pbpb-10q_20170924.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 September 24, 2017

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 – 24,804,265 shares as of September 24, 2017

 

 

 

 

 


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 Statement 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)

 

 

 

September 24,

 

 

December 25,

 

 

 

2017

 

 

2016

 

Assets

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

22,178

 

 

$

23,379

 

Accounts receivable, net of allowances of $112 and $78 as of September 24, 2017

   and December 25, 2016, respectively

 

 

5,858

 

 

 

3,787

 

Inventories

 

 

3,310

 

 

 

3,365

 

Prepaid expenses and other current assets

 

 

10,694

 

 

 

8,020

 

Total current assets

 

 

42,040

 

 

 

38,551

 

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

 

105,379

 

 

 

107,074

 

Indefinite-lived intangible assets

 

 

3,404

 

 

 

3,404

 

Goodwill

 

 

2,222

 

 

 

2,222

 

Deferred income taxes, non-current

 

 

18,381

 

 

 

19,410

 

Deferred expenses, net and other assets

 

 

4,804

 

 

 

4,784

 

Total assets

 

$

176,230

 

 

$

175,445

 

 

 

 

 

 

 

 

 

 

Liabilities and Equity

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

Accounts payable

 

$

4,569

 

 

$

3,111

 

Accrued expenses

 

 

24,194

 

 

 

23,082

 

Accrued income taxes

 

 

 

 

 

1,622

 

Total current liabilities

 

 

28,763

 

 

 

27,815

 

 

 

 

 

 

 

 

 

 

Deferred rent and landlord allowances

 

 

23,000

 

 

 

21,076

 

Other long-term liabilities

 

 

2,511

 

 

 

2,318

 

Total liabilities

 

 

54,274

 

 

 

51,209

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

 

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

   24,804,265 and 25,139,127 shares as of September 24, 2017 and December 25,

   2016, respectively

 

 

313

 

 

 

309

 

Warrants

 

 

 

 

 

909

 

Additional paid-in-capital

 

 

414,943

 

 

 

407,622

 

Treasury stock, held at cost, 6,498,908 and 5,753,412 shares as of

   September 24, 2017, and December 25, 2016, respectively

 

 

(81,174

)

 

 

(72,321

)

Accumulated deficit

 

 

(212,729

)

 

 

(213,034

)

Total stockholders’ equity

 

 

121,353

 

 

 

123,485

 

Non-controlling interest

 

 

603

 

 

 

751

 

Total stockholders' equity

 

 

121,956

 

 

 

124,236

 

 

 

 

 

 

 

 

 

 

Total liabilities and equity

 

$

176,230

 

 

$

175,445

 

 

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 39 Weeks Ended

 

 

 

September 24,

 

 

September 25,

 

 

September 24,

 

 

September 25,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sandwich shop sales, net

 

$

105,327

 

 

$

103,224

 

 

$

313,568

 

 

$

303,116

 

Franchise royalties and fees

 

 

800

 

 

 

558

 

 

 

2,394

 

 

 

1,657

 

Total revenues

 

 

106,127

 

 

 

103,782

 

 

 

315,962

 

 

 

304,773

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sandwich shop operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold, excluding depreciation

 

 

28,405

 

 

 

28,478

 

 

 

83,703

 

 

 

83,224

 

Labor and related expenses

 

 

31,187

 

 

 

30,163

 

 

 

93,213

 

 

 

88,260

 

Occupancy expenses

 

 

14,354

 

 

 

13,111

 

 

 

42,792

 

 

 

39,042

 

Other operating expenses

 

 

12,464

 

 

 

11,338

 

 

 

36,349

 

 

 

32,570

 

General and administrative expenses

 

 

12,104

 

 

 

9,999

 

 

 

33,375

 

 

 

30,827

 

Depreciation expense

 

 

6,315

 

 

 

5,656

 

 

 

18,960

 

 

 

16,996

 

Pre-opening costs

 

 

336

 

 

 

340

 

 

 

955

 

 

 

731

 

Impairment and loss on disposal of property and equipment

 

 

1,536

 

 

 

1,855

 

 

 

5,762

 

 

 

2,880

 

Total expenses

 

 

106,701

 

 

 

100,940

 

 

 

315,109

 

 

 

294,530

 

Income (loss) from operations

 

 

(574

)

 

 

2,842

 

 

 

853

 

 

 

10,243

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

32

 

 

 

33

 

 

 

101

 

 

 

102

 

Income (loss) before income taxes

 

 

(606

)

 

 

2,809

 

 

 

752

 

 

 

10,141

 

Income tax expense (benefit)

 

 

(487

)

 

 

960

 

 

 

252

 

 

 

3,732

 

Net income (loss)

 

 

(119

)

 

 

1,849

 

 

 

500

 

 

 

6,409

 

Net income attributable to non-controlling interest

 

 

121

 

 

 

54

 

 

 

195

 

 

 

153

 

Net income (loss) attributable to Potbelly Corporation

 

$

(240

)

 

$

1,795

 

 

$

305

 

 

$

6,256

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per common share attributable to common

   stockholders:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.01

)

 

$

0.07

 

 

$

0.01

 

 

$

0.24

 

Diluted

 

$

(0.01

)

 

$

0.07

 

 

$

0.01

 

 

$

0.24

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

24,959,023

 

 

 

25,240,374

 

 

 

25,030,951

 

 

 

25,772,846

 

Diluted

 

 

24,959,023

 

 

 

25,829,970

 

 

 

25,857,083

 

 

 

26,341,913

 

 

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 27, 2015

 

 

26,304,261

 

 

$

303

 

 

$

(50,000

)

 

$

909

 

 

$

399,458

 

 

$

(221,246

)

 

$

789

 

 

$

130,213

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

6,256

 

 

 

153

 

 

 

6,409

 

Stock-based compensation

   plans

 

 

511,781

 

 

 

5

 

 

 

 

 

 

 

 

 

5,414

 

 

 

 

 

 

 

 

 

5,419

 

Excess tax deficiencies

   associated with exercise

   of stock options

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(605

)

 

 

 

 

 

 

 

 

(605

)

Repurchases of common

   stock

 

 

(1,574,316

)

 

 

 

 

 

(20,447

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(20,447

)

Distributions to non-

   controlling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(249

)

 

 

(249

)

Contributions from non-

   controlling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

74

 

 

 

74

 

Amortization of

   stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,266

 

 

 

 

 

 

 

 

 

2,266

 

Balance at September 25, 2016

 

 

25,241,726

 

 

$

308

 

 

$

(70,447

)

 

$

909

 

 

$

406,533

 

 

$

(214,990

)

 

$

767

 

 

$

123,080

 

Balance at December 25, 2016

 

 

25,139,127

 

 

$

309

 

 

$

(72,321

)

 

$

909

 

 

$

407,622

 

 

$

(213,034

)

 

$

751

 

 

$

124,236

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

305

 

 

 

195

 

 

 

500

 

Stock-based compensation

   plans

 

 

168,930

 

 

 

2

 

 

 

 

 

 

 

 

 

1,179

 

 

 

 

 

 

 

 

 

1,181

 

Exercise of stock warrants

 

 

241,704

 

 

 

2

 

 

 

 

 

 

(909

)

 

 

2,879

 

 

 

 

 

 

 

 

 

1,972

 

Repurchases of common

   stock

 

 

(745,496

)

 

 

 

 

 

(8,853

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(8,853

)

Distributions to non-

   controlling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(354

)

 

 

(354

)

Contributions from non-

   controlling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

11

 

 

 

11

 

Amortization of

   stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3,263

 

 

 

 

 

 

 

 

 

3,263

 

Balance at September 24, 2017

 

 

24,804,265

 

 

$

313

 

 

$

(81,174

)

 

$

 

 

$

414,943

 

 

$

(212,729

)

 

$

603

 

 

$

121,956

 

 

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 39 Weeks Ended

 

 

 

September 24,

 

 

September 25,

 

 

 

2017

 

 

2016

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net income

 

$

500

 

 

$

6,409

 

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

 

 

 

 

 

 

 

 

Depreciation

 

 

18,960

 

 

 

16,996

 

Deferred income tax

 

 

 

 

 

397

 

Deferred rent and landlord allowances

 

 

1,924

 

 

 

1,912

 

Amortization of stock compensation expense

 

 

3,263

 

 

 

2,266

 

Excess tax deficiency (benefit) from stock-based compensation

 

 

292

 

 

 

(24

)

Asset impairment, store closure and disposal of property and equipment

 

 

5,922

 

 

 

2,897

 

Amortization of debt issuance costs

 

 

28

 

 

 

25

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable, net

 

 

(1,422

)

 

 

(61

)

Inventories

 

 

54

 

 

 

141

 

Prepaid expenses and other assets

 

 

(2,650

)

 

 

(457

)

Accounts payable

 

 

699

 

 

 

(1,496

)

Accrued and other liabilities

 

 

798

 

 

 

4,566

 

Net cash provided by operating activities

 

 

28,368

 

 

 

33,571

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Acquisition of franchise shop

 

 

 

 

 

(1,108

)

Purchases of property and equipment

 

 

(23,526

)

 

 

(19,883

)

Net cash used in investing activities

 

 

(23,526

)

 

 

(20,991

)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Proceeds from exercise of stock options

 

 

1,181

 

 

 

5,746

 

Proceeds from exercise of stock warrants

 

 

1,972

 

 

 

 

Treasury stock repurchases

 

 

(8,853

)

 

 

(20,447

)

Excess tax benefit from stock-based compensation

 

 

 

 

 

24

 

Contributions from non-controlling interest

 

 

11

 

 

 

74

 

Distributions to non-controlling interest

 

 

(354

)

 

 

(249

)

Net cash used in financing activities

 

 

(6,043

)

 

 

(14,852

)

 

 

 

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

 

(1,201

)

 

 

(2,272

)

Cash and cash equivalents at beginning of period

 

 

23,379

 

 

 

32,006

 

Cash and cash equivalents at end of period

 

$

22,178

 

 

$

29,734

 

 

 

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

 

 

 

Income taxes paid

 

$

3,346

 

 

$

2,265

 

Interest paid

 

 

73

 

 

 

82

 

Supplemental non-cash investing and financing activities:

 

 

 

 

 

 

 

 

Unpaid liability for purchases of property and equipment

 

$

2,752

 

 

$

3,142

 

 

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, operates or franchises Potbelly Sandwich Shops in 31 states and the District of Columbia. The Company also sells and administers franchises of Potbelly Sandwich Shops. The first domestic franchise location administered by the Company opened during February 2011. Additionally, in February 2011, the Company opened its first international franchise in the Middle East. In July 2015, the Company opened its first franchise shop in the United Kingdom and in October 2016, the Company opened its first franchise shop in Canada. Additionally, during April 2016, the Company transitioned a franchise shop to a company-operated shop for a purchase price of $1.1 million. The Company recorded $0.8 million of goodwill related to the transaction. The Company believes this acquisition is immaterial.

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 25, 2016. 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 September 24, 2017 and December 25, 2016, its statement of operations for the 13 and 39 weeks ended September 24, 2017 and September 25, 2016 and its statement of cash flows for the 39 weeks ended September 24, 2017 and September 25, 2016 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 five joint ventures, collectively, the “Company.” All significant 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 2017 consists of 53 weeks and 2016 consisted of 52 weeks. The fiscal quarters ended September 24, 2017 and September 25, 2016 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


 

New and Revised Financial Accounting Standards

 

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). The FASB approved a one-year deferral of the effective date of ASU 2014-09, such that it will become effective for the annual period beginning after December 15, 2017. 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 will adopt the standard effective the first quarter of 2018 and apply the amendments using the modified retrospective method. The Company has determined that the adoption will not have a material impact on sandwich shop sales, but will impact 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 is recognized as revenue when the shop opens. Effective for the annual period beginning January 1, 2018, initial franchise fees will generally be recognized as revenue over the life of the contract. 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 are not redeemed by the customer (“breakage”). Potbelly recognizes breakage two years after the period of sale. Effective for the annual period beginning January 1, 2018, expected breakage is anticipated to be recognized as customers redeem the gift cards. The Company is continuing its assessment, which may identify additional impacts this standard will have on its consolidated financial statements and related disclosures.

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 and 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.

In March 2016, the FASB issued ASU No. 2016-09, “Compensation – Stock Compensation (Topic 718).” The pronouncement simplifies the accounting for the taxes related to stock-based compensation, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification within the statement of cash flows. The pronouncement is effective for annual periods beginning after December 15, 2016, including annual and interim periods thereafter. Potbelly adopted ASU 2016-09 in the first quarter of 2017. The primary impact of adoption was the recognition of excess tax benefits and deficiencies that arise upon vesting or exercise of share-based payments in the Income Statement as income tax expense instead of a component of equity recorded to paid-in capital. This aspect of the new guidance, which was required to be adopted prospectively, resulted in an additional income tax expense of $45 thousand and $292 thousand for the 13 weeks and 39 weeks ended September 24, 2017, respectively. Potbelly has elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period. Excess income tax benefits and deficiencies from stock-based compensation arrangements are now classified as cash flow from operations, instead of as cash flow used in financing activities. The Company elected to apply this change in presentation prospectively and as such prior periods have not been adjusted. Additionally, in accordance with the new standard, the Company now excludes excess tax benefits and deficiencies from the assumed proceeds available to repurchase shares in the computation of the Company’s diluted earnings per share.

In January 2017, the FASB issued ASU No. 2017-04, “Intangibles – Goodwill and Other (Topic 350).” The new standard eliminates step 2 from the goodwill impairment test. Instead, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss will be recognized in an amount equal to that excess. Under current U.S. GAAP, to perform step 2 an entity must determine its implied fair value, which is determined in the same manner as the amount of goodwill recognized in a business combination. In addition to eliminating step 2, the new standard eliminates the requirement for a reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform step 2 of the goodwill impairment test. Instead, all reporting units, even those with a zero or negative amount will apply the same impairment test. An entity is required to disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets. The standard will be effective for Potbelly in the fiscal year beginning after December 15, 2019. Early adoption for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017 is permitted. This amendment is required to be applied on a prospective basis. Potbelly is currently assessing the impact and timing of adopting this guidance on its consolidated financial statements.

 

8


 

(2) 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 39 weeks ended September 24, 2017, 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 $1.5 million and $5.8 million for the 13 and 39 weeks ended September 24, 2017, respectively. Included within the impairment charge for the 13 and 39 weeks ended September 24, 2017, impairment charges of $0.7 million were recorded in relation to Hurricane Harvey, with insurance recoveries of $0.7 million also recorded within the same caption. The company recorded an impairment charge of $1.9 million and $2.9 million for the 13 and 39 weeks ended September 25, 2016, respectively.

 

(3) 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-dilutive. For the 13 weeks ended September 24, 2017, the Company had a loss per share, therefore, shares were excluded for potential stock option exercises and warrant exercises.

 

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

 

 

 

For the 13 Weeks Ended

 

 

For the 39 Weeks Ended

 

 

 

September 24,

 

 

September 25,

 

 

September 24,

 

 

September 25,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Net income (loss) attributable to Potbelly Corporation

 

$

(240

)

 

$

1,795

 

 

$

305

 

 

$

6,256

 

Weighted average common shares outstanding-basic

 

 

24,959,023

 

 

 

25,240,374

 

 

 

25,030,951

 

 

 

25,772,846

 

Plus: Effect of potential stock options exercise

 

 

 

 

 

533,249

 

 

 

770,965

 

 

 

514,257

 

Plus: Effect of potential warrant exercise

 

 

 

 

 

56,347

 

 

 

55,167

 

 

 

54,810

 

Weighted average common shares outstanding-diluted

 

 

24,959,023

 

 

 

25,829,970

 

 

 

25,857,083

 

 

 

26,341,913

 

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

 

$

(0.01

)

 

$

0.07

 

 

$

0.01

 

 

$

0.24

 

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

 

$

(0.01

)

 

$

0.07

 

 

$

0.01

 

 

$

0.24

 

Potentially dilutive shares that are considered anti-dilutive:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common share options

 

 

4,012,073

 

 

 

1,233,294

 

 

 

1,151,317

 

 

 

1,236,599

 

 

 

(4) Income Taxes

The Company recognized income tax benefit of $0.5 million on a pre-tax loss of $0.6 million, or an effective tax rate benefit of 80.4%, for the 13 weeks ended September 24, 2017, compared to income tax expense of $1.0 million on pre-tax income of $2.8 million, or an effective tax rate of 34.2%, for the 13 weeks ended September 25, 2016. The Company recognized income tax expense of $0.3 million on pre-tax income of $0.8 million, or an effective tax rate of 33.5%, for the 39 weeks ended September 24, 2017, compared to income tax expense of $3.7 million on pre-tax income of $10.1 million, or an effective tax rate of 36.8%, for the 39 weeks ended September 25, 2016. The effective tax rate differed from the federal statutory rate primarily due to a change in earnings and the adoption of ASU 2016-09, which had an unfavorable impact to the Company’s tax rate benefit of 7.5% for the 13 weeks ended September 24, 2017 and an unfavorable impact of 38.9% for the 39 weeks ended September 24, 2017. See Note 1 for additional information regarding the adoption of ASU 2016-09.

 

9


 

(5) Capital Stock

On September 8, 2016, the Company announced that its Board of Directors authorized a share repurchase program of up to $30.0 million of the Company’s common stock. The Company’s previous $35.0 million share repurchase program, authorized in September 2015, was completed in July 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 Securities Exchange Act of 1934, as amended) or in privately negotiated transactions. During the 39 weeks ended September 24, 2017, the Company repurchased 745,496 shares of its common stock for approximately $8.9 million, including cost and commission, in open market transactions. As of September 24, 2017, the remaining dollar value of authorization under the share repurchase program was $18.8 million, which does not include commission. Repurchased shares are included as treasury stock in the condensed consolidated balance sheets and the condensed consolidated statements of equity.

 

(6) Stock-Based Compensation

Stock options are awarded under the 2013 Long-Term Incentive Plan to eligible employees. 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 39 weeks ended September 24, 2017 was $4.58 per share, as estimated using the following weighted average assumptions: expected life of options – 6.25 years; volatility – 36.37%; risk-free interest rate – 2.23%; and dividend yield – 0.0%. 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 39 weeks ended September 24, 2017 is as follows:

 

Options

 

Shares

(Thousands)

 

 

Weighted

Average

Exercise

Price

 

 

Aggregate

Intrinsic

Value

(Thousands)

 

 

Weighted

Average

Remaining

Term

(Years)

 

Outstanding—December 25, 2016

 

 

4,013

 

 

$

10.61

 

 

$

13,455

 

 

 

4.78

 

Granted

 

 

263

 

 

 

11.55

 

 

 

 

 

 

 

 

 

Exercised

 

 

(125

)

 

 

9.48

 

 

 

 

 

 

 

 

 

Canceled

 

 

(68

)

 

 

15.23

 

 

 

 

 

 

 

 

 

Outstanding—September 24, 2017

 

 

4,083

 

 

$

10.63

 

 

$

7,390

 

 

 

4.44

 

Exercisable—September 24, 2017

 

 

3,288

 

 

$

10.06

 

 

$

7,185

 

 

 

3.54

 

 

The company also awards restricted stock units (“RSUs”) to certain non-employee members of its Board of Directors and the senior leadership team. In May 2017, the Company issued 153,369 shares of RSUs with a grant-date fair value of $11.05 upon issuance. In August 2017, the Company issued 2,608 shares of RSUs to certain non-employee members of its Board of Directors. The RSUs had a grant-date fair value of $11.15 upon issuance. The Board of Director grants have a vesting schedule of 50% on the first anniversary of the grant date and 50% on the second anniversary of the grant date. The senior leadership team grants vest in one-third increments over a three-year period beginning in March 2018.

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 weeks ended September 24, 2017, the Company recognized stock-based compensation expense of $1.4 million, of which $0.6 million was related to Chief Executive Officer (CEO) transition costs. For the 39 weeks ended September 24, 2017, the Company recognized stock-based compensation expense of $3.3 million, of which $0.8 million was related to CEO transition costs. For the 13 and 39 weeks ended September 25, 2016, the Company recognized stock-based compensation of $0.8 million and $2.3 million, respectively. As of September 24, 2017, unrecognized stock-based compensation expense was $4.9 million, which will be recognized through fiscal year 2021. The Company records stock-based compensation expense within general and administrative expenses in the condensed consolidated statements of operations.

 

(7) 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.

10


 

In 2016, the Company received notice of a potential claim alleging that it violated the Fair Labor Standards Act by not paying overtime to its assistant managers, whom the Company had classified as exempt employees. Although the Company believes that its assistant managers were properly classified as exempt under both federal and state laws, the Company agreed to mediate the matter. On February 20, 2017, the parties entered into a Settlement Agreement and Release whereby participating assistant managers agreed to release the Company from all federal and/or state wage and hour claims in exchange for a gross settlement amount of $1.3 million. As part of the settlement process, a complaint was filed on February 17, 2017 in the Circuit Court of the Fifteenth Judicial Circuit in and for Palm Beach County, Florida. A motion seeking the Court’s approval of the settlement was filed on February 21, 2017, which was subsequently approved. In March 2017, the Company paid out the settlement, which was booked against the previously recorded liability.

 

 

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 25, 2016. This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and involves numerous risks and uncertainties. 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” 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. 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 25, 2016, for a discussion of factors that could cause our actual results to differ from those expressed or implied by forward-looking statements.

Overview

 

Potbelly Corporation (the “Company” or “Potbelly”) is a fast-growing 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 27, 2015

 

 

372

 

 

 

24

 

 

 

12

 

 

 

36

 

 

 

408

 

Shops opened

 

 

15

 

 

 

5

 

 

 

2

 

 

 

7

 

 

 

22

 

Shops purchased from franchisee

 

 

1

 

 

 

(1

)