Noodles & Company

Good afternoon, and welcome to today's Noodles & Company second quarter 2023 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 would now like to introduce Noodles & Company's Chief Financial Officer, Mike Hines.

Thank you, and good afternoon, everyone. Welcome to our second quarter 2023 earnings call. Here with me this afternoon is Dave Beninghausen, 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 annual report on Form 10-K for its 2022 fiscal year 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 gap measures is available in our second quarter 2023 earnings release. To the extent that the company provides guidance, it does so only on a non-gap basis and does not provide reconciliations of forward-looking non-gap measures, specifically forecasted adjusted EBITDA, adjusted EPS, and contribution margins. Quantitative reconciling information for these measures is unavailable without unreasonable efforts. The corresponding GAAP measures are not accessible on a forward-looking basis, and such information is likely to be significant to an investor. Now, I would like to turn it over to Dave Binninghausen, our Chief Executive Officer.

Thanks, Mike, and good afternoon, everyone. In the second quarter, Noodles & Company's revenue decreased 4.5% versus prior year to $125.2 million, and adjusted EBITDA decreased 17% to $9.3 million. As we discussed in our last earnings call, during the last portion of Q1 as well as the beginning of Q2, we began to see softness in our guest trends, particularly surrounding the lower-income consumer. We believe our larger-than-historical price increases which included an additional 5% increase in the first quarter and therefore peaked at an overall 13% year-over-year in late Q1, ultimately led to a degradation in our overall value proposition, which manifested itself in a sudden and significant double-digit decline in traffic during the first portion of Q2. As we noted during the most recent call, we pivoted quickly to more prominent value messaging during the second quarter, including an effective 3% decrease in our menu pricing starting at the beginning of May. With this pivot, our traffic decline steadily improved from a negative 14% in April to a decline of 5.8% during July, the first month of Q3. Comparable restaurant sales, which was also impacted by lapping of price from 2022, fell 7.7% system-wide in May, before improving to a decline of 3.8% in July. Additionally, we're seeing an increase in our average unit volumes, which were $1.35 million during July, a 14% increase over the same period pre-COVID. We feel our strengths with off-premise and our suburban-oriented footprint remain long-term tailwinds. And as such, we feel we are well-aligned to benefit from longer-term macro and consumer trends. However, we do feel from a year-over-year perspective they've put more pressure on our near-term comparable sales trends. To put this in perspective, our comparable sales decline in the second quarter at company restaurants was 5.9%. However, our dine indication, which represented 22% of sales in the second quarter, saw a 14.2% increase in comparable sales growth. Similarly, while they represent a small percentage of our portfolio, On a year-over-year basis, our collegiate and urban restaurants outpaced our suburban locations. That said, our overall challenges during the second quarter have caused us to react and focus on opportunities to improve our overall competitive positioning, as we clearly do not believe the results represent the potential of the noodles and company brand. We are focused on the five following initiatives to drive our sales performance well above the current reset of revenue that we saw in the second quarter. First, price optimization with a balance of appropriate discounting and promotions. Second, advancement in our technology platform to increase guest engagement and analytics. Third, the introduction of a highly recognizable consumer favorite into the fast casual world, chicken parmesan. Fourth, a complete evaluation and assessment of our culinary offerings. including our approach to our menu layout, utilizing a leading industry third-party consulting firm, and fifth, a significant expansion of our catering program. The first area that we've been actively addressing has been around value and optimizing our pricing strategy. Our Q2 shift toward communicating our low entry-level price point and the introduction of a mac and cheese meal deal helped lead to an improvement and stabilization of traffic trends. As we look ahead, we're in the process of completing third-party research to enhance our overall pricing strategy, as well as how our menu is presented to guests, both online and in person. Our second area of focus to drive sales is improvements that we have made to our technology and data platforms. Nearly 50% of our guests experience the brand in restaurant, including dine-in and orders to go. We expect digital menu boards to be installed in 75% of company restaurants by the end of Q3. With our continued rollout of digital menu boards, we will be able to quickly incorporate any findings from the current pricing and extensive menu research across the majority of our system for our in-restaurant guests. We're already seeing the power of digital menu boards. As an example, when we introduced our mac and cheese meal deal in May, Restaurants that have digital menu boards achieve sales of that deal 24% greater than those with physical menu boards. In July, we completed the implementation of our CDP, our Customer Data Platform, which will now allow our marketing team to have a more complete and thorough understanding of our guests and the ability to communicate with them in a more personalized and effective fashion. Similarly, we have made enhancements to our online and app ordering systems, including launching a new product recommendation engine driven by machine learning. During the testing period, we saw 50% increase in recommended items purchased from this engine. Additionally, we recently have enhanced the flow of our web checkout page, which has driven a 220 basis point increase in our web order conversion. Finally, as we think about digital activation, our rewards program continues to strengthen. Our rewards membership grew 14% year-over-year during the second quarter to 4.8 million members. And importantly, we saw 2% growth in frequency amongst our rewards members during the quarter versus prior year. As a reminder, over 50% of our sales come through digital channels, and 25% of our sales can be attributed to rewards members. Consequently, we have a very strong technology foundation to build from. And with the further installation of digital menu boards, increased learnings from our customer data platform, and third-party work around optimizing our menu pricing and layout, I'm excited at the potential to positively impact the business both in the short and long term. We're also aggressively looking at our culinary and menu strategy, including menu design, to identify opportunities to assess and improve our positioning while still capitalizing on our strength. Noodles & Company continues to have a differentiated menu, bringing together made-to-order, globally-inspired dishes that meet a wide variety of tastes and preferences. Historically, we've had great success for much of our menu innovation, from being the first national chain to offer zucchini noodles to our popular tortelloni that was launched a couple years ago. Our newest menu activation will be the launch of chicken parmesan, a staple of Italian cuisine. We're very excited about Chicken Parmesan, given its broad appeal, guest familiarity, and our opportunity to provide a casual dining favorite at a fast, casual price point and speed. As we launch Chicken Parmesan, we're also in the process of engaging with an industry-leading, third-party culinary consulting firm to comprehensively assess and evaluate our current menu to ensure that every dish exceeds consumer expectations and is crafted to deliver exceptional taste and satisfaction in every bite. We anticipate this work to be completed by the end of the year, with the results being integrated into our strategy over the course of 2024. Finally, Noodles & Company has unique strengths for the growing catering market. The variety inherent in our menu, which eliminates the veto vote, combined with how well our food travels for the catering occasion, provides the opportunity to substantially grow this part of our business. Our catering program is easy for our restaurant teams to incorporate into their operations, and with staffing and turnover now at levels better than pre-COVID, we feel it's the appropriate time for our teams to be more focused on building catering sales. The company's catering represented 1.4% of sales during the second quarter, 40% growth from the second quarter of 2022. But we believe the opportunity is meaningfully larger. We've begun more aggressive promotion of our catering opportunity both inside and outside our restaurants to develop a business that we believe can be mid-single digits as a percentage of sales over the long term. Notably, our top 10% of restaurants already drive nearly 4% of sales from catering. An appropriate catering menu and offerings will also be incorporated into the work of our culinary consultant for further growth opportunities. Similar to our guest engagement strategies, we feel our menu and catering program have strong foundations to build from. And I look forward to sharing our progress to optimize sales and profitability as a result of our initiatives. As we execute our five sales driving initiatives, we additionally have taken actions to improve our overall financial position. These actions have been centered around three key areas. First, continued but moderated new restaurant growth, second, the streamlining of certain administrative functions to reduce G&A costs, and third, the return of shareholder value, including share repurchases. One of our primary objectives going forward is to achieve positive free cash flow in 2024. Through the combination of revised unit growth, the completion of our customer data platform and digital menu board investments, and a corporate restructuring effort to align our organization with our growth objectives. In support of our free cash flow objectives and considering continued delays in the development and permitting process, as well as construction inflation, we are revising our targeted annual unit growth rate to 5% for the coming years, including 2023. We continue to be pleased with the performance of our new units, but believe this slower growth rate will allow us to achieve long-term sustainable growth and achieve positive free cash flow next year. Combined with the completion of our customer data platform and digital menu board investments, these actions are driving factors in our revised capital expenditures guidance of $45 to $50 million for 2023, down from our prior guidance of $53 to $58 million. Additionally, earlier this quarter, we reviewed our needs as an organization to meet our long-term growth objectives. As a result of this review, we implemented a corporate restructure that we anticipate will yield nearly $2 million of G&A savings annualized. These actions allow us to continue to invest in areas such as our digital experience and technology initiatives while streamlining our administrative functions. Finally, today we announced that our Board of Directors has authorized a share repurchase program, giving the company the opportunity to purchase up to $5 million of common stock as part of our strategy to increase long-term shareholder value. Before I turn the call over to Mike, while we are disappointed in the results of the second quarter, I want to reiterate my belief that the core of the Noodles brand is well positioned for success, and there's significant upside potential over our current results. You have heard today our plans and strategies to address our current shortcomings, build upon our strengths, and deliver sustainable shareholder value. We are excited to provide you an update on our progress in the quarters to come. As we execute these strategies, I'm excited to welcome Mike Hines to the team as our Chief Financial Officer. Mike brings nearly 25 years of finance, accounting, and investor relations experience to the team, and I look forward to working with him and for Mike to have a significant influence with our team and company to achieve our full potential.