UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended January 1, 2019
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 001-35987
NOODLES & COMPANY
(Exact name of registrant as specified in its charter)
Delaware | 84-1303469 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |
520 Zang Street, Suite D | 80021 | |
Broomfield, CO | ||
(Address of Principal Executive Offices) | (Zip Code) | |
Registrant’s telephone number, including area code: (720) 214-1900
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common stock, par value $0.01 per share | Nasdaq (Global Select Market) | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer x | |
Non-accelerated filer o | Smaller reporting company x | |
(Do not check if a smaller reporting company) | Emerging growth company o | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the voting and non-voting common stock held by non-affiliates as of July 3, 2018, the last business day of the registrant’s most recently completed second fiscal quarter, was $170.1 million. This amount was calculated based on the closing price of the common stock on July 3, 2018 on the Nasdaq Global Select Market. All executive officers and directors of the registrant have been deemed, solely for the purpose of the foregoing calculation, to be “affiliates” of the registrant.
As of March 8, 2019, there were 43,930,438 shares of the registrant’s Class A common stock, par value of $0.01 per share outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s proxy statement relating to its 2019 Annual Meeting of Stockholders, to be held on or about May 15, 2019, are incorporated by reference into Part III of this Annual Report on Form 10-K, where so indicated. Such proxy statement will be filed with the U.S. Securities and Exchange Commission within 120 days after the end of the fiscal year to which this report relates.
TABLE OF CONTENTS
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PART I | ||
ITEM 1. | ||
ITEM 1A. | ||
ITEM 1B. | ||
ITEM 2. | ||
ITEM 3. | ||
ITEM 4. | ||
PART II | ||
ITEM 5. | ||
ITEM 6. | ||
ITEM 7. | ||
ITEM 7A. | ||
ITEM 8. | ||
ITEM 9. | ||
ITEM 9A. | ||
ITEM 9B. | ||
PART III | ||
ITEM 10. | ||
ITEM 11. | ||
ITEM 12. | ||
ITEM 13. | ||
ITEM 14. | ||
PART IV | ||
ITEM 15. | ||
ITEM 16. | ||
SIGNATURES | ||
EXHIBITS | ||
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PART I
ITEM 1. Business
General
Noodles & Company is a restaurant concept offering lunch and dinner within the fast-casual segment of the restaurant industry. We opened our first location in Denver, Colorado in 1995, offering noodle and pasta dishes, staples of many cuisines, with the goal of delivering fresh ingredients and flavors from around the world under one roof. Today, our globally-inspired menu includes a wide variety of high quality, cooked-to-order dishes, including noodles and pasta, soups, salads and appetizers. We believe that we offer our customers value, with per person spend of $8.99 for the fiscal year ended January 1, 2019.
We offer more than 20 globally-inspired dishes together on a single menu that can be enjoyed inside our restaurants, taken to-go, or, in most areas, delivered to our customers. We believe we will benefit from trends in consumer preferences such as the broader demand for international cuisines and the increasing desire for convenience. At many restaurants, customers are limited to a particular ethnic cuisine or type of dish, such as a sandwich, burrito or burger. At Noodles & Company, we aim to eliminate the “veto vote” by satisfying the preferences of a wide range of customers, whether a family or parent with kids, a group of coworkers, an individual or a large party.
We believe that our globally-inspired menu, focused on noodle and pasta dishes, differentiates us from other restaurants. We believe our attributes—global flavors, variety, dishes prepared-to-order and fast service—allow us to compete against multiple segments throughout the restaurant industry and provide us a larger addressable market for lunch and dinner than competitors who focus on a single cuisine. We strive to provide a pleasant dining experience by quickly delivering fresh food with friendly service at a price point we believe is attractive to our customers. In addition, we believe that our menu is well suited for off-premise dining occasions in which customers order at our restaurant or online but then eat their meal at their home or office.
Noodles & Company is a Delaware corporation that was organized in 2002. Noodles & Company and its subsidiaries are sometimes referred to as “we,” “us,” “our,” and the “Company” in this report. We refer to our Class A Common Stock, par value $0.01 per share, as our “common stock.”
Our Concept and Business Strengths
Variety. We have purposefully chosen a range of healthy to indulgent dishes to satisfy multiple dietary preferences. Our menu encourages customers to customize their meals to meet their tastes and nutritional preferences with our selection of 14 fresh vegetables and seven proteins.
All of our dishes are cooked-to-order with fresh, high quality ingredients sourced from our carefully selected suppliers. Our commitment to the freshness of our ingredients is further demonstrated by our use of seasonal ingredients and healthy add-in options (such as seasoned tofu). Our culinary team strives to develop new dishes and limited time offerings to further reinforce our World Kitchen brand positioning and regularly provide our customers additional options. For example, in 2018 we introduced our better-for-you platform with the launch of zucchini noodles (or “Zoodles”). Zoodles provide a low-carb, low-calorie option for our customers that can be substituted into any of our dishes or enjoyed in a signature dish such as our Zucchini Spicy Peanut Sauté. This focus on culinary innovation allows us to prepare and serve high quality food and meet changing consumer trends.
Value. The quality of our food and the welcoming ambiance of our restaurants creates an overall customer experience that we believe is unique and differentiated. Our per person spend is competitive not only within the fast-casual segment, but also within the quick-service segment. We deliver value by combining a family-friendly dining environment with the opportunity to enjoy many dishes containing a variety of fresh ingredients. We also offer kids meals which, at a fixed low price, provide the opportunity for parents to feed their children a balanced meal with sides such as broccoli, carrots, fruit, applesauce and a smaller portion of our house made rice crispy treat.
Our Restaurant Experience. We design each location individually, which we believe creates an inviting restaurant environment. We believe the ambiance is warm and welcoming, with muted lighting and colors, comfortable seating and our own custom music mix, which is intended to make our customers feel relaxed and at home.
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We believe we deliver an exceptional overall dining experience. We believe that our customers should expect not only great food from our restaurants, but also warm hospitality and attentive service. Whether you are a parent with kids or a businessperson with a laptop, you simply order your food, grab a drink and take a seat. We cook each dish to order in approximately five minutes and bring the food right to your table. Our customers may enjoy a relaxed meal or just eat and run.
We also believe that our experience meets consumers’ increasing desire for speed and convenience. A substantial amount of our revenue is derived from customers who consume their meal off-premise, either by ordering at the restaurant and taking the food to go or by ordering ahead of time through online, phone-in and delivery channels.
Consistent with our culture of enhanced customer service, we seek to hire individuals who will deliver prompt, attentive service by engaging customers the moment they enter our restaurants. Our training philosophy empowers both our restaurant managers and team members to add a personal touch when serving our customers, such as coming out from behind the counter to explain our menu and guiding customers to the right dish. Our restaurant managers are critical to our success, as we believe that their entrepreneurial spirit and outreach efforts build our brand in our communities. We call our cashiers “Noodle Ambassadors” to highlight their role in helping our customers explore our global menu. After our customers order at the counter, their food is delivered to their table by our friendly team members.
Our Operational Strategy
We believe our brand and globally-inspired menu resonates with consumers, and we believe our restaurants and team members provide customers a unique and high-quality experience. We are focused on offering customers flavorful, cooked-to-order dishes in a warm and welcoming environment at an attractive value.
Restaurant initiatives. Our plan to improve our performance includes the following four key strategies:
• | Focusing on our global flavors and menu offerings. We believe that our globally-inspired menu, focused on noodle and pasta dishes, differentiates us from other restaurants. We also believe this global variety, which includes a range of healthy to indulgent dishes that are cooked to order with fresh, high-quality ingredients, remains a competitive strength. We believe we have significant potential to build awareness for the zucchini offering with additional dishes and we are testing our next evolution of the better-for-you platform and anticipate introducing a new vegetable-infused noodle to our menu in 2019. |
• | Improving efficiencies and unit-level margins. We believe that there is significant opportunity to improve our operational consistency as well as our overall unit level margins. In 2016, we reduced the size of our core menu items, removing menu items that did not sell well and were challenging for our teams to execute. During 2017, we improved several processes inside our restaurants, such as the introduction of a produce chopper to improve consistency and labor efficiency in our restaurants. In 2018, we completed the national roll out of self-bussing stations, which we believe will reduce labor hours and improve cleanliness in our restaurants. We also believe that we have opportunity in our supply chain and food preparation procedures to reduce inbound ingredient costs and improve labor efficiency. |
• | Enhancing convenience for our customers. We believe there is significant opportunity to increase convenience for our customers. In 2017, we launched our NoodlesREWARDS program, a loyalty program that allows our customers the convenience of ordering their favorites quickly and easily as they earn rewards for free or discounted food. In 2018, we completed a national roll out of dedicated pickup areas for customers who order and pay ahead so that they can have a faster and more convenient takeout experience. Finally, we have continued to expand our delivery program through select third-party providers, which offers an additional level of convenience for our customers. |
• | Improving manager selection, training and development of our teams. We have increased our focus on the selection, training and development of our restaurant teams. We use assessment tools in management hiring, and we have implemented certain changes to our restaurant compensation program to encourage team member retention. We have rolled out training tools and learning management systems to improve execution and encourage career development within our teams. Finally, we utilize a thorough, disciplined process of sharing best practices throughout the organization. |
Restaurant Portfolio and Franchising
Restaurant Portfolio. As of January 1, 2019, we had 394 company-owned restaurants and 65 franchise restaurants in 29 states and the District of Columbia. Our restaurants are typically 2,600 to 2,700 square feet and are located in end-cap, in-line or free-standing
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locations across a variety of urban and suburban markets. During the near-term we anticipate limited unit growth as we embed our operational, financial and customer initiatives and roll-out the related team training and development processes. We also anticipate that during this period we will be able to test and define a prototype for new restaurants that will better facilitate future expansion and better meet the needs of the changing consumer experience.
Restaurant Development. Over the past two years, we have reduced our rate of company-owned restaurant unit growth. This has resulted in our revenue growing at a slower rate than would be expected if our unit growth rate continued at the historical rate. New restaurants have historically contributed substantially to our revenue growth. In 2018, we opened one company-owned restaurant. Given recent improvement in performance, we are currently pursuing a disciplined development pipeline to execute a modest new unit growth rate in the near term.
Certain Restaurant Closures. We closed 55 company-owned restaurants in the first quarter of 2017. These restaurants significantly underperformed our restaurant averages, as measured by average unit volumes (“AUVs”), restaurant contribution margin and cash flow. Many of these restaurants were open for only three or four years in newer markets where brand awareness of our restaurants was not as strong and where it had been more difficult to adequately staff our restaurants. Closing these restaurants has favorably affected our net income, restaurant contribution, restaurant contribution margin, EBITDA and adjusted EBITDA. Additionally, we closed 19 company-owned restaurants in 2018, most of which were at or approaching the expiration of their leases. We currently do not anticipate significant restaurant closures for the foreseeable future; however, we may from time to time close certain restaurants, including closures at, or near, the expiration of their leases.
Franchising. As of January 1, 2019, we had 65 franchise units in 14 states operated by 12 franchisees. In 2018, our franchisees did not open any new restaurants and closed one restaurant. As of January 1, 2019, a total of eight area developers have signed development agreements providing for the opening of 54 additional restaurants in their respective territories. We look for experienced, well-capitalized franchise partners who are able to leverage their existing infrastructure and local knowledge in a manner that benefits both our franchisees and us. We expect to continue to offer development rights in markets where we do not intend to build company-owned restaurants. We may offer such rights to larger developers who commit to open 10 or more units, or to smaller developers who may commit to open fewer restaurants. We do not currently intend to offer single-unit franchises. We believe the strength and attractiveness of our brand will attract experienced and well-capitalized area developers.
Site Development and Expansion
We consider our site selection and development process critical to our long-term success. We have used a combination of our own internal team and outside real estate consultants to locate, evaluate and negotiate new sites using various criteria. In making site selection decisions, we use several analytical tools designed to uncover the key site, demographic, business, retail, competitive and traffic characteristics that drive successful locations.
Once a location has been approved by our executive-level selection committee, we begin a design process to match the characteristics and feel of the location to the trade area. For example, in a trade area with a high percentage of families we will utilize additional booth seating in the dining room, and in an urban location we will typically alter our kitchen design to enhance throughput for the busy lunch hours.
Restaurant Management and Operations
Friendly Team Members. We believe our genuine, friendly team members separate us from our competitors. We value the individuality of our team members, which we believe results in a management, operations and training philosophy distinct from that of our competitors. We strive to hire team members who share a passion for food, have a competitive spirit and will operate our restaurants in a way that is consistent with our high standards. We seek to hire individuals who will deliver prompt, attentive service by engaging customers the moment they enter our restaurants. We empower our team members to enrich the experience of our customers and directly address any concerns that may arise in a manner that contributes to the success of our business.
Restaurant Management and Employees. Each restaurant typically has a restaurant manager, an assistant manager and 15 to 25 team members. We cross-train our employees in an effort to create a depth of competency in our critical restaurant functions. Consistent with our emphasis on customer interaction, we encourage our restaurant managers and team members to welcome and interact with customers throughout their visit. To lead our restaurant management teams, we have area managers (each of whom is responsible for between four and 10 restaurants), as well as regional directors (each of whom is responsible for between 40 and 70 restaurants).
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Training and Career Development. We believe that our training efforts create a culture of continuous learning and professional growth that allows our team members to continue their career development with us. Within each restaurant, two to four team members are designated to lead the training efforts and ensure a consistent approach to team member development. We produce training materials that encourage individual contributions and participation from our team members while also requiring adherence to certain guidelines and procedures.
Food Preparation and Quality. Our teams use classic professional cooking methods, including par boiling and sautéing many of our vegetables, in full kitchens resembling those of full-service restaurants. All team members, including our restaurant managers, spend their first several days working solely with food and learning these techniques, and we spend a significant amount of time ensuring that each team member learns how to prepare and cook our food properly. Despite our more labor-intensive method of food preparation, we believe that we produce food with an efficiency that enables us to compete effectively.
The majority of our restaurants have exhibition-style kitchens. This design demonstrates our commitment to cooking fresh food in an accessible manner. We provide each customer with individual attention and make every effort to respond to customer suggestions and concerns in a personal and hospitable way.
We require all of our dishes to be cooked to order at food safe temperatures or, in the case of salads, subject to our produce washing protocols, which helps to ensure that the food we serve to our customers is safe. We have designed our food safety and quality assurance programs to maintain high standards for our food and food preparation procedures. Our quality assurance manager oversees comprehensive restaurant and supplier audits based upon the potential food safety risk of each food. We also consider food safety and quality assurance when selecting our distributors and suppliers. Our suppliers are inspected by federal, state and local regulators or other reputable, qualified inspection services, which helps ensure their compliance with all federal food safety and quality guidelines. We regularly inspect our suppliers to ensure that the ingredients we buy conform to our quality standards and that the prices we pay are competitive. We also rely on our own recipes, specifications and protocols to ensure that our food is consistently the best quality that is possible when it is served, including a physical examination of ingredients when they arrive at our restaurants. We train our employees to pay detailed attention to food quality at every stage of the food preparation cycle, and we have developed a daily checklist that our employees use to assess the freshness and quality of food supplies. Finally, we encourage our customers to provide feedback regarding our food quality so that we can identify and resolve problems or concerns as quickly as possible.
Restaurant Marketing
Our marketing efforts seek to increase sales through a variety of channels and initiatives. Community-based restaurant marketing, as well as online, social and other media tools, highlight our competitive strengths, including our varied and healthy menu offerings and the value we offer our customers.
• | Our Menu Offerings. We focus some of our marketing efforts on new menu offerings to broaden our appeal to our customers. We promote these items through a variety of formats including public relations events, social media marketing, television appearances, radio promotions, and messaging to our NoodlesREWARDS members. In addition to increasing brand awareness, these promotions also encourage prompt consumer action, resulting in more immediate increases in our customer traffic. |
• | Online, Social and Other Media Tools. We rely on our website, www.noodles.com, to promote our business and increase brand awareness. The information on or available through our website is not, and should not be considered, a part of this report. Our customers are encouraged to sign up to receive communications through our NoodlesREWARDS program, updating them on new menu offerings and promotional opportunities. As of January 1, 2019, more than 2.0 million of our customers have signed up to receive communication through our rewards and e-club programs. We also communicate with our customers using social media, such as our Facebook and Instagram pages, our YouTube and Vimeo channels and our Twitter feed. Our online and social media engagement provides exciting opportunities to engage with our customers. Additionally, our media tools also include print and online advertising and direct mail, as well as mass communications including radio and out of home. |
• | Digital Advertising. We use targeted digital advertising in many of our markets. We believe this helps to increase top of mind awareness with potential customers and drives both frequency and trial. In addition, digital advertising provides us with the opportunity to promote specific product platforms and offerings such as online ordering. |
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• | Creating New Meal Occasions. We also focus on ways Noodles & Company can serve customers at different times and in new places. For example, our Kids Meal menu was created for the future foodies of the world: children aged ten and under are invited to design their own meal made fresh-to-order, with quality ingredients, by choosing their entrée, two sides and a drink for around $5. Customers who want to feed a large group can enjoy our catering options comprised of main entrées, sides and desserts. We market these offerings in a variety of ways, including through in-restaurant posters, email, NoodlesREWARDS messages, Facebook posts and other communications outside of our restaurants. |
• | Making Noodles & Company Easier to Use. Some of our marketing efforts focus on making our restaurants easier to use. We seek to deliver superior customer service at every opportunity, generating consumer awareness of menu offerings with in-restaurant communications such as displays of our menu offerings that are visible upon entry and table top cards that highlight healthy food offerings. We also continue to implement initiatives to improve convenience for our customers, such as expanding the availability of third-party delivery and introducing dedicated pick-up shelving to increase the speed of the to-go transaction. |
Suppliers
Maintaining a high degree of quality in our restaurants depends in part on our ability to acquire fresh ingredients and other necessary supplies that meet our specifications from reliable suppliers. We carefully select suppliers based on quality and their understanding of our brand, and we seek to develop mutually beneficial long-term relationships with them. We work closely with our suppliers and use a mix of forward, fixed and formula pricing protocols. In some cases, we have made efforts to increase the number of suppliers for our ingredients, which we believe can help mitigate pricing volatility. We monitor industry news, trade issues, weather, crises and other world events that may affect supply prices. In addition, a substantial volume of our produce items are grown in Mexico and other countries and any new or increased import duties, tariffs or taxes, or other changes in U.S. trade or tax policy, could result in higher food and supply costs.
Seasonality
Seasonal factors and the timing of holidays cause our revenue to fluctuate from quarter to quarter. Our revenue per restaurant is typically lower in the first and fourth quarters, due to reduced winter and holiday traffic, and higher in the second and third quarters.
Competition
We face competition from the casual dining, quick-service and fast-casual segments of the restaurant industry. These segments are highly competitive with respect to taste, price, food quality and presentation, service, location and the ambience and condition of each restaurant, among other things. Our competition includes a variety of locally owned restaurants and national and regional chains who offer dine-in, carry-out and delivery services. Many of our competitors have existed longer and have a more established market presence with substantially greater financial, marketing, personnel and other resources than we have. Among our competitors are a number of multi-unit, multi-market fast-casual restaurant concepts, some of which are expanding nationally. As we expand, we will face competition from these concepts and new competitors that strive to compete with our market segments.
We also face competition from firms outside the restaurant industry, such as grocery stores and home meal replacement services, who sell prepared meals for takeout and in some cases, offer delivery service.
Intellectual Property and Trademarks
We own a number of trademarks and service marks registered or pending with the U.S. Patent and Trademark Office (“PTO”). The marks we have registered with the PTO include the following: Noodles & Company, the Noodles & Company logo, Your World Kitchen, Noodles & Company World Kitchen, Noodles World Kitchen, Noodles Rewards and Wisconsin Mac & Cheese. We also have certain trademarks registered or pending in certain foreign countries. In addition, we own the Internet domain name www.noodles.com. The information on, or that can be accessed through, our website is not part of this report. We believe that our trademarks, service marks and other intellectual property rights have significant value and are important to the marketing of our brand, and it is our policy to protect and defend vigorously our rights to such intellectual property.
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Governmental Regulation and Environmental Matters
We are subject to extensive and varied federal, state and local government regulation, including regulations relating to public and occupational health and safety, sanitation and fire prevention. We operate each of our restaurants in accordance with standards and procedures designed to comply with applicable codes and regulations. However, an inability to obtain or retain health department or other licenses could adversely affect our operations. Although we have not experienced, and do not anticipate, any significant difficulties, delays or failures in obtaining required licenses, permits or approvals, any such problem could delay or prevent the opening of, or adversely impact the viability of, a particular restaurant or group of restaurants.
In addition, in order to develop and construct restaurants, we need to comply with applicable zoning, land use and environmental regulations. Federal and state environmental regulations have not had a material effect on our operations to date, but more stringent and varied requirements of local governmental bodies with respect to zoning, land use and environmental factors could delay or even prevent construction and increase development costs for new restaurants. We are also required to comply with the accessibility standards mandated by the U.S. Americans with Disabilities Act (“ADA”), which generally prohibits discrimination in accommodation or employment based on disability. We may in the future have to modify restaurants, for example by adding access ramps or redesigning certain architectural fixtures, to provide service to or make reasonable accommodations for disabled persons. While these expenses could be material, our current expectation is that any such actions will not require us to expend substantial funds.
In addition, we are subject to the U.S. Fair Labor Standards Act, the U.S. Immigration Reform and Control Act of 1986, the Occupational Safety and Health Act and various other federal and state laws governing similar matters including minimum wages, overtime, workplace safety and other working conditions. Our failure to fully comply with these laws could subject us to potential litigation and liability. We are also subject to various laws and regulations relating to our current and any future franchise operations.
We are also subject to the Patient Protection and Affordable Care Act of 2010 (the “PPACA”), which requires health care coverage for many previously uninsured individuals and expands coverage for those already insured. We began offering such benefits in 2015. It is possible that legislation will be passed by Congress and signed into law that repeals the PPACA, in whole or in part, and/or introduces a new form of health care reform. It is unclear at this point what the scope of any such legislation will be and when it would become effective. Because of the uncertainty surrounding possible replacement health care reform legislation, we cannot predict with any certainty the likely impact of the PPACA’s repeal or the adoption of any other health care reform legislation on our business, financial condition or results of operations. Whether or not there is alternative health care legislation enacted in the U.S., there may be significant disruption to the health care market in the coming months and years and the costs of the Company’s health care expenditures may increase.
We are subject to federal, state and local environmental laws and regulations concerning waste disposal, pollution, protection of the environment and the presence, discharge, storage, handling, release and disposal of, or exposure to, hazardous or toxic substances (“environmental laws”). These environmental laws can provide for significant fines and penalties for non-compliance and liabilities for remediation, sometimes without regard to whether the owner or operator of the property knew of, or was responsible for, the release or presence of the hazardous or toxic substances. Third parties may also make claims against owners or operators of properties for personal injuries and property damage associated with releases of, or actual or alleged exposure to, such substances. We are not aware of any environmental laws that will materially affect our earnings or competitive position, or result in material capital expenditures relating to our restaurants. However, we cannot predict what environmental laws will be enacted in the future, how existing or future environmental laws will be administered, interpreted or enforced, or the amount of future expenditures that we may need to make to comply with, or to satisfy claims relating to, environmental laws. It is possible that we will become subject to environmental liabilities at our properties, and any such liabilities could materially affect our business, financial condition or results of operations.
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Management Information Systems
We use a variety of applications and systems to securely manage the flow of information within each restaurant, and within our central support office infrastructure. All of our restaurants use computerized management information systems, which we believe are scalable to support any future growth plans. We use point-of-sale (“POS”) computers designed specifically for the restaurant industry. Our POS system provides a touch screen interface, a graphical order confirmation display and integrated, high-speed credit card and gift card processing. Our online ordering system allows customers to place orders online or through our mobile app. Orders taken remotely are routed to the point-of-sale system based on the time of customer order pickup. The POS system is used to collect daily transaction data, which generates information about daily sales, product mix and average check that we actively analyze. All products sold and prices at our company-owned restaurants are programmed into the system from our central support office. We also continue to modernize and make investments in our information technology networks and infrastructure, specifically in our physical and technological security measures, to anticipate cyber-attacks and defend against breaches and to provide improved control, security and scalability. Enhancing the security of our financial data, customer information and other personal information is a high priority for us.
Our in-restaurant back office computer system is designed to assist in the management of our restaurants and provide labor and food cost management tools. These tools provide restaurant operations management and our central support office quick access to detailed business data and reduces restaurant managers’ administrative time. The system provides our restaurant managers the ability to submit orders electronically with our distribution network. The system also supplies sales, bank deposit and variance data to our accounting department on a daily basis. We use this data to generate daily sales information and weekly consolidated reports regarding sales and other key measures.
Franchisees use similar point of sale systems and are required to report sales on a daily basis through an online reporting network and submit their restaurant-level financial statements on a quarterly and annual basis. We also offer certain restaurant technology support services to our franchisees.
Financial Information About Segments
We operate as a single accounting segment. Financial information related to our business is included in Item 8 of this Annual Report on Form 10-K.
Employees
As of January 1, 2019, we had approximately 9,400 employees, including approximately 500 salaried employees and approximately 8,900 hourly employees. None of our employees are unionized or covered by a collective bargaining agreement, and we consider our current employee relations to be good.
Available Information
We maintain a website at www.noodles.com, including an investor relations section at investor.noodles.com, on which we routinely post important information, such as webcasts of quarterly earnings calls, and any related materials. You may access our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, amendments to those reports and other reports relating to us that are filed with or furnished to the SEC, free of charge in the investor relations section of our website as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC.
The contents of the websites mentioned above are not incorporated into and should not be considered a part of this report. The references to the URLs for these websites are intended to be inactive textual references only.
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ITEM 1A. Risk Factors
Special Note Regarding Forward-Looking Statements
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties, including but not limited to the risks and uncertainties discussed under this Item 1A. “Risk Factors,” Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 1. “Business.” In some cases, you can identify forward-looking statements by terms such as “may,” “might,” “will,” “objective,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “design,” “estimate,” “predict,” “potential,” “plan” or the negative of these terms and similar expressions intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. We discuss these risks, uncertainties and other factors in greater detail below. These statements reflect our current views with respect to future events and are based on currently available operating, financial and competitive information. Unless required by United States federal securities laws, we do not intend to update any of these forward-looking statements to reflect circumstances or events that occur after the statement is made.
Risks Related to Our Business and Industry
We may not achieve our operational, strategic or financial goals.
We continue to pursue a number of financial, operational and strategic goals and we may be unsuccessful in achieving some or all of them. Our strategies are designed to, among other objectives, improve restaurant operations and increase our restaurant revenue, comparable restaurant sales, net income, restaurant contribution and restaurant contribution margin and adjusted EBITDA. However, these strategies may not be successful in achieving our goals in part or at all. Further, we may encounter difficulty in executing these strategies. Failing to execute our operational strategies could materially adversely affect our business, financial condition or results of operations.
Our strategies include improving our menu offerings, such as through the introduction of Zoodles; pursuing off-premise opportunities, for example through our dedicated pick-up shelving and third-party delivery; improving efficiencies and unit level margins by simplifying operations; enhancing our menu structure and layout; and improving manager selection, training and development of our teams. However, customers may not favor new menu offerings or may not find initiatives aimed at off-premise dining appealing, and our efforts to increase our sales growth and improve our offerings may be unsuccessful. Additionally, our operational initiatives may be ineffective at reducing costs or may reduce the quality of the customer experience. Any failure of our new initiatives could materially adversely affect our business, financial condition or results of operations.
Further, we have had, and expect to continue to have, priorities and initiatives in various stages of testing, evaluation and implementation, upon which we expect to rely to improve our results of operations and financial condition. Failure to achieve successful implementation of our initiatives could materially adversely affect our business, financial condition or results of operations.
We believe our culture, from the restaurant level up through management, is an important contributor to our success. As time passes, however, we may have difficulty maintaining our culture or adapting it sufficiently to meet the needs of our business. Among other important factors, our culture depends on our ability to attract, retain and motivate employees who share our enthusiasm and dedication to our concept. Our comparable restaurant sales, and more broadly, our business, financial condition or results of operations, could be materially adversely affected if we do not maintain our infrastructure and culture.
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Our strategic and operational goals are designed to improve our results of operations, including restaurant revenue and profitability. The level of comparable restaurant sales, which represent the change in year-over-year sales for restaurants open for at least 18 full periods, affects our restaurant revenue growth and will continue to be a critical factor affecting profitability. Our ability to increase comparable restaurant sales depends in part on our ability to successfully implement our initiatives. It is possible that such initiatives will not be successful, that we will not achieve our target comparable restaurant sales growth or that the change in comparable restaurant sales could be negative, which may cause a decrease in restaurant revenue and profitability that could materially adversely affect our business, financial condition or results of operations.
Changes in economic conditions could materially affect our ability to maintain or increase sales at our restaurants.
The restaurant industry depends on consumer discretionary spending. The United States in general or the specific markets in which we operate have suffered during certain historical periods and in the future may suffer from depressed economic activity, recessionary economic cycles, low consumer confidence as a result of stock market volatility and other reasons, high levels of unemployment, reduced home values, increases in home foreclosures, investment losses, personal bankruptcies, reduced access to credit or other economic factors that may affect consumers’ discretionary spending. Traffic in our restaurants could decline if consumers choose to dine out less frequently or reduce the amount they spend on meals while dining out. Negative economic conditions (including negative economic conditions resulting from war, terrorist activities, global economic occurrences or trends or other geo-political events) might cause consumers to make long-term changes to their discretionary spending behavior, including dining out less frequently or dining at lower priced restaurants on an extended or permanent basis. If comparable restaurant sales decrease, our profitability would decline as we spread fixed costs across a lower level of restaurant revenue. Reductions in staff levels, additional asset impairment charges and additional restaurant closures could result from prolonged negative comparable restaurant sales, which could materially adversely affect our business, financial condition or results of operations.
Competition from other restaurant companies could adversely affect us.
We face competition from the casual dining, fast-casual and quick-service segments of the restaurant industry. These segments are highly competitive with respect to taste, price, food quality and presentation, service, location and the ambience and condition of each restaurant, among other things. Our competition includes a variety of locally owned restaurants and national and regional chains who offer dine-in, carry-out and delivery services. Many of our competitors have existed longer and have a more established market presence with substantially greater financial, marketing, personnel and other resources than we have. Among our competitors are a number of multi-unit, multi-market fast-casual restaurant concepts, some of which are expanding nationally. We continually face competition from these concepts and new competitors that strive to compete with our market segments. For example, additional competitive pressures come from the deli sections and in-store cafés of grocery store chains, as well as from convenience stores and online meal preparation sites. These competitors may have, among other things, lower operating costs, food offerings more responsive to consumer preferences, better locations and facilities, more experienced management, more effective marketing and more efficient operations.
Several of our competitors compete by offering menu items that are specifically identified as low in carbohydrates, gluten-free, or rich in protein. In addition, many of our competitors emphasize lower-cost value options or meal packages, or strategies we do not currently pursue. Any of these competitive factors may materially adversely affect our business, financial condition or results of operations.
Our marketing programs may not be successful.
We incur costs and expend other resources in our marketing efforts to attract and retain customers. These initiatives may not be successful, resulting in expenses incurred without the benefit of higher revenues. Additionally, many of our competitors have more marketing resources and we may not be able to successfully compete. If our competitors increase spending on marketing, or if our marketing funds decrease for any reason, or if our advertising and promotions are less effective than those of our competitors, our financial performance could be adversely affected.
Many of our competitors are devoting increased resources to their social media marketing programs. Social media can be challenging because it reaches a broad audience with an ability to respond or react, in near real time. In addition, social media can facilitate the improper disclosure of proprietary information, personally identifiable information, or inaccurate information. As a result, if we do not appropriately manage our social media strategies, our marketing efforts in this area may not be successful and could damage our reputation, negatively impacting our restaurant sales and financial performance.
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Our inability or failure to recognize, respond to and effectively manage the accelerated impact of social media could have a material adverse impact on our business.
There has been a widespread and dramatic increase in the use of social media platforms that allow users to access a broad audience of consumers and other interested persons. The availability of information on social media can be virtually immediate, as can its impact, and users of many social media platforms can post information without filters or checks on the accuracy of the content posted. Adverse information concerning our restaurants or brand, including user reviews, whether accurate or inaccurate, may be posted on such platforms at any time and can quickly reach a wide audience. The resulting harm to our reputation may be immediate, without affording us an opportunity to correct or otherwise respond to the information, and it is challenging to monitor and anticipate developments on social media in order to respond in an effective and timely manner.
In addition, although search engine marketing, social media and other new technological platforms offer great opportunities to increase awareness of and engagement with our restaurants and brand, our failure to use social media effectively in our marketing efforts may further expose us to the risks associated with the accelerated impact of social media. Many of our competitors are expanding their use of social media and the social media landscape is rapidly evolving, potentially making more traditional social media platforms obsolete. As a result, we need to continuously innovate and develop our social media strategies in order to maintain broad appeal with guests and brand relevance, and we may not do so effectively. A variety of additional risks associated with our use of social media include the possibility of improper disclosure of proprietary information, exposure of personally identifiable information of our employees or guests, fraud, or the publication of out-of-date information, any of which may result in material liabilities or reputational damage. Furthermore, any inappropriate use of social media platforms by our employees could also result in negative publicity that could damage our reputation or lead to litigation that increases our costs.
New technologies or changes in consumer behavior facilitated by these technologies could negatively affect our business.
Advances in technologies or certain changes in consumer behavior driven by such technologies could impact the manner in which meals are marketed, prepared, ordered and delivered. We may pursue certain of those technologies, but consumers may not accept them, or we may fail to successfully integrate them into our operations, thereby harming our financial performance. In addition, our competitors, some of whom have more resources than us, may be more effective at responding to such advances in technologies and erode our competitive position.
Negative publicity relating to one or more of our restaurants, including our franchised restaurants, could reduce sales at some or all of our other restaurants.
Our success is dependent in part upon our ability to maintain and enhance the value of our brand, consumers’ connection to our brand and positive relationships with our franchisees. We may be faced with negative publicity relating to food quality, restaurant facilities, customer complaints or litigation alleging illness or injury, health inspection scores, integrity of our or our suppliers’ food processing, employee relationships or other matters, regardless of whether the allegations are valid or whether we are held to be responsible. The negative impact of adverse publicity relating to one restaurant may extend far beyond the restaurant or franchise involved to affect some or all of our other restaurants. The risk of negative publicity is particularly great with respect to our franchised restaurants because we are limited in the manner in which we can regulate them, especially on a real-time basis. Negative publicity generated by such incidents may be amplified by the use of social media. A similar risk exists with respect to unrelated food service businesses, if consumers associate those businesses with our own operations or are concerned with the food safety of the broader restaurant industry.
Additionally, employee claims against us based on, among other things, wage and hour violations, discrimination, harassment or wrongful termination may also create negative publicity that could adversely affect us and divert our financial and management resources that would otherwise be used to benefit the future performance of our operations. A significant increase in the number of these claims or an increase in the number or scope of successful claims could materially adversely affect our business, financial condition or results of operations. Consumer demand for our products and our brand’s value could diminish significantly if any such incidents or other matters create negative publicity or otherwise erode consumer confidence in us or our products, or in the restaurant industry as a whole, which would likely result in lower sales and could materially adversely affect our business, financial condition or results of operations.
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Food safety and foodborne illness concerns could have an adverse effect on our business.
We cannot guarantee that our internal controls and training will be fully effective in preventing all food safety issues at our restaurants, including any occurrences of foodborne illnesses such as E. coli, Hepatitis A, listeria, norovirus and salmonella. The risk of illnesses associated with our food might also increase in connection with the expansion of our catering and delivery businesses or other situations in which our food is served or delivered in conditions that we cannot control. Furthermore, we and our franchisees rely on third-party vendors throughout our supply chain, making it difficult to monitor food safety compliance and increasing the risk that foodborne illness would affect multiple locations rather than a single restaurant. Some foodborne illness incidents could be caused by third-party vendors and transporters outside of our control. New illnesses resistant to our current precautions may develop in the future, or diseases with long incubation periods could arise, that could give rise to claims or allegations on a retroactive basis. One or more instances of foodborne illness in any of our restaurants or markets or related to food products we sell could negatively affect our restaurant sales nationwide if highly publicized on national media outlets or through social media. This risk exists even if it were later determined that the illness was wrongly attributed to us or one of our restaurants.
A number of other restaurant chains have experienced incidents related to foodborne illnesses that have had a material adverse effect on their operations, including E. coli, listeria and norovirus outbreaks at other fast-casual concepts. These incidents at other restaurants could cause some customers to have a negative perception of fast-casual concepts generally, which can negatively affect our restaurants. The occurrence of a similar incident at one or more of our restaurants, or negative publicity or public speculation about an incident, could materially adversely affect our business, financial condition or results of operations.
Adverse weather conditions could affect our sales.
Adverse weather conditions, such as regional winter storms, floods and hurricanes, could affect our sales at restaurants in locations that experience these weather conditions, which could materially adversely affect our business, financial condition or results of operations. It is possible that weather conditions may impact our business more than other businesses in our industry because of the significant concentration of our restaurants in the Upper Midwest, Rocky Mountain and Mid-Atlantic states.
Our business could be adversely affected by difficulties in hiring and retaining top-performing employees.
Our success depends on the efforts of our employees and our ability to hire, motivate and retain qualified employees. There may be a small supply of qualified individuals in some of the communities in which we operate, and competition in these communities for qualified individuals could require us to pay higher wages and provide greater benefits. We devote significant resources to training our employees and strive to reduce turnover in order to keep top performing employees and better realize our investment in training new employees. However, turnover among our restaurant employees may increase. Failure to hire and retain top-performing employees could impact our financial performance by increasing our training and labor costs and reducing the quality of our customers’ experiences.
We rely heavily on information technology, and any material failure, weakness, interruption or breach of security could prevent us from effectively operating our business.
We rely heavily on information systems, including point-of-sale processing in our restaurants, for management of our supply chain, payment of obligations, collection of cash, credit and debit card transactions and other processes and procedures. We also rely on third-party vendors to provide information technology systems and to securely process and store related information, especially as it relates to credit and debit card transactions and online ordering. Our franchisees also rely on information systems and third-party vendors. Our ability to efficiently and effectively manage our business depends significantly on the reliability and capacity of these systems. Our operations depend upon our and our franchisees’, and our vendors’, ability to protect computer equipment and systems against damage from physical theft, fire, power loss, telecommunications failure or other catastrophic events, as well as from internal and external security breaches, viruses and other disruptive problems. Avoiding such incidents in the future will require us and our franchisees and vendors to continue to enhance information systems, procedures and controls and to hire, train and retain employees. The failure of these systems to operate effectively, maintenance problems, upgrading or transitioning to new platforms, or a breach in security of these systems could result in delays in customer service and reduce efficiency in our operations. Remediation of such problems could result in significant, unplanned capital investments and harm our business, financial condition or results of operations.
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We may be harmed by breaches of security of information technology systems or our confidential consumer, employee, financial, or other propriety data.
We use many information technology systems throughout our operations, including systems that record and process customer sales, manage human resources and generate accounting and financial reports. Through these systems, we have access to and store a variety of consumer, employee, financial and other types of information related to our business. We also rely on third-party vendors to provide information technology systems and to securely process and store related information. Our franchisees also use information technology systems and rely on third-party vendors. Like others in our industry, we have experienced many attempts to compromise our information technology and data, and we may experience more attempts in the future. We may not respond adequately or timely, because cyber-attacks take many forms, change frequently, are becoming increasingly sophisticated, and may be difficult to detect for significant periods of time. If we or our franchisees, or third-party vendors, were to experience a material breach resulting in the unauthorized access, use, or destruction of our information technology systems or confidential consumer, employee, financial, or other propriety data, it could negatively impact our reputation, reduce our ability to attract and retain customers and employees and disrupt the implementation and execution of our strategic goals. Moreover, such breaches could result in a violation of various privacy-related laws and subject us to investigations or private litigation, which, in turn, could expose us to civil or criminal liability. We strive to mitigate the risk of breaches of our information technology systems and confidential data by enhancing our technology, improving related procedures and controls and training our employees on cyber-security trends. Additionally, we carry cyber insurance to minimize the potential impact that a security breach may have on our financial condition or results of operations. Although we dedicate significant resources to preventing security breaches, we may be unsuccessful, which could adversely affect our business, financial condition or results of operations.
We may be unable to negotiate favorable borrowing terms, and any additional capital we may require could be senior to existing equity holders, dilute existing equity holders or include unfavorable restrictions.
As a general matter, operating and developing our business requires significant capital. Our credit agreement ends in 2022 and securing access to credit on reasonable terms thereafter will require us to extend or refinance such agreement. In addition, in order to pursue our business and operational strategies, we may need additional sources of liquidity in the future and it may be difficult or impossible at such time to increase our liquidity. Our lenders may not agree to amend our credit agreement at such time to increase our borrowing capacity. Further, our requirements for additional liquidity may coincide with periods during which we are not in compliance with covenants under our credit agreement and our lenders may not agree to further amend our credit agreement to accommodate such non-compliance. Even if we are able to access additional liquidity, agreements governing any borrowing arrangement could contain covenants restricting our operations. If we raise additional funds through future issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock. Any debt financing, we secure in the future could involve restrictive covenants relating to our capital-raising activities and other financial and operational matters, which might make it more difficult for us to obtain additional capital and to pursue business opportunities. Moreover, if we issue new debt securities, the debt holders would have rights senior to common stockholders to make claims on our assets.
Governmental regulation may adversely affect our ability to open new restaurants or otherwise adversely affect our business, financial condition or results of operations.
We are subject to various federal, state and local regulations, including those relating to building and zoning requirements and those relating to the preparation and sale of food. Our restaurants are also subject to state and local licensing and regulation by health, sanitation, food and occupational safety and other agencies. We may experience material difficulties or failures in obtaining the necessary licenses, approvals or permits for our restaurants, which could delay planned restaurant openings or affect the operations at our existing restaurants. In addition, stringent and varied requirements of local regulators with respect to zoning, land use and environmental factors could delay or prevent development of new restaurants in particular locations.
We are subject to the ADA and similar state laws that give civil rights protections to individuals with disabilities in the context of employment, public accommodations and other areas, including our restaurants. We may in the future have to modify restaurants, for example, by adding access ramps or redesigning certain architectural fixtures, to provide service to or make reasonable accommodations for disabled persons. The expenses associated with these modifications could be material.
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Our operations are also subject to the U.S. Occupational Safety and Health Act, which governs worker health and safety, the U.S. Fair Labor Standards Act, which governs such matters as minimum wages and overtime and a variety of similar federal, state and local laws that govern these and other employment law matters. In addition, federal, state and local proposals have been made related to paid sick leave and similar matters. Changes in these laws or implementation of new proposals could materially adversely affect our business, financial condition or results of operations.
We rely heavily on certain vendors, suppliers and distributors, which could adversely affect our business.
Our ability to maintain consistent price, quality and safety throughout our restaurants depends in part upon our ability to acquire specified food products and supplies in sufficient quantities from third-party vendors, suppliers and distributors at a reasonable cost. We do not control the businesses of our vendors, suppliers and distributors and our efforts to specify and monitor the standards under which they perform may not be successful. Furthermore, certain food items are perishable, and we have limited control over whether these items will be delivered to us in appropriate condition for use in our restaurants. If any of our distributors or suppliers performs inadequately, or our distribution or supply relationships are disrupted for any reason, our business, financial condition, results of operations or cash flows could be adversely affected. If we cannot replace or engage distributors or suppliers who meet our specifications in a short period of time, including any suppliers who are a sole source of supply of a particular ingredient, that could increase our expenses and cause shortages of food and other items at our restaurants, which could cause a restaurant to remove items from its menu. If that were to happen, affected restaurants could experience significant reductions in sales during the shortage or thereafter, especially if customers change their dining habits as a result. Our focus on a limited menu would make the consequences of a shortage of a key ingredient more severe. In addition, because we provide moderately priced food, we may choose not to, or may be unable to, pass along commodity price increases to consumers. These potential changes in food and supply costs could materially adversely affect our business, financial condition or results of operations.
In addition, we use various third-party vendors to provide, support and maintain most of our management information systems. We also outsource certain accounting, payroll and human resource functions to business process service providers. The failure of such vendors to fulfill their obligations could disrupt our operations. Additionally, any changes we may make to the services we obtain from our vendors, or new vendors we employ, may disrupt our operations. These disruptions could materially adversely affect our business, financial condition or results of operations.
We also partner with various third-party vendors to deliver our food. If any of our delivery vendors perform inadequately, or our delivery relationships are disrupted for any reason, our business, financial condition or results of operations could be adversely affected.
Our ability to continue to expand our digital business, delivery orders and catering is uncertain, and these new business lines are subject to risks.
Our revenue from digital orders has increased significantly from prior years. This growth rate may not be sustainable, and if our digital business does not continue to expand it may be difficult for us to achieve our planned sales growth. We have also increased our efforts to promote delivery orders, which have also grown considerably. We rely on third-party providers to fulfill delivery orders, and the ordering and payment platforms used by these third parties, or our mobile app or online ordering system, could be damaged or interrupted by technological failures, user errors, cyber-attacks or other factors, which may adversely impact our sales through these channels and could negatively impact our brand. Additionally, our delivery partners are responsible for order fulfillment and may make errors or fail to make timely deliveries, leading to customer disappointment that may negatively impact our brand. We also incur additional costs associated with using third-party service providers to fulfill these digital orders and the costs of delivering may have an adverse impact on restaurant level margins. Moreover, the third-party restaurant delivery business is intensely competitive, with a number of players competing for market share, online traffic, capital, and delivery drivers and other people resources. The third-party delivery services with which we work may struggle to compete effectively, and if they were to cease or curtail operations or fail to provide timely delivery services in a cost-effective manner, or if they give greater priority on their platforms to our competitors, our delivery business may be negatively impacted. We have also introduced catering offerings on both a pick-up and delivery basis, and customers may choose our competitors’ catering offerings over ours, be disappointed with their experience with our catering, or experience food safety problems if they do not serve our food in a safe manner, which may negatively impact us. Such delivery and catering offerings also increase the risk of illnesses associated with our food because the food is transported and/or served by third parties in conditions we cannot control.
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Because all of these offerings are relatively new, it is difficult for us to anticipate the level of sales they may generate. That may result in operational challenges, both in fulfilling orders made through these channels and in operating our restaurants as we balance fulfillment of these orders with service of our traditional in-restaurant guests as well. Any such operational challenges may negatively impact the customer experience associated with our digital, delivery or catering orders, the guest experience for our traditional in-restaurant business, or both. These factors may adversely impact our sales and our brand reputation.
Changes in food and supply costs could adversely affect our results of operations.
Our profitability depends in part on our ability to anticipate and react to changes in food and supply costs. Shortages or interruptions in the availability of certain supplies caused by seasonal fluctuations, unanticipated demand, problems in production or distribution, food contamination, product recalls, government regulations, inclement weather or other conditions could adversely affect the availability, quality and cost of our ingredients, which could harm our operations. Weather related issues, such as freezes, heavy rains or drought, may also lead to temporary spikes in the prices of some ingredients such as produce or meats. Increasing weather volatility or other long-term changes in global weather patterns, including any changes associated with global climate change, could have a significant impact on the price, availability and timing of delivery of some of our ingredients. In addition, at certain times of the year a substantial volume of our produce items are imported from Mexico and other countries. Any new or increased import duties, tariffs or taxes, or other changes in U.S. trade or tax policy, could result in higher food and supply costs. Any increase in the prices of the food products most critical to our menu, such as pasta, beef, chicken, wheat flour, cheese and other dairy products, tofu and vegetables, could adversely affect our operating results. Although we try to manage the impact that these fluctuations have on our operating results, we remain susceptible to increases in food costs as a result of factors beyond our control, such as general economic conditions, seasonal fluctuations, weather conditions, demand, food safety concerns, generalized infectious diseases, product recalls and government regulations.
Changes in employment laws may adversely affect our business.
Various federal and state labor laws govern the relationship with our employees and affect operating costs. These laws include employee classification as exempt/non-exempt for overtime and other purposes, minimum wage requirements, unemployment tax rates, workers’ compensation rates, mandatory health benefits, immigration status and other wage and benefit requirements. Some jurisdictions, including some of those in which we operate, have recently increased their minimum wage by a significant amount, and other jurisdictions are considering similar actions, which may increase our labor costs. Significant additional government-imposed increases in the following areas could materially affect our business, financial condition, operating results or cash flow: overtime rules; mandatory health benefits; vacation accruals; paid leaves of absence, including paid sick leave; and tax reporting.
Immigration laws have recently been an area of considerable focus by the Department of Homeland Security, with enforcement operations taking place across the country, resulting in arrests, detentions and deportation of unauthorized workers. Some of these changes and enforcement programs may increase our obligations for compliance and oversight, which could subject us to additional costs and make our hiring process more cumbersome or reduce the availability of potential employees. Although we require all workers to provide us with government-specified documentation evidencing their employment eligibility, some of our employees may, without our knowledge, be unauthorized workers. We currently participate in the “E-Verify” program, an Internet-based, free program run by the United States government to verify employment eligibility, in all of our restaurants and in our corporate support office. However, use of the “E-Verify” program does not guarantee that we will successfully identify all applicants who are ineligible for employment. Unauthorized workers are subject to deportation and may subject us to fines or penalties, and if any of our workers are found to be unauthorized we could experience adverse publicity that negatively impacts our brand and may make it more difficult to hire and keep qualified employees. Termination of a significant number of employees who were unauthorized employees may disrupt our operations, cause temporary increases in our labor costs as we train new employees and result in additional adverse publicity. We could also become subject to fines, penalties and other costs related to claims that we did not fully comply with all recordkeeping obligations of federal and state immigration compliance laws. These factors could materially adversely affect our business, financial condition or results of operations.
If we or our franchisees face labor shortages or increased labor costs, our operating results could be adversely affected.
Labor is a primary component in the cost of operating our restaurants. If we or our franchisees face labor shortages or increased labor costs because of increased competition for employees, higher employee turnover rates, increases in the federal, state or local minimum wage or other employee benefits costs (including costs associated with health insurance coverage), our operating expenses could increase. In addition, our success depends in part upon our and our franchisees’ ability to attract, motivate and retain a sufficient number of well-qualified restaurant operators and management personnel, as well as a sufficient number of other qualified employees,
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including customer service and kitchen staff. Qualified individuals needed to fill these positions are in short supply in some geographic areas, and the national unemployment rate, as well as the unemployment rates in many of the areas in which we operate, has continued to fall over the past few years. In addition, restaurants have traditionally experienced relatively high employee turnover rates. Our and our franchisees’ ability to recruit and retain qualified individuals may delay the planned openings of new restaurants or result in higher employee turnover in existing restaurants, which could have a material adverse effect on our business, financial condition or results of operations.
If we or our franchisees are unable to continue to recruit and retain sufficiently qualified individuals at wages comparable to those we currently pay, our business could be adversely affected. Competition for these employees could require us or our franchisees to pay higher wages, which could result in higher labor costs. In addition, increases in the minimum wage, which have become more common and more material in size in recent years, would increase our labor costs. Additionally, costs associated with workers’ compensation are rising, and these costs may continue to rise in the future. We may be unable to increase our menu prices in order to pass these increased labor costs on to consumers, in which case our margins would be negatively affected, which could materially adversely affect our business, financial condition or results of operations.
We depend on the services of key executives, the loss of which could materially harm our business.
We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives and senior management could adversely impact our business, our results of operations and may make recruiting for future management positions more difficult or may require us to offer more generous executive compensation packages to attract top executives. In recent years, we have experienced both executive and senior management turnover. Changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. Our future success depends on our ability to identify, attract and retain qualified personnel on a timely basis. In addition, we must successfully integrate newly hired management personnel within our organization in order to achieve our operating objectives.
The effect of changes to healthcare laws in the United States may increase the number of employees who elect to participate in our healthcare plans, which may increase our healthcare costs and further changes, or the repeal of existing healthcare laws may further significantly increase our healthcare costs and negatively impact our financial results in future periods.
The Patient Protection and Affordable Care Act of 2010 (the “PPACA”) requires health care coverage for many previously uninsured individuals and expands coverage for those already insured. We began offering such benefits in July 2015, and as a consequence we are incurring additional expenses for employee healthcare. If we fail to continue to offer such benefits, or the benefits we elect to offer do not meet the applicable requirements, we may incur penalties. It is also possible that by making changes or failing to make changes in the healthcare plans we offer, we will become less competitive in the market for our labor. Finally, continuing to implement the requirements of the PPACA is likely to impose additional administrative costs. The future costs and other effects of these new healthcare requirements cannot be determined with certainty, but they may continue to significantly increase our healthcare coverage costs and could materially adversely affect our, business, financial condition or results of operations.
In addition to changes to the PPACA that have been implemented recently, it is possible that additional legislation will be passed by Congress and signed into law that further repeals the PPACA, in whole or in part, and/or introduces a new form of health care reform. It is unclear at this point what the scope of such legislation would be and when it would become effective. Because of the uncertainty surrounding possible replacement health care reform legislation, we cannot predict with any certainty the likely impact of the PPACA’s repeal or the adoption of any other health care reform legislation on our business, financial condition or results of operations. Whether or not there is alternative health care legislation enacted in the U.S., there is likely to be significant disruption to the health care market in the coming months and years and the costs of the Company’s health care expenditures may increase.
We may not be successful in executing our franchise strategy.
It is possible that we will seek to sell restaurants within certain markets to new or existing franchisees. In connection with a sale to new or existing franchisees of restaurants in existing markets, we may enter into agreements that also provide for the development of new restaurants by such franchisees. We may be unable to identify franchisees willing to partner with us with respect to existing restaurants we elect to sell or new restaurants. Becoming a franchisee entails economic risks and uncertainties and the perceived risks and uncertainties may not, in the view of potential franchisees, outweigh the anticipated benefits. Our inability to identify franchisees, or to sell units to existing or new franchisees, could adversely affect our franchising strategy, which could materially adversely affect our business, financial condition or results of operations.
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In addition, to the extent we are able to identify franchisees for the franchising of existing restaurants or the development of new restaurants, our success is dependent on the performance of our franchisees in successfully operating the restaurants. Our franchisees may not achieve financial and operational objectives, and they may close existing restaurants due to underperformance or they may ultimately be unsuccessful in developing new restaurants. We may also not be able to manage our franchise system effectively. Failure to provide our franchisees with adequate support and resources could materially adversely affect these franchisees, as well as cause disputes between us and them and potentially lead to material liabilities.
We rely in part on our franchisees, and if our franchisees cannot develop or finance new restaurants, build them on suitable sites or open them on schedule, our success may be affected.
We rely in part on our franchisees and the manner in which they operate their locations to develop and promote our business. Although we have developed criteria to evaluate and screen prospective franchisees, we cannot be certain that our franchisees will have the business acumen or financial resources necessary to operate successful franchises in their franchise areas and state franchise laws may limit our ability to terminate or modify these franchise arrangements. Moreover, despite our training, support and monitoring, franchisees may not successfully operate restaurants in a manner consistent with our standards and requirements or may not hire and train qualified managers and other restaurant personnel. The failure of our franchisees to operate their franchises successfully could have a material adverse effect on us, our reputation, our brand and our ability to attract prospective franchisees and could materially adversely affect our business, financial condition or results of operations.
Franchisees may not have access to the financial or management resources that they need to open the restaurants contemplated by their agreements with us or be able to find suitable sites on which to develop them, or they may elect to cease development for other reasons. Franchisees may not be able to negotiate acceptable lease or purchase terms for the sites, obtain the necessary permits and government approvals or meet construction schedules. Any of these problems could reduce our franchise revenues. Additionally, our franchisees typically depend on financing from banks and other financial institutions, which may not always be available to them, in order to construct and open new restaurants. The lack of adequate financing could adversely affect the number and rate of new restaurant openings by our franchisees and could materially adversely affect our future franchise revenues.
Failure to support our franchise system could have a material adverse affect on our business, financial condition or results of operations.
Our strategy depends in part on our franchise network, which requires enhanced business support systems, management information systems, financial controls and other systems and procedures as well as additional management, franchise support and financial resources. We may not be able to manage our franchise system effectively. Failure to provide our franchisees with adequate support and resources could materially adversely affect both our new and existing franchisees as well as cause disputes between us and our franchisees and potentially lead to material liabilities. Any of the foregoing could materially adversely affect our business, financial condition or results of operations.
The provision of information technology support services to our franchisees may expose us to certain risks.
In 2018 we began to offer certain information technology (“IT”) support services to our franchisees. We may incur costs or expenses in providing these services that exceed the fee income we receive for such services. In addition, the allocation of our IT resources to providing such services may adversely affect the provision of such services to our company-owned restaurants. The provision of such services may also expose us to claims from franchisees or third parties, or to litigation or regulatory matters, which may not be completely covered, or covered at all, by our insurance.
Unionization activities or labor disputes may disrupt our operations and affect our profitability.
Although none of our employees are currently covered under collective bargaining agreements, our employees may elect to be represented by labor unions in the future. If a significant number of our employees were to become unionized and collective bargaining agreement terms were significantly different from our current compensation arrangements, it could adversely affect our business, financial condition or results of operations. In addition, a labor dispute involving some or all of our employees may harm our reputation, disrupt our operations and reduce our revenues and resolution of disputes may increase our costs. Potential changes in labor laws, including the possible passage of legislation designed to make it easier for employees to unionize, or increases in politically-inspired labor activism, could increase the likelihood of some or all of our employees being subjected to greater organized labor influence, and could have an adverse effect on our business and financial results by imposing requirements that could potentially increase our costs, reduce our flexibility and impact our employee culture.
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As an employer, we may be subject to various employment-related claims, such as individual, class action or government enforcement actions relating to alleged employment discrimination, employee classification and related withholding, wage-hour, labor standards or healthcare and benefit issues. Such actions, if brought against us and successful in whole or in part, may affect our ability to compete or could materially adversely affect our business, financial condition or results of operations.
Changes to estimates related to our property, fixtures and equipment or operating results that are lower than our current estimates at certain restaurant locations may cause us to incur impairment charges on certain long-lived assets, which may materially adversely affect our results of operations.
In accordance with accounting guidance as it relates to the impairment of long-lived assets, we make certain estimates and projections with regard to individual restaurant operations, as well as our overall performance, in connection with our impairment analyses for long-lived assets. When impairment triggers are deemed to exist for any location, the estimated undiscounted future cash flows are compared to its carrying value. If the carrying value exceeds the undiscounted cash flows, an impairment charge equal to the difference between the carrying value and the fair value is recorded. The projections of future cash flows used in these analyses require the use of judgment and a number of estimates and projections of future operating results. If actual results differ from our estimates, additional charges for asset impairments may be required in the future. Over the past several years we have recognized significant impairment charges and if future impairment charges continue to be significant, this could have a material adverse effect on our business, financial condition or results of operations.
We are subject to risks associated with long-term non-cancellable leases and the costs of exiting leases at restaurants we have closed or may close in the future may be greater than we estimate or could be greater than the funds we raise to address closure costs.
We do not own any real property. Payments under our operating leases account for a significant portion of our operating expenses and we expect the new restaurants we open in the future will similarly be leased. Our leases generally have an initial term of ten years and generally can be extended only in five-year increments (at increased rates). All of our leases require a fixed annual rent, although some require the payment of additional rent if restaurant sales exceed a negotiated amount. Generally, our leases are “net” leases, which require us to pay all of the cost of insurance, taxes, maintenance and utilities. We generally cannot cancel these leases. Additional sites that we lease are likely to be subject to similar long-term non-cancelable leases. In connection with closing restaurants, we may nonetheless be committed to perform our obligations under the applicable lease including, among other things, paying the base rent for the balance of the lease term. In addition, as each of our leases expires, we may fail to negotiate renewals, either on commercially acceptable terms or at all, which could cause us to pay increased occupancy costs or to close restaurants in desirable locations.
Opening and operating new restaurants entails numerous risks and uncertainties.
One element of our operational strategy is the opening of new restaurants and operating those restaurants on a profitable basis. In 2018, we opened one company-owned restaurant and closed 19 company-owned restaurants. Our franchisees did not open any new restaurants and closed one restaurant. We expect to open between four and six company-wide restaurants in 2019 with such openings primarily taking place in well-established existing markets.
Opening new restaurants presents numerous risks and uncertainties. We may not be able to open new restaurants as quickly as planned. In the past, we have experienced delays in opening some restaurants and that could happen again. Delays or failures in opening new restaurants could materially adversely affect our business strategy and our expected results.
Our ability to open new restaurants also depends on other factors, including: site selection; negotiating leases with acceptable terms; identifying, hiring and training qualified employees; the state of the labor market in each local market; timely delivery of leased premises to use; managing construction and development costs; avoiding the impact of inclement weather, natural disasters and other calamities; obtaining construction materials and labor at acceptable costs; securing required governmental approvals, permits and licenses; and accessing sufficient capital.
Our new restaurants may be smaller in terms of square footage and seating than our current restaurants, in accordance with our increased focus on off-premise dining opportunities. Customers may react negatively to these re-designed, smaller stores, which could materially adversely affect our business, financial condition or results of operations.
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Our long-term success is partially dependent on our ability to effectively identify appropriate target markets and secure appropriate sites for new restaurants.
In order to build new restaurants, we must first identify target markets where we can expand our footprint, taking into account numerous factors, including the location of our current restaurants, local economic trends, population density, area demographics and geography. The selection of target markets for expansion is challenging. We also must locate and secure appropriate sites for new restaurants, which is one of our biggest challenges. There are numerous factors involved in identifying and securing an appropriate site, including, among others: identification and availability of locations; competition; financial conditions affecting developers and potential landlords; developers and potential landlords obtaining licenses or permits for development projects on a timely basis; proximity of potential development sites to an existing location; anticipated development near our new restaurants; and availability of acceptable lease arrangements. If we are unable to fully implement our development plan, our business, financial condition or results of operations could be materially adversely affected.
New restaurants, once opened, may not be profitable.
New restaurants may not be profitable, and their sales performance may not follow historical patterns. In addition, our average restaurant sales and comparable restaurant sales may underperform our expectations. Our ability to operate new restaurants profitably and increase average restaurant sales and comparable restaurant sales will depend on many factors, some of which are beyond our control, including: consumer awareness, understanding and support of our brand; general economic conditions, local labor costs and prices we pay for the food products and other supplies we use; changes in consumer preferences; competition; temporary and permanent site characteristics of new restaurants; and changes in government regulation.
If our new restaurants do not perform as planned, our business and future prospects could be harmed. In addition, if we are unable to achieve our expected average restaurant sales, our business, financial condition or results of operations could be materially adversely affected.
Opening new restaurants in existing markets may negatively affect sales at our existing restaurants.
The consumer target area of our restaurants varies by location, depending on a number of factors, including population density, other local retail and business attractions, area demographics and geography. As a result, opening a new restaurant in or near markets in which we already have restaurants could adversely affect the sales of these existing restaurants. Existing restaurants could also make it more difficult to build our consumer base for a new restaurant in the same market. Our core business strategy does not entail opening new restaurants that we believe will materially affect sales at our existing restaurants, but we may selectively open new restaurants in and around areas of existing restaurants that are operating at or near capacity to effectively serve our customers. Sales cannibalization between our restaurants may become significant in the future as we continue to expand our operations and could affect our sales growth, which could, in turn, materially adversely affect our business, financial condition or results of operations.
New information or attitudes regarding diet and health could result in changes in regulations and consumer consumption habits that could adversely affect our results of operations.
Regulations and consumer eating habits may change as a result of new information or attitudes regarding diet, health and safety. Such changes may include federal, state and local regulations and recommendations from medical and diet professionals pertaining to the ingredients and nutritional content of the food and beverages we offer. The success of our restaurant operations is dependent, in part, upon our ability to effectively respond to changes in any consumer health regulations and our ability to adapt our menu offerings to trends in food consumption. If consumer health regulations or consumer eating habits change significantly, we may choose or be required to modify or remove certain menu items, which may adversely affect the appeal of our menu to new or returning customers. To the extent we are unwilling or unable to respond with appropriate changes to our menu offerings, it could materially affect consumer demand and could have an adverse impact on our business, financial condition or results of operations.
Government regulation and consumer eating habits may impact our business as a result of changes in attitudes regarding diet and health or new information regarding the adverse health effects of consuming certain menu offerings. These changes have resulted in, and may continue to result in, laws and regulations requiring us to disclose the nutritional content of our food offerings, and they have resulted, and may continue to result in, laws and regulations affecting permissible ingredients and menu offerings. For example, a number of states, counties and cities have enacted menu labeling laws requiring multi-unit restaurant operators to disclose to consumers certain nutritional information, or have enacted legislation restricting the use of certain types of ingredients in restaurants. These requirements may be different or inconsistent with requirements under the Patient Protection and Affordable Care Act of 2010
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(the “PPACA”), which establishes a uniform, federal requirement for certain restaurants to post nutritional information on their menus. Specifically, the PPACA requires chain restaurants with 20 or more locations operating under the same name and offering substantially the same menu to publish the total number of calories of standard menu items on menus and menu boards, along with a statement that puts this calorie information in the context of a total daily calorie intake. Inconsistencies among state laws with respect to presentation of nutritional content could be challenging for us to comply with in an efficient manner. The PPACA also requires covered restaurants to provide to consumers, upon request, a written summary of detailed nutritional information for each standard menu item, and to provide a statement on menus and menu boards about the availability of this information upon request. An unfavorable report on, or reaction to, our menu ingredients, the size of our portions or the nutritional content of our menu items could negatively influence the demand for our offerings.
Compliance with current and future laws and regulations regarding the ingredients and nutritional content of our menu items may be costly and time-consuming. Additionally, if consumer health regulations or consumer eating habits change significantly, we may be required to modify or discontinue certain menu items and we may experience higher costs associated with the implementation of those changes. The risks and costs associated with nutritional disclosures on our menus could also impact our operations, particularly given differences among applicable legal requirements and practices within the restaurant industry with respect to testing and disclosure, ordinary variations in food preparation among our own restaurants and the need to rely on the accuracy and completeness of nutritional information obtained from third-party suppliers.
We may not be able to effectively respond to changes in consumer health and safety perceptions or to successfully implement the nutrient content disclosure requirements and adapt our menu offerings to trends in eating habits. The imposition of additional menu labeling laws could materially adversely affect our business, financial condition or results of operations, as well as our position within the restaurant industry in general.
We may not be able to adequately protect our intellectual property, which could harm the value of our brand and could adversely affect our business.
Our intellectual property is material to the conduct of our business and our marketing efforts. Our ability to implement our business plan successfully depends in part on our ability to further build brand recognition using our trademarks, service marks, trade dress and other proprietary intellectual property, including our name and logos and the unique ambience of our restaurants. While it is our policy to protect and defend vigorously our rights to our intellectual property, we cannot predict whether steps taken by us to protect our intellectual property rights will be adequate to prevent misappropriation of these rights or the use by others of restaurant features based upon, or otherwise similar to, our concept. It may be difficult for us to prevent others from copying elements of our concept and any litigation to enforce our rights will likely be costly and may not be successful. Although we believe that we have sufficient rights to all of our trademarks and service marks, we may face claims of infringement that could interfere with our ability to market our restaurants and promote our brand. Any such litigation may be costly and divert resources from our business. Moreover, if we are unable to successfully defend against such claims, we may be prevented from using our trademarks or service marks in the future, may be liable for damages and may have to change our marketing efforts, which in turn could materially adversely affect our business, financial condition or results of operations.
We could be party to litigation that could adversely affect us by distracting management, increasing our expenses or subjecting us to material money damages and other remedies.
Our customers occasionally file complaints or lawsuits against us alleging we caused an illness or injury they suffered at or after a visit to our restaurants, or that we have problems with food quality or operations. These kinds of complaints or lawsuits may be more common in a period in which the public is focused on health safety issues, or may attract more attention due to publication on various social media outlets. We are also subject to a variety of other claims arising in the ordinary course of our business, including personal injury claims, contract claims and claims alleging violations of federal and state law regarding workplace and employment matters, equal opportunity, discrimination and similar matters and we could become subject to class action or other lawsuits related to these or different matters in the future. Regardless of whether any claims against us are valid, or whether we are ultimately held liable, claims may be expensive to defend and may divert time and money away from our operations and hurt our performance. A judgment in excess of our insurance coverage for any claims could materially adversely affect our financial condition or results of operations. Any adverse publicity resulting from these allegations, even if proven to be false, may also materially adversely affect our reputation or prospects, which in turn could materially adversely affect our business, financial condition or results of operations.
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In addition, the restaurant industry has from time to time been subject to claims based on the nutritional content of food products sold and disclosure and advertising practices. We may in the future also be subject to this type of proceeding or to publicity about these matters (particularly those directed at the quick-service or fast-casual segments of the industry) may harm our reputation and could materially adversely affect our business, financial condition or results of operations.
Our current insurance may not provide adequate levels of coverage against claims.
There are types of losses we may incur that cannot be insured against or that we believe are not economically reasonable to insure against. Such losses could have a material adverse effect on our business and results of operations. In addition, we self-insure a significant portion of expected losses under our employee health, workers’ compensation, general liability, property and cyber insurance programs. Unanticipated changes in the actuarial assumptions and management estimates underlying our reserves for these losses could result in materially different amounts of expense under these programs, which could have a material adverse effect on our financial condition, results of operations and liquidity. Failure to obtain and maintain adequate directors’ and officers’ insurance could materially adversely affect our ability to attract and retain qualified officers and directors.
Changes to accounting rules or regulations may adversely affect our results of operations.
Changes to existing accounting rules or regulations may impact our future results of operations or cause the perception that we are more highly leveraged. Other new accounting rules or regulations and varying interpretations of existing accounting rules or regulations have occurred and may occur in the future. For instance, accounting regulatory authorities have implemented a requirement that lessees capitalize operating leases in their financial statements beginning in 2019. Such change will require us to record significant lease obligations on our balance sheet and make other changes to our financial statements. This and other future changes to accounting rules or regulations could materially adversely affect our business, financial condition or results of operations.
Failure of our internal control over financial reporting could adversely affect our business and financial results.
Our management is responsible for establishing and maintaining effective internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that we would prevent or detect a misstatement of our financial statements or fraud. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to report our financial results accurately and timely or to detect and prevent fraud. The identification of a material weakness could indicate a lack of controls adequate to generate accurate financial statements that, in turn, could cause a loss of investor confidence and decline in the market price of our common stock. We may not be able to timely remediate any material weaknesses that may be identified in future periods or maintain all of the controls necessary for continued compliance. Likewise, we cannot assure you that we will be able to retain sufficient skilled finance and accounting personnel, especially in light of the increased demand for such personnel among publicly traded companies.
Our principal stockholders and their affiliates own a substantial portion of our outstanding equity, and their interests may not always coincide with the interests of the other holders.
As of January 1, 2019, L Catterton and certain of its affiliates, Argentia Private Investments, Inc. (“Argentia”) and Mill Road Capital II, L.P. and certain of its affiliates (“Mill Road”) beneficially owned in the aggregate shares representing approximately 35.2% of our outstanding voting power. L Catterton and certain of its affiliates beneficially owned, in the aggregate, shares representing approximately 14.3% of our outstanding equity interests and voting power as of January 1, 2019. Argentia beneficially owned shares representing approximately 9.9% of our outstanding equity interests and voting power as of January 1, 2019. Mill Road and certain of its affiliates beneficially owned, in the aggregate, shares representing approximately 11.0% of our outstanding equity interests and voting power as of January 1, 2019. As a result, L Catterton, Argentia and Mill Road could continue to potentially have significant influence over all matters presented to our stockholders for approval, including election and removal of our directors and change in control transactions. The interests of L Catterton, Argentia and Mill Road may not always coincide with the interests of the other holders of our common stock.
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Our quarterly operating results may fluctuate significantly and could fall below the expectations of securities analysts and investors due to seasonality and other factors, some of which are beyond our control, resulting in a decline in our stock price.
Our quarterly operating results may fluctuate significantly because of several factors, including but not limited to: increases and decreases in AUVs and comparable restaurant sales; profitability of our restaurants; labor availability and costs for hourly and management personnel; changes in interest rates; macroeconomic conditions, both nationally and locally; negative publicity relating to the consumption of products we serve; changes in consumer preferences and competitive conditions; impairment of long-lived assets and any loss on and exit costs associated with restaurant closures; expansion to new markets; the timing of new restaurant openings and related expense; restaurant operating costs for our newly-opened restaurants; increases in infrastructure costs; and fluctuations in commodity prices.
Seasonal factors, particularly weather disruptions, and the timing of holidays also cause our revenue to fluctuate from quarter to quarter. Our revenue per restaurant is typically lower in the first and fourth quarters due to reduced winter and holiday traffic and higher in the second and third quarters. As a result of these factors, our quarterly and annual operating results and comparable restaurant sales may fluctuate significantly. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year and comparable restaurant sales for any particular future period may decrease. In the future, operating results may fall below the expectations of securities analysts and investors. In that event, the price of our common stock would likely decrease.
The price of our common stock may be volatile.
The market price of our common stock could fluctuate significantly. Those fluctuations could be based on various factors, including: our operating performance and the performance of our competitors or restaurant companies in general; the public’s reaction to our press releases, our other public announcements and our filings with the SEC; changes in earnings estimates or recommendations by research analysts who follow us or other companies in our industry; global, national or local economic, legal and regulatory factors unrelated to our performance; changes in, or our ability to achieve, projections or estimates of our operating results made by analysts, investors or management; future sales of our common stock by our officers, directors and significant stockholders; the exercise of warrants for shares of common stock; the arrival or departure of key personnel; and other developments affecting us, our industry or our competitors.
In addition, in recent years the stock market has experienced significant price and volume fluctuations. These fluctuations may be unrelated to the operating performance of particular companies. These broad market fluctuations may cause declines in the market price of our common stock. The price of our common stock could fluctuate based upon factors that have little or nothing to do with our business, financial condition or results of operations, and those fluctuations could materially reduce the price of our common stock.
We do not intend to pay dividends for the foreseeable future.
We have never declared nor paid any cash dividends on our common stock. For the foreseeable future, we intend to retain any earnings to finance the operation of our business, and we do not anticipate paying any cash dividends on our common stock. See Item 5. “Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities-Dividends.”
Future sales of our common stock, or the perception that such sales may occur, could depress our common stock price.
Sales of a substantial number of shares of our common stock in the public market, or the perception that such sales may occur, could depress the market price of our common stock. Our amended and restated certificate of incorporation authorizes us to issue up to 180,000,000 shares of Class A common stock and Class B common stock. As of January 1, 2019, we have 43,929,438 outstanding shares of Class A common stock and no outstanding shares of Class B common stock. In addition, as of such date, approximately 2,082,338 shares of Class A common stock are issuable upon the exercise of outstanding stock options and the vesting of restricted stock units, and 1,913,793 shares of Class A common stock and 28,850 shares of Class B common stock are issuable upon the exercise of warrants. Moreover, as of that date, approximately 4.1 million shares of our common stock are available for future grants under our stock incentive plan and for future purchase under our employee stock purchase plan.
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Provisions in our organizational documents and Delaware law may delay or prevent our acquisition by a third party.
Our amended and restated certificate of incorporation, our second amended and restated bylaws and Delaware law each contain several provisions that may make it more difficult for a third party to acquire control of us without the approval of our Board of Directors. For example, we have a classified Board of Directors with three-year staggered terms, which could delay the ability of stockholders to change the membership of a majority of our Board of Directors. Additionally, the terms of outstanding warrants contain change of control provisions which, in the event of a potential change of control transaction, may require the payment of a premium to holders of such warrants. These provisions may make it more difficult or expensive for a third party to acquire a majority of our outstanding equity interests. These provisions also may delay, prevent or deter a merger, acquisition, tender offer, proxy contest or other transaction that might otherwise result in our stockholders receiving a premium over the market price for their common stock.
ITEM 1B. Unresolved Staff Comments
None.
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ITEM 2. Properties
As of January 1, 2019, we and our franchisees operated 459 restaurants in 29 states and the District of Columbia. Our restaurants are typically 2,600 to 2,700 square feet and are located in a variety of suburban, urban and small markets. We lease the property for our central support office and all of the properties on which we operate restaurants. The chart below shows the locations of our company-owned and franchised restaurants as of January 1, 2019.
State | Company- owned | Franchised | Total | ||||||
Arizona | 5 | — | 5 | ||||||
California | 20 | — | 20 | ||||||
Colorado | 60 | — | 60 | ||||||
Connecticut | — | 4 | 4 | ||||||
District of Columbia | 1 | — | 1 | ||||||
Florida | 5 | 1 | 6 | ||||||
Idaho | 5 | — | 5 | ||||||
Illinois | 48 | 5 | 53 | ||||||
Indiana | 23 | — | 23 | ||||||
Iowa | 10 | 1 | 11 | ||||||
Kansas | 10 | — | 10 | ||||||
Kentucky | 1 | 4 | 5 | ||||||
Maryland | 23 | — | 23 | ||||||
Michigan | — | 23 | 23 | ||||||
Minnesota | 45 | 1 | 46 | ||||||
Missouri | 3 | 8 | 11 | ||||||
Montana | — | 2 | 2 | ||||||
Nebraska | — | 6 | 6 | ||||||
New York | — | 1 | 1 | ||||||
North Carolina | 13 | — | 13 | ||||||
North Dakota | — | 3 | 3 | ||||||
Ohio | 17 | — | 17 | ||||||
Oregon | 6 | — | 6 | ||||||
Pennsylvania | 9 | — | 9 | ||||||
South Dakota | — | 3 | 3 | ||||||
Tennessee | 4 | — | 4 | ||||||
Utah | 15 | — | 15 | ||||||
Virginia | 26 | — | 26 | ||||||
Washington | 2 | — | 2 | ||||||
Wisconsin | 43 | 3 | 46 | ||||||
394 | 65 | 459 | |||||||
We are obligated under non-cancelable leases for our restaurants and our central support office. Our restaurant leases generally have initial terms of 10 years with two or more five-year renewal options. Our restaurant leases may require us to pay a proportionate share of real estate taxes, insurance, common area maintenance charges and other operating costs. Some restaurant leases provide for contingent rental payments based on sales thresholds, although we generally do not expect to pay significant contingent rent on these properties based on the thresholds in those leases.
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ITEM 3. Legal Proceedings
Other Matters
In the normal course of business, the Company is subject to other proceedings, lawsuits and claims. Such matters are subject to many uncertainties, and outcomes are not predictable with assurance. Consequently, the Company is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact with respect to these matters as of January 1, 2019. These matters could affect the operating results of any one financial reporting period when resolved in future periods. The Company believes that an unfavorable outcome with respect to these matters is remote or a potential range of loss is not material to its consolidated financial statements. Significant increases in the number of these claims, or one or more successful claims that result in greater liabilities than the Company currently anticipates, could materially and adversely affect its business, financial condition, results of operations or cash flows.
ITEM 4. Mine Safety Disclosures
Not applicable.
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PART II
ITEM 5. | Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Our Class A common stock has traded on the Nasdaq Global Select Market under the symbol NDLS since it began trading on June 28, 2013, the date of our initial public offering (“IPO”). As of March 8, 2019, there were approximately 39 holders of record of our common stock. The number of holders of record is based upon the actual numbers of holders registered at such date and does not include holders of shares in “street name” or persons, partnerships, associates, corporations or other entities in security position listings maintained by depositories.
Purchases of Equity Securities by the Issuer
We had no share repurchases during the fourth quarter of 2018.
Sales of Unregistered Securities by the Issuer
We sold no unregistered securities that have not been previously included in a Quarterly Report on Form 10-Q or in a Current Report on Form 8-K.
Stock Performance Graph
The following graph compares the cumulative total shareholder return on our Class A common stock from the beginning of our fiscal year ended December 30, 2014 through the fiscal year ended January 1, 2019 to that of the total return of the Nasdaq Composite and the S&P 600 Restaurants Index. The comparison assumes $100 was invested in our common stock and in each of the forgoing indices at the beginning of the period and assumes the reinvestment of dividends. This graph is furnished and not “filed” with the Securities and Exchange Commission or “soliciting material” under the Exchange Act and shall not be incorporated by reference into any such filings, irrespective of any general incorporation contained in such filing.
The stock price performance included in this graph is not necessarily indicative of future stock price performance.
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Dividends
No dividends have been declared or paid on our shares of common stock. We do not anticipate paying any cash dividends on any of our shares of common stock in the foreseeable future. We currently intend to retain any earnings to finance the development and expansion of our business. Any future determination to pay dividends will be at the discretion of our Board of Directors and will be dependent upon then-existing conditions, including our earnings, capital requirements, results of operations, financial condition, business prospects and other factors that our Board of Directors considers relevant. Further, the Company’s credit facility and warrants each contain provisions that limit its ability to pay dividends on its common stock. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Certain Relationships and Related Transactions, and Director Independence” for additional information regarding our financial condition.
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ITEM 6. Selected Financial Data
The following table summarizes the consolidated historical financial and operating data for the periods indicated. The statements of operations data for the fiscal years ended January 1, 2019, January 2, 2018 and January 3, 2017, and the balance sheet data as of January 1, 2019 and January 2, 2018 have been derived from our audited consolidated financial statements included in Item 8. “Financial Statements and Supplementary Data,” and the statements of operations data from the fiscal years ended December 29, 2015 and December 30, 2014, and the balance sheet data as of January 3, 2017, December 29, 2015 and December 30, 2014 have been derived from our audited consolidated financial statements not included in this report.
The historical results presented below are not necessarily indicative of the results to be expected for any future period. This information should be read in conjunction with “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the related notes included elsewhere in this report.
We operate on a 52- or 53-week fiscal year ending on the Tuesday closest to December 31. Fiscal year 2016, which ended on January 3, 2017, contained 53 weeks, and all other fiscal years presented below contained 52 weeks. We refer to our fiscal years as 2018, 2017, 2016, 2015 and 2014. Our fiscal quarters each contain thirteen weeks, with the exception of the fourth quarter of a 53-week fiscal year, which contains fourteen weeks.
Fiscal Year | ||||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Revenue: | ||||||||||||||||||||
Restaurant revenue | $ | 453,671 | $ | 451,599 | $ | 482,544 | $ | 450,482 | $ | 398,993 | ||||||||||
Franchising royalties and fees | 4,170 | 4,893 | 4,930 | 4,969 | 4,748 | |||||||||||||||
Total revenue | 457,841 | 456,492 | 487,474 | 455,451 | 403,741 | |||||||||||||||
Costs and Expenses: | ||||||||||||||||||||
Restaurant operating costs (exclusive of depreciation and amortization, shown separately below): | ||||||||||||||||||||
Cost of sales | 121,102 | 121,473 | 130,630 | 120,455 | 107,217 | |||||||||||||||
Labor | 149,746 | 150,161 | 161,219 | 143,145 | 120,492 | |||||||||||||||
Occupancy | 49,020 | 51,877 | 55,912 | 50,300 | 42,540 | |||||||||||||||
Other restaurant operating costs | 65,575 | 64,091 | 73,011 | 63,549 | 52,580 | |||||||||||||||
General and administrative(1)(2) | 46,092 | 39,746 | 55,654 | 37,244 | 31,394 | |||||||||||||||
Depreciation and amortization | 22,872 | 24,613 | 28,134 | 27,802 | 24,787 | |||||||||||||||
Pre-opening | 50 | 935 | 3,131 | 4,407 | 4,425 | |||||||||||||||
Restaurant impairments, closure costs and asset disposals (3) | 7,142 | 37,446 | 47,311 | 29,616 | 1,391 | |||||||||||||||
Total costs and expenses | 461,599 | 490,342 | 555,002 | 476,518 | 384,826 | |||||||||||||||
(Loss) income from operations | (3,758 | ) | (33,850 | ) | (67,528 | ) | (21,067 | ) | 18,915 | |||||||||||
Debt extinguishment expense | 626 | — | — | — | — | |||||||||||||||
Interest expense, net | 4,305 | 3,839 | 2,916 | 1,432 | 365 | |||||||||||||||
(Loss) income before income taxes | (8,689 | ) | (37,689 | ) | (70,444 | ) | (22,499 | ) | 18,550 | |||||||||||
(Benefit) provision for income taxes | (248 | ) | (207 | ) | 1,233 | (8,734 | ) | 7,122 | ||||||||||||
Net (loss) income | (8,441 | ) | (37,482 | ) | (71,677 | ) | (13,765 | ) | 11,428 | |||||||||||
Accretion of preferred stock to redemption value (4) | — | (7,967 | ) | — | — | — | ||||||||||||||
Net (loss) income attributable to common stockholders | $ | (8,441 | ) | $ | (45,449 | ) | $ | (71,677 | ) | $ | (13,765 | ) | $ | 11,428 | ||||||
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(1) | General and administrative expenses in 2016 include a $10.6 million charge for estimated losses associated with claims and anticipated claims by payment card companies from the data security incident, a $2.7 million charge for severance expenses and a $3.0 million charge for an employment-related litigation settlement. |
(2) | General and administrative expenses in 2018 include a charge of $3.4 million for the final assessment related to data breach liabilities, and a $0.3 million charge for a litigation settlement related to a Delaware gift card matter. |
(3) | Restaurant impairments, closure costs and asset disposals include $1.5 million, $16.2 million, $41.6 million and $25.4 million of charges in 2018, 2017, 2016 and 2015, respectively related to one restaurant in 2018, 34 restaurants in 2017, 54 restaurants in 2016 and 39 restaurants in 2015 that were identified as impaired. Additionally, we recognized $4.1 million, $20.1 million, $2.3 million and $3.1 million in 2018, 2017, 2016 and 2015, respectively, of closure costs which are also included in restaurant impairments, closure costs and asset disposals. The closure costs recognized during 2018 include closure costs of 19 restaurants closed throughout 2018, most of which were at or approaching the expiration of their leases, 2017 includes closure costs of 55 restaurants closed during the first quarter of 2017 and 2015 includes closure costs of the 16 restaurants closed in the fourth quarter of 2015. Restaurant impairments and closure costs in 2018, 2017, 2016 and 2015 presented above include amounts related to restaurants previously impaired or closed. |
(4) | Represents the accretion of the preferred stock issued to L Catterton to its full redemption value. See Note 8, Stockholders’ Equity for additional information. |
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Fiscal Year | ||||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||
(in thousands, except share and per share data and restaurants) | ||||||||||||||||||||
(Loss) earnings per Class A and Class B common share, combined: | ||||||||||||||||||||
Basic | $ | (0.20 | ) | $ | (1.20 | ) | $ | (2.58 | ) | $ | (0.48 | ) | $ | 0.38 | ||||||
Diluted | $ | (0.20 | ) | $ | (1.20 | ) | $ | (2.58 | ) | $ | (0.48 | ) | $ | 0.37 | ||||||
Weighted average Class A and Class B common shares outstanding, combined: | ||||||||||||||||||||
Basic | 42,329,556 | 37,759,497 | 27,808,708 | 28,938,901 | 29,717,304 | |||||||||||||||
Diluted | 42,329,556 | 37,759,497 | 27,808,708 | 28,938,901 | 31,001,099 | |||||||||||||||
Selected Operating Data: | ||||||||||||||||||||
Company-owned restaurants at end of period | 394 | 412 | 457 | 422 | 386 | |||||||||||||||
Franchise-owned restaurants at end of period | 65 | 66 | 75 | 70 | 53 | |||||||||||||||
Company-owned: | ||||||||||||||||||||
Average unit volumes (1) | $ | 1,119 | $ | 1,072 | $ | 1,075 | $ | 1,103 | $ | 1,147 | ||||||||||
Comparable restaurant sales (2) | 3.4 | % | (2.7 | )% | (0.9 | )% | (0.2 | )% | 0.3 | % | ||||||||||
Restaurant contribution (3) | $ | 68,228 | $ | 63,997 | $ | 61,772 | $ | 73,033 | $ | 76,164 | ||||||||||
Restaurant contribution margin (3) | 15.0 | % | 14.2 | % | 12.8 | % | 16.2 | % | 19.1 | % | ||||||||||
As of | ||||||||||||||||||||
January 1, 2019 | January 2, 2018 | January 3, 2017 | December 29, 2015 | December 30, 2014 | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Balance Sheet Data: | ||||||||||||||||||||
Total current assets | $ | 23,351 | $ | 22,058 | $ | 25,788 | $ | 25,401 | $ | 22,776 | ||||||||||
Total assets | 172,032 | 185,233 | 209,461 | 239,961 | 238,539 | |||||||||||||||
Total current liabilities | 33,147 | 43,869 | 49,033 | 32,914 | 25,831 | |||||||||||||||
Total long-term debt | 44,183 | 57,624 | 84,676 | 67,732 | 27,136 | |||||||||||||||
Total liabilities | 119,351 | 149,372 | 183,643 | 146,189 | 98,424 | |||||||||||||||
Total stockholders' equity | 52,681 | 35,861 | 25,818 | 93,772 | 140,115 | |||||||||||||||
_____________
(1) | Average unit volumes (“AUVs”) consist of average annualized sales of all company-owned restaurants over the trailing 12 periods. |
(2) | Comparable restaurant sales represent year-over-year sales for restaurants open for at least 18 full periods. |
(3) | Restaurant contribution represents restaurant revenue less restaurant operating costs, which are the cost of sales, labor, occupancy and other operating items. Restaurant contribution margin represents restaurant contribution as a percentage of restaurant revenue. Restaurant contribution and restaurant contribution margin are non-GAAP measures that are neither required by, nor presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”), and the calculations thereof may not be comparable to similar measures reported by other companies. These measures are supplemental measures of the operating performance of our restaurants and are not reflective of the underlying performance of our business because corporate-level expenses are excluded from these measures. |
Restaurant contribution and restaurant contribution margin have limitations as analytical tools, and should not be considered in isolation or as substitutes for analysis of our results as reported under GAAP. Management does not consider these measures in isolation or as alternatives to financial measures determined in accordance with GAAP. However, management believes that restaurant contribution and restaurant contribution margin are important tools for investors and other interested parties because they are widely-used metrics within the restaurant industry to evaluate restaurant-level productivity, efficiency and performance. Management also uses these measures as metrics to evaluate the profitability of incremental sales at our restaurants, restaurant performance across periods and restaurant financial performance compared with competitors. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this annual report on Form 10-K for a discussion of restaurant contribution, restaurant contribution margin and other key performance indicators.
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A reconciliation of (loss) income from operations to restaurant contribution is presented below:
Fiscal Year | ||||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
(Loss) income from operations | $ | (3,758 | ) | $ | (33,850 | ) | $ | (67,528 | ) | $ | (21,067 | ) | $ | 18,915 | ||||||
Less: Franchising royalties and fees | 4,170 | 4,893 | 4,930 | 4,969 | 4,748 | |||||||||||||||
Add: General and administrative | 46,092 | 39,746 | 55,654 | 37,244 | 31,394 | |||||||||||||||
Depreciation and amortization | 22,872 | 24,613 | 28,134 | 27,802 | 24,787 | |||||||||||||||
Pre-opening | 50 | 935 | 3,131 | 4,407 | 4,425 | |||||||||||||||
Restaurant impairments, closure costs and asset disposals | 7,142 | 37,446 | 47,311 | 29,616 | 1,391 | |||||||||||||||
Restaurant contribution | $ | 68,228 | $ | 63,997 | $ | 61,772 | $ | 73,033 | $ | 76,164 | ||||||||||
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ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Item 6. “Selected Financial Data” and our consolidated financial statements and related notes included in Item 8. “Financial Statements and Supplementary Data.” In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors including, but not limited to, those discussed in Item 1A. “Risk Factors” and elsewhere in this report.
We operate on a 52- or 53-week fiscal year ending on the Tuesday closest to December 31. Both fiscal years 2018 and 2017, which ended on January 1, 2019 and January 2, 2018, respectively, contained 52 weeks. Fiscal year 2016, which ended on January 3, 2017, contained 53 weeks. We refer to our fiscal years as 2018, 2017 and 2016. Our fiscal quarters each contained 13 operating weeks, with the exception of the fourth quarter of 2016, which had 14 operating weeks.
Overview
Noodles & Company is a restaurant concept offering lunch and dinner within the fast-casual segment of the restaurant industry. We opened our first location in 1995, offering noodle and pasta dishes, staples of many cuisines, with the goal of delivering fresh ingredients and flavors from around the world under one roof. Today, our globally-inspired menu includes a wide variety of high quality, cooked-to-order dishes, including noodles and pasta, soups, salads and appetizers. We believe we offer our customers value with per person spend of approximately $8.99 in 2018.
Recent Trends, Risks and Uncertainties
Comparable Restaurant Sales. In fiscal 2018, system-wide comparable restaurant sales increased 3.7%, comprised of a 3.4% increase for company-owned restaurants and a 5.5% increase for franchise restaurants. Comparable restaurant sales represent year-over-year sales comparisons for restaurants open for at least 18 full periods. Our ability to continue to increase comparable restaurant sales depends in part on our ability to successfully implement our operational strategies and initiatives.
Increased Labor Costs. Similar to much of the restaurant industry, our base labor costs have risen in recent periods. In 2018, we were able to mitigate the impact of increased base labor costs through labor efficiencies; however, we expect that labor costs will continue to rise as wage rates and benefit costs increase. Some jurisdictions in which we operate have recently increased their minimum wage by a significant amount and other jurisdictions are considering similar actions. Significant additional government-imposed increases could materially affect our labor costs.
Certain Restaurant Closures. We closed 55 company-owned restaurants in the first quarter of 2017. These restaurants significantly underperformed our restaurant averages, as measured by average unit volumes (“AUVs”), restaurant contribution margin and cash flow. Closing these restaurants has favorably affected our net income, restaurant contribution, restaurant contribution margin, adjusted EBITDA and adjusted EBITDA. Additionally, we closed 19 company-owned restaurants in 2018, most of which were at or approaching the expiration of their leases. We currently do not anticipate significant restaurant closures for the foreseeable future; however, we may from time to time close certain restaurants, including closures at, or near, the expiration of their leases.
Restaurant Development. We have reduced our rate of company-owned restaurant unit growth, resulting in our revenue growing at a slower rate than would be expected if our unit growth rate continued at the historical rate. We believe this more moderate growth strategy will enhance our ability to focus on improving restaurant operations and profitability. New restaurants have historically contributed substantially to our revenue growth. In 2018, we opened one company-owned restaurant and closed 19 company-owned restaurants, while our franchisees did not open any new restaurants and closed one restaurant. As of January 1, 2019, we had 394 company-owned restaurants and 65 franchise restaurants in 29 states and the District of Columbia.
Given recent improvement in performance, operating effectiveness and liquidity, we are currently pursuing a disciplined development pipeline to execute a modest new unit growth rate in the near term. In 2019, we plan to open between four and six company-owned restaurants.
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Impairment of Long-lived Assets. Over the past several years we have recognized significant impairment charges. During 2017 and 2016, 34 restaurants and 54 restaurants were identified as impaired, respectively. Impairment is based on our current assessment of the expected future cash flows of various restaurants based on recent results and other specific market factors. Many of these restaurants we had opened in the last three to four years in newer markets where brand awareness of our restaurants was not as strong and where it had been more difficult to adequately staff our restaurants. In 2018 we identified one restaurant as impaired. Although impairment charges have meaningfully declined in 2018 versus prior years, we may recognize impairment charges in the future.
Key Measures We Use to Evaluate Our Performance
To evaluate the performance of our business, we utilize a variety of financial and performance measures. These key measures include revenue, AUVs, comparable restaurant sales, restaurant contribution, restaurant contribution margin, EBITDA and adjusted EBITDA.
Revenue
Restaurant revenue represents sales of food and beverages in company-owned restaurants. Several factors affect our restaurant revenue in any period, including the number of restaurants in operation and per-restaurant sales.
Franchise royalties and fees represent royalty income and initial franchise fees. While we expect that the majority of our revenue and net income growth will be driven by company-owned restaurants, our franchise restaurants remain an important factor impacting our revenue and financial performance.
Seasonal factors cause our revenue to fluctuate from quarter to quarter. Our revenue per restaurant is typically lower in the first and fourth quarters due to reduced winter and holiday traffic and higher in the second and third quarters. As a result of these factors, our quarterly and annual operating results and comparable restaurant sales may fluctuate significantly.
Average Unit Volumes
AUVs consist of the average annualized sales of all company-owned restaurants for the trailing 12 periods. AUVs are calculated by dividing restaurant revenue by the number of operating days within each time period and multiplying by the number of operating days we have in a typical year. This measurement allows management to assess changes in consumer traffic and per person spending patterns at our restaurants.
Comparable Restaurant Sales
Comparable restaurant sales refer to year-over-year sales comparisons for the comparable restaurant base. We define the comparable restaurant base to include restaurants open for at least 18 full periods. As of the end of 2018, 2017 and 2016, there were 392, 385 and 393 restaurants, respectively, in our comparable restaurant base for company-owned locations. This measure highlights performance of existing restaurants, as the impact of new restaurant openings is excluded. Changes in comparable restaurant sales are generated by changes in traffic, which we calculate as the number of entrées sold, or changes in per-person spend, calculated as sales divided by traffic. Per-person spend can be influenced by changes in menu prices and the mix and number of items sold per person.
Measuring our comparable restaurant sales allows us to evaluate the performance of our existing restaurant base. Various factors impact comparable restaurant sales, including:
• | consumer recognition of our brand and our ability to respond to changing consumer preferences; |
• | overall economic trends, particularly those related to consumer spending; |
• | our ability to operate restaurants effectively and efficiently to meet consumer expectations; |
• | pricing; |
• | the number of restaurant transactions, per-person spend and average check amount; |
• | marketing and promotional efforts; |
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• | abnormal weather patterns; |
• | food safety and foodborne illness concerns; |
• | local competition; |
• | trade area dynamics; |
• | introduction of new and seasonal menu items and limited time offerings; and |
• | opening new restaurants in the vicinity of existing locations. |
Consistent with common industry practice, we present comparable restaurant sales on a calendar-adjusted basis that aligns current year sales weeks with comparable periods in the prior year, regardless of whether they belong to the same fiscal period or not. Since opening new company-owned and franchise restaurants is a part of our growth strategy and we anticipate new restaurants will be a component of our revenue growth (albeit to a lesser extent in future periods, as discussed above), comparable restaurant sales are only one measure of how we evaluate our performance.
Restaurant Contribution and Restaurant Contribution Margin
Restaurant contribution represents restaurant revenue less restaurant operating costs which are cost of sales, labor, occupancy and other restaurant operating costs. Restaurant contribution margin represents restaurant contribution as a percentage of restaurant revenue. We expect restaurant contribution to increase in proportion to the number of new restaurants we open and our comparable restaurant sales growth.
We believe that restaurant contribution and restaurant contribution margin are important tools for investors and other interested parties because they are widely-used metrics within the restaurant industry to evaluate restaurant-level productivity, efficiency and performance. We also use restaurant contribution and restaurant contribution margin as metrics to evaluate the profitability of incremental sales at our restaurants, restaurant performance across periods and restaurant financial performance compared with competitors. Restaurant contribution and restaurant contribution margin are supplemental measures of the operating performance of our restaurants and are not reflective of the underlying performance of our business because corporate-level expenses are excluded from these measures.
EBITDA and Adjusted EBITDA
We define EBITDA as net income (loss) before interest expense, provision (benefit) for income taxes and depreciation and amortization. We define adjusted EBITDA as net income (loss) before interest expense, provision (benefit) for income taxes, depreciation and amortization, restaurant impairments, closure costs and asset disposals, certain litigation settlements, data breach assessments, non-recurring registration and related transaction costs, loss on extinguishment of debt, severance costs and stock-based compensation.
We believe that EBITDA and adjusted EBITDA provide clear pictures of our operating results by eliminating certain non-recurring and non-cash expenses that may vary widely from period to period and are not reflective of the underlying business performance.
The presentation of restaurant contribution, restaurant contribution margin, EBITDA and adjusted EBITDA is not intended to be considered in isolation or as a substitute for, or to be superior to, the financial information prepared and presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”). We use these non-GAAP financial measures for financial and operational decision making and as a means to evaluate period-to-period comparisons. We believe that they provide useful information to management and investors about operating results, enhance the overall understanding of past financial performance and future prospects and allow for greater transparency with respect to key metrics used by management in its financial and operational decision making.
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The following table presents a reconciliation of net loss to EBITDA and adjusted EBITDA:
Fiscal Year | ||||||||||||
2018 | 2017 | 2016 | ||||||||||
(in thousands) | ||||||||||||
Net loss | $ | (8,441 | ) | $ | (37,482 | ) | $ | (71,677 | ) | |||
Depreciation and amortization | 22,872 | 24,613 | 28,134 | |||||||||
Interest expense, net | 4,305 | 3,839 | 2,916 | |||||||||
(Benefit) provision for income taxes | (248 | ) | (207 | ) | 1,233 | |||||||
EBITDA | $ | 18,488 | $ | (9,237 | ) | $ | (39,394 | ) | ||||
Restaurant impairments, closure costs and asset disposals (1) | 7,142 | 37,446 | 47,311 | |||||||||
Litigation settlements and data breach assessments (2) | 3,796 | (401 | ) | 13,622 | ||||||||
Fees and costs related to the registration statement and related transactions (3) | 53 | 679 | — | |||||||||
Loss on extinguishment of debt (4) | 626 | — | — | |||||||||
Severance costs (5) | 278 | 581 | 2,034 | |||||||||
Stock-based compensation expense (6) | 2,979 | 1,513 | 2,319 | |||||||||
Adjusted EBITDA | $ | 33,362 | $ | 30,581 | $ | 25,892 | ||||||
_____________
(1) | Restaurant impairments and closure costs in all periods presented above include amounts related to restaurants previously impaired or closed. Additionally, 2018 includes closure costs of the 19 restaurants closed during 2018 and the impairment of one restaurant, 2017 includes the closure costs related to the 55 restaurants closed in the first quarter of 2017 and the impairment of 34 restaurants, and 2016 includes the impairment of 54 restaurants. See Note 6, Restaurant Impairments, Closure Costs and Asset Disposals. |
(2) | Fiscal year 2018 includes a charge of $3.4 million for the final settlement related to data breach liabilities, and a $0.3 million charge for a litigation settlement related to a Delaware gift card matter. Fiscal year 2017 includes a gain on an employment-related litigation settlement due to final settlement being less than what the Company had previously accrued. Fiscal year 2016 includes the initial charge of $10.6 million for estimated losses associated with claims and anticipated claims by payment card companies from a data security incident and a $3.0 million charge for estimated costs of the employment-related litigation settlement. |
(3) | Fiscal year 2018 includes expenses related to the registration statement the Company filed in the second quarter of 2018. Fiscal year 2017 includes expenses related to the registration statement the Company filed in the first quarter of 2017, which registration statement was later withdrawn. |
(4) | Fiscal year 2018 includes the loss on extinguishment of debt, which resulted from writing off certain remaining unamortized balances of debt issuance costs related to the our outstanding indebtedness with Bank of America, N.A. (the “Prior Credit Facility”) when it was repaid in full in the second quarter of 2018. |
(5) | Fiscal year 2018 includes severance costs from departmental structural changes. Fiscal year 2017 includes severance costs related to the departure of our Chief Operations Officer and additional changes to operations departmental structure. Fiscal year 2016 includes severance costs related to the departures of our Chief Executive Officer and Chief Marketing Officer and from a reduction in headcount as a result of reducing new restaurant development. |
(6) | Fiscal year 2018 includes additional expense due to the 2017 and 2018 annual grants both being granted in 2018. Fiscal year 2016 includes a $0.7 million charge for modifying the outstanding stock options for Kevin Reddy, who resigned from his positions as the Chairman of the Board and Chief Executive Officer of the Company in July 2016. |
Key Financial Definitions
Cost of Sales
Cost of sales includes the direct costs associated with the food, beverage and packaging of our menu items. Cost of sales also includes any costs related to discounted menu items. Cost of sales is a substantial expense and can be expected to change proportionally as our restaurant revenue changes. Fluctuations in cost of sales are caused primarily by volatility in the cost of commodity food items and related contracts for such items. Other important factors causing fluctuations in cost of sales include seasonality, discounting activity and restaurant level management of food waste.
Labor Costs
Labor costs include wages, payroll taxes, workers’ compensation expense, benefits and incentives paid to our restaurant teams. Similar to certain other expense items, we expect labor costs to change proportionally as our restaurant revenue changes. Factors that influence fluctuations in our labor costs include minimum wage and payroll tax legislation, the frequency and severity of workers’ compensation claims, health care costs and the performance of our restaurants.
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Occupancy Costs
Occupancy costs include rent, common area maintenance charges and real estate tax expense related to our restaurants and are expected to grow proportionally as we open new restaurants.
Other Restaurant Operating Costs
Other restaurant operating costs include the costs of repairs and maintenance, utilities, restaurant-level marketing, credit card processing fees, delivery fees, restaurant supplies and other restaurant operating costs. Similar to certain other costs, they are expected to grow proportionally as restaurant revenue grows.
General and Administrative Expense
General and administrative expense is composed of payroll, other compensation, travel, marketing, accounting and legal fees, insurance and other expenses related to the infrastructure required to support our restaurants. General and administrative expense also includes the non-cash stock compensation expense related to our stock incentive plan.
Depreciation and Amortization
Our principal depreciation and amortization charges relate to depreciation of long-lived assets, such as property, equipment and leasehold improvements, from restaurant construction and ongoing maintenance.
Pre-Opening Costs
Pre-opening costs relate to the costs incurred prior to the opening of a restaurant. These include management labor costs, staff labor costs during training, food and supplies utilized during training, marketing costs and other pre-opening related costs. Pre-opening costs also include rent recorded between the date of possession and the opening date for our restaurants.
Restaurant impairments, closure costs and asset disposals
Restaurant impairments, closure costs and asset disposals include the net gain or loss on disposal of long-lived assets related to retirements and replacement of equipment or leasehold improvements, restaurant closures and impairment charges.
Interest Expense
Interest expense consists primarily of interest on our outstanding indebtedness and amortization of debt issuance costs over the life of the related debt reduced by capitalized interest.
Provision (Benefit) for Income Taxes
Provision (benefit) for income taxes consists of federal, foreign, state and local taxes on our income.
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Restaurant Openings, Closures and Relocations
The following table shows restaurants opened or closed in the years indicated:
Fiscal Year | |||||||||
2018 | 2017 | 2016 | |||||||
Company-Owned Restaurants | |||||||||
Beginning of period | 412 | 457 | 422 | ||||||
Openings | 1 | 12 | 38 | ||||||
Closures | (19 | ) | (57 | ) | (3 | ) | |||
End of period | 394 | 412 | 457 | ||||||
Franchise Restaurants | |||||||||
Beginning of period | 66 | 75 | 70 | ||||||
Openings | — | 3 | 6 | ||||||
Closures | (1 | ) | (12 | ) | (1 | ) | |||
End of period | 65 | 66 | 75 | ||||||
Total restaurants | 459 | 478 | 532 | ||||||
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Results of Operations
The following table summarizes key components of our results of operations for the periods indicated as a percentage of our total revenue, except for the components of restaurant operating costs, which are expressed as a percentage of restaurant revenue. Fiscal years 2018 and 2017 each contained 52 operating weeks, and fiscal year 2016 contained 53 operating weeks.
Fiscal Year | |||||||||
2018 | 2017 | 2016 | |||||||
Revenue: | |||||||||
Restaurant revenue | 99.1 | % | 98.9 | % | 99.0 | % | |||
Franchising royalties and fees | 0.9 | % | 1.1 | % | 1.0 | % | |||
Total revenue | 100.0 | % | 100.0 | % | 100.0 | % | |||
Costs and expenses: | |||||||||
Restaurant operating costs (exclusive of depreciation and amortization, shown separately below): | |||||||||
Cost of sales | 26.7 | % | 26.9 | % | 27.1 | % | |||
Labor | 33.0 | % | 33.3 | % | 33.4 | % | |||
Occupancy | 10.8 | % | 11.5 | % | 11.6 | % | |||
Other restaurant operating costs | 14.5 | % | 14.2 | % | 15.1 | % | |||
General and administrative | 10.1 | % | 8.7 | % | 11.4 | % | |||
Depreciation and amortization | 5.0 | % | 5.4 | % | 5.8 | % | |||
Pre-opening | — | % | 0.2 | % | 0.6 | % | |||
Restaurant impairments, closure costs and asset disposals | 1.6 | % | 8.2 | % | 9.7 | % | |||
Total costs and expenses | 100.8 | % | 107.4 | % | 113.9 | % | |||
Loss from operations | (0.8 | )% | (7.4 | )% | (13.9 | )% | |||
Loss on extinguishment of debt | 0.1 | % | — | % | — | % | |||
Interest expense, net | 1.0 | % | 0.9 | % | 0.6 | % | |||
Loss before income taxes | (1.9 | )% | (8.3 | )% | (14.5 | )% | |||
(Benefit) provision for income taxes | (0.1 | )% | (0.1 | )% | 0.2 | % | |||
Net loss | (1.8 | )% | (8.2 | )% | (14.7 | )% | |||
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Fiscal Year 2018 compared to Fiscal Year 2017
Fiscal years 2018 and 2017 contained 52 operating weeks. The table below presents our operating results for 2018 and 2017, and the related year-over-year changes:
Fiscal Year | Increase / (Decrease) | ||||||||||||||
2018 | 2017 | $ | % | ||||||||||||
(in thousands) | |||||||||||||||
Revenue: | |||||||||||||||
Restaurant revenue | $ | 453,671 | $ | 451,599 | $ | 2,072 | 0.5 | % | |||||||
Franchising royalties and fees | 4,170 | 4,893 | (723 | ) | (14.8 | )% | |||||||||
Total revenue | 457,841 | 456,492 | 1,349 | 0.3 | % | ||||||||||
Costs and Expenses: | |||||||||||||||
Restaurant operating costs (exclusive of depreciation and amortization, shown separately below): | |||||||||||||||
Cost of sales | 121,102 | 121,473 | (371 | ) | (0.3 | )% | |||||||||
Labor | 149,746 | 150,161 | (415 | ) | (0.3 | )% | |||||||||
Occupancy | 49,020 | 51,877 | (2,857 | ) | (5.5 | )% | |||||||||
Other restaurant operating costs | 65,575 | 64,091 | 1,484 | 2.3 | % | ||||||||||
General and administrative | 46,092 | 39,746 | 6,346 | 16.0 | % | ||||||||||
Depreciation and amortization | 22,872 | 24,613 | (1,741 | ) | (7.1 | )% | |||||||||
Pre-opening | 50 | 935 | (885 | ) | (94.7 | )% | |||||||||
Restaurant impairments, closure costs and asset disposals | 7,142 | 37,446 | (30,304 | ) | (80.9 | )% | |||||||||
Total costs and expenses | 461,599 | 490,342 | (28,743 | ) | (5.9 | )% | |||||||||
Loss from operations | (3,758 | ) | (33,850 | ) | 30,092 | 88.9 | % | ||||||||
Loss on extinguishment of debt | 626 | — | 626 | 100.0 | % | ||||||||||
Interest expense, net | 4,305 | 3,839 | 466 | 12.1 | % | ||||||||||
Loss before income taxes | (8,689 | ) | (37,689 | ) | 29,000 | 76.9 | % | ||||||||
Benefit from income taxes | (248 | ) | (207 | ) | (41 | ) | 19.8 | % | |||||||
Net loss | $ | (8,441 | ) | $ | (37,482 | ) | $ | 29,041 | 77.5 | % | |||||
Company-owned: | |||||||||||||||
Average unit volumes | $ | 1,119 | $ | 1,072 | $ | 47 | 4.4 | % | |||||||
Comparable restaurant sales | 3.4 | % | (2.7 | )% | |||||||||||
Revenue
Total revenue increased by $1.3 million, or 0.3%, in 2018 compared to 2017. This increase was primarily due to the increase in comparable restaurant sales and additional restaurant openings since the beginning of 2017, partially offset by restaurants closed since the beginning of 2017, including the closing of 19 company-owned restaurants in 2018, most of which were at or approaching the expiration of their leases, and the closing of 55 company-owned restaurants in the first quarter of 2017.
System-wide comparable restaurant sales growth was 3.7% in 2018, comprised of a 3.4% increase at company-owned restaurants and a 5.5% increase at franchise-owned restaurants.
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Cost of Sales
Cost of sales decreased by $0.4 million, or 0.3%, in 2018 compared to 2017. As a percentage of restaurant revenue, cost of sales decreased to 26.7% in 2018 from 26.9% in 2017. The decrease as a percentage of restaurant revenue was primarily due to favorable commodity pricing and savings from supply chain initiatives, partially offset by the nationwide launch in the second quarter of 2018 of Zoodles, which have a higher cost of goods sold than other noodle offerings.
Labor Costs
Labor costs decreased by $0.4 million, or 0.3%, in 2018 compared to 2017. As a percentage of restaurant revenue, labor costs decreased to 33.0% in 2018 from 33.3% in 2017. The decrease as a percentage of restaurant revenue was driven by the benefit of closing underperforming restaurants in the first quarter of 2017, which generally had higher labor costs as a percentage of revenue than the balance of our portfolio, labor savings initiatives and leverage on higher AUVs, partially offset by labor inflation and increased incentive compensation.
Occupancy Costs
Occupancy costs decreased by $2.9 million, or 5.5%, in 2018 compared to 2017, due primarily to the favorable impact of restaurant closures since the beginning of 2017, which generally had higher occupancy costs as a percentage of revenue than the balance of our portfolio. As a percentage of restaurant revenue, occupancy costs decreased to 10.8% in 2018 from 11.5% in 2017, due to leverage on higher AUVs.
Other Restaurant Operating Costs
Other restaurant operating costs increased by $1.5 million, or 2.3%, in 2018 compared to 2017, due primarily to expenses associated with marketing, culinary, and off-premise initiatives in 2018. As a percentage of restaurant revenue, other restaurant operating costs increased to 14.5% in 2018 from 14.2% in 2017, due primarily to expenses associated with the above-mentioned initiatives, partially offset by leverage on higher AUVs.
General and Administrative Expense
General and administrative expense increased by $6.3 million, or 16.0%, in 2018 compared to 2017, primarily due to a $3.4 million charge for the final assessment related to the data breach liabilities, a $0.3 million charge for a litigation settlement related to a Delaware gift card matter and increased incentive compensation. As a percentage of revenue, general and administrative expense increased to 10.1% in 2018 compared to 8.7% in 2017.
Depreciation and Amortization
Depreciation and amortization decreased by $1.7 million, or 7.1%, in 2018 compared to 2017, due primarily to restaurants impaired or closed in prior years. As a percentage of revenue, depreciation and amortization decreased to 5.0% in 2018 from 5.4% in 2017.
Pre-Opening Costs
Pre-opening costs decreased by $0.9 million, or 94.7%, in 2018 compared to 2017 due to fewer restaurants under construction compared to the prior year.
Restaurant Impairments, Closure Costs and Asset Disposals
Restaurant impairments, closure costs and asset disposals decreased by $30.3 million, or 80.9%, in 2018 compared to 2017. In 2018, we recognized $4.1 million of closure costs primarily related to 19 restaurants closed in 2018, most of which were at or approaching the expiration of their leases, compared to $20.1 million of closure costs recognized in 2017 primarily related to the closure of 55 restaurants in the first quarter of 2017. Both periods include ongoing costs of restaurants closed in previous years.
Additionally, in 2018 we recognized $1.5 million of impairment charges related to the impairment of one restaurant, compared to $16.2 million of impairment charges recognized in 2017 related to the impairment of 34 restaurants. Both periods include ongoing equipment costs for restaurants previously impaired.
Each quarter we evaluate possible impairment of property and equipment at the restaurant level and record an impairment loss whenever we determine that the fair value of these assets is less than their carrying value. There can be no assurance that such evaluations will not result in additional impairment costs in future periods.
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Loss on Extinguishment of Debt
In May 2018, we entered into a credit facility with U.S. Bank National Association (the “2018 Credit Facility”) and repaid in full our outstanding indebtedness under the Prior Credit Facility using funds drawn on the 2018 Credit Facility. Upon repayment, the Prior Credit Facility and all related agreements were terminated. As a result, we wrote off the remaining unamortized balance of debt issuance costs related to the Prior Credit Facility and recognized a loss on extinguishment of debt in the amount of $0.6 million in 2018.
Interest Expense
Interest expense increased by $0.5 million, or 12.1% in 2018 compared to 2017. The increase was the result of an increase in the average interest rate on our credit facility and higher amortization of debt issuance costs, partially offset by lower average debt balances during 2018 compared to 2017.
Benefit from Income Taxes
The effective tax rate was 2.9% in 2018 compared to 0.5% in 2017. The effective tax rate in 2018 reflects changes made by the Tax Cuts and Jobs Act of 2017 (“Tax Act”), which enabled us to release a portion of the previously recorded valuation allowance as a benefit from income tax. The effective tax rate in 2017 is primarily related to disallowed tax amortization on indefinite-lived intangibles. We will continue to maintain a valuation allowance against deferred tax assets until there is sufficient evidence to support a full or partial reversal. The reversal of a previously recorded valuation allowance will generally result in a benefit from income tax.
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Fiscal Year 2017 compared to Fiscal Year 2016
Fiscal year 2017 contained 52 operating weeks and fiscal year 2016 contained 53 operating weeks. The table below presents our operating results for 2017 and 2016, and the related year-over-year changes:
Fiscal Year | Increase / (Decrease) | ||||||||||||||
2017 | 2016 | $ | % | ||||||||||||
(in thousands) | |||||||||||||||
Revenue: | |||||||||||||||
Restaurant revenue | $ | 451,599 | $ | 482,544 | $ | (30,945 | ) | (6.4 | )% | ||||||
Franchising royalties and fees | 4,893 | 4,930 | (37 | ) | (0.8 | )% | |||||||||
Total revenue | 456,492 | 487,474 | (30,982 | ) | (6.4 | )% | |||||||||
Costs and Expenses: | |||||||||||||||
Restaurant operating costs (exclusive of depreciation and amortization, shown separately below): | |||||||||||||||
Cost of sales | 121,473 | 130,630 | (9,157 | ) | (7.0 | )% | |||||||||
Labor | 150,161 | 161,219 | (11,058 | ) | (6.9 | )% | |||||||||
Occupancy | 51,877 | 55,912 | (4,035 | ) | (7.2 | )% | |||||||||
Other restaurant operating costs | 64,091 | 73,011 | (8,920 | ) | (12.2 | )% | |||||||||
General and administrative | 39,746 | 55,654 | (15,908 | ) | (28.6 | )% | |||||||||
Depreciation and amortization | 24,613 | 28,134 | (3,521 | ) | (12.5 | )% | |||||||||
Pre-opening | 935 | 3,131 | (2,196 | ) | (70.1 | )% | |||||||||
Restaurant impairments, closure costs and asset disposals | 37,446 | 47,311 | (9,865 | ) | (20.9 | )% | |||||||||
Total costs and expenses | 490,342 | 555,002 | (64,660 | ) | (11.7 | )% | |||||||||
Loss from operations | (33,850 | ) | (67,528 | ) | 33,678 | (49.9 | )% | ||||||||
Interest expense, net | 3,839 | 2,916 | 923 | 31.7 | % | ||||||||||
Loss before income taxes | (37,689 | ) | (70,444 | ) | 32,755 | (46.5 | )% | ||||||||
(Benefit) provision for income taxes | (207 | ) | 1,233 | (1,440 | ) | * | |||||||||
Net loss | $ | (37,482 | ) | $ | (71,677 | ) | $ | 34,195 | (47.7 | )% | |||||
Company-owned: | |||||||||||||||
Average unit volumes | $ | 1,072 | $ | 1,075 | $ | (3 | ) | (0.3 | )% | ||||||
Comparable restaurant sales | (2.7 | )% | (0.9 | )% | |||||||||||
_____________
* | Not meaningful. |
Revenue
Total revenue decreased by $31.0 million, or 6.4%, in 2017 compared to 2016. This decrease was due to the impact of closing 55 company-owned restaurants in the first quarter of 2017 and a decline in comparable company-owned restaurant sales (as described below), partially offset by additional restaurant openings since the beginning of 2016. Total revenue in the prior fiscal year was also higher by approximately $8.1 million due to the impact of an additional operating week in 2016.
Comparable restaurant sales decreased by 2.7% at company-owned restaurants, decreased by 0.5% at franchise-owned restaurants and decreased by 2.4% system-wide in 2017.
Cost of Sales
Cost of sales decreased by $9.2 million, or 7.0%, in 2017 compared to 2016, due primarily to the decrease in restaurant revenue in 2017 due to restaurant closures in the first quarter of 2017. As a percentage of restaurant revenue, cost of sales decreased to 26.9% in 2017 from 27.1% in 2016. The decrease as a percentage of restaurant revenue was primarily due to less promotional activity.
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Labor Costs
Labor costs decreased by $11.1 million, or 6.9%, in 2017 compared to 2016, due primarily to the decrease in restaurant revenue in 2017 due to restaurant closures in the first quarter of 2017. As a percentage of restaurant revenue, labor costs marginally decreased to 33.3% in 2017 from 33.4% in 2016. The decrease is due to the benefit of restaurant closures during the first quarter of 2017 and labor initiatives, mostly offset by labor inflation.
Occupancy Costs
Occupancy costs decreased by $4.0 million, or 7.2%, in 2017 compared to 2016, due primarily to the favorable impact of restaurant closures in the first quarter of 2017. As a percentage of restaurant revenue, occupancy costs decreased to 11.5% in 2017 from 11.6% in 2016.
Other Restaurant Operating Costs
Other restaurant operating costs decreased by $8.9 million, or 12.2%, in 2017 compared to 2016, due primarily to decreased restaurant revenue due to restaurant closures in the first quarter of 2017 and lower marketing expense in 2017. As a percentage of restaurant revenue, other restaurant operating costs decreased to 14.2% in 2017 from 15.1% in 2016, due primarily to a reduction in marketing spending.
General and Administrative Expense
General and administrative expense decreased by $15.9 million, or 28.6%, in 2017 compared to 2016, primarily due to the recognition in 2016 of a $10.6 million charge for estimated losses associated with claims and anticipated claims by payment card companies from the data security incident, a $2.7 million charge for severance expenses and a $3.0 million charge for an employment-related litigation settlement. As a percentage of revenue, general and administrative expense decreased to 8.7% in 2017 from 11.4% in 2016, due primarily to the charges recognized in 2016 discussed above.
Depreciation and Amortization
Depreciation and amortization decreased by $3.5 million, or 12.5%, in 2017 compared to 2016, due primarily to restaurants closed or impaired since 2015. As a percentage of revenue, depreciation and amortization decreased to 5.4% in 2017 from 5.8% in 2016.
Pre-Opening Costs
Pre-opening costs decreased by $2.2 million, or 70.1%, in 2017 compared to 2016 due to fewer restaurants under construction compared to the comparable period in the prior year. As a percentage of revenue, pre-opening costs decreased to 0.2% in 2017 from 0.6% in 2016.
Restaurant Impairments, Closure Costs and Asset Disposals
Restaurant impairments, closure costs and asset disposals decreased by $9.9 million, or 20.9%, in 2017 compared to 2016. In 2017, we recognized $20.1 million of closure costs related to the closure of 55 restaurants in the first quarter of 2017 and ongoing costs of restaurants closed in the fourth quarter of 2015, compared to $2.3 million of closure costs recognized in 2016 for ongoing costs of restaurants closed in the fourth quarter of 2015.
Additionally, in 2017, we recognized $16.2 million of impairment charges related to the impairment of 34 restaurants, compared to $41.6 million of impairment charges recognized in 2016 related to the impairment of 54 restaurants. Many of these restaurants were opened in the last three to four years in newer markets where brand awareness of our restaurants is not as strong and where it has been more difficult to adequately staff our restaurants. The underperformance of these restaurants, compounded by the higher than average construction costs of some of these restaurants, resulted in the recording of an impairment of fixed assets in both 2017 and 2016.
Each quarter we evaluate possible impairment of fixed assets at the restaurant level and record an impairment loss whenever we determine that the fair value of these assets is less than their carrying value. There can be no assurance that such evaluations will not result in additional impairment costs in future periods.
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Interest Expense
Interest expense increased by $0.9 million in 2017 compared to 2016. The increase was the result of an increase in the average interest rate on our credit facility and higher amortization of debt issuance costs, partially offset by lower average debt balances during 2017 compared to 2016.
(Benefit) Provision for Income Taxes
In 2016, we determined that it was appropriate to record a valuation allowance against U.S. deferred tax assets due to uncertainty regarding the realizability of future tax benefits, after which there was no material tax benefit or provision. We reported a benefit from income taxes of $(0.2) million in 2017 compared to a provision for income taxes of $1.2 million in 2016. The change in tax provision is primarily related to the U.S. valuation allowance that was initially recorded to tax expense in 2016. As a result, the effective tax rate changed to 0.5% in 2017 from (1.8)% in 2016. We will continue to maintain a valuation allowance against U.S. deferred tax assets until there is sufficient evidence to support a full or partial reversal.
During 2017, we closed all Canadian restaurants and discontinued foreign business operations. As a result, all Canadian deferred tax assets were written off against the previously recorded Canadian valuation allowance and did not impact tax expense or the effective tax rate.
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Quarterly Financial Data
The following table presents select historical quarterly consolidated statements of operations data and other operations data for fiscal years 2018 and 2017. Each fiscal quarter contained 13 operating weeks.
Quarter Ended | |||||||||||||||||||||||||||||||
January 1, 2019 | October 2, 2018 | July 3, 2018 | April 3, 2018 | January 2, 2018 | October 3, 2017 | July 4, 2017 | April 4, 2017 | ||||||||||||||||||||||||
(in thousands, except restaurants, unaudited) | |||||||||||||||||||||||||||||||
Revenue: | |||||||||||||||||||||||||||||||
Restaurant revenue | $ | 112,055 | $ | 115,552 | $ | 116,451 | $ | 109,613 | $ | 111,424 | $ | 113,020 | $ | 111,628 | $ | 115,527 | |||||||||||||||
Franchising royalties and fees | 1,138 | 1,175 | 944 | 913 | 1,350 | 1,191 | 1,164 | 1,188 | |||||||||||||||||||||||
Total revenue | $ | 113,193 | $ | 116,727 | $ | ||||||||||||||||||||||||||