pbpb-10q_20180701.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended July 1, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from                      to                     

Commission File Number: 001-36104

 

Potbelly Corporation

(Exact name of registrant as specified in its charter)

 

 

 

 

 

Delaware

 

36-4466837

(State or Other Jurisdiction of

Incorporation)

 

(IRS Employer

Identification Number)

111 N. Canal Street, Suite 850

Chicago, Illinois 60606

(Address, including Zip Code, of Principal Executive Offices)

Registrant’s telephone number, including area code: (312) 951-0600

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

 

 

 

 

 

 

 

Large accelerated filer

 

 

  

Accelerated filer

 

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Common stock, $0.01 Par Value – 25,457,575 shares as of July 29, 2018

 

 

 

 

 


Potbelly Corporation and Subsidiaries

Table of Contents

 

 

 

 

 

Page

PART I.

 

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

 

Financial Statements

 

3

 

 

 

 

 

 

Condensed Consolidated Balance Sheets

 

3

 

 

 

 

 

 

Condensed Consolidated Statements of Operations

 

4

 

 

 

 

 

 

Condensed Consolidated Statements of Equity

 

5

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows

 

6

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

7

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

12

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

20

 

 

 

 

Item 4.

 

Controls and Procedures

 

20

 

 

 

 

PART II.

 

OTHER INFORMATION

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

21

 

 

 

 

Item 1A.

 

Risk Factors

 

21

 

 

 

 

Item 2.

 

Unregistered Sale of Equity Securities and Use of Proceeds

 

21

 

 

 

 

Item 6.

 

Exhibits

 

22

 

 

 

 

 

 

Signature

 

23

 

2


PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Potbelly Corporation and Subsidiaries

Condensed Consolidated Balance Sheets

(amounts in thousands, except share and par value data, unaudited)

 

 

 

July 1,

 

 

December 31,

 

 

 

2018

 

 

2017

 

Assets

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

34,310

 

 

$

25,530

 

Accounts receivable, net of allowances of $105 and $129 as of July 1, 2018

and December 31, 2017, respectively

 

 

5,659

 

 

 

5,087

 

Inventories

 

 

3,262

 

 

 

3,525

 

Prepaid expenses and other current assets

 

 

13,242

 

 

 

11,061

 

Total current assets

 

 

56,473

 

 

 

45,203

 

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

 

99,551

 

 

 

103,859

 

Indefinite-lived intangible assets

 

 

3,404

 

 

 

3,404

 

Goodwill

 

 

2,222

 

 

 

2,222

 

Deferred income taxes, noncurrent

 

 

9,803

 

 

 

11,202

 

Deferred expenses, net and other assets

 

 

4,821

 

 

 

4,840

 

Total assets

 

$

176,274

 

 

$

170,730

 

 

 

 

 

 

 

 

 

 

Liabilities and Equity

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

Accounts payable

 

$

4,500

 

 

$

3,903

 

Accrued expenses

 

 

26,020

 

 

 

23,273

 

Accrued income taxes

 

 

 

 

 

176

 

Total current liabilities

 

 

30,520

 

 

 

27,352

 

 

 

 

 

 

 

 

 

 

Deferred rent and landlord allowances

 

 

22,811

 

 

 

22,987

 

Other long-term liabilities

 

 

3,609

 

 

 

3,153

 

Total liabilities

 

 

56,940

 

 

 

53,492

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

 

Common stock, $0.01 par value—authorized 200,000,000 shares; outstanding

25,651,953 and 24,999,688 shares as of July 1, 2018 and December 31,

2017, respectively

 

 

327

 

 

 

318

 

Additional paid-in-capital

 

 

430,643

 

 

 

421,657

 

Treasury stock, held at cost, 7,104,618 and 6,831,508 shares as of

July 1, 2018, and December 31, 2017, respectively

 

 

(88,827

)

 

 

(85,262

)

Accumulated deficit

 

 

(223,234

)

 

 

(219,990

)

Total stockholders’ equity

 

 

118,909

 

 

 

116,723

 

Non-controlling interest

 

 

425

 

 

 

515

 

Total stockholders' equity

 

 

119,334

 

 

 

117,238

 

 

 

 

 

 

 

 

 

 

Total liabilities and equity

 

$

176,274

 

 

$

170,730

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

3


Potbelly Corporation and Subsidiaries

Condensed Consolidated Statements of Operations

(amounts in thousands, except share and per share data, unaudited)

 

 

 

For the 13 Weeks Ended

 

 

For the 26 Weeks Ended

 

 

 

July 1,

 

 

June 25,

 

 

July 1,

 

 

June 25,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sandwich shop sales, net

 

$

109,381

 

 

$

107,382

 

 

$

211,628

 

 

$

208,241

 

Franchise royalties and fees

 

 

966

 

 

 

754

 

 

 

1,636

 

 

$

1,594

 

Total revenues

 

 

110,347

 

 

 

108,136

 

 

 

213,264

 

 

 

209,835

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sandwich shop operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold, excluding depreciation

 

 

28,639

 

 

 

28,635

 

 

 

55,275

 

 

 

55,298

 

Labor and related expenses

 

 

32,412

 

 

 

31,564

 

 

 

63,991

 

 

 

62,026

 

Occupancy expenses

 

 

14,985

 

 

 

14,269

 

 

 

29,711

 

 

 

28,438

 

Other operating expenses

 

 

12,793

 

 

 

12,252

 

 

 

25,293

 

 

 

23,885

 

General and administrative expenses

 

 

13,440

 

 

 

10,919

 

 

 

25,628

 

 

 

21,271

 

Depreciation expense

 

 

5,858

 

 

 

6,446

 

 

 

11,684

 

 

 

12,645

 

Pre-opening costs

 

 

68

 

 

 

546

 

 

 

136

 

 

 

619

 

Impairment and loss on disposal of property and equipment

 

 

2,057

 

 

 

3,341

 

 

 

4,081

 

 

 

4,226

 

Total expenses

 

 

110,252

 

 

 

107,972

 

 

 

215,799

 

 

 

208,408

 

Income (loss) from operations

 

 

95

 

 

 

164

 

 

 

(2,535

)

 

 

1,427

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

28

 

 

 

41

 

 

 

55

 

 

 

69

 

Income (loss) before income taxes

 

 

67

 

 

 

123

 

 

 

(2,590

)

 

 

1,358

 

Income tax expense (benefit)

 

 

302

 

 

 

186

 

 

 

(202

)

 

 

739

 

Net income (loss)

 

 

(235

)

 

 

(63

)

 

 

(2,388

)

 

 

619

 

Net income attributable to non-controlling interest

 

 

125

 

 

 

75

 

 

 

166

 

 

 

74

 

Net income (loss) attributable to Potbelly Corporation

 

$

(360

)

 

$

(138

)

 

$

(2,554

)

 

$

545

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per common share attributable to common

   stockholders:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.01

)

 

$

(0.01

)

 

$

(0.10

)

 

$

0.02

 

Diluted

 

$

(0.01

)

 

$

(0.01

)

 

$

(0.10

)

 

$

0.02

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

25,551,386

 

 

 

25,033,868

 

 

 

25,348,121

 

 

 

25,066,374

 

Diluted

 

 

25,551,386

 

 

 

25,033,868

 

 

 

25,348,121

 

 

 

25,981,051

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

4


Potbelly Corporation and Subsidiaries

Condensed Consolidated Statements of Equity

(amounts in thousands, except share data, unaudited)

 

 

 

Common Stock

 

 

Treasury

 

 

 

 

 

 

Additional

Paid-In-

 

 

Accumulated

 

 

Non-

Controlling

 

 

 

 

 

 

 

Shares

 

 

Amount

 

 

Stock

 

 

Warrants

 

 

Capital

 

 

Deficit

 

 

Interest

 

 

Total Equity

 

Balance at December 25, 2016

 

 

25,139,127

 

 

$

309

 

 

$

(72,321

)

 

$

909

 

 

$

407,622

 

 

$

(213,034

)

 

$

751

 

 

$

124,236

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

545

 

 

 

74

 

 

 

619

 

Stock-based compensation plans

 

 

158,235

 

 

 

2

 

 

 

 

 

 

 

 

 

1,113

 

 

 

 

 

 

 

 

 

1,115

 

Exercise of stock warrants

 

 

241,704

 

 

 

2

 

 

 

 

 

 

(909

)

 

 

2,879

 

 

 

 

 

 

 

 

 

1,972

 

Repurchases of common

   stock

 

 

(413,584

)

 

 

 

 

 

(4,996

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(4,996

)

Distributions to non-

controlling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(113

)

 

 

(113

)

Contributions from non-

controlling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

11

 

 

 

11

 

Amortization of

   stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,925

 

 

 

 

 

 

 

 

 

1,925

 

Balance at June 25, 2017

 

 

25,125,482

 

 

$

313

 

 

$

(77,317

)

 

$

 

 

$

413,539

 

 

$

(212,489

)

 

$

723

 

 

$

124,769

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2017

 

 

24,999,688

 

 

$

318

 

 

$

(85,262

)

 

$

 

 

$

421,657

 

 

$

(219,990

)

 

$

515

 

 

$

117,238

 

Cumulative impact of Topic

   606 at 1/1/2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(690

)

 

 

 

 

 

(690

)

Net income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,554

)

 

 

166

 

 

 

(2,388

)

Stock-based compensation plans

 

 

925,375

 

 

 

9

 

 

 

 

 

 

 

 

 

6,735

 

 

 

 

 

 

 

 

 

6,744

 

Repurchases of common

   stock

 

 

(264,339

)

 

 

 

 

 

(3,449

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(3,449

)

Distributions to non-

controlling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(256

)

 

 

(256

)

Treasury shares used for

    stock-based plans

 

 

(8,771

)

 

 

 

 

 

(116

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(116

)

Amortization of

   stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,251

 

 

 

 

 

 

 

 

 

2,251

 

Balance at July 1, 2018

 

 

25,651,953

 

 

$

327

 

 

$

(88,827

)

 

$

 

 

$

430,643

 

 

$

(223,234

)

 

$

425

 

 

$

119,334

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

5


Potbelly Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(amounts in thousands, unaudited)

 

 

 

For the 26 Weeks Ended

 

 

 

July 1,

 

 

June 25,

 

 

 

2018

 

 

2017

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(2,388

)

 

$

619

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation

 

 

11,684

 

 

 

12,645

 

Deferred income tax

 

 

(150

)

 

 

974

 

Deferred rent and landlord allowances

 

 

(176

)

 

 

1,097

 

Amortization of stock compensation expense

 

 

2,251

 

 

 

1,925

 

Excess tax deficiency from stock-based compensation

 

 

469

 

 

 

89

 

Asset impairment, store closure and disposal of property and equipment

 

 

4,221

 

 

 

4,262

 

Amortization of debt issuance costs

 

 

18

 

 

 

18

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable, net

 

 

(822

)

 

 

(1,789

)

Inventories

 

 

263

 

 

 

43

 

Prepaid expenses and other assets

 

 

(924

)

 

 

(1,376

)

Accounts payable

 

 

676

 

 

 

554

 

Accrued and other liabilities

 

 

2,745

 

 

 

(3,921

)

Net cash provided by operating activities:

 

 

17,867

 

 

 

15,140

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(11,614

)

 

 

(15,326

)

Net cash used in investing activities:

 

 

(11,614

)

 

 

(15,326

)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Proceeds from exercise of stock options

 

 

6,744

 

 

 

1,115

 

Proceeds from exercise of stock warrants

 

 

 

 

 

1,972

 

Employee taxes on certain stock-based payment arrangements

 

 

(512

)

 

 

 

Treasury stock repurchases

 

 

(3,449

)

 

 

(4,996

)

Contributions from non-controlling interest

 

 

 

 

 

11

 

Distributions to non-controlling interest

 

 

(256

)

 

 

(113

)

Net cash provided by (used in) financing activities:

 

 

2,527

 

 

 

(2,011

)

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

 

8,780

 

 

 

(2,197

)

Cash and cash equivalents at beginning of period

 

 

25,530

 

 

 

23,379

 

Cash and cash equivalents at end of period

 

$

34,310

 

 

$

21,182

 

 

 

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

 

 

 

Income taxes paid

 

$

244

 

 

$

3,253

 

Interest paid

 

 

38

 

 

 

53

 

Supplemental non-cash investing and financing activities:

 

 

 

 

 

 

 

 

Unpaid liability for purchases of property and equipment

 

$

1,299

 

 

$

2,397

 

 

See accompanying notes to the unaudited condensed consolidated financial statements

 

 

6


 

Potbelly Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements (unaudited)

 

(1) Organization and Other Matters

Business

Potbelly Corporation (the “Company” or “Potbelly”), through its wholly-owned subsidiaries, owns or operates over 400 shops in in 32 states and the District of Columbia, and our franchisees operate over 50 shops domestically, in the Middle East, Canada and India.

Basis of Presentation

The unaudited condensed consolidated financial statements and notes herein should be read in conjunction with the audited consolidated financial statements of Potbelly Corporation and its subsidiaries and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. The unaudited condensed consolidated financial statements included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”) regarding interim financial reporting. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to the SEC rules and regulations. In the opinion of management, all adjustments, which are of a normal and recurring nature (except as otherwise noted), that are necessary to present fairly the Company’s financial position as of July 1, 2018 and December 31, 2017, its statement of operations for the 13 and 26 weeks ended July 1, 2018 and June 25, 2017 and its statement of cash flows for the 26 weeks ended July 1, 2018 and June 25, 2017 have been included. The consolidated statements of operations for the interim periods presented herein are not necessarily indicative of the results to be expected for the full year.

The Company does not have any components of other comprehensive income recorded within its consolidated financial statements and therefore, does not separately present a statement of comprehensive income in its condensed consolidated financial statements.

Principles of Consolidation

The unaudited condensed consolidated financial statements include the accounts of Potbelly Corporation; its wholly owned subsidiary, Potbelly Illinois, Inc. (“PII”); PII’s wholly owned subsidiaries, Potbelly Franchising, LLC and Potbelly Sandwich Works, LLC (“LLC”); eight of LLC’s wholly owned subsidiaries and LLC’s six joint ventures, collectively, the “Company.” All intercompany balances and transactions have been eliminated in consolidation. For consolidated joint ventures, non-controlling interest represents a non-controlling partner’s share of the assets, liabilities and operations related to the five joint venture investments. The Company has ownership interests ranging from 51-80% in these consolidated joint ventures.

Fiscal Year

The Company uses a 52/53-week fiscal year that ends on the last Sunday of the calendar period. Approximately every five or six years a 53rd week is added. Fiscal year 2018 consists of 52 weeks and 2017 consisted of 53 weeks. The fiscal quarters ended July 1, 2018 and June 25, 2017 each consisted of 13 weeks.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Significant estimates include amounts for long-lived assets and income taxes. Actual results could differ from those estimates.

 

7


 

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, “Revenue from Contracts with Customers.” The pronouncement was issued to clarify the principles for recognizing revenue and to develop a common revenue standard and disclosure requirements for U.S. GAAP and International Financial Reporting Standards (IFRS). In addition, the FASB issued ASU 2016-08, ASU 2016-10 and ASU 2016-12 in March 2016, April 2016 and May 2016, respectively, to help provide interpretive clarifications on the new guidance in Accounting Standards Codification (ASC) Topic 606. Potbelly adopted the standard effective January 1, 2018 using the modified retrospective method applied to contracts that were not completed as of the date of adoption. The adoption does not have a material impact on sandwich shop sales, but impacted the recognition of franchise revenue and gift card breakage. Potbelly licenses intellectual property and trademarks to franchisees through franchise arrangements. As part of these agreements, Potbelly receives an initial franchise fee payment, which historically was recognized as revenue when the shop opened. Under the new guidance, these franchise fees are considered highly dependent upon and interrelated with the franchise right granted in the franchise agreement.  As such, these franchise fees are recognized over the contractual term of the franchise agreement. Effective for the annual period beginning January 1, 2018, initial franchise fees are recognized as revenue over the contractual term. Potbelly sells gift cards to customers and records the sale as a liability. The liability is released once the card is redeemed. Historically, a portion of these gift card sales were not redeemed by the customer (“breakage”) and Potbelly would recognize breakage two years after the period of sale. Effective for the annual period beginning January 1, 2018, expected breakage is recognized as customers redeem the gift cards. Upon adoption of the standard, Potbelly’s accumulated deficit increased by $0.7 million (net of tax). The franchise revenue adjustment impacted accrued expenses, other long-term liabilities and deferred income taxes. The breakage adjustment impacted accrued expenses and deferred income taxes. For the 13 weeks ended July 1, 2018, revenue recognized was $0.1 million higher than it would have been under the previous methodology, and for the 26 weeks ended July 1, 2018, revenue recognized was $0.2 million higher than it would have been under the previous methodology.

In February 2016, the FASB issued ASU No. 2016-02, “Leases,” which will replace the existing guidance in ASC 840, “Leases.” The pronouncement requires a dual approach for lessee accounting under which a lessee would account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use asset and a corresponding lease liability. For finance leases, the lessee would recognize interest expense and amortization of the right-of-use asset, while for operating leases, the lessee would recognize a straight-line total lease expense. The pronouncement is effective for fiscal years beginning after December 15, 2018, including annual and interim periods thereafter. In addition, the pronouncement requires the use of the modified retrospective method, which will require adjustment to all comparative periods presented in the consolidated financial statements. The Company is currently evaluating the impact ASU 2016-02 will have on its financial position, results of operations and cash flows, but expects that it will result in a material increase in its long-term assets and liabilities given the Company has a significant number of leases.

(2) Revenue

Potbelly primarily earns revenue at a point in time through sales at our sandwich shop locations and records such revenue net of sales-related taxes collected from customers. The payment on these sales is due at the time of the customer’s purchase. The Company also receives royalties from franchisees on their respective sales, which are recognized at the point in time the sale is made, and invoiced weekly. Potbelly also records revenue from sales over time related to upfront franchise fees, and gift card redemptions and breakage. For the 26 weeks ended July 1, 2018, revenue recognized from all revenue sources on point in time sales was $212.9 million, and revenue recognized from sales over time was $0.4 million.

Franchise Revenue

Potbelly licenses intellectual property and trademarks to franchisees through franchise agreements. As part of these franchise agreements, Potbelly receives an upfront payment from the franchisee, which the Company recognizes over the term of the franchise agreement. The Company records a contract liability for the unearned portion of the upfront franchise payments.

Gift Card Redemptions / Breakage Revenue

Potbelly sells gift cards to customers and records the sale as a contract liability and recognizes the associated revenue as the gift card is redeemed. A portion of these gift cards are not redeemed by the customer, which is recognized by the Company as revenue as a percentage of customers gift card redemptions. The expected breakage amount recognized is determined by a historical data analysis on gift card redemption patterns.

8


 

Contract Liabilities

As described above, the Company records current and noncurrent contract liabilities for upfront franchise fees as well as gift cards. There are no other contract liabilities and there are no contract assets recorded by the Company. The opening and closing balances of the Company’s current and noncurrent contract liabilities from contracts with customers were as follows:

 

 

 

Current Contract Liability

 

 

Noncurrent Contract Liability

 

 

 

(Thousands)

 

 

(Thousands)

 

Beginning balance as of January 1, 2018

 

$

(2,325

)

 

$

(2,144

)

Ending balance as of July 1, 2018

 

 

(1,415

)

 

 

(1,862

)

Decrease in contract liability

 

$

(910

)

 

$

(282

)

 

The aggregate value of remaining performance obligations on outstanding contracts was $3.3 million as of July 1, 2018. The decrease in the liability during the 26 weeks ended July 1, 2018 was a result of gift card redemptions offset by purchases of new gift cards and recognition of franchise fees. The Company expects to recognize revenue related to contract liabilities as follows (in thousands), which may vary based upon franchise activity as well as gift card redemption patterns:

 

Years Ending

 

Amount

 

2018

 

$

1,262

 

2019

 

 

334

 

2020

 

 

208

 

2021

 

 

201

 

2022

 

 

193

 

Thereafter

 

 

1,079

 

Total revenue recognized

 

$

3,277

 

 

For the 13 and 26 weeks ended July 1, 2018, the amount of revenue recognized related to the January 1, 2018 liability ending balance was $0.6 million and $1.6 million, respectively. This revenue related to the recognition of gift card redemptions and upfront franchise fees. For the 26 weeks ended July 1, 2018, the Company did not recognize any revenue from obligations satisfied (or partially satisfied) in prior periods.

(3) Fair Value Measurement

The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and all other current liabilities approximate fair values due to the short maturities of these balances.

The Company assesses potential impairments to its long-lived assets, which includes property and equipment, on a quarterly basis or whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. Shop-level assets are grouped at the individual shop-level for the purpose of the impairment assessment. Recoverability of an asset is measured by a comparison of the carrying amount of an asset to its estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of the asset group exceeds its estimated undiscounted future cash flows, an impairment charge is recognized as the amount by which the carrying amount of the asset exceeds the fair value of the asset. The fair value of the shop assets was determined using the discounted future cash flow method of anticipated cash flows through the shop’s lease-end date using fair value measurement inputs classified as Level 3. Level 3 inputs are derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. After performing a periodic review of the Company’s shops during the 13 weeks and 26 weeks ended July 1, 2018, it was determined that indicators of impairment were present for certain shops as a result of continued underperformance. The Company performed an impairment analysis related to these shops and recorded an impairment charge of $2.1 million and $4.1 million for the 13 and 26 weeks ended July 1, 2018, respectively. The Company recorded an impairment charge of $3.3 million and $4.2 million for the 13 and 26 weeks ended June 25, 2017, respectively.

(4) Earnings (Loss) Per Share

Basic and diluted income per common share attributable to common stockholders was calculated using the weighted average number of common shares outstanding for the period. Diluted income per common share attributable to common stockholders is computed by dividing the income allocated to common stockholders by the weighted average number of fully diluted common shares outstanding. In periods of a net loss, no potential common shares are included in diluted shares outstanding as the effect is anti-

9


 

dilutive. For the 13 and 26 weeks ended July 1, 2018, the Company had a loss per share, and therefore shares were excluded for potential stock option exercises.

The following table summarizes the earnings (loss) per share calculation:

 

 

 

For the 13 Weeks Ended

 

 

For the 26 Weeks Ended

 

 

 

July 1,

 

 

June 25,

 

 

July 1,

 

 

June 25,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Net income (loss) attributable to Potbelly Corporation

 

$

(360

)

 

$

(138

)

 

$

(2,554

)

 

$

545

 

Weighted average common shares outstanding-basic

 

 

25,551,386

 

 

 

25,033,868

 

 

 

25,348,121

 

 

 

25,066,374

 

Plus: Effect of potential stock options exercise

 

 

 

 

 

 

 

 

 

 

 

831,927

 

Plus: Effect of potential warrant exercise

 

 

 

 

 

 

 

 

 

 

 

82,750

 

Weighted average common shares outstanding-diluted

 

 

25,551,386

 

 

 

25,033,868

 

 

 

25,348,121

 

 

 

25,981,051

 

Income (loss) per share available to common stockholders-basic

 

$

(0.01

)

 

$

(0.01

)

 

$

(0.10

)

 

$

0.02

 

Income (loss) per share available to common stockholders-diluted

 

$

(0.01

)

 

$

(0.01

)

 

$

(0.10

)

 

$

0.02

 

Potentially dilutive shares that are considered anti-dilutive:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common share options

 

 

2,557,475

 

 

 

4,030,128

 

 

 

2,829,461

 

 

 

1,109,681

 

 

(5) Income Taxes

Our interim tax provision is determined using an estimated annual effective tax rate and adjusted for discrete taxable events that occur during the quarter.  The effective tax rate differed from the federal statutory rate primarily due to the impact of ASU 2016-09, state income taxes, federal and state tax credits, and certain discrete items.

 

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) was enacted into law making significant changes to the U.S. tax code, including: (1) reducing the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) implementing bonus depreciation that will allow for full expensing of qualified property; (3) implementing limitations on the deductibility of certain executive compensation; and (4) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.

 

On that same date, the SEC staff also issued Staff Accounting Bulletin (SAB) 118, which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740. A company must reflect the income tax effects of those aspects of the Tax Act for which accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete, but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements.

 

At July 1, 2018, the Company has not completed the accounting for the tax effects of enactment of the Tax Act; however, the Company made a reasonable estimate of the effects and booked a provisional tax expense adjustment in the fiscal year 2017, the period in which the legislation was enacted. During the second quarter, there have been no adjustments made to the provisional amounts previously recorded related to the enactment of the Tax Act.

(6) Capital Stock

On May 8, 2018, the Company announced that its Board of Directors authorized a stock repurchase program for up to $65.0 million of its outstanding common stock, replacing the Company’s previous $30.0 million share repurchase program.  The current program permits the Company, from time to time, to purchase shares in the open market (including in pre-arranged stock trading plans in accordance with the guidelines specified in Rule 10b5-1 under the Securities Exchange Act of 1934, as amended) or in privately negotiated transactions.  The number of common shares actually repurchased, and the timing and price of repurchases, will depend upon market conditions, Securities and Exchange Commission requirements and other factors.  Purchases may be started or stopped at any time without prior notice depending on market conditions and other factors.  For the 26 weeks ended July 1, 2018, the Company repurchased 259,339 shares of its common stock for approximately $3.3 million under the new stock repurchase program and had repurchased 5,000 shares of its common stock for approximately $0.1 million under the previous share repurchase program, including cost and commission, in open market transactions.  Repurchased shares are included as treasury stock in the condensed consolidated balance sheets and the condensed consolidated statements of equity.

10


 

On June 14, 2018, the Company registered 1,000,000 additional shares of its common stock, par value $0.01, reserved for issuance under the Amended and Restated 2013 Long-Term Incentive Plan.  This brings the total number of shares registered under the 2013 Long-Term Incentive Plan to 3,500,000.

(7) Stock-Based Compensation

Stock options are awarded under the 2013 Long-Term Incentive Plan to eligible employees and certain non-employee members of the Board of Directors. On June 14, 2018, the Company registered an additional 1,000,000 shares of its common stock reserved for issuance under the 2013 Long-Term Incentive Plan and brings the total number of shares registered under the plan to 3,500,000.  The fair value of stock options is determined using the Black-Scholes option pricing model. The weighted average fair value of options granted during the 26 weeks ended July 1, 2018 was $5.24 per share, as estimated using the following weighted average assumptions: expected life of options – 6.25 years; volatility – 35.39%; risk-free interest rate – 2.85%; and dividend yield – 0.00%. The Company used the simplified method for determining the expected life of the options. The expected volatility of the options was calculated using the Company’s historical data.

 

A summary of activity for the 26 weeks ended July 1, 2018 is as follows:

 

Options

 

Shares

(Thousands)

 

 

Weighted

Average

Exercise

Price

 

 

Aggregate

Intrinsic

Value

(Thousands)

 

 

Weighted

Average

Remaining

Term

(Years)

 

Outstanding—December 31, 2017

 

 

3,309

 

 

$

10.71

 

 

$

7,699

 

 

 

4.90

 

Granted

 

 

102

 

 

 

13.05

 

 

 

 

 

 

 

 

 

Exercised

 

 

(835

)

 

 

8.08

 

 

 

 

 

 

 

 

 

Canceled

 

 

(105

)

 

 

13.30

 

 

 

 

 

 

 

 

 

Outstanding—July 1, 2018

 

 

2,471

 

 

$

11.68

 

 

$

4,890

 

 

 

5.83

 

Exercisable—July 1, 2018

 

 

1,830

 

 

$

11.16

 

 

$

4,649

 

 

 

4.84

 

 

Stock-based compensation is measured at the grant date based on the calculated fair value of the award, and is recognized as expense over the requisite employee service period, which is generally the vesting period of the grant with a corresponding increase to additional paid-in-capital. For the 13 and 26 weeks ended July 1, 2018, the Company recognized stock-based compensation expense of $1.4 million and $2.3 million, respectively. For the 13 and 26 weeks ended June 25, 2017, the Company recognized stock-based compensation expense of $1.1 million and $1.9 million, respectively. As of July 1, 2018, unrecognized stock-based compensation expense was $3.6 million, which will be recognized through fiscal year 2022. The Company records stock-based compensation expense within general and administrative expenses in the condensed consolidated statements of operations.

 

(8) Commitments and Contingencies

The Company is subject to legal proceedings, claims and liabilities, such as employment-related claims and slip and fall cases, which arise in the ordinary course of business and are generally covered by insurance. In the opinion of management, the amount of ultimate liability with respect to those actions should not have a material adverse impact on the Company’s financial position or results of operations and cash flows.

In October 2017, plaintiffs filed a purported collective and class action lawsuit in the United States District Court for the Southern District of New York against the Company alleging violations of the Fair Labor Standards Act (FLSA) and New York Labor Law (NYLL). The plaintiffs allege that the Company violated the FLSA and NYLL by not paying overtime compensation to our assistant managers and violated NYLL by not paying spread-of-hours pay. Potbelly believes the assistant managers were properly classified under state and federal law. The Company intends to vigorously defend this action. This case is at an early stage, and Potbelly is therefore unable to make a reasonable estimate of the probable loss or range of losses, if any, that might arise from this matter.

 

 

11


 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, and involves numerous risks and uncertainties. Forward-looking statements may include, among others, statements relating to: our future financial position and results of operations, business strategy, budgets, projected costs and plans and objectives of management for future operations. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and generally contain words such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “intends,” “plans,” “strives,” “goal,” “estimates,” “forecasts,” “projects” or “anticipates” and the negative of these terms or similar expressions. Our forward-looking statements are subject to risks and uncertainties, which may cause actual results to differ materially from those projected or implied by the forward-looking statement, due to reasons including, but not limited to, our ability to manage our growth and successfully implement our business strategy; price and availability of commodities; changes in labor costs; consumer confidence and spending patterns; consumer reaction to industry-related public health issues and perceptions of food safety; and weather conditions. Forward-looking statements are based on current expectations and assumptions and currently available data and are neither predictions nor guarantees of future events or performance. You should not place undue reliance on forward-looking statements, which speak only as of the date hereof. See “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, for a discussion of factors that could cause our actual results to differ from those expressed or implied by forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.

Overview

Potbelly Corporation (the “Company” or “Potbelly”) is a neighborhood sandwich concept offering toasty warm sandwiches, signature salads and other fresh menu items served by engaging people in an environment that reflects the Potbelly brand. Our combination of product, people and place is how we deliver on our passion to be “The Best Place for Lunch.” Our sandwiches, salads and hand-dipped milkshakes are all made fresh to order and our cookies are baked fresh each day. Our employees are trained to engage with our customers in a genuine way to provide a personalized experience. Our shops feature vintage design elements and locally-themed décor inspired by the neighborhood that we believe create a lively atmosphere. Through this combination, we believe we are creating a devoted base of Potbelly fans that return again and again and that we are expanding one sandwich shop at a time.

We believe that a key to our past and future success is our culture. It is embodied in The Potbelly Advantage, which is an expression of our Vision, Mission, Passion and Values and the foundation of everything we do. Our Vision is for our customers to feel that we are their “Neighborhood Sandwich Shop” and to tell others about their great experience. Our Mission is to make people really happy, to make more money and to improve every day. Our Passion is to be “The Best Place for Lunch.” Our Values embody both how we lead and how we behave and form the cornerstone of our culture. We use simple language that resonates from the frontline associate to the most senior levels of the organization, creating shared expectations and accountabilities in how we approach our day-to-day activities. We strive to be a fun, friendly and hardworking group of people who enjoy taking care of our customers, while at the same time taking care of each other.

The table below sets forth a rollforward of company-operated and franchise operated activities:

 

 

 

Company-

 

 

Franchise-Operated

 

 

Total

 

 

 

Operated

 

 

Domestic

 

 

International

 

 

Total

 

 

Company

 

Shops as of December 25, 2016

 

 

411

 

 

 

30

 

 

 

13

 

 

 

43

 

 

 

454

 

Shops opened

 

 

16

 

 

 

8

 

 

 

3

 

 

 

11

 

 

 

27

 

Shops closed

 

 

(3

)

 

 

 

 

 

 

 

 

 

 

 

(3

)

Shops as of June 25, 2017

 

 

424

 

 

 

38

 

 

 

16

 

 

 

54

 

 

 

478

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shops as of December 31, 2017

 

 

437

 

 

 

39

 

 

 

16

 

 

 

55

 

 

 

492

 

Shops opened

 

 

5

 

 

 

2

 

 

 

2

 

 

 

4

 

 

 

9

 

Shops closed

 

 

(6

)

 

 

 

 

 

(1

)

 

 

(1

)

 

 

(7

)

Shops as of July 1, 2018

 

 

436

 

 

 

41

 

 

 

17

 

 

 

58

 

 

 

494

 

12


 

 

13 Weeks Ended July 1, 2018 Compared to 13 Weeks Ended June 25, 2017

The following table presents information comparing the components of net income for the periods indicated (dollars in thousands):

 

 

 

For the 13 Weeks Ended

 

 

 

 

 

 

 

 

 

 

 

July 1, 2018

 

 

% of

Revenues

 

 

June 25, 2017

 

 

% of

Revenues

 

 

Increase

(Decrease)

 

 

Percent

Change

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sandwich shop sales, net

 

$

109,381

 

 

 

99.1

%

 

$

107,382

 

 

 

99.3

%

 

$

1,999

 

 

 

1.9

%

Franchise royalties and fees

 

 

966

 

 

 

0.9

 

 

 

754

 

 

 

0.7

 

 

 

212

 

 

 

28.1

 

Total revenues

 

 

110,347

 

 

 

100.0

 

 

 

108,136

 

 

 

100.0

 

 

 

2,211

 

 

 

2.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sandwich shop operating

   expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold, excluding

   depreciation

 

 

28,639

 

 

 

26.0

 

 

 

28,635

 

 

 

26.5

 

 

 

4

 

 

*

 

Labor and related expenses

 

 

32,412

 

 

 

29.4

 

 

 

31,564

 

 

 

29.2

 

 

 

848

 

 

 

2.7

 

Occupancy expenses

 

 

14,985

 

 

 

13.6

 

 

 

14,269

 

 

 

13.2

 

 

 

716

 

 

 

5.0

 

Other operating expenses

 

 

12,793

 

 

 

11.6

 

 

 

12,252

 

 

 

11.3

 

 

 

541

 

 

 

4.4

 

General and administrative

   expenses

 

 

13,440

 

 

 

12.2

 

 

 

10,919

 

 

 

10.1

 

 

 

2,521

 

 

 

23.1

 

Depreciation expense

 

 

5,858

 

 

 

5.3

 

 

 

6,446

 

 

 

6.0

 

 

 

(588

)

 

 

(9.1

)

Pre-opening costs

 

 

68

 

 

 

0.1

 

 

 

546

 

 

 

0.5

 

 

 

(478

)

 

 

(87.5

)

Impairment and loss on disposal

   of property and equipment

 

 

2,057

 

 

 

1.9

 

 

 

3,341

 

 

 

3.1

 

 

 

(1,284

)

 

 

(38.4

)

Total expenses

 

 

110,252

 

 

 

99.9

 

 

 

107,972

 

 

 

99.8

 

 

 

2,280

 

 

 

2.1

 

Income from operations

 

 

95

 

 

 

0.1

 

 

 

164

 

 

 

0.2

 

 

 

(69

)

 

 

(42.1

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

28

 

 

*

 

 

 

41

 

 

*

 

 

 

(13

)

 

 

(31.7

)

Income before income taxes

 

 

67

 

 

 

0.1

 

 

 

123

 

 

 

0.1

 

 

 

(56

)

 

 

(45.5

)

Income tax expense

 

 

302

 

 

 

0.3

 

 

 

186

 

 

 

0.2

 

 

 

116

 

 

 

62.4

 

Net loss

 

 

(235

)

 

 

(0.2

)

 

 

(63

)

 

 

(0.1

)

 

 

(172

)

 

>100

 

Net income attributable to

   non-controlling interest

 

 

125

 

 

 

0.1

 

 

 

75

 

 

 

0.1

 

 

 

50

 

 

 

66.7

 

Net loss attributable to

   Potbelly Corporation

 

$

(360

)

 

 

(0.3

)%

 

$

(138

)

 

 

(0.1

)%

 

$

(222

)

 

>100%

 

 

*

Amount is less than 0.1%

Revenues

Total revenues increased by $2.2 million, or 2.0%, to 110.3 million during the 13 weeks ended July 1, 2018, from $108.1 million during the 13 weeks ended June 25, 2017. The revenue growth was driven by an increase in sales of $4.8 million from shops not yet in our company-operated comparable store sales base. These increases were partially offset by a decrease in sales of $0.2 million, or 0.2%, from company-operated comparable stores and a decrease in sales of $2.6 million from shops that have closed. The decrease in company-operated comparable store sales resulted from a decrease in traffic, partially offset by an increase in average transaction size.

Cost of Goods Sold

Cost of goods sold increased by $4 thousand, or less than 0.1%, to $28.6 million during the 13 weeks ended July 1, 2018, from $28.6 million during the 13 weeks ended June 25, 2017. As a percentage of revenues, cost of goods sold decreased to 26.0% during the 13 weeks ended July 1, 2018, from 26.5% during the 13 weeks ended June 25, 2017, primarily driven by certain menu price increases.

13


 

Labor and Related Expenses

Labor and related expenses increased by $0.8 million, or 2.7%, to $32.4 million during the 13 weeks ended July 1, 2018, from $31.6 million during the 13 weeks ended June 25, 2017, primarily due to new shop openings and inflationary wage increases in certain states, which was partially offset by a decrease in expense from closed shops. As a percentage of revenues, labor and related expenses increased to 29.4% during the 13 weeks ended July 1, 2018, from 29.2% during the 13 weeks ended June 25, 2017, primarily driven by new shop openings and inflationary wage increases in certain states.

Occupancy Expenses

Occupancy expenses increased by $0.7 million, or 5.0%, to $15.0 million during the 13 weeks ended July 1, 2018, from $14.3 million during the 13 weeks ended June 25, 2017 primarily due to inflation in certain occupancy related costs, including lease renewals, real estate taxes and common area maintenance. As a percentage of revenues, occupancy expenses increased to 13.6% during the 13 weeks ended July 1, 2018, from 13.2% during the 13 weeks ended June 25, 2017, primarily due to sales deleverage and inflation in certain occupancy related costs, including lease renewals, real estate taxes and common area maintenance.

Other Operating Expenses

Other operating expenses increased by $0.5 million, or 4.4%, to $12.8 million during the 13 weeks ended July 1, 2018, from $12.3 million during the 13 weeks ended June 25, 2017. The increase was primarily attributable to items such as repairs, maintenance, utilities, and other expenses not directly variable with sales. As a percentage of revenues, other operating expenses increased to 11.6% during the 13 weeks ended July 1, 2018, from 11.3% during the 13 weeks ended June 25, 2017, primarily driven by sales deleverage in operating expense items such as repairs, maintenance, utilities, and other expenses not directly variable with sales.

General and Administrative Expenses

General and administrative expenses increased by $2.5 million, or 23.1%, to $13.4 million during the 13 weeks ended July 1, 2018, from $10.9 million during the 13 weeks ended June 25, 2017. The increase was driven primarily by restructuring costs of $1.3 million, Chief Executive Officer (CEO) transition costs of $0.4 million and store closure expenses. As a percentage of revenues, general and administrative expenses increased to 12.2% during the 13 weeks ended July 1, 2018, from 10.1% during the 13 weeks ended June 25, 2017, primarily due to restructuring costs of $1.3 million, CEO transition costs of $0.4 million and store closure expenses.

Depreciation Expense

Depreciation expense decreased by $0.6 million, or 9.1%, to $5.9 million during the 13 weeks ended July 1, 2018, from $6.4 million during the 13 weeks ended June 25, 2017. The decrease was driven primarily by a lower depreciable base related to impairment charges taken subsequent to the 13 weeks ended June 25, 2017, as well as lower depreciation associated with new shops with longer expected useful lives for leasehold improvements and leasehold improvements at legacy shops with shorter expected useful lives being fully depreciated. These decreases were partially offset by new shops, existing shop capital investments and investments in technology such as the mobile application, which increased the depreciable base. As a percentage of revenues, depreciation decreased to 5.3% during the 13 weeks ended July 1, 2018, from 6.0% during the 13 weeks ended June 25, 2017. This decrease was driven by a lower depreciable base related to impairment charges taken subsequent to the 13 weeks ended June 25, 2017, as well as lower depreciation associated with new shops with longer expected useful lives for leasehold improvements and leasehold improvements at legacy shops with shorter expected useful lives being fully depreciated.

Pre-Opening Costs

Pre-opening costs decreased by $0.5 million, or 87.5%, to $0.1 million during the 13 weeks ended July 1, 2018, from $0.5 million during the 13 weeks ended June 25, 2017. As a percentage of revenues, pre-opening costs decreased to 0.1% during the 13 weeks ended July 1, 2018, from 0.5% during the 13 weeks ended June 25, 2017. These decreases were driven primarily by fewer shops opened during the 13 weeks ended July 1, 2018 compared to the 13 weeks ended June 25, 2017.

14


 

Impairment and Loss on Disposal of Property and Equipment

Impairment and loss on disposal of property and equipment decreased to $2.1 million during the 13 weeks ended July 1, 2018, from $3.3 million during the 13 weeks ended June 25, 2017. After performing periodic reviews of Company shops during the second quarter of 2018, it was determined that indicators of impairment were present for certain shops as a result of continued underperformance. The Company performed impairment analyses related to these shops and recorded an impairment charge of $2.1 million for the excess of the carrying amount recorded on the balance sheet over the shops’ estimated fair value. The Company performs impairment analyses on a quarterly basis, which involves significant judgment by management including estimates of future cash flows and future growth rates, among other assumptions. Based on the Company’s current projections, no impairment beyond what has already been recorded has been identified. However, given the current challenges facing the industry and our business, future evaluations could result in additional impairment charges.

Interest Expense

Interest expense was $28 thousand during the 13 weeks ended July 1, 2018 and $41 thousand during the 13 weeks ended June 25, 2017.

Income Tax Expense

Income tax expense increased by $0.1 million, or 62.4%, to $0.3 million for the 13 weeks ended July 1, 2018, from $0.2 million for the 13 weeks ended June 25, 2017, primarily attributable to the impact of ASU 2016-09. For the 13 weeks ended July 1, 2018, the effective tax rate was 450.7%, compared to 151.2% for the 13 weeks ended June 25, 2017. The change in the effective tax rate was driven by the impact of ASU 2016-09.

15


 

26 Weeks Ended July 1, 2018 Compared to 26 Weeks Ended June 25, 2017

The following table presents information comparing the components of net income for the periods indicated (dollars in thousands):

 

 

 

For the 26 Weeks Ended

 

 

 

 

 

 

 

 

 

 

 

July 1, 2018

 

 

% of

Revenues

 

 

June 25, 2017

 

 

% of

Revenues

 

 

Increase

(Decrease)

 

 

Percent

Change

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sandwich shop sales, net

 

$

211,628

 

 

 

99.2

%

 

$

208,241

 

 

 

99.2

%

 

$

3,387

 

 

 

1.6

%

Franchise royalties and fees

 

 

1,636

 

 

 

0.8

 

 

 

1,594

 

 

 

0.8

 

 

 

42

 

 

 

2.6

 

Total revenues

 

 

213,264

 

 

 

100.0

 

 

 

209,835

 

 

 

100.0

 

 

 

3,429

 

 

 

1.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sandwich shop operating

   expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold, excluding

   depreciation

 

 

55,275

 

 

 

25.9

 

 

 

55,298

 

 

 

26.4

 

 

 

(23

)

 

*

 

Labor and related expenses

 

 

63,991

 

 

 

30.0

 

 

 

62,026

 

 

 

29.6

 

 

 

1,965

 

 

 

3.2

 

Occupancy expenses

 

 

29,711

 

 

 

13.9

 

 

 

28,438

 

 

 

13.6

 

 

 

1,273

 

 

 

4.5

 

Other operating expenses

 

 

25,293

 

 

 

11.9

 

 

 

23,885

 

 

 

11.4

 

 

 

1,408

 

 

 

5.9

 

General and administrative

   expenses

 

 

25,628

 

 

 

12.0

 

 

 

21,271

 

 

 

10.1

 

 

 

4,357

 

 

 

20.5

 

Depreciation expense

 

 

11,684

 

 

 

5.5

 

 

 

12,645

 

 

 

6.0

 

 

 

(961

)

 

 

(7.6

)

Pre-opening costs

 

 

136

 

 

 

0.1

 

 

 

619

 

 

 

0.3

 

 

 

(483

)

 

 

(78.0

)

Impairment and loss on disposal

   of property and equipment

 

 

4,081

 

 

 

1.9

 

 

 

4,226

 

 

 

2.0

 

 

 

(145

)

 

 

(3.4

)

Total expenses

 

 

215,799

 

 

 

101.2

 

 

 

208,408

 

 

 

99.3

 

 

 

7,391

 

 

 

3.5

 

Income (loss) from operations

 

 

(2,535

)

 

 

(1.2

)

 

 

1,427

 

 

 

0.7

 

 

 

(3,962

)

 

>(100)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

55

 

 

*

 

 

 

69

 

 

*

 

 

 

(14

)

 

 

(20.3

)

Income (loss) before income taxes

 

 

(2,590

)

 

 

(1.2

)

 

 

1,358

 

 

 

0.6

 

 

 

(3,948

)

 

>(100)

 

Income tax expense (benefit)

 

 

(202

)

 

 

(0.1

)

 

 

739

 

 

 

0.4

 

 

 

(941

)

 

>(100)

 

Net income (loss)

 

 

(2,388

)

 

 

(1.1

)

 

 

619

 

 

 

0.3

 

 

 

(3,007

)

 

>(100)

 

Net income attributable to non-

   controlling interests

 

 

166

 

 

 

0.1

 

 

 

74

 

 

*

 

 

 

92

 

 

>100

 

Net income (loss) attributable to

   Potbelly Corporation

 

$

(2,554

)

 

 

(1.2

)%

 

$

545

 

 

 

0.3

%

 

$

(3,099

)

 

>(100)%

 

 

*

Amount is less than 0.1%

Revenues

Total revenues increased by $3.4 million, or 1.6%, to $213.3 million during the 26 weeks ended July 1, 2018, from $209.8 million during the 26 weeks ended June 25, 2017. The revenue growth was driven by an increase in sales of $12.5 million from shops not yet in our company-operated comparable store sales base. This increase was partially offset by a decrease in sales of $3.7 million, or 1.8%, from company-operated comparable stores and a decline of $5.5 million from shops that have closed. The decrease in company-operated comparable store sales resulted from a decrease in traffic, partially offset by an increase in average transaction size and certain menu price increases.

Cost of Goods Sold

Cost of goods sold decreased by $23 thousand, or less than 0.1%, to $55.3 million during the 26 weeks ended July 1, 2018, from $55.3 million during the 26 weeks ended June 25, 2017. As a percentage of revenues, cost of goods sold decreased to 25.9% during the 26 weeks ended July 1, 2018, from 26.4% during the 26 weeks ended June 25, 2017, primarily driven by certain menu price increases.

16


 

Labor and Related Expenses

Labor and related expenses increased by $2.0 million, or 3.2%, to $64.0 million during the 26 weeks ended July 1, 2018, from $62.0 million during the 26 weeks ended June 25, 2017, primarily due to new shop openings and inflationary wage increases in certain states. As a percentage of revenues, labor and related expenses increased to 30.0% during the 26 weeks ended July 1, 2018, from 29.6% during the 26 weeks ended June 25, 2017, primarily driven by a decrease in company-operated comparable store revenue and inflationary wage increases in certain states.

Occupancy Expenses

Occupancy expenses increased by $1.3 million, or 4.5%, to $29.7 million during the 26 weeks ended July 1, 2018, from $28.4 million during the 26 weeks ended June 25, 2017, primarily due to inflation in certain occupancy related costs, including lease renewals, real estate taxes and common area maintenance. As a percentage of revenues, occupancy expenses increased to 13.9% during the 26 weeks ended July 1, 2018, from 13.6% during the 26 weeks ended June 25, 2017, primarily due to sales deleverage and inflation in certain occupancy related costs, including lease renewals, real estate taxes and common area maintenance.

Other Operating Expenses

Other operating expenses increased by $1.4 million, or 5.9%, to $25.3 million during the 26 weeks ended July 1, 2018, from $23.9 million during the 26 weeks ended June 25, 2017. The increase was primarily attributable to items such as repairs, maintenance, utilities, and other expenses not directly variable with sales. As a percentage of revenues, other operating expenses increased to 11.9% during the 26 weeks ended July 1, 2018, from 11.4% during the 26 weeks ended June 25, 2017. This increase was primarily driven by sales deleverage in operating expense items such as repairs, maintenance, utilities, and other expenses not directly variable with sales.

General and Administrative Expenses

General and administrative expenses increased by $4.4 million, or 20.5%, to $25.6 million during the 26 weeks ended July 1, 2018, from $21.3 million during the 26 weeks ended June 25, 2017. The increase was driven primarily by restructuring costs of $1.3 million, CEO transition costs of $0.7 million and proxy related costs of $0.7 million. As a percentage of revenues, general and administrative expenses increased to 12.0% during the 26 weeks ended July 1, 2018, from 10.1% during the 26 weeks ended June 25, 2017. This increase was driven primarily by restructuring costs of $1.3 million, CEO transition costs of $0.7 million and proxy related costs of $0.7 million.

Depreciation Expense

Depreciation expense decreased by $1.0 million, or 7.6%, to $11.7 million during the 26 weeks ended July 1, 2018, from $12.6 million during the 26 weeks ended June 25, 2017, driven primarily by a lower depreciable base related to impairment charges taken subsequent to the 26 weeks ended June 25, 2017, as well as lower depreciation associated with new shops with longer expected useful lives for leasehold improvements and leasehold improvements at legacy shops with shorter expected useful lives being fully depreciated. These decreases were partially offset by new shops, existing shop capital investments and investments in technology such as the mobile application, which increased the depreciable base. As a percentage of revenues, depreciation decreased to 5.5% during the 26 weeks ended July 1, 2018, from 6.0% during the 26 weeks ended June 25, 2017, driven primarily by a lower depreciable base related to impairment charges taken subsequent to the 26 weeks ended June 25, 2017, as well as lower depreciation associated with new shops with longer expected useful lives for leasehold improvements and leasehold improvements at legacy shops with shorter expected useful lives being fully depreciated.

Pre-Opening Costs

Pre-opening costs decreased by $0.5 million, or 78.0%, to $0.1 million during the 26 weeks ended July 1, 2018, from $0.6 million during the 26 weeks ended June 25, 2017. As a percentage of revenues, pre-opening costs decreased to 0.1% during the 26 weeks ended July 1, 2018, from 0.3% during the 26 weeks ended June 25, 2017. These decreases were driven primarily by fewer shops opened during the 26 weeks ended July 1, 2018 compared to the 26 weeks ended June 25, 2017.

17


 

Impairment and Loss on Disposal of Property and Equipment

Impairment and loss on disposal of property and equipment decreased to $4.1 million during the 26 weeks ended July 1, 2018, compared to $4.2 million during the 26 weeks ended June 25, 2017. After performing periodic reviews of Company shops during the first and second quarter of 2018, it was determined that indicators of impairment were present for certain shops as a result of continued underperformance. We performed impairment analyses related to these shops and recorded impairment charges of $4.1 million for the excess of the carrying amount recorded on our balance sheet over the shops’ estimated fair value. We perform impairment analyses on a quarterly basis, which involve significant judgment by management including estimates of future cash flows and future growth rates, among other assumptions. Based on our current projections, no impairment, beyond what has already been recorded, has been identified. However, given the current challenges facing the industry and our business, future evaluations could result in additional impairment charges.

Interest Expense

Interest expense was $0.1 million for the 26 weeks ended July 1, 2018 and June 25, 2017.

Income Tax Expense

Income tax expense decreased by $0.9 million, or more than 100%, to a benefit of $0.2 million for the 26 weeks ended July 1, 2018, from an expense of $0.7 million for the 26 weeks ended June 25, 2017, primarily attributable to a pre-tax book loss and the change in the federal tax rate from 35 percent to 21 percent. For the 26 weeks ended July 1, 2018, the effective tax rate was 7.8%, compared to 54.4% for the 26 weeks ended June 25, 2017. The change in the effective tax rate was driven by a pre-tax book loss and the change in the federal tax rate from 35 percent to 21 percent, as well as certain discrete items.

Liquidity and Capital Resources

General

Potbelly’s ongoing primary sources of liquidity and capital resources are cash provided from operating activities, existing cash and cash equivalents and the Company’s credit facility. Potbelly’s primary requirements for liquidity and capital are new shop openings, existing shop capital investments (maintenance and improvements), repurchases of Company common stock, lease obligations, and working capital and general corporate needs. Potbelly’s requirement for working capital is not significant since the Company’s customers pay for their food and beverage purchases in cash or payment cards (credit or debit) at the time of sale. Thus, Potbelly is able to sell certain inventory items before the Company needs to pay its suppliers for such items. Company shops do not require significant inventories or receivables. Potbelly believes that these sources of liquidity and capital will be sufficient to finance the Company’s continued operations and expansion plans for at least the next twelve months.

The following table presents summary cash flow information for the periods indicated (in thousands):

 

 

 

For the 26 Weeks Ended

 

 

 

July 1,

 

 

June 25,

 

 

 

2018

 

 

2017

 

Net cash provided by (used in):

 

 

 

 

 

 

 

 

Operating activities

 

$

17,867

 

 

$

15,140

 

Investing activities

 

 

(11,614

)

 

 

(15,326

)

Financing activities

 

 

2,527

 

 

 

(2,011

)

Net increase (decrease) in cash

 

$

8,780

 

 

$

(2,197

)

 

Operating Activities

Net cash provided by operating activities increased to $17.9 million for the 26 weeks ended July 1, 2018, from $15.1 million for the 26 weeks ended June 25, 2017. The $2.7 million increase was primarily driven by changes in certain working capital accounts mainly due to timing.

Investing Activities

Net cash used in investing activities decreased to $11.6 million for the 26 weeks ended July 1, 2018, from $15.3 million for the 26 weeks ended June 25, 2017. The decrease was primarily due to fewer shops opened during the 26 weeks ended July 1, 2018 compared to the 26 weeks ended June 25, 2017, partially offset by an increase in information technology improvements.  

18


 

Financing Activities

Net cash provided by financing activities was $2.5 million for the 26 weeks ended July 1, 2018, compared to $2.0 million net cash used in financing activities for the 26 weeks ended June 25, 2017. The change in financing cash was driven by $6.7 million in proceeds from the exercise of stock options during the 26 weeks ended July 1, 2018, compared to $1.1 million during the 26 weeks ended June 25, 2017. Additionally, $0.5 million in employee taxes related to stock-based payment arrangements were withheld and paid during the 26 weeks ended July 1, 2018.

Stock Repurchase Program

On May 8, 2018, the Company announced that its Board of Directors authorized a stock repurchase program for up to $65.0 million of its outstanding common stock. The stock repurchase program replaced the previous program, authorized in September 2016.  Under the previous program, during the 26 weeks ended July 1, 2018, the Company repurchased 5,000 shares of its common stock for approximately $0.1 million, including costs and commissions, in open market transactions. The current program permits the Company, from time to time, to purchase shares in the open market (including in pre-arranged stock trading plans in accordance with the guidelines specified in Rule 10b5-1 under the Exchange Act or in privately negotiated transactions. Under the current program, during the 26 weeks ended July 1, 2018, the Company repurchased 259,339 shares of its common stock for approximately $3.3 million, including costs and commissions, in open market transactions. The number of shares of common stock repurchased in the future, and the timing and price of repurchases, will depend upon market conditions, Securities and Exchange Commission requirements, and other factors. Purchases may be started or stopped at any time without prior notice depending on market conditions and other factors. Repurchased shares are included as treasury stock in the condensed consolidated balance sheets and the condensed consolidated statements of equity.

Credit Facility

On December 9, 2015, the Company entered into an amended and restated five-year revolving credit facility agreement that expires in November 2020. The credit agreement provides, among other things, for a revolving credit facility in a maximum principal amount of $50.0 million, with possible future increases to $75.0 million under an expansion feature. Borrowings under the credit facility generally bear interest at our option at either (i) a eurocurrency rate determined by reference to the applicable London Interbank Offered Rate (LIBOR) plus a margin ranging from 1.00% to 1.75% or (ii) a prime rate as announced by JP Morgan Chase plus a margin ranging from 0.00% to 0.50%. The applicable margin is determined based upon our consolidated total leverage ratio. On the last day of each calendar quarter, the Company is required to pay a commitment fee ranging from 0.125% to 0.20% per annum in respect of any unused commitments under the credit facility, with the specific rate determined based upon our consolidated total leverage ratio. So long as the leverage ratios are met, there is no limit on the “restricted payments” (primarily distributions and equity repurchases) that the Company may make. As of July 1, 2018, the Company had no amounts outstanding under the credit facility.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Significant estimates include amounts for long-lived assets and income taxes. Actual results could differ from those estimates. Critical accounting policies are those that management believes are both most important to the portrayal of our financial condition and operating results and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company bases estimates on historical experience and other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. Potbelly had no significant changes in our critical accounting estimates since the last annual report. The Company’s critical accounting estimates are identified and described in our annual consolidated financial statements and related notes.

Off-Balance Sheet Arrangements

As of July 1, 2018, the Company does not have any off-balance sheet arrangements, synthetic leases, investments in special purpose entities or undisclosed borrowings or debt that would be required to be disclosed pursuant to Item 303 of Regulation S-K under the Exchange Act.

19


 

New and Revised Financial Accounting Standards

See Note 1 to the Consolidated Financial Statements for a description of recently issued Financial Accounting Standards.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For quantitative and qualitative disclosures about market risk, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. Our exposures to market risk have not changed materially since December 31, 2017.

 

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of July 1, 2018. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of July 1, 2018, our disclosure controls and procedures were effective in ensuring that information required to be disclosed in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the fiscal quarter ended July 1, 2018 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

The certifications required by Section 302 of the Sarbanes-Oxley Act of 2002 are filed as exhibits 31.1 and 31.2 to this Quarterly Report on Form 10-Q.

 

20


 

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Information pertaining to legal proceedings is provided in Note 8 to the Condensed Consolidated Financial Statements and is incorporated by reference herein.

ITEM 1A. RISK FACTORS

A description of the risk factors associated with our business is contained in Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. There have been no material changes to our Risk Factors as previously reported.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table contains information regarding purchases of our common stock made by or on behalf of Potbelly Corporation during the 13 weeks ended July 1, 2018:

 

Period

 

Total Number of

Shares

Purchased

 

 

Average Price Paid

per Share (1)

 

 

Total Number of Shares

Purchased as Part of

Publicly Announced

Program (2)

 

 

Maximum Value of

Shares that May Yet

be Purchased Under

the Program (2)

 

April 2, 2018 - April 29, 2018

 

 

-

 

 

$

-

 

 

 

-

 

 

$

14,700,014

 

April 30, 2018 - May 27, 2018

 

 

67,582

 

 

$

13.05

 

 

 

67,582

 

 

$

64,117,828

 

May 28, 2018 - July 1, 2018

 

 

191,757

 

 

$

13.03

 

 

 

191,757

 

 

$

61,619,141

 

Total:

 

 

259,339

 

 

 

 

 

 

 

259,339

 

 

 

 

 

 

(1)

Average price paid per share excludes commissions.

(2)

On May 8, 2018, the Company announced that its Board of Directors authorized a stock repurchase program for up to $65.0 million of its outstanding common stock. The stock repurchase program replaced the previous $30.0 million program, authorized in September 2016.  The current program permits the Company, from time to time, to purchase shares in the open market (including in pre-arranged stock trading plans in accordance with the guidelines specified in Rule 10b5-1 under the Exchange Act or in privately negotiated transactions. No time limit has been set for the completion of the repurchase program and the program may be suspended or discontinued at any time. See Note 6 for further information regarding the Company’s stock repurchase program.  

 

21


 

ITEM 6. EXHIBITS

The following exhibits are either provided with this Quarterly Report on Form 10-Q or are incorporated herein by reference.

 

 

 

 

Exhibit

No.

  

Description

 

 

 

31.1

  

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

31.2

  

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1

 

Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

101.INS

  

XBRL Instance Document

 

 

101.SCH

  

XBRL Taxonomy Extension Schema Document

 

 

101.CAL

  

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

101.LAB

  

XBRL Taxonomy Extension Label Linkbase Document

 

 

101.PRE

  

XBRL Taxonomy Extension Presentation Linkbase Document

 

 

101.DEF

  

XBRL Taxonomy Extension Definition Linkbase Document

 

22


 

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

POTBELLY CORPORATION

 

 

 

 

Date: August 8, 2018

 

By:

/s/ Michael Coyne

 

 

 

Michael Coyne

 

 

 

Chief Financial Officer

 

 

 

(Principal Financial Officer)

 

 

23