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NOODLES & CO - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Item 6. "Selected Consolidated Financial Data" and our consolidated financial statements and related notes included in Item 8. "Financial Statements and Supplementary Data." In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors including, but not limited to, those discussed in Item 1A. "Risk Factors" and elsewhere in this report. We operate on a 52 or 53 week fiscal year ending on the Tuesday closest to December 31. Fiscal years 2013 and 2012, which ended on December 31, 2013 and January 1, 2013, respectively, each contained 52 weeks. Fiscal year 2011, which ended on January 3, 2012, contained 53 weeks. We refer to our fiscal years as 2013, 2012 and 2011. Our fiscal quarters each contained 13 operating weeks, with the exception of the fourth quarter of 2011, which had 14 operating weeks. NOODLES & COMPANY A World of Flavors Under One RoofOverview Noodles & Company is a high growth, fast casual restaurant concept offering lunch and dinner within a fast growing segment of the restaurant industry. We opened our first location in 1995, offering noodle and pasta dishes, staples of many cuisines, with the goal of delivering fresh ingredients and flavors from around the world under one roof. Today, our globally inspired menu includes a wide variety of high quality, cooked-to-order dishes, including noodles and pasta, soups, salads and sandwiches, which are served on china by our friendly team members. We believe we offer our customers value with per person spend of approximately $8.00 in 2013. 2013 Highlights and Trends Restaurant Development. New restaurants have contributed substantially to our revenue growth and in 2013, we opened 42 company-owned restaurants net of one closure in the first quarter of 2013 and 11 franchise restaurants for a total of 53 restaurants opened system-wide. As of December 31, 2013, we had 318 company-owned restaurants and 62 franchise restaurants in 29 states and the District of Columbia. In 2014 we anticipate opening between 42 to 50 company-owned restaurants and 10 to 15 franchise restaurants. Comparable Restaurant Sales. Comparable restaurant sales increased by 3.0% system-wide in 2013. Comparable restaurant sales growth in 2013 was the result of both increases in per person spend and traffic. Comparable restaurant sales represent year-over-year sales comparisons for restaurants open for at least 18 full periods. Your World Kitchen. We completed installation of "Your World Kitchen" interior signage in all of our company-owned restaurants during the second quarter of 2013. Installations in our company-owned restaurants began in 2012 when we began using the phrase to describe the breadth of our offering and our customers' dining experience. Initial Public Offering. On July 2, 2013, we completed our IPO of Class A common stock at $18.00 per share. We issued 6,160,714 shares, including 803,571 shares of Class A common stock sold to the underwriters in the IPO pursuant to their over-allotment option. After underwriter discounts and commissions and estimated offering expenses, net proceeds from the offering were $100.2 million. We used these proceeds to repay all but $0.2 million of our outstanding debt as of July 2, 2013, including the full repayment of our term loan. As a result of the IPO and the repayment of nearly all our outstanding debt, we now benefit from savings on interest expense and management fees that we incurred as a private company, but we also incur incremental costs as a public company including incremental legal, accounting, insurance and other compliance costs. We will continue to use our operating cash flows and borrowings on our revolving line of credit to fund capital expenditures to support restaurant growth as well as to invest in our existing restaurants and infrastructure and information technology. See "-Liquidity and Capital Resources." Further, in connection with the IPO, we incurred $5.7 million of IPO related expenses, which includes $3.2 million of stock-based compensation expenses related to stock option grants and accelerated stock option vesting related to the IPO, $1.7 million of transaction bonuses and payroll tax, and $0.8 million paid to our Equity Sponsors. Additionally, the financial impact of the IPO will 28-------------------------------------------------------------------------------- Table of Contents affect the comparability of our post-IPO financial performance to our pre-IPO financial performance. We estimate recurring incremental legal, accounting, insurance and other company costs we would have incurred during the first two fiscal quarters of 2013 had we been a public company would have been approximately $714,000. Follow-on Offering. On December 5, 2013, we completed a follow-on offering of 4,500,000 shares of the our 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 us, the proceeds of which were used to repurchase the same number of shares from certain officers at the same price per share, net of commissions. We did not receive any net proceeds from the offering. The selling stockholders paid all of the underwriting discounts and commissions associated with the sale of the shares; however, we incurred approximately $0.7 million in costs and expenses related to this offering. 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 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") 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 equal to the number of operating days we have in a typical year. This measurement allows management to assess changes in consumer traffic and per person spending patterns at our restaurants. Comparable Restaurant Sales Comparable restaurant sales refer to year-over-year sales comparisons for the comparable restaurant base. We define the comparable restaurant base to include restaurants open for at least 18 full periods. As of 2013, 2012 and 2011, there were 248, 216 and 192 restaurants, respectively, in our comparable restaurant base for company owned locations. This measure highlights performance of existing restaurants, as the impact of new restaurant openings is excluded. Comparable restaurant sales growth is generated by increases 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; 29-------------------------------------------------------------------------------- Table of Contents • per person spend and average check amount; • marketing and promotional efforts; • 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. As a result of the 53-week fiscal year 2011, our fiscal year 2012 began one week later than our fiscal year 2011. 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 will be a significant component of our revenue growth, comparable restaurant sales are only one measure of how we evaluate our performance. Restaurant Contribution Restaurant contribution is defined as restaurant revenue less restaurant operating costs which are 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 (benefit) for income taxes and depreciation and amortization. We define adjusted EBITDA as net income before interest expense, debt extinguishment expense, provision (benefit) for income taxes, asset disposals, closure costs and restaurant impairments, depreciation and amortization, stock-based compensation, management fees, IPO related expenses, and follow-on offering expenses. EBITDA and Adjusted EBITDA provide clear pictures of our operating results by eliminating certain non-cash expenses that are not reflective of the 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 Year Ended December 31, January 1, January 3, December 28, December 29, 2013 2013 2012 2010 2009 (in thousands) Net income $ 6,665 $ 5,163 $ 3,829 $ 2,378 $ 1,067 Depreciation and amortization 20,623 16,719 14,501 13,932 13,315 Interest expense 2,196 5,028 6,132 1,819 1,840 Provision (benefit) for income taxes 4,767 3,215 1,780 (366 ) 1,343 EBITDA $ 34,251 $ 30,125 $ 26,242 $ 17,763 $ 17,565 Debt extinguishment expense 624 2,646 275 - - Asset disposals, closure costs and restaurant impairment 1,164 1,278 1,629 2,815 1,070 Management fees(a) 500 1,000 1,014 - - Stock-based compensation expense(b) 4,318 1,234 1,328 5,894 1,740 IPO related expenses(c) 5,667 - - - - Follow-on offering expenses(d) 696 - - - - Adjusted EBITDA $ 47,220 $ 36,283 $ 30,488 $ 26,472 $ 20,375 _____________(a) Fiscal year 2013 included $0.5 million in management fee expense, and fiscal years 2012 and 2011 each included $1.0 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 30-------------------------------------------------------------------------------- Table of Contents 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. (b) 2010 included $3.7 million of non-cash stock-based compensation expense and $0.3 million of expense for our portion of payroll taxes related to the 2010 Equity Recapitalization. See Note 2 of our consolidated financial statements, Equity Recapitalization. (c) Reflects certain expenses incurred in conjunction with the closing of our initial public offering. 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% were vested at grant, $1.7 million of transaction bonuses and related payroll tax and $0.8 million in transaction payments to our Equity Sponsors. (d) Reflects $0.7 million of offering expenses related to our follow-on offering completed in December of 2013. Key Financial Definitions Cost of Sales Cost of sales includes the direct costs associated with the food, beverage and packaging of our menu items. Cost of sales also includes any costs related to discounted menu items. Cost of sales is a substantial expense and can be expected to grow proportionally as our restaurant revenue grows. Fluctuations in cost of sales are caused primarily by volatility in the cost of commodity food items and related contracts for such items. Other important factors causing fluctuations in cost of sales include seasonality, discounting activity and restaurant level management of food waste. Labor Costs Labor costs include wages, payroll taxes, workers' compensation expense, benefits and bonuses paid to our management teams. Like other expense items, we expect labor costs to grow proportionally as our restaurant revenue grows. Factors that influence fluctuations in our labor costs include minimum wage and payroll tax legislation, the frequency and severity of workers' compensation claims, health care costs and the performance of our restaurants. Occupancy Costs Occupancy costs include rent, common area maintenance and real estate tax expense related to our restaurants and is expected to grow proportionally as we open new restaurants. Other Restaurant Operating Costs Other restaurant operating costs include the costs of utilities, restaurant-level marketing, credit card processing fees, restaurant supplies, repairs and maintenance and other restaurant operating costs. Like other costs, it is expected to grow proportionally as restaurant revenue grows. General and Administrative Expense General and administrative expense is composed of payroll, other compensation, travel, marketing, accounting fees, legal fees and other expenses related to the infrastructure required to support our restaurants. General and administrative expense also includes the non-cash stock compensation expense related to our employee stock incentive plan. General and administrative expense can be expected to grow as we grow, including incremental legal, accounting, insurance and other expenses incurred as a public company. Depreciation and Amortization Our principal depreciation and amortization charges relate to depreciation of fixed assets, including leasehold improvements and equipment, from restaurant construction and ongoing maintenance. Pre-Opening Costs Pre-opening costs relate to the costs incurred prior to the opening of a restaurant. These include management labor costs, staff labor costs during training, food and supplies utilized during training, marketing costs and other related pre-opening costs. Pre-opening costs also include rent recorded between date of possession and opening date for our restaurants. 31-------------------------------------------------------------------------------- Table of Contents Asset Disposals, Closure Costs and Restaurant Impairments Asset disposals, closure costs and restaurant impairments include the loss on disposal of assets related to retirements and replacement of leasehold improvements or equipment, non-cash restaurant closure and impairment charges. Debt Extinguishment In both 2013 and 2012, we amended our credit facility to extend the maturity date and to reduce interest rates on borrowings. As a result of these amendments, a portion of the existing and new fees were treated as debt extinguishment. In 2011, we wrote off debt issuance costs related to our credit facility refinancing. Interest Expense Interest expense consists primarily of interest on our outstanding indebtedness. Debt issuance costs are amortized at cost over the life of the related debt. Provision for Income Taxes Provision for income taxes consists of federal, state and local taxes on our income. Restaurant Openings, Closures and Relocations The following table shows restaurants opened, closed or relocated in the years indicated. Fiscal Year Ended January 1, January 3, December 31, 2013 2013 2012 Company-Owned Restaurant Activity Beginning of period 276 239 212 Openings 43 39 28 Closures and relocations(1) (1 ) (2 ) (1 ) Restaurants at end of period 318 276 239 Franchise Restaurant Activity Beginning of period 51 45 43 Openings 11 6 2 Closures and relocations(1) - - - Restaurants at end of period 62 51 45 Total restaurants 380 327 284 _____________(1) We account for relocated restaurants under both restaurant openings and closures and relocations. During 2012, we closed one restaurant and relocated another restaurant. In fiscal 2011 and 2013, we closed one restaurant at the end of its lease term. 32-------------------------------------------------------------------------------- Table of Contents 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 year 2013 and 2012 contained 52 operating weeks and fiscal year 2011 contained 53 operating weeks. Each fiscal quarter contained 13 weeks. Fiscal Year Ended December 31, 2013 January 1, 2013 January 3, 2012 Revenue: Restaurant revenue 98.9 % 99.0 % 99.0 % Franchising royalties and fees 1.1 1.0 1.0 Total revenue 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 26.6 26.2 Labor 30.0 30.1 29.8 Occupancy 10.1 9.9 9.9 Other restaurant operating costs 12.7 12.2 12.6 General and administrative(2) 10.2 9.7 10.3 Depreciation and amortization 5.9 5.6 5.7 Pre-opening 1.1 1.0 0.9 Asset disposals, closure costs and restaurant impairments 0.3 0.4 0.6 Total costs and expenses 95.9 94.7 95.3 Income from operations 4.1 5.3 4.7 Debt extinguishment expense 0.2 0.9 0.1 Interest expense 0.6 1.7 2.4 Income before income taxes 3.3 2.8 2.2 Provision for income taxes 1.4 1.1 0.7 Net income 1.9 % 1.7 % 1.5 % _____________(1) As a percentage of restaurant revenue. (2) Fiscal year 2013 included $500,000 of management fee expense, and fiscal years 2012 and 2011 each included $1.0 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. Additionally, we incurred $0.7 million of expenses related to our follow-on offering which closed in December of 2013. 33-------------------------------------------------------------------------------- Table of Contents Fiscal Year Ended December 31, 2013 compared to Fiscal Year Ended January 1, 2013 Fiscal years 2013 and 2012 contained 52 operating weeks. The table below presents our operating results for 2013 and 2012, and the related year-over-year changes: Fiscal Year Ended Increase / (Decrease) December 31, January 1, 2013 2013 $ % (in thousands, except percentages) Statements of Income Data: Revenue: Restaurant revenue $ 347,140 $ 297,264 $ 49,876 16.8 % Franchising royalties and fees 3,784 3,146 638 20.3 Total revenue 350,924 300,410 50,514 16.8 Costs and Expenses: Restaurant Operating Costs (exclusive of depreciation and amortization, shown separately below): Cost of sales 91,892 78,997 12,895 16.3 Labor 104,040 89,435 14,605 16.3 Occupancy 35,173 29,323 5,850 20.0 Other restaurant operating costs 44,078 36,380 7,698 21.2 General and administrative(1) 35,893 29,081 6,812 23.4 Depreciation and amortization 20,623 16,719 3,904 23.4 Pre-opening 3,809 3,145 664 21.1 Asset disposals, closure costs and restaurant impairments 1,164 1,278 (114 ) (8.9 ) Total costs and expenses 336,672 284,358 52,314 18.4 Income from operations 14,252 16,052 (1,800 ) (11.2 ) Debt extinguishment expense 624 2,646 (2,022 ) * Interest expense 2,196 5,028 (2,832 ) (56.3 ) Income before income taxes 11,432 8,378 3,054 36.5 Provision for income taxes 4,767 3,215 1,552 48.3 Net income $ 6,665 $ 5,163 $ 1,502 29.1 % _____________ * Not meaningful. (1) Fiscal year 2013 included $500,000 of management fee expense and 2012 included $1.0 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. Additionally, we incurred $0.7 million of expenses related to our follow-on offering which closed in December of 2013. Revenue Restaurant revenue increased by $49.9 million in 2013 compared to 2012. Restaurants not in the comparable restaurant base accounted for $40.6 million of this increase, with the balance attributed to growth in comparable restaurant sales. Comparable restaurant sales increased by $9.3 million or 3.0% in 2013, composed primarily of a modest price increase we took during 2013 and increases in traffic at our comparable base restaurants. Franchise royalties and fees increased by $0.6 million due to 11 new restaurant openings and increased comparable restaurant sales of 0.6% during 2013. 34-------------------------------------------------------------------------------- Table of Contents Cost of Sales Cost of sales increased by $12.9 million in 2013 compared to 2012, due primarily to the increase in restaurant revenue in 2013. As a percentage of restaurant revenue, cost of sales decreased to 26.5% in 2013 from 26.6% in 2012. This decrease as a percentage of restaurant revenue was the result of an increase in restaurant menu pricing, partially offset by a minimal increase in food cost inflation. Labor Costs Labor costs increased by $14.6 million in 2013 compared to 2012, due primarily to the increase in restaurant revenue in 2013. As a percentage of restaurant revenue, labor costs decreased to 30.0% in 2013 from 30.1% in 2012. The decrease in labor cost percentage was driven primarily by lower incentive compensation expense. Occupancy Costs Occupancy costs increased by $5.9 million in 2013 compared to 2012, due primarily to new restaurants opened in each of these years. As a percentage of restaurant revenue, occupancy costs increased to 10.1% in 2013, from 9.9% in 2012. The increase was due to an increase in the percentage of restaurants not in the comparable base restaurants which, due to not reaching mature volumes yet, on average have higher occupancy costs as a percentage of revenue. Other Restaurant Operating Costs Other restaurant operating costs increased by $7.7 million in 2013 compared to 2012, due primarily to the increase in restaurant revenue in 2013. As a percentage of restaurant revenue, other restaurant operating costs increased to 12.7% in 2013 from 12.2% in 2012. The increase in other restaurant operating cost percentage was the result of increased restaurant-level marketing costs in the 2013, as well as increased utilities and repair and maintenance costs. General and Administrative Expense General and administrative expense increased by $6.8 million in 2013 compared to 2012, due primarily to $5.7 million of expenses related to the closing of our IPO in the second quarter of 2013 and $0.7 million of expenses related to the closing of our follow-on offering in the fourth quarter of 2013. The $5.7 million of expenses related to the closing of our IPO was comprised of $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% were vested at grant, $1.7 million of transaction bonuses and related payroll taxes and $0.8 million in transaction payments to our Equity Sponsors. Excluding the impact of the $5.7 million of IPO related expense and $0.7 million of follow-on offering costs, general and administrative expense as a percentage of revenue decreased to 8.4% in the 2013 from 9.7% in 2012. The decrease is due to increasing revenue without proportionate increases in general and administrative costs or administrative personnel. General and administrative expense includes $4.3 and $1.2 million of stock-based compensation expense in 2013 and 2012, respectively, and $500,000 and $1.0 million of management fees in 2013 and 2012, respectively. Depreciation and Amortization Depreciation and amortization increased by $3.9 million in 2013 compared to 2012, due primarily to an increased number of restaurants. As a percentage of revenue, depreciation and amortization increased to 5.9% in 2013 from 5.6% in 2012, due to depreciation on new restaurants and initiatives, partially offset by leverage of increased AUVs. Pre-Opening Costs Pre-opening costs increased by $0.7 million in 2013 compared to 2012, due to 43 restaurant openings in 2013, compared to 39 in 2012. As a percentage of revenue, pre-opening costs increased to 1.1% in 2013 compared to 1.0% in 2012 due to the timing of restaurant openings including rent incurred for locations opening in the first quarter of 2014. 35-------------------------------------------------------------------------------- Table of Contents Asset Disposals, Closure Costs and Restaurant Impairments Asset disposals, closure costs and restaurant impairments decreased by $0.1 million in 2013 compared to 2012 due primarily to a lease termination and other related closing costs of one restaurant which closed in 2012, which was offset by increased loss on disposal of assets. Debt Extinguishment Debt extinguishment expense was $0.6 million in 2013 and $2.6 million in 2012, as a result of an amendment in November 2013 and August of 2012, respectively, to our credit facility to extend the maturity date and reduced interest rates on borrowings. A portion of the existing and new fees were treated as debt extinguishment expense. Interest Expense Interest expense decreased by $2.8 million in 2013 compared to 2012. The decrease was primarily due to lower average borrowings in the first three quarters of 2013 due to the payoff of the majority of our outstanding debt in conjunction with the IPO, and the favorable borrowing rates resulting from the 2012 amendment to our credit facility. Provision for Income Taxes Provision for income taxes increased by $1.6 million in 2013 compared to 2012, due to an increase in pre-tax net income in 2013 and an increase to our effective income tax rate. Our effective tax rate increased to 41.7% in 2013 from 38.4% in 2012 primarily due to the impact of non-deductible follow-on offering transaction costs. 36-------------------------------------------------------------------------------- Table of Contents Fiscal Year Ended January 1, 2013 compared to Fiscal Year Ended January 3, 2012 Fiscal year 2012 contained 52 operating weeks and fiscal year 2011 contained 53 operating weeks. The table below presents our operating results for 2012 and 2011, and the related year-over-year changes: Fiscal Year Ended Increase / (Decrease) January 1, January 3, 2013 2012 $ % (in thousands, except percentages) Statements of Income Data: Revenue: Restaurant revenue $ 297,264 $ 253,467 $ 43,797 17.3 % Franchising royalties and fees 3,146 2,599 547 21.0 Total revenue 300,410 256,066 44,344 17.3 Costs and Expenses: Restaurant Operating Costs (exclusive of depreciation and amortization, shown separately below): Cost of sales 78,997 66,419 12,578 18.9 Labor 89,435 75,472 13,963 18.5 Occupancy 29,323 25,208 4,115 16.3 Other restaurant operating costs 36,380 32,031 4,349 13.6 General and administrative(1) 29,081 26,463 2,618 9.9 Depreciation and amortization 16,719 14,501 2,218 15.3 Pre-opening 3,145 2,327 818 35.2 Asset disposals, closure costs and restaurant impairments 1,278 1,629 (351 ) (21.5 ) Total costs and expenses 284,358 244,050 40,308 16.5 % Income from operations 16,052 12,016 4,036 33.6 Debt extinguishment expense 2,646 275 2,371 * Interest expense 5,028 6,132 (1,104 ) (18.0 ) Income before income taxes 8,378 5,609 2,769 49.4 Provision for income taxes 3,215 1,780 1,435 80.6 Net income $ 5,163 $ 3,829 $ 1,334 34.8 % _____________ * Not meaningful. (1) Fiscal years 2012 and 2011 each included $1.0 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. Revenue Restaurant revenue increased by $43.8 million in 2012 compared to 2011. Restaurants not in the comparable restaurant base accounted for $30.8 million of this increase, with the balance attributed to growth in comparable restaurant sales. Comparable restaurant sales increased by $13.0 million or 5.2% in 2012, composed primarily of increases in traffic at our comparable base restaurants. Franchise royalties and fees increased by $0.5 million due to six new restaurant openings and increased comparable restaurant sales of 6.2% during 2012. The impact of 2011 having an additional operating week was approximately $4.8 million in total revenue. 37-------------------------------------------------------------------------------- Table of Contents Cost of Sales Cost of sales increased by $12.6 million in 2012 compared to 2011, due primarily to the increase in restaurant revenue in 2012. As a percentage of restaurant revenue, cost of sales increased to 26.6% in 2012 from 26.2% in 2011. This increase was primarily the result of food cost inflation, partially offset by a minimal increase in menu pricing. Labor Costs Labor costs increased by $14.0 million in 2012 compared to 2011, due primarily to the increase in restaurant revenue in 2012. As a percentage of restaurant revenue, labor costs increased to 30.1% in 2012 from 29.8% in 2011. The increase in labor cost percentage was driven by increased workers' compensation expense and payroll tax rates, offset partially by increases in AUVs. Occupancy Costs Occupancy costs increased by $4.1 million in 2012 compared to 2011, due primarily to new restaurants opened in each of these years. As a percentage of restaurant revenue, occupancy costs remained constant year-over-year at 9.9%. Increases in common area maintenance, real estate tax and new restaurant occupancy costs relative to comparable base restaurants were offset by leverage from increased AUVs. Other Restaurant Operating Costs Other restaurant operating costs increased by $4.3 million in 2012 compared to 2011, due primarily to the increase in restaurant revenue in 2012. As a percentage of restaurant revenue, other restaurant operating costs declined to 12.2% in 2012 from 12.6% in 2011. The decrease in other restaurant operating cost percentage was the result of leverage of increased AUVs on partially fixed costs, as well as lower than typical utility costs due to a mild winter in early 2012. General and Administrative Expense General and administrative expense increased by $2.6 million in 2012 compared to 2011, due primarily to costs associated with supporting an increased number of restaurants. As a percentage of revenue, general and administrative expense decreased to 9.7% in 2012 from 10.3% in 2011 due to increasing revenue without proportionate increases in general and administrative expense or administrative personnel. General and administrative expense includes $1.2 million and $1.3 million of stock-based compensation expense in 2012 and 2011, respectively, and $1.0 million of management fees in both 2012 and 2011. Depreciation and Amortization Depreciation and amortization increased by $2.2 million in 2012 compared to 2011, due primarily to an increased number of restaurants. As a percentage of revenue, depreciation and amortization decreased to 5.6% in 2012 from 5.7% in 2011, due to leverage of increased AUVs. Pre-Opening Costs Pre-opening costs increased by $0.8 million in 2012 compared to 2011, due to 39 restaurant openings in 2012, compared to 28 in 2011. As a percentage of revenue, pre-opening costs increased to 1.0% in 2012 compared to 0.9% in 2011 due to the increased rate of restaurant unit growth. Asset Disposals, Closure Costs and Restaurant Impairments Asset disposals, closure costs and restaurant impairments decreased by $0.4 million in 2012 compared to 2011 due primarily to the impairment of one restaurant in 2011, resulting in $0.7 million of expense. The decrease was offset by the lease termination and other related closing costs of one restaurant closed in 2012. Debt Extinguishment Debt extinguishment expense was $2.6 million in 2012, as a result of an amendment in August of 2012 to our credit facility to extend the maturity date to July 2017 and reduced interest rates on borrowings. A portion of the existing and new fees were treated as debt extinguishment, which resulted in a non-cash write-off of $2.3 million. In 2011, we wrote off $0.3 million of debt issuance costs related to our credit facility. 38-------------------------------------------------------------------------------- Table of Contents Interest Expense Interest expense decreased by $1.1 million in 2012 compared to 2011. The decrease was primarily due to the favorable borrowing rates resulting from the 2012 amendment to our credit facility, partially offset by increased borrowings to fund our capital expenditures. Provision for Income Taxes Provision for income taxes increased by $1.4 million in 2012 compared to 2011, due to the increase in pre-tax net income in 2012 and an increase to our effective income tax rate. Our effective tax rate increased to 38.4% in 2012 from 31.7% in 2011 primarily due to other items in our 2012 income tax provision which represented changes made between the provision for income taxes and the filed return and the impact of the prior year interest rate swap designation to interest expense. Quarterly Financial Data The following table presents select historical quarterly consolidated statements of operations data and other operations data for fiscal years 2013 and 2012. This quarterly information has been prepared using our unaudited consolidated financial statements and includes all adjustments consisting only of normal recurring adjustments necessary for a fair presentation of the results of the interim periods. Quarter Ended July 2, Jan. 1, Oct. 2, July 3, April 3, Dec. 31, 2013 Oct. 1, 2013 2013 April 2, 2013 2013 2012 2012 2012 (in thousands, unaudited) Total revenue $ 91,468 $ 88,936 $ 89,239 $ 81,280 $ 77,929 $ 77,099 $ 75,494 $ 69,888 Net income 2,407 3,265 68 924 1,559 133 2,180 1,291 Selected Operating Data: Company-owned restaurants at end of period 318 310 295 284 276 261 253 245 Franchise-owned restaurants at end of period 62 58 53 51 51 48 46 45 Company-owned: Average unit volumes(1) 1,179 1,181 1,184 1,180 1,178 1,175 1,170 1,161 Comparable restaurant sales(2) 4.3 % 2.4 % 4.7 % 2.2 % 4.2 % 3.4 % 6.8 % 6.8 % Restaurant contribution as a percentage of restaurant revenue(3) 21.0 % 20.7 % 22.4 % 18.6 % 21.3 % 21.0 % 21.8 % 20.7 % _____________ (1) AUVs consist of average annualized sales of all company-owned restaurants over the trailing 12 periods in a typical operating year. (2) Comparable restaurant sales represent year-over-year sales for restaurants open for at least 18 full periods. (3) Restaurant contribution represents restaurant revenue less restaurant operating costs which are cost of sales, labor, occupancy and other restaurant operating costs. Liquidity and Capital Resources Our primary sources of liquidity and cash flows are operating cash flows and borrowings on our revolving line of credit. We use this cash 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 collect cash from sales to customers the same day, or in the case of credit or debit card transactions, within several days of the related sale, and we typically have at least 30 days to pay our vendors. We believe that expected cash flow from operations and planned borrowing capacity are adequate to fund debt service requirements, operating lease obligations, capital expenditures and working capital obligations for the next 12 periods. 39-------------------------------------------------------------------------------- Table of Contents While operations continue to provide cash, our primary use of cash is in new restaurant development. Our total capital expenditures for 2013 were $54.4 million, and we expect to incur capital expenditures of about $50.0 million in 2014, of which $42.0 million relates to our construction of new restaurants before any reductions for landlord reimbursements, and the remainder relates primarily to restaurant reinvestments. In 2013, excluding one 5,400 square foot location and four urban locations that are atypical sites, we spent on average $819,000 in development and construction costs per restaurant, net of landlord reimbursements. For new restaurants to be opened in 2014, we anticipate average development costs will be $750,000 to $775,000, net of landlord reimbursements. Cash flows from operating, investing and financing activities are shown in the following table: Fiscal Year Ended December 31, 2013 January 1, 2013 January 3, 2012 (in thousands) Net cash provided by operating activities $ 43,634 $ 32,069 $ 27,922 Net cash used in investing activities (54,429 ) (47,384 ) (30,047 ) Net cash provided by (used in) financing activities 11,182 15,373 (10,654 ) Cash and cash equivalents at the end of period $ 968 $ 581 $ 523 Operating Activities Net cash provided by operating activities of $43.6 million for 2013 resulted primarily from net income, adjusted for items such as depreciation and amortization, stock-based compensation expense and the amortization and write-off of debt issuance costs. The $11.6 million increase in 2013 from 2012, was also impacted by working capital changes including the collection of tenant improvement receivables, the change in deferred rent due to a larger restaurant base and an increase in accrued expenses and other liabilities due to growth. Net cash provided by operating activities increased in 2012 from 2011 primarily due higher non-cash costs, such as depreciation and amortization, provision for income taxes and write-off of debt issuance costs as well as an increase in cash generated from restaurant operations as a result of comparable restaurant sales increases and a decrease in cash paid for interest, which was $4.4 million in 2012 compared to $5.2 million in 2011. In 2011, net cash provided by operating activities consisted of increased cash generated from restaurant operations as a result of comparable restaurant sales increases and normal increases in operating assets and liabilities, offset by an increase in cash paid for interest, which was $5.2 million in 2011. Investing Activities Net cash used in investing activities was related to new restaurant capital expenditures for the opening of 43, 39 and 28 restaurants, respectively, in 2013, 2012 and 2011 and infrastructure investment. In addition to our standard refresh and remodel investments in 2013 and 2012, we also invested additional funds in our existing restaurant base as we finished the roll out of our "Your World Kitchen" merchandising in the first quarter of 2013. Financing Activities Net cash provided by financing activities was $11.2 million and $15.4 million in 2013 and 2012, respectively. We used borrowings in both fiscal years to fund new restaurant capital expenditures. In addition, on July 2, 2013, we closed our IPO in which we sold 6,160,714 shares of Class A common stock at $18.00 per share and received net proceeds of approximately $100.2 million (after underwriting discounts, commissions and offering expenses). These net proceeds were used to pay off our outstanding term loan and repay all but $0.2 million of our revolving line of credit. Net cash provided by financing activities was $15.4 million in 2012, driven by increased borrowings on our credit facility to fund capital expenditures. In November of 2013, we amended and restated our credit facility to provide more favorable borrowing rates and fees, to extend borrowing capacity through July 2018 and to effect certain changes to the covenants. The credit facility had 40-------------------------------------------------------------------------------- Table of Contents been previously amended in August of 2012 to provide more favorable borrowing rates and extend borrowing capacity to July 2017, and in February 2011 to increase our borrowing capacity to $120.0 million. During 2011, net cash used in financing activities was $10.7 million due to cash payments made related to the 2010 Equity Recapitalization. In connection with our February 2011 refinancing, we repaid $46.0 million of bridge financing and paid-in-kind ("PIK") interest on borrowings from new investors in the 2010 transaction, as well as $4.2 million in refinancing fees. Additionally, $6.6 million of employee and employer payroll taxes related to the 2010 Equity Recapitalization were remitted in the first quarter of 2011. 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 July 2018 and to effect certain changes to the covenants. In connection with the IPO, we repaid our $75.0 million senior term loan under our credit facility and the majority of the revolving line of credit. We had $6.3 million of outstanding indebtedness, $2.8 million of outstanding letters of credit and $35.9 million available for borrowing under our revolving line of credit as of December 31, 2013. 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 December 31, 2013, 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 the personal property assets of us and our subsidiaries. Bridge Financing In conjunction with the February 2011 debt refinancing, we repaid $45.0 million of bridge financing, as well as $977,000 of 12% PIK interest. Noncash PIK interest of $947,000 was accrued and reported as other noncash in the consolidated statements of cash flows in 2011. 41-------------------------------------------------------------------------------- Table of Contents Contractual Obligations Our contractual obligations at December 31, 2013 were as follows: Payments Due by Period Less than 1 1 - 3 3 - 5 After 5 Total Year Years Years Years (in thousands) Operating lease obligations(1) $ 247,929 $ 33,912 $ 67,630 $ 57,057 $ 89,330 Purchase obligations(2) 14,135 14,135 - - - Long-term debt(3) 6,312 - - - 6,312 Other non current liabilities(4) 599 - - - 599 $ 268,975 $ 48,047 $ 67,630 $ 57,057 $ 96,241 _____________(1) We are obligated under non-cancelable leases for our restaurants, administrative offices and equipment. Some restaurant leases provide for contingent rental payments based on sales thresholds, which are excluded from this table. (2) We enter into various purchase obligations in the ordinary course of business. Those that are binding relate to volume commitments for beverage and food products, as well as binding commitments for the construction of new restaurants. (3) Reflects full payment of long-term debt at maturity of our credit facility in 2018. (4) Reflects the expected payments associated with our commitment under our non-qualified deferred compensation plan. Off-Balance Sheet Arrangements We had no off-balance sheet arrangements or obligations as of December 31, 2013. 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 Note 1 to our consolidated financial statements. 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. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements: Revenue Recognition We record revenue from the operation of company-owned restaurants when sales occur. In the case of gift card sales, we record revenue when: (i) the gift card is redeemed by the customer and (ii) we determine the likelihood of the gift card being redeemed by the customer is remote (gift card breakage). We record royalties from franchise restaurant sales based on a percentage of restaurant revenues in the period the related franchised restaurants' revenues are earned. Area development fees and franchise fees are recognized as income when all material services or conditions relating to the sale of the franchise have been substantially performed or satisfied by us. Both franchise fees and area development fees are generally recognized as income upon the opening of a franchise restaurant or upon termination of the agreement(s). Property and Equipment We state the value of our property and equipment, including primarily leasehold improvements and restaurant equipment, furniture and fixtures at cost, minus accumulated depreciation and amortization. We calculate depreciation using the straight-line method of accounting over the estimated useful lives of the related assets. We amortize our leasehold improvements using the straight-line method of accounting over the shorter of the lease term (including reasonably assured renewal periods) or the estimated useful lives of the related assets. We expense repairs and maintenance as incurred, but capitalize major improvements and betterments. We make judgments and estimates related to the expected useful lives of these assets that are affected by factors such as changes in 42-------------------------------------------------------------------------------- Table of Contents economic conditions and changes in operating performance. If we change those assumptions in the future, we may be required to record impairment charges for these assets. Self-Insurance Programs We are self-insured for health, workers' compensation, general liability and property damage. Predetermined loss limits have been arranged with insurance companies to limit our per occurrence cash outlay. Estimated costs to settle reported claims and incurred but unreported claims for health and workers' compensation self-insured plans are recorded in accrued payroll and benefits and for general liability and property damage in accrued expenses and other liabilities. Rent We record rent expense for our leases, which generally have escalating rentals over the term of the lease, on a straight-line basis over the lease term. The lease term includes renewal options that are reasonably assured. Rent expense begins when we have the right to control the use of the property, which is typically before rent payments are due under the lease. We record the difference between the rent expense and rent paid as deferred rent in the consolidated balance sheet. Rent expense for the period prior to the restaurant opening is reported as pre-opening rent expense in the consolidated statements of income. Tenant incentives used to fund leasehold improvements are recorded in deferred rent and amortized as reductions of rent expense over the term of the lease. Certain of our operating leases contain clauses that provide additional contingent rent based on a percentage of sales greater than certain specified target amounts. We recognize contingent rent expense when the achievement of specified targets is considered probable. Recent Accounting Pronouncements 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, shareholder advisory votes on golden parachute compensation and the extended transition period for complying with the new or revised accounting standards. 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. |