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 t