Potbelly Corporation (NASDAQ:PBPB) Q3 2023 Earnings Call Transcript

Potbelly Corporation (NASDAQ:PBPB) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Good afternoon, everyone, and welcome to Potbelly Corporation’s Third Quarter 2023 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, Chief Legal Officer and Secretary at 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 third quarter 2023 earnings call. By now, everyone should have access to our earnings release and accompanying investor presentation. If not, they can be found on the Investor Relation section of our website. Before we begin our formal remarks, I need to remind everyone certain comments made on this call will contain forward-looking statements regarding future events for the future financial performance of the Company. Any such statements including our outlook for 2023 or any other future period 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 in our 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. 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 their 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 of our website.

With that out of the way, I’ll like to turn the call over to Potbelly President and CEO, Bob Wright.

Bob Wright: Thank you, Lydia. Good afternoon and thank you for joining our call today. We delivered strong third quarter results demonstrated by solid top line improvement and 8% same-store sales growth. Notably, our traffic growth remained a strong contributor as we continued to take traffic share from the fast casual category each week through the quarter. We also grew shop level margins through continued leverage across food and labor costs, resulting in a 400 basis point improvement year-over-year. I’m proud to say that these results were driven by the cumulative effect of our disciplined strategy and execution over the past many quarters, driving our confidence in the sustainability of the results we’ve achieved thus far.

We remain focused on achieving the long-term growth potential of this amazing brand. As we look forward to the end of the year and into 2024, we will continue to execute against our five pillar strategic plan to achieve traffic driven profitability and unit growth. This includes crave-able quality food at a great value, people creating good vibes, customer experiences that drive traffic growth, digitally driven awareness and connection, and franchise focused development. With that, let me update you on our ongoing initiatives to support these pillars, starting with the Potbelly digital experience. We’re pleased with another quarter of outstanding performance in our digital business, driven by meaningful progress and our Perks Loyalty Program.

All-in-all, our digital business represented approximately 37% of our total shop sales during the quarter, an increase of approximately 150 basis points relative to the same period last year. Importantly, we also continue to see a shift in our digital business away from third-party channels and towards Potbelly-owned app, web, and Perks originated orders. We are committed to serving our customers with the occasions that best meet their needs each time they visit Potbelly, including our unique in-shop fast casual dining experience and through the variety of order occasions delivered by the Potbelly digital experience. During the quarter, we were thrilled to see growth in both verticals. Turning to our Potbelly Digital Kitchen, the rollout of PDK to our existing is progressing as planned, and we will continue the deployment of PDK across our system of existing shops, the standard in every new franchise location.

More importantly is the benefit of PDK to our operations, which are clearly demonstrated not only by the ongoing growth of our digital business and our ability to handle the incremental throughput, particularly during peak periods, but also operating efficiency and improvements in the customer experience from orders ready on time to accuracy of food and quality scores. Importantly, we continue to leverage the throughput learnings from PDK and shops yet to be rolled out in our ongoing effort to drive traffic. Our traffic driven foundation to sales growth continues to be supported by our marketing initiatives, including LTOs and digital only promotions designed to drive traffic, value and excitement for our customers. During the quarter, we introduced our latest underground menu item with the Lucky 7 sandwich, uniting all seven meats from two of our most popular sandwiches, the Italian and arec.

Overall, our underground menu introductions available only on the Potbelly app continue to be among the most searched menu items in our digital channels. As we look ahead, we will continue to focus on food and marketing innovation to further drive growth of our Perks Loyalty Program and digital channels. Lastly, let me share some exciting updates to our franchise growth acceleration initiative or FGA. As we mentioned on our last call, during the quarter, we signed a 27 unit deal in Maryland through a partnership with our company founder, Bryant Keil. During and subsequent to the end of the quarter, we signed multiple additional new development agreements, including a 40-unit deal that is comprised of four refranchised shops and a commitment to develop 36 new shops in both Ohio and Florida.

Our shop development commitments now totaled 150 shops to date. I’m proud of what our franchising team has accomplished in such a short period of time. We remain focused on achieving our 10% unit growth in 2024. We continue to have a highly active and fluid pipeline of qualified Potbelly franchise candidates. And when combined with our unique brand and proven business fundamentals, we believe we have the foundation and the right team in place to drive long-term growth. Looking forward, we will continue to emphasize our franchise focus and build the organization’s capability to support our franchise growth as we head towards 2,000 units in the U.S. We look forward to sharing additional updates on our next calls as more SDAA’s or shop development area agreements are finalized.

Finally, let me reiterate how proud I am of our Potbelly team. Their hard work and commitment to our unique brand have resulted in a strong third quarter performance and they do so by carrying out our mission to delight customers with great food and good vibes, creating a distinct and differentiated fast casual experience for each of our customers from their 1st moment to their last bite. With that, I will now turn the call over to Steve to detail our financial performance for the third quarter.

Steve Cirulis: Thank you, Bob. Good afternoon, everyone. Revenues in the third quarter increased approximately 3% of $120.8 million, driven by same-store sales growth of 8%, resulting in average weekly sales of approximately $25,190, partially offset by the short-term revenue impact of our recent refranchising transaction. System wide sales of $138.2 million grew by approximately 7%. Traffic continues to be a strong contributor to same-store sales growth as we drive demand through providing our customers value for what they pay and showcasing compelling marketing through our digital channels. Additionally, we implemented modest price increases to mitigate increases in input costs and will continue to do so as necessary, although Q3 saw appreciable inflation deceleration.

Our digital business continues to grow and currently represents approximately 37% of revenue, an increase of 150 basis points versus last year, predominantly through our owned channels. We attribute this growth to our progress in enhancing the overall Potbelly digital experience, dedicated efforts to increase Perks Loyalty Program member acquisition and activation, and engagement through targeted digital promotions and advertisements. Turning to expenses, food, beverage, and packaging costs were 27.8% of shop sales, a 210 basis point improvement versus the prior year period. Overall, Q3 commodity inflation was greatly improved at minus 1.5% versus last year. Our grocery category, which includes produce, soup, condiments, and chips, are the largest input cost increases, with meat, primarily chicken, retreating year-over-year.

Labor expenses were 28.9% of sales, a 200 basis point improvement versus the prior year period. This improvement is attributed to sales leverage, along with continued optimization of our hours-based labor guide. We continue to see wage rates moderate and expect this to continue to normalize through the end of the year. Occupancy was 10.7% of sales, a 90 basis point improvement versus the prior year period. The improvement was driven by top line leverage and the refranchising of our New York City market, which carried higher than average occupancy costs. Other operating expenses were 18% of sales, a 100 basis point increase versus the prior year period. This was predominantly due to increased brand fund spend. Overall, shop level margins in the third quarter were 14.6%, an increase of 400 basis points year-over-year.

I’ll cover our forward looking guidance in a moment, but as we look to our fourth quarter, last year we received one time benefits to our restaurant margin totaling 90 basis points that we do not expect to repeat this year. These results truly demonstrated increasing power of the Potbelly economic model with sustainable top line growth fueled by the effectiveness of our marketing efforts, including our Perks Loyalty Program. Operations focused on customer experience and throughput, prudent cost control and normalization of inflationary pressures. That said, we still have more work to do and are focused on achieving our 2024 shop level margin target of 16%. General and administrative expenses were 9.8% of revenue. The year-over-year increase in G&A was driven primarily by higher bonus accruals as we outperformed our targets in the quarter and increased headcount from a year ago to fuel our development efforts.

As we discussed last quarter, we continue to believe general and administrative expenses as a percentage of system wide sales is a more applicable way to view our business as we become more franchise based over time. For the third quarter, general and administrative expenses were approximately 8.6% of system wide sales. We are encouraged by these results as we continue to leverage sales, control costs, and build the development infrastructure ahead of our increasing pace of unit growth. We reported net income of $1.5 million for the quarter. Adjusted net income was $1.1 million, an $800,000 improvement versus the prior year period. Third quarter adjusted EBITDA was $7.3 million or 6% of total revenue. This was a $2.6 million increase year-over-year and a 200 basis point improvement on the margin.

Turning to our outlook, for the full year 2023, our outlook includes AUV of $1.29 million, same-store sales growth between 11.5% and 12%, stock level margins between 13.4% and 13.9%, adjusted EBITDA of between $25.9 million and $27.9 million. For the fourth quarter of 2023, we are currently forecasting the following. Average weekly sales between $24,250 and $24,750, same-store sales growth between 4% and 6%, shop level margin between 12.5% and 14.5%, and adjusted EBITDA between $5 million and $7 million. With that, I’ll turn the call back over to Bob.

Bob Wright: Thanks, Steve. Our third quarter results demonstrated what the Potbelly business model is capable of, and with our momentum continuing into the fourth quarter, we believe we have line of sight to achieving the full year 2024 growth targets. Our pipeline of additional shop development area agreements remains strong and we look forward to sharing additional updates in the coming quarters. While we’ve achieved a great deal in the recent quarters, I can assure you that we are only just getting started. With that, we’re happy to answer any questions. Operator, please open the line for questions.

See also 15 Countries That Contribute The Most To Climate Change and 10 Best ESG ETFs.

Q&A Session

Operator: [Operator Instructions] Today’s first question comes from Todd Brooks with The Benchmark Company. Please go ahead.

Todd Brooks: Good afternoon and congratulations on the results. Good progress. Couple of quick questions and maybe the easiest way to talk to it is the 4% to 6% same-store sales guidance for the fourth quarter. Can you disaggregate for us kind of pricing, traffic and mix assumptions within that 4% to 6% or if it’s easier to talk about a pricing waterfall, in the four quarters, we can attack it that way as well.

Steve Cirulis: Sure, Todd. Why don’t I start with pricing itself and then we can kind of get into some of the other components. So, for the quarter, we’re looking at a 4% overall price increase, and that includes some of the carry forward from the prior year. We had a pricing action early in P11 here in the quarter, which was a 1.5% price increase. So, you can think about our guide at an 8%, same-store sales rate, if you look at our guide, at four to six same-store sales. And then you take a look at our pricing of four, the rest ends up being a blend of traffic and mix shift. And no, we’ve got a business that we feel like is moving in the right direction here and is continuing, it’s strength. We know the category is roughly flat to negative on traffic.

I think we like where we are north of that. So, we don’t breakdown all the components beyond there, but if you take your 4% to 6% range on the same-store sales and our 4% price increase that should help you get to where you need to go.

Todd Brooks: And then, your consumer, I think last quarter you might have talked about, just a little bit of I don’t even know if it was check management versus people opting into many as an option. What do you think about how they’re building check? Are they behaving with a similar fashion as they were maybe at the outset of the year or what are you watching on the Potbelly consumer?

Bob Wright: Yes, it’s a great question, Todd. And I think some of it actually relates to build on what Steve was talking about, but we see a couple of things going on in there. Yes, there is a little bit of a size shift that seems to continue from our bigs and originals to our skinnies when you look at the traffic growth that we have and the amount of business that we’re driving, especially with the newer Perks consumers. We’re not 100% sure that that is actually a change in behavior of existing consumers or is it a change in the profile of our total consumer set. But it’s not at all unhealthy for us. It’s not driving a significant change in check. And the other thing is that it’s actually slightly better on margin as you move through that.

There’s another shift that’s happening. If you heard in my prepared remarks how the majority of our digital business is now coming through our own channels, our Perks app and web channels, and that’s the first time you’ve heard us say that. That means that there’s a shift by channel away from the DSPs,, so there’s third-party delivery orders. Those are always going to carry a higher check because of how we price it to offset the commission that we pay the DSPs. So again, it can have some deflationary impact on the check from a penny profit. We’ve engineered that to be just about even for us. So, there’s no profitability concern, in fact again, from a margin perspective that can be somewhat of a benefit. But because of that slight channel shift, you can see some adjustment in that check too.

So, what I think is the broader question for the consumer in general is are we seeing really significant shifts in consumer behavior, in their spending patterns and what’s going on with traffic patterns and our traffic patterns compared to the fast casual traffic. And the answer is our consumer seems to be hanging in there really well. Look, they’ve got the jobs market is strong. They’ve got the income to support it. The most revised savings numbers suggest that the consumer in this $7,500,000 plus range has not been impacted by the pricing that we’ve taken anyway to offset inflation over the last 12 months.