Good afternoon, and welcome to today’s Noodles & Company Second Quarter 2020 Earnings Conference Call. [Operator Instructions] After the presenters’ remarks, there will be a question-and-answer session. As a reminder, this call is being recorded. I will now introduce Noodles & Company’s Chief Financial Officer, Ken Kuick.

Thank you, and good afternoon, everyone. Welcome to our second quarter 2020 earnings call. Here with me this afternoon is Dave Boennighausen, 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, 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. The safe harbor statement in this afternoon’s news release and the cautionary statement in the company’s annual report on Form 10-K 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 Form 10-K 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 reconciliation of these measures to the most directly comparable GAAP measures is available in our second quarter 2020 earnings release and our supplemental information. Now I’d like to turn it over to Dave Boennighausen, our Chief Executive Officer.

Thanks, Ken, and good afternoon, everyone. Since we last spoke, of course, the country and 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, quickly 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 Noodles & Company’s future is particularly bright: first, the trust and branded 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 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…

Thanks, Dave. I’ll start with a brief overview of our second quarter results, and then I’ll finish with an update on our financial position. In response to the crisis, we’ve reduced all nonessential spending at both the restaurant and the corporate levels. At the restaurant level, this included eliminating or postponing nonessential spending and modifying our operating model to maximize efficiency at lower sales levels. Early on in the crisis, we introduced a new labor deployment model to reduce labor hours when restaurants fell below certain sales levels while maintaining the safety of our guests and team members and continue to offer to the level of service that our guests have come to count on at Noodles. Despite sales deleverage, thanks to the operational excellence of our team members in the restaurants, labor was 33.9% of sales, only a 120 basis point increase compared to the prior year quarter. As you can imagine, managing cost of goods sold in this environment has been a daily challenge, and we are proud of the work of our supply chain team and the execution of our team members in our restaurants. Our focus on improving our operating model over the past eight quarters, including enhancing our discipline on COGS, put us in a position of strength as we entered the crisis. During the quarter, the benefit from pricing of approximately 4% and the benefit from contract renegotiations that resulted in favorable commodity pricing more than offset the headwinds from increased waste and the shift to all-off-premise packaging. All in all, COGS was 25% of sales in the quarter, a 60 basis point improvement from the prior year quarter. Other operating expenses were 19.7% of sales. And as Dave mentioned, we were one of the first concepts to shift to an all-off-premise offering in…

Thanks, Ken. The COVID-19 pandemic, it’s caused a disruption in our business greater than anything I have seen in my 16 years at Noodles & Company. While it’s been heartbreaking to see the impact that the crisis has had on the restaurant industry as well as the impact to virtually everyone in our country, I am encouraged to what the future will bring, particularly for Noodles & Company. I do believe that when all is said and done, our strong business will only become stronger. Earlier, I noted three reasons for my particular confidence in Noodles & Company’s potential: 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 guests; second, the brand’s positioning and initiatives that have led to our sales recovery but also position us well to outperform the industry during the balance of 2020 and beyond; and finally, our strong unit performance and our increased confidence in the company’s ability to accelerate unit growth with a model that’s perfectly situated for the needs of today’s consumer. I am more excited than ever for the future of Noodles & Company. I would now like to turn it over to Michelle to open the lines for Q&A.

[Operator Instructions] Our first question comes from Jake Bartlett of Truist. Your line is open.

Great. Thanks for taking the question. My first is on the experience with stores that have dine-in reopened, and you have longer experience with the 40% as at the end of, I think, June. But what kind of boost to sales has that produced? And then also, what is it doing to margins? Is it – have a materially different margin profile once you get the full operations running? Or have you been able to retain some of these efficiencies?

Yes, I appreciate the question, Jake. And yes, as we mentioned earlier, it’s really been only in the past few days that most of our restaurants began offering on-premise dining, so it’s a bit too early to tell. But those data points I shared earlier, in particular how strong the dinner business has become, gives me a great deal of confidence that now as you’re starting to see the lunch business come back even further, that’s an area where we’ll see some pickup as we go through the balance of this quarter as well as through the balance of 2020. It is a touch early to understand exactly how much of that will be incremental, but we certainly believe a solid percentage will be. And from a margin perspective, I think we feel very comfortable that the way our teams have modified the labor model, there’s pretty minimal investment in terms of ensuring that, that execution is really strong. They were already going through with pretty significant enhanced QA and cleaning procedures. They’re really adding that element of the dining room. It’s been, for the most part, able to be absorbed in that model.

Okay. And then a bookkeeping question. Can you remind us or tell us – I don’t think I saw it in the release, but how many stores are still temporarily closed, how much that has been a drag on the July same-store sales that you reported as well as the second quarter?

Yes. It’s only a handful of restaurants that are still closed, Jake. What we do see is we take a very conservative approach in general. So as you look at temporary closures in totality, the impact is really very similar to the difference that you see between average unit volumes and same-store sales, particularly in those last two weeks as we did not have the closures for 4th of July weekend.

Okay. So it sounded like there is roughly a pretty significant delta between the average weekly sales that you’re talking about or average unit volumes and the same-store sales, so up to, what, 3.5% or somewhere around...

Yes, on a more normalized basis, it’s been roughly 3% to 4% of our sales that get impacted from a same-store sales perspective due to temporary closures.

Okay. And that still holds for July?

Correct.

Okay. And then, Ken, you mentioned the margins improving to – restaurant-level margins improving to double digits. I’m not sure what – yes, I wasn’t clear what period that covered. Was that in June and July? Or was it the last two weeks that you’re talking about?

That was May and June. So P5 and P6, the last two months of the quarter.

And I – no, and I’d add to that, Jake, that we feel really comfortable. It’s obviously very preliminary in terms of the seventh period being complete, but we feel very comfortable we’re able to hang on to a lot of the efficiencies we saw at the back half of Q2.

Okay. So May restaurant-level margins were double digits as well as June. And I would assume just given the much better comps in June, it would be much higher or still – and maybe if you can frame out kind of the progression there.

Yes. So margins, and Ken can certainly weigh in as well, we’re actually negative during the very first period, so the April fiscal period of the second quarter down mid-single digits. As you went forward, strength really across the board, with the exception that we did have some of the onetime expenses, in particular, the thank-you bonuses that went to our restaurant-level teams occurred during the P6 period. And then P7, we did have the loss of leverage from the two days of closure. Normalizing for those events, we feel very comfortable in kind of a continued upward trajectory between the last three months.

Our next question comes from Nicole Miller of Piper Sandler. Your line is open.

Thank you. Good afternoon. Hi, everybody. Thanks for the update. I have three questions, if it is okay. I can be brief with them. But I appreciated the comments around the real estate disruption and a more efficient footprint. What do you mean by that? And is there potentially a drive-through in your future?

Well, we already have – so what we’ve been talking about when we discussed the order-ahead, drive-through pickup windows, Nicole, we’ve been incorporating into that into most of our new restaurants already as well as a few retrofits. These behave very similar to those of you that are familiar with Chipotlanes, the exact same concept in terms of you order ahead, typically digitally, and then it’s a drive-through in terms of going to pick up that order. We actually opened just – the most recent opening was just yesterday in Minnesota, and we opened with a pickup window there – a drive-through pickup window. And the average transaction was only one minute. So we see great potential in that. We’ve already been down the road from a design and a perfection of some of the operational aspects of it. What I think gives us particular excitement, though, Nicole, so the drive-through’s already in progress, is when you look at the overall spectrum of where we could potentially take that footprint, we certainly see kind of the traditional Noodles & Company footprint, which would now still be smaller square footage, would incorporate those pickup drive-through windows. Then to the gamut of what if you have restaurants that are purely off-premise, whether it be just digital only, whether it be just the drive-through pickup window, we feel that there is a spectrum of real estate opportunities that, as we look four or five months ago, we maybe didn’t realize we had quite as many opportunities as we now do think we have in terms of some of the trade areas and how we can service guests in a wide variety of manners.

Excellent reminder, and thanks for the additional thought. A lot of your peers have been talking about alcohol sales. And I believe you have some permits in some, if not all the stores. Is that an opportunity that aligns with your brand?

Probably not. We still retain some of the permits from when we last had beer and wine, which was probably four years ago. Ultimately, we feel, as you look at the strength of our business for convenience in particular, that beer and wine sales are just not nearly the opportunity that we see in other aspects of the menu.

All right. Fair enough. And then the last one, wanting to just get one more question in on margins. Understanding that April, May improvement, as comps improve, when we think about June, I’ve got to believe there’s some leverage, I would think, on the labor line. It would seem that you would be in margin territory quarter-to-date above the prior year. Is there any error in that assumption?

I think what we’re – our target is, Nicole, to – in a post-COVID world or during COVID world, as things normalize, which realistically is more so the fourth quarter and then into 2021, our tenor objective is to get volumes at or above where they were pre-COVID or in 2019 as well as margin expansion. The margin side, similar to many other concepts, delivery being such a large percentage of our business, at the 30%, as Ken mentioned, during the second quarter, that is the biggest headwind that we have to overcome in order to maintain or increase margins relative to prior year. That said, we can leverage a lot of the labor model, which certainly changes in an environment where most of your sales are coming digitally. We’ve also seen a lot of areas where we streamlined the business just in general over the last few months. And we have several initiatives down the pipe in terms of, in particular, the kitchen and some of the equipment and those processes. So the long story short would be we do expect, as margins normalize, that we’ll be able to maintain margins on an apples-to-apples basis relative to prior year and potentially expand it. Certainly, there’s a lot of uncertainties. And additionally, we’ll use Q3 as a bit of a learning quarter, if you will, particularly on the delivery side because we do have significant control over or have certain control over the delivery margins, the fees that you pay, the fees that the guests pay, the pricing that you do in certain areas. We’ll be testing various approaches to that, and you’ll see us do that during Q3. Q4 is when we expect it will be a much more normal environment.

Excellent. Thanks again, for the update.

Our next question comes from Andrew Strelzik of BMO. Your line is open.

Hey, good afternoon. I have a couple of questions. My first one is on the unit growth, understanding that it’s maybe too early to talk about 2021. But can you talk about, number one, what your pipeline looks like right now; number two, kind of what the time line would be on when we might start to see the smaller footprint stores and if kind of leaning into that changes at all kind of the new market versus infill mix as we think about that going forward as maybe it opens up some new trade areas like you talked about?

Yes. I’ll address that last one first, actually, which is I think that’s one of the most exciting aspects of this, Andrew, is that we see – for brand like ourselves, which is so unique and has no direct competitors, from a new market perspective, in an urban perspective, it’s sometimes difficult to gain traction. We actually feel there’ll be a lot more opportunities for us to look at that. Now new markets, more urban, that’s something not from – more until the tail end of 2021 and potentially 2022, but there’s certainly a lot of opportunity there. The pipeline itself, as I said, we opened our second restaurant of 2020. Just yesterday, it opened with a great day. We will have a couple more that will open this year. Next year, it’s a bit early to give a specific target. What we can say is that we will continue to build up the pipeline. Our original target pre-COVID, we talked about returning to a 7% unit growth rate with a combination of company and franchise openings. We’ve maintained most of the existing pipeline that we already had working. So we’re not going to reach that 7% unit growth target for the full 2021 year. However, we think in the latter portion of the year, you’ll start seeing us get to annualized figures that will match that number. I do apologize, I think there was a third aspect of your question that I’m missing.

When we would see the smaller footprint stores.

Yes. We’ve – it’s already – we’ve already been moving in that direction and getting restaurants that – again, the portfolio average is 2,600 square feet. We’ve been building restaurants closer to 2,000 square feet. We already have prototypes designed. We have trade areas that we’ve identified. So we would expect that in the middle of 2021, maybe a little bit later on. But certainly, next year, you will see a smaller square – a much smaller square footage that’s much more off-premise oriented, incorporating those drive-through windows, et cetera.

Okay. Great. And then my last question. Curious – I know it’s too early to kind of say where the digital mix is going to fall. I’m just wondering if there’s anything that you’re going to do incrementally to retain those digital customers. And if you could talk – I know the check dynamics right now are tough across the space, but if you could maybe talk about frequency of the digital guests and maybe any other nuances that you see between that guest and your kind of traditional in-store ordering guests.

Yes. We’re still early enough in the system. So as a reminder, we launched the rewards program in October, November of last year. But I think getting the longitudinal lift to break out frequency, we’re not quite there yet. We are seeing from the reads that we have, that we are getting increase in frequency. However, I think what’s most exciting is what we talked about earlier on in the call, and that’s so many guests during the past few months have learned about our brand, tried our brand, got them to love our brand or found a different way to use us than ever before. We see a significant percentage of the guests that are signing up for that rewards program that are new to the brand in its entirety. That gives us a lot of confidence. And when you see the market performance of the Bay Area, Northern California, of Phoenix, where we don’t have a lot of brand awareness yet, and how they’re outperforming, how that overall dinner daypart in total for the company is performing gives us a lot of confidence that there’s a lot of stickiness to that digital transaction. What we will do, to your question about any changes, is I think you’ll continue to see us testing how to drive more and more people towards the direct delivery experience through our native digital channels. That allows us to have just a better experience for the guests. They’re able to participate in the rewards program. Certainly, there’s margin benefits to that as well. So you’ll see us probably test more things along those lines. And then otherwise, from a digital perspective, to maintain that, you will continue to see enhancements and improvements, whether it’s the usability and the functionality of the app. Curbside, where we have a strong program now, we believe there’s going to be an even stronger program we’ll be able to roll out later this year. We absolutely believe that, that digital percentage, while it will likely decline from a percentage of sales basis, the pure dollar figure, we think there’s great capabilities for us to actually maintain that in a post-COVID world.

Great. Thank you very much. Congratulations on the momentum.

Thank you, Andrew.

Our next question comes from Andy Barish of Jefferies. Your line is open.

Hey, guys. Wondering if you can give us a sense, I mean, in that delivery fee and other operating expense line. I think you offered free delivery. Just maybe what you’re doing marketing-wise and how that looks going forward. So that 6.4%, is that a kind of inflated number at this point?

I would say it’s modestly inflated because we’re seeing some progress, Andy, in terms of moving people over to those direct channels, which come with it a lower fee. From a free delivery perspective, I would not say that we were overly aggressive. In fact, we actually feel like we have the ability to be more aggressive than we’ve been in the past. Because free delivery, we did have for a portion of the quarter but not for the full quarter, so we’ll continue to push on that. Interestingly, as dining rooms have reopened, as restrictions have loosened across most states relative to where they were at the onset of the pandemic, we’re not seeing any decline in the overall volume on a daily basis from delivery. There’s clearly a significant amount of demand there. Our food really does function extremely well for the delivery occasion. This quarter is probably going to have a little bit more investment in testing in terms of how do you optimize that. Now from an overall marketing dollar figure, we would expect to be pretty consistent in Q3 and Q4 with what we had in Q2. And maybe Ken can elaborate a little bit more on what we saw there.

Yes. Yes, marketing. So marketing was 1.2% in Q2. And I would echo Dave’s sentiment that we expect that to be comparable in the third and fourth quarter.

And then just dovetailing on that, what will be the marketing focus in the back half? And how on some of your new product offerings, Perfect Bowls and Zoodles and Caulifloodle, how have those products been mixing, or Family Meal, build or drop off just given the dynamics of opening dining rooms and things like that?

Yes. We think as you see opening dining rooms come back, the Perfect Bowls will actually gain momentum. We’ve been pleased with the initial launch there. And we think that it’s such a great offering for healthy lifestyles that, that we expect to continue to gain nice momentum. We’re not necessarily disclosing the mix shifts on it, but we’re – we feel very good with where those are. Family Bowls, I think what we’ve identified during – or Family Meals, I should say, during these three months is one of the things that guests really gravitate towards our brand is the ability to customize, get something for everybody. So as we look at those Family Meals, what we’ll probably see us do is evolve them, Andy. And so they might have a little bit of a different kind of format in offering them versus what they are today. From the overall marketing objectives, certainly, building that rewards program is going to be the largest thing that we’ll be looking at because we just see great correlation between that and our overall sales trajectories.

Our next question comes from Todd Brooks of CL King & Associates. Your line is open.

Hey, good afternoon, guys. Just a couple of quick questions. One, during the heart of the pandemic, did you guys streamline the menu offering much? And were there learnings out of that, that as you roll back, the dining rooms reopen, that we may not go back to the full menu, that we have a more efficient offering that you’re comfortable with?

Ultimately, we see in kind of two phases, Todd. So we did do a bit of streamlining, not a significant amount, but we’ve reduced some of the areas that either felt there could be some supply chain disruptions that ultimately, unfortunately, didn’t come to pass. Additionally, we removed some that were more difficult to execute operationally. Overall, what we see is kind of a two-phase approach where we will keep some of those smaller kind of tertiary items where we won’t be bringing those necessarily back. But we do think that this environment, it gives concepts the ability to showcase the variety in their menu, in particular, Noodles & Company through digital channels. So you can see the variety that comes with things like the Perfect Bowls without introducing more complexity into the restaurants. So you will see us, over time, likely reduce the pure number of entrées on our menu but, from a guest perspective, actually show even a tremendous more variety, and we’ll probably get even more credit than we do today. So I think we’ll be able to balance that innovation of exciting things with cauliflower gnocchi, with also some streamlining to ensure that the operational and supply chain sides maintain intact.

Okay. Great. And do you think there’s a go-forward benefit from the streamlined menu from a COGS standpoint and now that performance was good in Q2?

Not really. I mean ultimately, there’s a little bit of benefit that we saw there, but we don’t – we didn’t necessarily see it as a great opportunity for us to reduce COGS. It is more so focused on the operational aspects and how do we ensure that the guest gets the same experience, where our operations teams can execute at a high level.

Okay. Great. And my second and final question, if you take your commentary, which you guys seem excited about learnings and what it means for new unit economics and chopping it a bit to kind of start opening stores again. I know you had talked about a certain balance that you were trying to achieve in new unit openings between corporate and franchise locations. If you look at kind of the franchisee reality coming out of the back end of the pandemic, do you expect to more corporate load the new unit mix in fiscal 2021 and then let franchisees start to carry the load a little bit more in fiscal 2022? Or is it a relatively unchanged mix from what you had going into the pandemic?

I think – let me address first specifically 2021 and 2022, which I think your instincts are right, Todd, in terms of we would expect 2021 might be a bit more company dominated than a longer-term growth equation. That said, our franchise community, which we’re very proud of and very pleased with their performance, they’ve shown a great amount of interest and potentially also being some of the test vehicles for some of the lower square footage profile. So there are indications that we might be able to have a good solid mix of company and franchise growth. When it comes to the overall environment and how the dust settles, if you really look at two pieces to your question, one is the overall real estate landscape. We already think the dust is starting to settle there in terms of identifying and seeing opportunities that maybe weren’t there in a pre-COVID perspective. Franchise might take a little bit longer for that to ultimately – the dust to settle. But you will see us over the next several months become more aggressive in terms of identifying sales opportunities, identifying growth opportunities from the franchise side. But to your point, those don’t necessarily come out of the ground until the 2022 fiscal year.

Okay, great. Thanks, guys.

[Operator Instructions] Our next question comes from Jake Bartlett of Truist. Your line is open.

Great. Thanks for taking the follow-ups. I had two. And one was on the steamers, the kind of the more abbreviated or modified version of the Kitchen of the Future. Can you maybe remind us or state again the pace that you expect those to be rolled out, what portion – I know originally, I think the savings kind of could have been in the area of $9 million to $20 million on an annualized basis for the full program. Maybe if you can give us any idea what this could mean for margins and also what it could cost on a per-store basis.

Yes. We think it’s ultimately a bit premature to talk to what the overall labor savings that we expect to see, some of the numbers that, Jake, you referenced. As a reminder, each hour of labor for us is worth equivalent of about $1.80 million to $2 million of annualized EBITDA. So the ability to reduce three hours to five hours to 10 hours over an extended amount of time can have significant impact on our overall economic model. With the steamers, the great part about the steamers, Jake, is relatively easy to install, very low capital investment. We think it’s several thousand in a restaurant, but it’s not north of 20, it’s much lower than that, and relatively easy for the teams to execute. However, we do need to do our standard test process. And the stage grade process by which we use test for testing, we’ll implement that starting in Q4 to expand the steamer test and then go from there throughout 2021. So bottom line is we think it is good upside to the overall margin story particularly in 2021 and beyond. It’s a bit premature for us to kind of go into what we expect the ultimate savings and even the ultimate capital investment will be.

Got it. And then last question, in your amended credit facility, there were some more restrictive CapEx limitations, I think, to $12 million in 2020 and the max of $24 million in 2021. Can you help us – I don’t think it’s been broken out explicitly before, but what kind of corporate CapEx is, what your annual maintenance CapEx would be? I’m just trying to see what’s left over, so I can kind of have a little bit of barriers here to figure out how much you could accelerate unit growth.

Yes, so ultimately, when you – we typically said there’s a good rule of thumb in terms of per restaurant kind of ongoing expense is roughly $18,000, $20,000 a restaurant. So that gives you roughly $7 million to $8 million in capital expense for 2021. We feel very comfortable, though, that as you look at the credit facility, we’ll be able to meet those performance targets to release that extra $12 million of capital. We do feel very comfortable that we’ll have a smaller square footage, more effective footprint from a cost perspective. So when all is said and done, is that number of new restaurants, probably we’re targeting somewhere at least 10 that we feel we can build in 2021.

Got it. Thank you so much.

There are no further questions. I’d like to turn the call back over to Dave for any closing remarks.

No, we, again, appreciate everybody’s time today. We know that the world is more exhausting and ever-changing than ever. I can tell you that this team and our team in the field, we’re extremely proud of the work that’s been done over the last few months and probably more excited and energized than ever at where this brand can be. So thank you very much. Appreciate the time.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.