Noodles & Co (NDLS) 2015 Q3 法說會逐字稿

Good morning and welcome to today's Noodles & Company third-quarter 2015 earnings conference call.

(Operator Instructions)

As a reminder, this call is being recorded. I will now introduce Noodles & Company's Chief Financial Officer, Dave Boennighausen. Mr. Boennighausen, you may begin.

Thank you Heather, and good morning everyone and welcome to our third-quarter 2015 earnings call. Here with me today this morning is Kevin Reddy, our Chairman and Chief Executive Officer; and Mark Mears, our Executive Vice President and Chief Marketing Officer.

Let me start by going over a few regulatory matters. I'd like to note that during our opening remarks and in response to your questions, we may make forward-looking statements regarding future events or the future financial performance of the Company. Any such items, including targeted results for 2015 and details related to our future performance, should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are only projections, and actual events or results could differ materially from those projections, due to a number of risks and uncertainties.

The Safe Harbor statement in this morning's news release and the cautionary statement in the Company's most recent form 10-K are considered a part of this conference call. I refer you to documents the Company files from time to time with the Securities and Exchange Commission, specifically the Company's annual report on form 10-K for it's FY14. This document contains and identifies important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. Now I would like to turn it over to Kevin.

Thanks Dave, and good morning.

We appreciate that you have joined us this morning to review the Q3 2015 results. As you saw on our earnings release, the third quarter was challenging, as comparable restaurant sales decreased 0.9% system-wide, adjusted EBITDA for the third quarter was $8.7 million, and our adjusted diluted earnings per share was slightly positive. Dave will discuss our financial results in more depth later in the call.

We are actively taking steps to address the challenges we have seen during the past few quarters. Although our investments in building the business have come in short-term financial cost, we believe strongly that we are allocating resources on the right initiatives, and actions to move the brand forward. The first step that I would like to discuss is our action to close select restaurants and reduce the associated resource and financial burden of these units. As we announced in the press release earlier this morning.

It is important to note that during the 20-year history of Noodles & Company, we have only closed a handful of restaurants. However, at this time we believe it is a better use of resources to allow our teams to focus support on culinary operations and marketing initiatives. We believe in the incredible potential of the brand and the uniqueness of the concept. And we plan on continuing to expand in those areas where we expect the strongest return on invested capital. Again, Dave will discuss more later on. As our development strategy has become more focused on the infield of existing restaurants, we are also sharpening our focus on how to bring the brand to life, both inside and outside our four walls.

Before I discuss our efforts in brand positioning, I would like to give a brief update on our initiatives to increase off premise sales from our restaurants. Today, roughly 40% of our sales are eaten off premise, a number which has steadily grown over the years. We believe we have tremendous potential in better meeting the needs of off premise dining occasions, and are actively working on three avenues to drive this opportunity: online ordering, catering, and delivery.

First, is increased promotion of our online ordering platform. Our online ordering system currently accounts for 5% of total sales and 12% of off premise sales. This number has grown organically over the past few years, and brings with it added convenience for the guests, as well as more seamless experiences at the restaurant level.

We will be more actively promoting online ordering in upcoming quarters, which includes the opportunity for the guests to make smaller catering orders online. And this smaller catering platform is primarily focused on groups of 10 to 20 guests, and was introduced earlier this year. It complements the larger catering offering we introduced just over a year ago. This offering is also available through digital ordering, and has helped overall catering reach 1.5% of sales, a 50% increase over the same time last year.

As we enter the holiday season, we expect to capitalize on the catering opportunity, and will support it through a variety of communications inside and outside of our restaurants. Finally, we have expanded our test of delivery to roughly 40 restaurants through various third party partners, primarily in college and urban trade areas. We are still very much in the early stage of this program, and are actively working on incorporating it into our overall online and mobile ordering systems, but believe there exists solid opportunity to meet this growing need of our guests.

Last month Noodles & Company celebrated our 20th anniversary, and national noodle day with new menu updates and the launch of our Made.Different. brand positioning. Noodles & Company's culinary platform and appeal to millennial parents is a significant strength, which we have not fully capitalized on over the years: this new positioning, our differentiated made-to-order fast casual dining experience, as well as our continued commitment to food quality and transparency.

Over the past few quarters, we've shared with you the work we've done from a rigorous review of the brand, to the selection of the Made.Different. brand positioning. During the third quarter, we began to bring this to life through an integrated media campaign focused in a few markets. While many of these messages have been more brand driven in nature, I am very pleased that our early read as shown improvements in traffic trends, especially given the improvements have come at a time of a slowdown in the broader industry. We have accelerated those efforts going into the fourth quarter with additional PR and supporting promotional marketing efforts.

As part of our brand positioning launch, we also announced the removal of all artificial colors, flavors, preservatives, and sweeteners from our core member, as well as our commitment to pursue an entire selection of meat and poultry never given antibiotics or hormones, by 2017. Finally, we are taking action to better capitalize on our strength with millennial parents. Our kids meal introduction, which Mark will discuss in a little more depth, is an example of our actions to increase our share with this segment.

While the industry backdrop has been challenging and our results are not yet where they need to be, we have seen important progress from these initiatives, which is also carrying into the fourth quarter. Comparable restaurant sales quoted today through November 3 stood at a negative 1.5%, which implies traffic improvement of roughly 120 basis points from Q3 trends. As we have overlapped nearly 200 basis points of price, an important metric we indicated last quarter we intended to drive and needed to proceed other initiatives in other metrics.

On a two-year cumulative basis, comparable sales increased 0.9% during the third quarter, 140-basis point improvement from the two year growth during the second quarter. During the third quarter, we outperformed the black box fast casual index in Colorado in comparable sales for the first time since 2013. As our media and operational initiatives began to take hold.

We also closed nearly the entire gap to the black box index in the mid Atlantic region, another market that had previously been under significant pressure. Moreover, catering and online ordering continues to grow and represents significant long-term potential. And finally, our newest markets, Orlando, Phoenix, and Toronto, continue to perform at volumes above Company average.

I would now like to turn the call over to Mark Mears, our Chief Marketing Officer, to discuss at more length our new Made.Different. brand positioning, and our ongoing marketing strategy. Mark has established a proven record of achieving outstanding results at a variety of fast casual and casual dining brands. And his impact on Noodles & Company is already being felt in the few short months he has been with us. Mark?

Thank you Kevin, and good morning everyone.

I am thrilled to be part of the talented and dedicated team at Noodles & Company, and I look forward to helping shape a powerful and enduring future for this great brand. In my first 100 days I have become fully immersed in my role as Chief Marketing Officer for Noodles & Company, working to understand our brand's DNA and mission, along with its relevancy within today's fast casual environment and related guest dining habits. Our mission is clear and powerful: to always nourish and inspire every team member, guest, and community we serve. To that end, we are embarking upon an integrated multifaceted strategic approach to bring this purpose-based mission to life in our quest to become the fast casual restaurant of choice for our millennial family target.

The three strategic pillars of this plan are first, build top of mind brand awareness. In concert with our agency we've developed a new strategic positioning to harness our key brand assets and equities in a way that creatively communicates the essence of our broader brand story, featuring the positioning line, Made.Different. This is focused on real food, real cooking, and real flavors.

To grow awareness for our new Made.Different. campaign, our strategy is to employ an integrated mix of both mass reach, and micro-targeted communications, including publicity, radio, out of home, online video, search engine optimization, digital and social media, as well as in restaurant merchandising, e-mail, and local restaurant marketing. This is to clearly highlight the fresh, high quality, clean ingredients and complex sauce differentiators of each handcrafted dish we serve, while creating an emotional connection with our millennial family target. We are bringing the family back together.

The second pillar of our plan is to encourage a deeper level of brand engagement to fulfill our brand's pan-to-table promise among all constituents. From the millions of guests we serve in our restaurants everyday to our 10,000 strong Noodle ambassadors who serve them. This emotional connection that we will forge externally through our increased advertising in key markets, expansion of our social media footprint, and system-wide local marketing efforts will be paired with engaging our team members internally through more focused training and an emphasis on improved operations execution.

The third, and clearly the most important pillar of our plan, is growing profitable sales. To accomplish this objective, we are executing a variety of integrated menu and marketing initiatives that will generate incremental guest visits and profitable sales in ways that will also reinforce our value proposition, and elevate the brand experience.

Just one example is our recently launched kids meal program to appeal to millennial parents and their families. We feel strongly and very encouraged by the early sales results, as well as the positive feedback we've received from both guests and our operations team.

And more than just offering great tasting food, we have partnered with Share Our Strength's No Kid Hungry program to help connect hungry kids with 1 million meals. While the aforementioned marketing activities are designed to grow comp sales in Q4, our team is already hard at work in developing a comprehensive Noodles & Company brand plan for 2016. This strategic plan will integrate both our marketing and menu focused brand and sales building initiatives, along with our operational excellence focused initiatives, designed to improve the stickiness of our marketing efforts by improving the key drivers of guest satisfaction.

Now I would like to turn it over to Dave to give an update on our development strategy and discuss financial results.

Thanks Mark.

As Kevin mentioned, and as we announced earlier today, we anticipate closing 16 restaurants during the balance of 2015, which we expect to have a positive impact on future earnings, average unit volumes, restaurant level margins, cash flow and return on capital. This decision was the process of a thorough evaluation of the performance of our real estate portfolio from a site characteristic, operational, and guest perspective.

As of last night we have closed all of our six restaurants in the Austin, Texas, area as well as one in Lubbock. As we've discussed in the past, we've had difficulty overcoming initial operational setbacks in the Austin area, despite a considerable investment in resources. While we have been successful in our entry further south in Houston, we also believe that the resource distraction to improve Austin is not where our focus should lie.

Of the remaining nine restaurants, several will be in the DC metro area. As Kevin mentioned, the market as a whole has improved, and we still have many great performing restaurants in this area. But similar to Austin, we believe our resources are better focused on supporting our initiatives, versus focusing on these underperformers.

In the third quarter, we incurred an non-cash impairment charge of $16.2 million associated with the impairment of 25 restaurants, which included 10 restaurants that are slated for closure, as well as 15 additional restaurants that will remain open, but we impaired based on our current assessment of future cash flows relative to net book value. During the fourth quarter, and potentially early into 2016, we estimate that we will incur pretax charges of approximately $5 million related to cash lease obligations, brokerage commissions and other direct costs associated with the closures, such as employee severance costs. We will update the estimated pretax charges relating to the restaurant closures when we report our fourth-quarter operating results early next year.

As for the benefits that we anticipate from this closure and impairment activity, based on the results thus far this year, the estimated pro forma impact would be 120 basis points increase in margins, and EBITDA would increase approximate $2.5 million on an annualized basis. Operating income would be increased by approximately $4 million to $4.5 million. The 16 restaurants we have closed or are in process of closing generated less than 3% of total sales during the third quarter. Their impact on comparable sales was negligible.

Looking forward, we do not anticipate additional closures in the near term, with the potential exception of those that during the normal course of business would be relocated or closed at the end of their lease term. New markets of Orlando, Phoenix, and Toronto are exceeding sales expectations. And our best comparable sales performance continues to be in markets where we are developing more restaurants and building organic brand awareness.

Where we have seen a common thread, though, in terms of underperforming real estate, is in urban neighborhoods that have fewer of our core family demographic. Consequently, our ongoing development focus will be on the infill of existing markets, with particular focus on family presence when securing new locations.

Our unit growth will be measured in 2016, and we expect between 50 and 60 openings system-wide, compared with up to 66 during FY15. Given the current status of the pipeline, we expect our openings in 2016 to be weighted towards the first half of the year, before we normalize to a lower unit growth rate during the back half of 2016.

As we reallocate resources, we will also be investing in the remodel of some of our older restaurants. As we've discussed in the past, while our research shows that our current design resonates well with guests, some of our more established markets have restaurants that need to be refreshed. We will begin remodeling some restaurants here in Colorado later this quarter, which will inform a larger program we will discuss at more length in upcoming calls.

Moving back to the third quarter, with new openings revenue in the third quarter increased 10.5% to $117.3 million. We reported adjusted net income of $98,000 and adjusted EBITDA decreased from $12.1 million to $8.7 million, due primarily to the impact of underperforming restaurants and investments in our marketing and operational initiatives. In the third quarter, comparable restaurant sales decreased 0.7% at company restaurants, 1.9% at franchise restaurants and 0.9% system-wide.

For company restaurants, comparable sales included approximately 2% of price, offset by negative traffic. From a cadence perspective for Q3, comparable sales were slightly positive in July and modestly negative during both August and September. As Kevin mentioned, during the fourth quarter we overlapped or prior price increase, and are currently running an effective price of only 10 basis points, 190 basis points less than what we've been running year to date. Fourth-quarter to date Company comparable restaurant sales through November 3 are running at negative 1.5%, reflecting an implied improvement in traffic of 120 basis points from the third quarter and the quarter to date Q4.

While we are seeing noticeable improvement in traffic trends, given negligible price we anticipate comparable sales to be modestly negative during the fourth quarter of 2015. As discussed, the underperforming restaurants that we are closing had a roughly 120-basis point pro forma drag on overall restaurant level margin, and a restaurant level margin of 15.2% in the third quarter was 320 basis points below the prior year.

Looking at the line items of the P&L, the primary cause of our overall decline in restaurant level margin can he found in our labor costs, which increased 210 basis points from prior year to 32.4% during the third quarter. Structural impacts from wage inflation and the implementation of the Affordable Care Act caused roughly half of the increase. The other half was caused by a combination of deleverage on lower average unit volumes, as well as the intentional investment in training and labor that we discussed during the most recent call, including those nonrecurring investments to support our Made.Different. launch. We anticipate similar overall increases in the labor line year over year during the fourth quarter.

Our cost of goods sold of 26.6% was a 40-basis point improvement from the prior year. We anticipate some added cost from the investments we are making in our real food and promotional initiatives, and we expect costs to be between 27% and 27.5% during the fourth quarter. During the third quarter, occupancy costs increased as a percentage of sales by 60 basis points, a similar increase to what we saw during the second quarter of this year. This is the result of deleverage on lower average unit volumes, as well as the pure number of openings that we've had.

Operating cost increased as a percentage of sales by 80 basis points during the third quarter. While much of this is tied to deleverage on lower unit volumes, we are also making smart investments in technology and marketing initiatives that we believe strongly will help us meet our strategic goals.

Our marketing spend for the third quarter was 1.5% of sales, a 20 basis point increase over Q3 of last year. We anticipate an increase in marketing spend to approximately 1.7% to 2% of sales during the fourth quarter, compared to 0.9% during Q4 of 2014. General and administrative expenses of 8% of revenue was a 90-basis point increase over Q3 of 2014. 50 basis points of this increase is due to the timing of a bonus accrual reversal during 2014, with the remainder coming from support of new markets and marketing initiatives. We expect unit expense to be approximately 8% in the fourth quarter of 2015.

Our tax rate for the third quarter on a GAAP basis was 37.4% and our estimated annual tax rate for 2015 is between 38% and 39%. During the third quarter, we completed our $35 million share repurchase program, and through the entire program purchased approximately 2.4 million shares. As of the end of the third quarter, the Company had $60.4 million in debt outstanding on our credit facility, and cash on hand was just over $2 million.

Given our third-quarter results, we now anticipate adjusted diluted earnings per share of between $0.13 and $0.15 for the full-year 2015, and adjusted EBITDA of between $37 million and $40 million. This guidance incorporates slightly negative full-year comparable sales and revenue of approximately $455 million. We now anticipated full-year contribution margin between 15.5% and 16%.

Looking forward to 2016, while we are seeing momentum in traffic from our initiatives, we do expect earnings will remain under pressure, particularly during the first half of the year. Given we have just recently entered the activation phase of many of our investments and are still finalizing our annual budget, we do not believe it is prudent at this time, so we will be providing more guidance on the 2016's expectations at our Q4 earnings call early next year. I would now like to turn it over to Kevin for final remarks before we go to Q&A.

Thank you.

In closing, I would like to reiterate the confidence we have in the plan and actions that we are taking in the future growth of Noodles & Company. At 20 years, and nearly 500 restaurants, we have reached milestones few concepts have been able to achieve. Yet we know we have much to do to maximize our potential.

Our actions towards underperforming restaurants will allow us to better support our growth initiatives in our existing restaurants. Our measurement and focus on the functional component of operations, combined with the leadership development programs will accelerate our in-store hospitality experience for our guests. Our focus on initiatives surrounding off premise sales will meet the challenging needs and desires of today's consumer.

Our new Made.Different. brand positioning captures the essence of what makes Noodles & Company such a powerful brand for our millions of guests. And along with our newly introduced kids meal program, better connects the brand to millennial parents as we strive to build awareness, deepen our level of engagement, and drive profitable sales into our restaurants.

Our continued investment in our ingredients furthers the promise to our guests of real food, real cooking, and real flavors. Results are not where they need to be. But we have the right plan in place, and we are seeing the progress as we activate this plan.

Thank you for your time, and if we can now please open the lines for Q&A.

(Operator Instructions)

Your first question comes from line of Keith Siegner with UBS, your line is open.

Thanks folks.

Kevin, with Mark in place now, with the Made.Different. program here, with all these other things you are considering. I'm sure you've taken a step back and looked at the menu, and thought is there anything we need to do here? Have you been testing recipe changes? Are you thinking about any changes to the pricing architecture? What about menu simplification?

Can you talk about these things? Maybe what you are testing, how we can think about those into next year? Thank you.

Sure. We are doing many of those things actually. From a menu standpoint, we clearly have some items that we have had in test and in ideation to continue to improve our labels and cooking procedures so that we can cook faster, and cleaner ingredients. We definitely have some innovation going on in our salad lines. We have excellent salads, we think we can have some great salads.

We have looked at improving some noodle dishes. We have had in test the items that we will have in the first quarter for our LTOs. So we are excited with both some of the more adventurous flavors and spices that we are bringing in that are unique. We have a variety of things through both noodles and pasta, salads, as well as some improvement in our sandwich line that we've been testing, from ideation in the kitchen to a few restaurants.

Price has been interesting. We have a couple of different price structures that we have experimented with in some small markets. Pretty pleased with what we're seeing there. We think it conveys greater value and will increase our protein incidence.

And that is, and actually some of the big improvement we are seeing in traffic is being driven by some of those tests. We are pleased with that momentum. So we do have quite a bit going in that area. And then next year we plan to both take some slow-moving items off the menu and replace them with, we think, stronger, more powerful menu dishes that we [provided that several time] focus on menu and pricing.

Dave, a quick one for you. We have heard a lot across the industry about commodity costs, and easing pressures there. How is inflation running for you now? And how is next year shaping up at least at this point?

Yes, I think we're seeing the same things Keith in terms of commodity inflation for this year. It's pretty negligible. As we look to next year it is a pretty favorable environment. At the same time we do need to invest in certain aspects of our food evolution in particular, on the proteins side, potentially have hormone-free dairy, as well. So while we expect costs will still be pretty favorable, there will be some investments there.

And one last one for me. Kevin, when you talked about normalizing to a slower growth rate in units in the back half of next year. If you're willing to talk about it, what level does that mean? Any details would be helpful, thanks.

I think that is a necessary question that we have been facing, and an important one to ask. You know when you're trailing your expectations by little bit. And although that number has remained about the same at 10 to 12 guests a day, what we expect is we will probably drop to the lower -- you know, that lower end of what we originally had as our long-term guidance will be off our current run rate by potentially 3 to 4 percentage points potentially.

I think more importantly than the number we will hit is to really convey, we aren't chasing a number. We have a guidance range that we think it's realistic. All of our actions have been to raise the screens in the markets where they need to be appropriately raised for real estate decisions. To make sure that we build in existing markets, so we are not adding the first store in a new market, we're not stretching the teams in that regard.

To continue to fill in existing markets, which should provide both brand awareness and economies of scale. Excuse me, in the slower growth rate that we are moving to, actually will be spread across a much larger productive asset base. So it will be easier for our teams to actually open just a couple of restaurants in the markets that we are in. So we think we have a strong asset base, that we need to make the right real estate decisions in, and that that will be get us back to the profitable growth and success that we need.

Thank you.

Your next question comes from line of Jeffrey Bernstein with Barclays, your line is open.

Great. Thank you.

First, just a follow-up on the unit topic. I think you said 50 to 60 units in 2016, which is again somewhat similar to 2015. I was just wondering whether those are units, sounds like if they're opening in the first half, perhaps those are units that are already committed to. I was just wondering if that was the case?

And just to clarify what you said earlier, I was under the impression your long-term guidance was for unit growth of 12% to 13% annually? I just want to make sure, I thought you said you'd lower that now by 3 to 4 percentage points. Was that meant to say that now we should expect once you get past the first half of 2016 that your longer-term annual unit growth will be more the high single-digit percentage growth range? And then I had a follow-up.

Great question Jeff.

I think in terms of 2016 guidance for units, you are looking at 50 to 60 versus 66 that we had this current year, that are committed to for the fast the vast majority for those for the first half of next year. So that's one reason why you don't see the unit growth dropping too much for the overall year of 2016.

As we look beyond that, I can tell you that we don't have a very specific target in terms of what that number has to be. We don't chase the number, as Kevin mentioned.

What I can tell you is it will absolutely be lower and it will be making sure that we are in filling markets and getting the right restaurants that will return -- get us a stronger returned in invested capital as we can. That number could be 3% to 4% off of that 12% to 13% guidance. It could still be in that low double-digits. It could be lower than that. But I think time will tell, we'll tell more at the next earnings call.

Just to clarify my comments. That drop I was referencing was to the run rate we have been at, versus the guidance range we originally had out there.

Okay. And then my second question was just on the media campaign. I think you mentioned it was just in certain key markets. I was wondering if you could share what market you are looking at? And Mark, if you could shed some light on how you then measure the return you get on those investments? I think you actually mentioned in the press release that you're seeing measurable improvement in the trendline. I didn't know that that was at all quantifiable?

Great question. A portion of our spend is system-wide. So in the four markets that we've chosen really a test, it's Colorado Springs and Madison, Wisconsin, Washington DC and right here in Denver. The point was to get a good range of our system, a heritage market. A market on the Atlantic coast, as well as some smaller markets to obtain the learnings that we are going to apply for 2016. And Dave can kind of give you an update on the results we've seen so far.

We are very excited what we're seeing on that front. It's very early so I think it would be very difficult to assign a specific same store lift that we're expecting left, where they are on the necessary ROI. What I can tell you is that, in particularly all four of those markets, they are moving in the right direction.

And as Kevin mentioned, we outperformed Colorado in the black box index for the first time since 2013. Almost did the same thing in DC, which is very encouraging. Particularly when you look at those markets -- those two markets we have been running 200 to 400 basis points behind the industry, prior to the media launch and so we are seeing some good movement in that direction. But it is a little bit early to talk about what the overall ROI would be in expected sales lift.

Understand.

Just lastly on the pricing outlook, it would seem to be a positive message you're sending in terms of the letting the pricing fall from 200 basis points in the third quarter. Now, talking about 10 basis points in the fourth quarter. I was wondering whether that was just timing-wise? What's your outlook in terms of at least initial thoughts on pricing into 2016 and things? Like you said commodities could be somewhat favorable next year. But labor obviously sounds like more of a headwind. How do you at least think about pricing relative to the 10 basis points you're running now?

Yes, absolutely, just to level our approach on why we didn't have more price going into Q4. First of all we think when traffic is under pressure we don't think it is the time to be too aggressive on the pricing side. We think that more importantly we needed to seed the Made.Different. positioning, get more credit for the quality of our ingredients, and raise that side of the equation.

We are absolutely still think there's opportunity in price. We do think there's flexibility there as we look towards 2016. It's a little bit early. We'll give more texture. But we do think that we will see us go back to the pricing board to offset those labor pressures in particular. So we could be as soon as, as we launch the next LTL in February, we might be in smaller chunks, we might do it multiple times versus one time a year. But we think we will have some price into 2016 for sure.

Great, thank you.

Your next question comes from the line of Jake Bartlett with SunTrust, your line is open.

Thanks for taking the question. Can you clarify, for the Colorado, are you talking about in October? Or was that for the third quarter that you exceeded black box in Colorado?

That was for the full third quarter.

Okay, would you be able to share what your results were like in Colorado? Were they positive? Because I know it has been running negative. Were they still negative in the third quarter?

Absolutely. We're comfortable with that. We are still running -- in the third quarter we are still running slightly negative comparable restaurant sales in Colorado. Some similar results, though, we had actually seen during the first half.

What we did see a big change in was that black box index, where again, it had about a 200 basis point drop for the category from Q2 to Q3 for the industry. So our performance stayed pretty steady, outperformed the black box index at a time when the black box index was softening.

Got it. By category do you mean all restaurants in general or fast casual?

Fast casual.

Just clarifying what changed in Colorado in the third quarter? Because the Made.Different. marketing plan really launched in the very end of the quarter. So what did you do during the quarter that would've caused that inflection in Colorado?

Colorado was one of our initial markets that the launch of media, so the Made.Different. platform was launched nationwide in early October. However, we were seeding some media efforts beginning kind of in the middle of the third quarter in markets like Colorado, so we did start seeing some of the benefit there. It's kind of just very steady improvement through the quarter. Some of it is operational and some of the initiatives we were working on that end. But the media did have a little bit of an impact in Colorado.

Again the early work was branding, we got some billboards up sooner. But it was not a significant weight, which is why I think that we didn't decelerate, like the rest of the industry was encouraging.

And then in October have you gone-- Is this all gaining more traction from maybe moving positive in a place like Colorado?

It's still a little early, and I see, you see the volatility from week to week. Colorado, I think, is still under pressure; actually I've seen it degrade even more from the industry perspective. So getting positive there might be more difficult. We are seeing the DC metro area move much closer in that direction, which is very positive data point for us.

Great. Then the last question. Maybe just so I understand the marketing is in test, but do you expect it to be -- How can we expect the rollout in 2016? Kind of ratably across the quarters? Or is it going to maybe still get learnings, and go more forcefully toward the back end? How should we think about rollout in 2016? And do you think you will have it in all markets by the end of the year?

This is Kevin.

I don't think we will have it in all markets across the year. We will have a national system spend, but not at the same level. One of the things that we are gaining from learnings is the various channels, what is most effective in what size markets? That's why we picked the original four that we did.

We expect that we will sustain a certain amount of spend in the markets that we launched Made.Different. in. And we will have a voice there, and then we will add additional markets, probably with the most effective bang for our buck in specific channels. So it is working, it is creating some brand awareness, it is connecting the messages that we think are important. So you will see us incrementally spend in a few more markets and continue, I think at this level, and add to it slightly quarter to quarter with a keen eye on making sure that we are getting the results that we are seeing in traffic trends.

Great, thank you very much.

Your next question comes from the line of Joseph Buckley with Bank of America. Your line is open.

Hi, thank you.

Dave, can I verify on the restaurant level margin guidance that it implies a fourth-quarter restaurant level margin of 14% or less? Is that how the math works?

We are definitely being appropriately prudent when you look at the Q4 guidance on margins. And the reasons for that I would say, first of all we are somewhat naked on price, so you are having the overall impact of the inflation that you're seeing, particularly in that labor line. We are absolutely having some investments in the marketing side, in the labor side in terms of the preparation and the launch of the Made.Different. platform. Also those underperforming restaurants, which have really been a significant drag for us. You will have a half of the quarter roughly where those restaurants are still in play and hurting the overall P&L. So it's going to be some softness until we get a little bit more sales momentum overlaps some of those investments we've made.

Can you remind us where the marketing expense, you've indicated that would be up year over year, where is that in the income statement?

That is an operating cost. So just in the other operating expense line.

Okay. And then the stores, the 15 stores that you impaired that are not closing, is there geographic concentration of those stores?

There really isn't much of a geographic concentration there. There actually isn't too much of a concentration from an age perspective, as well. What you see is a combination of restaurants that are nearing the end of their lease term, which we expect may be closed at the end of the lease term or relocated. That's one elements that you're seeing something of.

And there are some of those urban neighborhoods that they've got enough earnings power that we are covering our rent, the return on investment of closing those does not make sense. But we think at this time it is prudent just looking at the recent track record to look at the future cash flows and impair those.

Okay. And just one more on the expansion rate. If you scale it back some, it sounds like you are still fairly committed to a pretty aggressive expansion rate. Is there any thought of cutting that back more dramatically until you get your arms around the existing store sales?

We have looked at that hard. We believe that for the reasons that I expressed earlier that the growth going forward will be less strain on the system than it has been in the past. And we think the important thing to focus on is making sure that we learned from the restaurants that did not perform to our expectations, that we've appropriately adjusted those screens and trading areas. We believe that we are in the right zip code for that, and we will continue to closely monitor. We still see the benefit and positive impact of growing brand awareness in those smaller markets.

Yes, I would add to that. When you look at we've opened four to five new markets this year and that's a significant strain on the team. As you look at the strategy ongoing, it's very important to know that we are not looking at newer markets, we're looking at the infill of markets where we have seen historically over many, many years up to the present day, that's where you'd see the best return from an investment perspective and efficiencies.

Our best performing comp markets, they tend to be the Portlands, the Raleighs of the world where we are growing that organic brand awareness. In Q4 thus far, Sacramento, San Francisco have been two of our best comping markets. Those are the areas we're going to be growing in and they're going to, I think, absolutely have a nice return on investment. Absolutely, as Kevin mentioned we are monitoring it very closely, but we think that the track record even up to today tells us that this is the right approach for the next few quarters.

Okay. Thank you.

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

Hello. Just a question on the early remodel look, and maybe it is too early. But any parameters around what you are thinking cost-wise there? And I mean a lot of your system is new. But how many stores do you think need refreshes, given the competitive environment, et cetera?

We will absolutely give a much more further update on that during the next earnings call. It's absolutely a big opportunity for us. I mean the research we've done shows that the new sign resonates well. We need to refresh some of those older restaurants. What we are doing is a tiered program looking at different levels of spend and what the associated return on those investment are. That program is going -- that test is going to inform what the larger program looks like.

So I don't think we can give too much guidance in terms of what the CapEx spend is until we get to the next earnings call. What I can tell you is, as you said, relatively young footprint, so the amount of restaurants we'd be hitting, it might be up to that 75-restaurant top type range, it's not going to be the majority of the system. Accounting-wise, probably we'd be looking for something over the next 12 to 18 months.

Okay. And then just on the incremental marketing spend, and actually on food costs as well, I just want to understand the 100 basis points incrementally you're spending in the fourth quarter, you don't anticipate that continuing throughout 2016? And then should we balance food costs? It sounds like some investment back into some of the newer ingredients are antibiotic free. Is that the way to think about as an offset to potential lower commodity basket?

Yes, I believe that's absolutely appropriate. For the marketing spend, just to clarify what we had discussed earlier on the call, for the fourth quarter we are expecting 1.7% to 2% of sales to go towards marketing. That is compared to we had 0.9% in the fourth quarter of last year.

As we look forward into 2016, it is pretty early. We're still finalizing the budget, and ultimately if we continue to see the moment we're seeing you can see the number develop on the high side, if we are not seeing it we will of course adjusted accordingly. I would expected it though to be in the 1.5% to 2% range just as a preliminary thought. I don't think that you're going to see that necessarily drop. What will happen though is you will start overlapping from a year-over-year perspective as you get further on. On the cost side, with cost of goods sold, we do have some more ingredient investment that we will be doing, which you will absolutely see, it could be offset mostly by the overall favorable environment.

Andy, this is Kevin. One other comment on the remodels. Even in the least expensive tiers, we are going to have some physical changes on the exterior of the restaurants, which will help create some new news as people drive through the trading areas. Clearly our signage today is brighter, it incorporates world kitchen, we flushed some of the buildings with lights. I think that is important to note because you can't just do the inside of a restaurant and you've really got to influence what people see and where their eyes go as they are driving through a trading area, they pull into a center. So our least expensive tiers are going to have significant improvements in signage and visibility.

Those could touch some of the newer restaurants, as well. As an example, Southern California's an area where we are looking at doing some of those changes.

Thank you.

Your next question comes from line of John Glass with Morgan Stanley. Your line is open.

Thanks. Good morning.

Just maybe two follow-ups. One is on the marketing spend. How much are you spending in the markets themselves, maybe as a percentage of sales? The question is if you're spending, I don't know what you said this quarter, 1.5% in aggregate, you must be spending a lot more in concentrated markets. How do you get confidence you're not getting a read that maybe doesn't end up being sustainable if you have to spend that amount over a larger number of stores?

Yes, certainly John, in those particular markets you're probably in the 3% range. As a reminder, you still have a lot of spend that's been national in nature, particularly on the digital side. So 1.5% to 2%, it's not completely concentrated in those areas. There's a lot of that expense that is actually system-wide.

What we did look at is, what was the right level of spend to be sustainable in a long-term basis? A market like Colorado, we would have a heavy lift in Q3 and Q4 in terms of the amount of spend and then go down to a sustaining level, potentially then shifting resources over to a different market. So we don't think you need to go at this level of expense on an ongoing basis.

Okay. And then just a couple of questions on the restaurant closure. One is how of these expenses are going to be cash versus non-cash charges?

So we disclosed in Q3 we did almost all of the non-cash charges, there potentially a little bit still could come, but $6.2 million, which included some of the impairments. On the closure costs that are cash, that will be roughly $5 million, most of those will be in Q4.

Okay. And then two other questions. You mentioned the places where you found the brand did not work had been those urban neighborhoods with less families. When you look at the state of your portfolio, what percentage after these closures, what percentage would be in these type of markets?

1% to 2%, small.

Okay, so that's not really the relevant issue here. And then finally, just -- I know Austin was somewhat of a recent market. When were those stores -- is there a commonality opening over a short period of time and you were making real estate decisions then that you wouldn't make now? What's the timing of the openings of the stores that you're closing now?

It is a pretty broad mix to be honest. There are some that are more recent, but it is a pretty good mix overall.

I think they may span over a decade or more in deviation.

Got it okay. Thank you.

Your next question comes from line of David Tarantino with Robert W Baird. Your line is open.

Hi, good morning.

My question is on the store rationalization strategy you have. And one question is, have you considered re-franchising any of your units, so that you can perhaps concentrate more of your company resources in fewer markets and allow franchisees to operate some of the markets that are more far reaching?

David, yes, this is Kevin.

Yes we have. We have some discussions going on in place. So we are looking at -- we have some very strong franchisees. We think we have a strong internal franchise team, a great leader of that part of the business. And where it makes sense, you may see us re-franchise a few markets. And we are actually looking at some of the markets that we know there is opportunity to grow in. So it's not just re-franchising, but doesn't make sense to open a couple of markets that we may have considered this company has franchised going forward.

Okay. And Kevin, how quickly might you do some of those steps? Is that something we should expect to see over the next year or so? Or is it more of a long-term thinking?

I think it is probably more the normal course of business now. I don't know that I want to put time on it because, negotiations, as you are well aware, ebb and flow. I can tell you that the answer to your question is yes, we're thinking about it and it has become a more important component of our growth strategy.

Great. And then one question on the marketing. It sounds like you are pretty pleased that the marketing is starting to move the needle and stabilizing a traffic trend. Yet the comps are coming in for the year less than what you anticipated. The question is, is the marketing working as well as you hoped it would heading into the program? And if there was any shortfall, where would that have been?

I definitely believe it is. I think there are signs that we are making material and measurable progress in the markets that we are running in is a good data point to validate that. You know the macro industry still is volatile and it is seeing some deceleration. We are stabilizing and gaining in the markets that we are running media in.

I think, I wouldn't call them shortfall, from an early timing standpoint, some of the assets that we needed in channels of video we did a little bit later in the program. Because we were tweaking them, and wanted to make sure they were right. But I will tell you both the internal ops teams are excited about it, the message is resonating back from guests the way we need to. We are seeing what we believe was the most important first step was to focus on transactions.

You know we didn't think it was appropriate to raise prices in an environment we still believe the consumer is under pressure until we got back closer to flat transactions. That's what we believe was the most important thing that we had signaled, and we are moving in that direction. So I am pleased with that.

The other area that we are continuing to work with is to make sure that we have a strong strategic plan around promotional activity and events to complement what we are doing on brand positioning, and that is coming together, I think, nicely as well. So I feel actually incredibly confident in what we are doing from a marketing, a marketing calendar standpoint, and a brand standpoint.

Great. And last question, Dave, I don't know if you mentioned it, I might have missed it. What was the amount of cash you used for the buyback this quarter?

It will be in the Q, I don't have the exact number right with me. I believe we used roughly in the neighborhood of $5 million during Q2, so about $30 million this quarter. It will be in the Q though, which I believe will be filed shortly.

Great, thank you very much.

Your next question comes from line of Jason West with Credit Suisse, your line is open.

Yes, thanks. Just a few follow-ups. So the marketing I know, you said you're not quite decided what you're going to do continuing the spend from 4Q into next year. But can you remind us what the marketing spend was in the first half of this year?

This year, it was a 0.8% during the first half of 2015.

Okay, got it.

And then on the labor side, you may have said this. But what the underlying wage inflation that you're seeing there is?

It is in the neighborhood of 3% to 5% and it fluctuates by market. But that is in the neighborhood, Jason.

Okay. And then you mentioned on the Colorado market that you'd seen a step down in the third quarter in terms of the black box numbers. Is that something you are seeing across a lot of markets, or most of the markets nationally? Or was Colorado unique on that for some reason?

I think we did see nationwide a drop. And then, obviously, the reports going into a little more depth than what we probably can. I did you'd see a nationwide drop, Colorado definitely had more of a drop than what you saw in some other markets for the industry.

Okay. Got it.

And then last thing, for Kevin. Just big picture with the earnings issues we are having here and the thoughts around slowing down the growth rate. Maybe re-franchising some stores. How are you thinking about the overall corporate overhead and G&A? Is there some restructuring and cost opportunities there that we should be thinking about for next year, or is it too early to be making those types of changes?

I think it is too early to make some of those changes. We are shifting resources where we think we can get the biggest bang for the buck. And we are in some cases still adding some exceptionally strong talent to the team where we think that investment is necessary. So, I think when it comes out in the wash it's probably still too early to make any material changes for us to say anything about that.

Structurally I can give a little bit of texture into it in terms of, a benefit you'll have is that by not going into new markets, looking at our development strategy of being more infill, you'll be able to get more leverage than we've had in the past. At the same time structurally, as you can imagine, given some softness we have not had as much bonus as you would typically have, so that could be a potential headwind on the overall just pure number.

Got it, thanks lot.

Your next question comes from the line of Nicole Miller with Piper Jaffray, your line is open.

Thank you. Good morning.

In trying to better understand the comparisons in the quarter you're in, I seem to recall that I had written down that looking at October, November, December of last year, that comp was strongest in December. Can you remind us if that was the case? And what that strength came from and how we should expect as you lap that?

Yes, Absolutely. A good question. So the fourth quarter comp from a company perspective was 1.3% last year during Q4 in the call. December was the strongest quarter, partially driven by some good promotional activities that we had to have some significant strength. The one that we've gone through as you look at quarter to date numbers, actually was similar to that overall 1.3%. The softest spot was in the middle of November, so we're about to hit that spot right now.

We do have pretty similar and I think actually improved promotional activities that we are looking at for December. So while you could see some softening from a two-year perspective, I feel pretty good that we've got a good plan in place. Also, the marketing is really starting to kick and more and more.

That is very helpful, thank you. And then just the last one for me. Kind of big picture.

I thought about this model as you know 12% to 13%, or whatever it had been unit growth driving 25% or better earnings growth. And I'm just trying to better understand a long-term earnings algorithm. So as it culinary operations marketing is the enabler for earnings? Or how would you best describe the long-term earnings algorithm?

Thank you.

I definitely agree that the three items that you mentioned we believe are the strongest assets to drive long-term top running growth. We have great kitchen capacity, good culinary innovation. The marketing and brand positioning. We've now entered that stage of our life cycle and our growth, where we will sustain what we're spending and incrementally invest where it makes sense.

I also think you've called it from a pure operations initiatives. We have several things in that area that, that as we improve and tighten some of our consistency of execution that we have lift there. But as of recap the prepared remarks, I think we have the right initiatives, we have the right plan to get back to the numbers that we have to, to draw comparable restaurant sales.

Thank you.

Those should flow through to the bottom line.

Thanks.

Thank you, Nicole.

Your next question comes from line of David Palmer with RBC Capital Markets. Your line is open.

Hi, it's Eric Gonzalez in for Dave Palmer.

I wanted to ask about the performance of kids meals. It seems like something you seem to be excited about. If you could talk about how the mix, what the mix is of overall sales and how you are marketing that initiative. And then maybe if you could discuss from an industry perspective. Is family occasions a growing part of the industry, or is it just that your brand tends to resonate more with that type of party?

You have a few questions in there Eric, so if we miss something, please let us know. In terms of the kids meal, I will tackle some of the mix perspective we are seeing and then let Mark discuss how we are marketing it.

From the overall family occasions, I haven't seen a ton of data that says how it is overall is changing. I do know that the millennial parents are growing more and more important. And for us, we absolutely have a larger strength there, just across the board as you see it, we just resonate very well with that particular guest.

In terms of the mix, not comfortable, it's not generally one of our practices to disclose overall mix of it. I can tell you the take-up rate has been phenomenal in terms of the amount of kids that we have that are taking it on. From the mix shift, you think we didn't have a kids meal before, what we saw in the test and it has proven so far as we've launched nationwide, is roughly half of the kids meal guests are those that used to have two small dishes, and they are just going to two kids meals. And then you also that folks that were going from one large and splitting it between the two kids. So you are seeing a nice overall kind of mix where it's overall probably neutral to PPA.

I will add one comment on just a personal perspective on the size of that opportunity. Clearly the millennial group is going to exceed the size of the opportunity of the baby boomers. The other thing, you know even within the that pool of people, you look at the amount of families that still go to QSRs, that want to offer their children and themselves better food, better ingredients, real cooking.

Our kids meal priced at $5. The offers that they have, the variety of the taste, the nutritional content is far superior than most anything else there, that is out in the marketplace. And I believe it is a chance for that to trade up to the family. We have a very strong average check with the transaction level detail we see with the purchase of kids meals. And I think that allows us to take more market share going forward from a sector that does not participate as much today in fast casual, but would like to.

And now Mark you can talk about marketing.

Great question. We are really pulling out all the stops and we are starting from an inside-out perspective, so looking at the restaurant, you can't help but miss it, literally from the [plane] on the door to the ordering process, as well as at the table, with our e-club, which has now over 1.3 million members. To our digital efforts, with the video that we've just put forth, it really highlights the kind of emotional connection with the family interacting. And we know that life happens over a bowl of noodles.

And the idea of bringing the family back together is really what our messages is, versus we too have the kids meal. I think that is really to Kevin's point a strategic foundation of why this is so important against our very clearly targeted millennial parents. And we also have family nights coming up in November that will help to drive trial and create a habit that this is where they want to go for family dining.

Yes. Family Night (inaudible) is something we have not done in the past is have that partnership with a nonprofit and share our strength with their No Kid Hungry program. I think it's a phenomenal one. And for $0.05 of every kids meal that is purchased goes towards that, which we think is a great link for us.

Great, thank you.

Thank you, everyone.

Ladies and gentlemen this concludes the third-quarter 2015 earnings conference call. Thank you for your participation, and have a wonderful day. You may all disconnect.