Potbelly Corp (PBPB) 2014 Q2 法說會逐字稿

Good afternoon and welcome to Potbelly's Q2 2014 Earnings 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 Matthew Revord, Potbelly's Chief Legal Officer. Please, go ahead, sir.

Good afternoon, everyone and welcome to our 's second Quarter Earnings Call. Before we get started, I would 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, including our outlook for 2014, should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management views as of any subsequent date. Forward-looking statements involve significant risks and uncertainties, and events or results could differ materially from those presented due to a number of risks and uncertainties.

Additional detailed information concerning these risks regarding our business, and factors that could cause actual results to defer materially in the forward-looking statements, and other information we will be giving today can be found in our most recent annual report on Form 10-K under the headings Risk Factors and MB&A, and their subsequent filings with the Securities in Exchange Commission, which are available at SET.gov. Our presenters today are Alywin Lewis, our Chairman and Chief Executive Officer, and Charlie Talbot, our Chief Financial Officer. Alywn will begin with his perspective on the second quarter performance and discuss some recent developments, while providing discussion of our ongoing strategic initiatives. Charlie will then review our financial results and future outlook in more details before we open the call up for your questions. Alywin?

Bank you, Matt. Good afternoon, everyone and thanks for joining the call. I would be remiss if I didn't say that we are saddened by the sudden loss of our friend and lead director, Jerry Gallagher, who had a significant hand in helping us shaping the Co. up to this point. We'll miss his leadership and his guidance. I'm going to spend a few minutes highlighting our recent financial results. This is a follow-up to what we communicated in our prerelease on July 9.

More importantly, I will discuss our current situation and what we're doing to address some of the issues we are facing. So for the business update. We continue to grow new units by over 10%. We opened seven new company-operated shops and one domestic franchise shop in the second quarter. We opened one new Co. shop in our newest hub market, which is Denver. We expect to open at least three shops by the end of the year, additional shops, by the end of the year. We've opened our first shop in Tucson, Arizona, which is a spoke market for the Phoenix hub. We remain on track to open 40 to 48 total shops. The remaining shops will be heavily weighted in the fourth quarter.

We feel good about our new unit development and our development pipeline for the balance of this year and for early next year. And we are targeted at least 1,000 domestic units in this phase of our growth. Our company-operated comparable store sales decreased 1.6%. Down 0.9 when you neutralize for the [ease] to shift that occurred from Q1 to Q2. Decline is driven primarily by traffic, partially offset by the average check increase. Adjusted net income was $2 million, or $0.07 per diluted share for the quarter. That's slightly above the $0.06 that we projected in our July 9th prerelease. Finally, this is newsworthy. Our Board of Directors have authorized a $35 million share repurchase to be used to purchase the Company's common stock. We believe this is good use of our excess cash. Charlie will speak to you in more detail about our financials later in the call. I want to give a perspective on our current situation, our results and what we are doing about our issues.

There are three primary drivers of our profit growth. Our comp store sales, our base business [unit] economics and a productivity on those economics, and our profitable new units. Two of the three of these components continue to deliver our expected results. The obvious opportunity for us is regain our comparable same store sales momentum. And we believe coming out of Q1, which was a very difficult quarter, that our trends would rebound like they typically have done in the past. We moved up our Flats rollout to May because we thought that would help us overcome the first quarter sales shortfall. Our Flats have had a good impact on the business. It has not driven significant, meaningful, incremental sales traffic, which is unexpected.

We still believe that we're in good shape when you talk about our base unit and their productivity around the profit piece in the new unit development. These are still very good strengths for our Company. Our current comp sales growth is major gap in our growth model. We are working hard and fast to close this gap for the near term and for the long term. In the past few years we've spent a lot of organizational, a lot of time building the organizational muscle into our ops excellence, development activities and our neighborhood market activities. We look forward in the near future we're going to spend some time on how do we grow traffic in our business. So what's our problem?

I think our No. 1 problem is how do we find a way to message outside our four walls and augment the neighborhood approach. And we will explore digital, social and mobile tactics to solve this problem. We've identified our transition issues as 8 to 10 transactions per day per shop. Literally, one per hour per shop each day. This is a gap we know we can close by being smart and being diligent and we are very poised to do that. Our sales pyramid is constantly reinforced by those shops, and there's a sizable number in our fleet that have grown their business at least 3% annually the last several years.

These shops comprise the basis of the sales pyramid, which is strong operational efforts, being the best place for lunch, driving back line, low turnover, and low management [turn]. So what are some solutions we're working on? From an operational perspective, increased our training efforts for our shift leads by district managers. Shift leads are future managers as we grow. Our district managers influence our business in many neighborhoods in their district that increase our focus on through-put at peak. Single key opportunity for us to drive the business is through-put at peak.

We will continue to invest in technology and equipment and in staffing to reinforce through-put at peak. In a high [book] environment we've got to do a better job of managing general manager (inaudible). We use existing GMs to open new shops. Obviously, when you make that change, relationships that are established in neighborhoods can be severed. The key factor we've got to find a way to make those relationships more tied to the shop versus just to GM. We will be testing this month in several shops new service model.

Essentially, putting someone in the dining room during peak in a way to save customers that walk in that may see a line and walk out, performing table touches for our existing customers and just spreading that Potbelly magic inside the dining room during lunch. From a marketing perspective, we're conducting research to update our customer segmentation work, the foundation of how we target messages around customer segment. We will be testing new menu innovations, proteins, and other items that can help us grow. We will test drive in our business using our promise. That's our promise to the customer of being fresh, fast and friendly.

We'll use digital methods to help us drive this message. We've added breakfast menu in a number of shops that can sell breakfast in a profitable fashion. We are constantly servicing products that will help us grow in a two to five day part that we believe is an opportunity for us. We are even going try some promotional items and promotional messages in certain markets.

The goal is to have short-term and long-term solutions to our current growth situation. Additionally, continued focus on the back line. In Q4 we will release our newest Flats sandwich, which is a turkey, bacon, cheddar, and continue to focus on the back line. There's no silver bullet that can help us improve our comp trend. We have to work on several things over time to recapture that magic. What we are is very committed to finding solutions in the short term and long term to address the issue. I'm going to turn it over to Charlie now to give you the details of the quarter. Charlie?

Thanks, Alywin. Good afternoon, everyone. I'll walk down the P&L and give you some of the highlights. Starting from the top, total revenue increased 7% in the quarter to approximately $84 million, driven by new unit openings, partially offset a decrease in company-operated comparable store sales of 1.6%. Adjusting for the Easter shift in the second quarter, comparable store sales would have declined 0.9%. So to reiterate as we moved out of the first quarter, we felt better about our underlying traffic trends; however, our business did not get the balance we had expected after Easter holiday in May and June.

As we mentioned in the June 9th prerelease, comparable store sales growth improved as we moved throughout the quarter; however, it was driven more from comparisons easing versus traffic trends improving. Our most difficult comp month of the year was April driven from lapping our successful Buffalo chicken sandwich promotion in 2013, and just to further update this year, our July comps were flat, reflecting expected sequential improvement from Q2. Again, this is driven primarily by easing comparisons. Our average tech growth for the quarter was around 1.5% driven roughly 1% from pricing from the increase we took in the middle of the first quarter with the remaining for menu mix growth. Mix was stronger late in the quarter from our Flats intro and our bigs rollout in the northeast during May.

The reception of our new platform and bigs intro in the northeast has been really strong mixing above our internal expectations, and the customer feedback has been really, really positive. So as a result we are seeing Flats become a really healthy mix of our menu. We feel really good about the platform and how this sets us up for growth as we move forward. As we stated in our prerelease, our updated full year comp guidance is flat to negative low single digits, comparable store sales growth, which assumes current traffic trends for the balance of the year. We anticipate comparable store sales to improve in the second half compared to the first half, driven from easing comparisons and some modest pricing taken in the third quarter. In total, we anticipate pricing to be roughly 2% in the second half versus last year. Moving down to P&L, [shopping profit margins for the quarter was 20.5%, a decline of 160 basis points from prior year.

The decrease was primarily driven by deleverage of fixed expenses across our P&L due to the decline in comparable store sales and new units opening later in the quarter. Cost to goods sold is a percentage of net sandwich shop sales decreased in the quarter to 28.7%, down 50 basis points from prior year. Driven primarily by modest commodity cost deflation in addition to lower levels of waste at the shop. The deflation in the quarter was the result of a number key products locked in through the second quarter of favorable pricing terms. But despite this deflation in the first half of the year, we still expect roughly 1% to 2% inflation for the full year driven by higher levels of inflation over the balance of the year. Our fruit basket is roughly 90% to 95% locked for the full year, and the sequential step up in projection placement is being driven primarily by beef and pork costs.

Moving to labor. As a percent of net sandwich shop sales, labor increased in the quarter to 28.1%, an increase of 90 basis points from prior year. This was driven primarily by deleverage of fixed labor expenses in addition to the timing of seven company-operated shops opening in Q2, which we mentioned were back weighted in the quarter. Looking forward, embedded our projection is the impact from the Washington D.C, Minnesota and Michigan minimum wage increases effective in the third quarter. It also is important to note that labor dollars may fluctuate in the third and fourth quarter based on the sales, seasonality and timing of new unit openings, and again we expect the units to be more heavily weighted in the fourth quarter, which we'll cover later in the discussion. Operating expenses as a percentage of net sandwich shop sales increased in the quarter to 10.4%, up 30 basis points from prior year, and occupancy expenses increased in the quarter to 12.2%, up 90 basis points from prior year, both driven, primarily, by deleverage of the fixed expense of these lines. General and administrative expenses were approximately $8.9 million during the second quarter, an increase of approximately $1 million from prior year. The increase as a expense is driven primarily by a $400,000 increase in advertising expense from prior year associated with the rollout of our Flats platform in May.

In addition, public company related costs were $1 million for the quarter, which is roughly $800,000 higher than last year, excluding the $100,000 of one-time IPO expenses in the second quarter of last year. The public company costs were higher than anticipated in the second quarter driven by higher levels of stock compensation associated with board member stock grants. Given the higher level of expenses in the Quarter two, we are now believed total public company costs for the year will be at the high end of $2 million to $2.5 million range previously provided. When excluding the public company costs in advertising, base G&A was town roughly $200,000 from the quarter versus prior year.

As we move forward, we anticipate Q3 and Q4 total G&A spend to be in the $8 million range, which is consistent with the previous guidance. Our adjusted net income for the second quarter was $2 million or $0.07 per diluted share, which is a decline of $850,000 and roughly $0.02 from the prior year when using comparative dilutive share counts. The decline is driven from lower comparable store sales, higher advertising expenses and the costs associated with being a public company. For a reconciliation of our reported adjusted net income, please refer to the reconciliation table included in our second earnings release. Now turning to development. During the quarter, we opened seven new company-operated shops and one domestic franchise shop for a total unit growth of 13.4%. The majority of the shops opened in June. Also, more than half of the new Company-operated shops opened to date are in legacy markets. The legacy to new market opening mix will vary year-to-year as we move forward, but we'll target our new unit development to be split evenly between new and legacy markets over time.

Now I would like to discuss the full-year outlook that we've included in the July 9th prerelease. We expect adjusted net income per diluted share of approximately $0.18 to $0.21, flat to negative low sale digit comparable sales, an effective tax rate is estimated to be approximately 39.5% and 40 to 48 new shop openings. We anticipate a consistent level of new openings in the third quarter as we had in the second quarter, with the remaining units open in the fourth quarter. Also worth mentioning is our effective tax rate outlook assumes certain Federal tax credits that is are currently expired will be retroactively renewed by the government. In addition, we still expect capital expenditures of $30 million to $35 million and shares outstanding between 30 shares and 32 million shares for the year, and this excludes any share buyback influence.

It's important to understand the updated guidance is predicated on our current business trends and expectations for the remainder of the fiscal year. The primary drivers of the lower guidance beyond Q2 results are [around] comparable store sales assumption and the projected timing of our new unit openings. As we discussed above, the new unit outlook is now more quarter four weight, which brings more inefficiencies into the model during the year. The rest of the business is pretty much in line with previous expectations.

We have talked about this in the past, but I think it's important to break down how we think about our financial model relative to growth. Our financial model is predicated on growing comparable store sales at a low single-digit level, operational productivity to maximize the flow-through of those incremental sales and opening possible new units and leveraging our fixes costs. If any one aspect of our model is below expectations, given our size and leverage, it's difficult to hit our targets. In Q2, specifically, it was a decline in comparable store sales and public company related G&A expenses running higher. More broadly, it's our comparable store sales challenges that we've already discussed that we're working really hard to rectify driven from a number of initiatives Alywin has already mentioned.. So with that, I'm going to turn it back over to Alywin for summary remarks

So in summary, I'm not happy to be in a position of reporting results below our expected growth levels. I take it very personally. It's my accountability. I will remind you in the early stages of being a public company, so while we're disappointed we're by no means desperate. We have strong fundamentals in business. We continue to demonstrate the ability to grow new shops. We've got a view toward 1,000 units. We've identified the scope of our current sales issue. It is literally eight to ten daily transactions per shop per day, one per hour. While we are aware of external factors that may be impacting this industry, we are singularly focused internally to fix our problem through menu innovations, research, service improvement, staffing and in messaging.

We've got to find a way to drive the message outside the four walls, digitally, mobile and social. So, we believe in building this business one neighborhood at a time, through relations-based, experience-based and excellent operational-based performance. We know that drives loyalty, loyalty drives advocacy by our customers, and good old word-of-mouth is how we're trying to build this business. We may need a little bit more to get our message out in an efficient and effective way and we will explore that. It also should be noted that we're using our strong balance sheet to buy back stock because we believe the stock is a bargain at this level.. So, I thank you for listening today and we'll open it up for questions.

Thank you. (Operator Instructions). Your first question comes from the line of Nicole miller of piper Jaffrey

Good afternoon. A technicality on the share repurchase, is that in the guidance, would that be incremental should you execute on it?

Yes, Nicole, this is Charlie. How you doing?The guidance that we gave does not really include any impact from share repurchases based on the fact that the timing and the amount will be -- is to be determined. We do have authorization to buy up to $35 million in shares and we'll do that, you know, kind of appropriately.

Thank you. And from a regional perspective, can you talk about trends?I think maybe there are been mid-Atlantic issues, D.C., maybe, specifically, issues. Where to you stand today, third-quarter to date?Are you seeing those improve?

We typically don't talk about specific markets or regions, but I -- you know, and we typically don't update numbers, but I thought it was important to let people know how we're doing through the month of July, you know, as I explained, we're on trend with where we expected to be for the first part of Q3.

Thank you.

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

Hey, it's Greg on for Joe. I just have a couple questions. One, can you guys say what you were seeing I guess in the test markets for Flats and maybe didn't translate when you rolled it out more broadly, and why, you know, what changed or what you saw differently when you rolled it out?

We saw really great acceptance when we tested it. We did research in front of light and non-potbelly users and put the product in front of them and they gave a big thumbs up. We did it once; it got remarkable results. And we did it a second time because we didn't believe the remarkable results when it came back, you know. The mix is great. If you had told me that at this mix it would not be incremental, I would have lost a lot of money, so we're surprised by it. The first rollout is just the introduction, so it's functional around the features and benefits. We will start using it for further development, which was always our plan. We do see this as a food carrier for us. It's a different eating sensation, and we'll have a new recipe in about four weeks and we'll see what happens.

I think just to elaborate, we didn't see anything different, really. The only thing we saw different was it's mixed higher across the system than it did in the test market. Part of that is simply because the test markets we are very, very limited messaging outside the shop, and so at times we can expect that. But we were, if anything, we were surprised by the level of acceptance, as Alwyn mentioned, once we rolled it beyond our test markets.

Okay. That makes sense. And then just I think you said you expect 2% pricing in the back half because you're taking modest pricing in 3Q. I guess how are you thinking about that, and is it food inflation and guidance? Is it driven by that, or, you know, what's the main driver there?

Well, it's things. One is, you know, we price to cover inflation, and so as we've known all along the back half of inflation was going to be a little bit higher than the first half based on what we had locked in. The other thing that's really happening here is as we think ahead about pricing and our menu, we like to maintain relationships across the menu, so part of what we're doing today is resetting those relationships for the future pricing activities so we don't have to change everything on the menu at once, if you will. So think of it a couple different ways. One is recognizing additional inflation in the second half, which we kind of expected, and then second is just making sure relationships across the menu are in order, so that as we move forward we can be pretty flexible with the pricing activities

Okay. And then I guess, finally, can you give a little color on how the new units are performing, and what you're maybe seeing in some of your specific markets, maybe in New York, Boston and some of the other areas?

Yes. I'll start and then Alywin can chime in. We're happy with the unit performance. They continue to evolve and grow, so I mean I think that you have a number of different markets we've gone into, New York and Boston being two of them. And I think we're pretty satisfied with the way things are playing out, both operationally from a consumer standpoint, and so I would say that our -- as we've talked about, our development engine is doing fine and we expect that to continue.

OK. Thank you

(Operator Instructions). Your next question comes from the line of Jonathan Copp from Robert Baird.

Hi. Thank you. Good afternoon. Charlie, first if I could just clarify the comments on the pricing.

Yes.

Good you maybe just clarify when the pricing, the incremental pricing, might be rolling in, and I guess it may be easier just clarifying that flat July comp so far, you know, what the traffic and check component of that might be?

Way typically don't break down the traffic and check, but what I will tell you that like I said, it's on trend from Q2. The numbers are getting a little bit easier to roll over, and so that's why we wanted to just reiterate that piece of it. The pricing moved in through the month of July, so call it mid-July is when this that really took effect. And, again, it's roughly 1% is the incremental pricing we're going to be taking for the back half of the year.

Okay. Great. That's helpful. And then maybe a bigger picture question for Alywin. All the initiatives that you mentioned on trying to reignite the sales trends. You mentioned a lot of different categories and maybe a lot of different initiatives, so maybe just from a higher level picture, which of the different initiatives do you see as maybe having the biggest opportunity or maybe the greatest potential to, you know, turn the sales trends around?

Well, it starts with the excellent operation, so figuring out how to manage your churn in a high growth situation is important for us. And that's long lasting and that's very impactful. Every time you churn a manager, like I said, we're seeing severing of those relationships in the neighborhood, which is very important to our marketing effort so that's very big. To continue focus on transactions during our peak is another thing we have to do, and we can't lose sight of that and we got to continue to invest there. And then I think from a messaging standpoint, figuring out how you augment this word-of-mouth, high experienced, high loyalty model that we have with messaging outside the four walls, effectively and efficiently, is important to us. That's why mobile, digital and social are things that were exploring. We'll be testing some things. Now if we could find a solution there, I think it would have tremendous potential because, you know, to be effective in those venues, you have to be authentic, and to be authentic is kind of one of the things we really hold our hats on in terms of our food, high experience in our peak flow. Those are the three things that we're looking, and when you're in a situation like this where it's unexpected, quite frankly, you're trying to separate anecdote from what you see and hear to facts.

And so we're exploring a lot of things. I don't want to give people the impression that it's chaotic and we just throwing stuff across, you know, on the wall to see what sticks. We're being very methodical about it, but we want to be broad reaching because we want short-term and long-term solutions. We don't want -- we don't believe this thing is broken. We think it's tweaking and redirecting. You know, how we allocate resources is something we've taking a hard look at. That's kind of what we're doing. I hope that's kind of a long-winded answer but as completes as I can make it

No, that's very helpful. Much appreciated. Maybe just to follow up, you mentioned some aspects related to the market and the messaging, and I think in the prepared remarks you also mentioned maybe testing some promotions. So just wondering, does any of that imply that you've seen any change in the competitive environment recently, or is that just, you know, an opportunity that you see for the brand irrespective of the competition?

Yeah. It's -- you've got to be aware of stuff that's going on, but we've never been -- we're trying to build a company where we're very focused on bringing our best every day to the marketplace. So in this effort to be very thoughtful and very thorough, we're doing some things that may be out of character but we have to test it. When you're sitting here disappointing our investors and disappointing ourselves, we don't want to leave any stones unturned. We're not going to become a high transaction, high promotional house we are doing, you know,. Charlie always looks at me like when I do stuff like this,, you know, has a Martian invaded the body. But again that's just trying to be thorough and just trying to test the limit -- push the limit of what's possible out there. So that's what that's about. It's very targeted, very focused and it's being done with an eye towards profitable sales growth.

Great. And maybe just one more for me on the development outlook for this year. Just given that it is a little more back weighted now, is there any risk to some of those openings further slipping into next year, or what's the degree of confidence of getting all of the targeted unit openings this year?

That's why you do ranges and, obviously, absolutely the back end when you're dealing with new construction and depending on (inaudible) to deliver business, that's the risk. Fortunately, we believe those stores would still be in the fleet. If they're late a month, that's fine. The goal is to open profitable stores and successful stores. We're going to do everything in our power to hit the range that we talked about. And so we're still within that [40], [48] and we're going to work hard to make sure that happens, but we won't do anything foolish and we won't open a store the last week of January just to make the numbers.

Got it. Makes sense. Thank you very much

Thank you. At this time there are no further questions. I would like to turn it back to Alywin for any closing remarks.

No, listen. Are disappointed. We're not desperate. We are going to do everything possible to get our sales back on track, and we feel very good about this Company and our prospects. So thank you for your participation. Thank you for your interest, and go buy a sandwich tonight. Thank you.

Thank you. This does conclude today's conference call. You may now disconnect.