Potbelly Corp (PBPB) 2014 Q1 法說會逐字稿

Good afternoon. Welcome to Potbelly Corporation's first-quarter FY14 earnings conference call. The call will begin with prepared comments by management followed by a question and answer session.

Today's call is being recorded.

(Operator Instructions)

I would now like to turn the call over to Mr. Matt Revord, Potbelly's Chief Legal Officer. Please go ahead.

Good afternoon, everyone, and welcome to our first quarter 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 for the future financial performance of the Company. Any such items, including targeted results for 2014 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 over could differ materially from those projections due to a number of risks and uncertainties. Additional detailed information concerning many of the risks regarding our business and the factors that could cause actual results to differ materially from the forward-looking statements and other information we give you today, can be found in our most recent annual report on form 10K under the headings Risk Factors and MD&A, and in our subsequent filings with the Securities and Exchange Commission, which are available at sec.gov.

Our presenters our Aylwin Lewis, our Chairman & CEO, and Charlie Talbot our Chief Financial Officer. Aylwin will begin with a brief overview of our first quarter financial results and discuss some recent developments, while providing a discussion of our ongoing strategic initiatives. Charlie will then review our financial results and future outlook in more detail before we open the call up for your questions. Aylwin?

Thanks, Matt. Thank you, everybody. Thanks for joining the call.

I want to begin by saying our performance for the quarter was satisfactory, given the significant weather that negatively impacted our comps, roughly 375 basis points. Despite those headwinds, our adjusted net income increased 528% to $200,000 or $0.01 per diluted share. Our revenue increased 7.5%, basically on the strength of our new shop openings, which was partially offset by our Company operated shops same-store sales of negative 2.2%.

Everybody discussed the weather in Q1. We're kind of tired of it. But to dimensionalize, out of the 91 days in the quarter, 37 of those days were either impacted by extreme cold or extreme precipitation. That being said, we're very confident in the fundamentals of our business. We believe we are on track to achieve our previously disclosed guidance of low single-digit comps for the fiscal year.

Charlie's going to talk about our financials in much greater detail. What I'd like to do is talk about the business and how we're going to support our growth plans for the balance of the year and in the future.

First, an update on our development. We opened for four plus cities over the last couple of years, New York, Seattle, Boston and Phoenix. As I mentioned on our last call we are in line to open a new hub market every 18 to 24 months. Late last year, as we were examining our strategic plan, we decided that Denver would be our newest hub city.

We open a hub market in hopes eventually that hub will become a regional city for us. Denver and its adjacent markets will provide an awesome opportunity for us to grow neighborhood by neighborhood in that mountain region of the US. We currently have three to five shops in the pipeline for Denver this year. We expect our first shop to open this summer.

As we continue to expand the business our geographical imprint will also grow. We take a very measured and disciplined approach to development. We really believe in the Denver market. And we think by growing in our legacy markets, as well as new hub markets, we will achieve our stated goal of at least 10% new unit growth for a long, long period of time.

Let's talk about our menu and menu development. Our passion is to be the best place for lunch. A simple menu is very important for us, because a big part of what we do in that 60% of our business from 11:30 AM to 2:30 PM, is drive speed with great product quality. So our menu is very simple.

We recognize that we can't stand pat. So, first quarter we typically celebrate and market our skinny product, which is our answer to value and better for you because it has less calories. In mid-March we introduced a new salad, which was our Chicken Mediterranean salad, which was chicken with chickpeas, feta cheese, artichoke hearts, and roasted pepper. Salads are an important part of our menu.

I'm excited to talk to you today about a product that we feel very excited about. Today we rolled out in our legacy markets, a product that we call FLATS. FLATS is a thin, multi-grain bread that provides our customer with a whole new way to experience Potbelly. We believe FLATS will broaden the appeal of our sandwiches to both existing and new customers.

Customers who love originals will believe they can use FLATS to experience the great product and the sandwiches they like. For customers that are not ours, we believe that FLATS is a tremendous experience. It accentuates the flavor of our product. It's 90 calories less than our original product. We have been working on this product for multiple years and testing it and getting the formula right. Our test results in our test market was strong. We got great customer feedback. So FLATS is now part of our menu.

We will continue to drive menu innovation because we know it is necessary for us to grow. In our existing markets you will see a traditional media in Chicago and DC. We will use nontraditional media in the rest of the Company.

Also we will -- starting today we introduced Bigs in New York City and Boston. As part of our lifecycle approach to marketing where we're allowing the brand in the hub markets to develop naturally, the way Potbelly developed in our legacy markets. So now Bigs will be in New York and Boston. We are advertising our legacy salads in Seattle and Phoenix this quarter.

Technology is important, so we continue to use technology to drive our throughput at our critical lunch period. By the middle of the summer, all of our shops will have our fast oven. That oven reduces 40 seconds off our old oven time. We've had this oven in our fleet over the last five years. We decided to make sure it is in every shop by the end of this year.

In March, we introduced our mobile application which works on Android devices and iOS operating systems. In fact, you can get it off iTunes, the Apple system. The mobile app will allow customers to find their nearest Potbelly. Will also allow them to get nutritional information. They can also order product to pick up or be delivered. I think the mobile app is a great way for customers to access the brand and use the devices that are becoming very popular.

Over the last year and a half we have made great strides in our backline business. It's all the orders that happen not on the front line. It encompasses delivery, pick up, and catering. In fact, over the last two years we've hired six catering managers across five markets in our business. We are in the process of adding another catering manager in another market. These catering managers are dedicated 100% to driving our catering business -- big orders.

Backline business allows us to extend the brand outside the footprint of our shops. It is one of the fastest growing parts of our business. And in fact this year it really helped us in the first quarter as our managers and teams really worked hard on this part of the business. We operate it increasingly as a separate business from the front line. We call it a brick wall mentality between those two businesses. And it will become and continue to be a very essential part of how we run things and grow our business.

In summary, our teams, I think performed well in Q1. We are never pleased with our results when they don't hit what we have specified. But given the very challenging weather, it is hard as a management team to know what to do when you have things that you don't control. Those 37 days impacted our business approximately negative 7.7%. So you see we worked hard on the other days to whittle that down to negative 2.2%.

We continue to believe in this business. Our unit development, our menu development, our technology initiatives are all geared to help us grow this business. Our fundamentals are strong. Our culture is strong. The management team is strong. While Q1 was impacted negatively by weather, we believe the underlying business is still strong and we remain committed to delivering on our long-term results, as well as what we stated with the annual results will be for this fiscal year.

Now I will turn it over to Charlie and he will walk you through the details of our financial results.

Thanks, Aylwin.

As Aylwin mentioned, we delivered solid first quarter results. Total revenue increased 7.5% in the quarter, to $74 million driven by strong new unit results, partially offset by a decrease in Company operated comparable shop sales of 2.2%. As Aylwin state earlier, the winter weather is old news, but now that it is behind this I want to provide more specifics on the impact to our first quarter results.

Overall we estimate the weather impacted first quarter revenue by roughly $2.7 million and comps by 375 basis points. This is driven by nearly a 500 basis point impact in both January and February, and roughly 180 basis points impact in March. Nearly 80% of our shops are located in areas impacted by atypical weather during the first quarter, including the Midwest, Northeast, and Mid-Atlantic.

And as Aylwin mentioned, 37 of the 91 days, or roughly 40%, in the quarter were negatively impacted by either extreme cold temperatures and/or snowfall. Comparable shop sales for these 37 days were down 7.7%. It is also worth noting in the quarter results positively impacted by roughly 70 basis points from the Easter shift into the second quarter.

Neutralizing these factors the underlying comp trend was slightly below 1% comp growth for the quarter. With February and March trending in the 1.5% to 2% range. Our average check growth for the quarter was around 1.5%, driven from roughly 0.5% pricing that we discussed on the last call and the remaining from menu mix growth. So with all that being said, we are encouraged by the underlying business trends and the positive trajectory in the second half of Q1 and as we head into Q2.

Moving down the P&L, shop level profit margin for the quarter was 17.5%, a decline of 120 basis points from the prior year. The decrease was driven by deleverage of fixed expenses and the margin ramp up of nine new Company operating units openings in the quarter. I would say overall, our general managers did a really good job of managing what they could control inside the shops. Specifically on labor scheduling and food prep, given the inconsistency of volumes.

Cost of goods sold as a percentage of net sandwich shop sales decreased in the quarter to 28.7%, down 50 basis points from prior-year, driven primarily by lower commodity costs, in addition to lower levels of waste. In late 2012, we implemented a new food cost system. As our operating teams have become more comfortable with the new system we have started to lower levels of waste in the shop, which we are optimistic will continue.

The deflation the quarter was driven by number of key products locked into the first quarter and favorable pricing terms. Despite the deflation in the first quarter, I think it's important to note we still expect roughly 1% to 2% inflation for the year. Our food cost basket is roughly 70% locked for the full year, and the sequential step-up in inflation is really being driven by proteins and dairy, in the back half of the year.

Labor as a percent of net sandwich shop sales increased to 29.2%, an increase of 30 basis points from prior-year. This was driven primarily by deleverage of fixed labor expense and also the addition of nine Company-operated shops during the quarter versus six in the prior year. For the full year of FY14 we maintain our expectation that labor as a percentage of net sandwich shop sales will range from 28% to 29%. We anticipate leverage from our comp units, partially offset by labor efficiency in some of the 34 to 40 Company operating new openings in 2014.

Additionally, we will experience some impact from the Washington, DC and Minnesota minimum wage increases effective midyear. It's also important to note that labor will fluctuate by quarter, based on sales seasonality and timing of new unit openings, which we expect to be more heavily weighted toward the second half of the year. In addition, we recognize there may be some timing fluctuations from payroll tax expense on options that exercises in 2014, with more risk potential in the second quarter given the lockup expiration.

Operating expenses as a percentage of net sandwich shop sales increased in the quarter to 11.1%, up 60 basis points from the prior year, driven primarily by higher utility expenses and deleverage of fixed expenses. Occupancy expenses as a percentage of net sandwich shop sales increased in the quarter to 13.6%, up 90 basis points from prior-year, again, driven primarily by deleverage of fixed occupancy expenses, in addition to our new Company operated shops opening during the quarter. So for 2014, we reiterate our expectation that occupancy expenses as a percentage of net sandwich shop sales to be in the range of 12% to 12.5%.

Turning to the general and administrative expenses. They were around $7.8 million during the first quarter, an increase from Q4 levels, as expected, but down from prior-year by roughly $300,000, when you exclude the one-time IPO cost. This was driven primarily by the lower bonus expense and the timing of marketing expenses that I will talk about in a minute. As we move forward in Q2, we expect a higher level of G&A expense than Q1, driven from roughly $700,000 in higher marketing spend related to the FLATS introduction and $100,000 and $200,000 higher in stock comp expense versus Q1.

We anticipate Q3 and Q4 spend to be slightly higher than Q1, with a more normalized marketing spend and the continues level of higher stock compensation expense. As a percentage of revenue, we anticipate marketing dollars consistent with 2013, in total and shifts among quarters or promotion timing related to the FLATS introduction.

As we communicated in our Q4 call, at this time we still believe that $2 million to $2.5 million of public company costs range is an accurate projection for 2014. As Aylwin mentioned, our adjusted net income for the first quarter was $200,000 or $0.01 per diluted share, which is about 128% higher than the prior-year. We estimate that the impact related to the weather in Q1 to be about $0.02 on top of this number.

Our first quarter adjustment to net income includes the impact of $800,000 of impairment expense, gross of tax related to two of our shops in New York. For a reconciliation of our reported to adjusted net income, please refer to the reconciliation table included in our first quarter earnings release.

Turning to development. During the quarter we opened up nine new Company operated shops and two new franchise shops, for total unit growth rate of 16%. Seven of the new Company operated shops opened in our legacy markets. And for the year we expect our new shop openings to be more weighted towards legacy markets versus the last couple years. This mix will vary year to year as we move forward. And longer-term we expect our new unit development to be split evenly between new and legacy markets. Additionally, we expect our new shop openings to be weighted towards the back half of this year.

I'd like to reiterate our full-year outlook for FY14. We expect adjusted net income growth of 25% to 35%, low single-digit Company operated comparable sales growth, driven by a combination of traffic and check. Effective tax rate not to exceed 39.5%. Capital expenditures of $30 million to $35 million. And finally, shares outstanding between 30 million and 32 million shares.

With that I would like to turn it back over to Aylwin for a few summary remarks.

I really appreciate your willingness to join us on the call and your interest in Potbelly. A few of my thoughts -- our journey as a public company has been short. But it's been very interesting. If you would have scripted out these first three quarters, we would have scripted them differently. But I just want to reaffirm our commitment to this brand and its future.

We have had a very disruptive environment. The last two calls we have talked about weather. We wouldn't want to be in the situation to do this again, but it was significant. We will continue to recover from this disruptive environment.

We haven't changed our play book. We haven't changed outlook for the business, and we haven't changed outlook for what this business will be over time. We believe in the strength of the brand. It continues to resonate with our customers in the neighborhoods we operate. Our development continues to go -- very disciplined. We believe we are going to be at the higher end of the range we communicated with our new shop development.

When we were on the road we talked about a couple of things and why you should be excited about this Company. One was the management team that was experienced and committed to our mission. We have significant white space as a concept, as well as geography. We have a strong culture that we spend a lot of time talking about, training, and using it to run the business. And we have strong unit economics.

We are still very committed to the targets we laid out. Low single-digit same-store sales. Plus 10% unit growth for a long, long period of time. At least 20% unit margins, 25% return on our invested capital, and 20% growth in net income year-to-year. We believe these commitments make us a very attractive company and a high-growth company. Again, thank you for your time today and I'd like to turn it over to the operator and we will answer your questions.

(Operator Instructions)

Your first question comes from Joseph Buckley with Bank of America Merrill Lynch.

Hello?

Joe, are you there? I think he must have fallen off --

Hello. Can hear me okay?

We have got you, Joe.

Sorry about that. I wanted to ask a question on the FLATS sandwiches. You mentioned the incremental marketing spend to support the introduction. Can you tell us a little bit on how that is being spent? And maybe you talk a little bit about the test market results? And just how you see the product positioned? Is part of a value offering, or more premium? Or how do you think consumers will perceive it?

It is unique bread. It is less dense than our normal, original sandwich. It is actually priced $0.20 higher than our original product. When you taste this product -- it is toasted -- it is an explosion of flavors like you've never had with our product.

I tested this thing three years ago when it was [add a bump] project, just me and another person at the time. Because at the time the notion that we could have another bread was kind of heresy. All I could just personally taste was just an explosion of the meats, the cheeses, the vegetables.

We think this is a very unique product that will reside with our great product now. And we hope our customers that love the original will eat this product and say I've got to come one more time. We hope that folks who don't like our bread -- it's unbelievable, but we do have people that don't like our bread. We hope that those customers will come down and say you've eliminated a barrier for us.

The additional marketing spend, we do traditional marketing, primarily in the big markets of DC and Chicago. It's traditional stuff -- the outdoor transit advertising, we do radio in Chicago. So that is how we are spending. We have added some advertising in movie theaters in a couple of cities.

We're doing a lot of nontraditional media. We -- 10 days ago we invited bloggers in three cities to come taste the product. We had really good turnout and you should see some of their stuff online. Last night in about 30 shops we invited folks from the neighborhood to come and have a VIP party type to introduce them to the product. And we had a good turnout there.

Our crews are very excited about this. Nothing beats when you get folks really excited this. It is a big move for us. I see it as another way to Potbelly. A premium product, great tasting. A different sensation, and we think it should be additive.

We have one test market and we typically -- it is mainly an ops test. You do see a lot of work around customer acceptance and feedback on how you need to change it. All I would say is we did that twice with this product. We got great feedback from light users and heavy users. And the results are so good, I told them to go back and do it again to validate it.

We have been working on this for awhile. We're very excited about it. The waiting on a product like this is the hardest part. We started today. And we think it should help us balance the year.

Joe, couple other things, real quick. On the marketing spend, really it's a shift from, in particular, when we saw some of the issues in Q1, we decided to move some of the waiting into this launch. Which we thought was a good idea and looking back was a great idea, given some of the challenges we had in Q1. It is really not an incremental spend, it is a shift in media that will hit us in Q2 relative to other quarters.

I think just a couple other stats, which give us confidence about this product. We have all been eating it for a while and I think a lot of us have changed our habits around how we order our sandwiches. We did a ton of surveys on this stuff. People who have tried it. And some interesting facts. The feedback was that we surveyed, 96% of our existing customers that said they liked the sandwich, 88% said they were likely to purchase the FLATS sandwich again, and 37% they would visit more often because of FLATS.

Those are really powerful numbers coming from people. This was a significant number of people that we put this in front of. It gives us a lot of optimism as we approach, not just this window, looking out for the balance of the year and beyond with this part of our business.

Okay. And I heard you mention the legacy markets -- how many stores does that encompass?

Around 300. It's probably 90%.

Okay, thank you.

Your next question comes from the line of Sharon Zackfia with William Blair.

Hello, good afternoon. Just a few questions. On the FLATS -- the Jimmy Johns line of questioning, when you tested it, it sounds like it was mainly more in operations. But did you get any sense as to whether it was more impactful on the frequency of existing customers, or whether it was a pretty significant draw for newer customers? And then from a margin profile, I heard you say it is $0.20 priced above the rest of the sandwiches. Is it the better margin profile than the regular sandwiches or the Bigs?

It's not better than Bigs. Nothing is better than Bigs. (laughter) New York and Boston are excited to get it. The margin is higher than our original product. We see it coexisting with the original product.

In the test market we saw a 50/50 mix. You had some folks that converted and $0.20 helps you with that mix shift. And then obviously new customers. We targeted this for folks that are not currently today heavy users, and reject the brand because of the bread and the thickness of the bread. So this eliminates that. And we saw -- .

In our test market -- our test market is a concept -- to test a concept in an ops test. We don't do additional marketing spend. It gives us a really good idea of the product. Then we just spend a lot of time talking to customers in those shops. We feel very good about this product. We are excited about it. It's probably the biggest thing we have done since chicken.

Okay. And then a question for Charlie, on the cadence in the quarter, it sounded like you thought the underlying trend was in the 1.5% to 2% range, inside the [right] margin. I'm not sure if I heard that correctly. And I'm wondering if that included the benefit of Easter shifting from March into April?

Yes. That was kind of the clean look at February and March. The quarter got better, once we got -- January was, I think, a shock to everyone. And I think people got a little bit -- my sense is that people got a little more in tune with it. So February and March were more consistent. If you strip out the weather and you strip out the Easter shift, that is what I was referring to.

Okay, is the corresponding Easter penalty in the second quarter 70 basis points?

Yes. So it's about 70 basis points for P4 -- or in Q2, I should say.

Thank you.

Your next question comes from the line of the call Nicole Miller Regan with Piper Jaffrey.

Great. Thanks. This is Josh on for Nicole. Circling back to the inflation outlook. It seems like there might be a little more than we thought initially. But just curious, Charlie, if this more or less playing out like you thought, if we were to go back to the last call. And then you had called out the dairy and the protein. Any other items of note, or really those two just the primary drivers of that inflationary outlook?

Yes. A lot of people have talked about -- and we're in the same sort of vein. Inflation has kicked up as we have gone through the first quarter. The two drivers of the inflation -- and really in the back half of the year -- are the proteins, so a lot of news around beef and other proteins. And then the dairy products, which have been surprising, I guess, as we have gone through the year. Typically things settle down as we get late in two Q1 in the dairy markets.

They haven't done that yet, but as we sit here today we are actively looking at locking that in for the balance of the year. We think our 1% to 2% is appropriate at this point. Like we said, 70%, a probably little more, locked in for the year. The variables are really related to proteins and dairy.

Great. That's helpful. And then taking a step backward, maybe looking a little bit historically. As we think about the Potbelly promise and the three different components of that that were rolled out at the end of last year. Has that worked? And particularly I'm thinking about the eight minutes through the line max, and the branding and awareness around freshness and selection. I am curious if that had played out the way you thought it would, now that we have had some time to let the digest. And any sort of learnings that came out of that, as you were able to interface with the consumer with that messaging at the shop level?

We thought it was important to get our brand promise out. It's mainly been passive right now. The first year we did a launch each element by quarter and all three of them showed up at the end of the year. And so now we were going to plan to test, can we use it as a business driver, to be more aggressive around that. With the introduction of FLATS we haven't gotten to that work, but that is the intention to see if we can use that.

We think it is very important to have a very visible catalytic mechanism in our shops. One to announce to the customers, here is what you should expect and if we don't meet that we want to hear from you. The eight minutes for example, if we don't hit the eight minutes and the customer calls us on it, they get a free cookie on the spot. When we do stuff like this would typically have a multi-year plan. The first year is get it out, get it introduced, it's passive. And then hopefully you'll see it in the upcoming years where it will be much more aggressive around this promise.

That's helpful. Thank you.

Your next question comes from the line of Jonathan Tuft with Baird.

Thank you. Charlie, just first a clarification. Could you just mention again what's the pricing and all-in average check component was during the first quarter?

Sure. Pricing was around 0.5% for Q1. The mix component, if you will, was around 1.5% -- totals. I'm sorry, totals. So the total non-traffic related impact was 1.5%, pricing of which was 0.5% of that in Q1.

Okay. And then are you planning to take any additional price increases during the balance of the year? Or do you think half a point is it for the year?

We maintained consistency around our pricing approach, which is we price to cover inflation. If you think back, we have always targeted around 1% to 2% inflation for the year, so that forecast, if you will, hasn't really changed. We took a little bit of pricing in the beginning of the year to recover. We don't have any specific plans at this point to take pricing.

We are to try like the devil not to, but if things go sideways on outside our estimates on the inflation, we'll look at it. But we're going to do everything in our power to stick with what we've done so far and not do anything this year.

And the other point there, is that really also encompasses a lot of the work that is being done around minimum wage. And so we know that has a potential impact, if not this year, going forward. So, we like the fact we have got the ability to take pricing down the road if necessary.

Good. That's helpful perspective. Maybe just a broader question about holding the comps guidance for the year, and maybe your thinking there. It sounds like you're seeing an encouraging trendline on an underlying basis exiting Q1.

I just wanted to hear your thoughts on guidance. Low single-digits for the year, implies, given the softer start to Q1, it implies, I think, something near 2% to 3% or higher for the balance of the year. Even with the Easter shift going against you in Q2.

I just wanted to clarify the thinking there, if that is the range you are thinking for the balance of the year? And maybe how much contribution might be assumed from some of the new initiatives that you mentioned?

That's why we talked about the new initiatives, because that's what we're counting on. And Charlie can give his answer. We're sticking to that. The implication is the balance of the year will be stronger than we had talked about in the past with the low single-digits -- 1% to 3%.

We're going to have to jump on that pony and get riding. But we believe we have some really good things taking up [the stride in] the business. Without that we would not be sitting here with the same frame of mind.

Yes. I think Aylwin talked about some of the drivers of the growth in his comments. And I think it's is really important. We expect those two pay out in terms of top line growth. I think it is also important to note, if you look at -- we look at our business on a deseasonalized trend perspective. We have talked about that before.

And so as you look at 2013, as comparisons year-over-year, really the comparisons moderate in the back half of the year. And so we think even if we run the current trends x weather, we'll get to those levels that you discussed. But it is on us. We know what we have to do here.

Okay. Got it. Very helpful color. Thank you.

(Operator Instructions)

There are no further questions.

So in closing, thank you for your interest. Thank you for the questions. We believe in the brand. We believe in what we're doing here. Again, recently talking to some the Board, and they were disappointed we couldn't offset the impact of the weather and my comment was, I just don't know what to do when you close down. DC had four big waves of snow that forced them to close down. So when customers don't come, it's hard to say how you overcompensate for that, or try to compensate for that.

This is a strong company. Our future is very bright. The development stuff really worked. We have some work to do for the balance of the year, but remain committed to our stated goals.

With that, I will end the call and we will see you. Get out and buy either by Bigs or FLATS, please. Thank you.

Thanks.

Thank you, ladies and gentlemen. That does conclude the conference call for today. We thank you for your participation. And we ask that you please disconnect your lines.