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Table of Contents


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
_____________________________________________________________
FORM 10-Q
_____________________________________________________________


    x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
For the quarterly period ended October 2, 2018
or
    o 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)
 
(I.R.S. Employer Identification No.)
520 Zang Street, Suite D
 
 
Broomfield, CO
 
80021
(Address of principal executive offices)
 
(Zip Code)
 
(720) 214-1900
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
 
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 o
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).  
Yes  x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting 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 o
 
 
Emerging growth company x
 
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.    x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding at October 19, 2018
Class A Common Stock, $0.01 par value per share
 
43,922,066 shares



Table of Contents

TABLE OF CONTENTS

 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 





1

Table of Contents

PART I

Item 1. Financial Statements

Noodles & Company
Condensed Consolidated Balance Sheets
(in thousands, except share and per share data)
 
 
October 2,
2018
 
January 2,
2018
 
 
(unaudited)
 
 
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
1,918

 
$
3,361

Accounts receivable
 
1,959

 
2,434

Inventories
 
9,897

 
9,929

Prepaid expenses and other assets
 
6,704

 
6,258

Income tax receivable
 
122

 
76

Total current assets
 
20,600

 
22,058

Property and equipment, net
 
141,375

 
152,593

Goodwill
 
6,400

 
6,400

Intangibles, net

1,384

 
1,565

Other assets, net
 
2,573

 
2,617

Total long-term assets
 
151,732

 
163,175

Total assets
 
$
172,332

 
$
185,233

Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
7,294

 
$
10,929

Accrued payroll and benefits
 
9,851

 
11,719

Accrued expenses and other current liabilities
 
12,292

 
21,221

Current portion of long-term debt
 
688

 

Total current liabilities
 
30,125

 
43,869

Long-term debt, net
 
47,097

 
57,624

Deferred rent
 
37,592

 
38,872

Deferred tax liabilities, net
 
153

 
416

Other long-term liabilities
 
5,390

 
8,591

Total liabilities
 
120,357

 
149,372

 
 
 
 
 
Stockholders’ equity:
 
 
 
 
Preferred stock—$0.01 par value, 1,000,000 shares authorized and undesignated as of October 2, 2018 and January 2, 2018; no shares issued or outstanding
 

 

Common stock—$0.01 par value, 180,000,000 shares authorized as of October 2, 2018 and January 2, 2018; 46,340,013 issued and 43,916,142 outstanding as of October 2, 2018 and 43,550,329 issued and 41,126,458 outstanding as of January 2, 2018
 
463

 
436

Treasury stock, at cost, 2,423,871 shares as of October 2, 2018 and January 2, 2018
 
(35,000
)
 
(35,000
)
Additional paid-in capital
 
197,666

 
171,613

Accumulated deficit
 
(111,154
)
 
(101,188
)
Total stockholders’ equity
 
51,975

 
35,861

Total liabilities and stockholders’ equity
 
$
172,332

 
$
185,233

   See accompanying notes to condensed consolidated financial statements.

2

Table of Contents

Noodles & Company
Condensed Consolidated Statements of Operations
(in thousands, except share and per share data, unaudited)

 
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
 
October 2,
2018
 
October 3,
2017
 
October 2,
2018
 
October 3,
2017
Revenue:
 
 
 
 
 
 
 
 
Restaurant revenue
 
$
115,552

 
$
113,020

 
$
341,616

 
$
340,175

Franchising royalties and fees
 
1,175

 
1,191

 
3,032

 
3,543

Total revenue
 
116,727

 
114,211

 
344,648

 
343,718

Costs and expenses:
 
 
 
 
 
 
 
 
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
 
 
 
 
 
 
 
 
Cost of sales
 
30,617

 
29,955

 
90,962

 
91,640

Labor
 
37,738

 
36,897

 
112,353

 
112,921

Occupancy
 
12,035

 
12,709

 
37,155

 
39,340

Other restaurant operating costs
 
16,224

 
15,811

 
49,997

 
49,152

General and administrative
 
10,399

 
9,807

 
35,480

 
29,866

Depreciation and amortization
 
5,790

 
6,183

 
17,407

 
18,729

Pre-opening
 

 
69

 
50

 
860

Restaurant impairments, closure costs and asset disposals
 
1,792

 
10,263

 
5,952

 
35,147

Total costs and expenses
 
114,595

 
121,694

 
349,356

 
377,655

Income (loss) from operations
 
2,132

 
(7,483
)
 
(4,708
)
 
(33,937
)
Loss on extinguishment of debt
 

 

 
626

 

Interest expense, net
 
1,093

 
893

 
3,385

 
2,828

Income (loss) before income taxes
 
1,039

 
(8,376
)
 
(8,719
)
 
(36,765
)
(Benefit) provision for income taxes
 
(11
)
 
(41
)
 
(259
)
 
230

Net income (loss)
 
1,050

 
(8,335
)
 
(8,460
)
 
(36,995
)
Accretion of preferred stock to redemption value
 

 

 

 
(7,967
)
Net income (loss) attributable to common stockholders
 
$
1,050

 
$
(8,335
)
 
$
(8,460
)
 
$
(44,962
)
Earnings (loss) per share of Class A and Class B common stock, combined:
 
 
 
 
 
 
 
 
Basic
 
$
0.02

 
$
(0.20
)
 
$
(0.20
)
 
$
(1.23
)
Diluted
 
$
0.02

 
$
(0.20
)
 
$
(0.20
)
 
$
(1.23
)
Weighted average shares of Class A and Class B common stock outstanding, combined:
 
 
 
 
 
 
 
 
Basic
 
43,094,524

 
41,109,827

 
41,798,640

 
36,639,382

Diluted
 
44,829,363

 
41,109,827

 
41,798,640

 
36,639,382


See accompanying notes to condensed consolidated financial statements.

3

Table of Contents

Noodles & Company
Condensed Consolidated Statements of Comprehensive Income (Loss)
(in thousands, unaudited)

 
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
 
October 2,
2018
 
October 3,
2017
 
October 2,
2018
 
October 3,
2017
Net income (loss)
 
$
1,050

 
$
(8,335
)
 
$
(8,460
)
 
$
(36,995
)
Other comprehensive loss:
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 

 
(11
)
 

 
(20
)
Other comprehensive loss
 

 
(11
)
 

 
(20
)
Comprehensive income (loss)
 
$
1,050

 
$
(8,346
)
 
$
(8,460
)
 
$
(37,015
)

 See accompanying notes to condensed consolidated financial statements.

4

Table of Contents

Noodles & Company
Condensed Consolidated Statements of Cash Flows
(in thousands, unaudited)

 
 
Three Fiscal Quarters Ended
 
 
October 2,
2018
 
October 3,
2017
Operating activities
 
 
 
 
Net loss
 
$
(8,460
)
 
$
(36,995
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
17,407

 
18,729

Deferred income taxes
 
(263
)
 
230

Restaurant impairments, closure costs and asset disposals
 
5,289

 
28,867

Loss on extinguishment of debt
 
626

 

Amortization of debt issuance costs
 
484

 
288

Stock-based compensation
 
2,232

 
1,193

Gain on insurance proceeds received for property damage
 
(373
)
 

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
489

 
3,142

Inventories
 
(647
)
 
(358
)
Prepaid expenses and other assets
 
(402
)
 
(460
)
Accounts payable
 
(2,172
)
 
(1,093
)
Deferred rent
 
(1,278
)
 
1,517

Income taxes
 
(46
)
 
158

Accrued expenses and other liabilities
 
(17,754
)
 
(22,147
)
Net cash used in operating activities
 
(4,868
)
 
(6,929
)
Investing activities
 
 
 
 
Purchases of property and equipment
 
(9,937
)
 
(17,468
)
Insurance proceeds received for property damage
 
500

 

Net cash used in investing activities
 
(9,437
)
 
(17,468
)
Financing activities
 
 
 
 
Net (payments) borrowings from swing line loan
 
(101
)
 
6,042

Proceeds from issuance of long-term debt
 
74,889

 
10,532

Payments on long-term debt
 
(84,030
)
 
(37,015
)
Issuance of preferred stock and common stock warrants, net of transaction expenses (see Note 9)
 

 
16,589

Issuance of common stock, net of transaction expenses (see Note 9)
 
23,157

 
29,110

Proceeds from exercise of stock options and employee stock purchase plan
 
654

 
56

Debt issuance costs
 
(1,707
)
 
(662
)
Net cash provided by financing activities
 
12,862

 
24,652

Effect of exchange rate changes on cash
 

 
(4
)
Net (decrease) increase in cash and cash equivalents
 
(1,443
)
 
251

Cash and cash equivalents
 
 
 
 
Beginning of period
 
3,361

 
1,837

End of period
 
$
1,918

 
$
2,088


See accompanying notes to condensed consolidated financial statements.

5

Table of Contents

NOODLES & COMPANY
Notes to Condensed Consolidated Financial Statements
(unaudited)

1. Business Summary and Basis of Presentation
Business
Noodles & Company (the “Company”), a Delaware corporation, develops and operates fast casual restaurants that serve globally inspired noodle and pasta dishes, soups, salads and appetizers. As of October 2, 2018, the Company had 401 company-owned restaurants and 65 franchise restaurants in 29 states and the District of Columbia. The Company operates its business as one operating and reportable segment.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of Noodles & Company and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The accompanying interim unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements. In the opinion of the Company, all adjustments considered necessary for the fair presentation of the Company’s results of operations, financial position and cash flows for the periods presented have been included and are of a normal, recurring nature. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The results of operations for any interim period are not necessarily indicative of results for the full year. Certain information and footnote disclosures normally included in the Company’s annual consolidated financial statements on Form 10-K have been condensed or omitted. The condensed consolidated balance sheet as of January 2, 2018 was derived from audited financial statements. These financial statements should be read in conjunction with the audited financial statements and the related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 2, 2018.
Fiscal Year
The Company operates on a 52- or 53-week fiscal year ending on the Tuesday closest to December 31. Fiscal year 2018, which ends on January 1, 2019, and fiscal year 2017, which ended on January 2, 2018, both contain 52 weeks. The Company’s fiscal quarters each contain 13 operating weeks, with the exception of the fourth quarter of a 53-week fiscal year, which contains 14 operating weeks. The Company’s fiscal quarter that ended October 2, 2018 is referred to as the third quarter of 2018, and the fiscal quarter ended October 3, 2017 is referred to as the third quarter of 2017.
Recent Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” This pronouncement requires a lessee to recognize on the balance sheet a liability to make lease payments and a corresponding right-of-use asset. Additionally, the new lease guidance requires a dual approach for lessee accounting under which a lessee would account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use asset and a corresponding lease liability. For finance leases, the lessee would recognize interest expense and amortization of the right-of-use asset, while for operating leases, the lessee would recognize a straight-line total lease expense. The guidance also requires certain qualitative and quantitative disclosures about the amount, timing and uncertainty of cash flows arising from leases. This pronouncement will be effective for interim and annual periods beginning after December 15, 2018 (the Company’s first quarter of fiscal 2019). There have been multiple standards updates amending this guidance or providing corrections or improvements on issues in the guidance. In July 2018, the FASB issued ASU 2018-11 which provided either a modified retrospective transition approach with application in all comparative periods presented, or an alternative transition method, which permits a company to use its effective date as the date of initial application without restating comparative period financial statements. The Company anticipates implementing the standard by taking advantage of the alternative transition method and will apply the transition approach as of the beginning of the period of adoption and will not be restating comparative periods.
The Company believes the adoption of this lease guidance will have a significant impact on its consolidated balance sheets by significantly increasing its non-current assets and non-current liabilities in order to record the right of use assets and related lease liabilities for its existing operating leases. The Company is assessing the impact of the standard to our accounting policies, processes, and internal control over financial reporting and we are implementing necessary upgrades to our existing lease system. The

6


Company is still evaluating the impact the adoption of this accounting standard will have on its results of operations and cash flows and related disclosures.
Recently Adopted Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” which supersedes the revenue recognition requirements in Accounting Standards Codification 605, “Revenue Recognition.” This ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In August 2015, the FASB issued ASU No. 2015-14, which deferred the effective date of the new revenue standard by one year, and allowed entities the option to early adopt the new revenue standard as of the original effective date. There have been multiple standards updates amending this guidance or providing corrections or improvements on issues in the guidance. The requirements for these standards relating to Topic 606 are effective for interim and annual periods beginning after December 15, 2017. This standard permitted adoption using one of two transition methods, either the retrospective or the modified retrospective transition method.

The Company adopted these standards at the beginning of the first quarter of fiscal 2018 using the modified retrospective method. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. The adoption of these standards did not have a material impact on the Company’s Condensed Consolidated Statements of Operations in the third quarter of 2018 or the first three quarters of 2018. The primary impact of adoption was the enhancement of the Company’s disclosures related to contracts with customers and revenue recognized from those performance obligations, which includes revenue related to initial fees charged to franchisees and revenue recognized related to gift cards. See disclosure in Note 11, Revenue Recognition.

2. Supplemental Financial Information
Property and equipment, net, consists of the following (in thousands):
 
 
October 2,
2018
 
January 2,
2018
Leasehold improvements
 
$
199,056

 
$
199,211

Furniture, fixtures and equipment
 
122,036

 
120,234

Construction in progress
 
2,024

 
2,592

 
 
323,116

 
322,037

Accumulated depreciation and amortization
 
(181,741
)
 
(169,444
)
 
 
$
141,375

 
$
152,593



Accrued expenses and other current liabilities consist of the following (in thousands):
 
 
October 2,
2018
 
January 2,
2018
Gift card liability
 
$
2,520

 
$
4,078

Occupancy related
 
3,993

 
3,733

Utilities
 
1,603

 
1,705

Data breach liabilities
 

 
7,605

Other accrued expenses
 
4,176

 
4,100

 
 
$
12,292

 
$
21,221




7

Table of Contents

3. Long-Term Debt
2018 Credit Facility
On May 9, 2018, the Company entered into a credit facility with U.S. Bank National Association (the “2018 Credit Facility”). The 2018 Credit Facility consists of a term loan facility in an aggregate principal amount of $25.0 million and a revolving line of credit of $65.0 million (which may be increased to $75.0 million), which includes a letter of credit subfacility in the amount of $15.0 million and a swingline subfacility in the amount of $10.0 million. The 2018 Credit Facility has a four-year term and matures on May 9, 2022.
Borrowings under the 2018 Credit Facility, including the term loan facility, bear interest annually, at the Company’s option, at either (i) LIBOR plus a margin of 2.25% to 3.25% per annum, based upon the consolidated total lease-adjusted leverage ratio or (ii) the highest of the following base rates plus a margin of 1.25% to 2.25% per annum: (a) the federal funds rate plus 0.50%; (b) the U.S. Bank prime rate or (c) the one-month LIBOR plus 1.00%. The 2018 Credit Facility includes a commitment fee of 0.30% to 0.50% per annum, based upon the consolidated total lease-adjusted leverage ratio, on any unused portion of the revolving credit facility.
As of October 2, 2018, the Company had $49.6 million of indebtedness and $3.8 million of letters of credit outstanding under the 2018 Credit Facility. The term loan requires principal payments of $156,250 per quarter starting in the second quarter of 2018 through the first quarter of 2019, $187,500 per quarter through the first quarter of 2020, $375,000 per quarter through the first quarter of 2021, and $531,250 per quarter through maturity in the second quarter of 2022.
Aggregate maturities for debt outstanding as of October 2, 2018 are as follows (in thousands):
Year 1
$
688

Year 2
1,125

Year 3
1,813

Year 4
45,951

Total
$
49,577


The Company’s outstanding indebtedness bore interest at rates between 4.95% to 7.25% during the first three quarters of 2018.
The Company also maintains outstanding letters of credit to secure obligations under its workers’ compensation program and certain lease obligations. The Company was in compliance with all of its debt covenants as of October 2, 2018.
Prior Credit Facility
Upon execution of the 2018 Credit Facility, the Company repaid in full its outstanding indebtedness with Bank of America, N.A. (the “Prior Credit Facility”) using funds drawn on the 2018 Credit Facility. Upon repayment, the Prior Credit Facility and all related agreements were terminated. A loss on extinguishment of debt in the amount of $0.6 million was recorded during the second quarter of 2018 in connection with this repayment.

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4. Fair Value Measurements
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and all other current liabilities approximate their fair values due to their short-term nature. The carrying amounts of borrowings under the credit facility approximate fair value as the line of credit and term borrowings vary with market interest rates and negotiated terms and conditions are consistent with current market rates. The fair value of the Company’s line of credit and term loan borrowings are measured using Level 2 inputs.

Adjustments to the fair value of non-financial assets measured at fair value on a non-recurring basis as of October 2, 2018 and October 3, 2017 are discussed in Note 7, Restaurant Impairments, Closure Costs and Asset Disposals.

5. Income Taxes
The following table presents the Company’s (benefit) provision for income taxes (in thousands):
 
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
 
October 2,
2018
 
October 3,
2017
 
October 2,
2018
 
October 3,
2017
(Benefit) provision for income taxes
 
$
(11
)
 
$
(41
)
 
$
(259
)
 
$
230

Effective tax rate
 
(1.1
)%
 
0.5
%
 
3.0
%
 
(0.6
)%


The effective tax rates for the third quarter of 2018 and the first three quarters of 2018 reflect changes made by the Tax Cuts and Jobs Act (“Tax Act”), which was signed into law in December 2017. The primary change from the Tax Act that impacts fiscal 2018 is related to an indefinite carry forward for federal and conforming states’ net operating losses, which enabled the Company to release a portion of the previously recorded valuation allowance. For the remainder of fiscal 2018, the Company does not anticipate material income tax expense or benefit as a result of the valuation allowance recorded. The Company will maintain the remaining 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.

The Company is applying guidance provided by SEC Staff Accounting Bulletin No. 118, which is codified as Accounting Standards Update 2018-05 - Income Taxes (“ASU 2018-05”), in reporting the tax provision for the third quarter of 2018. This ASU 2018-05 applies in situations where the Company does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. While the amount recorded for the third quarter of 2018 is provisional, the Company expects that any material changes required by the Tax Act will be offset by the valuation allowance. The Company did not finalize any previously reported provisional impact from the Tax Act and will continue its analysis to determine if any adjustments are required to be made during the measurement period provided by ASU 2018-05.


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6. Stock-Based Compensation
The Company’s Stock Incentive Plan, as amended and restated in May of 2013, authorizes the grant of nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock, restricted stock units (“RSUs”) and incentive bonuses to employees, officers, nonemployee directors and other service providers. The number of shares of common stock available for issuance pursuant to awards granted under the Stock Incentive Plan on or after the Company’s initial public offering shall not exceed 3,750,500 shares.
The following table shows total stock-based compensation expense (in thousands):
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
October 2,
2018
 
October 3,
2017
 
October 2,
2018
 
October 3,
2017
Stock-based compensation expense
$
640

 
$
248

 
$
2,232

 
$
1,193

Capitalized stock-based compensation expense
$
12

 
$
44

 
$
37

 
$
145




7. Restaurant Impairments, Closure Costs and Asset Disposals
The following table presents restaurant impairments, closure costs and asset disposals (in thousands):
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
October 2,
2018
 
October 3,
2017
 
October 2,
2018
 
October 3,
2017
Restaurant impairments (1)
$
314

 
$
9,080

 
$
1,231

 
$
15,053

Closure costs (1)
1,488

 
779

 
3,561

 
19,194

(Gain) loss on disposal of assets and other (2)
(10
)
 
404

 
1,160

 
900

 
$
1,792

 
$
10,263

 
$
5,952

 
$
35,147


_____________________________
(1)
Restaurant impairments and closure costs in all periods presented above include amounts related to restaurants previously impaired or closed.
(2)
The third quarter of 2018 and the first three quarters of 2018 include a $0.4 million gain from insurance proceeds received for property damage in excess of the loss recognized.
During the third quarter of 2018, there were no restaurants identified as impaired, compared to 18 restaurant impairments during the third quarter of 2017. During the first three quarters of 2018, one restaurant was identified as impaired compared to 31 restaurant impairments during the first three quarters of 2017. Impairment is based on management’s current assessment of the expected future cash flows of a restaurant based on recent results and other specific market factors. Impairment expense is a Level 3 fair value measure and is determined by comparing the carrying value of restaurant assets to the estimated fair market value of the restaurant assets at resale value.
The closure costs of $1.5 million recognized during the third quarter of 2018 and $3.6 million during the first three quarters of 2018 are related to the three restaurants closed in the third quarter of 2018 and 12 restaurants closed in the first three quarters of 2018, most of which were approaching the expiration of their leases, as well as ongoing costs from restaurants closed in previous years. These ongoing costs include adjustments to the liabilities to landlords as lease terminations occur. The closure costs of $0.8 million recognized during the third quarter of 2017 and $19.2 million during the first three quarters of 2017 are related to the 55 restaurants closed during the first quarter of 2017, as well as ongoing costs of restaurants closed in the fourth quarter of 2015. Additionally, the $19.2 million of closure costs recognized during the first three quarters of 2017 is net of a gain of $3.6 million which was primarily due to adjustments to the liabilities to landlords as lease terminations occurred for 27 of the 55 restaurants closed during the first quarter of 2017. These expenses are included in the “Restaurant impairments, closure costs and asset disposals” line in the Condensed Consolidated Statements of Operations.


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8. Earnings (Loss) Per Share
Basic earnings (loss) per share (“EPS”) is calculated by dividing net income (loss) available to common stockholders by the weighted-average number of shares of common stock outstanding during each period. Diluted EPS is calculated using net income (loss) available to common stockholders divided by diluted weighted-average shares of common stock outstanding during each period. Potentially dilutive securities include shares of common stock underlying stock options, warrants and RSUs. Diluted EPS considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares would have an anti-dilutive effect.
The following table sets forth the computations of basic and diluted EPS (in thousands, except share and per share data):
 
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
 
October 2,
2018
 
October 3,
2017
 
October 2,
2018
 
October 3,
2017
Net income (loss) attributable to common stockholders
 
$
1,050

 
$
(8,335
)
 
$
(8,460
)
 
$
(44,962
)
Shares:
 
 
 
 
 
 
 
 
Basic weighted average shares outstanding
 
43,094,524

 
41,109,827

 
41,798,640

 
36,639,382

Effect of dilutive securities
 
1,734,839

 

 

 

Diluted weighted average shares outstanding
 
44,829,363

 
41,109,827

 
41,798,640

 
36,639,382

Earnings (loss) per share:
 
 
 
 
 
 
 
 
Basic earnings (loss) per share
 
$
0.02

 
$
(0.20
)
 
$
(0.20
)
 
$
(1.23
)
Diluted earnings (loss) per share
 
$
0.02

 
$
(0.20
)
 
$
(0.20
)
 
$
(1.23
)


The Company computes the effect of dilutive securities using the treasury stock method and average market prices during the period. Potential common shares are excluded from the computation of diluted earnings (loss) per share when the effect would be anti-dilutive. All potential common shares are anti-dilutive in periods of net loss. Shares issuable on the vesting or exercise of share based awards or exercise of outstanding warrants, and the shares underlying the 18,500 shares of convertible preferred stock outstanding in the first quarter of 2017, were excluded from the calculation of diluted loss per share because the effect of their inclusion would have been anti-dilutive. The number of such shares totaled 176,325 and 4,575,537 for the third quarters of 2018 and 2017, respectively, and totaled 2,758,848 and 7,031,639 for the first three quarters of 2018 and 2017, respectively.


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9. Stockholders’ Equity
Public Offering of Class A Common Stock
On July 31, 2018, the Company sold 2,500,000 shares of its Class A common stock at a public offering price of $10.00 per share. The shares offered were registered pursuant to a registration statement that the Company filed with the Securities and Exchange Commission (the “SEC”). The Company received net proceeds of $23.8 million, after deducting the underwriting discounts and commissions. The Company also incurred $0.6 million of transaction expenses related to the public offering. The proceeds of the offering were used by the Company to pay down borrowings under the 2018 Credit Facility and fund working capital obligations.

Securities Purchase Agreement with L Catterton
On February 8, 2017, the Company entered into a securities purchase agreement with L Catterton, pursuant to which the Company agreed, in return for aggregate gross proceeds of $18.5 million, to sell to L Catterton an aggregate of 18,500 shares of preferred stock convertible into 4,252,873 shares of the Company’s Class A common stock, par value $0.01 per share (“Class A common stock”), at a price per share of $1,000, plus warrants exercisable for five years beginning six months following their issuance for the purchase of 1,913,793 shares of the Company’s Class A common stock, at a price per share of $4.35 (such transactions, collectively, the “private placement”). The funding of the private placement occurred on February 9, 2017 and the net proceeds from the transaction were $16.6 million during the first three quarters of 2017, after $1.9 million of transaction expenses.
The Company determined that the preferred stock was more akin to a temporary equity security than permanent equity primarily because the preferred stock was contingently redeemable upon the occurrence of an event that was outside of the Company’s control. The proceeds were allocated between the three features of the private placement: the warrants, the embedded beneficial conversion feature in the preferred stock, and the preferred stock itself.  The fair values of the warrants of $3.1 million and the embedded beneficial conversion feature of $3.1 million were recorded as a discount against the stated value of the preferred stock on the date of issuance. The fair value of the warrants was estimated using a Black-Scholes option pricing model which is a Level 2 estimate of fair value. 
On April 5, 2017, the Company delivered a notice to L Catterton of its election to exercise the conversion option with respect to the Series A Convertible Preferred Stock. The terms of the preferred stock provided that the Company could, at its option upon the satisfaction of certain conditions, cause all outstanding shares of preferred stock to be automatically converted into the Company’s Class A common stock. The conversion of the preferred stock into 4,252,873 shares of the Company’s Class A common stock occurred on April 12, 2017. The discount was amortized, using the interest method, and treated as a deemed dividend through the date of conversion, which resulted in the accretion of the preferred stock to its full redemption value. After the conversion, no shares of preferred stock are outstanding.
At the conversion date, all unamortized discounts were recognized immediately as a deemed dividend, which increased the net loss attributable to common stockholders. The amortized discount, which was treated in the same manner as dividends, was $8.0 million for the first three quarters of 2017.
Securities Purchase Agreement with Mill Road Capital
On March 13, 2017, the Company entered into a securities purchase agreement with Mill Road Capital II, L.P. (“Mill Road”), pursuant to which the Company agreed, in return for aggregate gross proceeds of $31.5 million, to issue to Mill Road an aggregate of 8,873,240 shares of its Class A common stock at a price per share of $3.55, which was equal to the closing sale price for the Company’s Class A common stock on March 10, 2017. On April 3, 2017, such shares were issued and the funding of the private placement occurred. The net proceeds from the transaction were $29.1 million during the first three quarters of 2017, after $2.4 million of transaction expenses.
Conversion of Argentia Class B Common Stock
On May 24, 2018, Argentia Private Investments Inc. (“Argentia”) converted 1,522,098 shares of the Company’s Class B common stock, par value $0.01, it owned into the same number of shares of the Company’s Class A common stock. The rights of the holders of the Company’s Class A common stock and Class B common stock are identical in all respects, except that Class B common stock does not vote on the election or removal of directors. As a result of the conversion, no shares of the Company’s Class B common stock are outstanding.
 

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10. Supplemental Disclosures to Condensed Consolidated Statements of Cash Flows
The following table presents the supplemental disclosures to the Condensed Consolidated Statements of Cash Flows for the three quarters ended October 2, 2018 and October 3, 2017 (in thousands):
 
 
October 2,
2018
 
October 3,
2017
Interest paid (net of amounts capitalized)
 
$
3,006

 
$
3,028

Income taxes paid (refunded)
 
49

 
(158
)
Changes in purchases of property and equipment accrued in accounts payable, net
 
(1,346
)
 
(2,144
)
Conversion of Series A convertible preferred stock to common stock
 

 
18,500



11. Revenue Recognition
Revenue
Revenue consists of sales from restaurant operations and franchise royalties and fees. Revenue from the operation of company-owned restaurants are recognized when sales occur. The Company reports revenue net of sales and use taxes collected from customers and remitted to governmental taxing authorities.
The Company adopted the revenue recognition standards under Topic 606 at the beginning of the first quarter of fiscal 2018 using the modified retrospective method. The adoption of these standards did not have an impact on the Company’s recognition of revenue from company-owned restaurants or its recognition of continuing royalty fees from franchisees, which are based on a percentage of restaurant revenues and are recognized in the period the related franchised restaurants’ sales occur.
Gift Cards
The Company sells gift cards which do not have an expiration date, and it does not deduct non-usage fees from outstanding gift card balances. The Company recognizes revenue from gift cards when the gift card is redeemed by the customer or the Company determines the likelihood of the gift card being redeemed by the customer is remote (“gift card breakage”). The determination of the gift card breakage rate is based upon Company-specific historical redemption patterns. The Company has determined that approximately 8% of gift cards will not be redeemed and recognizes gift card breakage ratably over the estimated redemption period of the gift card, which is approximately 18 months. Gift card liability balances are typically highest at the end of each calendar year following increased gift card purchases during the holiday season. The adoption of Topic 606 did not have an impact on the Company’s recognition of revenue from gift cards, including the recognition of gift card breakage, as the new standard requires the use of the “proportionate” method for recognizing breakage, which the Company has historically utilized.
As of October 2, 2018 and January 2, 2018, the current portion of the gift card liability, $2.5 million and $4.1 million, respectively, is included in accrued expenses and other current liabilities, and the long-term portion, $0.3 million and $0.4 million, respectively, is included in other long-term liabilities in the Consolidated Balance Sheets.
Revenue recognized in the Condensed Consolidated Statements of Operations for the redemption of gift cards was $4.4 million and $4.1 million for the first three quarters of 2018 and 2017, respectively.
The revenue recognized from gift cards for the first three quarters of 2018 includes $0.3 million of gift card breakage that resulted from a change in the estimate for gift card unredeemed balances for the years 2014 and after. This change in estimate was a result of the Delaware Gift Card Litigation settlement in the second quarter of 2018 (see Note 12, Commitments and Contingencies).
Franchise Fees
Royalties from franchise restaurants are based on a percentage of restaurant revenues and are recognized in the period the related franchised restaurants’ sales occur. Development fees and franchise fees, portions of which are collected in advance, are nonrefundable and are recognized in income ratably over the term of the related franchise agreement or recognized upon the termination of the agreement between the Company and the franchisee. The adoption of Topic 606 impacted the Company’s accounting for initial fees charged to franchisees. In the past, the Company recognized initial franchise fees when all material services or conditions relating to the sale of the franchise had been substantially performed or satisfied by the Company, which was generally when a new franchise restaurant opened. In accordance with the new guidance, the Company has determined that the initial franchise services are not distinct from the continuing rights or services offered during the term of the franchise agreement and should be treated as a single performance obligation. Therefore, initial fees received from franchisees will be recognized as revenue over the term of each respective franchise agreement, which is typically 20 years.

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An adjustment to beginning retained earnings and a corresponding contract liability of $1.5 million was established on the date of adoption, at the beginning of the first quarter of 2018, associated with the initial fees received through January 2, 2018 that would have been deferred and recognized over the term of each respective franchise agreement if the new guidance had been applied in the past.
The Company recognized revenue of $0.1 million during the first three quarters of 2018 related to initial fees from franchisees that were included in the contract liability balance at the beginning of the year. This amount included fees recognized upon the termination of one franchise restaurant agreement in the first quarter of 2018. The Company expects to recognize approximately $0.1 million each fiscal year through fiscal 2022 and approximately $0.9 million thereafter related to performance obligations that are unsatisfied as of October 2, 2018.


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12. Commitments and Contingencies
Data Security Incident
On June 28, 2016, the Company announced that a data security incident compromised the security of the payment information of some customers who used debit or credit cards at certain Noodles & Company locations between January 31, 2016 and June 2, 2016. The malware involved in the incident has been removed, and the Company believes that it no longer poses a risk to credit or debit cards currently being used at affected locations. In the fourth quarter of 2016, the Company recorded a charge of $10.6 million for estimated losses, net of $1.0 million of insurance coverage, at the low end of an estimated range, associated with claims and anticipated claims by payment card companies for non-ordinary course operating expenses, card issuer losses and card replacement costs for which it expected to be liable (the “Data Breach Liabilities”). On June 7, 2018, the Company received the final assessment from the third of the three payment card companies to which it expected to owe Data Breach Liabilities. This assessment was $11.0 million. During the first three quarters of 2018, when the final assessment was received, the Company’s recorded a charge of $3.4 million to increase its accrual to cover this final assessment amount (which was within the range disclosed in prior reports filed with the SEC). The assessment was paid early in the third quarter of 2018 and there are no further obligations for Data Breach Liabilities outstanding.

Delaware Gift Card Litigation
As previously disclosed in prior reports filed with the SEC, the Company was named as a defendant in an action filed in the Superior Court of Delaware in New Castle County, entitled The State of Delaware, William French v. Card Compliant, LLC, et. al. The complaint in this case alleged that a number of large retailers and restaurant companies, including the Company, knowingly refused to fulfill obligations under Delaware’s Abandoned Property Law by failing to report and deliver “unclaimed gift card funds” to the State of Delaware, and knowingly made, used or caused to be made or used, false statements and records to conceal, avoid or decrease an obligation to pay or transmit money to Delaware in violation of the Delaware False Claims and Reporting Act. The complaint sought an order that the Company cease and desist from violating the Delaware Abandoned Property Law, monetary damages (including treble damages under the False Claims and Reporting Act), penalties and attorneys’ fees and costs. In 2015 the Company recorded a loss contingency accrual based on a reasonable estimate of the probable losses that might arise from this matter; this loss contingency accrual did not have a material effect on the Company’s results of operations. On July 3, 2018, a settlement was reached in this matter and a definitive settlement agreement was subsequently executed, disposing of all pending claims included in the litigation. The Company’s results of operations for the first three quarters of 2018 included a charge of $0.3 million for the Company’s liability under this settlement. The settlement was paid in the third quarter of 2018. The Company also recorded a loss contingency accrual based on a reasonable estimate of the probable losses that may arise under Delaware’s Abandoned Property Law in resolving claims for unclaimed gift card funds for the years 2011, 2012 and 2013, which were not included as part of the litigation.
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 October 2, 2018. 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.

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NOODLES & COMPANY
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and related notes in Item 1 and with the audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for our fiscal year ended January 2, 2018. We operate on a 52- or 53-week fiscal year ending on the Tuesday closest to December 31. Our fiscal quarters each contain 13 operating weeks, with the exception of the fourth quarter of a 53-week fiscal year, which contains 14 operating weeks. Fiscal years 2018 and 2017 each contain 52 weeks.    
Cautionary Note Regarding Forward-Looking Statements
In addition to historical information, this discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties such as the number of restaurants we intend to open, projected capital expenditures and estimates of our effective tax rates. 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 reflect our current views with respect to future events and are based on currently available operating, financial and competitive information. Examples of forward-looking statements include all matters that are not historical facts, such as statements regarding estimated costs associated with our closure of underperforming restaurants, the implementation and results of strategic initiatives and our future financial performance. Our actual results may differ materially from those anticipated in these forward-looking statements due to reasons including, but not limited to, our ability to achieve and maintain increases in comparable restaurant sales and to successfully execute our business strategy, including new restaurant initiatives and operational strategies to improve the performance of our restaurant portfolio; our ability to maintain compliance with debt covenants and continue to access financing necessary to execute our business strategy; the success of our marketing efforts; our ability to open new restaurants on schedule; current economic conditions; price and availability of commodities; our ability to adequately staff our restaurants; changes in labor costs; consumer confidence and spending patterns; consumer reaction to industry related public health issues and perceptions of food safety; seasonal factors; weather; and those discussed in “Special Note Regarding Forward-Looking Statements” and “Risk Factors” as filed in our Annual Report on Form 10-K for our fiscal year ended January 2, 2018.
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, average unit volumes (“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 is 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

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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. 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;

weather;

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 below), comparable restaurant sales is 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.

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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.
Management believes 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.
Recent Trends, Risks and Uncertainties
Comparable Restaurant Sales. In the third quarter of 2018, comparable restaurant sales increased 5.5% system-wide, increased 5.2% for company-owned restaurants, and increased 7.6% for franchise restaurants. Comparable restaurant sales growth was driven primarily by an increase in traffic related to successful implementation of recent operational and brand initiatives, as well as a modest price increase across our product offering, partially offset by the shift in the timing of the 4th of July holiday based on our fiscal quarter, which shift resulted in a reduction in comparable restaurant sales of approximately 50 basis points (“bps”).
Increased Labor Costs. Similar to much of the restaurant industry, our labor costs have risen in recent periods and we expect that labor costs will continue to rise in future periods as wage rates and benefit costs increase. 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. Significant additional government-imposed increases could materially affect our labor costs.
Restaurant Development. We have reduced our rate of company-owned restaurant unit growth, this 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 the first three quarters of 2018, we opened one company-owned restaurant. We currently do not intend to open any additional restaurants in 2018. As of October 2, 2018, we had 401 company-owned restaurants and 65 franchise restaurants in 29 states and the District of Columbia.
Given recent improvement in performance, we are currently pursuing a disciplined development pipeline to execute a modest new unit growth rate in 2019 and 2020.

Certain Restaurant Closures. We closed 55 restaurants in the first quarter of 2017. These restaurants significantly underperformed our restaurant averages, as measured by AUVs, restaurant contribution margin and cash flow. Closing these restaurants has favorably affected our restaurant contribution, restaurant contribution margin, adjusted EBITDA, adjusted EBITDA margin and net income. Additionally, we closed 12 company-owned restaurants in the first three quarters of 2018, most of which were approaching the expiration of their leases. We currently do not anticipate significant restaurant closures for the foreseeable future; however, we may continue to close certain restaurants at, or near, the expiration of their leases.


18

Table of Contents

Results of Operations
The following table presents a reconciliation of net income (loss) to EBITDA and adjusted EBITDA:
 
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
 
October 2,
2018
 
October 3,
2017
 
October 2,
2018
 
October 3,
2017
 
 
(in thousands, unaudited)
Net income (loss)
 
$
1,050

 
$
(8,335
)
 
$
(8,460
)
 
$
(36,995
)
Depreciation and amortization
 
5,790

 
6,183

 
17,407

 
18,729

Interest expense, net
 
1,093

 
893

 
3,385

 
2,828

(Benefit) provision for income taxes
 
(11
)
 
(41
)
 
(259
)
 
230

EBITDA
 
$
7,922

 
$
(1,300
)
 
$
12,073

 
$
(15,208
)
Restaurant impairments, closure costs and asset disposals (1)
 
1,792

 
10,263

 
5,952

 
35,147

Litigation settlements and data breach assessments (2)
 

 

 
3,796

 
(421
)
Fees and costs related to registration statements and related transactions (3)
 

 

 
53

 
679

Loss on extinguishment of debt (4)
 

 

 
626

 

Severance costs (5)
 

 
248

 
278

 
580

Stock-based compensation expense
 
640

 
248

 
2,232

 
1,193

Adjusted EBITDA
 
$
10,354

 
$
9,459

 
$
25,010

 
$
21,970

_____________________
(1)
Restaurant impairments and closure costs in all periods presented above include amounts related to restaurants previously impaired or closed. Additionally, the first three quarters of 2018 includes closure costs of the 12 restaurants closed in the first three quarters of 2018 and the impairment of one restaurant, and the first three quarters of 2017 includes the closure costs related to the 55 restaurants closed in the first quarter of 2017 and the impairment of 31 restaurants. The third quarter of 2018 and the first three quarters of 2018 also include a $0.4 million gain from insurance proceeds received for property damage in excess of the loss recognized. See Note 7, Restaurant Impairments, Closure Costs and Asset Disposals.
(2)
The first three quarters of 2018 includes 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 the Delaware gift card matter. The first three quarters of 2017 includes a gain on an employment-related litigation settlement due to final settlement being less than what the Company had previously accrued.
(3)
The first three quarters of 2018 includes expenses related to the registration statement the Company filed in the second quarter of 2018. The first three quarters of 2017 includes expenses related to the registration statement the Company filed in the first quarter of 2017, which registration statement was later withdrawn.
(4)
The first three quarters of 2018 includes the loss on extinguishment of debt which resulted from writing off the remaining unamortized balance of debt issuance costs related to the prior credit facility when it was repaid in full in the second quarter of 2018.
(5)
The first three quarters of 2018 and 2017 include severance costs from departmental structural changes.


19

Table of Contents

Restaurant Openings, Closures and Relocations
The following table shows restaurants opened or closed during the periods indicated:
 
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
 
October 2,
2018
 
October 3,
2017
 
October 2,
2018
 
October 3,
2017
Company-Owned Restaurant Activity
 
 
 
 
 
 
 
 
Beginning of period
 
404

 
413

 
412

 
457

Openings
 

 

 
1

 
11

Closures
 
(3
)
 

 
(12
)
 
(55
)
Restaurants at end of period
 
401

 
413

 
401

 
413

Franchise Restaurant Activity
 
 
 
 
 
 
 
 
Beginning of period
 
65

 
73

 
66

 
75

Openings
 

 
1

 

 
3

Closures
 

 
(8
)
 
(1
)
 
(12
)
Restaurants at end of period
 
65

 
66

 
65

 
66

Total restaurants
 
466

 
479

 
466

 
479


Statement of Operations as a Percentage of Revenue
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 Quarter Ended
 
Three Fiscal Quarters Ended
 
 
October 2,
2018
 
October 3,
2017
 
October 2,
2018
 
October 3,
2017
Revenue:
 
 
 
 
 
 
 
 
Restaurant revenue
 
99.0
 %
 
99.0
 %
 
99.1
 %
 
99.0
 %
Franchising royalties and fees
 
1.0
 %
 
1.0
 %
 
0.9
 %
 
1.0
 %
Total revenue
 
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Costs and expenses:
 
 
 
 
 
 
 
 
Restaurant operating costs (exclusive of depreciation and amortization shown separately below): (1)
 
 
 
 
 
 
 
 
Cost of sales
 
26.5
 %
 
26.5
 %
 
26.6
 %
 
26.9
 %
Labor
 
32.7
 %
 
32.6
 %
 
32.9
 %
 
33.2
 %
Occupancy
 
10.4
 %
 
11.2
 %
 
10.9
 %
 
11.6
 %
Other restaurant operating costs
 
14.0
 %
 
14.0
 %
 
14.6
 %
 
14.4
 %
General and administrative
 
8.9
 %
 
8.6
 %
 
10.3
 %
 
8.7
 %
Depreciation and amortization
 
5.0
 %
 
5.4
 %
 
5.1
 %
 
5.4
 %
Pre-opening
 
 %
 
0.1
 %
 
 %
 
0.3
 %
Restaurant impairments, closure costs and asset disposals
 
1.5
 %
 
9.0
 %
 
1.7
 %
 
10.2
 %
Total costs and expenses
 
98.2
 %
 
106.6
 %
 
101.4
 %
 
109.9
 %
Income (loss) from operations
 
1.8
 %
 
(6.6
)%
 
(1.4
)%
 
(9.9
)%
Loss on extinguishment of debt
 
 %
 
 %
 
0.2
 %
 
 %
Interest expense, net
 
0.9
 %
 
0.8
 %
 
1.0
 %
 
0.8
 %
Income (loss) before income taxes
 
0.9
 %
 
(7.3
)%
 
(2.5
)%
 
(10.7
)%
(Benefit) provision for income taxes
 
 %
 
 %
 
(0.1
)%
 
0.1
 %
Net income (loss)
 
0.9
 %
 
(7.3
)%
 
(2.5
)%
 
(10.8
)%
_____________________________
(1)
As a percentage of restaurant revenue.

20

Table of Contents



Third Quarter Ended October 2, 2018 Compared to Third Quarter Ended October 3, 2017
The table below presents our unaudited operating results for the third quarters of 2018 and 2017, and the related quarter-over-quarter changes.
 
 
Fiscal Quarter Ended
 
Increase / (Decrease)
 
 
October 2,
2018
 
October 3,
2017
 
$
 
%
 
 
 
 
 
 
(in thousands)
Revenue:
 
 
 
 
 
 
 
 
Restaurant revenue
 
$
115,552

 
$
113,020

 
$
2,532

 
2.2
 %
Franchising royalties and fees
 
1,175

 
1,191

 
(16
)
 
(1.3
)%
Total revenue
 
116,727

 
114,211

 
2,516

 
2.2
 %
Costs and expenses:
 
 
 
 
 
 
 
 
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
 
 
 
 
 
 
 
 
Cost of sales
 
30,617

 
29,955

 
662

 
2.2
 %
Labor
 
37,738

 
36,897

 
841

 
2.3
 %
Occupancy
 
12,035

 
12,709

 
(674
)
 
(5.3
)%
Other restaurant operating costs
 
16,224

 
15,811

 
413

 
2.6
 %
General and administrative
 
10,399

 
9,807

 
592

 
6.0
 %
Depreciation and amortization
 
5,790

 
6,183

 
(393
)
 
(6.4
)%
Pre-opening
 

 
69

 
(69
)
 
(100.0
)%
Restaurant impairments, asset disposals and closure costs
 
1,792

 
10,263

 
(8,471
)
 
(82.5
)%
Total costs and expenses
 
114,595

 
121,694

 
(7,099
)
 
(5.8
)%
Income (loss) from operations
 
2,132

 
(7,483
)
 
9,615

 
*

Interest expense, net
 
1,093

 
893

 
200

 
22.4
 %
Income (loss) before income taxes
 
1,039

 
(8,376
)
 
9,415

 
*

Benefit from income taxes
 
(11
)
 
(41
)
 
30

 
(73.2
)%
Net income (loss)
 
$
1,050

 
$
(8,335
)
 
$
9,385

 
*

Company-owned:
 
 
 
 
 
 
 
 
Average unit volumes
 
$
1,107

 
$
1,066

 
$
41

 
3.8
 %
Comparable restaurant sales
 
5.2
%
 
(3.8
)%
 


 


________________
*
Not meaningful.
Revenue
Total revenue increased $2.5 million in the third quarter of 2018, or 2.2%, to $116.7 million, compared to $114.2 million in the third quarter of 2017. This increase was primarily due to the increase in comparable restaurant sales, partially offset by the impact of restaurants closed since the third quarter of 2017, most of which were approaching the expiration of their leases.
AUVs increased $41,000 compared to the prior year. AUVs for the trailing twelve months were $1,107,000.
Comparable restaurant sales increased by 5.2% at company-owned restaurants, increased by 7.6% at franchise-owned restaurants and increased by 5.5% system-wide in the third quarter of 2018. Comparable restaurant sales growth was driven primarily by an increase in traffic related to successful implementation of recent operational and brand initiatives, as well as a modest price increase across our product offering, partially offset by the shift in the timing of the 4th of July holiday based on our fiscal quarter, which shift resulted in a reduction in comparable restaurant sales of approximately 50 bps.

21

Table of Contents

Cost of Sales
Cost of sales increased by $0.7 million, or 2.2%, in the third quarter of 2018 compared to the same period of 2017, due primarily to the increase in restaurant revenue in the third quarter of 2018. As a percentage of restaurant revenue, cost of sales remained flat at 26.5% in the third quarter of 2018 compared to the third quarter of 2017 as increased promotional activity and the nationwide launch of zucchini noodles, which have a higher cost of goods sold than the balance of our menu offerings, were offset by supply chain initiatives.
Labor Costs
Labor costs increased by $0.8 million, or 2.3%, in the third quarter of 2018 compared to the same period of 2017, due primarily to the increase in restaurant revenue in the third quarter of 2018. As a percentage of restaurant revenue, labor costs increased to 32.7% in the third quarter of 2018 from 32.6% in the third quarter of 2017. The nominal increase as a percentage of restaurant revenue was driven by wage inflation and increased incentive compensation, almost completely offset by the benefit of labor savings initiatives and leverage on higher AUVs.
Occupancy Costs
Occupancy costs decreased by $0.7 million, or 5.3%, in the third quarter of 2018 compared to the third quarter of 2017, due primarily to the impact of restaurants closed since the third quarter of 2017. As a percentage of revenue, occupancy costs decreased to 10.4% in the third quarter of 2018, compared to 11.2% in the third quarter of 2017 due to leverage on higher AUVs.
Other Restaurant Operating Costs
Other restaurant operating costs increased by $0.4 million, or 2.6%, in the third quarter of 2018 compared to the third quarter of 2017, due primarily to expenses associated with marketing, culinary and off-premise initiatives. As a percentage of restaurant revenue, other restaurant operating costs were 14.0% in both the third quarters of 2018 and 2017, as expenses associated with the above mentioned initiatives were offset by leverage on higher AUVs.
General and Administrative Expense
General and administrative expense increased by $0.6 million, or 6.0%, in the third quarter of 2018 compared to the third quarter of 2017, primarily due to a higher incentive compensation. As a percentage of revenue, general and administrative expense increased to 8.9% in the third quarter of 2018 from 8.6% in the third quarter of 2017.
Depreciation and Amortization
Depreciation and amortization decreased by $0.4 million, or 6.4%, in the third quarter of 2018 compared to the third quarter of 2017, due primarily to restaurants closed or impaired in prior quarters. As a percentage of revenue, depreciation and amortization decreased to 5.0% in the third quarter of 2018 from 5.4% in the third quarter of 2017.
Pre-Opening Costs
Pre-opening costs decreased by $0.1 million in the third quarter of 2018 compared to the third quarter of 2017. The decrease in pre-opening costs were due to no restaurants being under construction during the third quarter of 2018.
Restaurant Impairments, Closure Costs and Asset Disposals
Restaurant impairments, closure costs and asset disposals decreased by $8.5 million in the third quarter of 2018 compared to the third quarter of 2017, due primarily to the impairment of 18 restaurants in the third quarter of 2017 and no restaurants being impaired in the third quarter of 2018. Additionally, the third quarter of 2018 includes a gain of $0.4 million from the insurance proceeds received for property damage in excess of the loss recognized.
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.
Interest Expense
Interest expense increased by $0.2 million in the third quarter of 2018 compared to the third quarter of 2017. The increase was the result of an increase in the average interest rate on our credit facility and lower capitalized interest in the third quarter of 2018 compared to the third quarter of 2017.

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Table of Contents

Benefit from Income Taxes
The effective tax rate was (1.1)% for the third quarter of 2018 compared to 0.5% for the third quarter of 2017. The effective tax rate for the third quarter of 2018 reflects changes made by the Tax Cuts and Jobs Act (“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 for the third quarter of 2017 was primarily related to disallowed tax amortization on indefinite-lived intangibles. For the remainder of fiscal 2018, we do not anticipate material income tax expense or benefit as a result of the valuation allowance recorded. We will maintain the remaining 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.

Three Quarters Ended October 2, 2018 Compared to Three Quarters Ended October 3, 2017
The table below presents our unaudited operating results for the first three quarters of 2018 and 2017, and the related period-over-period changes.
 
 
Three Fiscal Quarters Ended
 
Increase / (Decrease)
 
 
October 2,
2018
 
October 3,
2017
 
$
 
%
 
 
 
 
 
 
(in thousands, except percentages)
Revenue:
 
 
 
 
 
 
 
 
Restaurant revenue
 
$
341,616

 
$
340,175

 
$
1,441

 
0.4
 %
Franchising royalties and fees
 
3,032

 
3,543

 
(511
)
 
(14.4
)%
Total revenue
 
344,648

 
343,718

 
930

 
0.3
 %
Costs and expenses:
 
 
 
 
 
 
 
 
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
 
 
 
 
 
 
 
 
Cost of sales
 
90,962

 
91,640

 
(678
)
 
(0.7
)%
Labor
 
112,353

 
112,921

 
(568
)
 
(0.5
)%
Occupancy
 
37,155

 
39,340

 
(2,185
)
 
(5.6
)%
Other restaurant operating costs
 
49,997

 
49,152

 
845

 
1.7
 %
General and administrative
 
35,480

 
29,866

 
5,614

 
18.8
 %
Depreciation and amortization
 
17,407

 
18,729

 
(1,322
)
 
(7.1
)%
Pre-opening
 
50

 
860

 
(810
)
 
(94.2
)%
Restaurant impairments, asset disposals and closure costs
 
5,952

 
35,147

 
(29,195
)
 
(83.1
)%
Total costs and expenses
 
349,356

 
377,655

 
(28,299
)
 
(7.5
)%
Loss from operations
 
(4,708
)
 
(33,937
)
 
29,229

 
86.1
 %
Loss on extinguishment of debt
 
626

 

 
626

 
100.0
 %
Interest expense, net
 
3,385

 
2,828

 
557

 
19.7
 %
Loss before income taxes
 
(8,719
)
 
(36,765
)
 
28,046

 
76.3
 %
(Benefit) provision for income taxes
 
(259
)
 
230

 
(489
)
 
*

Net loss
 
$
(8,460
)
 
$
(36,995
)
 
$
28,535

 
77.1
 %
Company-owned:
 
 
 
 
 
 
 
 
Average unit volumes
 
$
1,107

 
$
1,066

 
$
41

 
3.8
 %
Comparable restaurant sales
 
3.3
%
 
(3.4
)%
 


 


________________
*
Not meaningful.

23

Table of Contents

Revenue
Total revenue increased by $0.9 million, or 0.3%, in the first three quarters of 2018, to $344.6 million compared to $343.7 million in the same period of 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 55 restaurants in the first quarter of 2017.
Comparable restaurant sales increased by 3.3% at company-owned restaurants, increased by 5.6% at franchise-owned restaurants and increased by 3.6% system-wide in the first three quarters of 2018.
Cost of Sales
Cost of sales decreased by $0.7 million, or 0.7%, in the first three quarters of 2018 compared to the same period of 2017. As a percentage of restaurant revenue, cost of sales decreased to 26.6% in the first three quarters of 2018 from 26.9% in the first three quarters of 2017. The decrease as a percentage of restaurant revenue was primarily due to favorable commodity pricing, partially offset by the nationwide launch of zucchini noodles in the second quarter of 2018, which have a higher cost of goods sold than the balance of our menu offerings.
Labor Costs
Labor costs decreased by $0.6 million, or 0.5%, in the first three quarters of 2018 compared to the same period of 2017. As a percentage of restaurant revenue, labor costs decreased to 32.9% in the first three quarters of 2018 from 33.2% in the first three quarters of 2017. The decrease as a percentage of restaurant revenue was driven by the benefit of closing underperforming restaurants in the first quarter of 2017, labor savings initiatives and leverage on higher AUVs, partially offset by wage inflation.
Occupancy Costs
Occupancy costs decreased by $2.2 million, or 5.6%, in the first three quarters of 2018 compared to the first three quarters of 2017, due primarily to the favorable impact of restaurant closures since the beginning of 2017. As a percentage of revenue, occupancy costs decreased to 10.9% in first three quarters of 2018, compared to 11.6% in the first three quarters of 2017, due to leverage on higher AUVs.
Other Restaurant Operating Costs
Other restaurant operating costs increased by $0.8 million, or 1.7%, in the first three quarters of 2018 compared to the first three quarters of 2017 due to expenses associated with marketing, culinary, and off-premise initiatives. As a percentage of restaurant revenue, other restaurant operating costs increased to 14.6% in the first three quarters of 2018, compared to 14.4% in the first three quarters of 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 $5.6 million, or 18.8%, in the first three quarters of 2018 compared to the first three quarters of 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 the Delaware gift card matter and increased incentive compensation. Additionally, the first three quarters of 2017 included a $0.4 million gain recognized on the employment-related litigation settlement, which was settled in 2016, due to final settlement being less than what we had previously accrued. As a percentage of revenue, general and administrative expense increased to 10.3% in the first three quarters of 2018 compared to 8.7% in the first three quarters of 2017.
Depreciation and Amortization
Depreciation and amortization decreased by $1.3 million, or 7.1%, in the first three quarters of 2018 compared to the first three quarters of 2017, due primarily to restaurants impaired or closed in prior quarters. As a percentage of revenue, depreciation and amortization decreased to 5.1% in the first three quarters of 2018, compared to 5.4% in the first three quarters of 2017.
Pre-Opening Costs
Pre-opening costs decreased by $0.8 million, or 94.2%, in the first three quarters of 2018 compared to the first three quarters of 2017. The decrease in pre-opening costs was due to fewer restaurants under construction compared to the comparable period in the prior year. As a percentage of revenue, pre-opening costs were flat in the first three quarters of 2018 compared to the first three quarters of 2017.

24

Table of Contents

Restaurant Impairments, Closure Costs and Asset Disposals
Restaurant impairments, closure costs and asset disposals decreased by $29.2 million in the first three quarters of 2018 compared to the first three quarters of 2017. The decrease was primarily due to the closure of 55 restaurants in the first quarter of 2017 and the impairment of 31 restaurants during the first three quarters of