Potbelly Corp (PBPB) 2013 Q3 法說會逐字稿

Good afternoon and welcome to Potbelly Corporation's third-quarter fiscal 2013 earnings conference call. The call will begin with prepared comments by management followed by a question-and-answer session. (Operator Instructions). Please note today's call is being recorded. I would now like to turn the call over to Charlie Talbot, Potbelly's Chief Financial Officer. Please go ahead, sir.

Thanks. Good afternoon, everyone, and welcome to our third-quarter 2013 earnings call. Before we get started I'd like to note that certain comments made on this call will contain forward-looking statements regarding future events or the future financial performance of the Company. Any such items, including targeted results for 2013 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. I refer you to the documents the Company files with the Securities and Exchange Commission, specifically the Company's final prospectus for its initial public offering which was filed October 4, 2013. This document contains and identifies important factors that could cause actual results to differ materially from those contained in our projections and forward-looking statements.

Now I would like to turn it over to Aylwin Lewis, Potbelly's Chairman and Chief Executive Officer.

Thanks, Charlie, and welcome, everyone. Before I get started I'd like to give a moment to thank everyone that helped us through the recent IPO process. Our employees, customers, investors and advisors are all essential to this effort. I want to thank the new investors who spent time learning our story and they recognize hopefully the tremendous opportunity we have here to become a global iconic brand and to create shareholder value.

Our mindset around our IPO was never that it was a destination but rather it was a threshold and we are on this journey toward excellence. And excellence to us is meeting commitments to our long-term targets.

During the IPO process we communicated the following long-term targets -- new unit growth plus 10% for a long period of time; low single-digit same-store sales growth; at least 20% growth on our adjusted EBITDA; at least 20% growth on net income; and at least 25% return on invested capital as measured by second full year profit of our new shops. Also we communicated our shop margins would stay over 20%.

We will continue to report non-GAAP measures such as adjusted EBITDA and adjusted net income; we believe for the foreseeable future these metrics will help our investors get an appropriate view on the underlying growth of the business.

In regards to quarter three, our results were in line with our communicated targets. During the quarter we opened eight new Company operated shops and one franchise shop, bringing our year-to-date total to 25 company-owned shops and four franchise openings. This equates roughly to 14% shop growth over the last 12 months.

For the quarter our comp sales growth for Company operated shops were 2.5%, adjusted EBITDA improved by 24.9%, our net income rose 26.7% to $0.15 per share on a diluted basis. Charlie will go into much more detail about the numbers, but overall we are pleased with our first-quarter reporting and we feel like we are off to a good start.

Just want to take a minute to kind of reiterate who we are, what we are, what we are trying to do here. We compete in the fast casual category; we also compete in the sandwich category. The intersection of those two spaces we believe the concept has a lot of room to grow. We are fast casual because we have irresistible food at a fair price, we have customizable product, ease of ordering. We really spend a lot of time thinking about our experience which is our awesome product, people and place.

We operated at the end of the quarter about 307 shops, 288 are company-owned, located in 18 states and the District of Columbia. We have 19 franchise shops, 12 in the Middle East and seven in the US.

We talked about on the road show the four things that investors should look for and invest in us and we want to reiterate that. We believe we have significant whitespace, from a geography standpoint from a concept standpoint. Strong unit economics with our shop margins of over 20%. This is a self funding model; we use our cash that we generate from existing shops to invest in new shops. We also have a very bulletproof balance sheet.

We have a deep and abiding culture that we spend a tremendous amount of time talking about and using to run the Company. And then we have a strong management team, core, it's been together since 2008. Largely responsible for the results we've accomplished in that timeframe.

It's very important that everyone understand we run the business to grow cash each year. We have (inaudible) mentality around everything we do. Supplies to shop level sales, supplies of property results, supplies to G&A productivity. We build shops to make money so our focus is on the returns generated by our capital investments. It's important to understand that our new unit development and the models we use help us understand how much occupancy cost we should pay for our new shops.

We have a salary capped mentality at our support center, which means that we have a fixed dollar amount as we think about G&A. It's important that we leverage it over time as we grow the business. Very disciplined around our spending initiatives and we want to spend our money closer to the shops.

Same-store sales is important to us and we have committed to low single-digits. We have a process called a sales pyramid that we use to grow sales organically. The base of that pyramid is our best place for lunch, which means that between the hours of 11:30 and 2:30 we want to grow our business. This foundation was established to help us really understand how to grow -- our operators to understand how they should grow their sales day in and day out in our shops.

Second part of the pyramid is what we call growth drivers, (inaudible) client and catering, neighborhood outreach and music are all part of the tools that our operators can use at the shop level to grow their sales. From a promotional standpoint we have four windows a year that we merchandise and promote in the shops.

For example, in quarter three we introduced our Toasty Turkey BLT featuring premium bacon and that has performed well. This quarter you will find us advertising our new pizza sandwich in most of the markets.

Our promoted items are made from ingredients -- existing ingredients, so although they are a limited time offering you can always get the product in the shop once it is not advertised. Neighborhood sandwich shop is more than a slogan for us, it is our building model. It means that we expect the shops to open, create tremendous loyalty, word-of-mouth, that allows us to be a little market expense. In fact we spend less than 2% of our sales on marketing.

As we discussed in the road show, the foundation to our success is predicated on running great operations. We measure operators using a balanced scorecard approach which focuses on people, customer sales and profits.

Turning to development, as mentioned before, in quarter three we opened eight new Company restaurants and one franchise restaurant. And as of September 29 we've open 25 Company operated shops and four franchise shops. Over the last two years we've opened four hub markets which are Seattle, Boston, New York and Phoenix. We've also opened some help markets in Cleveland, Kansas City, St. Louis and Portland. Entry into these markets are key for us. We'll open a hub city every 18 to 24 months.

Every market that we currently do business and is open to growth. Expect the growth to be at least 10% in our legacy markets and in the hub markets the growth will average between 10% and 20%.

People ask us how and why can we grow faster? Our answer is, we always have to match our people capability with our financial capability. So the limit factor on our growth is building great Potbelly leaders that can run our shops, manage our shops so we continue to have excellent operations and have an excellent business model.

So the headlines here is that we kind of delivered on what we promised, we're recognized as the first -- our first-quarter reporting but is good news so far. So I will turn it over to Charlie and he will go through the details of our financial results.

Thanks, Aylwin. As Aylwin mentioned, we are pleased with our fiscal third-quarter results. Overall total revenue increased 11.7% in the quarter to $78 million driven by strong new unit results and an increase of Company operated comparable shop sales of 2.5%. The 2.5% comp growth, which continued the momentum from Q2, was driven primarily by check growth from our price increase back in Q1 of roughly 2% and also, as Aylwin referenced, our Toasty Turkey BLT Q3 promotion which helped our check.

Same-store traffic during the quarter was slightly negative but improving sequentially from the first half of the year. And one additional note, there will not be any -- there is no additional pricing contemplated for the fourth quarter. Moving to the P&L shop level profit margin for the quarter was 20.9%, above our long-term target of at least 20% an increase of 50 basis points from prior year, this improvement was driven by our comp growth and strong shop level flow-through, specifically in labor and operating expenses, slightly offset by new unit opening inefficiencies.

The following are some additional detail in Q3 results and Q4 outlook for major areas of our P&L. Cost of goods sold as a percent of net sandwich shop sales increased in the quarter to 29.6%, which is up 50 basis points from prior year and 40 basis points from Q2. It's driven by inflation and an introduction of the new higher-quality bacon that Aylwin mentioned in conjunction with our Toasty Turkey BLT launch.

From a dollars perspective year over year food inflation was roughly offset by pricing. And in looking at Q4 we expect food costs to come down slightly from current levels driven by a lower mix of Toasty Turkey BLT sandwiches and similar levels of food inflation, which should be mostly offset by our Q1 price increase.

Labor as a percent of net sandwich shop sales decreased in the quarter to 27.3%, down 90 basis points from prior year, driven by sales leverage from comp growth, timing and new shop inefficiencies. As a reminder, our new shops on average will open up with shop level profit margins in the high single-digit or low double-digit territory as we invest in labor and staff up the unit to enable a good strong opening.

This initial investment can vary depending on whether the shop is in a new market, which typically requires more investment to staff the bench, or an existing market which typically requires less. In Q4 we expect labor as a percent of net sandwich shop sales to increase by 75 to 100 basis points from Q3 driven by normal business seasonality in Q4, including holiday week and the deleverage of fixed labor.

Operating expenses as a percent of net sandwich shop sales decreased in the quarter to 10.2%, down 30 basis points from prior year, driven primarily from strong operating controls at the shop level and sales leverage. In Q4 we expect operating expenses as a percent of net sandwich shop sales to increase 30 to 40 basis points from Q3 driven primarily by normal business seasonality in Q4.

Occupancy expense as a percent of net sandwich shop sales increased in the quarter to 12%, up 30 basis points from prior year driven primarily by more shops operating in higher rent market such as New York City and Boston. In Q4 we expect occupancy expense as a percent of net sandwich shop sales to increase 50 basis points to 100 basis points from Q3 due to normal business seasonality in Q4.

General and administrative expenses increased to $8.3 million during the third quarter from $6.9 million in the third quarter of 2012. The increase was driven by approximately $1.8 million of costs associated with their IPO and ongoing public Company costs. Including a one-time $1.1 million charge for stock-based compensation and $300,000 of nonrecurring legal expense.

Upon completion of the IPO in Q4 we expect an additional nonrecurring stock-based compensation expense of approximately $8.8 million and one-time IPO-related expenses of approximately $200,000. As a percentage of revenues general and administrative expenses increased to 10.6% during the third quarter from 9.8% during the same period last year.

Excluding the public offering planning and ongoing public Company costs, general and administrative expenses was approximately $6.5 million or 8.3% of revenue which is a 140 basis point improvement from prior year. Driven partially by lower SportsCenter bonus and leverage. In Q4 we expect base G&A dollars to track similarly to Q3 levels.

Now as Aylwin mentioned, our adjusted net income for the third quarter was $3.2 million or $0.15 per diluted share compared to $2.5 million or $0.12 per diluted share in the same fiscal period of 2012, which equates to 26.7% growth over prior year. For clarity Q3 adjusted net income excludes the impact of the $900,000 nonrecurring public offering planning expenses, as well as 200,000 impairment expense net of tax.

Additionally, it is important to note that we had a full valuation allowance against our deferred tax assets which in effect reduced our tax effective tax rate in 2012 to approximately 8% while our effective tax rate and 2013, subsequent to the release of our full valuation allowance is approximately 38%. So if you apply the 2013 effective tax rate of 30 A % to the prior year our adjusted net income increased by approximately 95% versus 2012.

Adjusted EBITDA for the third quarter was $10 million compared to $8 million in the same fiscal period 2012 equating to a 24.9% growth over prior year. Adjusted EBITDA excludes the impact of impairments, closures and non-cash stock compensation expense, preopening expense, public offering, planning and ongoing public Company costs.

For a reconciliation of our reported to adjusted net income and adjusted EBITDA please refer to the reconciliation table included in our third-quarter earnings release.

Now let me turn to the fourth-quarter and full-year outlook. We will open 33 of the 34 Company operated units and seven to eight franchise shops for a total of 40 to 42 shops representing total shop growth of 14% to 15% for the full year. Looking ahead our 2014 outlook is 35 to 40 Company operated shop openings and five to eight franchise openings equating to 13% to 14% growth.

Turning to Company operated sales growth, I want to make sure everyone understands the holiday week comparability in 2013 versus 2012 due to the 53rd week in 2012 and the corresponding impact of our Q4 comp projection. So in week 52 of 2012 it was a non-holiday week when compared to 50 -- week 52 of 2011 which was a holiday week. Week 53 of 2012 was a holiday week compared against week one of 2012 which was a non-holiday week. Therefore Q4 2012 comps as reported at 2% is reflective of 14 weeks versus 14 weeks with holiday weeks included in both years.

In 2013 week 52 will be compared to a non-holiday week, week 52 of 2012. This will negatively impact our quarterly and full-year comp result. The impact due to the holiday shift is approximately 230 basis points and 50 basis points for the quarter and full-year respectively. With that being said our full year outlook, including the impact of cycling the 53rd week, is 1% to 1.3% excluding the holiday week impact this guidance would equate to comps of 1.5% to 1.8%.

Our projected adjusted net income for full-year is between $7.5 million and $8.1 million which equates to growth of approximately 40% when neutralizing the tax rate difference and eliminating the one-time benefit recorded for the release of our valuation allowance in Q4 2012. As we have outlined in the press release, adjusted net income excludes the impact of one-time IPO costs related to expenses and impairment, closures and disposal of expense.

Our projected number of shares outstanding for the full year 2013 is expected to range from 23.5 million to 24.5 million shares. This range is estimated based on the weighted average basis and accordance with GAAP as well as certain other assumptions. For the full year as well as for Q4 we expect an effective tax rate of 36% to 30%.

In addition, in the fourth quarter upon closing of the IPO in October on October 9, we received net proceeds from the offering of approximately $108.8 million after deducting the underwriting discount and other estimated offering expenses in the fourth quarter we paid the previously declared cash dividend of approximately $49.9 million and repaid borrowings of $14 million under our credit facility. We project our yearend cash balance in the range of $70 million to $75 million.

Finally, for the full year we project our CapEx to be between $28 million and $30 million. With that I will turn it over to Aylwin for summary remarks.

Thanks, Charlie. We really appreciate your willingness to join on the call and your interest in the Potbelly story. This is our first report, so it's positive, we feel good about that. This is a journey to us. We take our annual commitments very seriously and we are going to work as a management team to meet or exceed those on a routine basis.

We continue to work to deliver on our passion to be the best place for lunch, to be the neighborhood sandwich shop and our culture is what really helps us drive the business day in and day out. So with that I will turn it back over to the operator and we'll open it up for any questions we may have.

(Operator Instructions). Joseph Buckley, Bank of America.

A lot of information in this release. So I guess let me ask first just on the expansion numbers, are they coming in towards the low end of your expectations? Are they a little bit lower than what you were thinking a couple of months ago? And could you talk a little bit about where your opening the stores and kind of high-volume markets, low-volume markets, how the effect of the store openings is playing out in terms of the effect on the revenue growth?

Well, Joe, this is Charlie. Just really quickly on the numbers, I think we are right where we thought we would be from an opening standpoint. And so, we are pretty happy with the way this year is playing out with the 33 to 34 outlook.

In terms of where we are opening the stores, like we told you before, it is a mix between our heritage markets, which are markets we have been in for a number of years and some of the newer hub cities that Aylwin talked about. And so it is been roughly 50-50 for most of the year on that.

Okay, and then I guess you see -- just the guidance I guess for the rest of 2013. Could you just go through the same-store sales assumptions again for the fourth quarter kind of X the holiday week just like week to like week?

Sure. So just want to -- I mean I want to make sure because of the 53rd week last year that we are consistent with how we are talking about this. So, for Q4 from a reported standpoint we are looking at negative 1.2 to negative 0.5%, that is an actual number. Once adjusted Q4 would be in the 1.1% to 1.7% range, positive.

Okay. That is helpful. And then just a question, you gave us in the prospectus the account numbers for the first 11 weeks of the quarter, and up 2.3, you did 2.5 for the full quarter, so it looks like you closed the quarter on a pretty strong note. A lot of the companies have talked about sales getting better in October. So can you just talk a little bit about the trends you saw at the end of the quarter and maybe what you're seeing at the beginning of the fourth?

Yes, we saw -- I mean we have been -- our trends have been very stable for most of Q3 and into Q4. So really what you are seeing -- we measure our business from a sales standpoint on a DC's (inaudible) trend perspective so we don't get into the last year's noise discussions. So our trends are very stable, we fill good about where we are and they are very consistent with where we were ending Q3.

Okay, okay, thank you.

Nicole Miller, Piper Jaffray.

Could you please give us an update of the percentage of managers living in the market and where that still is from a long-term opportunity?

67%. It's the same number we kind of reported at the analyst day, the goal is to get to 80% over time. So we are at 67%.

Okay. And then in terms of extended hours and drive-through's, can you give us an update on those numbers as well? Because I think those are a couple of the comp drivers.

Drive-through hours are pretty -- the drive-through -- we don't have extended hours in the drive-through, so (multiple speakers).

Two separate things, I am sorry, Aylwin. I mean I think you are going a little bit in some places where you could extend maybe into the 2 to 5:00 PM dinner hour. Sorry to not have been clear. And then separately, how many stores with drive-through's today and would that be part of the remodels or just new unit development?

So 15 to 20 drive-through's, we like drive-through's, we will continue to build them. And the three to five day part is something that we believe we have an opportunity to grow. We haven't spent a lot of time putting plans together on it but it is an opportunity for us.

And just the last one, can you please hit on the investments you have made historically to achieve the 50% flow-through, which I believe is higher than your peers? And is that still the same flow-through you are seeing today? Thanks.

Are you talking about flow-through on incremental sales growth?

Yes.

Yes. So that is a measure we pay close attention to and we are on track to do 50% plus this year. So it is a number that we have built plans around, it is a number we talk about all the time. So we are very focused on that.

Thanks for the update.

Michael Kelter, Goldman Sachs.

I just wanted to maybe first follow up on Joe's question on same-store sales. So the guidance, if we just do it adjusted and adjust for these holiday weeks. So adjusted 1.1% to 1.7% is below the 2.5% that you just posted. So I am curious just to hear what other moving parts -- I know there are some other puts and takes around the fourth quarter you talked about over the last few months. Can you just remind us what those moving parts are and how we should be thinking about the fourth quarter number?

Yes, I think the best way to think about it and the way we think about it is just really to look at, as I mentioned, DC's last trends. And so the way we have modeled the business is assuming trends consistent with Q3. So you get into all sorts of questions around two year or three year rollover, but I guess the short answer is, Q4 is modeled basically with consistent trends to Q3.

And we also -- we had this little thing called a government shutdown that impacted -- it looks like it is going to be 0.3% to 0.5% from a DC standpoint. So you had two weeks of those shops with their business severely impacted. So that is a moving part that obviously we didn't plan for and has a negative impact.

And then you ended the IPO process with a lot of cash, I think you said $70 million to $75 million by the end of the year. But the unit growth, as you mentioned, is self-funded. So what is the thought on the cash that is now sitting on the balance sheet? Is it something that makes sense for you to keep just for the strength of the balance sheet? Is there a thought towards deploying it back to shareholders at some point? Or might this good towards accelerating unit growth over the next couple of years?

So obviously having the cash on the balance sheet is very helpful at this point. And we have not as a management team or with the Board kind of formulated uses of that. Obviously having it means that we are pretty bulletproof and we kind of like that. And over time we will determine what we are going to do with it.

And the class of stores for 2013 now that you are almost through the year, can you maybe kind of retroactively now look back and talk about what worked, what didn't, what the AVs and restaurant margins looked like for system average, things like that?

Well, it is kind of what we communicated before, the range is between [0.8%] and 1.4% with the average of 1.1%. And like Charlie mentioned the first your margin is 10% to 15% depending on whether it is a hub market or a legacy market. And we fully expect those to get to the return full second year. But the class has been a good class for us.

So it has been a good class. And we are at the point now -- in fact I met with the development team today and we talked about lessons learned and what can we apply to 2014. So we will be formulating that. We still have a few more to go before the end of the year. But it has been a good class.

And then lastly, just kind of talking about labor, you came down quite a bit with 2.5% same-store sales. I guess what is a level of same-store sales that you generally need to lever your fixed cost base? Is 2% plus enough to generate leverage or was there something specific about this quarter?

Low single-digits is what we are promising and with low single-digits the model kind of works.

That is great. Thank you very much.

Sharon Zackfia, William Blair.

Aylwin, you mentioned the government shutdown and that was actually one of my questions. I know you have got a lot of locations in the Washington DC area, can you kind of frame for us what, if any, hole that started for you in the month of October? I know Charlie said the trends were fairly consistent. But lunch in Washington DC I would assume would have had to have been tough for the first couple weeks of the month.

Yes, and like I said it was 0.3% to 0.5%. And obviously it was unplanned. But literally in those situations there is nothing you can do. We kept the shops open and ran them as tight as possible, but the folks that came in we wanted to give them good service. So two weeks was not onerous, a month would've been very tough. But we will finish out the quarter and see where we stand. But right now we are estimating it is a 0.3% to 0.5% hit to the top-line.

And that is for the full quarter?

Yes.

Yes.

Okay. And then just on G&A, I think it was a lot lower if you adjusted it down to the $6.5 million than we had expected and it sounds like it is going to be lower in the fourth quarter than initially expected. Is there anything -- it sounds like it must be ongoing if it is slower for two quarters than originally planned. So can you give us some more color on what is going on with G&A?

Well, one of the things to keep in mind, I mentioned in my remarks that the Q3 G&A was supported by a lower bonus accrual relative to the year before. So that is just something to keep in mind. But we do think the base trends on G&A for Q4 will be consistent with Q3.

Okay, thank you.

(Operator Instructions). David Tarantino, Robert W. Baird.

Congratulations on a good first report as a public Company. Charlie, my question -- and maybe Aylwin too, my question is really related to the same-store traffic trends. I think you mentioned slightly negative in the quarter and I realize it was a very tough environment to grow traffic.

But just curious to know your thoughts on your ability to drive traffic into positive territory and what you think some of the levers for that might be, whether it is better throughput during the peak lunch hour or more -- or different types of marketing tactics? If you could just talk about your thoughts on that, that would be great.

Well I think, -- I guess to answer your question, yes, it is a focus on throughput which is ongoing, it is a focus on the growth drivers that Aylwin mentioned in his remarks around back line in particular, but certainly the neighborhood activities that we have got going on.

And so, I think our mindset is around low single-digit comps. There are going to be some years that is traffic driven, some years that is [spec] driven. And we're going to continue to operate the model at that level. So we can make excuses, we could talk about the environment, but the reality is we delivered 2.5% growth and that helped us with the model.

Great. And then maybe as a follow-up, do you think you are somewhat constrained in your ability to drive that traffic at lunch given the high volumes you already have at lunch? Or do you think there is opportunity to really get more people through the line during that period?

No, we don't. In fact, it is the base of the sales pyramid. And we will use staffing levels, we'll use new equipment, we will use technology to help us with throughput. Our mission is, number one, we win by winning at lunch, fish where the customers are biting and we will continue to focus on throughput during that period of time. It is essential for us and it is a high focus area.

And I think the way we do that, just to give some color to Aylwin's point, we don't think there is any constraints that we can see simply because when you have 200 to 300 shops in your system there is always someone doing something that the other shops can learn from. And so, we have shops that are doing significantly higher throughput numbers than others and we point those shops that have opportunities to the shops that are performing well. So we will continue to do that. And so I think from an opportunity standpoint we will continue to drive it.

Great. And then one last one on the equipment side. I think you've talked in the past about rolling out faster ovens. Can you just give us an update on where you are on that at the end of the quarter and where you think you will be as you exit this year on that front?

We will have -- the goal is to have them in every shop by the end of next year. We will have about 80 that we will need to deploy for next year.

Great, thank you very much.

Joseph Buckley, Bank of America.

Thank you (inaudible). I got your opening range, 35 to 40, just as you told us. I was wondering if you could help us just the type of markets you are planning to open in the next year. Do you have a sense of the mix and how (inaudible) legacy markets?

Yes, we had said on the road show and we stick to it, 60% of next year's target will be in legacy markets, which means 40% will be in the newer hub markets.

Okay. And then just a question on the pizza sandwich promotion and actually in New York City we're seeing the [Clubby] I guess. And what impact -- so I'm assuming the big sandwich is probably the more prevalent one throughout your system. What impact will that have on check? And is that a little bit more food friendly, food cost friendly I guess then the Toasted Turkey BLT?

Yes, the Toasted Turkey had premium bacon, this one is not. And I have got to say that in the (technical difficulty) we are on a different calendar. We don't have a full menu into the hub cities. So that is why we are doing the Clubby in New York, it is also in Seattle, Phoenix and Boston. And over time we will merge the menus. But we call it lifecycle marketing for the hub cities. But the pizza is much more friendlier from a food cost perspective than the Toasty Turkey BLT.

Okay. And would it have a similar impact on check as the Toasted Turkey BLT, or would that be a little bit lower as well?

Yes -- same price point.

Okay. Okay, thank you.

And there are no further questions at this time. I would now like to turn the call back over to management for any closing remarks.

We want to thank everybody for participating on the call and for your interest in Potbelly. We are a lunch pail type of Company, believe in hard work, very dedicated to our customers and to our employees and to our investors. So we look forward to speaking to you next quarter and, if you have a chance, get out to the local Potbelly.

Thank you for participating in today's conference. You may now (technical difficulty).