Draft Registration Statement
Table of Contents

As filed with the Securities and Exchange Commission on November 13, 2012

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT UNDER THE

SECURITIES ACT OF 1933

 

 

Potbelly Corporation

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   5812   36-4466837
(State or other jurisdiction of incorporation or organization)  

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

222 Merchandise Mart Plaza, 23rd Floor

Chicago, Illinois 60654

(312) 951-0600

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Matthew Revord

Senior Vice President, General Counsel and Secretary

Potbelly Corporation

222 Merchandise Mart Plaza, 23rd Floor, Chicago, Illinois 60654

(312) 951-0600

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Edward S. Best

Scott J. Davis

Mayer Brown LLP

71 South Wacker Drive

Chicago, Illinois 60606

Telephone: (312) 782-0600

Facsimile: (312) 701-7711

 

John J. Sabl

Robert L. Verigan

Sidley Austin LLP

One South Dearborn Street

Chicago, Illinois 60603

Telephone: (312) 853-7000

Facsimile: (312) 853-7036

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.    ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

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

 

Large accelerated filer  ¨   Accelerated filer  ¨    Non-accelerated filer  þ   Smaller reporting company  ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class of securities to be registered   Proposed maximum aggregate
offering price (1)(2)
  Amount of
registration fee

Common Stock, $0.01 par value per share

  $                        $            

 

 

(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.

 

(2) Includes shares of common stock that the underwriters have the option to purchase to cover over-allotments, if any.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


Table of Contents

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion

Preliminary Prospectus dated November 13, 2012

PROSPECTUS

             Shares

 

LOGO

Potbelly Corporation

Common Stock

 

 

This is Potbelly Corporation’s initial public offering. We are selling              shares of our common stock and the selling stockholders are selling              shares of our common stock. We will not receive any proceeds from the sale of shares to be offered by the selling stockholders.

We expect the public offering price to be between $         and $         per share. Currently, no public market exists for the shares. After pricing of the offering, we expect that the shares will trade on the Nasdaq Global Select Market under the symbol “            .”

We are an “emerging growth company” under applicable Securities and Exchange Commission rules and will be subject to reduced public company reporting requirements.

Investing in the common stock involves risks that are described in the “Risk Factors” section beginning on page 11 of this prospectus.

 

 

 

      

Per Share

      

    Total    

 

Public offering price

     $                      $                

Underwriting discount

     $           $     

Proceeds, before expenses, to us

     $           $     

Proceeds, before expenses, to the selling stockholders

     $           $     

The underwriters may also exercise their option to purchase up to an additional              shares from us, and up to an additional              shares from the selling stockholders, at the public offering price, less the underwriting discount, for 30 days after the date of this prospectus to cover over-allotments, if any.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The shares will be ready for delivery on or about                     ,         .

 

 

 

BofA Merrill Lynch   Goldman, Sachs & Co.

 

 

The date of this prospectus is                     ,         .


Table of Contents

TABLE OF CONTENTS

 

Prospectus Summary

     1   

Summary Consolidated Financial and Other Data

     7   

Risk Factors

     11   

Cautionary Note Regarding Forward-Looking Statements

     25   

Use of Proceeds

     27   

Dividend Policy

     27   

Capitalization

     28   

Dilution

     29   

Selected Consolidated Financial and Other Data

     31   

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

     36   

Business

     51   

Management

     66   

Executive and Director Compensation

     73   

Related Party Transactions

     86   

Description of Credit Facility

     89   

Principal and Selling Stockholders

     90   

Description of Capital Stock

     92   

Shares Eligible For Future Sale

     96   

Material U.S. Federal Income Tax Considerations For Non-U.S. Holders

     98   

Underwriting

     102   

Legal Matters

     109   

Experts

     109   

Where You Can Find More Information

     109   

Index to Consolidated Financial Statements

     F-1   

 

 

You should rely only on the information contained in this prospectus or in any free writing prospectus that we authorize to be distributed to you. We have not, and the underwriters have not, authorized anyone to provide you with additional or different information. This document may only be used where it is legal to sell these securities. You should assume that the information contained in this prospectus is accurate only as of the date of this prospectus.

No action is being taken in any jurisdiction outside the United States to permit a public offering of the common stock or possession or distribution of this prospectus in that jurisdiction. Persons who come into possession of this prospectus in jurisdictions outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of the prospectus applicable to that jurisdiction.

 

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MARKET AND OTHER INDUSTRY DATA

In this prospectus, we rely on and refer to information regarding the restaurant industry and the limited-service restaurant and full-service restaurant segments of the restaurant industry, which has been sourced from Technomic Inc., a national consulting market research firm, and the National Restaurant Association, an industry trade group, or compiled from market research reports, analyst reports and other publicly available information. Other industry and market data included in this prospectus are from internal analyses based upon data available from known sources or other proprietary research and analysis. We believe these data to be accurate as of the date of this prospectus. However, this information may prove to be inaccurate because this information cannot always be verified with complete certainty due to the limitations on the availability and reliability of raw data, the voluntary nature of the data gathering process and other limitations and uncertainties. As a result, you should be aware that market and other similar industry data included in this prospectus, and estimates and beliefs based on that data, may not be reliable.

TRADEMARKS, SERVICE MARKS AND COPYRIGHTS

We own or have rights to trademarks, service marks or trade names that we use in connection with the operation of our business, including our corporate names, logos and website names. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this prospectus are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent permissible under applicable law, our rights to our copyrights, trademarks, service marks and trade names. All brand names or other trademarks appearing in this prospectus are the property of their respective owners, and their use or display should not be construed to imply a relationship with, or an endorsement or a sponsorship of us by, these other parties.

 

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PROSPECTUS SUMMARY

This summary highlights information appearing elsewhere in this prospectus. This summary does not contain all of the information that you should consider before investing in our common stock. You should carefully read the entire prospectus, including the financial data and related notes and the section entitled “Risk Factors,” before deciding whether to invest in our common stock. Unless otherwise indicated or the context otherwise requires, references in this prospectus to the “company,” “Potbelly,” “we,” “us” and “our” refer to Potbelly Corporation and its consolidated subsidiaries.

The Neighborhood Sandwich Shop

Potbelly is a fast-growing neighborhood sandwich concept offering simple, irresistible food served by friendly people in a warm and welcoming environment. Our unique combination of product, people and place is how we deliver on our passion to be “The Best Place for Lunch.” Our shops are a destination for people who love great food at a fair price. Our menu includes toasty warm sandwiches made fresh to order, craveable salads, hand-dipped milkshakes and delicious cookies baked fresh each day. We develop a strong connection with our customers, creating a devoted base of Potbelly fans that we are expanding one sandwich shop at a time.

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 awesome 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 are 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.

We believe executing on The Potbelly Advantage at a high level creates a distinct competitive advantage and drives our operating and financial results, as illustrated by the following:

 

   

As of September 23, 2012, we had a domestic base of 262 shops in 17 states and the District of Columbia, having grown 13.4% over the prior year;

 

   

We achieved ten consecutive quarters of positive comparable store sales growth through our fiscal quarter ended September 23, 2012;

 

   

From 2010 to 2011, we increased our total revenue 7.9% to $238.0 million, our adjusted EBITDA 27.1% to $26.8 million, our adjusted EBITDA margin by 170 basis points to 11.2%, and our net income to $7.2 million from a net loss of $0.5 million; and

 

   

From 2008 to 2011, we increased our shop-level profit margin by 610 basis points from 15.5% to 21.6%.

See “Selected Consolidated Financial and Other Data” for a discussion of adjusted EBITDA, adjusted EBITDA margin and shop-level profit margin and a reconciliation of the differences between adjusted EBITDA and net income (loss), as well as a calculation of shop-level profit margin. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a definition of comparable store sales.

 

 

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Our History

Potbelly started in 1977 as a small antique store on Lincoln Avenue in Chicago. To boost sales, the original owner began offering tasty toasted sandwiches and homemade desserts to customers. As time passed, Potbelly became a well-known neighborhood sandwich shop with a loyal following of regulars and frequent lines out the door. We opened our second shop in 1997 and continued to open shops in more neighborhoods throughout the country, reaching 100 shops in 2005 and 200 shops in 2008. Throughout our growth, each new shop has maintained the same look, vibe and experience that define the Potbelly brand.

Industry Overview

According to Technomic, Inc. (“Technomic”), a national consulting market research firm, the restaurant industry is divided into two primary segments, limited-service restaurants (“LSRs”) and full-service restaurants, and is generally categorized by price, quality of food, service and location. LSRs are defined as establishments with patrons who pay before eating and generate an average check between $3 and $12. The LSR segment is further divided into (i) quick-service restaurants, which are defined as traditional “fast food” restaurants, generally with check averages between $3 and $8, and (ii) fast-casual restaurants, which are establishments with limited service, check averages generally between $8 and $12, food prepared to order, fresh (or perceived as fresh) ingredients, innovative food suited to sophisticated tastes, and upscale or highly developed interior design.

Technomic reported that LSRs accounted for 72% of the sales of the Top 500 U.S. restaurant chains in 2011. We operate in the “Other Sandwich” category, which includes LSRs specializing in sandwiches and wraps, other than hamburgers. This category accounted for $20.6 billion of sales in 2011 by the Top 500 chains. Sales in this category increased 4.7% from 2010 to 2011, outperforming the broader LSR growth rate of 3.7% over the same time period.

Our Competitive Strengths

Simple, Irresistible Food. Our menu features wholesome, addictively great tasting food made from high quality ingredients. Our incredibly tasty sandwiches are made fresh to order, and many are based on the original recipes from 1977. They are served toasty warm on our signature multigrain wheat or regular bread. We slice our meats and cheeses daily in each shop to ensure freshness. We believe our customers love our sandwiches because they have the perfect balance of ingredients with the last bite tasting as good as the first. We believe our simple and delicious menu offers ease of ordering and broad appeal and helps us create loyal Potbelly fans that return again and again.

Differentiated Customer Experience That Delivers a Neighborhood Feel. We provide a superior customer experience that is driven by both our employees and the lively atmosphere of our shops. Our employees are nice people that interact with our customers in a genuine way while providing fast service. To support the neighborhood feel of our shops, most of our managers live in the neighborhood where their shop is located. This allows them to get to know their customers and understand the unique character of each neighborhood. Each of our shops features vintage décor and shared design elements, such as the use of wood and our signature Potbelly stove. Our atmosphere is enhanced by live, local musicians that add to the positive vibe. We believe the unique Potbelly experience encourages repeat customer visits and drives increased sales.

Powerful Shop Economics with Attractive Returns. Our proven shop model is designed to generate strong cash flow, attractive shop-level financial results and high returns on investment. We operate our shops successfully in a wide range of geographic markets, population densities and real estate settings. We aim to generate average shop-level profit margins above 20% and cash-on-cash returns above 25%. We have achieved these targets in 2010, 2011 and the 52 weeks ended September 23, 2012. We believe our powerful shop economics support our ability to profitably grow our brand in new and existing markets.

 

 

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Proven Management Team with Substantial Operating Experience. Our senior management team has extensive operating experience, with an average of over 16 years in the restaurant industry. Our core senior team has been together since 2008, when we hired our President and CEO, Aylwin Lewis. Aylwin was previously with Yum! Brands, Inc. from 1991 to 2004, most recently as President and Chief Multibranding and Operating Officer, as well as with Sears Holdings from 2004 to 2008, most recently as President and CEO. We believe our proven leadership team is a key driver of our success and positions us to execute our long-term growth strategy.

Distinct, Deep-Rooted Culture: The Potbelly Advantage. Our culture is a key to our success. It is embodied in The Potbelly Advantage, which is a clear expression of our Vision, Mission, Passion and Values. Our Vision is for our customers to feel we are their “Neighborhood Sandwich Shop” and to become Potbelly fans and advocates. Our Mission is to make our customers and employees happy, to make more money and to improve our business every day. Our Passion is to be “The Best Place for Lunch.” Our Values of integrity, teamwork, accountability, positive energy and coaching are emphasized throughout all levels of our organization and form a common language across our organization. We believe The Potbelly Advantage allows us to deliver operational excellence, encourage innovation, and grow our business and our base of devoted Potbelly fans.

Our Growth Strategy

Run Great Shops. We believe that continued excellence in shop-level execution is fundamental to our growth strategy. To maintain our operational standards we use a Balanced Scorecard approach to measure People, Customers, Sales and Profits at each of our shops. Hiring the right people and maintaining optimal staffing levels enable us to run efficient operations. We track metrics such as peak hour throughput, mystery shopper scores and neighborhood engagement activities. Shop sales and profitability are benchmarked against prior year periods and budget, and we focus on achieving targets on a shop-by-shop basis. To support our shop operators, we invest in systems and technology that can meaningfully improve shop-level execution.

Find and Build Great Shops. Our shops are successful in diverse markets in 17 states and the District of Columbia, and we intend to continue to build company-operated shops in both new and existing markets utilizing our rigorous site selection process. Our location-specific approach to development allows us to leverage our versatile shop format to achieve strong returns across a wide range of real estate settings. In 2011 and for the 39 weeks ended September 23, 2012 we opened 21 and 24 new shops, respectively, and expanded into New York, Seattle, Boston and Phoenix. In 2013, we expect to open 25 to 35 new shops. Over the long term, we plan to grow the number of Potbelly shops 10% annually.

Achieve High Margins and Terrific Returns. Our approach to margin enhancement begins with continuous efforts to improve the financial results of our shops. We focus on cash-on-cash returns and look to grow shop-level profitability each year through sales growth and productivity improvements. Between 2008 and 2011, we increased our shop-level profit margin from 15.5% to 21.6%. Our intention is to maintain average shop-level profit margins over 20% as we continue to grow. We exercise strong financial discipline and strive to achieve and maintain general and administrative expenses under 10% of sales.

Become a Global Iconic Brand. We believe that our premise of a “Neighborhood Sandwich Shop” has broad appeal across a wide range of market types and geographies. We find that Potbelly is now a recognized brand beyond the neighborhoods in which we currently operate. A significant contributor to this success is word-of-mouth publicity by our customers who enjoy their Potbelly experience and tell others about it. We believe that our positive brand perception helps drive interest in our shops in both existing and new markets.

Be a Great Franchisor. In 2010, we initiated a program to franchise shops in selected markets in the U.S. and internationally. We intend to expand the number of franchise shops on a disciplined basis as we develop our franchise program. As of September 23, 2012, our franchisees operated five shops in the U.S. and seven

 

 

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shops in the Middle East. Although we do not expect franchise activities to result in significant revenue in the near term, we see the selective expansion of our franchising efforts to be a valuable potential growth opportunity over time.

Risk Factors

Before you invest in our common stock, you should carefully consider all of the information in this prospectus, including matters set forth under the heading “Risk Factors.” Risks relating to our business include the following, among others:

 

   

we face significant competition for customers that could affect our results of operations;

 

   

changes in economic conditions could materially affect our business;

 

   

our operations and future development could be significantly disrupted if we lose key members of our management team;

 

   

changes in food availability and costs could adversely affect our operating results;

 

   

our inability to find and hire qualified employees could slow our growth or harm our current operations; and

 

   

our long-term success is highly dependent on our ability to successfully identify new shop locations and develop and expand our operations.

Company Information

We were incorporated in Delaware in 2001 as Potbelly Sandwich Works, Inc. and changed our name to Potbelly Corporation in 2002. Our principal executive offices are located at 222 Merchandise Mart Plaza, 23rd Floor, Chicago, Illinois 60654, our telephone number at that address is (312) 951-0600 and our internet address is www.potbelly.com. Our website and the information contained on or accessible through our website are not part of this prospectus.

Implications of Being an Emerging Growth Company

As a company with less than $1.0 billion in revenue during our last fiscal year, we qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. As an emerging growth company, we may take advantage of specified reduced reporting requirements and are relieved from certain other significant requirements that are otherwise generally applicable to public companies. We may choose to take advantage of some but not all of these provisions for as long as we remain an emerging growth company. We will remain an emerging growth company until the earlier of (1) the last day of the fiscal year (a) following the fifth anniversary of the completion of this offering, (b) in which we have total annual gross revenue of at least $1.0 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700 million as of the prior June 30th, or (2) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period. See “Risk Factors—We are an ‘emerging growth company,’ and any decision on our part to comply only with certain reduced reporting and disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors.”

 

 

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The Offering

 

Common stock offered by us

             shares

 

Common stock offered by the selling stockholders

             shares

 

Common stock to be outstanding immediately after the completion of this offering

             shares

 

Option to purchase additional shares

We, along with certain of the selling stockholders, have granted the underwriters a 30-day option to purchase up to an additional              shares. If this option is exercised in full, we will issue and sell              shares and the selling stockholders will sell              shares.

 

Use of proceeds

We expect to receive net proceeds, after deducting estimated offering expenses and underwriting discounts and commissions payable by us, of approximately $         million (or $         million if the underwriters exercise their option to purchase additional shares in full), based on an assumed offering price of $         per share (the midpoint of the price range set forth on the cover page of this prospectus). We intend to use the net proceeds from this offering for working capital and general corporate purposes. We will not receive any proceeds from the sale of shares of common stock by the selling stockholders. See “Use of Proceeds” and “Principal and Selling Stockholders.”

 

Dividend policy

We do not currently pay cash dividends on our common stock and do not anticipate paying any dividends on our common stock in the foreseeable future. Any future determinations relating to our dividend policies will be made at the discretion of our board of directors and will depend on various factors. See “Dividend Policy.”

 

Risk factors

You should read carefully the “Risk Factors” section of this prospectus for a discussion of factors that you should consider before deciding to invest in shares of our common stock.

Proposed Nasdaq Global Select Market symbol

Unless otherwise indicated, all information in this prospectus relating to the number of shares of common stock to be outstanding immediately after the completion of this offering:

 

   

assumes the conversion of all outstanding shares of all series of our preferred stock into, and the exercise of all outstanding warrants for, an aggregate of 16,897,088 shares of common stock immediately prior to the completion of this offering;

 

   

assumes the effectiveness of our amended and restated certificate of incorporation and amended and restated by-laws, which we will adopt prior to the completion of this offering;

 

 

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excludes outstanding options to purchase 4,446,049 shares of our common stock at a weighted average exercise price of $9.16 per share, of which options to purchase 3,032,113 shares at a weighted average exercise price of $9.90 were vested as of September 23, 2012. See “Executive and Director Compensation;”

 

   

excludes              shares of our common stock reserved for future grants under our 2012 Long-Term Incentive Plan, which we intend to adopt in connection with this offering; and

 

   

assumes no exercise by the underwriters of their option to purchase up to              additional shares.

Except for pro forma and pro forma as adjusted data and as otherwise indicated, financial data does not give effect to the conversion of all outstanding shares of all series of our preferred stock and the exercise of all outstanding warrants.

 

 

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SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA

The following table sets forth our summary consolidated financial and other data as of the dates and for the periods indicated. The summary consolidated financial data as of December 25, 2011 and December 26, 2010 and for each of the two fiscal years in the period ended December 25, 2011 presented in this table have been derived from the audited consolidated financial statements included elsewhere in this prospectus. The summary consolidated interim financial data as of and for the 39 weeks ended September 23, 2012 and for the 39 weeks ended September 25, 2011 have been derived from the unaudited condensed interim consolidated financial statements included elsewhere in this prospectus. The unaudited financial information for the 52 weeks ended September 23, 2012 has been derived by adding our financial information for the fiscal year ended December 25, 2011 to the unaudited financial information for the 39 weeks ended September 23, 2012 and subtracting the unaudited financial information for the 39 weeks ended September 25, 2011.We believe that presentation of unaudited financial information for these 52-week periods is useful to investors because it presents information about how our business has performed in the 52-week period immediately preceding the date of our most recent interim financial statements, which allows investors to review our current performance trends over a full 52-week period, and because it presents results for four consecutive quarters, which presentation compensates for seasonal factors that might influence results in a particular quarter within the year. Historical results are not necessarily indicative of the results to be expected for future periods, and our interim results are not necessarily indicative of the results to be expected for the full fiscal year.

Our fiscal year ends on the last Sunday of each year. The first three quarters of our fiscal year consist of 13 weeks and our fourth quarter consists of 13 weeks for 52-week fiscal years and 14 weeks for 53-week fiscal years. The fiscal years ended December 25, 2011 and December 26, 2010 each had 52 weeks. The fiscal year ending December 30, 2012 will have 53 weeks.

 

 

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This summary consolidated financial and other data should be read in conjunction with the disclosures set forth under “Capitalization” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the related notes thereto appearing elsewhere in this prospectus.

 

    Fiscal Year Ended     39 Weeks Ended     52 Weeks
Ended
 
    December 26,
2010
    December 25,
2011
    September 25,
2011
    September 23,
2012
    September 23,
2012
 
    ($ in thousands, except per share data)  

Consolidated Statements of Operations Data:

         

Total revenues

  $ 220,573      $ 237,966      $ 176,651      $ 201,406      $ 262,721   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses:

         

Sandwich shop operating expenses:

         

Cost of goods sold, excluding depreciation

    63,009        68,491        50,784        58,389        76,096   

Labor and related expenses

    63,506        67,036        49,865        56,618        73,789   

Occupancy expenses

    25,238        26,511        19,493        22,885        29,903   

Other operating expenses

    22,620        24,095        17,899        20,767        26,963   

General and administrative expenses

    26,563        26,911        20,308        22,542        29,145   

Depreciation expense

    15,647        14,838        11,085        11,633        15,386   

Pre-opening costs

    267        1,521        1,046        1,760        2,235   

Impairment and loss on disposal of property and equipment

    2,952        365        29        78        414   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

    219,802        229,768        170,509        194,672        253,931   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

    771        8,198        6,142        6,734        8,790   

Interest expense

    519        495        359        427        563   

Other expense (income)

    9        1        (2     6        9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

    243        7,702        5,785        6,301        8,218   

Income tax expense

    773        537        591        765        711   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    (530     7,165        5,194        5,536        7,507   

Net income (loss) attributable to non-controlling interests (1)

    —          —          —          (35     (35
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to Potbelly Corporation

  $ (530   $ 7,165      $ 5,194      $ 5,571      $ 7,542   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accretion of redeemable convertible preferred stock to maximum redemption value

    (45,992     (17,410     (9,011     (13,887     (16,609
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common
stockholders

  $ (46,522   $ (10,245   $ (3,817   $ (8,316   $ (9,067
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per common share attributable to common stockholders (2):

         

Basic

  $ (9.34 )     $ (2.35   $ (0.85   $ (2.09   $ (2.29

Diluted

    (9.34     (2.35     (0.85     (2.09     (2.29

Weighted average shares outstanding:

         

Basic

    4,978,621        4,359,930        4,503,982        3,972,873        3,962,294   

Diluted

    4,978,621        4,359,930        4,503,982        3,972,873        3,962,294   

Unaudited pro forma net income per common share attributable to common stockholders (3):

         

Basic

    $ 0.34        $ 0.27     

Diluted

      0.33          0.27     

Unaudited pro forma weighted average shares
outstanding (3):

         

Basic

      21,386,375          20,787,320     

Diluted

      21,437,590          20,855,416     

Statement of Cash Flows Data:

         

Net cash provided by (used in):

         

Operating activities

  $ 18,780      $ 20,121      $ 10,839      $ 20,457      $ 29,740   

Investing activities

    (6,243     (17,758     (13,070     (19,700     (24,388

Financing activities

    (4,382     (7,197     (7,659     51        513   

Selected Other Data:

         

Total company-operated shops (end of period)

    218        234        231        257        257   

Total comparable stores (end of period)

    211        211        211        221        221   

Change in comparable store sales

    1.8     1.7     1.3     3.9     3.7

Shop-level profit margin (4)

    20.9     21.6     21.7     21.0     21.1

Capital expenditures

  $ 6,243      $ 17,758      $ 13,070      $ 19,700      $ 24,388   

Adjusted EBITDA (5)

  $ 21,051      $ 26,752      $ 19,670      $ 22,741      $ 29,823   

Adjusted EBITDA margin (5)

    9.5     11.2     11.1     11.3     11.4

 

 

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     December 26,
2010
    December 25,
2011
    September 23, 2012
         Actual     Pro Forma (6)      Pro Forma
As Adjusted (7)
     ($ in thousands)

Balance Sheet Data:

           

Cash and cash equivalents

   $ 28,980      $ 24,146      $ 24,954      $ 26,930      

Working capital

     14,764        16,490        15,204        16,880      

Total assets

     98,424        99,110        108,797        110,773      

Total debt

     9,313        15,243        15,409        15,409      

Total redeemable convertible preferred stock

     228,544        239,848        253,735        —        

Total equity (deficit)

     (169,643     (185,302     (191,103     64,608      

 

(1) Non-controlling interests represent the non-controlling partner’s share of the assets, liabilities and operations related to the joint venture investment in Potbelly Airport II Boston, LLC, related to one shop located in the Boston Logan International Airport. We own a seventy-five percent interest in this consolidated joint venture.

 

(2) Net loss per common share attributable to common stockholders is calculated under the two-class method, as our redeemable convertible preferred stock participates in the undistributed earnings of the company. Earnings of the company are allocated between the common and preferred stockholders to account for the accretion of the redeemable convertible preferred stock to its maximum redemption value, thereby reducing the earnings of the company attributable to common stockholders. For the periods presented, this resulted in net losses attributable to common stockholders, in total and on a per share basis, as the net income attributable to the company (if any) was exceeded by the change in maximum redemption value of the redeemable convertible preferred stock.

 

(3) Pro forma net income per common share attributable to stockholders and the number of weighted average common shares used in computing pro forma net income per common share attributable to stockholders gives effect to the conversion of all of our outstanding redeemable convertible preferred stock into, and the exercise of all outstanding warrants for, common stock upon the closing of a qualified public offering as if such conversion had occurred as of the beginning of the fiscal year. See “Related Party Transactions—Arrangements with Our Investors.”

 

(4) Shop-level profit margin is defined as net company-operated sandwich shop sales less company-operated sandwich shop operating expenses, including cost of goods sold, labor and related expenses, other operating expenses and occupancy expenses, expressed as a percentage of net company-operated sandwich shop sales. Shop-level profit margin is a supplemental measure of operating performance of our shops that does not represent and should not be considered an alternative to net income or revenues as determined by U.S. generally accepted accounting principles, or GAAP, and our calculation thereof may not be comparable to that reported by other companies. Shop-level profit margin has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Management believes shop-level profit margin is an important component of financial results because it is a widely used metric within the restaurant industry to evaluate restaurant-level productivity, efficiency and performance. Management uses shop-level profit margin as a key metric to evaluate the profitability of incremental sales, to evaluate our performance across periods and to evaluate our financial performance compared with our competitors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a definition of shop-level profit margin and other key performance indicators.

A calculation of shop-level profit margin is provided below:

 

    Fiscal Year Ended     39 Weeks Ended     52 Weeks
Ended
 
    December 26,
2010
    December 25,
2011
    September 25,
2011
    September 23,
2012
    September 23,
2012
 
    ($ in thousands)  

Total revenues

  $ 220,573      $ 237,966      $ 176,651      $ 201,406      $ 262,721   

Less: Franchise royalties and fees

    —          503        348        553        708   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Sandwich Shop Sales, net [X]

    220,573        237,463        176,303        200,853        262,013   

Sandwich shop operating expenses:

         

Cost of goods sold

    63,009        68,491        50,784        58,389        76,096   

Labor and related expenses

    63,506        67,036        49,865        56,618        73,789   

Occupancy expenses

    25,238        26,511        19,493        22,885        29,903   

Other operating expenses

    22,620        24,095        17,899        20,767        26,963   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Shop-level profit [Y]

  $ 46,200      $ 51,330      $ 38,262      $ 42,194      $ 55,262   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Shop-level profit
margin [Y÷X]

    20.9     21.6     21.7     21.0     21.1

 

 

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(5) Adjusted EBITDA has been presented in this prospectus and is a supplemental measure of financial performance that is not required by, or presented in accordance with, GAAP. We define adjusted EBITDA as net income (loss) before depreciation and amortization expense, interest expense and provision for income taxes, adjusted to eliminate the impact of certain items, including non-cash or other items that we do not consider representative of our ongoing operating performance. Adjusted EBITDA margin is calculated by dividing adjusted EBITDA by total revenues. Adjusted EBITDA has limitations as an analytical tool and our calculation thereof may not be comparable to that reported by other companies; accordingly, you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Adjusted EBITDA is included in this prospectus because it is a key metric used by management. Additionally, adjusted EBITDA is frequently used by analysts, investors and other interested parties to evaluate companies in our industry. We use adjusted EBITDA, alongside other GAAP measures such as operating income (loss) and net income (loss), to measure profitability, as a key profitability target in our annual and other budgets, and to compare our performance against that of peer companies. We believe that adjusted EBITDA provides useful information facilitating operating performance comparisons from period to period and company to company.

A reconciliation of adjusted EBITDA to net income (loss) attributable to Potbelly Corporation is provided below:

 

    Fiscal Year Ended     39 Weeks Ended     52 Weeks
Ended
 
    December 26,
2010
    December 25,
2011
    September 25,
2011
    September 23,
2012
    September 23,
2012
 
    ($ in thousands)  

Net income (loss) attributable to Potbelly Corporation

  $ (530   $ 7,165      $ 5,194      $ 5,571      $ 7,542   

Depreciation expense

    15,647        14,838        11,085        11,633        15,386   

Interest expense

    519        495        359        427        563   

Income tax expense

    773        537        591        765        711   

Impairment and closures (a)

    3,344        672        299        265        638   

Pre-opening costs (b)

    267        1,521        1,046        1,760        2,235   

Stock-based compensation (c)

    1,031        1,524        1,096        2,320        2,748   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

  $ 21,051      $ 26,752      $ 19,670      $ 22,741      $ 29,823   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (a) Includes costs related to impairment of long-lived assets, gain or loss on disposal of property and equipment and shop closure expenses.

 

  (b) Includes expenses directly associated with the opening of new shops and are incurred prior to the opening of the shop.

 

  (c) Includes non-cash stock-based compensation.

 

(6) Assumes the conversion of all outstanding shares of all series of our preferred stock into, and the exercise of all outstanding warrants for, an aggregate of 16,897,088 shares of common stock immediately prior to the completion of this offering, and excludes outstanding options to purchase 4,446,049 shares of our common stock at a weighted average exercise price of $9.16 per share, of which options to purchase 3,032,113 shares at a weighted average exercise price of $9.90 were vested as of September 23, 2012.

 

(7) Gives effect to the transactions described in footnote 6 and the sale of          shares of common stock in this offering by us at the estimated initial public offering price of $         per share (the midpoint of the price range set forth on the cover page of this prospectus), after deducting underwriting discounts and commissions and estimated expenses payable by us.

 

 

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RISK FACTORS

An investment in our common stock involves various risks. You should carefully consider the following risks and all of the other information contained in this prospectus before investing in our common stock. The risks described below are those that we believe are the material risks that we face. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment in our common stock.

Risks Related to Our Business and Industry

We face significant competition for customers and our inability to compete effectively may affect our traffic, sales and shop-level profit margins, which could adversely affect our business, financial condition and results of operations.

The restaurant industry is intensely competitive with many well-established companies that compete directly and indirectly with us with respect to food quality, ambience, service, price and value and location. We compete in the restaurant industry with national, regional and locally-owned limited-service restaurants and full-service restaurants. Some of our competitors have significantly greater financial, marketing, personnel and other resources than we do, and many of our competitors are well established in markets in which we have existing shops or intend to locate new shops. In addition, many of our competitors have greater name recognition nationally or in some of the local markets in which we have shops. Any inability to successfully compete with the restaurants in our markets will place downward pressure on our customer traffic and may prevent us from increasing or sustaining our revenues and profitability. Consumer tastes, nutritional and dietary trends, traffic patterns and the type, number and location of competing restaurants often affect the restaurant business, and our competitors may react more efficiently and effectively to those conditions. Further, we face growing competition from the supermarket industry, with the improvement of their “convenient meals” in the deli section, and from limited-service and fast casual restaurants, as a result of higher-quality food and beverage offerings by those restaurants. In addition, some of our competitors have in the past implemented programs which provide price discounts on certain menu offerings, and they may continue to do so in the future. If we are unable to continue to compete effectively, our traffic, sales and shop-level profit margins could decline and our business, financial condition and results of operations would be adversely affected.

Changes in economic conditions, including continuing effects from the recent recession, could materially affect our business, financial condition and results of operations.

The restaurant industry depends on consumer discretionary spending. During the economic downturn starting in 2008, continuing disruptions in the overall economy, including the ongoing impacts of the housing crisis, high unemployment, and financial market volatility and unpredictability, caused a related reduction in consumer confidence, which negatively affected customer traffic and sales throughout our industry. These factors, as well as national, regional and local regulatory and economic conditions, gasoline prices, disposable consumer income and consumer confidence, affect discretionary consumer spending. If these economic conditions persist or worsen, customer traffic could be adversely impacted if our customers choose to dine out less frequently or reduce the amount they spend on meals while dining out. If current negative economic conditions persist for a long period of time or become more pervasive, consumer changes to their discretionary spending behavior, including the frequency with which they dine out, could be more permanent. The ability of the U.S. economy to continue to recover from these challenging economic conditions is likely to be affected by many national and international factors that are beyond our control. If sales decrease, our profitability could decline as we spread fixed costs across a lower level of sales. Prolonged negative trends in shop sales could cause us to, among other things, reduce the number and frequency of new shop openings, close shops or delay remodeling of our existing shops or take asset impairment charges.

 

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Our business operations and future development could be significantly disrupted if we lose key members of our management team.

The success of our business continues to depend to a significant degree upon the continued contributions of our senior officers and key employees, both individually and as a group. Our future performance will be substantially dependent in particular on our ability to retain and motivate Aylwin Lewis, our Chief Executive Officer, Charlie Talbot, our Senior Vice President and Chief Financial Officer, John Morlock, our Senior Vice President of Operations, and other members of our senior leadership team. We currently have employment agreements in place with all of the members of our senior leadership team. The loss of the services of any of these executive officers or other key employees could have a material adverse effect on our business and plans for future development. In addition, we may have difficulty finding appropriate replacements and our business could suffer. We also do not maintain any key man life insurance policies for any of our employees.

Increased commodity, energy and other costs could decrease our shop-level profit margins or cause us to limit or otherwise modify our menus, which could adversely affect our business.

Our profitability depends in part on our ability to anticipate and react to changes in the price and availability of food commodities, including among other things beef, poultry, grains, dairy and produce. Prices may be affected due to market changes, increased competition, the general risk of inflation, shortages or interruptions in supply due to weather, disease or other conditions beyond our control, or other reasons. For example, certain regions of the U.S. experienced a significant drought in 2012, and the resulting effects on certain commodities prices, including those of meats and grains, may not be fully experienced to date. Increased prices or shortages could affect the cost and quality of the items we buy or require us to raise prices or limit our menu options. These events, combined with other more general economic and demographic conditions, could impact our pricing and negatively affect our sales and shop-level profit margins. We enter into certain forward pricing arrangements with our suppliers from time to time, which may result in fixed or formula-based pricing with respect to certain food products. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Quantitative and Qualitative Disclosures of Market Risks—Commodity Price Risk.” However, these arrangements generally are relatively short in duration and may provide only limited protection from price changes, and the extent to which we use these arrangements varies substantially from time to time. In addition, the use of these arrangements may limit our ability to benefit from favorable price movements.

Our profitability is also adversely affected by increases in the price of utilities, such as natural gas, whether as a result of inflation, shortages or interruptions in supply, or otherwise. Our profitability is also affected by the costs of insurance, labor, marketing, taxes and real estate, all of which could increase due to inflation, changes in laws, competition or other events beyond our control. Our ability to respond to increased costs by increasing menu prices or by implementing alternative processes or products will depend on our ability to anticipate and react to such increases and other more general economic and demographic conditions, as well as the responses of our competitors and customers. All of these things may be difficult to predict and beyond our control. In this manner, increased costs could adversely affect our performance.

Our inability to identify qualified individuals for our workforce could slow our growth and adversely impact our ability to operate our shops.

Our success depends in part upon our ability to attract, motivate and retain a sufficient number of qualified managers and associates to meet the needs of our existing shops and to staff new shops. A sufficient number of qualified individuals to fill these positions may be in short supply in some communities. Competition in these communities for qualified staff could require us to pay higher wages and provide greater benefits. In addition, significant improvement in regional or national economic conditions could increase the difficulty of attracting and retaining qualified individuals and could result in the need to pay higher wages and provide greater benefits. We place a heavy emphasis on the qualification and training of our personnel and spend a significant amount of time and money on training our employees. Any inability to recruit and retain qualified individuals

 

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may result in higher turnover and increased labor costs, and could compromise the quality of our service, all of which could adversely affect our business. Any such inability could also delay the planned openings of new shops and could adversely impact our existing shops. Any such inability to retain or recruit qualified employees, increased costs of attracting qualified employees or delays in shop openings could adversely affect our business and results of operations.

Our long-term success is highly dependent on our ability to successfully identify appropriate sites and develop and expand our operations in existing and new markets.

One of the key means of achieving our growth strategies will be through opening new shops and operating those shops on a profitable basis. We expect this to be the case for the foreseeable future. We opened 24 new shops in the 39 weeks ended September 23, 2012 and expect to open 25 to 35 new shops in 2013. There can be no assurance that any new shops that we open will have similar operating results to those of existing shops. We may not be able to open our planned new shops on a timely basis, if at all, and, if opened, these shops may not be operated profitably. The number and timing of new shops opened during any given period, and their associated contribution to operating growth, may be negatively impacted by a number of factors including, without limitation:

 

   

the availability of attractive sites for new shops and the ability to negotiate suitable lease terms;

 

   

the cost and availability of capital to fund construction costs and pre-opening expenses;

 

   

our ability to control construction and development costs of new shops;

 

   

recruitment and training of qualified operating personnel in the local market;

 

   

our ability to obtain all required governmental permits, including zoning approvals, on a timely basis;

 

   

our ability to predict and respond to consumer tastes in new geographic regions and acceptance or awareness of our concept;

 

   

competition in new markets, including competition for appropriate sites;

 

   

limitations under our current and future credit facilities; and

 

   

unanticipated increases in costs, any of which could give rise to delays or cost overruns.

Our results have been, and in the future may continue to be, significantly impacted by the timing of new shop openings (often dictated by factors outside of our control), including associated shop pre-opening costs and operating inefficiencies, as well as changes in our geographic concentration due to the opening of new shops. We typically incur the most significant portion of pre-opening expenses associated with a given shop within the five months immediately preceding and the month of the opening of the shop. Our experience has been that labor and operating costs associated with a newly opened shop for the first several months of operation are materially greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenues. Our new shops commonly take 10 to 13 weeks to reach planned operating levels due to inefficiencies typically associated with new shops, including the training of new personnel, lack of market awareness, inability to hire sufficient qualified staff and other factors. Accordingly, the volume and timing of new shop openings may have a meaningful impact on our profitability.

Although we target specified operating and financial metrics, new shops may not meet these targets or may take longer than anticipated to do so. Any new shops we open may not be profitable or achieve operating results similar to those of our existing shops. We may not be able to respond on a timely basis to all of the

 

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changing demands that our planned expansion will impose on management and on our existing infrastructure, or be able to hire or retain the necessary management and operating personnel. Our existing management systems, financial and management controls and information systems may not be adequate to support our planned expansion. Our ability to manage our growth effectively will require us to continue to enhance these systems, procedures and controls and to locate, hire, train and retain management and operating personnel.

We cannot assure you that we will be able to successfully expand or acquire critical market presence for our brand in new geographical markets, as we may encounter well-established competitors with substantially greater financial resources. We may be unable to find attractive locations, build name recognition, successfully market our brand or attract new customers. We may incur additional costs in new markets, particularly for transportation, distribution and training of new personnel, which may impact the profitability of those shops. Competitive circumstances and consumer characteristics and preferences in new market segments and new geographical markets may differ substantially from those in the market segments and geographical markets in which we have substantial experience. If we are unable to expand in existing markets or penetrate new markets, our ability to increase our revenues and profitability may be harmed.

Damage to our reputation or lack of acceptance of our brand in existing or new markets could negatively impact our business, financial condition and results of operations.

We believe we have built our reputation on the high quality of our food, service and staff, as well as on our unique culture and the ambience in our shops, and we must protect and grow the value of our brand to continue to be successful in the future. Any incident that erodes consumer affinity for our brand could significantly reduce its value and damage our business. For example, our brand value could suffer and our business could be adversely affected if customers perceive a reduction in the quality of our food, service or staff, or an adverse change in our culture or ambience, or otherwise believe we have failed to deliver a consistently positive experience.

We may be adversely affected by news reports or other negative publicity regardless of their accuracy, regarding food quality issues, public health concerns, illness, safety, injury or government or industry findings concerning our shops, restaurants operated by other foodservice providers, or others across the food industry supply chain. The risks associated with such negative publicity cannot be completely eliminated or mitigated and may materially harm our results of operations and result in damage to our brand.

Also, there has been a marked increase in the use of social media platforms and similar devices, including weblogs (blogs), social media websites and other forms of Internet-based communications which allow individuals access to a broad audience of consumers and other interested persons. The availability of information on social media platforms is virtually immediate as is its impact. Many social media platforms immediately publish the content their subscribers and participants can post, often without filters or checks on accuracy of the content posted. The opportunity for dissemination of information, including inaccurate information, is seemingly limitless and readily available. Information concerning our company may be posted on such platforms at any time. Information posted may be adverse to our interests or may be inaccurate, each of which may harm our performance, prospects or business. The harm may be immediate without affording us an opportunity for redress or correction. Such platforms also could be used for dissemination of trade secret information, compromising valuable company assets. In sum, the dissemination of information online could harm our business, prospects, financial condition and results of operations, regardless of the information’s accuracy.

Our marketing programs may not be successful.

We incur costs and expend other resources in our marketing efforts to attract and retain customers. These initiatives may not be successful, resulting in expenses incurred without the benefit of higher revenues. Additionally, some of our competitors have greater financial resources, which enable them to spend significantly more on marketing and advertising than we are able to. Should our competitors increase spending on marketing

 

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and advertising or our marketing funds decrease for any reason, or should our advertising and promotions be less effective than our competitors, there could be a material adverse effect on our results of operations and financial condition.

Our business is subject to seasonal fluctuations.

Historically, customer spending patterns for our established shops are lowest in the first quarter of the year. Our quarterly results have been and will continue to be affected by the timing of new shop openings and their associated pre-opening costs. As a result of these and other factors, our financial results for any quarter may not be indicative of the results that may be achieved for a full fiscal year.

Because many of our shops are concentrated in local or regional areas, we are susceptible to economic and other trends and developments, including adverse weather conditions, in these areas.

Our financial performance is highly dependent on shops located in Illinois, Texas, Washington, D.C., Michigan, Minnesota and Ohio, which comprised approximately 73% of our total domestic shops as of September 23, 2012. Shops located in the Chicago metropolitan area comprised approximately 30% of our total domestic shops as of such date. As a result, adverse economic conditions in any of these areas could have a material adverse effect on our overall results of operations. In recent years, certain of these states have been more negatively impacted by the economic crisis than other geographic areas. In addition, given our geographic concentrations, negative publicity regarding any of our shops in these areas could have a material adverse effect on our business and operations, as could other regional occurrences such as local strikes, terrorist attacks, increases in energy prices, or natural or man-made disasters. In particular, adverse weather conditions, such as regional winter storms, floods, severe thunderstorms and hurricanes, could negatively impact our results of operations. For example, we experienced substantial temporary shop closures in the Chicago metropolitan area following a severe blizzard in February 2011. More recently, we have experienced temporary shop closures on the east coast due to Hurricane Sandy. Temporary or prolonged shop closures may occur and customer traffic may decline due to the actual or perceived effects of future weather-related events.

Legislation and regulations requiring the display and provision of nutritional information for our menu offerings, and new information or attitudes regarding diet and health or adverse opinions about the health effects of consuming our menu offerings, could affect consumer preferences and negatively impact our results of operations.

Government regulation and consumer eating habits may impact our business as a result of changes in attitudes regarding diet and health or new information regarding the health effects of consuming our menu offerings. These changes have resulted in, and may continue to result in, the enactment of laws and regulations that impact the ingredients and nutritional content of our menu offerings, or laws and regulations requiring us to disclose the nutritional content of our food offerings.

For example, a number of states, counties and cities have enacted menu labeling laws requiring multi-unit restaurant operators to disclose certain nutritional information to customers, or have enacted legislation restricting the use of certain types of ingredients in restaurants. Furthermore, the Patient Protection and Affordable Care Act of 2010 (the “PPACA”) establishes a uniform, federal requirement for certain restaurants to post certain nutritional information on their menus. Specifically, the PPACA amended the Federal Food, Drug and Cosmetic Act to require chain restaurants with 20 or more locations operating under the same name and offering substantially the same menus to publish the total number of calories of standard menu items on menus and menu boards, along with a statement that puts this calorie information in the context of a total daily calorie intake. The PPACA also requires covered restaurants to provide to consumers, upon request, a written summary of detailed nutritional information for each standard menu item, and to provide a statement on menus and menu boards about the availability of this information. The PPACA further permits the United States Food and Drug Administration (the “FDA”) to require covered restaurants to make additional nutrient disclosures, such as disclosure of trans-fat content. An unfavorable report on, or reaction to, our menu ingredients, the size of our portions or the nutritional content of our menu items could negatively influence the demand for our offerings.

 

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Compliance with current and future laws and regulations regarding the ingredients and nutritional content of our menu items may be costly and time-consuming. Additionally, if consumer health regulations or consumer eating habits change significantly, we may be required to modify or discontinue certain menu items, and we may experience higher costs associated with the implementation of those changes. Additionally, some government authorities are increasing regulations regarding trans-fats and sodium, which may require us to limit or eliminate trans-fats and sodium from our menu offerings, switch to higher cost ingredients or may hinder our ability to operate in certain markets. If we fail to comply with these laws or regulations, our business could experience a material adverse effect.

We cannot make any assurances regarding our ability to effectively respond to changes in consumer health perceptions or our ability to successfully implement the nutrient content disclosure requirements and to adapt our menu offerings to trends in eating habits. The imposition of menu-labeling laws could have an adverse effect on our results of operations and financial position, as well as the restaurant industry in general.

We are subject to many federal, state and local laws with which compliance is both costly and complex.

The restaurant industry is subject to extensive federal, state and local laws and regulations, including the recently enacted comprehensive health care reform legislation and those relating to building and zoning requirements and those relating to the preparation and sale of food. The development and operation of restaurants depend to a significant extent on the selection and acquisition of suitable sites, which are subject to zoning, land use, environmental, traffic and other regulations and requirements. We are also subject to licensing and regulation by state and local authorities relating to health, sanitation, safety and fire standards.

We are subject to federal and state laws governing our relationships with employees (including the Fair Labor Standards Act of 1938, the Immigration Reform and Control Act of 1986 and applicable requirements concerning the minimum wage, overtime, family leave, working conditions, safety standards, immigration status, unemployment tax rates, workers’ compensation rates and state and local payroll taxes) and federal and state laws which prohibit discrimination. As significant numbers of our associates are paid at rates related to the applicable minimum wage, further increases in the minimum wage or other changes in these laws could increase our labor costs. Our ability to respond to minimum wage increases by increasing menu prices will depend on the responses of our competitors and customers.

In March 2010, the United States federal government enacted comprehensive health care reform legislation which, among other things, includes guaranteed coverage requirements, eliminates pre-existing condition exclusions and annual and lifetime maximum limits, restricts the extent to which policies can be rescinded and imposes new and significant taxes on health insurers and health care benefits. The legislation imposes implementation effective dates that began in 2010 and extend through 2020, and many of the changes require additional guidance from government agencies or federal regulations. To date, we have not experienced material costs related to such legislation. However, due to the phased-in nature of the implementation and the lack of interpretive guidance, it is difficult to determine at this time what impact the health care reform legislation will have on our financial results. Possible adverse effects could include increased costs, exposure to expanded liability and requirements for us to revise the ways in which we provide healthcare and other benefits to our employees.

There is also a potential for increased regulation of certain food establishments in the United States, where compliance with a Hazard Analysis and Critical Control Points (“HACCP”) approach may now be required. HACCP refers to a management system in which food safety is addressed through the analysis and control of potential hazards from production, procurement and handling, to manufacturing, distribution and consumption of the finished product. Many states have required restaurants to develop and implement HACCP Systems, and the United States government continues to expand the sectors of the food industry that must adopt and implement HACCP programs. For example, the Food Safety Modernization Act (the “FSMA”), signed into law in January 2011, granted the FDA new authority regarding the safety of the entire food system, including

 

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through increased inspections and mandatory food recalls. Although restaurants are specifically exempted from or not directly implicated by some of these new requirements, we anticipate that the new requirements may impact our industry. Additionally, our suppliers may initiate or otherwise be subject to food recalls that may impact the availability of certain products, result in adverse publicity or require us to take actions that could be costly for us or otherwise impact our business.

We are subject to the Americans with Disabilities Act (the “ADA”), which, among other things, requires our shops to meet federally mandated requirements for the disabled. The ADA prohibits discrimination in employment and public accommodations on the basis of disability. Under the ADA, we could be required to expend funds to modify our shops to provide service to, or make reasonable accommodations for the employment of, disabled persons. In addition, our employment practices are subject to the requirements of the Immigration and Naturalization Service relating to citizenship and residency. Government regulations could affect and change the items we procure for resale such as commodities.

In addition, our franchising activities are subject to laws enacted by a number of states, rules and regulations promulgated by the U.S. Federal Trade Commission and certain rules and requirements regulating franchising activities in foreign countries. Failure to comply with new or existing franchise laws, rules and regulations in any jurisdiction or to obtain required government approvals could negatively affect our franchise sales and our relationships with our franchisees.

The impact of current laws and regulations, the effect of future changes in laws or regulations that impose additional requirements and the consequences of litigation relating to current or future laws and regulations, or our inability to respond effectively to significant regulatory or public policy issues, could increase our compliance and other costs of doing business and, therefore, have an adverse effect on our results of operations. Failure to comply with the laws and regulatory requirements of federal, state and local authorities could result in, among other things, revocation of required licenses, administrative enforcement actions, fines and civil and criminal liability. In addition, certain laws, including the ADA, could require us to expend significant funds to make modifications to our shops if we failed to comply with applicable standards. Compliance with all of these laws and regulations can be costly and can increase our exposure to litigation or governmental investigations or proceedings.

Food safety and food-borne illness concerns may have an adverse effect on our business by reducing demand and increasing costs.

Food safety is a top priority, and we dedicate substantial resources to help ensure that our customers enjoy safe, quality food products. However, food-borne illnesses and food safety issues have occurred in the food industry in the past, and could occur in the future. Any report or publicity linking us to instances of food-borne illness or other food safety issues, including food tampering or contamination, could adversely affect our brands and reputation as well as our revenues and profits. In addition, instances of food-borne illness, food tampering or food contamination occurring solely at restaurants of our competitors could result in negative publicity about the food service industry generally and adversely impact our sales.

Furthermore, our reliance on third-party food suppliers and distributors increases the risk that food-borne illness incidents could be caused by factors outside of our control and that multiple locations would be affected rather than a single shop. We cannot assure that all food items are properly maintained during transport throughout the supply chain and that our employees will identify all products that may be spoiled and should not be used in our shops. If our customers become ill from food-borne illnesses, we could be forced to temporarily close some shops. Furthermore, any instances of food contamination, whether or not at our shops, could subject us or our suppliers to a food recall pursuant to the recently enacted the Food and Drug Administration Food Safety Modernization Act.

 

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Shortages or interruptions in the supply or delivery of fresh food products could adversely affect our operating results.

We are dependent on frequent deliveries of fresh food products that meet our specifications. Shortages or interruptions in the supply of fresh food products caused by problems in production or distribution, inclement weather, unanticipated demand or other conditions could adversely affect the availability, quality and cost of ingredients, which would adversely affect our operating results.

We have a limited number of suppliers for our major products and rely on one custom distribution company for the majority of our national distribution program in the U.S. If our suppliers or distributors are unable to fulfill their obligations under their contracts, we could encounter supply shortages and incur higher costs.

We have a limited number of suppliers for our major products, such as bread. In 2011, we purchased all of our bread from one supplier and more than 95% of our meat products from nine suppliers. In addition, we use one distribution company to provide the majority of our distribution services in the U.S. If our suppliers or distributors are unable to fulfill their obligations under their contracts, we could encounter supply shortages and incur higher costs.

Failure to obtain and maintain required licenses and permits or to comply with food control regulations could lead to the loss of our food service licenses and, thereby, harm our business.

Restaurants are required under various federal, state and local government regulations to obtain and maintain licenses, permits and approvals to operate their businesses and such regulations are subject to change from time to time. The failure to obtain and maintain these licenses, permits and approvals could adversely affect our operating results. Typically, licenses must be renewed annually and may be revoked, suspended or denied renewal for cause at any time if governmental authorities determine that our conduct violates applicable regulations. Difficulties or failure to maintain or obtain the required licenses and approvals could adversely affect our existing shops and delay or result in our decision to cancel the opening of new shops, which would adversely affect our business.

Information technology system failures or breaches of our network security could interrupt our operations and adversely affect our business.

We rely on our computer systems and network infrastructure across our operations, including point-of-sale processing at our shops. Our operations depend upon our ability to protect our computer equipment and systems against damage from physical theft, fire, power loss, telecommunications failure or other catastrophic events, as well as from internal and external security breaches, viruses and other disruptive problems. Any damage or failure of our computer systems or network infrastructure that causes an interruption in our operations could have a material adverse effect on our business and subject us to litigation or actions by regulatory authorities.

Security breaches of confidential customer information in connection with our electronic processing of credit and debit card transactions may adversely affect our business.

The majority of our sales are by credit or debit cards. Other restaurants and retailers have experienced security breaches in which credit and debit card information of their customers has been stolen. We may in the future become subject to lawsuits or other proceedings for purportedly fraudulent transactions arising out of the actual or alleged theft of our customers’ credit or debit card information. Any such claim or proceeding, or any adverse publicity resulting from these allegations, may have a material adverse effect on our business.

 

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Changes to estimates related to our property, fixtures and equipment or operating results that are lower than our current estimates at certain shop locations may cause us to incur impairment charges on certain long-lived assets, which may adversely affect our results of operations.

In accordance with accounting guidance as it relates to the impairment of long-lived assets, we make certain estimates and projections with regard to individual shop operations, as well as our overall performance, in connection with our impairment analyses for long-lived assets. When impairment triggers are deemed to exist for any location, the estimated undiscounted future cash flows are compared to its carrying value. If the carrying value exceeds the undiscounted cash flows, an impairment charge equal to the difference between the carrying value and the sum of the discounted cash flows is recorded. The projections of future cash flows used in these analyses require the use of judgment and a number of estimates and projections of future operating results. If actual results differ from our estimates, additional charges for asset impairments may be required in the future. We have experienced significant impairment charges in past years. If future impairment charges are significant, our reported operating results would be adversely affected.

We may not be able to adequately protect our intellectual property, which, in turn, could harm the value of our brands and adversely affect our business.

Our ability to implement our business plan successfully depends in part on our ability to further build brand recognition using our trademarks, service marks and other proprietary intellectual property, including our name and logos and the unique ambiance of our shops. We have registered or applied to register a number of our trademarks. We cannot assure you that our trademark applications will be approved. Third parties may also oppose our trademark applications, or otherwise challenge our use of the trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our goods and services, which could result in loss of brand recognition, and could require us to devote resources to advertising and marketing new brands.

If our efforts to register, maintain and protect our intellectual property are inadequate, or if any third party misappropriates, dilutes or infringes on our intellectual property, the value of our brands may be harmed, which could have a material adverse effect on our business and might prevent our brands from achieving or maintaining market acceptance. We may also face the risk of claims that we have infringed third parties’ intellectual property rights. If third parties claim that we infringe upon their intellectual property rights, our operating profits could be adversely affected. Any claims of intellectual property infringement, even those without merit, could be expensive and time consuming to defend, require us to rebrand our services, if feasible, divert management’s attention and resources or require us to enter into royalty or licensing agreements in order to obtain the right to use a third party’s intellectual property.

Restaurant companies have been the target of class action lawsuits and other proceedings alleging, among other things, violations of federal and state workplace and employment laws. Proceedings of this nature are costly, divert management attention and, if successful, could result in our payment of substantial damages or settlement costs.

Our business is subject to the risk of litigation by employees, consumers, suppliers, stockholders or others through private actions, class actions, administrative proceedings, regulatory actions or other litigation. The outcome of litigation, particularly class action and regulatory actions, is difficult to assess or quantify. In recent years, restaurant companies have been subject to lawsuits, including class action lawsuits, alleging violations of federal and state laws regarding workplace and employment matters, discrimination and similar matters. A number of these lawsuits have resulted in the payment of substantial damages by the defendants. Similar lawsuits have been instituted from time to time alleging violations of various federal and state wage and hour laws regarding, among other things, employee meal deductions, overtime eligibility of assistant managers and failure to pay for all hours worked. While we have not been a party to any of these types of lawsuits in the past, there can be no assurance that we will not be named in any such lawsuit in the future or that we would not be required to pay substantial expenses and/or damages.

 

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Occasionally, our customers file complaints or lawsuits against us alleging that we are responsible for some illness or injury they suffered at or after a visit to one of our shops, including actions seeking damages resulting from food-borne illness or accidents in our shops. We are also subject to a variety of other claims from third parties arising in the ordinary course of our business, including contract claims. The restaurant industry has also been subject to a growing number of claims that the menus and actions of restaurant chains have led to the obesity of certain of their customers. We may also be subject to lawsuits from our employees, the U.S. Equal Employment Opportunity Commission or others alleging violations of federal and state laws regarding workplace and employment matters, discrimination and similar matters.

Regardless of whether any claims against us are valid or whether we are liable, claims may be expensive to defend and may divert time and money away from our operations. In addition, they may generate negative publicity, which could reduce customer traffic and sales. Although we maintain what we believe to be adequate levels of insurance, insurance may not be available at all or in sufficient amounts to cover any liabilities with respect to these or other matters. A judgment or other liability in excess of our insurance coverage for any claims or any adverse publicity resulting from claims could adversely affect our business and results of operations.

Our insurance may not provide adequate levels of coverage against claims.

We believe that we maintain insurance customary for businesses of our size and type. However, there are types of losses we may incur that cannot be insured against or that we believe are not economically reasonable to insure. Such losses could have a material adverse effect on our business and results of operations.

We have limited control with respect to the operations of our franchisees which could have a negative impact on our business.

Our franchisees are obligated to operate their shops according to the specific guidelines we set forth. We provide training opportunities to these franchisees to integrate them into our operating strategy. However, since we do not have control over these shops, we cannot give assurance that there will not be differences in product quality, operations, marketing or profitably or that there will be adherence to all of our guidelines at these shops. The failure of these shops to operate effectively could adversely affect our cash flows from those operations or have a negative impact on our reputation or our business.

Risks Related to this Offering and Our Common Stock

Our stock price could be extremely volatile and, as a result, you may not be able to resell your shares at or above the price you paid for them.

Volatility in the market price of our common stock may prevent you from being able to sell your shares at or above the price you paid for your shares. The stock market in general has been highly volatile, and this may be especially true for our common stock given our growth strategy and stage of development. As a result, the market price of our common stock is likely to be similarly volatile. You may experience a decrease, which could be substantial, in the value of your stock, including decreases unrelated to our operating performance or prospects, and could lose part or all of your investment. The price of our common stock could be subject to wide fluctuations in response to a number of factors, including those described elsewhere in this prospectus and others such as:

 

   

actual or anticipated fluctuations in our quarterly or annual operating results and the performance of our competitors;

 

   

publication of research reports by securities analysts about us, our competitors or our industry;

 

   

our failure or the failure of our competitors to meet analysts’ projections or guidance that we or our competitors may give to the market;

 

   

additions and departures of key personnel;

 

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sales, or anticipated sales, of large blocks of our stock or of shares held by our stockholders, directors or executive officers;

 

   

strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic investments or changes in business strategy;

 

   

the passage of legislation or other regulatory developments affecting us or our industry;

 

   

speculation in the press or investment community, whether or not correct, involving us, our suppliers or our competitors;

 

   

changes in accounting principles;

 

   

litigation and governmental investigations;

 

   

terrorist acts, acts of war or periods of widespread civil unrest;

 

   

a food-borne illness outbreak;

 

   

natural disasters and other calamities; and

 

   

changes in general market and economic conditions.

As we operate in a single industry, we are especially vulnerable to these factors to the extent that they affect our industry or our products. In the past, securities class action litigation has often been initiated against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs and divert our management’s attention and resources, and could also require us to make substantial payments to satisfy judgments or to settle litigation.

There is no existing market for our common stock, and we do not know if one will develop to provide you with adequate liquidity.

Prior to this offering, there has not been a public market for our common stock. An active market for our common stock may not develop following the completion of this offering, or if it does develop, may not be maintained. If an active trading market does not develop, you may have difficulty selling any of our common stock that you buy. The initial public offering price for the shares of our common stock will be determined by negotiations between us and the representatives of the underwriters and may not be indicative of prices that will prevail in the open market following this offering. Consequently, you may not be able to sell shares of our common stock at prices equal to or greater than the price you paid in this offering.

There may be sales of a substantial amount of our common stock after this offering by our current stockholders, and these sales could cause the price of our common stock to fall.

After this offering, there will be              shares of common stock outstanding (             if the underwriters exercise their option to purchase additional shares from us in full). Of our issued and outstanding shares, all the common stock sold in this offering will be freely transferable, except for any shares held by our “affiliates,” as that term is defined in Rule 144 under the Securities Act of 1933, as amended. Following completion of this offering,     % of our outstanding common stock will be held by our pre-IPO stockholders, including our directors, members of our management and employees (or     % if the underwriters exercise their option to purchase additional shares from us and the selling stockholders in full).

Each of our directors and executive officers and all of our stockholders have entered into a lock-up agreement with the representatives of the underwriters which regulates their sales of our common stock for a period of at least 180 days after the date of this prospectus, subject to certain exceptions. See “Underwriting.”

 

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Sales of substantial amounts of our common stock in the public market after this offering, or the perception that such sales will occur, could adversely affect the market price of our common stock and make it difficult for us to raise funds through securities offerings in the future. Of the shares to be outstanding after the offering, the shares offered by this prospectus will be eligible for immediate sale in the public market without restriction by persons other than our affiliates. Our remaining outstanding shares will become available for resale in the public market as shown in the chart below (less any shares sold as a result of the exercise of the underwriters’ option to purchase additional shares), subject to the provisions of Rule 144 and Rule 701.

 

Number of Shares

  

Date Available for Resale

   On the date of this offering (                    ,     )
   180 days after this offering (                    ,     ), subject to certain exceptions

Beginning 180 days after this offering, subject to certain exceptions, holders of shares of our common stock may require us to register their shares for resale under the federal securities laws, and holders of additional shares of our common stock would be entitled to have their shares included in any such registration statement, all subject to reduction upon the request of the underwriter of the offering, if any. See “Related Party Transactions—Arrangements With Our Investors.” Registration of those shares would allow the holders to immediately resell their shares in the public market. Any such sales or anticipation thereof could cause the market price of our common stock to decline.

In addition, after this offering, we intend to register shares of common stock that are reserved for issuance under our stock incentive plans. See “Executive and Director Compensation—Equity Incentive Plans.”

Provisions in our certificate of incorporation and by-laws and Delaware law may discourage, delay or prevent a change of control of our company or changes in our management and, therefore, may depress the trading price of our stock.

Our certificate of incorporation and by-laws include certain provisions that could have the effect of discouraging, delaying or preventing a change of control of our company or changes in our management, including, among other things:

 

   

our board initially will be classified into three classes of directors with only one class subject to election each year, with a 3-year phase-out period beginning with our fifth annual meeting of stockholders following the completion of this offering;

 

   

restrictions on the ability of our stockholders to fill a vacancy on the board of directors;

 

   

our ability to issue preferred stock with terms that the board of directors may determine, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquirer;

 

   

the inability of our stockholders to call a special meeting of stockholders;

 

   

our directors may only be removed from the board of directors for cause by the affirmative vote of the holders of at least 66-2/3% of the voting power of outstanding shares of our capital stock entitled to vote generally in the election of directors;

 

   

the absence of cumulative voting in the election of directors, which may limit the ability of minority stockholders to elect directors;

 

   

advance notice requirements for stockholder proposals and nominations, which may discourage or deter a potential acquirer from soliciting proxies to elect a particular slate of directors or otherwise attempting to obtain control of us; and

 

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our by-laws may only be amended by the affirmative vote of the holders of at least 66-2/3% of the voting power of outstanding shares of our capital stock entitled to vote generally in the election of directors or by our board of directors.

Section 203 of the Delaware General Corporation Law may affect the ability of an “interested stockholder” to engage in certain business combinations, including mergers, consolidations or acquisitions of additional shares, for a period of three years following the time that the stockholder becomes an “interested stockholder.” An “interested stockholder” is defined to include persons owning directly or indirectly 15% or more of the outstanding voting stock of a corporation.

We will incur increased costs and obligations as a result of being a public company.

As a privately held company, we were not required to comply with certain corporate governance and financial reporting practices and policies required of a publicly-traded company. As a publicly-traded company, we will incur significant legal, accounting and other expenses that we were not required to incur in the recent past, particularly after we are no longer an “emerging growth company” as defined under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. In addition, new and changing laws, regulations and standards relating to corporate governance and public disclosure, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and the rules and regulations promulgated and to be promulgated thereunder, as well as under the Sarbanes-Oxley Act of 2002, as amended (the “Sarbanes-Oxley Act”), and the rules and regulations of the Securities and Exchange Commission and the Nasdaq Stock Market, have created uncertainty for public companies and will increase our costs and the time that our board of directors and management must devote to complying with these rules and regulations. Furthermore, the need to establish the corporate infrastructure demanded of a public company may divert management’s attention from implementing our growth strategy, which could prevent us from improving our business, results of operations and financial condition.

We are an “emerging growth company,” and any decision on our part to comply only with certain reduced reporting and disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors.

We are an “emerging growth company,” as defined in the JOBS Act, and, for as long as we continue to be an “emerging growth company,” we may choose to take advantage of exemptions from various reporting requirements applicable to other public companies but not to “emerging growth companies,” including, but not limited to, not being required to have our independent registered public accounting firm audit our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We may choose to take advantage of some but not all of these reduced burdens until we are no longer an “emerging growth company.” We will remain an emerging growth company until the earlier of (1) the last day of the fiscal year (a) following the fifth anniversary of the completion of this offering, (b) in which we have total annual gross revenue of at least $1.0 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700 million as of the prior June 30th, or (2) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period. We cannot predict if investors will find our common stock less attractive if we choose to rely on these exemptions. If some investors find our common stock less attractive as a result of any choices to reduce future disclosure, there may be a less active trading market for our common stock and our stock price may be more volatile.

Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards, and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

 

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If you purchase shares in this offering, you will suffer immediate and substantial dilution.

If you purchase shares of our common stock in this offering, you will incur immediate and substantial dilution in the book value of your stock, because the price that you pay will be substantially greater than the net tangible book value per share of the shares you acquire. The pro forma as adjusted net tangible book value per share, calculated as of                     , 2012 and after giving effect to the offering at an estimated initial public offering price of $         (the midpoint of the price range set forth on the cover page of this prospectus), is $        , resulting in dilution of your shares of $         per share.

You will experience additional dilution upon the exercise of options and warrants to purchase our common stock, including those options currently outstanding and possibly those granted in the future, and the issuance of restricted stock or other equity awards under our stock incentive plans. To the extent we raise additional capital by issuing equity securities, our stockholders may experience substantial additional dilution. See “Dilution.”

If securities analysts or industry analysts downgrade our stock, publish negative research or reports, or do not publish reports about our business, our stock price and trading volume could decline.

We expect that the trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us, our business and our industry. If one or more analysts adversely change their recommendation regarding our stock or our competitors’ stock, our stock price would likely decline. If one or more analysts cease coverage of us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Because we have no plans to pay cash dividends on our common stock for the foreseeable future, you may not receive any return on investment unless you sell your common stock for a price greater than that which you paid for it.

We may retain future earnings, if any, for future operations, expansion and debt repayment and have no current plans to pay any cash dividends for the foreseeable future. Any decision to declare and pay dividends in the future will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, financial condition, cash requirements, contractual restrictions and other factors that our board of directors may deem relevant. In addition, our ability to pay dividends may be limited by covenants of any existing and future outstanding indebtedness we or our subsidiaries incur, including our credit facility. As a result, you may not receive any return on an investment in our common stock unless you sell our common stock for a price greater than that which you paid for it. See “Dividend Policy” and “Description of Credit Facility.”

Our ability to raise capital in the future may be limited, which could make us unable to fund our capital requirements.

Our business and operations may consume resources faster than we anticipate. In the future, we may need to raise additional funds through the issuance of new equity securities, debt or a combination of both. Additional financing may not be available on favorable terms or at all. If adequate funds are not available on acceptable terms, we may be unable to fund our capital requirements. If we issue new debt securities, the debt holders would have rights senior to common stockholders to make claims on our assets, and the terms of any debt could restrict our operations, including our ability to pay dividends on our common stock. If we issue additional equity securities, existing stockholders may experience dilution, and the new equity securities could have rights senior to those of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future securities offerings reducing the market price of our common stock and diluting their interest.

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus includes statements that express our opinions, expectations, beliefs, plans, objectives, assumptions or projections regarding future events or future results and therefore are, or may be deemed to be, “forward-looking statements.” These forward-looking statements can generally be identified by the use of forward-looking terminology, including the terms “believes,” “estimates,” “anticipates,” “expects,” “strives,” “goal,” “seeks,” “projects,” “intends,” “forecasts,” “plans,” “may,” “will” or “should” or, in each case, their negative or other variations or comparable terminology. They appear in a number of places throughout this prospectus and include statements regarding our intentions, beliefs or current expectations concerning, among other things, our results of operations, financial condition, liquidity, prospects, growth, strategies and the industry in which we operate.

By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. We believe that these risks and uncertainties include, but are not limited to, those described in the “Risk Factors” section of this prospectus, which include, but are not limited to, the following:

 

   

competition in the restaurant industry, which is highly competitive and includes many larger, more well-established companies;

 

   

changes in economic conditions, including continuing effects from the recent recession, the effects of consumer confidence and discretionary spending; the future cost and availability of credit; and the liquidity or operations of our suppliers and other service providers;

 

   

fluctuation in price and availability of commodities, including but not limited to items such as beef, poultry, grains, dairy and produce and energy supplies, where prices could increase or decrease more than we expect;

 

   

our ability to identify new locations and expand our operations (which is dependent upon various factors such as the availability of attractive sites for new shops), negotiate suitable lease terms, obtain all required governmental permits including zoning approvals on a timely basis, control construction and development costs and obtain capital to fund such costs, and recruit, train and retain qualified operating personnel;

 

   

changes in consumer tastes and lack of acceptance or awareness of our brand in existing or new markets; damage to our reputation caused by, for example, any perceived reduction in the quality of our food, service or staff or an adverse change in our culture, concerns regarding food safety and food-borne illness or adverse opinions about the health effects of our menu offerings;

 

   

local, regional, national and international economic and political conditions; the seasonality of our business; demographic trends; traffic patterns and our ability to effectively respond in a timely manner to changes in traffic patterns; the cost of advertising and media; inflation or deflation; unemployment rates; interest rates; and increases in various costs, such as real estate and insurance costs;

 

   

adverse weather conditions, local strikes, natural disasters and other disasters, especially in local or regional areas in which our shops are concentrated;

 

   

litigation or legal complaints alleging, among other things, illness, injury or violations of federal and state workplace and employment laws and our ability to obtain and maintain required licenses and permits;

 

   

government actions and policies; tax and other legislation; regulation of the restaurant industry; and accounting standards or pronouncements;

 

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our reliance on a limited number of suppliers for our major products and on one distribution company for the majority of our national distribution program;

 

   

security breaches of confidential customer information in connection with our electronic processing of credit and debit card transactions or the failure of our information technology system;

 

   

our ability to adequately protect our intellectual property; and

 

   

other factors discussed under the headings “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.”

Although we base these forward-looking statements on assumptions that we believe are reasonable when made, we caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, and industry developments may differ materially from statements made in or suggested by the forward-looking statements contained in this prospectus. In addition, even if our results of operations, financial condition and liquidity, and industry developments are consistent with the forward-looking statements contained in this prospectus, those results or developments may not be indicative of results or developments in subsequent periods.

In light of these risks and uncertainties, we caution you not to place undue reliance on these forward-looking statements. Any forward-looking statement that we make in this prospectus speaks only as of the date of such statement, and we undertake no obligation to update any forward-looking statement or to publicly announce the results of any revision to any of those statements to reflect future events or developments. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless specifically expressed as such, and should only be viewed as historical data.

 

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USE OF PROCEEDS

We estimate that the net proceeds we will receive from the sale of              shares of our common stock in this offering, after deducting underwriter discounts and commissions and estimated expenses payable by us, will be approximately $         million (approximately $         million if the underwriters exercise their option to purchase              additional shares in full). This estimate assumes an initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus.

A $1.00 increase (decrease) in the assumed initial public offering price of $         per share would increase (decrease) the net proceeds to us from this offering by $         million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated expenses payable by us.

We intend to use the net proceeds from this offering for working capital and general corporate purposes. Pending such use, we may use the net proceeds to temporarily reduce borrowings under our credit facility (which had a weighted average interest rate of 1.35% as of September 23, 2012 and expires in September 2017). We may also invest the net proceeds in short- and intermediate-term interest-bearing obligations.

We will not receive any proceeds from the sale of shares of common stock by the selling stockholders. See “Principal and Selling Stockholders.”

DIVIDEND POLICY

We do not currently pay cash dividends on our common stock and do not anticipate paying any dividends on our common stock in the foreseeable future. Any future determinations relating to our dividend policies will be made at the discretion of our board of directors and will depend on conditions then existing, including our financial condition, results of operations, contractual restrictions, capital requirements, business prospects and other factors our board of directors may deem relevant. In addition, our ability to pay dividends on our common stock is limited under the terms of our credit facility. See “Description of Credit Facility.”

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and our capitalization as of September 23, 2012:

 

   

on an actual basis;

 

   

on a pro forma basis to give effect to the conversion of all outstanding shares of all series of our preferred stock into, and the exercise of all outstanding warrants for, common stock immediately prior to this offering; and

 

   

on a pro forma as adjusted basis to give effect to the transactions described in the bullet immediately above and (1) the sale of              shares of common stock in this offering by us at the estimated initial public offering price of $         per share (the midpoint of the price range set forth on the cover page of this prospectus), after deducting underwriting discounts and commissions and estimated expenses payable by us and (2) the application of the net proceeds of this offering as described under “Use of Proceeds,” as if the events had occurred on September 23, 2012.

This table should be read in conjunction with “Use of Proceeds,” “Selected Consolidated Financial and Other Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes appearing elsewhere in this prospectus.

 

     As of September 23, 2012  
     Actual     Pro
Forma(1)
    Pro Forma
As Adjusted(1)
 
     (in thousands)  

Cash and cash equivalents

   $ 24,954      $ 26,930      $                
  

 

 

   

 

 

   

 

 

 

Long-term debt, including current portion:

      

Credit facility

   $ 14,221      $ 14,221     

Note payable

     1,188        1,188     
  

 

 

   

 

 

   

 

 

 

Total long-term debt

     15,409        15,409     
  

 

 

   

 

 

   

 

 

 

Redeemable convertible preferred stock, $0.01 par value—17,183,632 shares authorized and 16,086,375 shares issued and outstanding on an actual basis; 17,183,632 shares authorized and no shares issued and outstanding on a pro forma basis; and no shares authorized or issued on a pro forma as adjusted basis

     253,735        —       

Equity (deficit):

      

Common stock, $0.01 par value—35,500,000 shares authorized and 3,972,873 issued and outstanding on an actual basis; 35,500,000 shares authorized and 20,809,961 shares issued and outstanding on a pro forma basis; and              shares authorized and              shares issued and outstanding on a pro forma as adjusted basis

     40        204     

Warrants

     2,977        —       

Additional paid-in-capital

     —          258,524     

Accumulated deficit

     (194,315     (194,315  
  

 

 

   

 

 

   

 

 

 

Total stockholders’ equity (deficit)

     (191,298     64,413     

Non-controlling interests

     195        195     
  

 

 

   

 

 

   

 

 

 

Total equity (deficit)

     (191,103     64,608     
  

 

 

   

 

 

   

 

 

 

Total capitalization

   $ 78,041      $ 80,017      $     
  

 

 

   

 

 

   

 

 

 

 

(1) Assumes the conversion of all outstanding shares of all series of our preferred stock into, and the exercise of all outstanding warrants for, an aggregate of 16,897,088 shares of common stock immediately prior to the completion of this offering, and excludes outstanding options to purchase 4,446,049 shares of our common stock at a weighted average exercise price of $9.16 per share, of which options to purchase 3,032,113 shares at a weighted average exercise price of $9.90 were vested as of September 23, 2012. See “Executive and Director Compensation.”

 

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DILUTION

If you invest in our common stock, your ownership interest will experience immediate book value dilution to the extent of the difference between the initial public offering price per share of our common stock and the net tangible book value per share of our common stock after this offering. Dilution results from the fact that the initial public offering price per share of the common stock is substantially in excess of the net tangible book value per share of common stock attributable to the existing stockholders for the presently outstanding shares of common stock. Net tangible book value per share represents the amount of our total tangible assets less our total liabilities, divided by the number of shares of our common stock outstanding.

Our pro forma net tangible book value at September 23, 2012 was approximately $         million, or $         per share of our common stock, after taking into account the conversion of our outstanding shares of our preferred stock and the exercise of our outstanding warrants but before giving effect to this offering. Dilution in net tangible book value per share represents the difference between the amount per share that you pay in this offering and the net tangible book value per share immediately after this offering.

After giving effect to our sale of shares in this offering and the conversion of our outstanding shares of our preferred stock and the exercise of our outstanding warrants, assuming an initial public offering price of $         per share (the midpoint of the price range set forth on the cover page of this prospectus), and the application of the estimated net proceeds as described under “Use of Proceeds,” our pro forma as adjusted net tangible book value at September 23, 2012 would have been approximately $         million, or $         per share of common stock. This represents an immediate increase in net tangible book value per share of $         to existing stockholders and an immediate and substantial dilution of $         per share to new investors. The following table illustrates this dilution per share.

 

Assumed initial public offering price per share of common stock

      $                

Pro forma net tangible book value per share at September 23, 2012

   $                   

Increase per share attributable to new investors in the offering

     
  

 

 

    

Pro forma as adjusted net tangible book value per share of common stock after this offering

      $     
     

 

 

 

Dilution per share to new investors

      $     
     

 

 

 

If the underwriters were to fully exercise their option to purchase additional shares of our common stock, the pro forma as adjusted net tangible book value per share of our common stock after giving effect to this offering would be $         per share of our common stock. This represents an increase in net tangible book value of $         per share of our common stock to existing stockholders and dilution of $         per share of our common stock to new investors.

A $1.00 increase (decrease) in the assumed initial public offering price of $         per share of our common stock would increase (decrease) our net tangible book value after giving effect to the offering by $         million, or by $         per share of our common stock, assuming no change to the number of shares of our common stock offered by us as set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts and commissions and estimated expenses payable by us.

 

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Table of Contents

The following table sets forth, as of September 23, 2012, the number of shares of common stock purchased from us, the total consideration paid to us and the average price per share paid by existing stockholders and to be paid by new investors purchasing shares of common stock in this offering, before deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

     Shares Purchased      Total Consideration     Average
price  per
share
 
     Number    Percent     Amount
(in thousands)
     Percent    

Existing stockholders

            $                          $                

New investors

            
  

 

  

 

 

   

 

 

    

 

 

   

Total

        100.0   $                    $ 100.0  
  

 

  

 

 

   

 

 

    

 

 

   

If the underwriters were to exercise in full their option to purchase additional shares of our common stock, the percentage of shares of our common stock held by existing stockholders would be     %, and the percentage of shares of our common stock held by new investors would be     %.

The discussion and tables above assume the conversion of all outstanding shares of our preferred stock into, and the exercise of all outstanding warrants for, an aggregate of 16,897,088 shares of common stock immediately prior to the completion of this offering and excludes, as of September 23, 2012:

 

   

outstanding options to purchase 4,446,049 shares of our common stock at a weighted average exercise price of $9.16 per share, of which options to purchase 3,032,113 shares at a weighted average exercise price of $9.90 were vested as of September 23, 2012; and

 

   

             shares of our common stock reserved for future grants under our 2012 Long-Term Incentive Plan, which we intend to adopt in connection with this offering.

To the extent any outstanding options or other equity awards are exercised or become vested or any additional options or other equity awards are granted and exercised or become vested or other issuances of shares of our common stock are made, there may be further economic dilution to new investors.

 

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Table of Contents

SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

The following table sets forth our selected consolidated financial and other data as of the dates and for the periods indicated. The selected consolidated financial data as of December 25, 2011 and December 26, 2010 and for each of the two fiscal years in the period ended December 25, 2011 presented in this table have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The selected consolidated financial data as of December 27, 2009, December 28, 2008 and December 30, 2007 and for the fiscal years then ended have been derived from our unaudited consolidated financial statements for such years, which are not included in this prospectus. The selected consolidated interim financial data as of and for the 39 weeks ended September 23, 2012 and for the 39 weeks ended September 25, 2011 have been derived from the unaudited condensed interim consolidated financial statements included elsewhere in this prospectus. The unaudited financial information for the 52 weeks ended September 23, 2012 has been derived by adding our financial information for the fiscal year ended December 25, 2011 to the unaudited financial information for the 39 weeks ended September 23, 2012 and subtracting the unaudited financial information for the 39 weeks ended September 25, 2011. We believe that presentation of unaudited financial information for these 52-week periods is useful to investors because it presents information about how our business has performed in the 52-week period immediately preceding the date of our most recent interim financial statements, which allows investors to review our current performance trends over a full 52-week period, and because it presents results for four consecutive quarters, which presentation compensates for seasonal factors that might influence results in a particular quarter within the year. Historical results are not necessarily indicative of future results, and our interim results are not necessarily indicative of the results to be expected for the full fiscal year.

Our fiscal year ends on the last Sunday of each year. The first three quarters of our fiscal year consist of 13 weeks and our fourth quarter consists of 13 weeks for 52-week fiscal years and 14 weeks for 53-week fiscal years. The fiscal years ended December 25, 2011, December 26, 2010, December 27, 2009, December 28, 2008 and December 30, 2007 all had 52 weeks. The fiscal year ending December 30, 2012 will have 53 weeks.

 

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This selected consolidated financial and other data should be read in conjunction with the disclosure set forth under “Risk Factors,” “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the related notes thereto appearing elsewhere in this prospectus.

 

    Fiscal Year Ended     39 Weeks Ended     52 Weeks
Ended
 
    December 30,
2007
    December 28,
2008
    December 27,
2009
    December 26,
2010
    December 25,
2011
    September 25,
2011
    September 23,
2012
    September 23,
2012
 
    ($ in thousands, except per share data)  

Consolidated Statements of Operations Data:

               

Total Revenues

  $ 177,505      $ 207,686      $ 214,733      $ 220,573      $ 237,966      $ 176,651      $ 201,406      $ 262,721   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses:

               

Sandwich shop operating expenses:

               

Cost of goods sold, excluding depreciation

    52,499        62,612        61,700        63,009        68,491        50,784        58,389        76,096   

Labor and related expenses

    55,852        66,756        63,939        63,506        67,036        49,865        56,618        73,789   

Occupancy expenses

    17,612        23,429        25,574        25,238        26,511        19,493        22,885        29,903   

Other operating expenses

    17,615        22,752        22,373        22,620        24,095        17,899        20,767        26,963   

General and administrative expenses

    25,027        30,785        27,840        26,563        26,911        20,308        22,542        29,145   

Depreciation expense

    14,126        17,599        17,586        15,647        14,838        11,085        11,633        15,386   

Pre-opening costs

    2,532        1,887        95        267        1,521        1,046        1,760        2,235   

Impairment and loss on disposal of property and equipment

    60        2,852        5,511        2,952        365        29        78        414   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

    185,323        228,672        224,618        219,802        229,768        170,509        194,672        253,931   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

    (7,818     (20,986     (9,885     771        8,198        6,142        6,734        8,790   

Interest expense (income)

    (573     681        828        519        495        359        427        563   

Other expense (income)

    4        20        4        9        1        (2     6        9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    (7,249     (21,687     (10,717     243        7,702        5,785        6,301        8,218   

Income tax expense

    206        121        219        773        537        591        765        711   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    (7,455     (21,808     (10,936     (530     7,165        5,194        5,536        7,507   

Net income (loss) attributable to non-controlling interests (1)

    —          —          —          —          —          —          (35     (35
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to Potbelly Corporation

  $ (7,455   $ (21,808   $ (10,936   $ (530   $ 7,165      $ 5,194      $ 5,571      $ 7,542   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accretion of redeemable convertible preferred stock to maximum redemption value

    21,968        8,814        (14,568     (45,992     (17,410     (9,011     (13,887     (16,609
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common stockholders

  $ 14,513      $ (12,994   $ (25,504   $ (46,522   $ (10,245   $ (3,817   $ (8,316   $ (9,067
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per common share attributable to common stockholders (2):

               

Basic

  $ (1.52)      $ (4.40)      $ (5.13)      $ (9.34)      $ (2.35   $ (0.85)      $ (2.09   $ (2.29)   

Diluted

  $ (1.52)      $ (4.40)      $ (5.13)      $ (9.34)      $ (2.35 )     $ (0.85)      $ (2.09 )     $ (2.29)   

Weighted average shares outstanding:

               

Basic

    4,896,891        4,960,984        4,975,511        4,978,621        4,359,930        4,503,982        3,972,873        3,962,294   

Diluted

    4,896,891        4,960,984        4,975,511        4,978,621        4,359,930        4,503,982        3,972,873        3,962,294   

 

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Table of Contents
    Fiscal Year Ended     39 Weeks Ended     52 Weeks
Ended
 
    December 30,
2007
    December 28,
2008
    December 27,
2009
    December 26,
2010
    December 25,
2011
    September 25,
2011
    September 23,
2012
    September 23,
2012
 
    ($ in thousands, except per share data)  

Statement of Cash Flows Data:

               

Net cash provided by (used in):

               

Operating activities

  $ 15,719      $ 5,195      $ 11,277      $ 18,780      $ 20,121      $ 10,839      $ 20,457      $ 29,740   

Investing activities

    (36,110     (24,856     (4,385     (6,243     (17,758     (13,070     (19,700     (24,388

Financing activities

    433        21,219        5,152        (4,382     (7,197     (7,659     51        513   

Selected Other Data:

               

Total company-operated shops (end of period)

    182        214        213        218        234        231        257        257   

Total comparable stores (end of period)

    122        165        205        211        211        211        221        221   

Change in comparable store sales

    5.4     (4.3 )%      (2.4 )%      1.8     1.7     1.3     3.9     3.7

Shop-level profit
margin (3)

    19.1     15.5     19.2     20.9     21.6     21.7     21.0     21.1

Capital expenditures

  $ 34,556      $ 24,856      $ 4,398      $ 6,243      $ 17,758      $ 13,070      $ 19,700      $ 24,388   

Adjusted EBITDA (4)

  $ 10,818      $ 4,038      $ 15,732      $ 21,051      $ 26,752      $ 19,670      $ 22,741      $ 29,823   

Adjusted EBITDA margin (4)

    6.1     1.9     7.3     9.5     11.2     11.1     11.3     11.4

 

    December 30,
2007
    December 28,
2008
    December 27,
2009
    December 26,
2010
    December 25,
2011
    September 23,
2012
 
    ($ in thousands)  

Balance Sheet Data:

           

Cash and cash equivalents

  $ 7,223      $ 8,781      $ 20,825      $ 28,980      $ 24,146      $ 24,954   

Working capital (deficit)

    (5,050     (4,142     6,014        14,764        16,490        15,204   

Total assets

    104,054        107,440        101,976        98,424        99,110        108,797   

Total debt

    865        13,440        13,544        9,313        15,243        15,409   

Total redeemable convertible preferred stock

    176,797        167,983        182,551        228,544        239,848        253,735   

Total equity (deficit)

    (105,105     (105,859     (124,712     (169,643     (185,302     (191,103

 

(1) Non-controlling interests represent the non-controlling partner’s share of the assets, liabilities and operations related to the joint venture investment in Potbelly Airport II Boston, LLC, related to one shop located in the Boston Logan International Airport. We own a seventy-five percent interest in this consolidated joint venture.

 

(2) Net loss per common share attributable to common stockholders is calculated under the two-class method, as our redeemable convertible preferred stock participates in the undistributed earnings of the company. Earnings of the company are allocated between the common and preferred stockholders to account for the accretion of the redeemable convertible preferred stock to its maximum redemption value, thereby reducing the earnings of the company attributable to common stockholders. For the periods presented, this resulted in net losses attributable to common stockholders, in total and on a per share basis, as the net income attributable to the company (if any) was exceeded by the change in maximum redemption value of the redeemable convertible preferred stock.

 

(3) Shop-level profit margin is defined as net company-operated sandwich shop sales less company-operated sandwich shop operating expenses, including cost of goods sold, labor and related expenses, other operating expenses and occupancy expenses, expressed as a percentage of net company-operated sandwich shop sales. Shop-level profit margin is a supplemental measure of operating performance of our shops that does not represent and should not be considered an alternative to net income or revenues as determined by U.S. generally accepted accounting principles, or GAAP, and our calculation thereof may not be comparable to that reported by other companies. Shop-level profit margin has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Management believes shop-level profit margin is an important component of financial results because it is a widely used metric within the restaurant industry to evaluate restaurant-level productivity, efficiency and performance. Management uses shop-level profit margin as a key metric to evaluate the profitability of incremental sales, to evaluate our performance across periods and to evaluate our financial performance compared with our competitors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a definition of shop-level profit margin and other key performance indicators.

 

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Table of Contents

A calculation of shop-level profit margin is provided below:

 

    Fiscal Year Ended     39 Weeks Ended     52 Weeks
Ended
 
    December 30,
2007
    December 28,
2008
    December 27,
2009
    December 26,
2010
    December 25,
2011
    September 25,
2011
    September 23,
2012
    September 23,
2012
 
    ($ in thousands)  

Total revenues

  $ 177,505      $ 207,686      $ 214,733      $ 220,573      $ 237,966      $ 176,651      $ 201,406      $ 262,721   

Less: Franchise royalties and fees

    —          —          —          —          503        348        553        708   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Sandwich Shop Sales,
net [X]

    177,505        207,686        214,733        220,573        237,463        176,303        200,853        262,013   

Sandwich shop operating expenses:

               

Cost of goods sold

    52,499        62,612        61,700        63,009        68,491        50,784        58,389        76,096   

Labor and related expenses

    55,852        66,756        63,939        63,506        67,036        49,865        56,618        73,789   

Occupancy expenses

    17,612        23,429        25,574        25,238        26,511        19,493        22,885        29,903   

Other operating expenses

    17,615        22,752        22,373        22,620        24,095        17,899        20,767        26,963   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Shop-level profit [Y]

  $ 33,927      $ 32,137      $ 41,147      $ 46,200      $ 51,330      $ 38,262      $ 42,194      $ 55,262   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Shop-level profit margin [Y÷X]

    19.1     15.5     19.2     20.9     21.6     21.7     21.0     21.1

 

(4) Adjusted EBITDA has been presented in this prospectus and is a supplemental measure of financial performance that is not required by, or presented in accordance with, GAAP. We define adjusted EBITDA as net income (loss) before depreciation and amortization expense, interest expense and provision for income taxes, adjusted to eliminate the impact of certain items, including non-cash or other items that we do not consider representative of our ongoing operating performance. Adjusted EBITDA margin is calculated by dividing adjusted EBITDA by total revenues. Adjusted EBITDA has limitations as an analytical tool and our calculation thereof may not be comparable to that reported by other companies; accordingly, you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Adjusted EBITDA is included in this prospectus because it is a key metric used by management. Additionally, adjusted EBITDA is frequently used by analysts, investors and other interested parties to evaluate companies in our industry. We use adjusted EBITDA, alongside other GAAP measures such as operating income (loss) and net income (loss), to measure profitability, as a key profitability target in our annual and other budgets, and to compare our performance against that of peer companies. We believe that adjusted EBITDA provides useful information facilitating operating performance comparisons from period to period and company to company.

A reconciliation of adjusted EBITDA to net income (loss) attributable to Potbelly Corporation is provided below:

 

    Fiscal Year Ended     39 Weeks Ended     52 Weeks
Ended
 
    December 30,
2007
    December 28,
2008
    December 27,
2009
    December 26,
2010
    December 25,
2011
    September 25,
2011
    September 23,
2012
    September 23,
2012
 
    ($ in thousands)  

Net income (loss) attributable to Potbelly Corporation

  $ (7,455   $ (21,809   $ (10,936   $ (530   $ 7,165      $ 5,194      $ 5,571      $ 7,542   

Depreciation expense

    14,126        17,599        17,586        15,647        14,838        11,085        11,633        15,386   

Interest expense (income)

    (573     681        828        519        495        359        427        563   

Income tax expense

    206        121        219        773        537        591        765        711   

Impairment and
closures (a)

    60        3,343        6,824        3,344        672        299        265        638   

Pre-opening costs (b)

    2,532        1,887        95        267        1,521        1,046        1,760        2,235   

Stock-based
compensation (c)

    1,922        2,216        1,116        1,031        1,524        1,096        2,320        2,748   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

  $ 10,818      $ 4,038      $ 15,732      $ 21,051      $ 26,752      $ 19,670      $ 22,741      $ 29,823   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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  (a) Includes costs related to impairment of long-lived assets, gain or loss on disposal of property and equipment and shop closure expenses.

 

  (b) Includes expenses directly associated with the opening of new shops and are incurred prior to the opening of a new shop.

 

  (c) Includes non-cash stock-based compensation.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read in conjunction with the “Selected Consolidated Financial and Other Data” and the audited and unaudited historical consolidated financial statements and related notes. This discussion contains forward-looking statements about our markets, the demand for our products and services and our future results 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” for a discussion of factors that could cause our actual results to differ from those expressed or implied by forward-looking statements.

Operating results are reported on a 52-week fiscal year calendar, with a 53-week year occurring every seventh year. Our fiscal year ends on the last Sunday of each year. Fiscal years 2011 and 2010 were 52-week years. References to fiscal years 2011 and 2010 are references to fiscal years ended December 25, 2011 and December 26, 2010, respectively. Fiscal year 2012 will include a 53rd week. The first three quarters of our fiscal year consist of 13 weeks and our fourth quarter consists of 13 weeks for 52-week fiscal years and 14 weeks for 53-week fiscal years.

We own and operate Potbelly Sandwich Works sandwich shops in the United States. We also have domestic and international franchise operations of Potbelly Sandwich Works sandwich shops. Our chief operating decision maker is our Chief Executive Officer. Based on how our Chief Executive Officer reviews financial performance and allocates resources on a recurring basis, the company has one operating segment and one reportable segment.

Overview

Potbelly is a fast-growing neighborhood sandwich concept offering simple, irresistible food served by friendly people in a warm and welcoming environment. Our unique combination of product, people and place is how we deliver on our passion to be “The Best Place for Lunch.” Our shops are a destination for people who love great food at a fair price. Our menu includes toasty warm sandwiches made fresh to order, craveable salads, hand-dipped milkshakes and delicious cookies baked fresh each day. We develop a strong connection with our customers, creating a devoted base of Potbelly fans that we are expanding one sandwich shop at a time.

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 awesome 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 are 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.

 

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We believe executing on The Potbelly Advantage at a high level creates a distinct competitive advantage and drives our operating and financial results, as illustrated by the following:

 

   

As of September 23, 2012, we had a domestic base of 262 shops in 17 states and the District of Columbia, having grown 13.4% over the prior year;

 

   

We achieved ten consecutive quarters of positive comparable store sales growth through our fiscal quarter ended September 23, 2012;

 

   

From 2010 to 2011, we increased our total revenue 7.9% to $238.0 million, our adjusted EBITDA 27.1% to $26.8 million, our adjusted EBITDA margin by 170 basis points to 11.2%, and our net income to $7.2 million from a net loss of $0.5 million; and

 

   

From 2008 to 2011, we increased our shop-level profit margins by 610 basis points from 15.5% to 21.6%.

See “Selected Consolidated Financial and Other Data” for a discussion of adjusted EBITDA, adjusted EBITDA margin and shop-level profit margin and a reconciliation of the differences between adjusted EBITDA and net income (loss) and a calculation of shop-level profit margin.

Outlook

Potbelly operates in a highly competitive segment of the restaurant industry. We compete with sandwich concepts that have significant scale and presence, as well as with the multitude of locally-owned sandwich shops. Additionally, we compete with many non-sandwich concepts that fall into the limited-service restaurants category. However, we believe that we will continue to succeed in the marketplace based on our differentiated combination of excellent product, people and place. The following competitive strengths provide a platform for us to achieve continued growth:

 

   

Simple, Irresistible Food. Our menu features wholesome, addictively great tasting food made from high quality ingredients. Our incredibly tasty sandwiches are made fresh to order and served toasty warm on our signature multigrain wheat or regular bread. Our menu also features amazing cookies basked fresh daily in each shop, and our hand-dipped shakes, malts and smoothies are made from real, wholesome ingredients. We believe the unique Potbelly experience encourages repeat customer visits and drives increased sales.

 

   

Differentiated Customer Experience That Delivers a Neighborhood Feel. We provide a superior customer experience that is driven by both our employees and the lively atmosphere of our shops. Our employees are nice people that interact with our customers in a genuine way while providing fast service. Our atmosphere is enhanced by live, local musicians that add to the positive vibe. Every Potbelly location strives to the “The Neighborhood Sandwich Shop,” creating devoted fans who tell others about their experience.

 

   

Powerful Shop Economics with Attractive Returns. Our proven shop model is designed to generate strong cash flow, with above 20% shop-level profit margins and cash-on-cash returns exceeding 25%. We have achieved these targets in 2010, 2011 and the 52 weeks ended September 23, 2012. We believe our shop economics support our ability to profitably grow our brand in new and existing markets.

 

   

Proven Management Team with Substantial Operating Experience. Our senior management team has extensive operating experience across disciplines in the restaurant and retail sectors. Our senior team, led by our CEO, Aylwin Lewis, averages over 16 years of restaurant industry experience and embraces the daily intensity needed to deliver growth in existing shops as well as growing the business in new neighborhoods. We believe our proven leadership team is a key driver of our success and positions us to execute our long-term growth strategy.

 

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Distinct, Deep-Rooted Culture: The Potbelly Advantage. Our culture is a key to our success. It is embodied in The Potbelly Advantage, which is a clear expression of our Vision, Mission, Passion and Values. The Potbelly Advantage is a statement of our intentions and is the foundation of everything we do, including how we plan and manage our business. It allows us to deliver operational excellence, encourage innovation, and grow our business and our base of devoted fans.

We believe the combination of these strengths provides a competitive advantage in the marketplace. Continuing to execute at a high level across all aspects of our business is imperative to realize the growth potential for Potbelly. We are confident in our strategies, our people and the opportunity to make Potbelly a “Global Iconic Brand.”

Key Performance Indicators

In assessing the performance of our business, we consider a variety of performance and financial measures. The key measures for determining how our business is performing are comparable store sales growth, number of shop openings, shop-level profit margins and adjusted EBITDA.

Comparable Store Sales Growth

Comparable store sales growth reflects the change in year-over-year sales for the comparable company-operated store base. We define the comparable store base to include those shops open for 15 months or longer. As of the fiscal years ended December 26, 2010 and December 25, 2011 and the 39 weeks ended September 23, 2012, there were 211, 211 and 221 shops, respectively, in our comparable store base. Comparable store sales growth can be generated by an increase in entree counts and/or by increases in the average check amount resulting from a shift in menu mix and/or increase in price. This measure highlights performance of existing shops as the impact of new shop openings is excluded. Entree counts are defined as sandwiches, salads and bowls of soup.

Number of Company-operated Shop Openings

The number of company-operated shop openings reflects the number of shops opened during a particular reporting period. Before we open new shops, we incur pre-opening costs, which are defined below. Often, new shops open with an initial start-up period of higher than normal sales volumes, which subsequently decrease to stabilized levels. While sales volumes are generally higher during the initial opening period, new shops typically experience normal inefficiencies in the form of higher cost of sales, labor and other direct operating expenses and as a result, shop-level profit margins are generally lower during the start-up period of operation. The average start-up period is 10 to 13 weeks. The number and timing of shop openings has had, and is expected to continue to have, an impact on our results of operations.

Shop-Level Profit Margin

Shop-level profit margin is defined as net company-operated sandwich shop sales less company-operated sandwich shop operating expenses, including cost of goods sold, labor and related expenses, other operating expenses and occupancy expenses, as a percentage of net company-operated sandwich shop sales. We believe shop-level profit margin is important in evaluating shop-level productivity, efficiency and performance.

Adjusted EBITDA

We define adjusted EBITDA as net income (loss) before depreciation and amortization, interest expense and provision for income taxes, adjusted for the impact of the following items that we do not consider representative of our ongoing operating performance: stock-based compensation expense, impairment and shop closure expenses, gain or loss on disposal of property and equipment and pre-opening expenses. We believe that adjusted EBITDA is a more appropriate measure of operating performance, as it provides a clearer picture of operating results by eliminating expenses that are not reflective of underlying business performance.

 

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Key Financial Definitions

Revenues

We generate revenue from net company-operated sandwich shop sales and our franchise operations.

Net company-operated shop sales consist of food and beverage sales, net of promotional allowances and employee meals. Company-operated shop sales are influenced by new shop openings and comparable store sales.

Franchise royalties and fees consist of royalty income from the franchisee and a one-time upfront fee.

Cost of Goods Sold

Cost of goods sold consists primarily of food and beverage related costs. The components of cost of goods sold are variable in nature, change with sales volume, are influenced by menu mix and are subject to increases or decreases based on fluctuations in commodity costs.

Labor and Related Expenses

Labor and related expenses include all shop-level management and hourly labor costs, including salaries, wages, benefits and performance incentives, labor taxes and other indirect labor costs.

Occupancy Expenses

Occupancy expenses include fixed and variable portions of rent, common area maintenance and real estate taxes.

Other Operating Expenses

Other operating expenses include all other shop-level operating costs, the major components of which are operating supplies, utilities, repair and maintenance costs, shop-level marketing costs, musician expense and credit card fees.

General and Administrative Expenses

General and administrative expenses is comprised of expenses associated with corporate and administrative functions that support the development and operations of shops, including compensation and benefits, travel expenses, stock compensation costs, legal and professional fees, advertising costs, costs related to abandoned new shop development sites and other related corporate costs.

Depreciation Expense

Depreciation expense includes the depreciation of fixed assets and capitalized leasehold improvements.

Pre-Opening Costs

Pre-opening costs consist of costs incurred prior to opening a new shop and are made up primarily of manager salaries, travel, employee payroll and training costs incurred prior to the shop opening, as well as occupancy costs incurred from when we take site possession to shop opening. Shop pre-opening costs are expensed as incurred.

Impairment and Loss on Disposal of Property and Equipment

We review long-lived assets, such as property and equipment and intangibles, for impairment when events or circumstances indicate the carrying value of the assets may not be recoverable and record an impairment charge when appropriate. The impairment loss recognized is the excess of the carrying value of the asset over its fair value. Typically, the fair value of the asset is determined by estimating future cash flows associated with the asset.

 

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Loss on disposal of property and equipment represents the net book value of property and equipment less proceeds received, if applicable, on assets abandoned or sold. These losses are related to normal disposals in the ordinary course of business, along with disposals related to shop closures and selected shop remodeling activities.

Interest Expense

Interest expense consists primarily of interest expense related to our credit facility.

Non-controlling Interests

Non-controlling interests represent the non-controlling partner’s share of the assets, liabilities and operations related to the joint venture investment in Potbelly Airport II Boston, LLC, related to one shop located in the Boston Logan International Airport. The company owns a seventy-five percent interest in this consolidated joint venture.

Accretion of Redeemable Convertible Preferred Stock to Maximum Redemption Value

Accretion of redeemable convertible preferred stock reflects the changes in measurement of the redeemable convertible preferred stock each reporting period to record the redeemable convertible preferred stock at its maximum redemption value at each reporting period.

39 Weeks Ended September 23, 2012 Compared to 39 Weeks Ended September 25, 2011

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

 

    39 Weeks Ended              
    September 25,
2011
    % of
Revenues
    September 23,
2012
    % of
Revenues
    Increase
(Decrease)
    Percent
Change
 

Revenues

           

Sandwich shop sales, net

  $ 176,303        99.8   $ 200,853        99.7   $ 24,550        13.9

Franchise royalties and fees

    348        0.2        553        0.3        205        58.9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total revenues

    176,651        100.0        201,406        100.0        24,755        14.0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Expenses

           

Sandwich shop operating expenses

           

Cost of goods sold, excluding depreciation

    50,784        28.7        58,389        29.0        7,605        15.0   

Labor and related expenses

    49,865        28.2        56,618        28.1        6,753        13.5   

Occupancy expenses

    19,493        11.0        22,885        11.4        3,392        17.4   

Other operating expenses

    17,899        10.1        20,767        10.3        2,868        16.0   

General and administrative expenses

    20,308        11.5        22,542        11.2        2,234        11.0   

Depreciation expense

    11,085        6.3        11,633        5.8        548        4.9   

Pre-opening costs

    1,046        0.6        1,760        0.9        714        68.3   

Impairment and loss on disposal of property and equipment

    29        *        78        *        49        169.0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total expenses

    170,509        96.5        194,672        96.7        24,163        14.2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Income from operations

    6,142        3.5        6,734        3.3        592        9.6   

Interest expense

    359        0.2        427        0.2        68        18.9   

Other expense (income)

    (2     *        6        *        8        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Income before income taxes

    5,785        3.3        6,301        3.1        516        8.9   

Income tax expense

    591        0.3        765        0.4        174        29.4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Net income

    5,194        2.9        5,536        2.7        342        6.6   

Net income (loss) attributable to non-controlling interests

    —          —          (35     *        (35     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Net income attributable to Potbelly Corporation

    5,194        2.9        5,571        2.8        377        7.3   

Accretion of redeemable convertible preferred stock to maximum redemption value

    (9,011     (5.1     (13,887     (6.9     (4,876     (54.1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Net loss attributable to common stockholders

  $ (3,817     (2.2 )%    $ (8,316     (4.1 )%    $ (4,499     (117.9 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

* Amount is less than 0.1%.

 

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Percentages reflected may not compute to the percentages that precede them due to rounding adjustments.

Revenues

Revenues increased by $24.8 million, or 14.0%, to $201.4 million during the 39 weeks ended September 23, 2012, from $176.7 million during the 39 weeks ended September 25, 2011. Company-operated non-comparable store sales contributed $18.0 million, or 72.6%, of the total revenue increase, company-operated comparable store sales contributed $6.6 million, or 26.6% of the total revenue increase, and franchise shops contributed $0.2 million, or 0.8% of the total revenue increase. Comparable store sales increased 3.9% as a result of a 3.2% increase in average check, driven by price increases and a shift in menu mix, and a 0.7% increase in entree counts.

Cost of Goods Sold

Cost of goods sold increased by $7.6 million, or 15.0%, to $58.4 million during the 39 weeks ended September 23, 2012, from $50.8 million during the 39 weeks ended September 25, 2011, primarily due to the increase in revenues. As a percentage of revenues, cost of goods sold increased to 29.0% in the 39 weeks ended September 23, 2012, from 28.7% in the 39 weeks ended September 25, 2011. The increase in cost of goods sold as a percentage of revenues was primarily driven by higher commodity costs partially offset by menu price increases.

Labor and Related Expenses

Labor and related expenses increased by $6.8 million, or 13.5%, to $56.6 million during the 39 weeks ended September 23, 2012, from $49.9 million during the 39 weeks ended September 25, 2011, primarily due to additional labor costs associated with new shops. As a percentage of revenues, labor and related expenses decreased to 28.1% for the 39 weeks ended September 23, 2012, compared to 28.2% for the 39 weeks ended September 25, 2011, primarily driven by labor productivity improvements offset by higher payroll tax rates.

Occupancy Expenses

Occupancy expenses increased by $3.4 million, or 17.4%, to $22.9 million during the 39 weeks ended September 23, 2012, from $19.5 million during the 39 weeks ended September 25, 2011, primarily due to new shop openings. As a percentage of revenues, occupancy expenses increased to 11.4% in the 39 weeks ended September 23, 2012, from 11.0% in the 39 weeks ended September 25, 2011, due to more shop openings in higher rent markets, specifically New York City and Boston. There were 14 company-operated shops in New York City and Boston as of September 23, 2012, compared to three company-operated shops as of September 25, 2011.

Other Operating Expenses

Other operating expenses increased by $2.9 million, or 16.0%, to $20.8 million during the 39 weeks ended September 23, 2012, from $17.9 million during the 39 weeks ended September 25, 2011, mainly due to new shop openings as well as an increase in fees associated with higher credit card usage in our shops. As a percentage of revenues, operating expenses increased to 10.3% in the 39 weeks ended September 23, 2012, from 10.1% in the 39 weeks ended September 25, 2011, driven by the increase in credit card usage.

General and Administrative Expenses

General and administrative expenses increased by $2.2 million, or 11.0%, to $22.5 million during the 39 weeks ended September 23, 2012, from $20.3 million during the 39 weeks ended September 25, 2011, primarily

 

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due to $0.9 million in stock-based compensation expense related to warrants, $0.7 million increase in corporate personnel and $0.4 million in initial public offering planning costs. As a percentage of revenues, general and administrative expenses decreased to 11.2% in the 39 weeks ended September 23, 2012, from 11.5% in the 39 weeks ended September 25, 2011, driven by sales leverage (i.e., the ability to spread certain expenses over a higher revenue base).

Depreciation Expense

Depreciation expense increased by $0.5 million, or 4.9%, to $11.6 million for the 39 weeks ended September 23, 2012, from $11.1 million for the 39 weeks ended September 25, 2011, primarily due to a higher depreciable base from newly opened shops. As a percentage of revenue, depreciation decreased to 5.8% from 6.3%, primarily driven by greater coverage of the depreciable asset base due to the increase in revenue.

Pre-Opening Costs

Pre-opening costs increased by approximately $0.8 million, or 68.3%, to $1.8 million for the 39 weeks ended September 23, 2012, from $1.0 million for the 39 weeks ended September 25, 2011, mainly due to an increase in the number of new shop openings and, notably, initial investments in new markets such as New York City, Boston and Phoenix. There were 24 new company-operated shop openings during the 39 weeks ended September 23, 2012, compared to 16 new company-operated shop openings during the 39 weeks ended September 25, 2011.

Interest Expense

Interest expense increased by $0.1 million, or 18.9%, primarily due to additional debt incurred related to the repurchase of preferred and common shares in June of 2011. Outstanding debt was $15.4 million as of September 23, 2012, as compared to $15.2 million as of September 25, 2011.

Income Tax Expense

Income tax expense increased by $0.2 million, or 29.4%, to $0.8 million during the 39 weeks ended September 23, 2012, from $0.6 million during the 39 weeks ended September 25, 2011, primarily due to higher pre-tax income and an increase in the effective income tax rate to 12.1% from 10.2%. We have a full valuation allowance against all deferred tax assets. As a result, our income tax expense primarily relates to current state income taxes payable and the increase in our effect tax rate is due to certain states suspending the utilization of net operating losses against taxable income, as well as changes in state statutory tax rates.

 

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Fiscal Year 2011 Compared to Fiscal Year 2010

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

 

    Fiscal Year              
    2010     % of
Revenues
    2011     % of
Revenues
    Increase
(Decrease)
    Percent
Change
 

Revenues

           

Sandwich shop sales, net

  $ 220,573        100.0   $ 237,463        99.8   $ 16,890        7.7

Franchise royalties and fees

    —          —          503        0.2        503        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total revenues

    220,573        100.0        237,966        100.0        17,393        7.9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Expenses

           

Sandwich shop operating expenses

           

Cost of goods sold, excluding depreciation

    63,009        28.6        68,491        28.8        5,482        8.7   

Labor and related expenses

    63,506        28.8        67,036        28.2        3,530        5.6   

Occupancy expenses

    25,238        11.4        26,511        11.1        1,273        5.0   

Other operating expenses

    22,620        10.3        24,095        10.1        1,475        6.5   

General and administrative expenses

    26,563        12.0        26,911        11.3        348        1.3   

Depreciation expense

    15,647        7.1        14,838        6.2        (809     (5.2

Pre-opening costs

    267        0.1        1,521        0.6        1,254        469.7   

Impairment and loss on disposal of property and equipment

    2,952        1.3        365        0.2        (2,587     (87.6
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total expenses

    219,802        99.7        229,768        96.6        9,966        4.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Income from operations

    771        0.3        8,198        3.4        7,427        963.3   

Interest expense

    519        0.2        495        0.2        (24     (4.6

Other expense

    9        *        1        *        (8     (88.9
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Income before income taxes

    243        0.1        7,702        3.2        7,459        3,069.5   

Income tax expense

    773        0.4        537        0.2        (236     (30.5
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Net income (loss)

    (530     (0.2     7,165        3.0        7,695        —     

Net income (loss) attributable to non-controlling interest

    —          *        —          *        —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Net income (loss) attributable to Potbelly Corporation

    (530     (0.2 )%      7,165        3.0        7,695        —     

Accretion of redeemable convertible preferred stock to maximum redemption value

    (45,992     (20.9     (17,410     (7.3     28,582        62.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Net loss attributable to common stockholders

  $ (46,522     (21.1 )%    $ (10,245     (4.3 )%    $ 36,277        78.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

* Amount is less than 0.1%.

Percentages reflected may not compute to the percentages that precede them due to rounding adjustments.

Revenues

Revenues increased by $17.4 million, or 7.9%, to $238.0 million for fiscal year 2011, from $220.6 million for fiscal year 2010. Company-operated non-comparable store sales contributed $13.2 million, or 75.8%, of the total revenue increase, company-operated comparable store sales contributed $3.7 million, or 21.3%, of the total revenue increase, and franchise shops contributed $0.5 million, or 2.9%, of the total revenue increase. Comparable store sales increased 1.7% as a result of a 1.4% increase in average check, primarily due to a shift in menu mix, and a 0.3% increase in entree counts.

 

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Cost of Goods Sold

Cost of goods sold increased by $5.5 million, or 8.7%, to $68.5 million for fiscal year 2011, compared to $63.0 million for fiscal year 2010, due to the increase in revenues. As a percentage of revenues, cost of goods sold increased slightly to 28.8% for fiscal year 2011, from 28.6% for fiscal year 2010, primarily driven by higher commodity costs.

Labor and Related Expenses

Labor and related expenses increased by $3.5 million, or 5.6%, to $67.0 million for fiscal year 2011, from $63.5 million for fiscal year 2010, primarily due to new shop openings. As a percentage of revenues, labor and related expenses decreased to 28.2% for fiscal year 2011, from 28.8% for fiscal year 2010, primarily due to leverage of shop personnel and improved labor productivity.

Occupancy Expenses

Occupancy expenses increased by $1.3 million, or 5.0%, to $26.5 million for fiscal year 2011, from $25.2 million for fiscal year 2010, primarily due to new shop openings. As a percentage of revenues, occupancy expenses decreased to 11.1% for fiscal year 2011, from 11.4% for fiscal year 2010, primarily due to sales leverage.

Other Operating Expenses

Other operating expenses increased by $1.5 million, or 6.5%, to $24.1 million for fiscal year 2011, from $22.6 million for fiscal year 2010, primarily due to new shop openings. As a percentage of revenues, other operating expenses decreased to 10.1% for fiscal year 2011, from 10.3% for fiscal year 2010, primarily due to sales leverage and more efficient execution to drive lower operating expenses at our shops.

General and Administrative Expenses

General and administrative expenses increased by $0.3 million, or 1.3%, to $26.9 million for fiscal year 2011, from $26.6 million for fiscal year 2010. The increase was primarily due to an increase of $0.5 million in stock compensation expense in addition to $0.1 million for our General Manager conference in Chicago, offset by lower legal related expenses. As a percentage of revenues, general and administrative expenses decreased to 11.3% for fiscal year 2011, from 12.0% for fiscal year 2010, primarily due to sales leverage and effective cost containment at our corporate headquarters, which we refer to as the Support Center.

Depreciation Expense

Depreciation expense decreased by $0.8 million, or 5.2%, to $14.8 million for fiscal year 2011, from $15.6 million for fiscal year 2010, primarily due to certain fixed assets being fully depreciated. As a percentage of revenues, depreciation decreased to 6.2% for fiscal year 2011, from 7.1% for fiscal year 2010.

Pre-Opening Costs

Pre-opening costs increased by approximately $1.2 million to $1.5 million for fiscal year 2011, from $0.3 million for fiscal year 2010. The increase was due to 21 new company-operated shop openings during fiscal year 2011, compared to six new company-operated shop openings during fiscal year 2010, including one re-location.

Impairment and Loss on Disposal of Property and Equipment

Impairment and loss on disposal of property and equipment decreased by $2.6 million to $0.4 million for fiscal year 2011, from $3.0 million for fiscal year 2010. Due to unfavorable operating results at certain shops, the related assets were assessed for impairment. A determination was made that certain shops had carrying amounts in excess of their fair value as of December 25, 2011 and December 26, 2010. An impairment charge of

 

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$0.4 million and $2.9 million was recorded in fiscal years 2011 and 2010, respectively. The reduction in expense is primarily driven by improved operating performance and lower levels of new shop development activities in the immediately preceding years.

Interest Expense

Interest expense remained constant at $0.5 million for fiscal years 2011 and 2010, respectively.

Income Tax Expense

Income tax expense decreased approximately $0.3 million to $0.5 million in fiscal year 2011, from $0.8 million in fiscal year 2010. We have a full valuation allowance against all deferred tax assets. Our income tax expense primarily relates to current state income taxes payable and the decrease in our effect tax rate is due to the impact of an adjustment in fiscal 2010, offset by changes in state statutory tax rates.

Quarterly Results and Seasonality

The following table sets forth certain unaudited financial and operating data in each of the first three fiscal quarters during fiscal year 2012. The unaudited quarterly information includes all normal recurring adjustments that we consider necessary for a fair presentation of the information shown. This information should be read in conjunction with the audited consolidated and unaudited condensed consolidated financial statements and related notes thereto appearing elsewhere in this prospectus.

 

     For the 13 Weeks Ended  
     March 25,
2012
    June 24,
2012
    September 23,
2012
 
     (unaudited)  

Total Revenues

   $ 62,381      $ 69,156      $ 69,869   

Income from operations

     1,592        2,325        2,817   

Net income attributable to Potbelly Corporation

     1,274        1,749        2,548   

Adjusted EBITDA (1)

   $ 6,545      $ 8,251      $ 7,945   

Total company-operated shops (end of period)

     239        248        257   

Change in comparable store sales

     6.4     3.3     2.2

 

(1) The following table presents a reconciliation of net income (loss), the most directly comparable GAAP financial measure, to adjusted EBITDA for the periods indicated below. For further discussion of the use of adjusted EBITDA, see footnote 4 to the table included in “Selected Consolidated Financial and Other Data.”

 

     For the 13 Weeks Ended  
     March 25,
2012
     June 24,
2012
     September 23,
2012
 
     (amount in thousands)  

Net Income (loss) attributable to Potbelly Corporation

   $ 1,274       $ 1,749       $ 2,548   

Depreciation expense

     3,837         3,716         4,080   

Interest expense

     128         123         176   

Income tax expense

     206         476         84   

Impairment and closures

     93         171         —     

Pre-opening costs

     537         593         630   

Stock compensation

     470         1,423         427   
  

 

 

    

 

 

    

 

 

 

Adjusted EBITDA

   $ 6,545       $ 8,251       $ 7,945   
  

 

 

    

 

 

    

 

 

 

Historically, customer spending patterns for our established shops are lowest in the first quarter of the year. Our quarterly results have been and will continue to be affected by the timing of new shop openings and their associated pre-opening costs. As a result of these and other factors, our financial results for any quarter may not be indicative of the results that may be achieved for a full fiscal year.

 

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Liquidity and Capital Resources

General

Our primary sources of liquidity and capital resources have been cash provided from operating activities, cash and cash equivalents, and our credit facility. Our primary requirements for liquidity and capital are new shop openings, existing shop capital investments (maintenance and improvements), principal and interest payments on our debt, lease obligations, and working capital and general corporate needs. Our requirement for working capital is not significant since our customers pay for their food and beverage purchases in cash or payment cards (credit or debit) at the time of sale. Thus, we are able to sell many of our inventory items before we have to pay our suppliers for such items. Our shops do not require significant inventories or receivables. During the last three fiscal years and the 39 weeks ended September 23, 2012, net cash provided by operating activities exceeded cash used in investing activities. We believe that these sources of liquidity and capital will be sufficient to finance our 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):

 

     2010     2011     39 Weeks Ended  
         September 25,
2011
    September 23,
2012
 
          

Net cash provided by (used in):

        

Operating activities

   $ 18,780      $ 20,121      $ 10,839      $ 20,457   

Investing activities

     (6,243     (17,758     (13,070     (19,700

Financing activities

     (4,382     (7,197     (7,659     51   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash

   $ 8,155      $ (4,834   $ (9,890   $ 808   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Activities

Net cash provided by operating activities increased to $20.5 million for the 39 weeks ended September 23, 2012, from $10.8 million for the 39 weeks ended September 25, 2011, primarily due to the increase in shop-level profits as a result of new shop openings and increased working capital.

Net cash provided by operating activities was $20.1 million for fiscal year 2011, compared to $18.8 million for fiscal year 2010. The increase was primarily due to an increase in shop-level profits as a result of new shop openings.

Investing Activities

Net cash used in investing activities increased to $19.7 million for the 39 weeks ended September 23, 2012, from $13.1 million for the 39 weeks ended September 25, 2011. The increase in the use of cash was primarily due to increased purchases of property and equipment related to new company-operated shop openings, which were funded primarily by cash provided by operating activities.

For fiscal years 2011 and 2010, purchases of property and equipment were $17.8 million and $6.2 million, respectively. Each year, new company-operated shop development accounted for the majority of the expenditures and the increase in 2011, as compared to 2010, is driven by an increase in the number of shop openings. We estimate that total capital expenditures for fiscal year 2012 will be approximately $26 million to $28 million, with 31 new company-operated shop openings planned. We estimate a similar range of capital expenditures for 2013, with 25 to 35 new company-operated shop openings planned.

Financing Activities

Net cash provided by (used in) financing activities was $0.1 million for the 39 weeks ended September 23, 2012, compared to $(7.7) million for the 39 weeks ended September 25, 2011. The variance was primarily due to the repurchase of preferred stock ($5.0 million) and common stock ($8.5 million) in June 2011. This was partially offset by $6.0 million of net proceeds from borrowings under the credit facility.

 

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Net cash (used in) provided by financing activities was $(7.2) million and $(4.4) million during fiscal years 2011 and 2010, respectively. The increase in net cash used in fiscal year 2011 as compared to fiscal year 2010 was primarily due to the repurchase of preferred stock ($5.0 million) and common stock ($8.5 million) during 2011, which was partially offset by $6.0 million of net proceeds from borrowings under the credit facility.

Credit Facility

On September 21, 2012, we entered into a new five-year revolving credit facility agreement that expires in September 2017 and provides for borrowings up to $35.0 million to fund capital expenditures for new shops, renovations and maintenance of existing shops, and to provide ongoing working capital for other general and corporate purposes. The credit facility contains customary representations, warranties, negative and affirmative covenants, including a requirement to maintain a maximum leverage ratio, as defined, of 2.25:1 and a minimum debt service coverage ratio, as defined, of 1.5:1. The company was in compliance with these restrictions and conditions as of September 23, 2012. The credit facility is secured by substantially all assets of the company. Borrowings under the credit facility bear interest at our option at either (i) a eurocurrency rate determined by reference to the applicable LIBOR rate plus an applicable margin or (ii) a prime rate as announced by JPMorgan Chase plus an applicable margin. As of September 23, 2012, we had $14.2 million outstanding under the credit facility with a weighted-average interest rate of 1.35%. Our previous credit facility, which we entered into in January 2008, would have expired in January 2013 and was repaid in full and terminated when we entered into our new credit facility. See “Description of Credit Facility.”

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements, 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 Securities Exchange Act of 1934. Additionally, we do not have any synthetic leases.

Contractual Obligations

The following table presents contractual obligations and commercial commitments as of December 25, 2011 (in thousands):

 

     Payments Due By Period  
     Total      Less than
1 year
     1-3 years      3-5 years      More than
5 years
 

Long-term debt (including current portion) (a)

   $ 15,243       $ 74       $ 14,163       $ 1,006       $ —     

Operating leases (b)

     124,333         22,716         40,328         31,117         30,172   

Capital leases

     226         25         201         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 139,802       $ 22,891       $ 54,616       $ 32,123       $ 30,172   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(a) On January 15, 2008, we entered into a five-year revolving credit facility agreement that would have expired in January 2013 and provided for borrowings up to $35.0 million to fund capital expenditures for new shops, renovations and maintenance of existing shops and to provide ongoing working capital for other general and corporate purposes. Interest on the credit facility was variable and is not included in the table above. Interest expense on the credit facility in 2011 was $0.4 million. The credit facility was repaid in full and terminated upon entering into a new credit facility on September 21, 2012, as described above under “Credit Facility.” Long-term debt also includes a note payable with $1.2 million outstanding as of September 23, 2012. As of December 25, 2011:

 

   

scheduled principal payments on the previous revolving credit facility were $14.0 million in fiscal year 2013; and

 

   

scheduled principal payments on the note payable were $0.1 million in fiscal year 2012, $0.1 million in fiscal year 2013, $0.1 million in fiscal year 2014 and $1.0 million in fiscal year 2015. The above table excludes interest on the note, payable quarterly at an interest rate of 6%.

 

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(b) Includes base lease terms and certain optional renewal periods that are included in the lease term in accordance with accounting guidance related to leases. Certain of these options are subject to escalation based on various market-based factors.

Impact of Inflation

Our profitability is dependent, among other things, on our ability to anticipate and react to changes in the costs of key operating resources, including food and beverages, labor, energy and other services. Substantial increases in costs and expenses could impact our operating results to the extent such increases cannot be passed along to our customers. Apart from the commodity effects discussed above, in general, we have been able to substantially offset shop and operating cost increases resulting from inflation by altering our menu items, increasing menu prices, making productivity improvements or other adjustments. However, certain areas of costs, notably labor and utilities, can be significantly volatile or subject to significant changes due to changes in laws or regulations, such as the minimum wage laws. There can be no assurance that we will continue to generate increases in comparable store sales in amounts sufficient to offset inflationary or other cost pressures.

New and Revised Financial Accounting Standards

We qualify as an “emerging growth company” pursuant to the provisions of the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, enacted on April 5, 2012. Section 102 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended (the “Securities Act”), for complying with new or revised accounting standards. However, we are choosing to “opt out” of such extended transition period, and as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Our decision to opt out of the extended transition period is irrevocable.

Critical Accounting Policies

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 accounting principles generally accepted in the U.S. (“GAAP”). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. 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. We base our 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. Our significant accounting policies can be found in Note 2 to our consolidated financial statements. We consider the following policies to be the most critical in understanding the judgments that are involved in preparing our consolidated financial statements.

Impairment of Long-Lived Assets and Disposal of Property and Equipment

We assess potential impairments to long-lived assets, which includes property and equipment, whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. 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 exceeds its estimated undiscounted future cash flows, an impairment charge is recognized as the amount by which the carrying amount

 

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of the asset exceeds the fair value of the asset. Shop-level assets are grouped together for the purpose of the impairment assessment. Due to unfavorable operating results at certain shops, we assessed the related assets for impairment as of December 25, 2011 and December 26, 2010. 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. We used a weighted average cost of capital to discount the future cash flows. A 100 basis point change in weighted average cost of capital would not have a material impact on the calculation of an impairment charge. We recorded an impairment charge of $0.4 million and $2.9 million, included in impairment and loss on disposal of property and equipment in the consolidated statements of operations for the fiscal years 2011 and 2010, respectively.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are attributable to differences between financial statement and income tax reporting. Deferred tax assets, net of any valuation allowances, represent the future tax return consequences of those differences and for operating loss and tax credit carryforwards, which will be deductible when the assets are recovered. Deferred tax assets are reduced by a valuation allowance if it is deemed more likely than not that some or all of the deferred tax assets will not be realized. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Deferred tax liabilities are recognized for temporary differences that will be taxable in future years’ tax returns. While management believes the company will be profitable in the future and will be able to utilize these deferred tax assets, in accordance with ASC 740, Income Taxes, the existing evidence of past operating losses is weighted more heavily than the forecast of future earnings; therefore, due to the uncertainty of future recoverability of the deferred tax assets, management has determined that a valuation allowance for the full amount of net deferred taxes is warranted. However, the company may re-evaluate the need for a full valuation allowance if forecasted results of operations indicate increased profitability and actual results demonstrate a sustained level of profitability.

Stock-Based Compensation

Our 2001 and 2004 Equity Incentive Plans (the “Plans”) permit the granting of awards to employees and nonemployee officers, consultants, agents, and independent contractors of the Company in the form of stock appreciation rights, stock awards, and stock options. We account for our stock-based employee compensation in accordance with ASC 718, Stock Based Compensation. Because our stock option plan contains a performance condition that restricts certain option holders’ ability to exercise vested options until the consummation of an initial public offering (an “IPO”) under the Securities Act or at the discretion of our board of directors, no compensation cost related to vested employee stock options with these performance conditions has been recognized through September 23, 2012. Since the probability and the date of an IPO cannot be determined, we have not estimated what the potential compensation cost associated with vested options would be as of September 23, 2012. We will recognize non-cash stock compensation expense with respect to these options in the period in which the offering is consummated. Based on an estimated initial public offering price of $             (the midpoint of the price range set forth on the cover page of this prospectus), we estimate that this expense will be $             million. For stock options granted without these performance conditions, we record stock compensation expense on a straight-line basis over the vesting period based on the grant-date fair value of the option, determined using the Black-Scholes option pricing valuation model. In addition to the grant date fair value of our common stock, the Black-Scholes model requires inputs for risk-free interest rate, volatility and expected lives of the options. Since we do not have a history of traded common stock activity, expected volatility of the options is based on historical data from selected peer public company restaurants. The expected life of options granted is derived from the average of the vesting period and the term of the option. The risk-free rate is based on U.S. Treasury rates in effect at the time of the grant with a similar duration of the expected life of the options.

 

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Common Stock Equity Valuations

Our policy is to have all options granted to be exercisable at a price per share not less than the per-share fair value of our common stock underlying those options on the date of grant. The range of exercise prices of options granted as of September 23, 2012 is $5 to $14 per option, and the options vest over a five-year period from the date of grant. Also, we measure our redeemable convertible preferred stock at its maximum redemption value at each reporting period. The fair value of the company, used to calculate the maximum redemption value of the redeemable convertible preferred stock and to measure the value of the common stock as a key assumption in our stock options, was determined with assistance from an independent third-party valuation specialist. The valuations of the company and our common stock were determined based on valuation methodologies and assumptions selected in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Companies Equity Securities Issued as Compensation. In the absence of observable market data regarding the value of our stock, the valuation of the company and our common stock was estimated using multiple valuation approaches, primarily an income and market approach. The income approach is based on the present value of estimated future cash flows and relies upon significant assumptions and estimates, including those related to the selected discount rate and forecasted revenues and expenses. The market approach is based on a comparison to observed fair values of comparable peer companies and recent market transactions, adjusted for the relative size and profitability of these peer companies.

During the twelve months prior to September 23, 2012, 333,000 options were granted at a common stock fair value of $8.16; the fair value of our common stock used as the grant price for these options was based on a concurrent valuation prepared by an independent valuation specialist as discussed in Note 9 to our consolidated financial statements.

Quantitative and Qualitative Disclosures of Market Risks

Interest Rate Risk

We are subject to interest rate risk in connection with borrowings under our credit facility, which bear interest at variable rates. As of September 23, 2012, we had $14.2 million outstanding under our credit facility. A 100 basis point change in the interest rate would not have a material impact on our financial condition or results of operations. We did not have any material exposure to interest rate market risks for fiscal year 2011 or for the 39 weeks ended September 23, 2012.

Commodity Price Risk

We are also exposed to commodity price risks. Many of the food products we purchase are subject to changes in the price and availability of food commodities, including among other things beef, poultry, grains, dairy and produce. Prices may be affected due to market changes, increased competition, the general risk of inflation, shortages or interruptions in supply due to weather, disease or other conditions beyond our control, or other reasons. For example, the drought conditions of 2012 have affected commodity prices. We work with our suppliers and use a mix of forward pricing protocols for certain items under which we agree with our supplier on fixed prices for deliveries at some time in the future, fixed pricing protocols under which we agree on a fixed price with our supplier for the duration of that protocol, and formula pricing protocols under which the prices we pay are based on a specified formula related to the prices of the goods, such as spot prices. Our use of any forward pricing arrangements varies substantially from time to time and these arrangements tend to cover relatively short periods (i.e., typically twelve months or less). We do not enter into futures contracts or other derivative instruments. Increased prices or shortages could generally affect the cost and quality of the items we buy or may require us to raise prices or limit our menu options. These events, combined with other general economic and demographic conditions, could impact our pricing and negatively affect our sales and profit margins.

 

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BUSINESS

 

LOGO

The Neighborhood Sandwich Shop

Potbelly is a fast-growing neighborhood sandwich concept offering simple, irresistible food served by friendly people in a warm and welcoming environment. Our unique combination of product, people and place is how we deliver on our passion to be “The Best Place for Lunch.” Our shops are a destination for people who love great food at a fair price. Our menu includes toasty warm sandwiches made fresh to order, craveable salads, hand-dipped milkshakes and delicious cookies baked fresh each day. We develop a strong connection with our customers, creating a devoted base of Potbelly fans that we are expanding one sandwich shop at a time.

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 awesome 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 are 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.

We believe executing on The Potbelly Advantage at a high level creates a distinct competitive advantage and drives our operating and financial results, as illustrated by the following:

 

   

As of September 23, 2012, we had a domestic base of 262 shops in 17 states and the District of Columbia, having grown 13.4% over the prior year;

 

   

We achieved ten consecutive quarters of positive comparable store sales growth through our fiscal quarter ended September 23, 2012;

 

   

From 2010 to 2011, we increased our total revenue 7.9% to $238.0 million, our adjusted EBITDA 27.1% to $26.8 million, our adjusted EBITDA margin by 170 basis points to 11.2%, and our net income to $7.2 million from a net loss of $0.5 million; and

 

   

From 2008 to 2011, we increased our shop-level profit margin by 610 basis points from 15.5% to 21.6%.

See “Selected Consolidated Financial and Other Data” for a discussion of adjusted EBITDA, adjusted EBITDA margin and shop-level profit margin and a reconciliation of the differences between adjusted EBITDA and net income (loss), as well as a calculation of shop-level profit margin. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a definition of comparable store sales.

Our History

Potbelly started in 1977 as a small antique store on Lincoln Avenue in Chicago. To boost sales, the original owner began offering tasty toasted sandwiches to customers. Soon, people who had no interest in antiques were stopping by to enjoy the delicious sandwiches, homemade desserts and live music featured in the shop. As time passed, Potbelly became a well-known neighborhood destination with a loyal following of regulars and frequent lines out the door.

 

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The original owner sold the Lincoln Avenue store to Bryant Keil in 1996. Bryant was the entrepreneur with the vision to expand Potbelly. We opened our second shop in 1997 and continued to open shops in more neighborhoods throughout the country, reaching 100 shops in 2005 and 200 shops in 2008. Throughout our growth, each new shop has maintained the same look, vibe and experience that defines the Potbelly brand. Though our shops vary in size and shape, we maintain core elements in each new location, such as fast and efficient line flow, vintage décor customized with local details and exceptional customer focus. Just like our first shop on Lincoln Avenue, we are committed to building deep community roots in all the neighborhoods we serve.

Industry Overview

According to the National Restaurant Association (“NRA”), U.S. restaurant industry sales were $610 billion in 2011 and are projected to grow 3.5% to $632 billion in 2012, representing approximately 4% of the U.S. gross domestic product. The NRA projects that 48% of total U.S. food expenditures will be spent at restaurants in 2012, up from 44% in 1996 and 25% in 1955.

According to Technomic, Inc. (“Technomic”), a national consulting market research firm, the restaurant industry is divided into two primary segments, limited-service restaurants (“LSRs”) and full-service restaurants (“FSRs”), and is generally categorized by price, quality of food, service and location. LSRs are defined as establishments with patrons who pay before eating and generate an average check between $3 and $12. The LSR segment is further divided into (i) quick-service restaurants, which are defined as traditional “fast food” restaurants, generally with check averages between $3 and $8, and (ii) fast-casual restaurants, which are establishments with limited service, check averages generally between $8 and $12, food prepared to order, fresh (or perceived as fresh) ingredients, innovative food suited to sophisticated tastes, and upscale or highly developed interior design.

Technomic reported that LSRs accounted for 72% of the sales of the Top 500 U.S. restaurant chains in 2011. We operate in the “Other Sandwich” category, which includes LSRs specializing in sandwiches and wraps, other than hamburgers. This category accounted for $20.6 billion of sales in 2011 by the Top 500 chains. Sales in this category increased 4.7% from 2010 to 2011, outperforming the broader LSR growth rate of 3.7% over the same time period.

Our Competitive Strengths

We believe the following competitive strengths provide a platform for us to achieve continued growth:

Simple, Irresistible Food. Our menu features wholesome, addictively great tasting food made from high quality ingredients. Our incredibly tasty sandwiches are made fresh to order, and many are based on the original recipes from 1977. They are served toasty warm on our signature multigrain wheat or regular bread. We slice our meats and cheeses daily in each shop to ensure freshness. Our sandwiches can be customized with a variety of toppings, including our unique Potbelly hot peppers. We believe our customers love our sandwiches because they have the perfect balance of ingredients with the last bite tasting as good as the first. Our generously sized cookies are baked fresh daily in each shop, and our hand-dipped shakes, malts and smoothies are made from real, wholesome ingredients and come with our signature butter cookie on the straw. Our menu regularly evolves based on consumer trends and customer feedback. For example, we now offer craveable salads that are made to order and have recently introduced the all-veggie Mediterranean sandwich. We believe our simple and delicious menu offers ease of ordering and broad appeal and helps us create loyal Potbelly fans that return again and again.

Differentiated Customer Experience That Delivers a Neighborhood Feel. We provide a superior customer experience that is driven by both our employees and the lively atmosphere of our shops. Our employees are nice people that interact with our customers in a genuine way while providing fast service. To support the neighborhood feel of our shops, most of our managers live in the neighborhood where their shop is located. This

 

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allows them to get to know their customers, understand the unique character of each neighborhood and form deep roots within the community. Each of our shops features vintage décor and shared design elements, such as the use of wood, wallpaper motifs and our signature Potbelly stove. In addition, our shops display locally-themed photos and other decorative items inspired by the neighborhood. Our atmosphere is enhanced by live, local musicians that add to the positive vibe. Every Potbelly location strives to be “The Neighborhood Sandwich Shop,” creating devoted fans who tell others about their experience. Our shops are strongly integrated into the neighborhood and engage with customers through initiatives such as fundraising for local causes and other promotions that cater to local interests. We believe the unique Potbelly experience encourages repeat customer visits and drives increased sales.

Powerful Shop Economics with Attractive Returns. Our proven shop model generates strong cash flow, attractive shop-level financial results and high returns on investment. We operate our shops successfully in a wide range of geographic markets, population densities and real estate settings. The broad appeal of our menu offerings and the moderate investment requirements of our shops allow us to generate average shop-level profit margins above 20% and cash-on-cash returns above 25%. We have achieved these targets in 2010, 2011 and the 52 weeks ended September 23, 2012. We believe our powerful shop economics support our ability to profitably grow our brand in new and existing markets.

Proven Management Team with Substantial Operating Experience. Our senior management team has extensive operating experience across disciplines in the restaurant and retail sectors, including store operations, marketing, human resources, innovation, real estate, supply chain and finance. This team has an average of over 16 years of restaurant industry experience, and many of our executives have experience at large public companies. Our core senior management team has been together since 2008, when we hired our President and CEO, Aylwin Lewis. Aylwin was previously with Yum! Brands, Inc. from 1991 to 2004, most recently as President and Chief Multibranding and Operating Officer, as well as with Sears Holdings from 2004 to 2008, most recently as President and CEO. We believe our proven leadership team is a key driver of our success and positions us to execute our long-term growth strategy.

Distinct, Deep-Rooted Culture: The Potbelly Advantage. Our culture is a key to our success. It is embodied in The Potbelly Advantage, which is a clear expression of our Vision, Mission, Passion and Values. The Potbelly Advantage is a statement of our intentions and is the foundation of everything we do, including how we plan and manage our business. Our Vision is to create the “Potbelly Nation.” We want our customers to feel we are their “Neighborhood Sandwich Shop” and to become Potbelly fans and advocates. Our Mission is to make our customers and employees happy, to make more money and to improve our business every day. Our Passion is to be “The Best Place for Lunch.” Our Values of integrity, teamwork, accountability, positive energy and coaching are emphasized throughout all levels of our organization. We also place importance on values for our leaders, such as delivering results through execution and building and inspiring teams. The Potbelly Values form a common language across our organization and make Potbelly a place our employees love to work. We empower our employees to do what is right, encourage them to perform at their personal best and help them to work together as a team to make sure we deliver a positive experience to everyone who works here. Our culture helps us attract and retain employees and has contributed to our hourly employee turnover rate of 71% for the twelve months ended September 23, 2012, which we believe is meaningfully lower than the U.S. restaurant industry as a whole. We believe The Potbelly Advantage allows us to deliver operational excellence, encourage innovation, and grow our business and our base of devoted Potbelly fans.

Our Growth Strategy

We believe we can grow profitability and create value for our stockholders by pursuing the following core strategies:

Run Great Shops. We believe that continued excellence in shop-level execution is fundamental to our growth strategy. To maintain our operational standards we use a Balanced Scorecard approach to measure People, Customers, Sales and Profits at each of our shops. Hiring the right people and maintaining optimal

 

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staffing levels enable us to run efficient operations. We track metrics such as peak hour throughput, mystery shopper scores and neighborhood engagement activities to improve the customer experience. Shop sales and profitability are benchmarked against prior year periods and budget, and we focus on achieving targets on a shop-by-shop basis. To support our shop operators, we invest in systems and technology that can meaningfully improve shop-level execution. For example, we have enhanced capabilities around in-line order-taking by using a proprietary tablet system to further increase throughput. In addition, we are expanding our backline businesses, including catering, delivery and online ordering, which we view as additional growth drivers.

Find and Build Great Shops. Our shops are successful in diverse markets in 17 states and the District of Columbia, and we intend to continue to build company-operated shops in both new and existing markets utilizing our rigorous site selection process. We evaluate a number of metrics to assess the optimal sites for our new shops, including neighborhood daytime population, site visibility, traffic and accessibility, along with an on-the-ground qualitative assessment of the characteristics of each unique trade area. This location-specific approach to development allows us to leverage our versatile shop format to achieve strong returns across a wide range of real estate settings. In 2011 and for the 39 weeks ended September 23, 2012, we opened 21 and 24 new shops, respectively, and expanded into New York, Seattle, Boston and Phoenix. We expect to open 25 to 35 new shops in 2013. Over the long term, we plan to grow the number of Potbelly shops 10% annually.

Achieve High Margins and Terrific Returns. Our approach to margin enhancement begins with continuous efforts to improve the financial results of our shops. We focus on cash-on-cash returns and look to grow shop-level profitability each year through sales growth and productivity improvements. Between 2008 and 2011, we increased our shop-level profit margin from 15.5% to 21.6%. We also focus on cash flow generation, which supports our self-funded development model. We exercise strong financial discipline and strive to achieve and maintain general and administrative expenses under 10% of sales. In addition, we expect our sales and shop-level profit margin to grow faster than general and administrative expenses. Our intention is to maintain average shop-level profit margins over 20% as we continue to grow.

Become a Global Iconic Brand. We believe that our premise of a “Neighborhood Sandwich Shop” has broad appeal across a wide range of market types and geographies. We believe that Potbelly is a recognized brand beyond the neighborhoods in which we currently operate. A significant contributor to this success is word-of-mouth publicity by our customers who enjoy their Potbelly experience and tell others about it, as well as our grass roots approach to integrating our shops deep within a neighborhood. We believe that our positive brand perception helps drive interest in our shops in both existing and new markets.

Be a Great Franchisor. In 2010, we initiated a program to franchise shops in selected markets in the U.S. We intend to expand the number of franchise shops on a disciplined basis as we develop our franchise program. As of September 23, 2012, our franchisees operated five shops domestically. In addition, we have signed a franchise development agreement with the Alshaya Trading Company W.L.L. (“Alshaya”), a leading franchisee of retail brands, to develop shops in the Middle East. As of September 23, 2012, Alshaya operated seven shops in Kuwait, Dubai and Bahrain. Although we do not expect franchise activities to result in significant revenue in the near term, we see the selective expansion of our franchising efforts to be a valuable potential growth opportunity over time.

Our Food

Our Menu

Each of our shops offers a simple menu of great tasting food made from high quality ingredients. The majority of our sales are generated during lunchtime hours, but dinner and breakfast (in locations with high early morning traffic) are also important to our business. Our menu currently includes incredibly tasty sandwiches, craveable salads, soups, chili, sides, delicious desserts and, in our breakfast locations, breakfast sandwiches and steel cut oatmeal.

 

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Every toasty warm sandwich on the Potbelly menu is made-to-order and customizable and many are based on the original recipes from 1977. Sandwiches are made with our signature multigrain wheat or regular bread as “Originals” (our “regular” size), “Bigs” (30% bigger) and “Skinnys” (less meat and cheese on thin cut bread with 20% less fat than Originals). We slice our meats and cheeses daily in each shop to ensure freshness, and each of our sandwiches can be customized with a variety of toppings, including our unique Potbelly hot peppers. We believe our sandwiches have the perfect balance of ingredients with the last bite tasting as good as the first.

Our core sandwich offerings include the following:

 

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Customers can also order off-menu sandwiches and variations on our sandwiches, including the “Wrecking Ball” (A Wreck plus meatballs), the “Lucky Seven” (which includes all seven of our sliced meat choices) and the “Cheeseburger” (the Meatball with cheddar cheese and no marinara). These items are on what our loyal fans call the “Underground Menu,” which contributes to the special connection between Potbelly and our customers.

 

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Our shops also offer craveable salads which are made-to-order with high quality ingredients. Our signature salads include the following:

 

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Customers may order any of our salads without meat for a vegetarian option and may customize a salad as they desire. Salads come with a choice of dressing, including Potbelly Vinaigrette, Balsamic Vinaigrette, Buttermilk Ranch, Caesar and Non-Fat Vinaigrette. We believe our craveable salads are key to diversifying our menu and help ensure that there is something for everyone at our shops.

We also offer soups, chili and side dishes. Different soups are offered daily, including varieties such as Broccoli Cheddar, Chicken Noodle, Loaded Baked Potato, Southwestern Chicken and Spicy Southwest Veggie. We have multiple vegan soup options, including Garden Vegetable and Spicy Black Bean. Our chili is available seven days a week and is a hearty recipe of ground beef, kidney beans, onions and bell peppers sweetened with a touch of molasses. Additionally, customers can choose tasty side dishes of coleslaw, macaroni salad, potato salad, potato chips or a whole dill pickle.

Our hand-dipped shakes and smoothies are made with real, wholesome ingredients and come with our signature butter cookie on the straw. Our classic shake flavors include vanilla, chocolate, strawberry, coffee and Oreo®, and our smoothies include real fruit, such as bananas and strawberries. Our delicious varieties of cookies are baked fresh in each shop daily and include Oatmeal Chocolate Chip, Sugar, Chocolate Brownie and Chocolate Cherry Granola cookies. Customers can also order an ice cream sandwich, with their choice of cookies and ice cream, or our signature chocolate and caramel Dream Bar.

Certain of our shops in areas with high early morning traffic also offer breakfast selections. Our breakfast menu includes made-to-order breakfast sandwiches on our signature multigrain wheat or regular bread and include Egg & Cheddar Cheese; Bacon, Egg & Cheddar Cheese; Sausage, Egg & Cheddar Cheese; and Ham, Mushroom, Egg & Swiss Cheese. Like our lunch and dinner sandwiches, our breakfast sandwiches are served toasty warm and any of our toppings can be added. We also offer steel cut oatmeal with toppings such as raisins, brown sugar, bananas, walnuts, apples and cranberries, and have other breakfast items available such as yogurt parfaits, bagels and dark roast coffee.

Overall, we believe our menu of high quality food at reasonable prices offers considerable value to our customers. Our system-wide average check has historically been under $7.00. We generally do not discount our core menu items in order to help ensure that we are able to maintain our high standards.

 

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Evolution of Our Menu

We have selectively expanded our menu offerings in response to shifts in customer tastes and demand. For example, we began offering breakfast items in 2001 and Bigs and Skinnys in 2008. We also added new grilled chicken salads in 2010 and recently introduced the all-veggie Mediterranean sandwich. We will continue to respond to consumer trends and customer feedback as we believe menu innovations are a way for us to continue to grow our business.

When we enter new markets, we employ a “lifecycle” approach to introducing our menu. Shops opened in new markets initially offer only our Original sandwiches to introduce new customers to our core menu items. Additionally, this approach simplifies our line operations and allows our new shops to focus on execution and speed of service. We gradually increase our menu offerings at these shops until the full range of Potbelly offerings are available.

Food Preparation and Safety

We focus on using high quality ingredients in our menu items, including the grade of our meats and freshness of our produce. Food safety is a top priority, and we dedicate substantial resources to help ensure that our customers enjoy safe, quality food products. We have taken various steps to mitigate food quality and safety risks, including having personnel focused on this goal together with our supply chain team. Our shops undergo third-party food safety reviews, internal safety audits and routine health inspections. We also consider food safety and quality assurance when selecting our distributors and suppliers.

Shop Operations and Management

We believe having an excellent manager in each shop is a critical factor in achieving continuous excellence in operations. Managers hire our friendly and outgoing employees, help ensure consistent execution of our menu items and strive to achieve specific targets that are evaluated on a quarterly basis. We devote significant time and resources to identifying, selecting and training our managers who plan, manage and operate their shops and who, along with our employees, provide a superior customer experience to our Potbelly fans. We believe our comprehensive processes for developing business leaders, such as our shop managers, are a key factor in driving our success.

Potbelly Operations

Our operations are structured around the elements of People, Customers, Sales and Profits. During our peak hours of 11:30 a.m. to 1:30 p.m., our employees greet our customers and take their orders while they wait in line using a proprietary tablet system in some shops to communicate with our food preparation employees. We focus on effective communication, technology and management to provide a quick and seamless experience for our customers. In addition, each shop completes quarterly tactical plans designed to help the shop achieve its targets relative to each element. In order to better assess and improve the Potbelly experience, we use a Balanced Scorecard that tracks elements such as sales and profitability metrics, employee turnover and a “mystery shopper” score, which essentially is a survey of customer satisfaction with the Potbelly experience. We review overall scores locally, regionally and nationally in order to assess our operational progress and identify areas of operational focus. Attaining certain ratings on the Balanced Scorecard allows a shop to be eligible for incentive targets paid quarterly and annual merit awards.

Our People

We look to attract, hire and retain smart, talented and nice people who share and demonstrate our values. We value friendly employees who engage with our customers in a genuine way to provide a personalized experience. We believe our sustainable process to hire, train and develop our people enables us to deliver a superior customer experience. A typical Potbelly shop consists of one manager, one assistant manager and as many as 12 to 16 employees during our peak hours.

 

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Most of our managers live in the neighborhood in which their shop is located. We believe this allows them to get to know their customers, understand the unique character of each neighborhood and form deep roots within the community. The shop manager has primary responsibility for the day-to-day operation of the shop and is required to abide by Potbelly’s operating standards. Our Management Training Program provides new managers with six to eight weeks of training that emphasizes culture, standards, strategy and procedures to prepare them for success, and is followed by on-going in-shop coaching with their District or Market manager. Our shop managers report to District or Market Managers who typically report to a Zone Manager, and ultimately to our Senior Vice President of Operations. In addition, members of senior management visit shops regularly to help ensure that our culture, strategy and quality standards are being adhered to in all aspects of our operations.

Shop managers are responsible for selecting and training the employees for each new shop. The training period for new non-management employees lasts approximately eight weeks and is characterized by on-the-job supervision by an experienced employee. Ongoing employee training remains the responsibility of the shop manager, but we provide specific training for our employees around The Potbelly Advantage several times a year. Special emphasis is placed on the consistency and quality of food preparation and service which is monitored through ongoing meetings with managers. In addition, we have other continuing communications with all of our employees.

The Potbelly Experience

We seek to deliver a superior experience for every customer at every opportunity through our irresistible food, unique atmosphere and outgoing and engaging employees. We seek to staff each shop with experienced teams to ensure consistent and attentive customer service. We choose employees who are friendly and responsive to the needs of our customers as they assist them in selecting menu items complementing individual preferences. We strive to staff at 110% during peak hours to ensure a fast yet personal Potbelly experience for each customer, with face-to-face interaction from start to finish. We also provide backline services, including catering, delivery and online ordering to serve our Potbelly fans.

In addition, music has been integral to the Potbelly culture since our first shop opened in 1977 and adds a neighborhood vibe. Local musicians frequently perform live at Potbelly shops creating a distinctive dining experience. Some of our shops also host special events. For example, the Potbelly Jazz Series in Chicago features solo jazz musicians and Open Mic Night in Ann Arbor and New York City feature up-and-coming local musicians.

We believe the combination of our great food, people and atmosphere makes Potbelly “The Best Place for Lunch.”

 

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Site Selection and Expansion

We believe we are well positioned to continue growth in our existing markets and have significant expansion potential in new geographic areas throughout the United States. As of September 23, 2012, we had a domestic base of 262 shops in 17 states and the District of Columbia. Of these, the company operates 257 shops and franchisees operate five shops. In addition, there are seven franchised shops in Kuwait, Dubai and Bahrain. The following map shows the number of stores in each of the states in which we operated as of September 23, 2012.

 

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We plan to grow our number of shops by 10% annually. In 2011 and for the 39 weeks ended September 23, 2012 we opened 21 and 24 new shops, respectively, and expanded into New York, Seattle, Boston and Phoenix. In 2013, we expect to open 25 to 35 shops.

Our proven shop model is designed to generate strong cash flow, attractive shop-level financial results and high returns on investment. With an average new shop investment of approximately $600,000 and average unit volumes in excess of $1 million, we strive to generate average shop-level profit margins above 20% and cash-on-cash returns above 25%.

Site Selection Process

We consider the location of a shop to be a critical variable in its long-term success and as such, we devote significant effort to the investigation and evaluation of potential locations. We actively develop shops in both new and existing markets and plan to continue to expand in selected regions throughout the United States. Our Real Estate Committee, which includes most of our senior management team, meets weekly to discuss all aspects of our development program. The process for selecting locations incorporates management’s experience and expertise and includes extensive data collection and analysis. We proactively seek new shop locations based on specific criteria, such as demographic characteristics, daytime population thresholds and traffic patterns, along with the potential visibility of, and accessibility to, the shop. Additionally, we use information and intelligence gathered from managers and other shop personnel that live in or near the neighborhoods we are considering. New shops are built with only one purpose in mind: to generate cash flow that meets or exceeds those modeled in our return targets. We are disciplined in our development, and we routinely forego sites that have many positive attributes, including strong visibility and street presence, but have challenging economics, such as high occupancy costs.

 

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Since we do not have standardized requirements with respect to size, shape or location, we are flexible in our site selection process. This allows us to choose and open shops with a wide variety of shapes in a wide variety of areas, including in urban central business districts and suburban areas near shopping malls or other high-traffic locations. Proposed locations are visited, reviewed and approved by key members of our Real Estate Committee.

Shop Design

We strive to create a unique customer experience that delivers a neighborhood feel for each shop. We typically design the interior of our shops in-house, utilizing outside architects when necessary. Our design team sources most furnishings and decorations for our shops. Each of our shops features vintage décor and shared design elements, such as the use of wood, wallpaper motifs and our signature Potbelly stove. Consistent with The Potbelly Advantage, our shops display locally-themed photos and other decorative items inspired by the neighborhood. Most of our shops also feature a space for musicians to perform. Our shop size averages approximately 2,300 square feet; however, we currently target shop sizes between 1,800 and 2,200 square feet for new openings. The dining area of a typical shop can seat anywhere from 50 to 60 people. Some of our shops incorporate larger dining areas and outdoor patios. We believe the unique experience of a lively neighborhood hangout encourages repeat visits by our customers and drives increased sales.

Construction

Construction of a new shop generally takes approximately 50 to 70 days from the date the location is leased or under contract and fully permitted. Each new shop requires a total cash investment of approximately $600,000, but this figure could be materially higher or lower depending on the market, shop size and condition of the premises upon landlord delivery. We generally construct shops in third-party leased retail space but also construct free-standing buildings on leased properties. In the future, we intend to continue converting existing third-party leased retail space or constructing new shops in the majority of circumstances. For additional information regarding our leases, see “—Properties.”

Franchising

In 2010, we initiated a program to selectively franchise our shops to take advantage of incremental growth opportunities. We intend to expand the number of franchise shops on a disciplined basis as we develop our franchise program. As of September 23, 2012, we had five domestic franchised shops in five locations. Internationally, our first franchise partner is Alshaya, a company with which we had discussions for several years. At September 23, 2012, Alshaya operated seven franchised shops in Kuwait, Dubai and Bahrain. We look for franchisees who love working with a team and have solid business experience, financial qualifications and personal motivation. Our franchise arrangements grant third parties a license to establish and operate a shop using our systems and our trademarks in a given area. The franchisee pays us for the ideas, strategy, marketing, operating system, training, purchasing power and brand recognition. All new franchisees participate in an eight week training program consisting of real life experience in our company-operated stores, as well as training at our Potbelly Support Center in Chicago. Franchised shops must be operated in compliance with our methods, standards and specifications, regarding menu items, ingredients, materials, supplies, services, fixtures, furnishings, décor and signs. Although we do not expect franchise activities to result in significant revenue in the near term, we see the selective expansion of our franchising efforts to be a valuable potential growth opportunity over time.

Advertising and Marketing

We believe our shops appeal to a broad base of loyal customers who return again and again for our great food and fun environment staffed by friendly people. Historically, one to two percent of our annual revenue has been spent on traditional marketing efforts. A portion of our marketing budget is spent at the shop level, with the

 

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goal of building relationships within our neighborhoods to increase the frequency of return visits and attract new customers. Our methods of marketing and advertising promote and maintain the Potbelly brand image and, among other things, generate awareness of shop locations and new menu offerings.

Neighborhood Shop Marketing

Consistent with our neighborhood approach, a portion of our marketing investments are made at the shop level. Neighborhood shops frequently hire local musicians and hold a variety of community events, including fundraisers. For example, during a “Shake Fundraiser” for smaller community organizations, Potbelly donates a portion of sales for each customized milkshake sold. For larger organizations, Potbelly sponsors local cause fundraisers, where 25% of sales gathered at the event are donated to the organization’s cause. Our shops promote these events and other events through social media, public relations, in-shop materials and local support, which results in increased traffic. Additionally, we engage in a variety of promotional activities, such as contributing food, time and money to charitable, civic and cultural programs, in order to give back to the communities we serve and increase public awareness and appreciation of our shops and our employees.

Advertising

We also promote our shops through regional and local media in markets in which we have scale. The use of radio and outdoor media are the most common advertising vehicles used in these markets. Additionally, we rely on in-shop materials to communicate and market to our customers. Our internal corporate production staff is responsible for the creative work around our advertising and other forms of communication. In the end, our best advertising comes from our customers. We believe the Potbelly experience fosters strong customer loyalty and encourages our fans to promote the brand through word-of-mouth marketing.

E-Marketing and Social Media

We have increased our use of e-marketing tools, which enable us to reach a significant number of people in a timely and targeted fashion at a fraction of the cost of traditional media. We believe that our customers are frequent internet users and will use social media to make dining decisions or to share dining experiences. We have a Facebook page and Twitter feed and advertise on various social media and other websites.

Sourcing and Supply Chain

Our Supply Chain team sources, negotiates and purchases food supplies for our shops. We believe in using high quality ingredients while maintaining our value position in the marketplace. We benchmark our products against the competition using consumer panels. We contract with Distribution Market Advantage, or DMA, a cooperative of multiple food distributors located throughout the nation. DMA is a broker with whom we negotiate and gain access to third-party food distributors and suppliers. For the twelve months ended September 23, 2012, distributors through our DMA arrangement supplied us with approximately 90%-95% of our food supplies through four primary distributors: Reinhart FoodService, L.L.C., Ben E. Keith Company, Food Services of America, and Shamrock Foods. Our remaining food supplies are distributed by other distributors under separate contracts. Our distributors deliver supplies to our shops approximately two to three times per week.

We negotiate pricing and volume terms directly with certain of our suppliers and distributors or through DMA. Our supply chain team uses a flexible cost lock-in model, and currently we have pricing understandings of varying lengths with our distributors and suppliers, including distributors and suppliers of meats, dairy, bread, cookie dough and other products. Meats represent about 25% of our product purchasing composition. In fiscal year 2011, more than 95% of our meat products were sourced from nine suppliers under non-exclusive contracts.

 

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For all our signature multi-grain and regular bread, we have a non-exclusive contract with Turano Baking Company. Changes in the price or availability of certain products may affect the profitability of certain items, our ability to maintain existing prices and our ability to purchase sufficient amounts of items to satisfy our customers’ demands.

Due to the nature of our industry, we expect to continue to purchase a substantial amount of our products from a small number of suppliers. However, we believe that there are other available suppliers for our products. Our supply chain team is currently updating our procurement strategy to include contingency plans for key products, ingredients and supplies. These plans include selecting suppliers that maintain alternative production facilities capable of satisfying our requirements, or in certain instances, the approval of secondary suppliers or alternative products. We believe our procurement strategy currently allows us to obtain sufficient product quantities from other sources at competitive prices.

Management Information Systems

Shop level financial and accounting controls are handled through a point-of-sale computer system and network in each shop that communicates with our corporate headquarters. The POS system is also used to authorize and transmit credit card sales transactions and to manage the business and control costs, such as labor. Our company-operated shops are connected through data centers and a portal to provide our corporate employees with access to business information and tools that allow them to collaborate, communicate, train and share information between shops and the corporate office. We believe our systems currently comply with all credit card industry security standards for processing of credit and gift cards.

Competition

We compete in the restaurant industry, primarily in the LSR segment but also with restaurants in the FSR segment, and face significant competition from a wide variety of restaurants, convenience stores and other outlets on a national, regional and local level. We believe that we compete primarily based on product quality, restaurant concept, service, convenience, value perception and price. Our competition continues to intensify as competitors increase the breadth and depth of their product offerings and open new units. Although new competitors may emerge at any time due to the low barriers to entry, our competitors include: Chipotle, Jimmy John’s, Panera Bread and Subway, among others. Additionally, we compete with LSRs, specialty restaurants and other retail concepts for prime shop locations.

Government Regulation

We and our franchisees are subject to various federal, state, local and international laws affecting our business. Each of our shops is subject to licensing and regulation by a number of governmental authorities, which may include, among others, health and safety, nutritional menu labeling, health care, environmental and fire agencies in the state, municipality or country in which the shop is located. Difficulty in obtaining or failing to obtain the required licenses or approvals could delay or prevent the development of a new shop in a particular area. Additionally, difficulties or inabilities to retain or renew licenses, or increased compliance costs due to changed regulations, could adversely affect operations at existing shops.

Our shop operations are also subject to federal and state labor laws, including the Fair Labor Standards Act, governing such matters as minimum wages, overtime and worker conditions. Significant numbers of our food service and preparation personnel are paid at rates related to the applicable minimum wage, and further increases in the minimum wage or other changes in these laws could increase our labor costs. Our ability to respond to minimum wage increases by increasing menu prices will depend on the responses of our competitors and customers. Further, we are continuing to assess the impact of federal health care legislation on our health care benefit costs. The requirement that we provide health insurance benefits to employees that are more extensive than the health insurance benefits we currently provide, or the imposition of additional employer paid

 

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employment taxes on income earned by our employees, could have an adverse effect on our results of operations and financial position. Our distributors and suppliers also may be affected by higher minimum wage and benefit standards, which could result in higher costs for goods and services supplied to us.

We and our franchisees may also be subject to lawsuits from our employees, the U.S. Equal Employment Opportunity Commission or others alleging violations of federal and state laws regarding workplace and employment matters, discrimination and similar matters.

The Patient Protection and Affordability Act of 2010 (the “PPACA”) enacted in March 2010 requires chain restaurants with 20 or more locations in the United States to comply with federal nutritional disclosure requirements. It is expected that the FDA will issue final regulations by the end of 2012 or the beginning of 2013 and will begin enforcing regulations by the middle of 2013. A number of states, counties and cities have also enacted menu labeling laws requiring multi-unit restaurant operators to disclose certain nutritional information to customers, or have enacted legislation restricting the use of certain types of ingredients in restaurants. Although the federal legislation is intended to preempt conflicting state or local laws on nutrition labeling, until we are required to comply with the federal law we will be subject to a patchwork of state and local laws and regulations regarding nutritional content disclosure requirements. Many of these requirements are inconsistent or are interpreted differently from one jurisdiction to another. While our ability to adapt to consumer preferences is a strength of our concepts, the effect of such labeling requirements on consumer choices, if any, is unclear at this time.

There is also a potential for increased regulation of certain food establishments in the United States, where compliance with a HACCP approach may now be required. HACCP refers to a management system in which food safety is addressed through the analysis and control of potential hazards from production, procurement and handling, to manufacturing, distribution and consumption of the finished product. Many states have required restaurants to develop and implement HACCP Systems and the United States government continues to expand the sectors of the food industry that must adopt and implement HACCP programs. For example, the FSMA, signed into law in January 2011, granted the FDA new authority regarding the safety of the entire food system, including through increased inspections and mandatory food recalls. Although restaurants are specifically exempted from or not directly implicated by some of these new requirements, we anticipate that the new requirements may impact our industry. Additionally, our suppliers may initiate or otherwise be subject to food recalls that may impact the availability of certain products, result in adverse publicity or require us to take actions that could be costly for us or otherwise harm our business.

We and our franchisees are subject to the Americans with Disabilities Act (the “ADA”), which, among other things, requires our shops to meet federally mandated requirements for the disabled. The ADA prohibits discrimination in employment and public accommodations on the basis of disability. Under the ADA, we and our franchisees could be required to expend funds to modify our shops to provide service to, or make reasonable accommodations for the employment of, disabled persons. In addition, our employment practices are subject to the requirements of the Immigration and Naturalization Service relating to citizenship and residency. Government regulations could affect and change the items we procure for resale. We and our franchisees may also become subject to legislation or regulation seeking to tax and/or regulate high-fat and high-sodium foods, particularly in the United States, which could be costly to comply with. Our results can be impacted by tax legislation and regulation in the jurisdictions in which we operate and by accounting standards or pronouncements.

We and our franchisees are also subject to laws and regulations relating to information security, privacy, cashless payments, gift cards and consumer credit, protection and fraud, and any failure or perceived failure to comply with these laws and regulations could harm our reputation or lead to litigation, which could adversely affect our financial condition.

 

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Our franchising activities are subject to the rules and regulations of the Federal Trade Commission (“FTC”) and various state laws regulating the offer and sale of franchises. The FTC’s franchise rule and various state laws require that we furnish a franchise disclosure document (“FDD”) containing certain information to prospective franchisees and a number of states require registration of the FDD with state authorities. Substantive state laws that regulate the franchisor-franchisee relationship exist in a substantial number of states, and bills have been introduced in Congress from time to time that would provide for federal regulation of the franchisor-franchisee relationship. The state laws often limit, among other things, the duration and scope of non-competition provisions, the ability of a franchisor to terminate or refuse to renew a franchise and the ability of a franchisor to designate sources of supply. We believe that our FDDs, together with any applicable state versions or supplements, and franchising procedures comply in all material respects with both the FTC franchise rule and all applicable state laws regulating franchising in those states in which we have offered franchises.

See “Risk Factors” for a discussion of risks relating to federal, state, local and international regulation of our business.

Employees

As of September 23, 2012, we employed approximately 4,900 persons, of which approximately 160 are corporate personnel, 480 are shop management personnel and the remainder are hourly shop personnel.

Properties

We do not own any real property. As of September 23, 2012, we had the following number of company-operated shops located in the following areas:

 

Location

   Number of Shops     

Location

   Number of Shops  

Illinois

     83       Wisconsin      8   

Texas

     39       Washington      5   

District of Columbia

     23       Indiana      4   

Michigan

     17       Pennsylvania      3   

Maryland

     16       Arizona      2   

Virginia

     15       Massachusetts      2   

Minnesota

     14       Kentucky      1   

New York

     12       New Jersey      1   
        

 

 

 

Ohio

     12       Total      257   
        

 

 

 

Initial lease terms for our properties are generally ten years, with the majority of the leases providing for an option to renew for two additional five-year terms. Nearly all of our leases provide for a minimum annual rent, and some of our leases call for additional rent based on sales volume at the particular location over specified minimum levels. Generally, the leases are net leases that require us to pay our share of the costs of real estate taxes, utilities, building operating expenses, insurance and other charges in addition to rent. For additional information regarding our leases, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations.”

As of September 23, 2012, we leased approximately 20,000 square feet of office space in Chicago, Illinois for our corporate headquarters under a lease expiring February 29, 2016.

 

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Intellectual Property and Trademarks

We regard our “Potbelly” and “Potbelly Sandwich Works” trademarks as having significant value and as being important factors in the marketing of our shops. We have also obtained trademarks for several of our other menu items, such as “A Wreck,” and for various advertising slogans, including “Good Vibes, Great Sandwiches” and “A First Class Dive.” We are aware of names and marks similar to the trademarks of ours used by other persons in certain geographic areas in which we have shops. However, we believe such uses will not adversely affect us. Our policy is to pursue registration of our intellectual property whenever possible and to oppose vigorously any infringement thereof.

We license the use of our registered trademarks to franchisees through franchise arrangements. The franchise arrangements restrict franchisees’ activities with respect to the use of our trademarks and impose quality control standards in connection with goods and services offered in connection with the trademarks.

Legal Proceedings

We are 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 our financial position or results of operations and cash flows.

 

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MANAGEMENT

Below is a list of the names, ages as of September 23, 2012, positions, and a brief account of the business experience, of the individuals who serve as the executive officers and directors as of the date of this prospectus.

 

Name

   Age     

Position

Aylwin Lewis

     58      

Director, Chief Executive Officer and President

John Morlock

     57      

Senior Vice President of Operations

Matthew Revord

     49      

Senior Vice President, General Counsel and Secretary

Carl Segal

     46      

Senior Vice President of Operations—Operations Support

Charles Talbot

     47      

Senior Vice President and Chief Financial Officer

Nancy Turk

     48      

Senior Vice President Human Resources and Corporate Communications

Bryant Keil

     48      

Director and Founding Chairman (2)(3)

Vann Avedisian

     48      

Director (3)

Peter Bassi

     63      

Director (1)

Gerald Gallagher

     71      

Director (3)

Marla Gottschalk

     52      

Director (1)(2)

Matthew Levine

     37      

Director (1)

Dan Levitan

     55      

Director (2)(3)

 

(1) Member of Audit Committee.

 

(2) Member of Nominating and Corporate Governance Committee.

 

(3) Member of Compensation Committee.

Aylwin Lewis has served as our Chief Executive Officer and President and a director since June 2008. From September 2005 to February 2008, Aylwin served as Chief Executive Officer and President of Sears Holdings Corporation. Prior to that, Aylwin was President of Sears Holdings and Chief Executive Officer of KMart and Sears Retail following Sears’ acquisition of KMart Holding Corporation in 2005. Aylwin had been President and Chief Executive Officer of KMart since October 2004 until that acquisition. From January 2003 to October 2004, he was President, Chief Multi-Branding and Operating Officer of Yum! Brands, Inc. and served as Chief Operating Officer of Yum! Brands from December 1999 to January 2003. Aylwin has over 26 years of experience in the restaurant industry. Aylwin is also a member of the board of directors of The Walt Disney Company. Our board of directors believes Aylwin’s qualifications to serve as a member include his role as Chief Executive Officer and President, his extensive experience in the restaurant industry and his leadership experience as an executive at publicly-traded companies in the restaurant and retail sectors.

John Morlock has been our Senior Vice President of Operations since December 2002. John has deep experience in the restaurant and retail industries. John started his career with S & A Restaurants from 1978 to 1983. He then went on to be an Operational Partner with Grady’s Goodtimes, a casual dining restaurant from 1983 to 1986. John became Director of Operations for the largest Blockbuster Franchisee and in 1991 became the Zone Vice President for Blockbuster Entertainment Corporation. John’s experience includes Senior Vice President of Operations of Boston Chicken, Inc. from 1992 to 1994 and then as a Midwest Franchisee with over 100 stores of Boston Market and Einstein Bros. Bagels until 1997. John has also served as Chief Executive Officer of Clubhouse International Inc., an owner and operator of three country club themed restaurants.

Matthew Revord has been our Senior Vice President, General Counsel and Secretary since January 2007 and oversees all legal matters of the company and international development. From January 2002 to January 2007, Matt served as Deputy General Counsel of Brunswick Corporation and General Counsel of Brunswick New Technologies. He began his career at the law firm of Kirkland & Ellis LLP and has worked with several

 

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Chicago-based companies, including Sears, Roebuck and Co. and True North Communications Inc., where he handled mergers and acquisitions, litigation and corporate securities. Matt is also a member of the board of directors of The Illinois Restaurant Association.

Carl Segal has been our Senior Vice President of Operations—Operations Support since August 2009 and has been an executive officer of Potbelly since 2000, including as Senior Vice President of Operations—Special Projects from March 2007 to August 2009 and as Chief Training and Recruiting Officer, Chief People Officer and Senior Vice President—Operations and Development. Carl has broad experience in the restaurant industry. He was a founding partner of Bistro Zinc restaurants in Chicago and previously served as a principal in the consulting firm of Segal Eslick Associates, Ltd. where he created and executed restaurant concepts for Boston Chicken, The Levy Restaurants and The Rosenthal Group/Sopraffina. Carl began his restaurant career with Lettuce Entertain You Enterprises, where he spent ten years managing restaurants and working on restaurant concepts such as Ed Debevic’s, Scoozi, Maggiano’s Little Italy and Foodlife.

Charles Talbot has been our Senior Vice President and Chief Financial Officer since October 2008. From March 2007 to September 2008, Charlie served as Vice President of Strategy, Corporate Planning and Development of Nuveen Investments, a global provider of investment services to institutional and individual investors. Prior to his role with Nuveen, Charlie spent nine years in the restaurant industry with Yum! Brands in various roles, including Vice President of Corporate Strategy and Mergers and Acquisitions, and as Chief Financial Officer of Long John Silver’s and A&W Restaurants.

Nancy Turk has been our Senior Vice President, Human Resources and Corporate Communications since September 2008. Nancy has extensive experience in Human Resources and Corporate Communications in retail, credit and manufacturing organizations. From 2005 to September 2008, Nancy served as the Divisional Vice President of Corporate Communications at Sears Holdings, and held various HR leadership roles at Sears Holdings since 1993, where she was involved in divestitures, mergers and acquisitions with Sears Credit, Lands’ End and KMart. Prior to joining Sears, Nancy led Human Resources for Packard Instrument Company and Ametek, Inc.

Bryant Keil has been our Founding Chairman since June 2011 and a director since 1996. Bryant currently serves as a director pursuant to our Stockholders Agreement. In 1996, Bryant acquired Potbelly Sandwich Works as a single unit operation on Lincoln Avenue in Chicago and has been instrumental in our expansion since then. Bryant is a 2007 Ernst & Young Entrepreneur of the Year Award recipient. He was named the 2003 Illinois Restaurateur of the Year by the Illinois Restaurant Association and was named a Henry Crown Fellow, a part of the Aspen Institute, in 2007. Bryant is currently a director of Vingette Beverage Company and a board member of The Field Museum of Natural History, Big Shoulders and The Chicago Entrepreneur Center. Our board of directors believes Bryant’s qualifications to serve as a member include his extensive experience in the restaurant industry and his historical perspective of our business and strategic challenges, including his leadership in expanding Potbelly to over 200 stores.

Vann Avedisian has served as our director since September 2001 and was appointed to the board of directors by Oxford Blackpoint Venture Partners VII, LLC pursuant to our Stockholders Agreement. Vann is a Principal of Highgate Holdings, a fully integrated real estate investment firm that has acquired more than $7 billion of real estate assets. Vann serves on Highgate’s Investment Committee, oversees the firm’s capital markets activities and serves as an integral member of the investment platform. Prior to joining Highgate, Vann co-founded Oxford Capital Partners and directed the firm’s real estate principal investments with an aggregate value in excess of $1 billion. Vann currently serves on the Board of Trustees of the William Blair Mutual Funds were he serves on the Audit and Nominating and Governance Committees. Vann was a Vice President at LaSalle Partners and a Director and Shareholder of Citizens National Bank of Lake Geneva. Our board of directors believes Vann’s qualifications to serve as a member of our board include his financial expertise, his knowledge of our business and his extensive experience in managing capital intensive operations, corporate finance and strategic advisory services.

 

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Peter Bassi has served as our director since January 2009 and was appointed to the board of directors by Maveron Equity Partners 2000, L.P., Maveron Equity Partners III, L.P. and their affiliated funds pursuant to our Stockholders Agreement. Peter retired in 2005 as Chairman of Yum! Restaurants International (“YRI”), the international division of Yum! Brands, Inc., where he served as President beginning in July 1997 and was in charge of YRI’s Asian business prior to that. Yum! was created in 1997 in a spin-off from PepsiCo, Inc. Peter joined PepsiCo in 1972 and served in various assignments at Pepsi Cola International, Pizza Hut (U.S. and International), Frito Lay and Taco Bell. From 2002 to 2009, Peter served on the board of The Pep Boys – Manny, Moe & Jack and from 2008 to 2010, he served on the board of El Pollo Loco, Inc. Peter currently serves on the board of BJ’s Restaurants, Inc. Our board of directors believes Peter’s qualifications to serve as a member of our board include his extensive experience in the restaurant industry and his years of experience in his leadership roles as a director and executive officer.

Gerald Gallagher has served as our director since November 2007 and was jointly appointed to the board of directors by Oak Investment Partners IX, Limited Partnership, and Benchmark Capital Partners IV, L.P., and each of their respective related entities pursuant to our Stockholders Agreement. Jerry has been involved with the retail industry for over 40 years, holding positions as an analyst, manager and venture capitalist. His career includes a Wall Street background at Donaldson, Lufkin & Jenrette where he was a retail industry analyst and an Institutional Investor Magazine “All American.” Jerry joined Oak Investment Partners, a venture capital partnership, in 1987, and through Oak has sponsored many restaurant and retail industry businesses, including Baja Fresh, Chamate, Cheddar’s Casual Café, Dick’s Sporting Goods, Jamba Juice, Office Depot, PetSmart, P.F. Chang’s China Bistro, Ulta Salon, Cosmetics & Fragrance and Whole Foods Market. Prior to joining Oak, Jerry was Vice Chairman of Dayton-Hudson Corporation where he served for ten years in both operating and staff positions. Jerry also served as an officer in the submarine service of the U.S. Navy. He is currently a director of six privately held companies. Our board of directors believes Jerry’s qualifications to serve as a member of our board include his extensive experience with the retail industry and his experience as an analyst, manager and venture capitalist.

Marla Gottschalk has served as our director since November 2009. She has served as Chief Executive Officer of The Pampered Chef Ltd., a marketer of kitchen tools, food products and cookbooks for preparing food in the home, since May 2006 and as its President and Chief Operating Officer since December 2003. Marla joined Pampered Chef from Kraft Foods, Inc., where she worked for 14 years in various management positions, including as Senior Vice President of Financial Planning and Investor Relations for Kraft, Executive Vice President and General Manager of Post Cereal Division and Vice President of Marketing and Strategy of Kraft Cheese Division. Marla is currently a member of the Board of Trustees of Underwriters Laboratories, a world leader in safety testing and certification, and has previously served as independent director of GATX Corp. and as a director of Visteon Corp. Our board of directors believes Marla’s qualifications to serve as a member of our board include her extensive experience with global companies, her expertise in the food industry and her years of experience in operations and strategic management.

Matthew Levine has served as our director since April 2009 and was appointed to the board of directors by ASP PBSW, LLC, an affiliate of American Securities, pursuant to our Stockholders Agreement. He is a Principal of American Securities and has been with the firm since 1999. Matthew’s private equity experience spans the industrial and consumer industry and particularly the restaurant segment where he has built expertise in restaurant franchising and expansion with both Potbelly and El Pollo Loco, Inc. Prior to American Securities, he was with Salomon Smith Barney in the Financial Entrepreneurs Group, focusing on leveraged buyouts and recapitalizations. Matthew is also a director of United Central Industrial Supply, Global Tel*Link and FiberMark, Inc. Our board of directors believes Matthew’s qualifications to serve as a member of our board include his extensive private equity experience in the industrial and consumer industry, particularly within the restaurant segment and his experience in leadership roles as a director.

Dan Levitan served as our director since September 2001 and was appointed to the board by the holders of our Series A Preferred Stock pursuant to our Stockholders Agreement. Dan has served as a co-founder and Managing Member of Maveron, a venture capital firm, since 1998. Prior to Maveron, he was a Managing

 

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Director at Schroder Wertheim & Co., an investment banking firm in New York, where he headed consumer investment banking, new business development and founded the West Coast investment banking division. Dan also serves on the boards of nine privately held companies and organizations. Our board of directors believes Dan’s qualifications to serve as a member of our board include his extensive venture capital experience, his industry and financial and real estate expertise and his years of experience providing strategic advisory services to complex organizations.

Board Composition

Our board of directors currently consists of eight directors, all of whom were elected as directors pursuant to our Stockholders Agreement. The Stockholders Agreement, including the provisions regarding the right of our stockholders to nominate and elect members of the board, will terminate upon the completion of this offering. See “Related Party Transactions—Arrangements with Our Investors—Stockholders Agreement.”

Upon completion of this offering, our board of directors will consist of nine members, including                     , and our certificate of incorporation will provide that our board of directors will consist of not more than twelve directors, as such number of directors may from time to time be fixed by our board of directors pursuant to our by-laws. Upon the completion of this offering, our certificate of incorporation will divide our board into three classes with staggered three-year terms. At each annual meeting of stockholders, the successors to directors whose terms then expire will be elected to serve from the time of election and qualification until the third annual meeting following election or until their earlier death, resignation or removal. Our classified board structure will be in effect for at least one full election cycle so that at the fifth annual meeting of stockholders, we will begin the process of phasing out our staggered elections.

Our certificate of incorporation, as amended and restated upon completion of the offering, will provide that directors may only be removed for cause. To remove a director for cause, 66-2/3% of the voting power of the outstanding voting stock must vote as a single class to remove the director at an annual or special meeting. The certificate will also provide that, if a director is removed or if a vacancy occurs due to either an increase in the size of the board or the death, resignation, disqualification or other cause, the vacancy will be filled solely by the affirmative vote of a majority of the remaining directors then in office, even if less than a quorum remain.

This classification of the board of directors, together with the ability of the stockholders to remove our directors only for cause and the inability of stockholders to call special meetings, may have the effect of delaying or preventing a change in control or management. See “Description of Capital Stock—Anti-Takeover Effects of Our Certificate of Incorporation and By-laws” for a discussion of other anti-takeover provisions that will be found in our certificate of incorporation.

Director Independence

Our board of directors has determined that all directors except Aylwin Lewis are “independent” as such term is defined by the Nasdaq Stock Market (“Nasdaq”), corporate governance standards and the federal securities laws.

Board Leadership Structure

Our board of directors does not have a formal policy on whether the roles of Chief Executive Officer and chairman of the board of directors should be separate. However, upon completion of this offering, Aylwin Lewis will serve as both Chief Executive Officer and Chairman. Our board of directors has carefully considered its leadership structure and believes at this time that the company and its stockholders are best served by having one person serve both positions. We believe that combining the roles fosters accountability, effective decision-making and alignment between interests of the board of directors and management. Aylwin also is able to use the in-depth focus and perspective gained in his executive function to assist our board of directors in addressing both internal and external issues affecting the company.

 

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Our board of directors determined as part of our corporate governance principles, and our by-laws will provide, that the chairperson of our nominating and governance committee will serve as lead independent director. The by-laws also will provide that the chairperson of each of our committees will rotate every three years, so that our board of directors will have a new lead director every three years. The lead director will, among other responsibilities, preside over periodic meetings of our independent directors and oversee the function of our board of directors and committees. Further, our board of directors believes that its other structural features, including only one non-independent director and key committees consisting entirely of independent directors, provide for substantial independent oversight of the company’s management.

Our board of directors recognizes that depending on future circumstances, other leadership models may become more appropriate. Accordingly, our board of directors will continue to periodically review its leadership structure.

Board Committees

Our board of directors has established three standing committees to assist it with its responsibilities. The composition and responsibilities of each committee are described below. Members will serve on these committees until their resignation or until otherwise determined by our board of directors. Furthermore, the chairperson of each committee will rotate every three years. In the future, the board may establish other committees, as it deems appropriate, to assist it with its responsibilities.

Audit Committee

The purpose of the audit committee will be set forth in the audit committee charter and will be primarily to assist the board in overseeing: