Q3 2014 10Q
Table of Contents


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

(Mark One)
    x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
For the quarterly period ended September 30, 2014
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 and posted on its corporate Web site, if any, 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).  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,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer o
 
 
 
Non-accelerated filer x
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
 
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 31, 2014
Class A Common Stock, $0.01 par value per share
 
28,267,144 shares
Class B Common Stock, $0.01 par value per share
 
1,522,098 shares

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TABLE OF CONTENTS

 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 





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Table of Contents

PART I

Item 1. Financial Statements

Noodles & Company
Condensed Consolidated Balance Sheets
(in thousands, except share and per share data)
 
 
September 30,
2014
 
December 31,
2013
 
 
(unaudited)
 
 
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
2,248

 
$
968

Accounts receivable
 
3,910

 
4,832

Inventories
 
9,154

 
7,223

Prepaid expenses and other assets
 
6,690

 
5,310

Total current assets
 
22,002

 
18,333

Property and equipment, net
 
195,105

 
167,614

Intangibles
 
1,789

 
351

Goodwill

6,543



Other assets, net
 
2,079

 
1,504

Total long-term assets
 
205,516

 
169,469

Total assets
 
$
227,518

 
$
187,802

Liabilities and Stockholders' Equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
11,713

 
$
8,167

Accrued payroll and benefits
 
7,349

 
7,121

Accrued expenses and other current liabilities
 
12,937

 
8,877

Total current liabilities
 
31,999

 
24,165

Long-term debt
 
21,500

 
6,312

Deferred rent
 
33,745

 
28,846

Other long-term liabilities
 
4,619

 
4,006

Total liabilities
 
91,863

 
63,329

Stockholders' equity:
 
 
 
 
Preferred stock—$0.01 par value, authorized 1,000,000 shares as of September 30, 2014 and December 31, 2013; no shares issued or outstanding
 

 

Common stock—$0.01 par value, authorized 180,000,000 shares as of September 30, 2014 and December 31, 2013; 29,785,717 and 29,544,557 issued and outstanding as of September 30, 2014 and December 31, 2013, respectively
 
298

 
295

Treasury stock, at cost, 67,586 and 65,478 shares as of September 30, 2014 and December 31, 2013, respectively
 
(2,848
)
 
(2,777
)
Additional paid-in capital
 
120,003

 
116,647

Retained earnings
 
18,202

 
10,308

Total stockholders' equity
 
135,655

 
124,473

Total liabilities and stockholders' equity
 
$
227,518

 
$
187,802

   See accompanying notes to consolidated financial statements.

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Table of Contents

Noodles & Company
Consolidated Statements of Income
(in thousands, except share and per share data, unaudited)
 
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
 
September 30,
2014
 
October 1,
2013
 
September 30,
2014
 
October 1,
2013
Revenue:
 
 
 
 
 
 
 
 
Restaurant revenue
 
$
105,143

 
$
87,864

 
$
291,789

 
$
256,744

Franchising royalties and fees
 
1,073

 
1,072

 
3,406

 
2,711

Total revenue
 
106,216

 
88,936

 
295,195

 
259,455

Costs and expenses:
 
 
 
 
 
 
 
 
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
 
 
 
 
 
 
 
 
Cost of sales
 
28,359

 
23,127

 
78,533

 
67,524

Labor
 
31,884

 
26,345

 
88,410

 
77,464

Occupancy
 
11,004

 
8,870

 
31,114

 
25,824

Other restaurant operating costs
 
14,532

 
11,315

 
38,981

 
32,962

General and administrative
 
7,545

 
6,939

 
22,806

 
27,808

Depreciation and amortization
 
6,454

 
5,238

 
17,969

 
15,074

Pre-opening
 
1,142

 
1,183

 
3,282

 
2,873

Asset disposals, closure costs and restaurant impairments
 
251

 
339

 
658

 
837

Total costs and expenses
 
101,171

 
83,356

 
281,753

 
250,366

Income from operations
 
5,045

 
5,580

 
13,442

 
9,089

Interest expense
 
112

 
132

 
168

 
2,199

Income before income taxes
 
4,933

 
5,448

 
13,274

 
6,890

Provision for income taxes
 
1,990

 
2,183

 
5,380

 
2,633

Net income
 
$
2,943

 
$
3,265

 
$
7,894

 
$
4,257

Earnings per share of Class A and Class B common stock, combined:
 
 
 
 
 
 
 
 
Basic
 
$
0.10

 
$
0.11

 
$
0.27

 
$
0.17

Diluted
 
$
0.10

 
$
0.11

 
$
0.25

 
$
0.16

Weighted average shares of Class A and Class B common stock outstanding, combined:
 
 
 
 
 
 
 
 
Basic
 
29,757,820

 
29,399,650

 
29,689,342

 
25,382,805

Diluted
 
30,893,904

 
31,063,213

 
31,042,443

 
26,528,004


See accompanying notes to consolidated financial statements.

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Table of Contents

Noodles & Company
Consolidated Statements of Comprehensive Income
(in thousands, unaudited)
 
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
 
September 30,
2014
 
October 1,
2013
 
September 30,
2014
 
October 1,
2013
Net income
 
$
2,943

 
$
3,265

 
$
7,894

 
$
4,257

Other comprehensive income:
 
 
 
 
 
 
 
 
Cash flow hedges:
 
 
 
 
 
 
 
 
Reclassification of loss to net income
 

 

 

 
39

Unrealized income on cash flow hedges
 

 

 

 
39

Provision for income tax on cash flow hedges
 

 

 

 
(15
)
Other comprehensive income, net of tax
 

 

 

 
24

Comprehensive income
 
$
2,943

 
$
3,265

 
$
7,894

 
$
4,281


 See accompanying notes to consolidated financial statements.

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Table of Contents

Noodles & Company
Consolidated Statements of Cash Flows
(in thousands, unaudited)
 
 
Three Fiscal Quarters Ended
 
 
September 30,
2014
 
October 1,
2013
Operating activities
 
 
 
 
Net income
 
$
7,894

 
$
4,257

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
17,969

 
15,074

Deferred income taxes
 
5,380

 
366

Asset disposal, closure costs and restaurant impairments
 
658

 
837

Amortization of debt issuance costs and debt extinguishment expense
 
76

 
82

Stock-based compensation
 
1,028

 
4,065

Other noncash
 

 
(205
)
Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
318

 
(1,276
)
Inventories
 
(1,639
)
 
(1,040
)
Prepaid expenses and other assets
 
(2,040
)
 
(1,050
)
Accounts payable
 
3,169

 
787

Deferred rent
 
4,660

 
4,583

Income taxes
 
(505
)
 
1,904

Accrued expenses and other liabilities
 
485

 
4,078

Net cash provided by operating activities
 
37,453

 
32,462

Investing activities
 
 
 
 
Purchases of property and equipment
 
(39,943
)
 
(39,788
)
Acquisition of franchise restaurants
 
(13,623
)
 

Net cash used in investing activities
 
(53,566
)
 
(39,788
)
Financing activities
 
 
 
 
Proceeds from issuance of long-term debt
 
211,326

 
101,731

Payments on long-term debt
 
(196,138
)
 
(194,498
)
Issuance of common stock, net of transaction expenses
 

 
100,101

Conversion of Class B to Class A shares
 
(60
)
 

Acquisition of treasury stock
 
(71
)
 

Proceeds from exercise of stock options, warrants and employee stock purchase plan
 
2,336

 

Net cash provided by financing activities
 
17,393

 
7,334

Net increase in cash and cash equivalents
 
1,280

 
8

Cash and cash equivalents
 
 
 
 
Beginning of period
 
968

 
581

End of period
 
$
2,248

 
$
589

   
See accompanying notes to consolidated financial statements.

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Table of Contents

NOODLES & COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. Business and Summary and Basis of Presentation
Business
Noodles & Company, (the "Company" or "Noodles & Company"), a Delaware corporation, develops and operates fast casual restaurants that serve globally inspired noodle and pasta dishes, soups, salads and sandwiches. As of September 30, 2014, there were 370 company-owned restaurants and 55 franchise restaurants in 32 states and the District of Columbia. The Company operates its business as one operating and reportable segment.
On July 2, 2013, the Company completed an initial public offering ("IPO") of shares of Class A common stock at $18.00 per share. The Company issued 6,160,714 shares of Class A common stock, $0.01 par value, including 803,571 shares sold to the underwriters in the IPO pursuant to their over-allotment option. After underwriter discounts and commissions and offering expenses, the Company received net proceeds from the offering of approximately $100.1 million. These proceeds were used to repay all but $0.2 million of outstanding debt under the Company's credit facility.
On December 5, 2013, the Company completed a follow-on offering of 4,500,000 shares of Class A common stock at a price of $39.50 per share. All of the shares in the offering were offered by selling stockholders, except for 108,267 shares offered by the Company, the proceeds of which were used to repurchase the same number of shares from certain officers at the same net price per share at which shares were sold in the follow-on offering. The Company did not receive any net proceeds from the offering of shares by the selling stockholders. The selling stockholders paid all of the underwriting discounts and commissions associated with the sale of the shares; however, the Company incurred approximately $696,000 in costs and expenses related to this offering.
The accompanying interim unaudited 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 generally accepted accounting principles in the United States ("U.S. 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 results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. 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 December 31, 2013.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Noodles & Company and its subsidiaries. All material intercompany balances and transactions are eliminated in consolidation.
Fiscal Year
The Company operates on a 52- or 53-week fiscal year ending on the Tuesday closest to December 31. Fiscal year 2014, which ends on December 30, 2014 and fiscal year 2013, which ended on December 31, 2013, each contain 52 weeks. Fiscal quarters each contain thirteen weeks, with the exception of the fourth quarter of a 53-week fiscal year, which contains fourteen weeks.
Recent Accounting Pronouncements
In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Updated ("ASU"), "Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern." This update requires management of the Company to evaluate whether there is substantial doubt about the Company’s ability to continue as a going concern. This update is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. Early adoption is permitted. The Company does not expect this standard to have an impact on the Company’s consolidated financial position or results of operations.
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers." The pronouncement was issued to clarify the principles for recognizing revenue and to develop a common revenue standard and disclosure requirements for U.S. GAAP and International Financial Reporting Standards ("IFRS"). The pronouncement is effective for reporting periods beginning after December 15, 2016. The adoption of ASU 2014-09 is not expected to significantly affect the Company’s consolidated financial position or results of operations.

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2. Supplemental Financial Information
Property and equipment, net, consist of the following (in thousands):
 
 
September 30,
2014
 
December 31,
2013
Leasehold improvements
 
$
199,261

 
$
169,953

Furniture, fixtures and equipment
 
108,882

 
92,695

Construction in progress
 
9,832

 
11,209

 
 
317,975

 
273,857

Accumulated depreciation and amortization
 
(122,870
)
 
(106,243
)
 
 
$
195,105

 
$
167,614


3. Borrowings
The Company has a credit facility with a borrowing capacity of $45.0 million in the form of a revolving line of credit, expiring in November 2018. Prior to the IPO, the Company had a credit facility with a borrowing capacity of $120.0 million, consisting of a $75.0 million senior term loan and a $45.0 million revolving line of credit. In the second quarter of 2013 the Company repaid its outstanding $75.0 million senior term loan and the majority of the revolving line of credit.

As of September 30, 2014, the Company had $21.5 million outstanding and $20.8 million available for borrowing under the credit facility. Outstanding letters of credit aggregating $2.7 million reduce the amount available to borrow. The credit facility bore interest at a range of 3.25% to 3.50% during the first three quarters of 2014. The Company was in compliance with all of its debt covenants as of September 30, 2014.

4. Fair Value Measurements
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and all other current liabilities approximate fair values due to the short maturities of these instruments. The carrying amounts of borrowings approximate fair value as interest rates on the the line of credit borrowings vary with market interest rates and negotiated terms and conditions are consistent with current market rates. The fair value of our line of credit borrowings is measured using Level 2 inputs.

5. Income Taxes
The following table presents the Company's provision for income taxes for the third quarters of 2014 and 2013 and the first three quarters ended September 30, 2014 and October 1, 2013 (dollars in thousands):

 
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
 
September 30,
2014
 
October 1,
2013
 
September 30,
2014
 
October 1,
2013
Provision for income taxes
 
$
1,990

 
$
2,183

 
$
5,380

 
$
2,633

Effective tax rate
 
40.3
%
 
40.1
%
 
40.5
%
 
38.2
%

The 2014 estimated annual effective tax rate is expected to be between 40% and 41% compared to 41.7% for 2013. The effective tax rate for both the third quarter of 2014 and the first three quarters of 2014 includes the change to a 35% federal income tax rate compared to a 34% rate in 2013. The effective tax rate for the first three quarters of 2013 includes the discrete adjustment for certain transaction costs related to the IPO.

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 and incentive bonuses to employees, officers, non-employee 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 closing of the IPO shall not exceed 3,750,500.

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The following table presents information related to the Stock Incentive Plan (in thousands, except for share and per share amounts):
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
September 30,
2014
 
October 1,
2013
 
September 30,
2014
 
October 1,
2013
Outstanding, beginning of period
3,324,822

 
3,474,398

 
3,309,872

 
2,973,168

Granted (1)
22,000

 

 
253,552

 
538,273

Exercised
37,313

 

 
230,551

 

Forfeited
1,401

 
1,961

 
24,765

 
39,004

Outstanding, end of period
3,308,108

 
3,472,437

 
3,308,108

 
3,472,437

Weighted average fair market value on option grant date
$
7.47

 
N/A
 
$
10.63

 
$
5.81

Stock based compensation expense
$
368

 
$
131

 
$
1,025

 
$
4,065

Capitalized stock based compensation expense
$
25

 
$
15

 
$
54

 
$
56

______________________
(1)
The stock options granted in the first three quarters of 2013 included 403,900 options awarded to two executive officers of which 50% vested at the time of the IPO and the remaining vest annually in equal installments over four years on the anniversary of the grant.

7. Earnings Per Share
Earnings per share ("EPS") is calculated by dividing income available to common stockholders by the weighted-average number of shares of common stock outstanding during each period. Diluted earnings per share ("diluted EPS") is calculated using income 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 and warrants. The following table sets forth the computations of basic and dilutive earnings per share:
 
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
 
September 30,
2014
 
October 1,
2013
 
September 30,
2014
 
October 1,
2013
Net income (in thousands):
 
$
2,943

 
$
3,265

 
$
7,894

 
$
4,257

Shares:
 
 
 
 
 
 
 
 
Basic weighted average shares outstanding
 
29,757,820

 
29,399,650

 
29,689,342

 
25,382,805

Dilutive stock options and warrants
 
1,136,084

 
1,663,563

 
1,353,101

 
1,145,199

Diluted weighted average number of shares outstanding
 
30,893,904

 
31,063,213

 
31,042,443

 
26,528,004

Earnings per share:
 
 
 
 
 
 
 
 
Basic EPS
 
$
0.10

 
$
0.11

 
$
0.27

 
$
0.17

Diluted EPS
 
$
0.10

 
$
0.11

 
$
0.25

 
$
0.16

In the third quarters of 2014 and 2013, there were 267,196 and zero outstanding options, respectively, excluded from the diluted earnings per share calculation because they were anti-dilutive. In the first three quarters of 2014 and 2013, there were 243,552 and 488,018 outstanding options, respectively, excluded from the diluted earnings per share calculation because they were anti-dilutive. All outstanding warrants are dilutive and were included in the calculation of diluted earnings per share.

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8. Acquisition of Franchised Restaurants
On July 2, 2014, the Company acquired 16 restaurants from one of its franchisees. The cash purchase price was $13.6 million and the Company incurred acquisition costs related to the transaction of $0.06 million reflected in General and Administrative expense for the three quarters ended September 30, 2014. The consolidated statements of income include the results of operations for the restaurants from the date of acquisition. The pro forma impact of the acquisition is not presented as the impact was not material to reported results.
The acquisition of the 16 restaurants was accounted for using the purchase method as defined in ASC 805, Business Combination. The goodwill generated by the acquisition is not amortizable for book purposes but is amortizable and deductible for tax purposes. The Company has completed a preliminary allocation of the purchase price to the fair value of acquired assets and assumed liabilities as follows (in thousands):
 
 
Fair Value at July 2, 2014
Inventories
 
292

Prepaid expenses and other assets
 
27

Property and equipment
 
5,649

Intangibles
 
1,421

Goodwill
 
6,521

Deferred Rent and Other Liabilities
 
(275
)
Total purchase price
 
$
13,635

Of the $1.4 million of intangible assets, $1.3 million are related to reacquired franchise rights, which will be amortized on a straight-line basis over an average life of approximately 15 years and $0.1 million are related to favorable leases, which will be amortized on a straight-line basis over an average life of eight years. The unfavorable leases, which were included in deferred rent in the accompanying condensed consolidated balance sheets, will be amortized on a straight-line basis over an average period of seven years. The fair value measurement of tangible and intangible assets and liabilities as of the acquisition date is based on significant inputs not observed in the market and thus represents a Level 3 measurement that is subject to change.
9. Employee Benefit Plans
Deferred Compensation Plan
The Company’s deferred compensation plan, under which compensation deferrals began during the third quarter of 2013, is a non-qualified deferred compensation plan which allows highly compensated employees to defer a portion of their base salary and variable compensation each plan year. To offset its obligation, the Company purchases Company-owned whole-life insurance contracts on certain team members. As of September 30, 2014 and December 31, 2013, $1.1 million and $0.6 million, respectively, were included in other assets, net, which represents the cash surrender value of the associated life insurance policy. As of September 30, 2014 and December 31, 2013, $1.2 million and $0.6 million, respectively, were included in other long-term liabilities, which represent the carrying values of the liability for the deferred compensation plan.

10. Supplemental Disclosures to Consolidated Statements of Cash Flows
The following table presents the supplemental disclosures to the consolidated statements of cash flows for the first three quarters ended September 30, 2014 and October 1, 2013 (in thousands):
 
 
September 30,
2014
 
October 1,
2013
Interest paid (net of amounts capitalized)
 
$
81

 
$
2,748

Income taxes paid
 
505

 
400

Changes in purchases of property and equipment accrued in accounts payable, net
 
(377
)
 
(1,363
)





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NOODLES & COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)


11. Commitments and Contingencies
The Company is 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 case was filed under seal in June 2013 and was unsealed on March 26, 2014. The complaint in this case alleges that the Company and the other defendants in the case, including a number of large retailers and restaurant companies, 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 seeks an order that the Company cease and desist from violating the Delaware False Claims and Reporting Act, monetary damages (including treble damages under the False Claims and Reporting Act), penalties and attorneys' fees and costs. The case was removed to U.S. federal district court for the District of Delaware and the plaintiffs have filed a motion to remand the case to the Superior Court for the State of Delaware. The Company has also filed a motion to dismiss the complaint. The case is at an early stage, and the Company therefore is unable to make a reasonable estimate of the probable loss or range of losses, if any, that might arise from this matter. The Company intends to vigorously defend this action.
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 September 30, 2014. These matters could affect the operating results of any one financial reporting period when resolved in future periods. Management believes that an unfavorable outcome with respect to these matters is remote or a potential range of loss is not material to the Company's 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 the Company's business, financial condition, results of operations or cash flows.
The Company entered into employment agreements with two of its executives in connection with the IPO superseding the previous employment agreements with these executives. The agreements have an initial term of three years and automatically renew annually unless canceled by either party within 90 days of the end of the initial term or anniversaries thereof. Under each of the employment agreements, if the executive's employment is terminated by the Company without "cause" or by the executive with "good reason," (as such terms are defined in the applicable employment agreement) the executive is entitled to receive compensation equal to 18 months of the executive's then-current base salary, payable in equal installments over 18 months, a pro rata bonus for the year of termination and reimbursement of "COBRA" premiums for up to 18 months for the executive and his dependents. The severance payments are conditioned upon the executive entering into a mutual release of claims with the Company.
12. Related-Party Transactions
In the first three quarters of 2013, the Company paid $375,000 to Catterton Partners and Argentia Private Investments Inc. or their affiliates ("Equity Sponsors") for management service fees and Class C Dividends pursuant to a management services agreement and an agreement to pay dividends on its Class C common stock. In connection with the IPO, the management services agreement expired and the one share of Class C common stock was redeemed; therefore, no payments were made subsequent to the second quarter of 2013. Management service fees and Class C dividends paid in prior fiscal quarters varied due to the timing of the payments.

In connection with the IPO, during the second quarter of 2013, the Company paid $1.7 million of transaction bonuses and related payroll taxes to employees of the Company and $800,000 in transaction payments to the Equity Sponsors.

13. Subsequent Events
The Company has evaluated subsequent events and found there to be no events requiring recognition or disclosure through the date of issuance of this report.

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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
        The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying unaudited 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 December 31, 2013. 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 year, which contains 14 operating weeks. Fiscal years 2014 and 2013 each contain 52 weeks.
Cautionary Note Regarding Forward-Looking Statements
        In addition to historical information, this discussion and analysis contains forward-looking statements 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 assumptions and are subject to risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements including, but not limited to, 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 December 31, 2013.
2014 Highlights and Trends
Restaurant Development. New restaurants have contributed substantially to our revenue growth. In the third quarter of 2014, we opened 11 company-owned restaurants and four franchise restaurants. During the three quarters ended September 30, 2014, we opened 36 company-owned restaurants and nine franchise restaurants. Additionally, on July 2, 2014, we purchased 16 restaurants from a franchisee. As of September 30, 2014, we had 370 company-owned restaurants and 55 franchise restaurants in 32 states and the District of Columbia. In 2014, we anticipate opening between 48 and 50 company-owned restaurants, and between 10 and 12 franchise restaurants, including the restaurants opened through the end of our third quarter.
Comparable Restaurant Sales. Comparable restaurant sales increased by 1.6% at company-owned restaurants, 2.0% at franchise owned restaurants and 1.7% system-wide in the third quarter of 2014. In the first three quarters of 2014, comparable restaurant sales decreased 0.1% for company-owned restaurants, 1.0% for franchise restaurants and 0.2% system-wide.
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, 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 part of our financial success.
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. These seasonal factors could cause our quarterly and annual operating results and comparable restaurant sales to fluctuate significantly.




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Average Unit Volumes ("AUVs")
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 361, which is 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. This measure highlights performance of existing restaurants, as it excludes the impact of new restaurant openings. Comparable restaurant sales growth is generated by increases in traffic, which we calculate as the number of entrees 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;

per-person spend and average check amount;

marketing and promotional efforts;

weather;

local competition;

trade area dynamics;

introduction of new and seasonal menu items and limited time offerings; and

opening of new restaurants in the vicinity of existing locations.
Since opening new company-owned and franchise restaurants is an important part of our growth strategy and we anticipate new restaurants will be a significant component of our revenue growth, comparable restaurant sales are only one measure of how we evaluate our performance.

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Restaurant Contribution
Restaurant contribution is defined as restaurant revenue less restaurant operating costs, which consist of cost of sales, labor, occupancy and other restaurant operating costs. We expect restaurant contribution to increase in proportion to the number of new restaurants we open and our comparable restaurant sales growth. Fluctuations in restaurant contribution margin can also be attributed to those factors discussed above for the components of restaurant operating costs.
EBITDA and Adjusted EBITDA
We define EBITDA as net income before interest expense, provision for income taxes and depreciation and amortization. We define adjusted EBITDA as net income before interest expense, provision for income taxes, asset disposals, closure costs and restaurant impairments, depreciation and amortization, stock-based compensation, management fees and IPO-related expenses.
EBITDA and adjusted EBITDA provide clear pictures of our operating results by eliminating certain expenses that do not reflect our underlying business performance. We use these metrics to facilitate a comparison of our operating performance on a consistent basis from period to period and to analyze the factors and trends affecting our business.
The following table presents a reconciliation of net income to EBITDA and adjusted EBITDA:
 
 
Fiscal Quarter Ended
Three Fiscal Quarters Ended
 
 
September 30,
2014
 
October 1,
2013
 
September 30,
2014
 
October 1,
2013
 
 
(in thousands, unaudited)
Net income
 
$
2,943

 
$
3,265

 
$
7,894

 
$
4,257

Depreciation and amortization
 
6,454

 
5,238

 
17,969

 
15,074

Interest Expense
 
112

 
132

 
168

 
2,199

Provision for income taxes
 
1,990

 
2,183

 
5,380

 
2,633

EBITDA
 
$
11,499

 
$
10,818

 
$
31,411

 
$
24,163

Asset disposals, closure costs and restaurant impairment
 
251

 
339

 
658

 
837

Management fees (1)
 

 

 

 
500

Stock-based compensation expense (2)
 
357

 
131

 
1,028

 
873

IPO-related expenses (3)
 

 

 

 
5,667

Adjusted EBITDA
 
$
12,107

 
$
11,288

 
$
33,097

 
$
32,040

______________________
(1)
The first three quarters of 2013 included $0.5 million of management fee expense in accordance with our management services agreement and through the Class C common stock dividend paid to the holder of the one share of our Class C common stock then outstanding. In connection with our IPO, the management services agreement expired and the one share of Class C common stock was redeemed.

(2)
Includes only the non-cash portion of stock-based compensation expense.

(3)
Reflects certain expenses incurred in conjunction with the closing of our IPO. This amount includes $2.0 million of stock-based compensation related to accelerated vesting of outstanding stock options, $1.2 million of stock-based compensation related to stock options granted to our Chief Executive Officer and President and Chief Operations Officer (of which 50% vested at grant), $1.7 million of transaction bonuses and related payroll tax and $800,000 in transaction payments to our Equity Sponsors.



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Restaurant Openings, Closures and Relocations
The following table shows restaurants opened, closed or relocated during the periods indicated.
 
 
Fiscal Quarter Ended
 
Three Fiscal Quarters Ended
 
 
September 30,
2014
 
October 1,
2013
 
September 30,
2014
 
October 1,
2013
Company-Owned Restaurant Activity
 
 
 
 
 
 
 
 
Beginning of period
 
343

 
295

 
318

 
276

Openings
 
11

 
15

 
36

 
35

Acquisitions (1)
 
16

 

 
16

 

Closures and relocations (2)
 

 

 

 
(1
)
Restaurants at end of period
 
370

 
310

 
370

 
310

Franchise Restaurant Activity
 
 
 
 
 
 
 
 
Beginning of period
 
67

 
53

 
62

 
51

Openings
 
4

 
5

 
9

 
7

Divestitures (1)
 
(16
)
 

 
(16
)
 

Restaurants at end of period
 
55

 
58

 
55

 
58

Total restaurants
 
425

 
368

 
425

 
368

_____________________________
(1)
Represents franchise restaurants acquired by the Company.
(2)
Relocated restaurants are accounted for under both restaurant openings and restaurant closures and relocations. In the first quarter of 2013, we closed one restaurant at the end of its lease term.

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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 Quarter Ended
 
Three Fiscal Quarters Ended
 
 
September 30,
2014
 
October 1,
2013
 
September 30,
2014
 
October 1,
2013
Revenue:
 
 
 
 
 
 
 
 
Restaurant revenue
 
99.0
%
 
98.8
%
 
98.8
%
 
99.0
%
Franchising royalties and fees
 
1.0

 
1.2

 
1.2

 
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
 
27.0

 
26.3

 
26.9

 
26.3

Labor
 
30.3

 
30.0

 
30.3

 
30.2

Occupancy
 
10.5

 
10.1

 
10.7

 
10.1

Other restaurant operating costs
 
13.8

 
12.9

 
13.4

 
12.8

General and administrative (2)
 
7.1

 
7.8

 
7.7

 
10.7

Depreciation and amortization
 
6.1

 
5.9

 
6.1

 
5.8

Pre-opening
 
1.1

 
1.3

 
1.1

 
1.1

Asset disposals, closure costs and restaurant impairments
 
0.2

 
0.4

 
0.2

 
0.3

Total costs and expenses
 
95.2

 
93.7

 
95.4

 
96.5

Income from operations
 
4.8

 
6.3

 
4.6

 
3.5

Interest expense
 
0.1

 
0.1

 
0.1

 
0.8

Income before income taxes
 
4.7

 
6.1

 
4.5

 
2.7

Provision for income taxes
 
1.9

 
2.5

 
1.8

 
1.0

Net income
 
2.8
%
 
3.7
%
 
2.7
%
 
1.6
%
______________________________
(1)
As a percentage of restaurant revenue.

(2)
In the second quarter of 2013, we incurred $5.7 million of IPO-related expenses: $2.0 million of stock-based compensation related to accelerated vesting of outstanding stock options, $1.2 million of stock-based compensation related to stock options granted to our Chief Executive Officer and President and Chief Operating Officer (of which 50% vested at grant), $1.7 million of transaction bonuses and related payroll taxes and $0.8 million in transaction payments to our Equity Sponsors. Additionally, the first three quarters of 2013 included $0.5 million of management fee expense in accordance with our management services agreement and through the Class C common stock dividend paid to the holder of the one share of our Class C common stock then outstanding. In connection with our IPO, the management services agreement expired and the one share of Class C common stock was redeemed.



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Third Quarter Ended September 30, 2014 compared to Third Quarter Ended October 1, 2013
The table below presents our unaudited operating results for the third quarters of 2014 and 2013, and the related quarter-over-quarter changes.
 
 
Fiscal Quarter Ended
 
Increase / (Decrease)
 
 
September 30,
2014
 
October 1,
2013
 
$
 
%
 
 
 
 
 
 
(in thousands, except percentages)
Revenue:
 
 
 
 
 
 
 
 
Restaurant revenue
 
$
105,143

 
$
87,864

 
$
17,279

 
19.7
 %
Franchising royalties and fees
 
1,073

 
1,072

 
1

 
0.1

Total revenue
 
106,216

 
88,936

 
17,280

 
19.4

Costs and expenses:
 
 
 
 
 
 
 
 
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
 
 
 
 
 
 
 
 
Cost of sales
 
28,359

 
23,127

 
5,232

 
22.6

Labor
 
31,884

 
26,345

 
5,539

 
21.0

Occupancy
 
11,004

 
8,870

 
2,134

 
24.1

Other restaurant operating costs
 
14,532

 
11,315

 
3,217

 
28.4

General and administrative
 
7,545

 
6,939

 
606

 
8.7

Depreciation and amortization
 
6,454

 
5,238

 
1,216

 
23.2

Pre-opening
 
1,142

 
1,183

 
(41
)
 
(3.5
)
Asset disposals, closure costs and restaurant impairments
 
251

 
339

 
(88
)
 
(26.0
)
Total costs and expenses
 
101,171

 
83,356

 
17,815

 
21.4

Income from operations
 
5,045

 
5,580

 
(535
)
 
(9.6
)
Interest expense
 
112

 
132

 
(20
)
 
(15.2
)
Income before income taxes
 
4,933

 
5,448

 
(515
)
 
(9.5
)
Provision (benefit) for income taxes
 
1,990

 
2,183

 
(193
)
 
(8.8
)
Net income
 
$
2,943

 
$
3,265

 
$
(322
)
 
(9.9
)%
Company owned:
 
 
 
 
 
 
 
 
Average unit volumes
 
$
1,152

 
$
1,181

 
$
(29
)
 
(2.5
)%
Comparable restaurant sales
 
1.6
%
 
2.4
%
 


 



Revenue
Restaurant revenue increased by $17.3 million in the third quarter of 2014 compared to the same period of 2013. An increase in operating weeks resulted in $16.4 million of this increase, as well as an increase in comparable restaurant sales of $0.9 million, or 1.6%, in the third quarter of 2014 compared to the same period in 2013. The comparable restaurant sales increase in the third quarter was the result of a modest price increase and product mix during the quarter.
Franchise royalties and fees increased by $1,000 in the third quarter of 2014 compared to the same period of 2013 due to four new restaurant openings, an increase in comparable restaurant sales, and an increase in operating weeks, offset by the sale of 16 franchise restaurants to the Company on July 2, 2014.
Cost of Sales
Cost of sales increased by $5.2 million in the third quarter of 2014 compared to the same period of 2013, due primarily to the increase in restaurant revenue in the third quarter of 2014. As a percentage of restaurant revenue, cost of sales increased to 27.0% in the third quarter of 2014 from 26.3% in third quarter of 2013. The increase was the result of increased promotional activity and an increase in ingredient costs.


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Labor Costs
Labor costs increased by $5.5 million in the third quarter of 2014 compared to the same period of 2013, due primarily to the increase in restaurant revenue in the third quarter of 2014. As a percentage of restaurant revenue, labor costs increased to 30.3% in the third quarter of 2014 from 30.0% in the third quarter of 2013. The increase as a percentage of restaurant revenue was the result of deleverage due to lower average unit volumes and expenses related to the launch of our catering initiative.
Occupancy Costs
Occupancy costs increased by $2.1 million in the third quarter of 2014 compared to the third quarter of 2013, due primarily to 59 net restaurant openings, as well as the acquisition of 16 franchise restaurants. As a percentage of revenue, occupancy costs increased to 10.5% in the third quarter of 2014, compared to 10.1% in the second quarter of 2013. The increase was due primarily to an increased percentage of new restaurants, which on average have higher occupancy costs.
Other Restaurant Operating Costs
Other restaurant operating costs increased by $3.2 million in the third quarter of 2014 compared to the third quarter of 2013, due primarily to increased restaurant revenue in the third quarter of 2014. As a percentage of restaurant revenue, other restaurant operating costs increased to 13.8% in the third quarter of 2014 from 12.9% in the third quarter of 2013. The increase as a percentage of restaurant revenue was due primarily to increased restaurant marketing expense.
General and Administrative Expense
General and administrative expense increased by $0.6 million in the third quarter of 2014 compared to the third quarter of 2013. This increase was primarily driven by our biennial All Managers Conference which was held during the current quarter as well as an increase in non-cash stock compensation expense.
Depreciation and Amortization
Depreciation and amortization increased by $1.2 million in the third quarter of 2014 compared to the third quarter of 2013, due primarily to the increase in the number of restaurants. As a percentage of revenue, depreciation and amortization increased to 6.1% in the third quarter of 2014, compared to 5.9% in the third quarter of 2013, due primarily to depreciation on new restaurants.
Pre-Opening Costs
Pre-opening costs remained relatively flat in the third quarter of 2014 compared to the third quarter of 2013. As a percentage of revenue, pre-opening costs decreased to 1.1% in the third quarter of 2014 compared to 1.3% in the third quarter of 2013. This decrease was due to four fewer restaurants in various stages of development in the third quarter of 2014 compared to the third quarter of 2013.
Provision for Income Taxes
Provision for income taxes decreased by $0.2 million in the third quarter of 2014 compared to same period of 2013 due to a decrease in pre-tax net income of $0.5 million in the third quarter of 2014 compared to the third quarter of 2013. The effective tax rate for the first three quarters of 2014 includes the change to a 35% federal income tax rate compared to 34% in 2013. The 2014 estimated annual effective tax rate is expected to be 40% to 41% compared to 41.7% for 2013.


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Table of Contents

Three Quarters Ended September 30, 2014 compared to Three Quarters Ended October 1, 2013
The table below presents our unaudited operating results for the first three quarters of 2014 and 2013, and the related quarter-over-quarter changes.
 
 
Three Fiscal Quarters Ended
 
Increase / (Decrease)
 
 
September 30,
2014
 
October 1,
2013
 
$
 
%
 
 
 
 
 
 
(in thousands, except percentages)
Revenue:
 
 
 
 
 
 
 
 
Restaurant revenue
 
$
291,789

 
$
256,744

 
$
35,045

 
13.6
 %
Franchising royalties and fees
 
3,406

 
2,711

 
695

 
25.6

Total revenue
 
295,195

 
259,455

 
35,740

 
13.8

Costs and expenses:
 

 

 
 
 
 
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
 

 

 
 
 
 
Cost of sales
 
78,533

 
67,524

 
11,009

 
16.3

Labor
 
88,410

 
77,464

 
10,946

 
14.1

Occupancy
 
31,114

 
25,824

 
5,290

 
20.5

Other restaurant operating costs
 
38,981

 
32,962

 
6,019

 
18.3

General and administrative (1)
 
22,806

 
27,808

 
(5,002
)
 
(18.0
)
Depreciation and amortization
 
17,969

 
15,074

 
2,895

 
19.2

Pre-opening
 
3,282

 
2,873

 
409

 
14.2

Asset disposals, closure costs and restaurant impairments
 
658

 
837

 
(179
)
 
(21.4
)
Total costs and expenses
 
281,753

 
250,366

 
31,387

 
12.5

Income from operations
 
13,442

 
9,089

 
4,353

 
47.9

Interest expense
 
168

 
2,199

 
(2,031
)
 
(92.4
)
Income before income taxes
 
13,274

 
6,890

 
6,384

 
92.7

Provision for income taxes
 
5,380

 
2,633

 
2,747

 
104.3

Net income
 
$
7,894

 
$
4,257

 
$
3,637

 
85.4
 %
Company owned:
 
 
 
 
 
 
 
 
Average unit volumes
 
$
1,152

 
$
1,181

 
$
(29
)
 
(2.5
)%
Comparable restaurant sales
 
(0.1
)%
 
3.1
%
 


 


______________________________

(1)
In the second quarter of 2013, we incurred $5.7 million of IPO-related expenses: $2.0 million of stock-based compensation related to accelerated vesting of outstanding stock options, $1.2 million of stock-based compensation related to stock options granted to our Chief Executive Officer and President and Chief Operating Officer (of which 50% vested at grant), $1.7 million of transaction bonuses and related payroll taxes and $0.8 million in transaction payments to our Equity Sponsors. Additionally, the first three quarters of 2013 included $0.5 million of management fee expense in accordance with our management services agreement and through the Class C common stock dividend paid to the holder of the one outstanding share of our Class C common stock. In connection with our IPO, the management services agreement expired and the one share of Class C common stock was redeemed.








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Table of Contents

Revenue
Restaurant revenue increased by $35.0 million in the first three quarters of 2014 compared to the same period of 2013. An increase in operating weeks resulted in $36.5 million of this increase, offset by a sales decrease in comparable restaurants of $1.5 million, or 0.1%, in the first three quarters of 2014 compared to the same period in 2013. The comparable restaurant sales decline in the first three quarters was the result of a decrease in traffic due to abnormally severe weather in the first quarter, as well as the loss of an operating day in January 2014 due to a fiscal calendar shift.
Franchise royalties and fees increased by $695,000 in the first three quarters of 2014 compared to the same period of 2013 due to nine new restaurant openings and an increase in operating weeks, offset by a reduction in royalties caused by a decrease in franchise comparable restaurant sales of 1.0% in the first three quarters of 2014, as well as our purchase of 16 franchise restaurants on July 2, 2014.
Cost of Sales
Cost of sales increased by $11.0 million in the first three quarters of 2014 compared to the same period of 2013, due primarily to the increase in restaurant revenue in the first three quarters of 2014. As a percentage of restaurant revenue, cost of sales increased to 26.9% in the first three quarters of 2014 from 26.3% in the first three quarters of 2013. The increase in cost of sales was the result of increased promotional activity and an increase in ingredient costs.
Labor Costs
Labor costs increased by $10.9 million in the first three quarters of 2014 compared to the same period of 2013, due primarily to the increase in restaurant revenue in the first three quarters of 2014. As a percentage of restaurant revenue, labor costs increased to 30.3% in the first three quarters of 2014 from 30.2% in the first three quarters of 2013.
Occupancy Costs
Occupancy costs increased by $5.3 million in the first three quarters of 2014 compared to the first three quarters of 2013, due primarily to 44 net restaurant openings, as well as the acquisition of 16 franchise restaurants. As a percentage of revenue, occupancy costs increased to 10.7% in first three quarters of 2014, compared to 10.1% in the first three quarters of 2013. The increase was due primarily to an increased percentage of new restaurants, which on average have higher occupancy costs as a percentage of revenue. Additionally, there was an increase in common area maintenance charges as a percentage of sales in the first quarter due to increased snow removal in 2014 compared to 2013.
Other Restaurant Operating Costs
Other restaurant operating costs increased by $6.0 million in the first three quarters of 2014 compared to the first three quarters of 2013, due primarily to increased restaurant revenue in the first three quarters of 2014. As a percentage of restaurant revenue, other restaurant operating costs increased to 13.4% in the first three quarters of 2014, compared to 12.8% in the first three quarters of 2013. The increase as a percentage of restaurant revenue was due to increased utilities and maintenance expense.
General and Administrative Expense
General and administrative expense decreased by $5.0 million in the first three quarters of 2014 compared to the first three quarters of 2013. As a percentage of revenue, general and administrative expense decreased to 7.7% in the first three quarters of 2014 compared to 10.7% in first three quarters of 2013. This decrease was due to primarily to the recognition of $5.7 million of non-recurring expenses related to our IPO in the second quarter of 2013. We recognized $2.0 million of stock-based compensation related to accelerated vesting of outstanding stock options, $1.2 million of stock-based compensation related to stock options granted to our Chief Executive Officer and President and Chief Operating Officer (of which 50% vested at grant), $1.7 million of transaction bonuses and related payroll tax and $0.8 million in transaction payments to our Equity Sponsors, all in connection with our IPO.
Depreciation and Amortization
Depreciation and amortization increased by $2.9 million in the first three quarters of 2014 compared to the first three quarters of 2013, due primarily to the increase in the number of restaurants. As a percentage of revenue, depreciation and amortization increased to 6.1% in the first three quarters of 2014, compared to 5.8% in the first three quarters of 2013, due to depreciation on new restaurants.



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Table of Contents

Pre-Opening Costs
Pre-opening costs increased by $0.4 million in the first three quarters of 2014 compared to the first three quarters of 2013. As a percentage of revenue, pre-opening costs remained flat at 1.1% in the first three quarters of 2014 and in the first three quarters of 2013. The increase in expense was due to one additional restaurant in the development stage in the first three quarters of 2014 compared to the first three quarters of 2013 as well as an increase in overall costs related to restaurants opened in remote markets.
Interest Expense
Interest expense decreased by $2.0 million in the first three quarters of 2014 compared to the same period of 2013. The decrease was the result of lower average borrowings in the first three quarters of 2014 compared to the first three quarters of 2013 due to the payoff of the majority of our outstanding debt in conjunction with our IPO, which we completed on July 2, 2013.
Provision for Income Taxes
Provision for income taxes increased by $2.7 million in the first three quarters of 2014 compared to same period of 2013 due to an increase in pre-tax net income of $6.4 million, as well as an increase in effective tax rate of 2.3% in the first three quarters of 2014 compared to the first three quarters of 2013. The effective tax rate for the first three quarters of 2014 includes the change to a 35% federal income tax rate compared to 34% in 2013. The 2014 estimated annual effective tax rate is expected to be 40% to 41% compared to 41.7% for 2013.
Liquidity and Capital Resources
Summary of Cash Flows
Our primary sources of liquidity and cash flows are operating cash flows and borrowings on our revolving line of credit. We use these cash sources to fund capital expenditures for new restaurant openings, reinvest in our existing restaurants, invest in infrastructure and information technology and maintain working capital. Our working capital position benefits from the fact that we generally achieve time-of-sales collection of cash from sales to customers, or in the case of credit or debit card transactions, we collect cash within several days of the related sale. In contrast, we typically have at least 30 days to pay our vendors.
Cash flows from operating, investing and financing activities are shown in the following table (in thousands):    
 
 
Three Fiscal Quarters Ended
 
 
September 30,
2014
 
October 1,
2013
Net cash provided by operating activities
 
$
37,453

 
$
32,462

Net cash used in investing activities
 
(53,566
)
 
(39,788
)
Net cash provided by financing activities
 
17,393

 
7,334

Net increase in cash and cash equivalents
 
$
1,280

 
$
8

Operating Activities
Net cash provided by operating activities of $37.5 million for the first three quarters ended September 30, 2014 resulted primarily from net income, adjusted for non-cash items such as depreciation and amortization, stock-based compensation expense and the amortization of debt issuance costs. The $5.0 million increase compared to the prior year comparable period was primarily driven by an increase in net income and accounts payable due to the timing of payments and a decrease in accounts receivable due to the collection of tenant improvement credits, offset by the timing of accrued incentive compensation payments.
Investing Activities
Net cash flows used in investing activities increased to $53.6 million in the first three quarters ended September 30, 2014 from $39.8 million in the first three quarters of 2013. The increase over the prior year is primarily due to $13.6 million used to acquire 16 restaurants from a franchisee.






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Financing Activities
Net cash provided by financing activities was $17.4 million and $7.3 million in the first three quarters of 2014 and 2013, respectively. We used borrowings in both fiscal years to fund new restaurant capital expenditures and to fund the acquisition of 16 franchise locations in 2014. The increase over 2013 is due to additional borrowings related to the purchase of 16 franchise restaurants as well as the closing of our IPO in the second quarter of 2013, in which we sold 6,160,714 shares of Class A common stock at $18.00 per share and received net proceeds of approximately $100.1 million. These net proceeds were used to repay all of our outstanding term loan and all but $0.2 million of our revolving line of credit. Additionally, in the first three quarters of 2014, we received proceeds of $2.3 million from the exercise of stock options.
Capital Resources
Future Capital Requirements. Our capital requirements are primarily dependent upon the pace of our real estate development program and resulting new restaurants. Our real estate development program is dependent upon many factors, including economic conditions, real estate markets, site locations and the nature of lease agreements. Our capital expenditure outlays are also dependent on costs for maintenance and capacity additions in our existing restaurants as well as information technology and other general corporate capital expenditures.
We currently estimate capital expenditures for 2014 to be in the range of approximately $50 to $55 million, excluding the acquisition of 16 franchise restaurants for $13.6 million. Such capital expenditures are primarily related to the anticipated opening of 48 to 50 restaurants in 2014, the start of construction on restaurants to be opened in early 2015 and normal maintenance-related capital expenditures on our existing restaurants. We expect such capital expenditures to be funded by a combination of cash from operations and borrowings under our revolving credit facility.
Current Resources. Our operations have not required significant working capital and, like many restaurant companies, we operate with negative working capital. Restaurant sales are primarily paid for in cash or by credit card, and restaurant operations do not require significant inventories or receivables. In addition, we receive trade credit for the purchase of food, beverages and supplies, therefore reducing the need for incremental working capital to support growth.
Credit Facility
We maintain a $45.0 million revolving line of credit under our credit facility. The revolving line of credit includes a swing line loan of $10.0 million used to fund working capital requirements. On November 22, 2013, we amended and restated our credit facility to provide more favorable borrowing rates and fees, to extend borrowing capacity through November 2018 and to change certain of the loan's covenants.
As of September 30, 2014, we had $21.5 million of outstanding indebtedness, $2.7 million of outstanding letters of credit and $20.8 million available for borrowing under our revolving line of credit. Borrowings under our amended and restated credit facility bear interest, at our option, at either (i) LIBOR plus 1.00 to 1.75%, based on the lease-adjusted leverage ratio or (ii) the highest of the following rates plus zero to 0.75%: (a) the federal funds rate plus 0.50%; (b) the Bank of America prime rate or (c) the one month LIBOR plus 1.00%. The facility includes a commitment fee of 0.125 to 0.25%, based on the lease-adjusted leverage ratio, per year on any unused portion of the facility. We also maintain outstanding letters of credit to secure obligations under our workers’ compensation program and certain lease obligations.
Availability of borrowings under the revolving line of credit is conditioned on our compliance with specified covenants, including a maximum lease-adjusted leverage ratio and a minimum consolidated fixed charge coverage ratio. We are subject to a number of other customary covenants, including limitations on additional borrowings, acquisitions, dividend payments and lease commitments. As of September 30, 2014, we were in compliance with all of our debt covenants.
Our credit facility is secured by a pledge of stock of substantially all of our subsidiaries and a lien on substantially all of our and our subsidiaries' personal property assets.
Off-Balance Sheet Arrangements
We had no off-balance sheet arrangements or obligations as of September 30, 2014.

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Critical Accounting Policies and Estimates
Our consolidated financial statements and accompanying notes are prepared in accordance with US GAAP. Preparing consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. These estimates and assumptions are affected by the application of our accounting policies. Our significant accounting policies are described in our Annual Report on Form 10-K for the year ended December 31, 2013. Critical accounting estimates are those that require application of management's most difficult, subjective or complex judgments, often as a result of matters that are inherently uncertain and may change in subsequent periods. While we apply our judgment based on assumptions believed to be reasonable under the circumstances, actual results could vary from these assumptions. It is possible that materially different amounts would be reported using different assumptions. Our critical accounting estimates are identified and described in our annual consolidated financial statements and the related notes included in our Annual Report on Form 10-K for our fiscal year ended December 31, 2013.
Recent Accounting Pronouncements
In August 2014, the FASB issued ASU, "Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern." This update requires management of the Company to evaluate whether there is substantial doubt about the Company’s ability to continue as a going concern. This update is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. Early adoption is permitted. The Company does not expect this standard to have an impact on the Company’s consolidated financial position or results of operations.
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers." The pronouncement was issued to clarify the principles for recognizing revenue and to develop a common revenue standard and disclosure requirements for U.S. GAAP and IFRS. The pronouncement is effective for reporting periods beginning after December 15, 2016. The adoption of ASU 2014-09 is not expected to have a significant impact on the Company’s consolidated financial position or results of operations.
JOBS Act
We qualify as an "emerging growth company" pursuant to the provisions of the JOBS Act. For as long as we are an "emerging growth company," we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not "emerging growth companies," including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, exemptions from the requirements of holding advisory "say-on-pay" votes on executive compensation and shareholder advisory votes on golden parachute compensation.
In addition, Section 107 of the JOBS Act also provides that an "emerging growth company" can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. An "emerging growth company" can therefore delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we have chosen to "opt out" of such extended transition period and, as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.


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Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
We are exposed to market risk from changes in interest rates on debt. Our exposure to interest rate fluctuations is limited to our outstanding bank debt, which bears interest at variable rates. As of September 30, 2014, there was $21.5 million outstanding under our revolving line of credit and $20.8 million available for borrowing under the credit facility. A plus or minus 1.0% change in the effective interest rate applied on this loan would have resulted in a pre-tax interest expense fluctuation of $0.2 million of gross interest expense on an annualized basis.
Commodity Price Risk
We purchase certain products that are affected by commodity prices and are, therefore, subject to price volatility caused by weather, market conditions and other factors which are not considered predictable or within our control. Although these products are subject to changes in commodity prices, certain purchasing contracts or pricing arrangements contain risk management techniques designed to minimize price volatility. The purchasing contracts and pricing arrangements we use may result in unconditional purchase obligations, which are not reflected in our consolidated balance sheets. Typically, we use these types of purchasing techniques to control costs as an alternative to directly managing financial instruments to hedge commodity prices. In many cases, we believe we will be able to address material commodity cost increases by adjusting our menu pricing or changing our product delivery strategy. However, increases in commodity prices, without adjustments to our menu prices, could increase restaurant operating costs as a percentage of company-owned restaurant revenue.
Inflation
The primary inflationary factors affecting our operations are food, labor and energy costs as well as labor and materials used in the construction of new restaurants. Increases in the minimum wage directly affect our labor costs. Many of our leases require us to pay taxes, maintenance, repairs, insurance and utilities, all of which are generally subject to inflationary increases. Over the past five years, inflation has not significantly affected our operating results.

Item 4. Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2014, pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
We have not engaged an independent registered accounting firm to perform an audit of our internal control over financial reporting as of any balance sheet date or for any period reported in our financial statements. Presently, we are not an accelerated filer, as such term is defined by Rule 12b-2 of the Exchange Act and therefore, our management is not presently required to perform an annual assessment of the effectiveness of our internal control over financial reporting. This requirement could apply as early as our Annual Report on Form 10-K for the year ending December 29, 2015 if certain triggers requiring large accelerated filing deadlines are met prior to that. Our independent public registered accounting firm will first be required to attest to the effectiveness of our internal control over financial reporting for our Annual Report on Form 10-K for the first year we are no longer an "emerging growth company."
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II

Item 1. Legal Matters
As previously disclosed in our Quarterly Reports on Form 10-Q filed on April 30, 2014 and August 14, 2014, the Company is 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 case was filed under seal in June 2013 and was unsealed on March 26, 2014. The complaint in this case alleges that the Company and the other defendants in the case, including a number of large retailers and restaurant companies, 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 seeks an order that we cease and desist from violating the Delaware False Claims and Reporting Act, monetary damages (including treble damages under the False Claims and Reporting Act), penalties, and attorneys' fees and costs. The case was removed to U.S. federal district court for the District of Delaware, and plaintiffs have filed a motion to remand the case to the Superior Court for the State of Delaware. We have also filed a motion to dismiss the complaint. The case is at an early stage and we are therefore unable to make a reasonable estimate of the probable loss or range of losses, if any, that might arise from this matter. We intend to vigorously defend this action.
In the normal course of business, we are subject to other proceedings, lawsuits and claims. Such matters are subject to many uncertainties, and outcomes are not predictable with assurance. Consequently, we are unable to ascertain the ultimate aggregate amount of monetary liability or financial impact with respect to these matters as of September 30, 2014. These matters could affect the operating results of any one financial reporting period when resolved in future periods. We believe that an unfavorable outcome with respect to these matters is remote or a potential range of loss is not material to our consolidated financial statements. Significant increases in the number of these claims, or one or more successful claims that result in greater liabilities than we currently anticipate, could materially and adversely affect our business, financial condition, results of operations or cash flows.

Item 1A. Risk Factors
A description of the risk factors associated with our business is contained in the “Risk Factors” section of our Annual Report on Form 10-K for our fiscal year ended December 31, 2013.  There have been no material changes to our Risk Factors as previously reported.


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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.

Item 3. Defaults upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
None.



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Item 6. Exhibit Index
Exhibit Number
 
Description of Exhibit
10.1

 
Amendment No. 1 to Registration Rights Agreement, dated as of July 8, 2014, among Noodles & Company and certain of its stockholders
31.1

 
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2

 
Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1

 
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS

 
XBRL Instance Document
101.SCH

 
XBRL Taxonomy Extension Schema Document
101.CAL

 
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF

 
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB

 
XBRL Taxonomy Extension Label Linkbase Document
101.PRE

 
XBRL Taxonomy Extension Presentation Linkbase Document



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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NOODLES & COMPANY
By:
/s/ DAVE BOENNIGHAUSEN
 
Dave Boennighausen
Chief Financial Officer
Date
November 6, 2014



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