Noodles & Company

Good afternoon and welcome to today's Noodles and Company second quarter 2020 earnings conference call. All participants are now in a listen-only mode. After the presenter's remarks, there will be a question and answer session. As a reminder, this call is being recorded. I will now introduce Noodles and Company's chief financial officer, Ken Kiewik.

Thank you and good afternoon, everyone. Welcome to our second quarter 2020 earnings call. Here with me this afternoon is Dave Benninghausen, our Chief Executive Officer. I'd like to start by going over a few regulatory matters. During our opening remarks and in response to your questions, we may make forward-looking statements regarding future events or the future financial performance of the company. Any such items, including details relating to our future performance, Thank you for joining us. for its 2019 fiscal year and subsequent filings with the SEC are considered a part of this conference call, including the portions of each that set forth the risks and uncertainties related to the company's forward-looking statements. I refer you to the documents the company files from time to time with the Securities and Exchange Commission, specifically the company's annual report on 4A for its 2019 fiscal year and subsequent filings we have made. These documents contain and identify important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. 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 reference to these measures to the most directly comparable gap measures is available in our second quarter 2020 earnings release and our supplemental information. Now, I'd like to turn it over to Dave Benninghausen, our Chief Executive Officer.

Thanks, Ken, and good afternoon, everyone. Since we last spoke, of course, the country, the restaurant industry have continued to face unique challenges in all walks of American life. I'm immensely proud of our team members and our partners for their unwavering commitment to providing delicious meals prepared safely and consistently at our restaurants across the country. Our team members and partners have risen to the challenge presented during the last few months. And as a result, I am confident that Noodles & Company is positioned to be one of the strongest performers in the restaurant space for the balance of 2020 and for years to come. I'd like to spend our time today focusing on the three primary reasons We feel the Newels & Company's future is particularly bright. First, the trust and brand equity we have gained over the past few months through our approach to ensuring a safe and healthy environment for our team members and for our guests. Second, the brand's positioning and the initiatives that have led to our sales recovery since the onset of the COVID pandemic. And finally, our strong new unit performance and our increased confidence in the company's ability to accelerate unit growth with a prototype that's perfectly situated for the needs of today's consumer. Of course, our first priority remains ensuring a safe environment for our teams and guests, particularly as we reopen our restaurants for on-premise dining. During the crisis, Noodles & Company has been an industry leader in terms of implementing health and safety protocols, including being one of the first to shift to an off-premise only model back in March, supplemented with enhanced cleaning and QA procedures in all of our restaurants. This commitment has continued as we now reopen dining rooms, with the recent implementation of face masks required for all team members and guests at company restaurants, and generally just taking a conservative approach to the reopening of dining rooms based on the COVID trends that we see in each particular market. It's worth pointing out that the guest satisfaction scores have improved meaningfully over the past few months, particularly in those order methods where guests interact directly with the brand in the order process. We feel this improvement reflects that our approach has helped gain the trust of guests and that's going to be really influential as we grow in the years to come. This leading approach to health and safety has been complemented with an incredibly strong digital business that allows guests to enjoy contactless transactions both at our restaurants and in the comfort of their own homes. The company really did not begin offering on-premise dining in earnest until just recently in most of our locations. As of yesterday, 92% of company locations offer limited-in restaurant dining or patio seating. This is up from just 40% as of the end of June, with really most of that increase occurring just in the last several days. Our ability to achieve solid sales growth over the last few months, particularly with limited dine-in, is evident to the brand's strength in both digital and off-premise. This strength leads to our second focus of today, which is a discussion of our recent sales trajectory and the financial performance from Q2. As we announced earlier today, our comparable restaurant sales during the second quarter were down 30.1% at company-owned restaurants. Our average unit volumes, normalizing for temporary restaurant closures, declined 25.8% year-over-year. Restaurant-level margins in the second quarter were 6.7% and adjusted diluted loss per share was 18 cents. However, as you look at the monthly cadence of comparable restaurant sales at company-owned restaurants, sales declined 47% during our fiscal fourth period, improved to a 29% decline in the fifth fiscal period, and then improved to a 17.7% decline during the period of Q2. Thus far, during the third quarter, our comparable restaurant sales at company-owned restaurants continue to significantly improve, not to an 8.8% decline during the fiscal seventh period. Meanwhile, average unit volumes, which again normalized for temporary closures, including our closure of all company restaurants during the 4th of July weekend, saw only a decline of 0.5% versus prior year, as we show further progress in returning to prevails levels. Average unit volumes increased to 1.18 million during the last two weeks of the July fiscal period, and average unit volumes have continued to increase into the first week of August. The fact that our average unit volumes are now nearly in line with prior year results is a testament to the brand's particular strength in meeting the changing consumer needs that have occurred over the past few years but have really accelerated during the COVID pandemic. First, let's talk about the particular resonance for the off-premise occasion. Even prior to the onset of the COVID pandemic, off-premise sales had grown to 60%. as our concept possesses the speed of service, value, and the variety necessary to meet the consumer need for convenience. Additionally, our food travels extremely well relative to many competitors, and we resonate with younger demographics and families who have gravitated towards off-premise occasions. Of course, capitalizing on this competitive advantage has required a strong digital, which has been bolstered by investments made over the last few years in our digital infrastructure and in our rewards programs. Additionally, since the COVID pandemic began, the company has made several significant enhancements to our digital and off-premise offerings, including the national expansion of our partnership with Uber Eats, the implementation of curbside delivery at the vast majority of our restaurants, and the ability to order delivery directly from our website and app. Our digital strength has been a tremendous driver of our improving sales trends over the weeks, culminating in digital growth during the June fiscal period of 155% over last year in pure dollars and accounting for 67% of overall sales. With many of our restaurants opening for in-restaurant dining really just in the past several days, it's too early to determine exactly how much of our digital sales increase will be retained. However, during our most recent July fiscal period, even as dining rooms open, digital sales continue to represent almost two-thirds of all revenue. Our initial results as we reopen dining rooms do support our thesis that much of the digital sales gained during the COVID pandemic have come from increased trial and market share gains as guests have either newly discovered the brand or they've discovered new ways to use us. I want to share two data points that give me great confidence in this thesis. First is the strength of our afternoon and dinner business. During the last fiscal period, sales from 2 p.m. to close represented nearly 70% of our overall sales volume, and comparable sales during this timeframe were up 5%. While our lunch business remains down, it's improved meaningfully since the onset of the pandemic, and it's only going to strengthen as on-premise dine-in resumes and further on as guests return to offices during the workday. Another data point is that we have seen particular strength in markets with less brand awareness, where adoption of our digital platforms have spurred strong sales. As an example, Northern California and Phoenix achieved AUV growth of 7.6% during the July fiscal period, with 64% of their sales coming from digital transactions. Our digital growth has been buoyed by a continually strengthening rewards program, which has now grown to 3.3 million members. During the COVID pandemic, we've seen record number of daily signups, with an average 40% increase relative to pre-COVID levels. While we've been able to target specific messages and promotions based on certain guest behavior, we really believe we are still very early in unlocking the ability to utilize great guest data to better engage with our guests. We expect our rewards program to be a meaningful driver of AUV growth during the balance of 2020 and beyond. While we've improved access and engagement with the brand over the past few years and during the pandemic, we've additionally innovated around our core menu to meet changing consumer needs. During the second quarter, we introduced Perfect Bowls, which are available online and they offer pre-customized curated versions of our popular dishes to meet keto, paleo, gluten-sensitive, and vegetarian diets. We've also innovated around our popular mac and cheese lineup, introducing a new ham and gruyere mac and cheese as well as introducing kid-friendly animal noodle shapes into our kids' menu. As we previously discussed, due to COVID, we had delayed testing new menu items over the past few months, but we continue to make progress in building our pipeline and are returning to testing new menu items again. One example of this will be cauliflower gnocchi, which will be entering in-market test next Wednesday, August 12th. Building off the great success of our zucchini and cauliflower noodle launches of the past couple years, were particularly excited to get this dish in front of our guest. The cauliflower gnocchi meets several diets of today's consumer, including being gluten-free with significantly reduced carbohydrates and calories relative to a traditional wheat pasta, all with the great taste that people expect from Noodles & Company. Of course, these initiatives would not have had nearly the impact if it weren't for a tremendous team executing the brand every day inside our restaurants. For the past few years, and even more so in the past few months. We've invested in building our people and our culture as a competitive strength. Since the onset of the COVID pandemic, we have committed to our team through the activation of our foundation and the introduction of emergency paid sick leave to support team members impacted by the pandemic. We've also provided bonuses to our field level employees during Q2 and we closed our company restaurants the 4th of July weekend as a thank you for their incredible work over the past few months. Most recently, we have taken several actions to enhance the focus on inclusion and diversity throughout the organization to fulfill our mission to always nourish and inspire every team member, guest, and community we serve. As many restaurateurs will tell you, few things are as correlated with success as management tenure. Our current average restaurant general manager has been with the company for almost five and a half years. This is an improvement of 15 months from our average tenure just two years ago, as our retention has improved dramatically. This bodes extremely well for our ability to maintain our momentum and successfully execute our growth strategy, which leads to the third reason that we think Noodles & Company is positioned to be a winner in the current environment. That is our potential to meaningfully accelerate unit growth. As we have said in prior calls, our most recent openings have been particularly strong. and that continued during the second quarter. The six restaurants that opened in 2019 or 2020 achieved average unit volumes 14% above the company average and also an impressive restaurant level margin of 19.4%. Many of these restaurants include the order ahead drive-through pickup windows, a feature that we will target in at least 70% of new units in the future pipeline. While during the uncertainty at the onset of the pandemic we intentionally delayed our unit growth, the success of these recent openings, our overall sales recovery, and the strength of our cash position as well as the support of an amended senior credit facility gives us increments in our ability to accelerate unit growth in 2021 and beyond. We do anticipate that there is going to be meaningful disruption in the real estate environment for restaurants in the coming years. and we're excited about the opportunity for us to take advantage of that disruption with a more efficient, off-premise oriented footprint. During the fiscal seventh period, we had 50 company restaurants with annualized volume above $1 million coming solely from digital options. As you can imagine, that provides us greater confidence, not just in a reduced square footage in general, but additionally in the potential to test extremely cost-effective build-outs that only incorporate off-premise and or digital sales. This efficiency to build that will additionally be supported by ongoing efforts to improve labor efficiency in our operating model. While we have delayed certain elements of our Kitchen of the Future initiative, we anticipate expanding the most promising aspects of that, such as the introductions of steamers to improve the throughput and efficiency of our cook line during the fourth quarter and into 2021. While it is still too early to determine exactly how many restaurants will target for 2021 and beyond, we are very confident that our economic and operating model will be attractive both for company unit growth as well as more aggressive franchise growth. I again would like to thank our teams for their tremendous effort over the past few years and in particular since the COVID pandemic. The trust gained through our commitment to safety before and during the COVID pandemic The strength of the concept in our recent sales initiatives and the unit runway ahead of us have all positioned Noodles & Company to have a prosperous future, and their efforts is what has made that possible. I'd now like to turn it over to Ken to share some highlights on our financial results during the second quarter. Thanks, Dave.