Potbelly Corporation (NASDAQ:PBPB) Q4 2023 Earnings Call Transcript

Potbelly Corporation (NASDAQ:PBPB) Q4 2023 Earnings Call Transcript March 7, 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, and welcome to Potbelly Corporation’s Fourth Quarter and Full Year 2023 Earnings Conference Call. Today’s call is being recorded. [Operator Instructions] On today’s call, we have Bob Wright, President and Chief Executive Officer; Steven 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 fourth-quarter and full-year 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 Relations 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 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.

The 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 headings Risk Factors 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 US 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.

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

Bob Wright: Thank you, Adiya, good afternoon and thank you for joining our call today. So I’m very proud of what our team accomplished in 2023. Our five-pillar strategy maintains our focus on what matters most to our customers and associates, while growing our brand and the benefit of our franchisees and shareholders. We strengthened the Potbelly brand with increased system wide sales driven by 12% same-store sales growth, while simultaneously improving profitability with a 370 basis point improvement to shop margins, achieving 14.2% for the year. We made significant progress with our franchise growth acceleration initiative and ended 2023 with 612 open and committed shops. These development commitments support our target of approximately 10% unit growth in 2024 with growth rates increasing in the coming years.

Finally, we fortified our corporate balance sheet by achieving a net cash position through the generation of positive free cash flow and the proceeds from our strategic refranchising efforts. As I mentioned, these successes began three years ago with the introduction of our five-pillar strategy and a unifying objective of traffic-driven profitability and unit growth. Following year-end March 2022, we introduced our three-year targets of achieving average unit volumes of $1.3 million, shop level margins of 16% and 10% annual unit growth. So how have we done? We currently generate average unit volumes of $1.3 million, have the opportunity to achieve 16% shop level margins and have visibility into reaching our 10% unit growth goal. With the achievement of our 2024 targets in sight, we think it is prudent to provide a view of what we believe we can achieve next.

Specifically, we are introducing our new long-term growth ranges that we see as a framework, we can sustain over time that also coincides with our path to a 2,000 unit system. We expect to generate the following long-term growth. Same store sales growth in the low to mid-single digits, unit growth in the low-double digits, adjusted EBITDA growth in the low to mid-double digits. We have historically proven that we like to set challenging but achievable targets aligned with how we operate the business. We believe this new long-term growth algorithm has an even better way to understand the power of the Potbelly Corporation as a growth brand in the coming years. Turning back to the fourth quarter now, we delivered strong quarterly results with solid top-line performance and 6.3% same-store sales growth.

I feel like a broken record at this point, but again this quarter, I’m proud to say that our strong sales results were driven primarily through traffic growth, demonstrating our ability to grow our traffic share within the fast casual category. In terms of profitability, our team successfully leveraged our food and labor costs, against a strong sales trend resulting in a 150 basis point improvement, in shop level margins year over year at 15.7% for the quarter. And as I’ve said in the past, these results were made possible through our disciplined strategy and execution over the past many quarters, as we have strategically rebuilt Potbelly for sustainable, long-term success. Let us now dive into the specifics on, how we plan to achieve our new long-term growth targets I laid out earlier, starting with the Potbelly Digital experience.

For the quarter, our Digital business represented approximately 40% of our total shop sales, an increase of approximately 150 basis points versus last year, driven by continued progress in our Perks loyalty program. Notably, we continue to see a shift in our Digital business away from third-party channels and towards Potbelly owned app, web and Perks originated orders. Specifically, on Perks, our effort to increase Perks loyalty program member acquisition and activation continues to bear fruit, as we grew Perks acquisition by an impressive 87% during the fourth quarter. In January, we further strengthen our digital platform, as we launched our enhanced Potbelly Perks loyalty program .Our upgraded Perks program celebrates what our customers love the most about Potbelly, great Food.

Perks members can now earn rewards faster than ever before and have more of our menu items available for Rewards Redemptions. Previously perks could only be redeemed after 1,000 points were earned, which we believe could take too long and too many visits. Now redemptions can begin and only 200 points. Not only that, we now also offer, 12 different menu items for redemption including Entrees, Sides & Desserts. Additionally, members can accelerate the rate with which they earn coins, as their status moves from Rocky, to PRO, to Boss level. We’re excited by the reception thus far, and have already seen substantial redemptions for the new menu options. While Digital is an area of strength for Potbelly, we’re not standing still. Now, delighting our customers with Great Food and Good Vibes is always the foundation for sales growth.

I continue to be so proud of our company and franchise operators focus on customer experiences and throughput, to drive top line. Additionally, our marketing initiatives continue to fuel our traffic driven sales. As we look into 2024, we intend to sustain our traffic outperformance. To that end, we will continue to strategically invest our brand marketing fund, which is expected to be over 20% larger versus 2023, benefiting from a full year of 3% contributions from company and franchise shops, as well as ongoing system-wide sales growth. We believe this full-court press on marketing will help us further drive growth of our Potbelly Perks loyalty program and Digital channels; all designed to drive traffic, value and excitement for our customers.

With that, I’d like to update you on our Franchise Growth Acceleration Initiatives. Our franchising team continues to be very busy at work growing our pipeline of qualified Potbelly franchise candidates, as we made great progress, building toward our goal of 2,000 units in the US. Historically, we’ve reported new shop commitments to-date, under the Franchise Growth Acceleration Initiative, at the time of our earnings call. This number currently stands at 202 shops. Going forward, starting with our first quarter report, we will begin speaking about shops committed year-to-date, as of quarter end, which we believe, gives investors a better view as to the progress, we are making in achieving commitments for the remaining approximately 1,400 locations still available in the US.

For that end, under our new Reporting Framework, we are pleased to have signed several development deals in 2023, bringing our total year end shop commitments to 188 shops. Combined with our 424 open shops, we are ending the year with 612 open and committed shops. We plan to continue reporting quarterly shop commitments as well as total open and committed shops as meaningful measures, of unit growth progress. As we look at our development pipeline, we have visibility into achieving approximately 10% unit growth in 2024. At Illinois in our operations development team worked closely with our franchisees to ensure minimal delays at all stages of the development process. That said, as we’ve spoken to previously, we expect our new shop openings in 2024 to be heavily weighted in the back half of the year, as we ramp up development sequentially through the year.

We look forward to sharing additional updates on both shop development area agreements and new shop openings, as we go through the year. With that, I’ll now turn the call over to Steve to detail our financial performance for the fourth quarter.

Steven Cirulis : Thank you, Bob. Good afternoon everyone. Revenues in the fourth quarter increased approximately 4.7% to $125.7 million, partially offset by the short-term revenue impact of our recent refranchising transactions and benefiting from the impact of the 53rd week. Average weekly sales were approximately $24,960. Our system-wide sales of $147.5 million grew by approximately 11.4%. Same-store sales growth of 6.3% in the quarter, excludes the effect of the 53rd week to better align compares against holiday timing. Traffic continues to be a strong contributor to that same-store sales growth, as we drive demand with our compelling value proposition and impactful marketing through our digital channels. Turning to expenses.

Food, beverage and packaging costs were 27.2% of shop sales, a 150 basis point improvement versus the prior year period. Overall, Q4 commodity inflation was greatly improved at negative 110 basis points versus last year. Our grocery category, which includes produce, soups, condiments and chips for the largest input cost increases, with meat primarily chicken retreating year-over-year. Labor expenses were 28.8% of sales, a 200 basis point improvement versus the prior year period. This improvement is attributed to sales leverage along with ongoing optimization of our hours based labor guides. Occupancy was 10.5% of sales, a 70 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 earlier in the year, which carried higher than average occupancy costs.

Other operating expenses were 17.7% of sales, a 260 basis point increase versus the prior year period. This was predominantly due to increased brand fund spend. Overall, shop level margins in the fourth quarter were 15.7%, an increase of 150 basis points year-over-year. General and administrative expenses were 11.9% 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, stock compensation and increased payroll costs to fuel our development efforts. As we discussed in recent quarters, we continue to believe general and administrative expenses as a percent of system-wide sales is a more applicable to view our business, as we become more franchise-based over time.

For the fourth quarter, general and administrative expenses were approximately 10.1% of system-wide sales. Fourth quarter adjusted EBITDA was $7.5 million, or 5.9% of total revenue. This was approximately flat year-over-year, driven by the impact of refranchising, bonus accrual and investments in development G&A mostly offset by a 150 basis point improvement on shop level margin. We reported net income of $2.7 million for the quarter. Adjusted net income was $0.7 million, a $1.9 million decrease versus the prior year period. This decrease was primarily due to similar drivers affecting adjusted EBITDA, as well as higher stock compensation, interest and depreciation compared to 2022. As we announced a few weeks ago, we recently signed a new three-year $30 million revolving credit facility led by Wintrust Bank.

This new facility provides us with significant financial flexibility to pursue our growth ambitions under our five pillar strategy, as well as approximately $2 million in net cash interest savings versus a year ago. 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 to mid single digits, unit growth of approximately 10% and adjusted EBITDA growth in the high-single to low double-digits. The EBITDA growth expectations for 2024 overcoming the effects of refranchising 33 shops and the 53rd week in 2023. The impact of refranchising on our 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 operational model and management team, we expect to be able to achieve high single to low double-digit adjusted EBITDA growth despite these headwinds. For the first quarter of 2024, we anticipate following: same-store sales growth of between negative 25 basis points and positive 50 basis points, including the impact of weather to start the quarter and adjusted EBITDA of between $4.4 million and $5.2 million. Finally, as Bob mentioned today, we introduced the following long-term growth ranges, same-store sales growth in the low to mid single-digits, unit growth in the low double-digits and adjusted EBITDA growth in the low to mid double-digits. With that, I’ll turn the call back over to Bob.

Bob Wright: Thanks, Steven. Let me end by thanking all of our Potbelly associates for their continued hard work and commitment to this unique brand from our frontline associates to our support center employees. For the past two years, we’ve been working tirelessly to provide our guests with the Potbelly experience and their tenacity. It’s what drove our success in 2023, paving the way for us to meet our 2024 growth targets. As we look ahead, we are excited with what we can accomplish over the long-term. We’ve laid the foundation for success as a growth company and with our five-pillar strategic plan, we are on the right track to capitalize on the opportunities ahead and maximize long-term shareholder value. I look forward to another great year of carrying out our mission to delight customers with great food and good vibes into achieving our vision to be the most loved sandwich brand in every neighborhood.

With that we’re happy to answer your 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] The first question today comes from Jeremy Hamblin with Craig-Hallum Capital Group. Please go ahead.

Jeremy Hamblin: Thanks for taking the questions. Congrats on a really strong year and significant progress. I wanted to start by just making sure that I understood the FY 2024 guidance on adjusted EBITDA. So just in terms of the table and how it was presented, was the guide a high single-digit to low double-digit growth rate or as a percent of total revenue?

Steven Cirulis: Yeah. Hey, how are you Jeremy? Good to hear your voice again. Yeah. The guidance of high single-digit to low double-digit those are growth rates on EBITDA, adjusted EBITDA dollars.

Jeremy Hamblin: Got it. Super helpful. And then just coming back to the target on your restaurant level margins approaching here 16% for 2024. If you look across your line items, where do you see the biggest contributors to making progress towards that target this year, roughly almost 200 basis points of improvement year-over-year?

Steven Cirulis: Sure. I’ll take that one. I think we will certainly benefit from sales leverage in achieving that 16% margin. But we also continue to benefit from efficiencies on the labor side, the ops team does a nice job continuing to optimize our space labor guide. We are obviously keen to continue to roll our PDK shops. There’s some efficiencies in there as well. We have expanding aspirations for our catering business which will also help those margins. And really when you look down the shop P&L, the occupancy piece will be leveraged quite a bit and into the other OpEx side less leverage but certainly some leverage. I think we’ve talked in the past about 50% of that other OpEx gets leveraged with sales. So we’re if you could see the velocity we came out of Q4 into 2024 with that 16% margin is certainly within our sights.

Jeremy Hamblin: Fantastic. And then just I noticed in your cash flow statement, it looked like you saw nearly $5 million of proceeds from refranchising in Q4. Pretty healthy step up from what you had seen earlier in the year. I think it implies that you had sold maybe 13 units to franchisees in the quarter. Just wanted to confirm that number. And then with the $5 million, is that all related just to the 13 locations sold or were there some trailer fees on prior deals that you guys had already agreed to?

Steven Cirulis: Sure. I think, first of all first of all, we sold four shops in Columbus that hit that quarter. And then we had our Seattle shops as well, which were 12 shops. And the majority of the proceeds certainly came from the sales of those shops. And we’ve talked in the past with our refranchising, we don’t we don’t necessarily have a target for refranchising. We got a few deals done in the fourth quarter, which make us pretty excited given the additional unit counts that will come with those on the franchise side but that the proceeds definitely came from the sale of those shops. And as we go forward with refranchising we’ve discussed to it, it’s going to be much more selective in terms of the deals that we might that we might do.

Jeremy Hamblin: So in terms of thinking about that that number that you had laid out before, I think it was roughly 100 locations over a three year period. Is that now a number that you expect maybe to be a little bit less of that target?

Bob Wright: Yeah, Jeremy, I think we always said we’d be willing to sell 100 and we still would be, we’re just going to be a lot more selective about when and where we do it. It was always for the purpose of development and getting the unit count development that went with it. And if it made sense for a particular market or group of shops to let those go then, we knew that was part of the long-term play. And we just think that as the sales pipeline has strengthened, franchise candidate interest has strengthened certainly the business, the underpinning business has strengthened that. We’re in a position to be more selective and probably take our time in getting to those. And it gives us a chance to make sure that we’re more focused on growth.

We never saw it as a financial engineering goal. And that’s why we’ve been — we haven’t guided to the exact target on an annual basis. But as we said, we’re going to be just much more selective with whom and when and how many units as we go forward because we can be.

Jeremy Hamblin: Great. Thanks for taking the questions. I’ll hop out of the queue.

Bob Wright: Thanks Jeremy.

Operator: The next question is from Mark Smith with Lake Street Capital Markets. Please go ahead.

Alex Sturnieks: Hi. This is Alex Sturnieks on the line for Mark Smith today. Thank you for taking my questions. The first one for me, just looking at the pipeline for new franchise units, it’s growing very strong. Are the current units developing? And are there any headwinds for franchisees they’re facing anything now getting into a new restaurant?

Bob Wright: Yeah, thanks. We’re excited about the pipeline at all levels. And I think we’ve shared in previous calls, our visibility into each step of the process is where our confidence comes from. And so I think the other element to reverse of that confidence is our concern that we might see along the way. And frankly we’re very involved from the time of franchising to deal structure, the size and layout of those SDAA’s that we’re talking about. We then go as we’ve previously shared we go straight into target area planning and mapping for those targeted trade areas in partnership with the franchisee that puts their master broker and their brokers focused on the trade areas that can be potentially most successful for them and they can they can shop all of those trades at the same time with those real estate brokers.

Our pre-approved architectural engineering firms that, franchisees work with gives us visibility there. I think, we’ve shared in the past that we do site inspections before the franchisee signs the lease, which does two things. It empowers them, if they have issues. And we are — we believe that we will have far fewer surprises when you get to the permitting phase and you get into the construction phase, and it really sets up our contractors to be much more efficient. If you use those designers then, of course, you’re going to get your designs approved by us in a much more expedient fashion. So, look from all along the way, I think we — we see each of those steps and we’re building confidence in our pipeline as a result of it. So no significant slowdowns that we’d be reporting at this point.