before landlord reimbursements. Management expected 2017 capital spending to decline with fewer openings.
- On November 4, 2016, after quarter-end, the credit facility was amended to add $2.5 million quarterly amortization beginning in Q3 2017, increase pricing, tighten growth-capital and new-lease restrictions, and revise covenants. Growth capital expenditures are limited to $4 million in Q4 2016 and $10 million per fiscal year thereafter; new restaurant leases require either compliance with a 5.00x lease-adjusted leverage ratio or at least $10 million liquidity. Management expected covenant compliance for FY2016 but cautioned that a future breach could require a waiver and adversely affect liquidity.
- A payment-card data incident affected certain locations from January 31 through June 2, 2016. The company expected processor assessments and faced three purported financial-institution class actions. Potential losses and total future costs were not reasonably estimable; the company warned they could exceed applicable insurance coverage and materially affect future results.
- The labor-law class/collective action settlement was agreed in principle and subject to court approval; the company recorded a $3.0 million charge. CEO and chairman Kevin Reddy resigned in July 2016; related Q3 charges included $2.5 million severance and $0.7 million for modification of his stock options.
- The company recorded a $0.9 million valuation allowance against U.S. and Canadian deferred tax assets and said it did not anticipate material income tax expense or benefit for the remainder of FY2016 as a result.
Important facts for investors to verify
- Whether comparable sales, AUVs, and restaurant-level margins stabilize, particularly at newer locations.
- Whether the company can meet revised credit covenants and fund operations and capital needs under the amended facility’s growth restrictions and repayment schedule.
- The eventual cost, insurance recovery, and litigation outcomes related to the data incident, including whether losses exceed policy limits.
- Court approval and final cost of the labor-law settlement, and whether severance and overhead-reduction plans deliver expected savings.
- Actual restaurant openings and capital expenditures versus management’s plans, and the effect of continued labor, commodity, and interest-rate pressures.