Noodles & Co (NDLS) 2017 Q3 法說會逐字稿

Good afternoon, and welcome to today's Noodles & Company Third Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded. I will now introduce Noodles & Company's Interim Chief Financial Officer, Sue Daggett.

Thank you and good afternoon everyone. Welcome to our Third Quarter 2017 Earnings Call. Here with me this afternoon are Paul Murphy, our Executive Chairman, and Dave Boennighausen, our Chief Executive 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 our guidance about our anticipated results in 2017 and details relating 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 afternoon's news release and the cautionary statement in the company's most recent Form 10-K and subsequent filings with the SEC are considered a part of this conference call, including the portions of each that set forth the risks and uncertainties related to the company's forward-looking statements.

I refer you to the documents that the company files from time to time with the Securities and Exchange Commission, specifically the company's annual report on Form 10-K for its 2016 fiscal year and subsequent filings we have made. These documents contain and identify 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 Dave.

Thank you, Sue. Before Paul and I discuss the comprehensive strategy that we have embarked on, I'd like to take a few moments to highlight what we have accomplished over the past year in strengthening the company's foundation.

As we look back to last fall, the company was faced with many organizational challenges. We had a large group of underperforming restaurants that were causing a persistent burden on both human and financial capital. Our menu had also become highly complex, resulting in executional challenges and a drop in employee engagement, resulting in high turnover.

Since last fall, we have taken numerous steps to address these challenges. During Q1 of this year, we closed 55 underperforming restaurants, funded in part by 2 capital raises that significantly improved our balance sheet. Earlier this year, we also began streamlining our menu and simplifying several operational processes inside the restaurants, resulting in improved operational metrics and a re-engaged field team.

Moreover, we shifted our focus to the off-premise dining occasion, expanding our use of third party delivery programs, and launching our Noodles Reward Loyalty App. We believe our actions have already yielded improved results, particularly at a time when the restaurant industry continues to be challenged. We believe the underlying results of our third quarter speak to this improvement, which include adjusted net income of approximately $1 million and adjusted EBITDA of $9.5 million, a 52.9% increase over the prior year.

Moreover, as Sue will outline, restaurant margin continues to move in the right direction, including a 320 basis point increase over the prior year to 15.6%. During the third quarter, comparable restaurant sales decreased 3.5% system wide, including a 3.8% decline in company owned restaurants, and a 1.6% decline in franchise locations. While we recognize that comparable sales remain a large opportunity, encouragingly, the comparable sales trend improved during the course of Q3, despite lapping a significant amount of marketing and discounting that had occurred during Q3 of 2016.

Before Paul discusses some of our activities around improving our comparable sales trajectory, I would like to discuss some of the actions we have taken in the past few months. On the menu front, as we've discussed in the past, we felt it was important to reinvest in our top selling dish, our Wisconsin Mac and Cheese. During the past 11 months, we have worked on increasing the sharpness of the cheddar profile, testing a revised recipe that has a higher quality white cheddar and deeper flavor.

We also developed a permanent mac and cheese menu to further capitalize on our strengths in this platform. During October, we launched this new and improved cheese sauce nationwide, including it in our core mac and cheese, as well as in a barbecue pork mac, buffalo chicken mac, and in the return of our popular truffle mac. We have been extremely pleased with the performance of our improved mac and cheese, with menu mix and taste of food scores for these dishes continuing to improve since our launch.

We also continued to accentuate our rewards app to foster online ordering with our guests. Off premise occasions accounted for nearly 50% of our sales during the quarter compared with 41% just 2 years ago. Remarkably, 75% of our guests who order to go currently come into our restaurant, wait in line to order, and then wait for the food to be prepared. This results in a sub-optimal experience for a large percentage of our guests, particularly from a time and convenience perspective. We believe there is tremendous opportunity to both frequency and satisfaction by continuing to make that visit more convenient.

To facilitate activation of our app and online ordering, we are installing quick pick-up shelving units in our restaurants and testing improved communication and signage to increase adoption of the platform. Even before we have implemented these changes system wide, online as a whole accounted for 9% of sales during the third quarter, an increase of 250 basis points from Q3 of last year.

Additionally, in support of our off-premise initiatives, we continue to expand our delivery platform and anticipate offering third party delivery in nearly 50% of our locations within the next few months. As we innovate around the brand and our culinary strategy, we clearly understand the importance of executing at a high level inside our restaurants. In particular, we have placed significant importance over the past few months on following our daily shift routines and people deployment, ensuring consistent execution, order accuracy, and speed of service.

During August, we announced the hiring of Brad West as our EVP of Operations. Brad is an operator's operator with over 40 years of experience in the industry. Brad and the team have been intensely focused on identifying the best practices found within our restaurants that are outperforming the base and consistently growing transactions month in and month out. Our operational and guest metrics continue to be above where they were a year ago with additional opportunity for improvement. Over the next several months, we will be working to embed the best practices from our top transaction building restaurants throughout the organization.

Further supporting these efforts has been the introduction of our web-based learning management system, which will be completely rolled out within the next few months. This system allows us to better train all of our team members, validate knowledge, and develop future leaders throughout our organization.

Finally, we continue to strengthen our leadership team. As we have worked on solidifying the foundation over the past 12 months, one concept that I watched from afar was Del Taco, which executed a successful turnaround over the past several years. I've admired work that Paul Murphy and the team at Del Taco did in executing their combined solution strategy. I feel extremely fortunate that Paul has joined our team in Denver as our full-time Executive Chairman.

Paul and I are working closely together to implement a strategic roadmap that will build sustained growth for years to come. I'd now like to turn over it to Paul to share his thoughts on the business.

Thank you, Dave. I am now in my fourth month full-time on the ground here at Noodles and wanted to briefly take some time this afternoon to give my perspective on the business.

One reason I decided to join the team at Noodles was the tremendous opportunity I see for the brand. I continue to be extremely optimistic about the brand's potential and am confident that the challenges we face are solvable. The work Dave and the team have done over the past 12 months has strengthened our foundation and put us in a position to address these challenges.

One of the first actions that we performed as I came on board, and as Dave was appointed permanent CEO, was to conduct the research and discovery needed to clarify our transformation strategy. This has included a best practice quest within our restaurant operations, as well as research into both the brand and menu equity.

As the foundation has solidified, this work has allowed us to narrow our focus on returning to comparable sales and AUV growth, while continuing to expand margins.

I would first like to start with the Noodles brand, which we believe at its core has all of the elements needed to excel in today's competitive environment. Our noodles and pasta based menu with flavors from around the world, complemented with a compelling approach to clean ingredients and fresh preparation remains unique and differentiated in the restaurant space.

Our research validates that Noodles has the ability to meet several different need states for today's consumer, in particular, our relevance to both off premise and group occasions. As Dave discussed, we have already begun work to improve the off premise experience for our guests and we will continue to innovate around this opportunity. As we make the brand easier for our guests to use, we also see an opportunity to improve our messaging inside and outside the 4 walls, to better communicate our brand strengths.

Our research has indicated that over the years, the brand has become a bit too serious and our communication a bit too broad. We are currently in test with an updated look and feel inside our restaurants that we believe will capitalize on our strengths with families and groups, and develop stronger emotional connections with our guests.

As Dave mentioned, we recently invested in the quality of the highest selling dish on our menu, our mac and cheese. Through our research, we have also recognized the importance of developing a lighter segment of our menu to increase frequency and remove the potential for a veto vote. Correspondingly, the research indicates that we have opportunities to innovate around the noodle with a particular focus on health.

We are currently in tests with zucchini noodles, spiralized in-house in our restaurants. We are encouraged by the taste and popularity of these dishes, as well as the ease of execution. We are in the process of further testing to support a potential Q2 2018 national launch of a signature zucchini noodle dish, as well as the opportunity to substitute the zucchini noodle in any of our noodle entrees.

Lastly, on menu, we are completing preliminary work on a line of cold noodle offerings, which have the potential to complement our successful salad line up and bolter our existing menu platforms. We believe that collectively, our efforts against the brand, the menu, our operational execution, and the off-premise occasion will provide the critical mass for us to make meaningful progress in 2018.

Many of the components of our strategy are already in test, and as I have mentioned, we are encouraged by our initial results. A lot of hard work has been done over the last 12 months, improving our people and operational metrics, re-engaging our talented field team, strengthening our leadership, and solidifying the financial profile of our base. While there is still work to be done, the progress being made is tangible and I for one am excited about the opportunities ahead.

I will now turn it over to Sue to discuss our Q3 results in more detail.

Thank you, Paul.

Third quarter 2017 total revenue decreased 6.9% year-over-year to $114.2 million. The decrease was primarily due to the impact of closing 55 company owned restaurants in the first quarter of 2017 combined with a decline in comparable company owned restaurant sales. The decline was offset by contributions from restaurants opened during and subsequent to last year's third quarter.

As Steve noted, during the third quarter, comparable restaurant sales decreased 3.5% system-wide, comprised of a 3.8% decrease at company-owned restaurants and a 1.6% decrease at franchise locations. Comparable company owned restaurant sales included a 2% price increase and a negligible benefit from menu mix shift to average check. We anticipate running approximately 2% of price during the balance of 2017.

From a cadence perspective, and as mentioned on our prior call, the second quarter ended with sale softness that continued through July and August. In September, though, we began to see improvement with traffic ahead of the black box fast casual restaurant trend.

Restaurant contribution margin in the third quarter was 15.6%, a 320 basis point improvement over the prior year and a 60 basis point improvement over the second quarter of 2017. We saw a significant benefit from the restaurant closures, but we also saw improvements related to the implementation of labor savings initiatives and lower marketing spend during the third quarter versus the prior year. This resulted in contribution margin expansion in the current base of restaurants.

From a commodity inflation standpoint, we experienced a neutral to slightly favorable impact relative to prior year.

Adjusted EBITDA increased 52.9% to $9.5 million versus $6.2 million earned last year. As a percentage of total revenues, adjusted EBITDA was 8.3%, a 330 basis point improvement from the prior year. We are proud of the improvement that the company has made in the expansion of our EBITDA and restaurant contribution margin. These improvements have solidified our financial base and coupled with our more moderate short-term unit growth strategy allow us the opportunity to generate free cash flow exclusive of one-time non-recurring events.

On a non-cash basis, restaurant impairments in the third quarter were $8.9 million as we continue to take a critical look at our portfolio given the challenging comparable sales growth backdrop for the company and the industry. As in prior quarters, the impairment was most prominent in restaurants that were built during our time of rapid expansion.

During the third quarter, one new franchise restaurant opened. Through the third quarter, we have opened a total of 11 company restaurants. As we have moderated growth, we anticipate only 2 additional company openings during the fourth quarter of 2017. We do not anticipate any additional franchise openings through the balance of the year.

Encouragingly, our class of 2017 continues to significantly outperform prior classes. Volumes have maintained well above company average, as have restaurant margins. We attribute the success to more disciplined real estate selection as well as the streamlining of the menu and procedures that we have enacted over the past 12 months.

While we still anticipate a modest growth rate in the near term, with likely only a few openings during fiscal year 2018, recent results reinforce our confidence in the longer-term growth opportunity still ahead of us.

Turning to the remainder of 2017, we are optimistic that we will continue to benefit from prior restaurant closures, as well as the continued execution of our culinary, off-premise, and operational initiatives.

I would now like to touch on our 2017 guidance. As we discussed on our last earnings call, we anticipated that we would likely be on the low end of our previously stated guidance ranges. We have revised our guidance for full year 2017, which includes a comparable restaurant sales decline of 3% to 3.5%, leading to total revenue of $452 million to $458 million. We are maintaining our guidance of restaurant contribution margin of 13.5% to 14.5% and have revised our expectations on adjusted EBITDA to $28 million to $30 million.

Finally, I would like to share some context on our credit facility. Our debt balance as of the end of Q3 was $65 million compared with $85.4 million at the end of fiscal year 2016. Our liquidity position has improved due to our EBITDA improvement and lower short-term unit growth expectations. We expect this improvement will continue through the balance of 2017 and through 2018. We have, though, entered into an amendment of our credit facility (inaudible) revises certain credit commitments and terms, while also affecting certain covenant ratios to enhance flexibility to execute our strategic roadmap.

Now, I would like to turn it over to Dave for some final remarks.

Thank you, Sue. While margin and EBITDA continue to expand, clearly, in today's competitive environment, it remains essential that we work diligently on executing a strategic roadmap that elevates the brand's profile and resonance with today's consumer. Work has been done across the organization to increase our capabilities to drive meaningful progress during fiscal year 2018 and beyond.

We believe our initiative toward our brand, our menu, our operational execution, and our off-premise occasion will have a meaningful impact on Noodles' long-term trajectory. I am extremely excited to work with Paul and the team on executing this strategy. Before we close, anything else you'd like to add, Paul?

Sure, Dave. I continue to be excited regarding the potential of the Noodles brand and confident about our strategy moving forward. While many of these initiatives remain in test, I am encouraged by the initial results and the direction that the company is going in. I want to thank you for your time today, and with that, Kevin, please go ahead and turn the call over to any questions.

(Operator Instructions) Our first question comes from John Glass with Morgan Stanley.

First, Dave or Paul, maybe just talk a little bit more about the brand research that you did. I know you've done a number of pieces over the years. It sounds like you are going back to kind of what the brand was originally, sort of focusing on the core menu items and maybe a core customer base. So is your view of the brand going forward that it's going to be more narrowly focused, both menu and in customers? How do you think about your repositioning the brand, going back to your core or is there incremental users you haven't addressed yet? Maybe a little more detail around that please?

John, this is Paul. I actually think it's a combination. I think it is a -- we're really seeing a couple of interesting things in the research, is that around the core menu there is room for people to become much more aware of the number of great dishes that we have. We see that if we maybe section our menu more into a platform type approach that we can I think drive a little bit more interest and then also be able to address some different occasions in there.

I think one of the things that surprised me when I joined the brand was the off-premise use being right about 50%. I think that really says there's a predisposition to use the brand in different ways and I think that we can, from a culinary standpoint, really continue to innovate against that. We will keep the menu smaller than maybe it has been over the past 2 or 3 years to make sure that we can do a great job of executing the menu, of executing against order accuracy, which as you know is very important in obviously any occasion, but specifically the off-premise occasion.

So it's really a combination of both. We're returning to our roots so to speak, but I think we can broaden the need states and occasions that we are dealing with. One other part of the research is that we really are doing -- we have an opportunity to do even far better with families and with group occasions, and you'll see us be working against that as we move into the future.

Two other just more model based questions, I guess. What was the restaurant margin improvement? You excluded the closures of stores. Did you make headway or backpedal given the comp decline excluding the closures?

In terms of restaurant contribution margin?

Yes.

We did make some headway on that. Of the 320 basis point improvement, 300 basis points were attributable to the closures, but 20 basis points were attributable to the core restaurants.

And then finally you mentioned some optimism around September and you quoted relative to the Black Box fast casual index. I guess not knowing what that number was in September, what was the relative trend or what was the improvement or maybe absolute magnitude of improvement in September?

Yes, it was in the neighborhood of 200 basis points John.

Relative to Q1?

Relative to where we were during the month of July and August.

Okay, so not relative to the quarter you reported but just to the first 2 months of the quarter?

Correct.

Our next question comes from Dennis Geiger with UBS.

Wanted to dive into the improvement in the operational metrics if I could. You mentioned solid improvement, I think, relative to the prior year. Can you say sort of what you've seen in recent quarters and even recent months? And was some of that one of the bigger drivers of the improvement that you saw into September? And if it wasn't that, what do you attribute the improvement in September to?

So I think I'll go ahead and take some of the answers when it comes to sales and then let Sue talk about some of the margin improvements. When it comes to sales during the month of August, Paul, myself, and a couple of others actually went out and visited nearly every one of our general managers and assistant general managers, really focusing on routines, deployment, order accuracies, some of the key areas where we feel we need to execute a little bit stronger.

I think we're starting to see some of the momentum from those actions because we still know that while we've got a lot of great news in terms of improvements that we've made in operational metrics we know there's still room to go. So I think we saw some improvement there. One other aspect that will also fold into Sue's comments on margin. We did start to finally lap all of the incremental discounting that had been done during 2016. So while we still saw improvement even ex-that, there was a little bit of that component where we had lapped some of the discounting from the prior year.

I can address the improvement in the contribution margin. I think on the last couple of calls we've talked about a specific focus on targeted labor initiatives and in the second quarter, we talked about introducing [small ware] equipment in order to improve efficiency in the restaurants. For example, choppers for our vegetables as well as saving labor with our procedures of rolling silverware. So that was done in the middle of Q2.

So in Q3 we're seeing the full benefit of that -- of the positive impact of that initiative and we've also talked about going into Q4, more efficiencies. We've identified more efficiencies that don't impact the guest experience, but that the teams are able to execute. So we would expect to see that improvement on the labor line continue based on those initiatives into the balance of the year. And then I think the only other thing that I would say there is that we did have year-over-year lower marketing spend Q3 2017 over 2016.

And then if I could just sneak one additional one in. As we look into '18 and sort of key drivers to reaccelerate this comp, is the biggest thing sort of the operational metrics coming through, the guest satisfaction scores going up, Dave? I feel like you've highlighted that in the past, that you kind of see that come through first. Several months after that you kind of start to see the sales come through generally speaking. Is that the biggest driver? Is it off-premise? Is it loyalty? What are the biggest things that we should be looking for to kind of get the top line going into '18?

Sure. As we've talked about, operational improvements tend to be a little bit of a slower burn and a little bit more of a leading indicator. We certainly anticipate that we'll continue to reap some benefits from that.

I think as we look into 2018, the item we are most excited about is off-premise. As Paul mentioned, we're almost 50% of sales right now from off-premise and that is without really having a very concerted effort towards it. So as we continue to innovate around that platform, change some of our communication around that platform, I think off-premise is where we really feel there's a great opportunity for us to start moving AUVs again in the right direction.

That's going to be supported by the REWARDS program. So the REWARDS program, Dennis, certainly gives us the opportunity to have better communication with our guests, more emotional connections, learn their behaviors, specifically target communication to them. But it also enables us to really promote online ordering and for us that's such a throughput equalizer. When we can get people to order ahead of time, come to the restaurants, skip the line and just pick it up, it makes an enormous difference in their overall satisfaction.

So I think those 2 together have a great opportunity. And then for me, personally, I'm very excited about the zucchini noodle that Paul mentioned as well. I think that there's great opportunity there to address one of the gaps we have in our menu, which is potentially a little bit more healthy items and so pretty excited about that opportunity.

Our next question comes from Jake Bartlett with SunTrust Robinson Humphrey.

Dave, you typically will give some flavor about the current quarter to date trends and I'm curious also in the context with October and the launch of the new mac and cheese earlier in the month, whether that would have maintained some of the momentum you had in September.

So we certainly see that absolute comparable restaurant sales are a bit better thus far in Q4 than where they landed for the entire Q3. The one challenge, Jake, is that we continue to see a little bit of volatility from a week-to-week basis based on the type of discounting that we did. So while we have lapped the large promotions from the prior year, what we do see is that there's still some timing aspects to where now as we move much more towards the REWARDS program as our vehicle, the discounting tends to be much more consistent.

So while we do have some improvement in Q4 numbers to date relative to where we were for the full Q3, also encouragingly, our comparisons actually get a little bit softer throughout the quarter. I think there's a little too much volatility to provide more color than that.

So it sounds as the math would be that October sounds like a step down from where you were in September. How do you think about that in the context of the mac and cheese launch?

It doesn't concern me at all because I do truly think there are some timing aspects that are at play from a promotion. As a reminder, last year we did have an LTO there was being promoted at the same time as we had this one this year.

And then you've talked in the past about some opportunities on the margin side and maybe as margins kind of being much the more tangible drivers in the near term at least; what progress have you made potentially on your supply chain? Any updates there in terms of your initiatives to drive margins?

Yes, we are really taking a hard look at our supply chain and the procurement function in general. I think we have quite a bit of optimism about it. It's probably a little bit too early at this point to articulate what we think the overall savings are, but I think we are optimistic about focusing on the supply chain and the opportunities there in 2018 and beyond.

Okay, and then just you might have mentioned it, but if you could just remind us of the timing of when you're going to put the shelves for rapid pick up, when they should be in the system, where your progress is with delivery as well.

Sure. So I'll start with quick pick up. So those shelving units are in process of getting implemented right now. Probably will go through roughly the balance of Q1 and then our intent would be to really be able to promote it and have more communication and marketing around it during Q2 of next year.

As it relates to delivery, we do continue to utilize third party providers there. So from one aspect there is a little bit of a dependence on their ability to integrate with our systems in the restaurants. Do anticipate that we'll have up to 50% of our restaurants on delivery within the next few months. Where we're at today is probably closer to 15%, so pretty meaningful impact there. The third one, I apologize, I forgot what the third one you were looking for from a cadence perspective.

I think that was it, so I appreciate it. And then actually real last question, which is how do you view just one of the headwinds that you and others in the fast casual spaces have been seeing is the growth of just competition, kind of new entrants. Any comments there in terms of whether you think that some of the unit growth is slowing at your competitors, whether they be large or small? Any commentary on the competitive environment?

Yes, I haven't seen -- certainly that's been a large factor, I think in terms of ourselves as well as other fast casual concepts and little bit of the downward trajectory we've seen over the last year. That said, I'm somewhat encouraged with some of the leading indicators that we're seeing. The markets that tend to be the most penetrated for fast casual, such as DC Metro and Denver seem to be hitting much more of an equilibrium.

And given our penetration levels, our brand awareness in some of those markets, I think you're starting to see that headwind certainly probably still a headwind, Jake, but not nearly what we were seeing during the first part of this year.

Our next question comes from Joshua Long with Piper Jaffray.

I wanted to circle back to making off-premise a focus. It sounds like there might be a little bit of investment there around the rapid pickup shelves, but then the fact that you're using a lot of third parties as well. Just curious on what kind of other investments might be needed to support that. You've got a strong base to build from but just curious on if it's more human hours and time behind the scenes or if there's any sort of kind of CapEx or money needed to get some of the systems up in place, so we can watch this grow going forward?

Sure, I think from the immediate initiatives that we're working on such as the quick pick up shelving units, our IT component when it comes to online ordering has already been in place and the shelving units are actually relatively inexpensive. So we don't anticipate in the near term for there to be immediate CapEx needs. That said, as we look at the overall strategic roadmap, we think we're just scratching the surface, Josh, at what the opportunity is in off-premise.

So I think that's something, stay tuned, and I think we'll continue to talk about it more certainly on our next earnings call as well on where we see off-premise going. We will continue to utilize third parties for delivery for the near term given just the amount of resources that would be required to try to do that in-house.

That makes sense; and then Dave, some of your comments on kind of where we were through the first part of I guess it was kind of September, October, and I think you made a comment in terms of maybe year-over-year comparisons. I just wanted to make sure I understood that correctly with your point that last year's 4Q as we go through the compares get easier because of that discounting?

Yes, that's exactly right. So to put in perspective, Josh, our promotional activity right now tends to be utilizing our REWARDS program and what it allows us to do is pulse out much more targeted our discounting and our promotion. So as we look at the quarter, it's much more balanced with how we approach discounting in promotion versus in prior years, including Q4 of last year, we had much more reliance on the email program that we still have today, but we were utilizing that and tended to do much more, much broader promotions and discounts.

Those happened early in Q4, during the first half of Q4 of last year. So I think as you look at the balance of this quarter, we expect that that will become a benefit. And then I think ongoing we've now -- we've talked about this over several calls as many of you know, we've been lapping a significant amount of discounting in general. So it's nice to have that now behind us.

And then as we think about the rationalized unit base, you've got systems in place now. You're continuing to execute against those. As we think about the environment for real estate sites and the fact that you've become more disciplined there, is 10 or something around this range for what we've seen this year for new units in terms of 13, is that kind of a healthy number for you going forward or do you expect that to tick down over time in favor of just focusing on the operational execution?

Yes, so 2018 we haven't given formal guidance, but as Sue mentioned, we expect there to really only be a handful of restaurants on the company side. There's a few in the pipeline on the franchise side as well. But for 2018, we actually think there will be less units than what you saw -- I'm sorry in 2018, less units than 2017.

We're also taking the opportunity, aside from focusing on the base, Josh, this is a good opportunity for us to really look at that off-premise occasion and what does the restaurant of the future look like, which could entail a smaller footprint, incorporating potentially pick up windows and things along those lines that would allow us to really capitalize on the off-premise occasion. So we're taking this pause to really validate that we've got the right prototype moving forward.

(Operator Instructions) Our next question comes from Andrew Strelzik with BMO Capital Markets.

This is actually Ryan Royce on for Andrew. I just wanted to follow up on --- hey how are you -- I just wanted to follow up on your comments on delivery. I recognize it's still early, and in 15% of units, but is there any color you can give there on what you're seeing from delivery in terms of check size or incrementally?

We've talked about in the past that we've seen it be up to around 10% to 15% of sales on the high end and that tends to be incremental sales. The one challenge I would say is that we tended to start our tests with restaurants that had a little bit more resonance with deliveries. So you think of urban sites, you think of collegiate sites, et cetera. So I wouldn't necessarily expect that that would be our number as we expand the program, but what we do see is that there's definitely some meaningful opportunity there and it does tend to be incremental.

And then I just wanted to ask one more on the restaurant margin side. I think the restaurant margin guidance at the midpoint would imply a smaller rate of margin expansion in the fourth quarter relative to what you saw this quarter. So is there any level of reinvestment there or can you help me understand some of the puts and takes for fourth quarter margins?

I would just say from that perspective, I think some of it is just seasonality driven and we also are experiencing a little bit as we go into the back end of 2017 and into 2018, looking at a little bit of modest commodity inflation.

Yes we do anticipate while COGS were -- cost of goods sold was about 26.5% in Q3, we expect that will tick up a bit during Q4, Ryan.

(Operator Instructions) Our next question comes from David Palmer with RBC Capital Markets.

Another follow-up on pickup and delivery. You've tested results for delivery. I guess you have 15% rolled out there. Do you have the pickup shelves rolled out anywhere significantly thus far?

They've only been in place for a small amount of time, David. We do have it really probably in only 10%, 15% of the system at the moment. So we're continuing to roll that out, just kind of a steady week after week basis.

Do you sense that that's going to have incrementality as well or is that something that you think it will be a slow build and perhaps respond more to the advertising when you switch that on next year?

Yes, I'll tell you and I think Paul can weigh in as well. We still have a little bit of opportunity to make sure that we get order accuracy 100% right. So we continue to work with Brad and Brad's working with the teams to get that 100% right as we implement the quick pick up shelving units into our restaurants. I do think it's ultimately a relatively slow burn over the next few months, but then as we get the signage communication, as well as marketing in place, I think it can have a very large impact.

Yes David, this is Paul. I mean as we're doing the rollout, I mean the one thing that -- we have slowed down just a hair because we're addressing, frankly, some procedural things to make sure that it's intuitive for the guests when they walk into the restaurant to know the travel path, to be able to use the quick pick up, that they're not getting in the queue line with people who are ordering and then also just kind of the signage against it.

And once again as Dave mentioned, making sure from an operational execution that we continue to work hard against the order accuracy part, and that's just really retraining and working hard on our procedures to make sure that before any product goes out, it's double-checked, triple checked to make sure that we hit the expectation on that. So I think there's really nice upside there, but as we're doing it, we want to make sure that we do a great job of executing it.

I guess a lot of the question -- I don't know if you are thinking about it this way -- you mentioned half your business is on premise and half off. You're talking about these off-premise initiatives. I would imagine that on premise is comping down more than your overall and your off-premise is comping, I don't know, maybe even positively now, I would imagine. Maybe you want to comment on that.

But there's also going to be some law of big numbers where you have perhaps over the next couple of quarters some of these things start to layer in and your comps can finally tip to the positive on a real inflection point basis. How are you thinking about that and can you separate the 2 halves in terms of comp momentum? Thanks.

Sure. You let me just, I will let Paul address some of the comp momentum that we would expect to see, but I want to reiterate one of the numbers that we talked about today on the call, which was 75% of our off-premise sales right now are guests that are coming into our restaurants, waiting in line, ordering and then waiting again for their food to be prepared. And our research continues to show that those folks that are doing that experience aren't as satisfied as those that are utilizing the online platforms, skipping the line, and picking it up through that vehicle. So there is absolutely tremendous upside just even in our existing core base of getting them to have a better experience.

As for things layering on and where the comp momentum could potentially go, I will let Paul to weigh in.

David, I think as you probably heard on the call, as we look at 2018, we're looking at really a combination of things that we can bring to bear on the business, off-premise certainly being one of the leaders in that, but it's not going to be the sole driver of the business. A bit to, I think, David's point in terms of off-premise is it is really getting people out of the line so to speak that are basically doing off-premise.

I think that over time that actually will drive the on premise business because the line will be shorter. So I think part of the solution is making sure that we do a great job of communicating our off-premise programs, how to use those programs, the convenience that they do for you, the quality of the product as you do it. And so I look at yes, it having an influence on 2018, but I think that's in conjunction with the operational work that we're doing, the menu work around the zucchini noodles, and then other things that we're testing in terms of off-premise.

So I think you're right in your hypothesis as to can the brand make that turn in 2018. We certainly believe so, but we are also looking for what I would call enduring growth. And so as we make that turn, how are we able to do that and maintain that momentum '19, '20, '21, going forward? And from my standpoint that's a bit of a more holistic approach, but off-premise being both a near, mid, and long term driver. We should be the best in the business at it.

I'm not showing any further questions at this time, so that means that the conference call is concluded for today. You may all disconnect and have a wonderful day.