NOODLES & Co Q2 FY2022 Earnings Call

Good afternoon and welcome to today’s Noodles & Company’s Second Quarter 2022 Earnings Conference Call. All participants are now in a listen-only mode. After the presenters’ remarks, there will be a question-and-answer session. As a reminder, this call is being recorded. I would now like to introduce Noodles & Company’s Chief Financial Officer, Carl Lukach.

Thank you, and good afternoon, everyone. Welcome to our second quarter 2022 earnings call. Here with me this afternoon is Dave Boennighausen, our Chief Executive Officer. I’d like to start by going over a few regulatory matters. During our opening remarks 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 details relating to our future performance, should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act. 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 annual report on Form 10-K for its 2020 fiscal year and subsequent filings with the SEC are considered a part of this conference call, including the portions of each that set forth the risk and uncertainties related to the company’s forward-looking statements. I’ll refer you to the documents and the company’s files from time to time with the Securities and Exchange Commission, specifically the company’s annual report on Form 10-K for its 2021 fiscal year and subsequent filings we have made. Each document contains and identifies important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. During the call, we will discuss non-GAAP measures which we believe can be useful in evaluating the company's operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measures is available on our second quarter 2022 earnings release and our supplemental information. Now I would like to turn it over to Dave Boennighausen, our Chief Executive Officer.

Thanks, Carl. And good afternoon, everyone. I'd like to start today by sharing some of the highlights from our second quarter results, which overall met our expectations despite volatility in the market environment. I would also like to spend some time addressing our confidence level and strategies towards achieving our 2024 accelerated growth objectives. Our second quarter revenue of $131.1 million reflected system-wide comparable restaurant sales of 5.1%, which was highlighted by record average unit volumes of $1.42 million. That company restaurants are 18.3% above pre-COVID 2019 levels. After a challenging first quarter due to the impact of temporary closures from the Omicron variant, our restaurants are now staffed above pre-COVID levels, and we recaptured meaningful momentum relative to Q1, including restaurant level margins of 15.5% compared to 9.7% in the first quarter. As we move to our ongoing strategy, I would like to remind you of our accelerated growth objectives, which include first, $1.5 million average unit volume by 2024, second, a 20% restaurant level margin again by 2024, and finally, at least 10% unit growth commencing in 2023. Let's start with our average unit volume target of $1.5 million. The company has made clear progress over the last few years in growing average unit volume from $1.2 million in Q2 of 2019 to $1.42 million in the recently completed second quarter of 2022. The brand's ability to meet the needs of today's consumer, particularly with the variety inherent in our flavorful menu, our digital strengths, and how well our food travels positions the brand for continued growth in our average unit volumes. As we've all witnessed throughout the restaurant industry, we experienced some softening in our sales trends during the last part of Q2 and into the beginning of Q3. While sales have quickly stabilized, we expect positive comparable restaurant sales in the current third quarter. The stability of our recent sales is encouraging; however, we recognize the near-term economic environment is unstable and difficult to predict. As a reminder, though, the company achieved positive comparable restaurant sales during the 2008 and 2009 recession, driven by the strength of the brand's value proposition and our ability to benefit from trade downs in a softer consumer environment. This ability to succeed in a more difficult environment is bolstered by the strength of our menu innovation and our strong entry-level price point. From our recently introduced LEANguini offering, which offers 56% less net carbs and 44% more protein than traditional wheat pasta, to our artisanal sauces, our menu offers great variety that is not easy to replicate at home or in other restaurant competitors. Additionally, we are leaning into the strength of our entry-level price point with increased communication and messaging of seven core dishes that are priced at $7, including popular favorites such as our Wisconsin Mac & Cheese. This core menu strength and value proposition are further supported by the insights and engagement that we derive from our digital ecosystem and our rewards program, an asset that we did not have during prior economic downturns. Our frequency and guest metrics have improved meaningfully in recent months, and we will continue to leverage this strengthening capability to drive consumer engagement that is personalized, relevant, and develops guest loyalty. In the coming months, you can expect us to continue to evolve and fine-tune these areas of the business, streamlining and improving our digital experience for guests and continuing to increase our trial awareness of LEANguini, which we are seeing is associated with higher repurchase, tastier food, and frequency metrics. We continue to believe that LEANguini will be a transformative introduction for Noodles & Company, with our focus now shifting from introduction and commercialization to increasing trial among new, lapsed, and loyal guests alike. While we are prepared for potential volatility during the coming months, as I noted, sales have quickly stabilized and we anticipate positive comparable restaurant sales in the third quarter. Moreover, during the second quarter, 41% of our restaurants achieved our accelerated growth objective of average unit volume of over $1.5 million, with strength from coast to coast and in a variety of different restaurant formats. The average restaurant margin of these restaurants was nearly 21%, which brings us to our second accelerated growth objective, achieving a target for 20% company restaurant level margin by 2024. As a reminder, our pre-inflation results from Q2 of last year included a restaurant level margin of 18.9%. Clearly, the unprecedented inflationary environment that we're now seeing has led to some challenges thus far in 2022. But with the combination of more normalized commodity markets and the execution of our efficiency initiatives that I will discuss further, our 20% target remains in sight. As you know, cost of goods sold has been the most challenging area of the margin story in recent months. Our cost of goods sold in the second quarter was 27.8% of sales, 280 basis points above our target for COGS of approximately 25%. Carl will go into more depth later, but importantly, we are confident that we have reached the peak of our cost inflationary pressures. Several key ingredients, particularly chicken and durum, have seen meaningful declines from their recent historic highs. Additionally, we are currently rolling out a more efficient cut of our boneless chicken breast with significant cost benefits. While our COGS remains elevated in Q3 due to the timing of lower cost items rolling through the system, we expect to execute in Q4 with meaningfully lower COGS than we saw during the second quarter. As we consider our 2024 target of 20% restaurant level margin, we also see opportunities in several other areas of the P&L. Delivery fees are beginning to come down as a percentage of sales as this area of the business normalizes, and we are also seeing strong leverage on our fixed costs from recent price actions. Additionally, the company is focused on a few key optimization activities to support margin expansion over both the short and long term, including menu optimization to eliminate select higher-cost ingredients and better highlight menu items that are both guest favorites and margin-accretive, testing of high ROI alternatives to improve efficiencies within our restaurants, particularly focusing on our prep activities and our protein preparation, and the introduction of technology within our restaurants to drive consumer behavior and eliminate select current expense items. Importantly, today, we announced the refinancing of our credit facility, which gives us additional flexibility to pursue and implement these and other high-return initiatives to achieve our 20% restaurant level margin target. With stronger average unit volumes and restaurant level margins, we are well positioned to take advantage of our third accelerated growth objective, which is to achieve at least 10% unit growth by 2023, taking advantage of the tremendous whitespace potential for the brand. It's no surprise that certain external factors, including municipal and landlord delays and supply chain issues, have added challenges to the typical restaurant development timeline. That's currently reflected in our unit growth expectations for 2022. However, we remain confident in our long-term target. This pipeline is bolstered by improvements that we are currently seeing in much of our development input costs, as well as an overall more favorable real estate environment to execute our lower square footage off-premise-oriented prototype. Moreover, our confidence in achieving our 30% cash-on-cash return is supported by the success of our recent restaurant openings, including our first restaurant in the suburbs of Las Vegas, which is tracking above our $1.5 million average unit volume objective. Finally, supporting our unit growth objective is progress we are making in our franchise sales program. We are in the final stages of an agreement for a large area development in the southern part of the United States and have been very pleased with the increase in franchise interest that we have seen in recent months. As I turn it over to Carl, I'd like to reiterate my confidence in how well the brand is positioned to succeed in the short term, as well as achieve our outlined growth objectives. Our unique brand positioning with strong value offerings allows us to navigate a more challenging consumer environment. Our strong digital ecosystem and guest insights allow the brand to drive consumer engagement, and our improving operating model, bolstered by high-return, low square footage investments, allows us to take advantage of the tremendous whitespace potential. Now I'd like to turn it over to Carl.

Thank you, Dave, and good afternoon, everyone. I'm pleased to share our second quarter results, including our record average unit volume of $1.42 million, which reflects continued recapturing of momentum. In terms of the financial highlights, total revenue for the second quarter increased 4.3% to $131.1 million compared to last year. Comparable restaurant sales increased 5.1% system-wide, comprised of a 5.1% increase at company-owned restaurants and a 5.3% increase at franchise restaurants. Our second quarter revenue was negatively impacted from the January 2022 sale of our California locations, which we estimate was approximately $4.1 million and includes lost revenue net of royalty payments received. As a reminder, that transaction will be EBITDA neutral for 2022 and accretive in future years. Underlying our revenue growth, our average unit volumes were $1.42 million for the quarter, a 5.3% increase from last year and an 18.3% increase versus pre-COVID levels in 2019. As Dave mentioned, we experienced some softening in sales trends during the latter part of the quarter, particularly in June. However, it's worth noting that in June, our average unit volumes were $1.39 million, which represents 15% average unit volume growth from pre-COVID levels in 2019. We are encouraged that average unit volume growth quickly stabilized at these levels and have remained at approximately 15% thus far in July. For the second quarter, restaurant contribution margin was 15.5%, which was a significant improvement from the first quarter levels of 9.7%. Restaurant margin did decrease 340 basis points compared to Q2 of 2021, with the vast majority of that decrease found in our cost of goods sold, which improved 20 basis points relative to the first quarter but was at 27.8%, nearly 300 basis points above both the second quarter of 2021 and our historical norm. The cost of chicken remains the most material driver of inflation in our basket, as over 50% of our guests choose boneless all-white meat chicken breast as an add-on to their noodle dishes. The price of chicken rose throughout the second quarter to unprecedented levels, peaking at the end of May. However, as of today, the market has already declined by 20% versus those historical highs, and we anticipate continued normalization. Adjusting for the processing through our distribution systems, we estimate that the decline in chicken price will lead to a 50 basis point improvement in cost of goods sold as we exit the third quarter from peak levels in July. We will be able to realize this benefit having remained in variable pricing with our vendors, which was both a strategic decision to remain flexible on our purchases and driven by our vendors who were unable to set fixed pricing given the high volatility in the chicken market. Additionally, we have strategically worked with our existing and new vendors to optimize the cut of our chicken breast to further reduce waste. These vendors are now able to deliver the same high-quality boneless chicken breast in a more cost-effective way, reducing the required preparation. The runway impact of this initiative is nearly a 100 basis point improvement in cost of goods sold. This initiative is expected to be rolled out during the third quarter and largely complete by the end of October, positively impacting cost of goods sold in the fourth quarter and beyond. Other areas of our commodity basket remain fairly stable. We are seeing some modest increases across our dairy and produce baskets, but more favorable costs in such areas as durum wheat, which is a core ingredient of our process. For the third quarter, we anticipate cost of goods sold slightly below our second quarter levels ahead of realizing the benefits of more favorable chicken pricing and efficiency initiatives during the fourth quarter when we expect to see cost of goods sold closer to the mid-to-high 26% area. Labor costs for the quarter were 30.3% of sales, which is 200 basis points better than the first quarter and 50 basis points unfavorable compared to last year. Our labor margins continue to benefit from the full annualized impact of our kitchen of the future initiative, which has allowed us to offset continued wage inflation, which grew nearly 13% during the quarter. While wage inflation is moderating somewhat, we anticipate elevated levels will continue into the third quarter, with our labor margins expected to be largely in line with the second quarter levels. Other operating costs for the quarter were 17.8% of sales compared to 17.0% in the prior year. This increase was driven by an increase in marketing expense related to the launch of our Uncommon Goodness platform and the rollout of LEANguini. Marketing expense for the second quarter was 2% of sales, an increase of 80 basis points versus the prior year. We expect third quarter other operating costs to be at a similar level to the second quarter as marketing normalizes to approximately 1.5% of sales, offset by an anticipated increase in our utility expense due to normal seasonality. Pricing during the second quarter was just north of 10%, a level we expect to maintain during the third quarter. We are fortunate to maintain a strong value proposition with an attractive entry-level price point of around $7. This has allowed us to take price without meaningful guest resistance, bolstered by the fact that our core price has been relatively stable during the last few years, as most pricing has been concentrated on third-party delivery. General and administrative expenses for the quarter were $12.7 million compared to $13 million last year. G&A includes non-cash stock-based compensation of $1.5 million during the second quarter, compared to $1.6 million last year. For the third quarter, we anticipate G&A in line with the second quarter, and approximately $1.4 million in stock-based compensation. GAAP net income for the second quarter was $1.3 million or $0.03 per diluted share, compared to net income of $5.7 million last year or $0.12 per diluted share. We also report net income on an adjusted basis, which adjusts the impact of impairments, divestitures, and closures. Excluding these adjustments, our second quarter net income was $2.4 million or $0.05 per diluted share, compared to net income of $6 million or $0.13 per diluted share last year. We expect our effective tax rate to remain low at least through 2022, and we do not expect to be a cash taxpayer for the foreseeable future given our sizable net operating loss and other tax credits of over $150 million. Switching to our outlook, for the third quarter, we anticipate total revenue to range between $125.5 million and $128.5 million with positive low single-digit comparable restaurant sales. The midpoint of our range assumes that the stabilization of average unit volume growth at approximately 15% growth relative to 2019 and reflects the historical negative impact on our absolute sales of the third quarter containing both the Fourth of July and Labor Day holidays. From a contribution margin perspective, we anticipate third quarter restaurant level margins between 15% and 15.5%, as costs, in particular, are expected to remain elevated during the first part of the third quarter. During the quarter, we opened three new locations, all of which are company-owned. We anticipate 21 to 23 openings for the full year reflecting a 5% unit growth versus the prior year, including four openings during the third quarter. For the full year, we now expect $30 million to $33 million of capital expenditure from our previous guidance of $30 million to $34 million supporting new unit growth and continued innovation of our website and mobile app. Turning to the balance sheet, at quarter end, we had cash and cash equivalents of $1.8 million and a total debt balance of approximately $32.2 million, representing approximately $3 million of debt pay down relative to the first quarter. We are very pleased with the closing of our amended credit agreement yesterday, which upsized the credit facility from $100 million to $125 million, eliminated the term loan and principal amortization components of the credit facility, lowered the spread within the company's cost of borrowing, improved financial covenants, and enhanced overall flexibility. We are confident that, with our amended facility, our highly supportive lender partners, and our strong liquidity profile, we are well capitalized to support our accelerated growth objectives and strategic investments. With that, I would like to turn the call back over to Dave for final remarks.

Thanks, Carl. As we consider the current environment, we're very confident in the brand's positioning, the uniqueness of our menu, our strong value proposition, and our digital strengths—all executed by a team of dedicated, passionate employees—allows us the opportunity to directly engage with guests and to be a beneficiary of potential trade downs within the industry. Additionally, we remain confident in our accelerated growth objectives as our 2023 unit pipeline strengthens, average unit volume quickly approaches the $1.5 million target, and we see a clear pathway and progress to a 20% restaurant level margin by 2024. With that, please open the lines for Q&A.

Our first question comes from Nicole Miller Regan with Piper Sandler. Your line is open.

Good evening and thank you. Can you talk a little bit about the cohort you're trying to speak to with the seven entrees at $7? Wondering specifically how did you land on $7? And then in terms of maybe income profiles, how much of your sales come from a lower-end household income versus the higher-end household income?

Sure, we'll start with the actual price point of $7. What's exciting is that that actually is already, Nicole, the natural starting price point for so many of our dishes. So we're able to lean into what already is a great value proposition. To answer your question, in terms of the percentage of our guests that are low income, it is pretty small. And as we look at the trends that we saw in the business throughout Q2, one thing that's important to know is that a lot of the traffic trends actually didn't change at all. Our core guests actually remained very strong, with no real change in their purchase behavior by channel or day part. We actually saw their frequency improved throughout the quarter, but what you saw is that pullback from that low-income consumer occurred similarly across all channels. Now we see that through our rewards program and other third-party data we have, that that's the one group we've potentially lost. Now, interestingly and I think encouragingly, we really just started messaging more explicitly on our digital assets and our menu, that $7 entry price point, just about a week ago, and we're already seeing some nice momentum from that particular segment, the low-income consumer, and we're not seeing any trade down at all either. So we feel that that’s addressing what’s not the largest part of our guests—we definitely tend to skew towards higher income. But for that low-income guest, just reminding them of the great value proposition that we have as a company.

Nicole, to add on to what Dave said, about 52% of our guests have an average household income over $75,000.

Got you. Okay. And that messaging piece was helpful too, because I was curious about exactly that. So then can you just quickly touch on a 5% company comp, and I think you ran just under 10% price in the quarter. So there's a lot of noise in terms of transaction with both mixing and traffic in there. Can you just validate those numbers if I was spot on? Or help us out? And let me fix it help me fix that or? And then speak to the transaction part?

Yes, that is correct. So we're just north of 10% on price overall since your sales and just north of 5%. So you did see traffic lead moderate; traffic was modestly negative, but tracking on the higher side of our expected range, closer to flat to slightly positive traffic prior to when we saw that slowdown that occurred in June, but then quickly stabilized from that point forward.

Thank you so much.

Our next question comes from Andrew Barish with Jefferies. Your line is open.

Hey, guys, it looks like you saw some normalization in the digital mix. Did that surprise you? Or is that just kind of a normal resumption of guest behavior back into the restaurants, and how much do you think that impacted just that channel impacting the overall mix numbers as a component of same-store sales?

Yes, as we look at the mix over the course of the quarter, Andy, it's actually been remarkably consistent. I think there was a little bit of a decline in delivery that we saw at a certain point, but then that quickly rebounded. So it's been actually remarkably consistent. As a reminder, we have always been one of the leaders when it comes to digital sales, and we see that as continuing to be a very sticky channel for us. So still, north of 50%, even as we said, thus far, three or four weeks into Q3, we still have very similar figures. We also think we're just getting started in terms of as we get more insight into our guests and continue to be more personalized with our communication, which we think is a great asset as we've headed into a more uncertain environment. Being able to hold on to those digital sales, while at the same time, dine in is now starting to increase. So you're seeing dine in return to about 20% of sales during the second quarter, still well below where we were pre-COVID, which was closer to 35% to 40%. There's still opportunity for some tailwind as dining returns. But at the same time, as digital remains very sticky, it still has some growth opportunity.

Okay, and then on the development pipeline, those kind of 10 or so units that you took out of this year, how do we think about that next year? I mean, does that make the development pipeline a little more even? Did those units stick around, I imagine? And then you add on top of that, just give us a little more color on the cadence of openings next year; we're obviously significantly ramping up.

Certainly more even cadence than what we saw here in 2022. And as I said earlier, the 2023 pipeline is stronger than I've ever seen it, as we have actually three times as many sites in various stages of development. And when I consider there are restaurants that were already leased and signed, sites that are in lease negotiation, or sites with our letters of intent out, we are significantly stronger today than we were at any time I've seen in the last several years. We're also reminded that back 18 months ago, Andy, is when we set out to really accelerate growth at Noodles & Company. And that is what we are doing in 2022. We will open over 20 restaurants—that's the most that we've opened in several years. Back in two months ago, we didn't foresee that the development environment would have these unusual delays, which has certainly pushed some of that into 2023, but we believe this gives us upside to that potential 10% unit growth target.

Our next question comes from Todd Brooks with The Benchmark Company. Your line is open.

Hey, thank you. Good afternoon, guys. A couple of questions. One, with the relief that you've seen recently in chicken prices and the benefit that you're expecting from the new cuts, what's the status of the chicken surcharge, and how long do you think that that's going to stick around on the menu? Is that based on the response to; is that a longer stickier type of pricing upcharge that we're going to be able to harvest going forward even as the commodity corrects?

Sure. So, Todd, as an update, that chicken surcharge, which was reviewed as temporary, has rolled off the menu. We rolled off about a week and a half ago. At the same time, to keep pricing consistent, we spread that increase throughout the entire menu. So there really is a neutral effect in terms of overall pricing. So you're right, the chicken improvement has really driven the decision for us to take that pricing off the chicken specifically.

Yes, that's something Todd that Carl mentioned on the call in terms of our overall inflationary basket has been impacted more than many in the industry during the first half of 2022. We firmly believe that we are actually in a position where you're going to start seeing improvement. As we get the rollout of significantly lower market costs that you're seeing from chicken breast, as well as some initiatives around that cut. As Carl mentioned, we see very clearly that's getting worked through the system as we speak, being able to exit Q3 at meaningfully lower cost of goods sold than where we are today, and then have nice improvement as you go into Q4 and really beyond. So we feel that there's been kind of an outlier in chicken breast that has caused us to have some particular inflation here in the first half that we are now on the better side of that equation.

Okay, great. Thanks, Dave. Second question on the franchise deal that you teased as close to the finish line. Is there anything you'd share with us on the type of partner compared to the California deal? Is this another large multi-brand, multi-unit operator well capitalized that you're bringing into the fold? And you probably can't give us a sense of scale yet, but I guess where are we in the process as far as being able to get some visibility on what this means towards the pipeline as we get to '24, '25?

Sure, I can share that unlike the California deal, this is not a refranchise; it is a new market. We'll share more details as the deal gets finalized, but we're in the final stages of one that's for one of the southern markets that we've targeted of good size deal. As a reminder, and you alluded to it, Todd, we target well-established multi-unit operators. As you can imagine in the uncertain environment, that's increased the lead time of it as they navigate inflation demand in their own businesses. But what we're seeing, and we're very happy with the amount of interest we've seen over the past few months, again, with these types of high-quality, well-capitalized partners that see the overall potential and future of this brand. So more information to come on that particular deal, but we're feeling pretty good with where the momentum is going from the franchise side.

That's great, Dave. And then finally, on amending the credit facility, congrats on getting that done. You talked about some covenant relief without much specifics. I know the old facility had a covenant prohibiting share repurchase. Can we comment on any covenants regarding share repurchase in the new facility?

Sure. So first of all, thanks for that. We are very encouraged by the closing of our credit facilities; the amendment is highly favorable to us. It provides us with the additional flexibility on certain covenants, which indeed you pointed out, specifically on restricted payments. So yes, it does provide us enhanced flexibility there. And of course, any type of restricted payment is a topic we discussed frequently with our demand.

Yes, I'm very pleased with just the work we've seen with our partners, continuing to have the same lead bank with U.S. Bank. They've been fantastic partners and certainly a favorable outcome in terms of giving us flexibility as we pursue these objectives.

Our next question comes from Andrew Strelzik with BMO Capital Markets. Your line is open.

Great, thank you. And good afternoon. My first question: you had a couple of encouraging initiatives, I guess, that launched during what was a challenging period, the drive sales and LEANguini and the brand building campaign. Can you just comment? Obviously, kind of some of the results are obscured by the macro. But can you comment on what you saw as a result of that? Was it in line with what you expected? Are you happy with how that went? Or any tweaks or anything like that?

Yes, great question. And we're very pleased with what we're seeing from both the LEANguini launch as well as Uncommon Goodness. With LEANguini, as we saw in test, it's associated with higher frequency and higher repurchase rates. The objective right now is really to increase trial. As you know, particularly in this environment, it can be difficult to get people to shift from their familiar favorites. But we see that when they do try LEANguini, they're amazed at the quality and taste. We believe this is very much a transformative introduction from a culinary side. As for Uncommon Goodness, where it's less of a short-term traffic driver and more of a long-term positioning of the brand, showcasing how we infuse Uncommon Goodness into every aspect that we do—from how we treat our people to how we actually saute and use real, sophisticated cooking methodologies to the quality of our ingredients. We're very pleased with some of the leading indicators we’re seeing because we track brand regard and brand perceptions. We're seeing nice improvements across all of those, and we see the power of this potentially, not just externally, but internally. So you are correct; there's obviously a lot more talk in the industry around the overall market dynamics and inflation and so forth. But underneath the foundation at Noodles, we’re very pleased with what we're seeing with LEANguini and Uncommon Goodness, and we think that is going to be a key factor as we grow to a million and beyond.

Okay, great. And then, I guess I was just hoping you could help frame the different cost of goods sold opportunities, because it sounds like there's a lot there. You have the new chicken agreement, you have other commodities that are coming down, you have some cost-saving efficiencies internally that you're also working on. I mean, can you frame kind of the magnitudes or the cadence, or how quickly maybe you could start to realize some of the commodity declines should they sustain? It just—there's a lot that I'm trying to frame the potential impact that it could have?

Yes, we'll let Carl walk through that. But one thing that I think is important to note is that these are known savings. These aren't ones that it’s a matter of them just working through the system. As you can imagine, when you purchase chicken this morning, it's not going to the guest plate that afternoon. It takes some time to get through the system, but these are known savings that will start realizing in short order. So Carl, you can go through a few of those.

Sure. And in terms of the savings, chicken really is the outlier here. And as Dave alluded to, the worst is behind us in terms of the market volatility. There are two major components. The first is purely just the price of chicken, which has come down by over 20% from historical highs. And we're expecting just where the prices are today, that’s a 50 basis point run rate improvement on cost of goods sold. The second is the initiatives that we're executing with our vendors that are about efficiency and reducing waste, and a run rate improvement on that initiative is 100 basis points. So in total, 150 basis points, really adjusting for the lead times and working inventory quickly through our systems. That's where we get the confidence in forecasting cost of goods sold in the mid-to-high 26% range in Q4.

Got it. Okay, that makes sense. And just one quick last one for me. You said the stores that are at or above the $1.5 million average unit volume are doing a 21% restaurant margin, which is already ahead of the 20% target. And then you've got these cost of goods sold savings coming in on top of that. Is there a reason that you would be limited in the rest of the system to 20%? Or is that just a nice starting point? And then maybe we start to build from there, even at that $1.5 million average unit volume? I'm just trying to make sure I understand the different pieces. Thank you.

Yes, you know, don't make it premature, given the uncertainties in the environment. But yes, absolutely. And I really feel that there is a strong capability to continue to leverage those sales grow the concept itself. Fundamentally, historically, we think is a great strength with a low cost of goods sold that can significantly improve the labor model to be more efficient. You see that in those restaurants that are north of $1.5 million, being at 20%. So we absolutely believe there could be upside. That said, we recognize there's work to be done; we need to see where the markets ultimately land in certain areas. So we are as confident as we've been, in terms of that 20% restaurant-level margin. As a reminder, just a year ago, we were approaching 19%. So we know the fundamental operating model was actually quite strong.

Our next question comes from Todd Brooks with The Benchmark Company. Your line is open.

Hey, thanks. Just a quick follow-up, guys. If I may, you talked about the average unit volumes kind of stabilizing after the pullback that you saw in June and maintaining that stability so far in July. Just want to triangulate that to the low single-digit positive same-store sales guidance. Does that level of AUV, that $1.39 type of level, does that support positive low single-digit same-store sales? Or do we require a bit of a lift as the quarter progresses to get to the positive low single-digit same-store sales? Thanks.

Sure. So first, the way we look at the growth as we think about third quarter average unit volume, there is a normalization for closures. So as we think about the trajectory for the rest of the quarter and the stability in terms of what we’re seeing so far in July, there will be somewhat of a closure impact, which will help support the low single-digit same-store sales. As a reminder, last year in the second quarter, I'm sorry, in the third quarter, we saw about 150 basis points from a comp perspective from closures.

Yes. Also to add to it, we're already as we sit today in Q3, we are in our range for what we’re targeting for Q3. The absolute dollar figure, though, Todd, to your point, there is a little bit more seasonality from we have both the Fourth of July and Labor Day in Q3 relative to what you see in Q2, which doesn't have as much impact. So actually, that $1.39 million would mathematically translate to even higher sales.

Our next question comes from Jake Bartlett with Truist. Your line is open.

Great, thanks for taking the questions. My first, I just want to build on that last one. And maybe if you could explicitly frame your sales trajectory in terms of sales kind of in relation to the guidance of low single digits. So did you just say that that essentially in July, you've seen low single-digit same-store sales? I believe, as of the last call in April was roughly 4%, if I got that right. So it sounds like it went up and then it came down. Could you just help us with the trajectory of same-store sales for the last month, and just what you're running today, or in the last month, would be really helpful.

Yes, so as we said, so far here in July, we are in low single-digit positive territory, Jake. And encouragingly, especially as we started to highlight the seven for $7, we're seeing continued stabilization and potentially even a little bit of improvement in some of those underlying metrics. As you bifurcate out Q2, the fiscal month of June was actually softer than low single digits for the last couple of weeks, so it actually started off reasonably strong, but then actually saw some deceleration just in the late June timeframe. Then we saw immediate stabilization, and now starting to see a little bit of a bounce back. Hopefully, that helps a bit, but ultimately, sales were sort of flat in that June late timeframe.

Okay. And then, as we think going forward from here, can you help us understand some of the drivers of sales? So it sounds like you're getting an incremental boost from the marketing of the $7 menu. Anything else you talked about kind of more effectively driving frequency or trial with the LEANguini? How confident are you in terms of really material, intangible drivers to offset some concern about further weakness on the consumer?

Well, I think part of the confidence just comes from the fact that we've actually started seeing some momentum here in the last week or two, and we have a clear impact. Whether it be LEANguini, which we see continuing to increase in mix week after week. So we feel that that will continue to be kind of a slow burn, and will continue to be a driver of sales as we go forward. We have seen our net promoter score—the guest metrics improved dramatically over the last several months, and our teams are running at better cook times than what they did a year ago. Staffing is back to prior levels, so we do see a tailwind as you have more dine-in guests come that will help as you've seen with the delivery or the digital numbers. We've been able to retain that. So between our digital strengths, LEANguini gaining traction, and the nice momentum, we’re seeing in some of the really targeted marketing around seven for $7, we still feel there are quite a bit of potential tailwinds. Not to mention we will kind of reinforce catering for the first time in a few years as we go into Q4; there will be some culinary innovation, looking at plant-based protein potentially rolling out nationwide during Q4. So we'll have continued innovation pipeline as well to help support that average unit volume growth target.

Great. And then on the development for 2022, obviously a pretty large decrease to 21 to 23 from 35 new openings. And before you had given us that 70%, we're expecting to be company-owned of the 21 to 23. How many of those are expected to be company-owned?

The vast majority; there will only be three or four that are likely to be franchise. They're encountering some of the same challenges that we've seen, and you see it throughout the industry as well. Again, when we set those targets in early 2021, we didn't foresee how challenging the environment would get from the real estate timing perspective. The availability actually is quite strong, but it's been the timing. And we hope that we have been able to navigate through that here in 2022. Ultimately—and just to give examples—we've seen things like utility companies not having the staff to turn power on time. We've seen developers with new developments unable to get asphalt to complete their base building delivery day for us. You're seeing permitting take a lot longer than historical. So much of that has been seen not just by the company, but also in franchises as well. But this also gives us confidence that as we see the strength of that 2023 pipeline, we see some of the benefit from some of the carryovers of some of these sites that have taken longer, so we've got great confidence in that target for 2023.

Okay, great. And then my last question is just on pricing. You mentioned that your pricing in the second quarter was about 10%. You think it’s going to be about 10% in the third quarter. I was wondering just when new pricing has come on, when it's rolled off, just in terms of the impact of that $1 surcharge, that’s now no longer going to be in effect. If you could help us understand when you've taken price too, so we can kind of have some visibility into the fourth quarter. And then also whether you're open to larger competitors taking in more price. And that's healthy margins. But what's your appetite for continuing to take any price, even in this environment?

That's right, so you're right, for the second quarter, we have pricing just over 10%, and we're expecting the same for the third quarter. Predominantly because that chicken surcharge, which contributed about 3% of price, is rolling over towards the core menu. Encouragingly, when we had the surcharge in place, we did not see really any impact in terms of chicken or protein attachment. We didn't see guests opting out of chicken or swapping chicken for other proteins. In terms of attachment, that continues to build our confidence in terms of the price that we have on the menu. When we thought about pushing the surcharge throughout the entire menu, again, we look at this surgically through the inelasticity of the dishes. But predominantly, we were preserving $7 entry points still for seven of our core dishes because that's really critical in terms of an entry point. So even by pushing that price out, we were able to preserve that. And that helps just to underscore the value proposition.

Yes, in terms of additional price, we've experienced some impact on the low-income consumer in terms of some pullback. That’s I think others have seen similar things. Fortunately, again for us, that's not much of our consumer. I would say that what is maybe a little bit unique, Jake, is for us, the particular inflation, we believe has peaked, and we are now on the other side of it. So in terms of needing incremental pricing to overcome additional inflation, when you see chicken prices down pretty dramatically for chicken breast. And it’s chicken breast, as a reminder, as that comes down dramatically, as you see some of these initiatives roll in, we believe we can absolutely expand margins without having to adjust the menu. Not to say we don't have pricing power; we absolutely believe we do. But we feel that there is enough momentum that we can see that we are actually on the rank side of seeing inflation start to come down.

Great, and then I'll just sneak one quick one. You mentioned 13% wage inflation. I think you stated that's industry-wide as well as I would imagine higher wage inflation from the back half of last year. So what is your expectation that wage inflation is going to come into a more historical range? Or are you kind of planning for it to remain quite high for the back half of the year?

Embedded into our Q3 guidance is that we continue to see some relatively high inflation, so above double-digit. There are signs that you're seeing throughout not just the industry, but kind of throughout the economy, that this is starting to normalize. Similar to many others, we did a lot of investment in our teams during the back half of 2021. So mathematically, we would assume that there’s potentially some relief there. But it’s probably a bit premature to guide to what we would expect that inflation number to be in Q4 of this year.

Thanks. I appreciate it.

Thank you, Jake.

There are no further questions. I'd like to turn the call back over to David Boennighausen for any closing remarks.

Thank you, Michelle. You know, lots of discussion inside and outside the industry on the current economic environment, everything from demand to inflation. But I will tell you from our brand's perspective, we remain extremely confident in the business's trajectory and our ability to meet our objectives. Importantly, we're seeing strong signs and we have a clear path toward accelerated unit growth and margin expansion. We feel we're on the positive side of both of those initiatives, and we look forward to sharing with you that progress on our future call. So thank you and stay safe.

This concludes the program. You may now disconnect. Everyone have a great day.