Noodles & Company (NASDAQ:NDLS) Q1 2024 Earnings Call Transcript May 11, 2024

Noodles & Company isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, and welcome to today's Noodles & Company First Quarter 2024 Earnings Conference Call. All participants are in 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 like to introduce Noodles & Company's Chief Financial Officer, Mike Hynes.

Mike Hynes: Thank you, and good afternoon, everyone. Welcome to our first quarter 2024 earnings call. Here with me this afternoon is Drew Madsen, our Chief Executive Officer. I'd like to start by going over a few regulatory matters. During our remarks, we may make forward-looking statements regarding future events or the future financial performance of the company. Any such items should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Such statements are only projections, and actual events or results could differ materially from those projections due to a number of risks and uncertainties, including those referred to in this afternoon's news release and the cautionary statement in the company's quarterly report on Form 10-Q and subsequent filings with the SEC.

During the call, we will discuss non-GAAP measures, which we believe can be useful in evaluating the company's operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measures is available in our first quarter 2024 earnings release. To the extent that the company provides guidance, it does so only on a non-GAAP basis and does not provide a reconciliation of forward-looking non-GAAP measures. Quantitative reconciling information for these measures is unavailable without unreasonable efforts. With that, I would like to turn the call over to Drew Madsen, our Chief Executive Officer.

Drew Madsen: Thanks, Mike, and good afternoon, everyone. We are definitely encouraged by our first quarter results as we continue to make progress against all five of our strategic priorities. Now I use the word encouraged because of the improving trends we saw in traffic and sales as we moved through the first quarter and into April. More specifically, traffic during Q4 of 2023 was down 9%. This year, traffic during Q1 was down 7.3%, only modestly better than Q4 of 2023. But what we find encouraging is the improving month-to-month trend during the quarter and into April. January traffic was minus 12% and heavily impacted by severe weather in the Midwest where we have a disproportionate number of our restaurants as well as a difficult comp prior to last year's price increase in February.

February traffic improved to minus 4.9%. March was about the same as February at minus 5.5% despite Easter shifting into the month and negatively impacting results. And most notably, traffic in April increased 0.3%. Driven by this improvement in traffic, our same-store sales gap to the fast-casual benchmark narrowed sequentially each month of the quarter with a significant improvement in April. Also in April, we exceeded the fast-casual and industry benchmarks on same-store sales for the first time since early 2023. Of course, this is only one month. We expect that our progress going forward will continue to see variability until we fully activate our strategic priorities, but we are encouraged by what we've seen thus far. Combining these sales results with strong cost management and favorable commodity costs helped us to deliver restaurant contribution margin and adjusted EBITDA above our expectations for the quarter.

Now let's talk about the progress on our five strategic priorities. Like all successful restaurant companies, creating a foundation of operations excellence is our top priority. And last quarter, we reviewed our plans to focus our operations teams on the guest experience attributes and related operations team behaviors that correlate most strongly with traffic growth. Those guests experience attributes are overall satisfaction, accuracy and taste of food. We also talked about the need to focus more on the dinner daypart, where we have lower guest satisfaction and have experienced greater traffic loss than during the lunch daypart. During the first quarter, we introduced biweekly training sessions across the system to review proper execution of a new service standard, a new accuracy standard and a new food execution standard during each training session.

We also improved the execution of our General Manager and Assistant General Manager scheduling guidelines to ensure these critical positions were in our restaurants more often during our busiest times, especially to coach and reinforce the standards that were just trained. These efforts have paid off. Overall guest satisfaction ratings at dinner after being flat every quarter in 2023 improved significantly in the first quarter this year. Food taste and accuracy guest ratings also both improved. And most importantly, we believe these guest satisfaction improvements led to improved dinner traffic versus prior year that slightly outpaced lunch during the quarter. We will continue to focus on improving guest satisfaction across all our restaurants in these areas going forward.

Supporting this guest experience progress is improved staffing and retention. In particular, our General Manager retention is significantly better than the industry and at a 10-year high for Noodles. Our second priority is to stimulate more guest desire for Noodles and make our brands more relevant, primarily through a comprehensive menu transformation that is guided by our contemporary Comfort Kitchen North Star. We will also use compelling LTOs to bridge the gap until our core menu testing plan has been successfully completed. We have finished the first two phases of our menu transformation test plan, and we are really excited about the opportunities this will present. As a reminder, Phase 1 of our menu transformation plan involved a rigorous concept testing process with a best-in-class vendor, data essentials to identify the highest potential concepts to take into actual menu development.

We completed this phase in late February and the culinary edge began development against the strongest ideas for both new and improved dishes. During Phase II, we placed the new and improved dishes created by the culinary edge in a central location test where Noodles customers who are also concept acceptors tasted and rated each dish. To move forward, improvements to existing dishes had to be preferred compared to the existing dish and score higher than our current menu average. New dishes also had a score higher than our current menu average. The result of all this work is very encouraging. We have identified multiple new dishes that address gaps in our current menu plus improvements to existing niches that meet our concept and central location excellence standards and are ready for in-market testing, which will begin this summer as we ensure operations and our supply chain can support an in-market test.

We are also working on a new menu board design that is much easier for guests to navigate, easier to place an order and more contemporary and look and feel. Results from our menu design test will be available at the end of May. Phase 3 of our carbon menu transformation will marry our new and improved dishes with our new menu board design in the three market in-restaurant test this summer. Our goal is to keep the number of menu items and operational complexity close to the current menu. So the addition of new items will likely result in the elimination of some existing weaker performers. Managing both the guest and operator reaction to these menu additions and deletions is one of the most important reasons to do an in-market test. Assuming positive in-market test results, we will introduce these new and improved dishes as well as our new menu design nationally early in Q1 of 2025 as we develop significant marketing plans, necessary operational training and supply chain capabilities and get past the holidays, which would not be the right time for a full product rollout.

We plan to introduce a second phase of new dishes and product improvements nationally during Q2 of 2025, once our guests and restaurant teams have had a chance to acclimate to the changes, both additions and deletions introduced during Q1 of 2025. Product testing is already underway for this second phase. Now let's talk about our LTO plans. I mentioned earlier, our plan to regularly introduce LTOs as a bridge to excite guests and help drive traffic until our menu transformation is complete. Our current LTO, Steak Stroganoff, has been very successful with sales almost 50% higher than our forecast, so successful, in fact, that we ran out of product several weeks before we intended to end the promotion. Our new production run is in process, and we will bring Steak Stroganoff back in mid-May.

Our next LTO will be Baked Alfredo with Grilled Chicken. This will launch in early June and is another broadly appealing comfort dish similar to Chicken Parmesan and Steak Stroganoff. Concept scores for Baked Alfredo with Grilled Chicken are meaningfully higher than Chicken Parmesan, which was a strong LTO last year. So we're excited about what this dish can do. Finally, to bridge Q4 to early 2025, two of the new TCE dishes going into test in late June will be introduced nationally in early Q4 this year and remain on the menu. Our third strategic priority is to broaden our guest base by further leveraging our strong digital ecosystem. As a reminder, Noodles has 53% of sales from digital channels and 26% of orders from loyalty members and our loyalty members spend twice as much per year as non-loyalty members.

Our strategy for 2024 is to build on this strength by increasing active membership and frequency in our loyalty program, leverage personalized data from our new customer data platform to increase conversion and build frequency and extend our reach by expanding digital marketing touch points. During Q1, we increased our active rewards audience and transactions while reducing our discount rate by using smart segmented and personalized offers. During the quarter, active users and their transactions increased roughly 7%, while our related discounts dropped by approximately 15%. To accelerate our progress here, we plan to launch SMS communication channel during the second half of 2024. This allows us to send text messages to anyone who has opted in to this communication channel.

They do not need to have downloaded our app or be a loyalty member, so it's a great way to expand our reach to non-loyalty members. To drive greater brand awareness and attract more new customers to our digital assets, we're testing additional investment in digital media channels that have broader reach and can tell a more compelling brand story. Connected TV refers to any device that can stream content from the Internet, including services like Hulu, Amazon Prime and Disney+. Our first test on Connected TV showed a 2.8% lift in incremental traffic and delivered a solid return on investment. We will continue to learn and refine this new tactic in preparation for our new menu launch. Additionally, we are increasing our focus and investment in search engine optimization to ensure our brand is outperforming competitors in search results.

We believe there is significant opportunity to drive digital traffic by strengthening organic search and investing in tactics that build top-of-mind brand awareness. Third-party delivery was one of our strongest channels this quarter, especially in April. We will continue to invest in a multipronged strategy that is yielding profitable incremental traffic. Our fourth strategic priority is to maintain double-digit quarterly growth in our catering business, while we also fixed the fundamentals as a prerequisite before driving even more aggressive growth in the future. Noodles has never made a sustained commitment to grow catering sales and it shows in our fundamentals. In particular, we want to reduce friction for operations and ultimately create a culture where we can confidently say yes to every order.

This will include revisiting our ship processes to clarify who delivers a catering order, removing additional steps required to input an order into our POS and updating our catering menu offerings and pricing. We now have an industry experienced catering leader for the first time, and I am excited about the focus she has already brought to this area where Noodles should excel. Catering is roughly 1.5% of sales today. We believe it can be 5% of sales or more. But we need to reduce the complexity in our operating model and enhance our menu offering before aggressively pursuing new growth opportunities later this year and into next year. Our final strategic priority is to strengthen our financial foundation with proactive cash management and an increased emphasis on operational efficiency across the business.

We have reduced our capital spending from $51 million in 2023 to a projection of $28 million to $32 million this year. This is largely driven by a reduction in new restaurants and the completion of our digital menu boards rollout. In addition, during January, we implemented a major cost reduction effort that will save approximately $4 million this year, which was reflected in our guidance. This cost reduction initiative includes headcount reduction in areas we have deprioritized in the short term like new unit openings, plus benefit adjustments that save money while still keeping us competitive in the marketplace and supply chain savings through improved vendor management and product optimization. None of this was easy, but it was necessary.

And our cost structure is now more closely aligned with the size of our current business. We have also created a smart cost savings team to continue to look for cost savings opportunities going forward. As you can see, we've made substantial progress and are excited about the future of our brand as we implement and execute on our strategic priorities and restore our culture of winning. Now I'll turn it over to Mike to review our financial results in more detail.

Mike Hynes: Thank you, Drew. In the first quarter, our total revenue decreased 3.7% compared to last year to $121.4 million. Company average unit volumes in the first quarter were $1.25 million. System-wide comp restaurant sales during the first quarter decreased 5.4%, including a decrease of 5.7% at company-owned restaurants and a decrease of 4.5% at franchise restaurants. Company comp traffic during the first quarter declined 7.3% and pricing contributed 1.4%. We estimate that severe weather during the first quarter, primarily in January, negatively impacted our first quarter comp sales by approximately 60 basis points. We also experienced a shift in the Easter holiday from the second quarter in 2023 to the first quarter in 2024.

We estimate that the Easter holiday shift negatively impacted our first quarter comp sales by approximately 30 basis points. As Drew mentioned, we are encouraged by recent sales trends turning positive in April, fueled by an enthusiastic guest response to our Steak Stroganoff LTO and as we have fully lapped last year's price increase. April company-owned comp sales increased 2.7% and traffic increased 0.3%. Turning back to our first quarter. Restaurant level contribution margin was 13.1%, down from 13.7% in the first quarter of 2023. The decrease in our restaurant contribution margin was primarily due to sales deleverage. As a reminder, our first quarter is historically seasonally slower than our second and third quarters, which has a negative impact on our first quarter restaurant contribution margin compared to the full year.

Costs in the first quarter was 25% of sales, a 20-basis point improvement from last year, with year-over-year food inflation coming in below 1% for the quarter. Labor costs for the first quarter were 32.3% of sales, which was flat to prior year. Labor productivity and lower benefit costs contributed 80 basis points to restaurant contribution margin when compared to 2023, which was offset by wage inflation and sales deleverage. Wage inflation continued to moderate in the first quarter with year-over-year early rate growth of 2.1% for the full quarter primarily due to sales deleverage, occupancy costs increased 60 basis points over prior year to 9.9%, and other restaurant operating costs increased by 20 basis points in the first quarter to 19.7%.

G&A for the first quarter was $13 million compared to $13.6 million in 2023, primarily due to a decrease in employee-related costs, partially offset by an increase in planned marketing spend. G&A in the first quarter of 2024 was also negatively impacted by $473,000 of severance and executive transition costs. Net loss for the first quarter was $6.1 million or a loss of $0.14 per diluted share compared to a net loss of $3.1 million and a loss of $0.07 per diluted share last year. Adjusted EBITDA for the first quarter was $5.5 million compared to $6.2 million in the first quarter of 2023. In the first quarter, we opened two new company-owned restaurants and closed two restaurants at or nearly beat expiration. One franchise restaurant was opened and two were closed in the first quarter of 2024.

In April, we opened two new company-owned restaurants, bringing our year-to-date total company openings to 4. We continue to expect to open 10 to 12 total new company-owned restaurants in 2024 for the full year. Subsequent to the end of the quarter, we refranchised six restaurants in the Portland, Oregon area to a new franchise group. These units were geographically distant from the rest of our company-operated system. In addition, our franchise partner has signed a development agreement to open a total of 20 new restaurants in the Portland, Oregon area through 2030. Turning to the balance sheet. At quarter end, we had cash-and-cash equivalents of $1.3 million and a total debt balance of $83 million. This is just $800,000 higher than our debt balance from the previous quarter despite a seasonally low quarter for operating cash flows.

We currently have over $30 million of incremental liquidity available for future borrowings under our credit facility. We are committed to strengthening our balance sheet, and our goal is to be free cash flow positive on a sustainable basis heading into 2025. With capital expenditures forecasted to decrease in the back half of the year, we feel positive about our ability to make debt paydowns in the fourth quarter of 2024. With that, I'll turn the call back over to Drew for final remarks.

Drew Madsen: Thanks, Mike. We've made substantial progress across all five of our strategic pillars and are confident in our ability to regain consistent, profitable growth with this unique brand. Our foundation of operations excellence is improving. The guest reception of our LTOs like Steak Stroganoff has showcased that when we get our menu offerings right, we can drive traffic into our stores and close the gap too and even exceed the industry. Accordingly, our core menu update continues to progress on track with the market test scheduled for this summer. And finally, we believe continued improvement in our sales trends, combined with smart cost savings and thoughtful investment will position us to be free cash flow positive by the fourth quarter of 2024. Thank you for your time today. Operator, please open the lines for Q&A.

Operator: Thank you. At this time, we will conduct a question-and-answer session. [Operator Instructions] Our first question comes from the line of Todd Brooks of The Benchmark Company. Your line is now open.

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