Potbelly Corp (PBPB) 2016 Q3 法說會逐字稿

Greetings and welcome to the Potbelly Corporation third-quarter 2016 earnings conference call. (Operator Instructions) As a reminder this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Matt Revord, Chief Legal Officer. Thank you, Mr. Revord. You may begin.

Good afternoon, everyone. Welcome to our third-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 or the future financial performance of the Company. Any such statements including our outlook for 2016 or other future periods should be considered forward-looking statements within the meaning of the Private Securities and Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance nor should they be relied upon as representing Management's 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 the factors that could cause actual results to differ materially from the forward-looking statements and other information that will be given today can be found in our most recent Annual Report on Form 10-K 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 today are Aylwin Lewis, our Chairman and Executive Officer, and Mike Coyne, our Chief Financial Officer. Aylwin will begin with his perspective on the third-quarter performance and provide a discussion of our ongoing strategic initiatives. Mike will then review our financial results and future outlook in more detail, before we open up the call for your questions. Aylwin?

Thank you, Matt. Good afternoon, everyone. Thanks for joining the call today.

During the third quarter we generated revenue of $104 million, an increase of 8%, driven by new unit growth, and Company-operated comparable same-store sales growth of 0.6%.

We opened 8 shops, including 6 new Company-operated shops and 2 franchise shops.

We delivered adjusted EBITDA growth of 11% to $12 million and adjusted net income growth, up 38% to $3 million, and EPS growth of 50%, $0.12 per diluted share.

As we discussed in our Q2 earnings call, we expected the second half of the year to be challenging as we faced a strong mix comparison from our robust menu innovation program with avocado and mac and cheese last year, and confronted the broader weakness in the industry that started to materialize in April and accelerated through the second quarter. Unfortunately, these macro headwinds continued during the third quarter. Traffic in particular continued to decline from the second quarter through the third quarter and came in slightly below our expectations, to put pressure on our sales growth.

As we look into the fourth quarter, we expect a continuation of the macro trends that we saw at the end of the third quarter. We remain focused on executing on the fundamentals of the business to drive sales growth and profitability, and we're on track to achieve our full-year outlook of comp sales growth between 1% to 2%.

Let me update you on our key priorities, first, menu innovation. We view menu innovation as an important driver of sales. During the third quarter we introduced a new hot protein, our pastrami sandwich, which performed to our expectation relative to mix. And we saw solid attachment rate. This product will return in the future.

In September we launched our Buffalo mac and cheese. It's really an extension of our craft-your-own mac and cheese platform, which we introduced in the fourth quarter of last year. We expect mac and cheese to be an annual fall/winter item that we add to the menu going forward. We also brought back Buffalo chicken sandwich for this current quarter. During the third quarter we also introduced our seasonal pumpkin spice cookies for those looking for a midday snack. The goal of our pipeline of menu items is to drive mix and traffic. And we believe we have a robust pipeline for the next 18 to 24 months.

Secondly, let me just discuss the backline. Our backline business grew in the low double digits during the third quarter, and was between 14% and 15% of our sales. It remains a huge part of our future growth story.

We have an elevated position within the shops called catering coordinator, which is a dedicated role that manages the in-shop backline operations, interacts with our catering sales managers and with our outside customers, and goes out to canvas business to drive sales. This role has its own career path and we believe it will be a driver of sales in the future. We have implemented this role in about 50% of the shops. Our goal is to eventually have this role in all shops.

We will add additional outside catering sales managers in 2017. The catering sales manager growth will also match the growth of our catering kitchens in 2017.

There are two additional topics that need to be addressed. One is investment in technology to grow sales, and the other is labor control.

Investment in technology must continue in order for us to grow the sales and profits of the business. There are two examples of this.

We're testing digital menu boards in several shops. If tests go well, we plan on completing being in digital menu boards over the next several years. The ability to enhance our in-shop messaging should have a positive impact upon our sales. It will allow us to drive menu innovation as well as day part sales.

Additionally, our new mobile app will be in beta test beginning the fourth quarter. We've worked on this app all year. Our mobile app will be best in class. It will have the ability for us to help ordering, pay, and customer engagement. The customer engagement program that we are contemplating will have several levels of membership.

We're excited about how the use of technology can help us grow this business. These are the two examples that we have ready to talk about and to implement.

The second item is labor control. Hourly labor has to be addressed for a business like ours. The government mandated labor increases have produced additional costs without any obvious additional benefits.

We have developed and are in the last stages of implementing a new labor management system. The system is designed to help us schedule and control labor more effectively. This is an important tool.

However, more needs to be done as the journey to $15 per hour continues across the country. Early next year, we will be picking a market to test changes to our operation that will be designed to mitigate the financial impact of the government-mandated labor regulations. In my mind, there's no greater initiative in our company that we must test and find solutions.

The bottom line is we recognize the need to adapt and innovate in order to thrive in the current market environment. We're confident about our long-term opportunities and remain extremely focused on identifying and implementing appropriate sales and operational tactics to drive near-term sales growth.

We're thoroughly examining our cost structure and will remain extremely disciplined in our expense and our investments in order to ensure we meet our profits and return commitments.

[A side] of that effort is the fact that during this quarter our shop margins increased 40 basis points versus 2015 of the same quarter last year. As such, we remain committed to delivering our full-year targets of adjusted net income growth, at least 20%, and adjusted diluted earnings per share in a range of $0.36 to $0.38.

Turning to our new unit development, we continue to find and build great shops. As I mentioned earlier, during the third quarter we opened 8 new shops for a total year-over-year growth of approximately 10%, which is in line with our stated long-term development target.

We've opened 6 Company-operated shops, 5 of which were drive-through locations which have historically generated good sales and returns for us, and 2 franchise shops.

In October we opened our first franchise shop in Toronto, Canada. We're ecstatic to be in Canada, and have Canada part of the Potbelly Nation.

For the full year, we reaffirm our outlook for 40 to 45 new Company-operated shops and 10 to 15 new franchise shops. However, we now expect to come in at the lower end of those ranges. As we discussed in prior calls, we expect our shop development to be heavily back-ended, weighted in the fourth quarter. We recognize potential slippage of shops from December to January. However, we remain committed to delivering the 10% annual system new unit growth.

Now, let me turn it over to Mike and he'll go through the details of the P&L in the third quarter and our expectations for the remainder of 2016.

Thanks, Aylwin, and good afternoon, everyone. Thank you all for joining us today and for your interest in the Potbelly story.

As Aylwin mentioned, I'll review the P&L and give you some of the highlights associated with our third-quarter results. I'll also provide a summary of our full-year 2016 outlook.

Starting with the top line, total revenue increased about 8% to approximately $104 million in the third quarter, driven by our new unit growth and our Company-operated same-store sales of 0.6%.

Breaking down same-store sales, our average check grew approximately 4.6%, driven predominantly by price. As we have previously stated, we expect our fourth quarter to be the toughest comp of the year, as we continue to lap avocado as well as our mac and cheese offering in the fourth quarter of last year. Although we continue to operate in a very difficult environment, we remain confident in our ability to achieve our full-year sales guidance for same-stores sales growth in the range of 1% to 2%.

Moving down to shop P&L, shop-level margin for the quarter was 19.5% of Company-operated sales, an improvement of 40 basis points from the prior-year quarter.

Our cost of goods sold was 27.6%, an improvement of 90 basis points to the prior year. Food commodities continued to remain favorable and for the year we continue to expect our COGS to be slightly below 28%.

Labor was 29.2% for the quarter, which was an increase of about 30 basis points from the prior year, driven primarily by wage inflation, offset by pricing increases and improved labor productivity. For the year, we continue to expect labor as a percent of sales to be in the range of 29% to 30%.

Occupancy expense was 12.7% in the quarter, an increase of 30 basis points as compared to the prior year, due to lease renewals and higher real estate taxes.

Operating expenses were 11% in the quarter, or flat as compared to the prior-year period. Our G&A expenses were approximately $10 million in the quarter, or 9.6% of total revenue, which is flat as compared to the prior-year period. For the year, we continue to expect our G&A in the range of $40.5 million to $41.5 million.

Our adjusted EBITDA was $12 million for the quarter, which was an increase of 11% from the prior year. Our adjusted net income for the third quarter was $3 million, an increase of 38%, from $2.2 million in the prior year. And our adjusted net income per diluted share was $0.12, an increase of approximately 50% from the $0.08 per diluted share in the prior year.

Now an update on our share repurchase program. During the third quarter we completed our $35 million share repurchase plan, which was authorized in September of 2015. In September of 2016 the Board authorized a new $30 million program.

During the third quarter we repurchased approximately 300,000 shares of Potbelly common stock in the open market for a total of approximately $3.8 million, which included shares from the new program as well as from the previously completed program. At the end of the third quarter we had $29.6 million available from our Board-authorized program for repurchases, which we'll continue as we move forward.

Our balance sheet remains very strong, with a cash balance at the end of the quarter of $29.7 million, and we have zero debt.

To summarize our full-year outlook for fiscal 2016, we expect comparable sales growth of 1% to 2%; 50 to 60 total new shops, at the lower end of the range, including 40 to 45 Company-owned shops and 10 to 15 franchise shops; $36 million to $38 million in capital expenditures; adjust net income growth of at least 20%; and adjusted diluted earnings per share in the range of $0.36 to $0.38.

We expect an effective tax rate in the range of 37% to 39%.

So with that, I'm going to turn it back over to Aylwin for summary remarks. Aylwin?

Thank you, Mike.

You know, we're not discouraged, although we are disappointed in the sales growth. We will continue to attack sales by the basics of backline, new innovation, digital and mobile investments, and a focus on throughput. Digital menu boards and our new mobile apps are new tools for us to grow sales for 2017 and in the future.

Labor management will be helped by our new labor management tool, and by the test market in early 2017 that will allow us to discover new ways to offset the government-mandated minimum wage laws.

I want to thank the men and women of our Potbelly Nation for using the culture and using our tools that help us navigate the strong macro headwinds.

We remain committed to the following: At least 10% new unit system growth; net income growth of at least 20%; new unit capital of at least 25% return; and strong flow through. So we can reaffirm all of our profit commitments for 2017.

Now, I'll open it up for questions.

Thank you. (Operator Instructions) Sharon Zackfia; William Blair.

Just a few questions. I guess, Aylwin, when you were talking about the test market for the changes in operations next year, are you thinking more front of house? I mean, (inaudible) anything with the kiosks for the customers. Or are you thinking more back of the house, in prep times? Just trying to get kind of a handle on what kind of operational changes you might be thinking about.

It's a whiteboard and everything's on the table. We are looking to take out significant hours and of hourly labor. And so we're basically starting with a clean sheet of paper and that's why we're picking a small market to test to see what can be scaled. But given the dash to $15 an hour across the nation, it's just imperative that we come up with some solutions.

So we're not limited at this point to front of house, back of house. Everything's on the table.

Okay. I think secondarily, just maybe a couple of questions on guidance for development. I know you expect to be heavily weighted in the fourth quarter this year. I'm just curious whether you have an opportunity to be more equal-weighted in your development in 2017 on a calendar basis. And if you can give us any update on how the franchising process is going in California.

We're still working on California. Still anticipate 2017 to have units open from a franchise perspective.

We are working hard to rebalance the new openings and we believe you'll see a change in 2017, first half of the year versus this year. Think we opened, like, 9 or 11 first half of the year. We definitely will work to improve that and try to smooth it out. There's just a tremendous strain on the system when we've still got about 19 or 20 shops to open before the end of the year. So the goal is to balance that out.

Great. Thank you.

Joshua Long; Piper Jaffray.

I was curious if we might be able to talk about the cadence through the quarter this past 3Q, and then maybe go back to last year's 4Q and review the cadence there. Because it seems like you've got -- optically you've got similar compares from a pure same-stores sales level in 3Q and 4Q of 2015, but want to make sure that we really appreciate kind of the timing of the product rollouts that were such strong contributors to your comp last year.

Okay, yes. This is Mike. I can address that. So, the cadence in this quarter was that we did see a little bit of worsening as we went from July into August, and we've really been at a similar level in August, September and even into October at a similar level.

As we look at last year, and we've talked about this a few times, a challenging comp in the fourth quarter. And that gets more difficult as the months go on. In particular, December of last year was a very strong comp, had the benefit of a very strong mix, which I believe you were alluding to, and actually had positive traffic as well. So things do get a little bit more difficult over the next couple of months.

That's helpful. Thank you. And then in terms of the average check during the quarter, could we talk about the new price that was in place and then kind of the resulting mix contributor to the 3Q comp?

Yes, sure, no problem. Yes, when I was referring to things got quite a bit worse it was traffic that got a little bit worse as we went from July into August. In terms of mix -- well, let me just break down the quarter overall. So the 4.6% check that we just talked about, 4.2% of that was price, and 0.4% of that was mix. And traffic averaged down about minus 4%. That's for the quarter as a whole.

As I mentioned, things got slightly worse, by a matter of tenths, as we went through the quarter. Mix moved around a little bit but it didn't stray too far from the average of the 0.4% that I just mentioned.

That's helpful. And then as we think about the current environment that we're in, we're obviously facing some headwinds on the cost front, and then we also want to maintain the value and affordability of the core product. How do you think about balancing the menu price aspect as you go through the back half of this year and into 2017 with some of those other initiatives you're talking about in terms of labor management and obviously the cost of goods sold environment that is currently favorable? Just trying to think about how you balance all those pieces in the current backdrop.

We still have significant price/value relationship to our direct competitors, so we'll price accordingly, primarily to offset inflation as we look to it. And the inflation we see next year, it's still early, but it's primarily labor. We get good flow-through on the pricing. And that's how we're thinking about it.

It's not clear what's going to happen with the consumer. Hopefully after the election something breaks. But we're going to try to drive menu innovation and some of the technology tools I talked about that I think can help us -- particularly the app we think could be a real business driver.

But we still have significant pricing room when we look at our direct competitors versus our current prices.

And just as a reminder, the pricing that we did in late July of this year was focused on our catering business. It was not increases at all to the rest of the menu.

Got it. Thank you.

Karen Holthouse; Goldman Sachs.

This is [Louis] on for Karen. Can you elaborate on the slowing consumer trends you said impacted sales growth in the third quarter? And do you expect these trends to continue in the fourth quarter?

Yes, I think most people in the industry would say yes. Wish we had the crystal ball. But still the biggest thing we look at is the relationship of food eaten at home and food eaten away from home. That gap is the biggest I've seen in a long time. And consumers are getting tremendous value in the supermarket because of the low commodity pricing. That's definitely helping our business.

So we don't know how long it's going to do, they'll be sitting on their wallets. That's why we're going to try to be aggressive with the technology investments and with the app and the digital menu board and product innovation. But we're talking a wait-and-see attitude.

And explicitly, the guidance we gave assumes the continuation of those trends that Aylwin just talked about.

Great. Thank you.

Mary McNellis; Robert W. Baird.

You mentioned [in terms of] stabilized here in September and October. Do you think that that's more of a function of the year-ago comparison or do you think that it's been helped by some of the internal drivers like the new mac and cheese?

And then just any perspective that you're willing to provide on some of the levers you think you can pull in the near term, whether that's menu innovation or execution of a digital marketing to help you cycle these tougher comparisons in the balance of Q4?

Yes, the technology innovation starts are going to be for 2017. We're doing first concept now, with beta testing the app which we've been developing all year. So that should help us in 2017.

I think our attitude is what happened in quarter 3 from a consumer standpoint is likely still going to happen in quarter 4. So the goal there is to manage costs really tightly so we get really get flow-through so we can hit our profit commitment. We're going to work hard not to go negative on sales. And that's what we're trying to do every day. So that's through execution and treating the customers that come in the door with exceptional care so they'll come back more often.

We have a mac and cheese platform, have our pumpkin cookie, we have our Buffalo sandwich. We have a fairly robust program for Christmas around our gift cards. So all that stuff we think will help. And just got to keep driving the business.

That's helpful. Thank you. And then, I know you're not ready to provide specifics on the 2017 outlook just yet, but wondering if you could just provide some high level thoughts on how you're thinking about the unit development outlook for next year in terms of whether you expect to continue the pace of 10%-plus Company-operated unit growth or if there's potential for an increased mix of franchise growth as development from some of these multi-unit market agreements start to accelerate.

Well, we think the mix -- we're committed to at least a 10% unit growth. We would like for that for the system. We had a Board meeting last week and what we told the Board is, we want -- whatever happens in the marketplace, we want to be prudent and take advantage of it. So if there's dislocation that should cause us to slow down we'll be in the position to do that. If there's dislocation in the marketplace where real estate becomes available that is attractive to us with our balance sheet, we can take advantage. We're going to be very prudent. We will have a conservative and kind of defensive bent. But the 10% system growth is what we're trying to drive.

Now, the interesting is, looking at some of the pronouncements of our competitors, is that the labor thing is driving everyone to kind of look at their business model and look at development. So we're not alone in that aspect. But we're committed to the 10% unit growth, and with the appropriate mix of Company and franchises.

Thank you. That's helpful.

(Operator Instructions) Joshua Long; Piper Jaffray.

Just wanted to make sure that I was clear on the current guidance and the commentary you were discussing in terms of just the difficult macro environment and then the tough year-ago comparison. Strong results in 3Q from an EPS and from a top-line perspective, but just as I look at your guidance for the year, that reiterated range of $0.36 to $0.38, that does suggest that some downside on a year-over-year basis from an EPS perspective in 4Q. And so just curious if that is largely being driven by the macro environment, the comparisons we talked about, or if there's other cost issues in kind of the middle of the P&L, or items in the middle of the P&L, that we should take into consideration as we fine tune our models for this year.

Yes. I'll start maybe. First it's in the bit of the backdrop of the macro environment in which we make decisions around whether we should revise that EPS guidance or not. Obviously it's softer sales. You pointed out the comps get a little bit tougher as we go through the next couple of months.

And Aylwin has also mentioned, we talked throughout the year about being very back-end weighted on our new shops. We have a tremendous number of shops that will be opening at the very end of the year. Those tend to be very inefficient initially and can be a little bit of a drag on the bottom line.

So I would say we're just being prudent in how we're approaching the guidance to the bottom line.

Great. Thank you for the clarification.

Joseph Buckley; Bank of America.

Apologize if some of these have been asked, but I got knocked off the call for a short period. With the heavy fourth-quarter opening schedule, can you give us some help on what the preopening expense is going to look like in the fourth quarter?

Yes. I'm trying to think how to best answer. We haven't specifically guided on that line, as you know. The preopening expenses we've seen so far year to date continue to be below where others may have estimated. So there would be a bit more of a catch-up in the fourth quarter. I think where folks have been estimating, that number, without providing very specific guidance, has been in the range, a reasonable range within where we're likely to come in.

Okay. And then the new overtime rules that go into effect December 1st, can you discuss the impact of those and how you're handling them?

Yes. We're in the process of internally communicating to the affected assistant manager group. And so we will implement solutions that would mitigate almost 100% of the financial impact for this year, as well as in the future. So there are a couple options that you know very well, and because other folks have talked about it. And we're going to implement one of those.

I'm not being coy. But we haven't talked to our assistant managers. In fact, we talk to them next week. So it would be inappropriate for me to tell you specifically. But the cost will largely be mitigated by us. And we shouldn't -- that's not a line that we'd say we'd have cost inflation on for this year or for 2017.

Okay. And then last one, Aylwin, you talked about testing digital menu boards and I guess obviously hopefully rolling them out next year perhaps. Talk about the investment behind that. Is it a significant capital investment? And are there costs and expenses associated with that that we should start thinking about? Or just tighten it up for us a little bit financially.

Yes. So obviously there's capital, but it would be done within the range of our capital plan. It will be a multiyear approach. We'll start kind of with high volume in new units. And it's like we did the fast oven. We didn't do all of those in one year. Took us 3.5 years to get that done. I'm thinking about the same level of pace for this.

It's a powerful tool that allows us to message in the shops. Should help us drive the new innovation, and also help us drive day part sales. So I think it's a tremendous tool. But we'll be prudent as we roll it out, and it will be multiyear. And, again, it will be within the range of our current capital expenditure.

Okay. Thank you.

And, Joe, this is Mike. Just to add -- back to your question on preopening, one way maybe for you to think about is that our average preopening costs per shop really haven't changed significantly over time. So you just take your estimate of new shop openings for the fourth quarter and apply that, what you've used in the past in terms of average preopening costs. So that might help you get to a more refined number.

Thank you. (Operator Instructions) There are no further questions at this time. I would like to turn the call back over to Mr. Lewis for any closing remarks.

I want to thank everybody for your interest, being on the call, and for your questions.

You know, there are two strengths that this company has: a strong culture and a strong balance sheet. We believe these two things will allow us to maximize the opportunities in the marketplace. There are strong headwinds that are impacting us, but we're very committed to driving our throughput and our profits. We're going to invest in technology that's going to help us grow the business in the future.

And we have a strong belief in what we're doing. The fundamentals are strong. And we should expect strong flow-through so we can meet our profit commitments for the balance of this year, as well as next year. So, disappointed, but still very committed to the business and to our growth story.

Thank you, and get some sandwiches, please.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.