NOODLES (NDLS) – Q4 RESULTS WERE PROMISING – UPDATED WRITEUP

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CONCLUSION:

Noodles seems to have moved through an inflection point, in terms of sales trends and profit generation. New products as well as operational improvements have both played important roles. Most importantly, there seem to be important levers to further enhance results. Along with new products, the digital initiative, its connection to a new rewards program, and a more efficient physical plant turning out higher quality products could take sales to a materially higher level over the next several years. This in turn would encourage more rapid unit growth of company stores as well as franchised expansion. In terms of valuation: while the price earnings multiple is rather high, the enterprise value relative to EBITDA, largely due to the depreciation on so many company stores, is modest, especially considering the differentiation of the Noodles format. It should be noted that Catterton Management owns 18.5% of the common stock and Mill Road Capital Management separately owns 10.9%. Catterton or Mill Road’s inclinations aside, NDLS, in terms of the current reward/risk relationship, is one of the more interesting situations among publicly held restaurant companies.

 THE COMPANY:

 Noodles is a Fast-Casual restaurant concept with a menu featuring noodles, pasta dishes, and globally inspired staples of many cuisines. Within the modest physical 26-2700 square footage, with AUVs averaging $1.131M, Noodles features a value proposition where the average person spend for fiscal 2019 was $$9.53, up from $8.99 in ’18. At 12/31/19 there were 457 locations in the system, about 85% of which are company operated.

After coming public in 2013, at $18.00 per share, the stock quickly soared to over $40/share but the Company lost its way over the next several years. The improved results, presenting themselves in the last 12-18 months and described in more detail below under “Recent Developments” are the result of the turnaround initiatives launched in 2017. The improvements generally consisted of refocusing on Noodles core strengths: its people, its differentiation within the Fast Casual segment, its operations, and its off-premise sales opportunities (which include take-out, catering and delivery, together accounting for 56% of 2019 sales, 58% in Q4’19, and 60% in Q1’20).

UNIT LEVEL ECONOMICS COMMENTARY:

Cost of Goods Sold decreased 100 basis points in 2019. The decrease was primarily attributable to favorable commodity pricing and savings from supply chain initiatives, partially offset by the nationwide launch of higher cost Zoodles. Labor with Benefits costs was flat, affected by the benefit of closing underperforming restaurants, supply chain and labor efficiencies and pricing, partially offset by wage inflation of 4-5%. Other Restaurant Expenses increased by 10 basis points, within which was a 160 bp increase from delivery (7% of sales) expense. Occupancy & Other Expenses decreased by 10 basis points and was due primarily to the favorable impact of restaurant closures. Overall, store level EBITDA increased 110 basis points in calendar ’19, the largest variables being  the lower cost of goods and the absorption of delivery expense within Other Store Expense.

DEVELOPMENT COMMENTARY:

 Noodles slowed their growth of company operated restaurants over the last several years as they focused on operations. Company stores that were closed were largely the result of lease expirations. in the wake of the progress demonstrated in 2019, the Company is now planning 8-11 Company locations in existing markets, plus 2 to 4 franchised units (further described below under Recent Developments). Systemwide growth of 5-7% annually is contemplated starting in 2021.

SAME STORE SALES COMMENTARY:

Since 85% of the system is company operated, that’s where the leverage is, and the franchise sales trends are not materially different.  The Company same store sales gain in ’19  of 2.9% consisted of an average check increase of 3.6% and 0.7% of negative traffic. Quarterly Company store results are shown in the template above.

RECENT DEVELOPMENTS: Per Q4 Report and Conference Call

The fourth quarter continued the progress that Noodles has been making over the last two years. Company store comps were up 1.5% (traffic was down 2.3%, price and mix were up 3.8%) and the franchise stores were up 2.5%. Digital sales grew to 23% of sales, up 46% for the quarter. Off premise sales hit a high of 58% of sales. There was a GAAP loss of $0.2M vs breakeven a year earlier. Income from operations was $0.2M vs. $1.0M in ’19. However, Q4’19 GAAP earnings included $0.4M of closure costs plus $3.6M of impairment charges from the sale of nine restaurants to franchisees that took place in January 2020. Adjusted Net Income in Q4’19  was $3.0M  vs. $0.5M in ’18. Most importantly, restaurant level EBITDA was up 200 bp to 17.2%, primarily due to the sales leverage and lower CGS, partially offset by the expense of off-premise initiatives. It was, importantly, pointed out that Q1’20 comp sales are running ahead by 5.7%, 5.8% at the Company and 5.0% for franchisees.

Line by line in Q4: CGS was down 190 bp to 25.0%. Labor was down 80 bp to 32.6%. Occupancy was up 10 bp. Other Store Costs were up 50 bp to 14.4%. Store level EBITDA was up an impressive 100 bp to 17.2%. Below the store level, G&A was up 30 bp to 9.7%. Depreciation was flat at 4.8%.

For the year, Adjusted Net Income improved dramatically to $8.1M vs. $1.0M in ’18. Corporate GAAP  EBITDA of $26.M increased to $38.4M (up 15.2% from ’18), after adding back non-cash items including $7.7M of impairments, $.7M of cost on extinguishment of debt, $0.5M of severance costs and $2.4M of stock based compensation.

The Company is guiding to 10-15 new locations systemwide, 8 to 11 for the Company, comp sales of 3-5% (about 3% price), restaurant EBITDA margin of about 17.0%, Adjusted EBITDA of $42-$46M, Capex of $20-30M and Adjusted EPS of $0.21-$0.26.

Per the conference call: Digital sales in Q4 were up 34% to 25% of total sales. Off-premise was up 420 bp to 58% (including 8 points of delivery sales. Both Digital and Off-Premise are increasing further in 2020, to 28% and 60% (30 points of which is “pick-up”) respectively. The cauliflower-infused rigatoni was well received, complementing the zucchini noodle platform. In Q1, Grilled Orange Chicken Lo Mein was introduced and Zucchini Shrimp Scampi was brought back as an LTO. A new catering menu will be introduced in May, and the Mac & Cheese and healthy noodle alternatives will be beefed up (so to speak) as well. There is a major focus on labor efficiency, which is complemented by retrofitting of kitchen equipment.

Franchising is picking up momentum, with the re-franchising of the nine restaurants in Charlotte and Orlando to an existing franchisee who is committing to 22 additional locations over several years. New locations will have a smaller footprint and the majority will have pick up windows, no doubt due to the success of off-premise sales. It is noteworthy, though, that delivery accounted for 8.8% of sales in Q4, has increased modestly in 2020, and a 10% delivery charge was implemented during Q4. The Company plans to transition, starting in Q2’20 to “direct” delivery, physically delivered by a third party but ordered through the Company’s digital system. This approach is expected to provide a lower delivery expense combined with more consistent and productive customer engagement.

CONCLUSION: PROVIDED AT THE BEGINNING OF THIS ARTICLE

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