Potbelly Corporation (NASDAQ:PBPB) Q1 2024 Earnings Call Transcript

Potbelly Corporation (NASDAQ:PBPB) Q1 2024 Earnings Call Transcript May 8, 2024

Potbelly Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, everyone, and welcome to Potbelly Corporation’s First Quarter 2024 Earnings Conference Call. Today’s call is being recorded. At this time, all participants have been placed in a listen-only mode, and the lines will be open for your questions following the prepared remarks. On today’s call, we have Bob Wright, President and Chief Executive Officer; Steve Cirulis, Senior Vice President and Chief Financial Officer; and Adiya Dixon, Senior Vice President, Chief Legal Officer, and Secretary of Potbelly Corporation. At this time, I’ll turn the call over to Adiya Dixon. Please go ahead.

Adiya Dixon: Good afternoon, everyone, and welcome to our first quarter 2024 earnings call. By now, everyone should have access to our earnings release and accompanying investor presentations. If not, they can be found in the Investors tab of our website. Before we begin our formal remarks, I need to remind everyone 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 2024 or any other future periods 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’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 under the risk factors heading in our filings with the Securities and Exchange Commission, which are available at sec.gov. During the call, there will also be a discussion of some items that do not conform to U.S. Generally Accepted Accounting Principles, or GAAP. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are included in the appendix to the press release and investor presentation issued this afternoon, both of which are available in the Investors tab on our website.

And now, I’ll turn the call over to Potbelly’s President and CEO, Bob Wright.

Robert Wright: Thank you, Adiya. Good afternoon, and thank you for joining our call today. We are proud of our solid start to the year across multiple fronts. In terms of profitability, we successfully managed both restaurant-level and corporate costs, driving a 150-basis point expansion to shop-level margins year-over-year to 13.5%, as well as strong corporate profitability with adjusted EBITDA of $5.7 million. This was made possible through the disciplined execution of our team members as we work to achieve our long-term sustainable growth. On the development front, our franchise sales team added 32 additional franchise commitments to our pipeline during the quarter, while our franchise development team helped open three new shops.

Importantly, our momentum on both fronts continues into the second quarter. On the top-line, we continue to outpace the fast casual segment and once again took traffic share for the quarter. That said, industry trends were marginally softer than we were anticipating, leading our results to be below our expectations and slightly below Q1 2023 comps by 0.2%. As with industry trends, we saw some slight declines in transactions from our more infrequent customers. These customers tend to skew to more in-shop visits and slightly less digital. Importantly, though, as I’ll share shortly, our digital marketing and promotional efforts as well as our new Perks loyalty program drove growth. Those elements of our plan that we drive continue to build top-line sales, traffic growth and profitability.

We believe our less frequent customers will benefit from some additional value support over the coming months. As we look into the second quarter, we’re back into positive low-single-digits and we plan to further accelerate traffic driven top-line growth leveraging our five pillar strategy with particular emphasis on tactics that build on our past success, while expanding our appeal. Our focus is heightened in three areas. First and foremost, Potbelly’s great food is the reason our brand is the favorite in so many neighborhoods. We plan to continue to enhance our innovation pipeline of hot toasted sandwiches, hand dipped ice cream shakes and our best-in-class baked fresh daily cookies. Next, recognizing that the very best Potbelly experience, includes access to and the use of our digital assets, we plan to continue to push growth in Perks member acquisition as a way to expose our newer customers to the best experience and value Potbelly has to offer and every day value.

It’s clear to us that consumers of all income brackets can use our help managing their budget pressures. Our customers give us significant credit for everyday value today, including our picture pair combinations and skinny sized sandwiches. We’ve been developing additional ways to deliver value to both in-shop customers and those that engage more often with our digital platforms. Our intent with these expanded everyday value options is to provide an additional access point to the brand and build increased frequency. Now, turning to the drivers of our business. Let’s start with the Potbelly digital experience. For the quarter, our digital business represented approximately 41% of our total shop sales, an increase of approximately 200 basis points versus last year, driven in large part by ongoing progress in our Perks loyalty program.

In January, as we spoke to last quarter, we further strengthen our digital platform with the launch of our enhanced Potbelly Perks loyalty program. The upgraded Perks program celebrates what our customers love the most about Potbelly, great food. Perks members can earn rewards faster than ever before and have more of our menu items available for reward redemptions by using a broader range of coins to do so. We’re so proud to say that we’re seeing the expected customer behavior under the new program and we consider the transition to be a big success. As we’ve said in recent quarters, we continue to see a shift in our digital business away from third-party channels and towards Potbelly’s owned app, web and Perks originated orders. We continue to view this as a positive shift.

We saw strong growth in our Perks sales, orders and active users during the quarter. In fact, Perks’ active members were 36% year-over-year. While the Potbelly digital experience has been a significant area of growth for us in recent quarters and years, we are not standing still. When customers utilize our digital platforms it not only ensures a better experience, but also allows us to more effectively communicate with and market to them. We maintain an extensive app of digital enhancements aimed to continually improving our Potbelly digital experience to best suit customers’ needs, expectations, and reduce friction, while driving Potbelly brand awareness, customer engagement, and business results. Now, delighting customers with great food and good vibes is always the foundation for sales growth.

And I’m pleased with our strong shop operations and the continued progress of our marketing initiatives in fueling our traffic driven sales growth strategy. Beginning in the second quarter, we introduced the Jalapeño Popper Chicken along with the Dulce de Leche cookie and the Cinnamon Churro Shake. While the success of each of these promotions to date is encouraging, we’re not stopping there. As we move through the remainder of the year, you should expect to see additional limited time offers of our hot oven toasted sandwiches, brushed baked daily cookies and hand dipped shakes. In addition, we expect to bring back more underground menu items this year as well. Importantly, we know that today’s consumers more than ever are looking for value when they choose to eat out.

The first pillar of our five pillar strategy has always been great food at a good value and we’ve taken great care to protect our value position. We enjoy strong value ratings overall as well as from our digital and Perks loyalty members, who are among our most frequent customers. We believe we can do more. It’s clear that less frequent customers are looking for everyday value options to support their pressured wallets. We have the tools and strategies to support this customer group by building on everyday value already in our core menu, Meal Deal and Pick-Your-Pair and options, and look forward to expanding on these offerings throughout the year. Now, let me update you on our Franchise Growth Acceleration Initiative. Our franchising team continues to make great progress building towards our goal of 2,000 units in the U.S. And as I mentioned earlier, we are pleased to add 32 franchise shops to the pipeline during the first quarter, bringing our total to 642 open and committed shops.

To put that in perspective, that equates to 26% growth versus the 508 open and committed shops in the first quarter of 2023. We believe our ability to consistently attract high quality franchisees has been driven by three major factors. One, Potbelly is an incredibly strong brand with 47 years of success with our customers’ end markets all across the country. Yet we still have significant multi-unit market development potential in areas like the South, the Southeast, and the West. Number two, we’ve invested heavily in our systems and tools that support franchising and franchisees, particularly in the areas of operations, marketing, and development. You see franchisees see us as a franchise company through and through. And number three, last but certainly not least, franchisees are attracted to our strong unit level operating and investment economics led by a 2 to 1 sales to investment ratio with our system AUVs of approximately $1.3 million and an investment cost as low as approximately $650,000.

Despite our investment costs already being compelling when compared to the industry, we are never satisfied. Our shops currently average approximately 2,300 square feet. And we’re excited to announce the introduction of our new prototype shop that is now only approximately 1,800 square feet. An average reduction of 500 square feet positively impacting leasing and construction costs of new shops. This new prototype is designed to be more digitally-centric along with improved customer flows. Bottom-line, we believe the new design simultaneously enhances the historic traditional in-shop experience and improves the digital experience for our customers and associates alike. Importantly as well, the prototype is flexible to support our growth in the varied lease spaces our franchisees are developing.

In partnership with our design and engineering team, our franchisees will be able to fit the new prototype into each location they lease. And as a reminder PDK or Potbelly Digital Kitchen is standard equipment in all new Potbelly locations as well. We believe this new prototype will bring additional flexibility and cost savings to our franchisees as they search for the optimal site to build Potbelly shops. Our brand design team and engineering teams have been working on the new prototypes since last year, and we began shifting all our planning and permitting to the new design several months ago. In fact, our first franchise shop with the new design is expected to open this month in Arkansas. As we look at our development pipeline, the first quarter saw the opening of three new franchise shops.

Importantly, our momentum is building as we expected into the second quarter. As we looked at the full year, we have 30 units in various stages of the 2024 development cycle. We also have another 10 units in early stages of development that are expected to open in the later months of 2024 or in 2025. With the work of Adam Noyes and his development team, we expect our annualized fourth quarter run rate to put us in a solid position to achieve our long-term growth range of low double-digit unit growth annually over the coming years. With that, I’ll now turn the call over to Steve to detail our financial performance for the quarter.

Steven Cirulis: Thank you, Bob. Good afternoon, everyone. Revenues in the first quarter decreased approximately 6.0% to $111.2 million, majority driven by the short-term revenue impact of last year’s refranchising transaction. Average weekly sales were approximately $24,250, up approximately 1.6%, and system-wide sales of $134.2 million grew by approximately 1.9%. Same-store sales were down 20 basis points in the quarter. Despite this, we continue to take sales and traffic share from both the broader restaurant industry as well as the fast casual industry during the quarter. Turning to expenses. Food, beverage, and packaging costs were 27.2% of shop sales, a 70 basis point improvement versus the prior year period. Overall, Q1 commodity inflation was greatly improved at negative 170 basis points versus last year.

Meat, primarily turkey, retreated the most year-over-year, and we saw some relief in our grocery category, which includes produce, soup, condiments, and cookies. Labor expenses were 30.0% of sales, a 120 basis point improvement versus the prior year period. This improvement is primarily attributed to ongoing optimization of our hours-based labor guide. Occupancy was 10.9% of sales, a 50 basis point improvement versus the prior year period. The improvement was driven by the refranchising of our New York City market in Q1 last year, which carried higher than average occupancy costs. Other operating expenses were 18.4% of sales, a 90 basis point increase versus the prior year period. This was predominantly due to increased brand fund spend. Overall, shop level margins in the first quarter were 13.5%, an increase of 150 basis points year-over-year, inclusive of a one-time legal settlement gain that we mentioned last quarter.

General and administrative expenses were 8.6% of system-wide sales. The year-over-year increase in G&A was driven primarily by stock compensation and increased payroll costs to fuel our development efforts. First quarter adjusted EBITDA was $5.7 million or 5.1% of total revenue. This was approximately flat year-over-year, driven by the impact of refranchising and investments in development G&A, mostly offset by 150 basis point improvement in shop level margin. Importantly, we saw 40 basis point improvement in adjusted EBITDA margin as we continue our transition to a higher margin franchise business model. We reported a net loss of $2.8 million for the quarter, majority driven by the accounting treatment of our debt refinancing. We replaced our $25 million term loan with a $30 million revolving credit facility that provides us with ongoing financial flexibility.

Adjusted net income was $0.2 million, a $0.4 million decrease versus the prior year period. This decrease was primarily due to similar drivers affecting adjusted EBITDA as well as higher stock comp expense compared to 2023, partially offset by lower interest expense from our refinance debt. Also, I’m pleased to announce that our Board of Directors has authorized a $20 million share repurchase program. This is driven by their confidence in the sustainability of the momentum in our business, our strong balance sheet, and the increased predictability of our cash flows as a franchise business model. Given our flexible capital structure, this is an additional tool that management now has to continue to create shareholder value. Finally, I would now like to provide you with the following guidance items.

For the full year 2024, we anticipate the following. Same-store sales growth in the low-single-digits, unit growth of approximately 10% and adjusted EBITDA growth in the mid- to high-single-digits. The adjusted EBITDA growth expectations for 2024 incorporate our slower Q1 performance and overcome the effects of refranchising 33 shops and a 53rd week in 2023. The impact of refranchising on our adjusted EBITDA growth rate is most pronounced in the first three quarters of 2024, as the majority of our refranchised sales occurred in the second half of 2023. With the strength of our operating model and management team, we expect to be able to achieve mid- to high-single-digit adjusted EBITDA growth for the year. For the second quarter of 2024, we anticipate the following.

Same-store sales growth of between 0% and 2%, and adjusted EBITDA of between $7 million and $8.5 million. With that, I’ll turn the call back over to Bob.

Robert Wright: Thanks, Steve. Despite the macro headwinds during the first quarter, we are thrilled with what 2024 has in store for us. First, we have an extensive roadmap of digital enhancements that we believe will further strengthen our Potbelly digital experience. Second, our marketing initiatives continue to support our traffic-driven sales growth strategy. And finally, our franchise growth initiative is progressing very well as we build toward our goal of 2,000 units in the U.S., putting us in a position to achieve our long-term growth range of low-double-digit unit growth annually over the coming years. The work our teams have done for the past 2 years have positioned us to capitalize on the opportunities ahead. We look forward to sharing additional updates in the coming quarters.

In closing, I would like to thank all of our Potbelly team members, from our frontline associates to our support center employees and, of course, our franchisees and their teams for their hard work and commitment to making Potbelly the most loved sandwich brand in every neighborhood. With that, we’re happy to answer any questions. Operator, please open the line for questions.

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Mark Smith with Lake Street Capital Markets. Please go ahead.

Alex Sturnieks: Hey, guys, this is Alex Sturnieks on the line today for Mark Smith. Thanks for taking my question. First one for me, as we look at consumer behavior throughout the quarter, did you guys see any trends with comps sequentially? And then to add onto that, are you seeing any consumer shifts with different locations, maybe anything from a CBD location to a suburban store standpoint?

Robert Wright: Yeah, Alex, thanks for the question. I think that what we saw, first of all, is probably similar to what you’re hearing about the industry, that January was certainly the softer month of the quarter, some that’s weather and could just be more seasonality returning to those consumer behaviors. But February and March certainly started to strengthen, and as we mentioned, even into the second quarter, we’re seeing those positive sales return to us. I think both our internal data that we have with all of our digital business and then the syndicated data that we have access to our indications that just there’s a slight pullback in the more infrequent customer and the infrequent consumer. To be clear, these are our customers.

They’re coming to Potbelly, but they’re clearly managing their wallet a little bit more maybe than even a year ago. And that’s why you heard some of my remarks about how we’ve got this great everyday value platform, we’ve had at Potbelly all these years, really going back to 2021 when we rebuilt the menu. That was a big part of the work we did to work on the menu. But we think we can do more. And we think that that’s going to be an area of focus for us. When you hear all of the numbers that we shared on the digital growth that we had in the quarter, those are our most frequent consumers. Those are the ones that we can see the data most clearly. It’s the reason that we continue to bring people into that frequency funnel, starting off as a customer that begins to visit the shop, and then they start becoming a little more frequent, a little more affinity for the brand.

We draw them into our digital assets and eventually get them into the Perks membership. And so, we think we’ve analyzed it more as a frequency, a slight shift in frequency that we think we can address.

Alex Sturnieks: Got it. Yeah. No, that’s helpful. And then last one for me, could you give any updates on your desire to sell company units or the demand from others to purchase existing company locations? I know you previously mentioned being more selective about where and when, but just curious if that has changed at all.

Robert Wright: Yeah, look, I think the strategy is still the same. What you see in the numbers is that we’re deploying the strategy with a little more judiciously than we have in the past. It has always been that we would refranchise to catalyze growth. And what you see with our continuing growing number of open and committed shops, and the new commitments that we got in Q1 and what we can see that we obviously haven’t announced until each quarter comes along what we can see in the pipeline. We’re really pleased with our development efforts. And even if you take the Washington, D.C. market as an example, we did refranchise some locations there, but we’re still operating in that market with company units and franchise units.

And brands are very comfortable doing that. So I think that continues to be something that we’ll do. We’ll be a little more careful about it. We shared with you last quarter. We thought there’d be a lot fewer of those this year. Out of that 100, roughly one-third of them have been sold. And, again, we’re still willing to go with the rest, but we’re in no rush to do that if it isn’t a significant part of our growth.

Alex Sturnieks: Got it. Thank you for taking my questions today.

Robert Wright: You’re welcome.

Operator: The next question is from Jeremy Hamblin with Craig-Hallum. Please go ahead.

Jeremy Hamblin: Thanks, and congrats on the strong results. I wanted to start with the franchise unit development. I think this is kind of a milestone here, if I’m not mistaken, the first time that the ending unit count is up on a year-over-year basis in like 6 years. So kudos on that. And I wanted to make sure that I heard the details behind the shovels in the ground, so to speak, in units in progress. Did you say you had 30 that were in progress today, and then 10 that were in the early stages? I wanted to get a sense if you could help us think about the cadence of franchise unit openings this year. And then as a back part of that question, how long does it take once you start in on a unit kind of from getting the first work done to completing the unit and getting it open?

Robert Wright: Yeah, Jeremy, thank you. And you’re right, we’re celebrating that milestone as well. It’s really good to be growing again and, obviously, we’re in the very, very early innings of delivering those new units, now, we’re really pleased. I’ll start with the back end, because I think it informs the pipeline a little bit. There was a time when it took much longer to develop a Potbelly, but today we’ve got it down to between 11 and 12 months. We mentioned, gosh, more than a year ago how we reorganized the development function, split that between our franchising efforts, all focused on franchise sales and then everything from the real estate all the way to opening, and the construction and engineering in between those reports to two different leaders on the SLT.

As a result, that reengineered timeline means we can from the time we sign a deal, we can open a unit in less than a year. So you can imagine the fact that we just get deeper and deeper into these deals, we have the ability to open units at an ever accelerating rate. That does vary a little bit by unit, by location, but that’s why our franchisees are working their entire market at one time and not simply looking for one site at a time. You asked about the cadence of opening. That’s going to reflect the deal timing that we went through last year. So that’s why a lot of our openings are a little more back loaded this year. That’s not unusual in the restaurant space anyway, I know, you know that. But we are going to continue to see some acceleration and really some quickening if you will in Q2.

But, we are still very much a back loaded opening schedule for the 2023 year. And that’s why, frankly, that’s the reason we wanted to give you that exposure to the 30 and the 10. Those 30 are units we can see in every stage of development. That’s why we’re counting them in that pipeline for 2024. And then, you get a little deeper into that development cadence, and you can certainly get them open by the end of the year, but we all know that sometimes something might slip. And we wanted to start to separate those into categories. I will also tell you that that isn’t a full list. There is still time this year to add units to that pipeline, and we’re working like crazy to do that as well.

Jeremy Hamblin: Great. Thanks for that color. I wanted to come back to the sales trends for a second, and like get a sense for, I think a lot of restaurants have called out that Easter had a bit of a negative impact on the March quarter. I wanted to get a sense for whether or not that, if you saw that impact, particularly given your exposure in CBD areas. And then, as we think about the customer spend, are you seeing any change in terms of the average ticket? Are you seeing any check management from your customers?

Robert Wright: Yeah, look, the Easter flip from one quarter to the other is always going to affect us a little bit. And we still are more focused on the trends that we see through the quarter, what happened in January, and then how we saw February and March start to blend together. And there’s no question that there was probably a little bit of extra pressure on March, because of that shift, but that’s not really what we’re pointing to, because those holidays swing back the other way too. And over the period of a quarter, it’s an impact, but it’s not one of the biggest ones we wanted to call out. And, when it comes to customer spend, we’ve shared this in past quarters. We’re watching those mixed numbers as indicators that customers are using our menu in a way that fits their budget.

One of the great things about our three sizes is you can move up and down those sizes. And there is some evidence with a little bit of shift from bigs to originals, or maybe originals to skinnies that there’s some wallet management going on. The great news is we have all of those sizes and people don’t have to pull their occasion completely from us if they can move around the menu. But they are not dramatic or significant shifts, but I think they are indicators of where people are feeling some pressure.

Jeremy Hamblin: Got it. And then you guys made great progress on the restaurant level margins this quarter, particularly in light of a flat comp 150 basis points. That’s pretty impressive. The one-off line item that you saw some deleverage in was your other operating expenses, I think was down about 90 basis points year-over-year, and wanted to see if you could provide a bit more color on that. I know that you’re making progress on bringing more of the digital orders on through your app. So I would think that maybe you would see your exposure to third party delivery down, but any color that you could provide on what was the culprit there on the deleverage on other operating expenses and how we should think about that particular line item the remainder of the year?

Steven Cirulis: Yeah, sure. Hi, Jeremy. Yeah, I think we’re really proud of the margin expansion that we experienced in the quarter, despite some of the consumer changes that we saw. But you’ll have to remember within that other operating expenses line for us is our brand fund, and our conversations over the last several quarters we’ve talked about how we took last year to ladder up our spend to that 3% of sales, and we didn’t achieve that until the second half of the year. So, lapping Q1 this year, you can see the difference. We have more brand fund expense that sat in that other OpEx line Q1 this year versus what sat in that line last year. So that’s really where a lot of it sits. We also have in there, obviously, our digital fees and so forth.

And Q1 is interesting, because there’s always a little bit of a shift around the delivery piece, because of the weather and so forth, but nothing that I think would outstrip the brand fund expense. And, even though, we’ve got restaurant margins where they are with some expansion. We’re ultimately focused on our overall profitability at the corporate level, and our ability to offset anything that we see on the restaurant margin line. We work to offset that with some savings at the corporate level, whether that be through corporate costs like G&A or otherwise. So the other thing to mention, I think, which is important, particularly to think about next year, some of our shop margin benefited from the third party settlement that we had as well, as that is reflected in this quarter.

But as we head into quarter one next year, we’ll have to just remember that that was there. But even with the benefit of that settlement sitting in our shop margin, it was still an expansion, some expanding quarter for us.

Jeremy Hamblin: Got it. And then just to clarify of the 90 basis points, how much of it was due to the brand fund? Was that 50 basis points or more like 75?

Steven Cirulis: It was more than half of the hit.

Jeremy Hamblin: Got it. And then just the third party settlement, the line item that that falls under?

Steven Cirulis: It got spread across a couple of line items within shop margin. It sat within our labor and it sat within our other OpEx. It sat within labor, because it affected our ability to schedule properly and so forth. And on the other OpEx line, it affected our ability to really kind of manage some of the details around how we report and some of those fees that come in from third parties, et cetera. So I can evenly split among those two items.

Jeremy Hamblin: Got it. Thanks for taking the questions and good luck this year.

Robert Wright: Thanks, Jeremy.

Steven Cirulis: Thanks, Jeremy.

Operator: The next question is from Todd Brooks with The Benchmark Company. Please go ahead.

Todd Brooks: Hey, thanks for taking my questions. Would like to lead off, Bob, I was excited to hear about the new work cementing the new prototype, the 1,800 square feet. I don’t think, did you share a new build cost relative to the prior 650 that you’re looking at for the new box?

Robert Wright: We didn’t, not in the remarks, but happy to discuss it, Todd. I’ll tell you, we’re really excited about this. We’ve been working on it, as I mentioned, since last year and it’s not like we’ve been keeping it secret. We like to talk about things when we’re really proud of the work and not before that. But, that’s an average to an average, first of all, let’s make that clear. But an average of 500 feet, if you look at today’s average lease cost, triple net charges, those are hundreds of basis points of leasing margin expansion for franchisees that are able to take advantage of that. And so that’s where the big win is, is the OpEx side of things. The other thing is, I’m sure you’ve talked to many restaurant companies, but the inflation that hit every bit of the economy, hit construction and durable goods pretty hard.