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As filed with the Securities and Exchange Commission on August 29, 2013

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 J. 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 Jennifer J. Carlson 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, offered by the Registrant		$		$
Common Stock, $0.01 par value per share, offered by the selling stockholders		$		$
Total		$75,000,000		$10,230

(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.

 

 

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.

 

 

 

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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 August 29, 2013

PROSPECTUS

             Shares

 

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 “PBPB.”

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 12 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.

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             , 2013.

 

 

 

BofA Merrill Lynch					Goldman, Sachs & Co.
Baird		William Blair			Piper Jaffray

 

 

The date of this prospectus is             , 2013.

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Prospectus Summary			1
Summary Consolidated Financial and Other Data			8
Risk Factors			12
Cautionary Note Regarding Forward-Looking Statements			29
Use of Proceeds			31
Dividend Policy			31
Capitalization			32
Dilution			34
Selected Consolidated Financial and Other Data			36
Management’s Discussion and Analysis of Financial Condition and Results of Operations			39
Business			60
Management			76
Executive and Director Compensation			83
Related Party Transactions			100
Description of Credit Facility			103
Principal and Selling Stockholders			104
Description of Capital Stock			108
Shares Eligible For Future Sale			113
Material U.S. Federal Income Tax Considerations For Non-U.S. Holders			115
Underwriting			119
Legal Matters			126
Experts			126
Where You Can Find More Information			126
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.

Until                 , 2013 all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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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 reliable as of the date of this prospectus. You should carefully consider the inherent risks and uncertainties associated with the market and other industry data contained in this prospectus.

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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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, which increased the price of certain food commodities, including beef. We have partially offset these costs by increasing menu prices. Other events could increase commodity prices or cause shortages that could affect the cost and quality of the items we buy or require us to further 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

 

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amount of time and money on training our employees. Any inability to recruit and retain qualified individuals 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 and secure 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 31 new company-operated shops in 2012 and expect to open 32 to 35 new company-operated shops in 2013. We must identify target markets where we can enter or expand, taking into account numerous factors such as the location of our current shops, demographics, traffic patterns and information gathered from local employees. We may not be able to open our planned new shops on a timely basis, if at all, given the uncertainty of these factors. In the past, we have experienced delays in opening some shops and that could happen again. Delays or failures in opening new restaurants could adversely affect our business and results of operations. As we operate more shops, our rate of expansion relative to the size of our restaurant base will eventually decline.

The number and timing of new shops opened during any given period may be negatively impacted by a number of factors including, without limitation:

 

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

 

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competition in new markets, including competition for appropriate sites;

 

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anticipated commercial, residential and infrastructure development near our new shops;

 

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the proximity of potential sites to an existing shop;

 

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

 

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

 

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

 

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

 

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

 

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avoiding the impact of inclement weather, natural disasters and other calamaties.

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 and secure attractive locations, build name recognition, successfully market our brand or attract new customers. 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.

 

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Our expansion into new markets may present increased risks.

We plan to open shops in markets where we have little or no operating experience. Shops we open in new markets may take longer to reach expected sales and profit levels on a consistent basis and may have higher construction, occupancy or operating costs than shops we open in existing markets, thereby affecting our overall profitability. New markets may have competitive conditions, consumer tastes and discretionary spending patters that are more difficult to predict or satisfy than our existing markets. We may need to make greater investments than we originally planned in advertising and promotional activity in new markets to build brand awareness. We may find it more difficult in new markets to hire, motivate and keep qualified employees who share our values. We may also incur higher costs from entering new markets if, for example, we assign area managers to manage comparatively fewer shops than we assign in more developed markets. As a result, these new shops may be less successful or may achieve target shop-level profit margins at a slower rate. If we do not successfully execute our plans to enter new markets, our business, financial condition or results of operations could be adversely affected.

New shops, once opened, may not be profitable, and the increases in comparable store sales that we have experienced in the past may not be indicative of future results.

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. 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. 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. For example, in 2011, 2012 and the 26 weeks ended June 30, 2013, we closed five shops, one shop and one shop, respectively, due to under-performance or lease expirations. If our new shops do not perform as planned, our business and future prospects could be harmed. In addition, if we are unable to achieve our expected comparable store sales, our business, financial condition or results of operations could be adversely affected.

Our sales and profit growth could be adversely affected if comparable store sales are less than we expect.

The level of comparable store sales, which represent the change in year-over-year sales for company-operated shops open for 15 months or longer, will affect our sales growth and will continue to be a critical factor affecting profit growth. Our ability to increase comparable store sales depends in part on our ability to successfully implement our initiatives to build sales. It is possible such initiatives will not be successful, that we will not achieve our target comparable store sales growth or that the change in comparable store sales could be negative, which may cause a decrease in sales and profit growth that would adversely affect our business, financial condition or results of operations.

Our failure to manage our growth effectively could harm our business and operating results.

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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 may not be able to respond on a timely basis to all of the 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, which could harm our business, financial condition or results of operations.

The planned rapid increase in the number of our shops may make our future results unpredictable.

In 2013, we have or plan to open between 32 and 35 company-operated shops and between seven and ten franchisee-operated shops, and we plan to continue to increase the number of our shops in the next several years. This growth strategy and the substantial investment associated with the development of each new shop may cause our operating results to fluctuate and be unpredictable or adversely affect our profits. Our future results depend on various factors, including successful selection of new markets and shop locations, local market acceptance of our shops, consumer recognition of the quality of our food and willingness to pay our prices, the quality of our operations and general economic conditions. In addition, as has happened when other restaurant concepts have tried to expand, we may find that our concept has limited appeal in new markets or we may experience a decline in the popularity of our concept in the markets in which we operate. Newly opened shops or our future markets and shops may not be successful or our average net sandwich shop sales may not increase at historical rates, which could adversely affect our business, financial condition or results of operations.

Opening new shops in existing markets may negatively affect sales at our existing shops.

The consumer target area of our shops varies by location, depending on a number of factors, including population density, other local retail and business attractions, area demographics and geography. As a result, the opening of a new shop in or near markets in which we already have shops could adversely affect the sales of those existing shops. Existing shops could also make it more difficult to build our consumer base for a new shop in the same market. Our business strategy does not entail opening new shops that we believe will materially affect sales at our existing shops, but we may selectively open new shops in and around areas of existing shops that are operating at or near capacity to effectively serve our customers. Sales cannibalization between our shops may become significant in the future as we continue to expand our operations and could affect our sales growth, which could, in turn, adversely affect our business, financial condition or results of operations.

We are subject to risks associated with leasing property subject to long-term non-cancelable leases.

We do not own any real property and all of our company-owned shops are located in leased premises. The leases for our shop locations generally have initial terms of 10 years and typically provide for two renewal options in five-year increments as well as for rent escalations. Generally, our 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. We generally cannot cancel these leases. Additional sites that we lease are likely to be subject to similar long-term non-cancelable leases. If we close a shop, we nonetheless may be obligated to perform our monetary obligations under the applicable lease, including, among other things, payment of the base rent for the balance of the lease term. In addition, as each of our leases expire, we may fail to negotiate renewals, either on commercially acceptable terms or at all, which could cause us to close shops in desirable locations.

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.

 

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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 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 69% of our total domestic shops as of June 30, 2013. Shops located in the Chicago metropolitan area comprised approximately 27% 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. Thirty-nine

 

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shops were closed for at least one day and three shops remained closed for a period of approximately three to five months. A total of 269 and 377 full shop operating days were lost by December 30, 2012 and June 30, 2013, respectively. 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.

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.

 

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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 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

 

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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.

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 2012, we purchased all of our bread from one supplier, Campagna-Turano Bakery, Inc., and more than 95% of our meat products from nine suppliers. In addition, we contract with Distribution Market Advantage, Inc., or DMA, a cooperative of multiple food distributors located throughout the nation to provide the majority of our food distribution services in the U.S. Although we believe that alternative supply and distribution sources are available, there can be no assurance that we will be able to identify or negotiate with such sources on terms that are commercially reasonable to us. If our suppliers or distributors are unable to fulfill their obligations under their contracts or we are unable to identify alternative sources, we could encounter supply shortages and incur higher costs. See “Business—Sourcing and Supply Chain.”

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

 

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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.

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.

 

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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.

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.

Unionization activities or labor disputes may disrupt our operations and affect our profitability.

Although none of our employees are currently covered under collective bargaining agreements, our employees may elect to be represented by labor unions in the future. If a significant number of our employees were to become unionized and collective bargaining agreement terms were significantly different from our

 

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current compensation arrangements, it could adversely affect our business, financial condition or results of operations. In addition, a labor dispute involving some or all of our employees may harm our reputation, disrupt our operations and reduce our revenues, and resolution of disputes may increase our costs.

As an employer, we may be subject to various employment-related claims, such as individual or class actions or government enforcement actions relating to alleged employment discrimination, employee classification and related withholding, wage-hour, labor standards or healthcare and benefit issues. Such actions, if brought against us and successful in whole or in part, may affect our ability to compete or could adversely affect our business, financial condition or 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.

In addition, franchisees may not have access to the financial or management resources that they need to open the shops contemplated by their agreements with us, or be able to find suitable sites on which to develop them, or they may elect to cease development for other reasons. Franchisees may not be able to negotiate acceptable lease or purchase terms for the sites, obtain the necessary permits and governmental approvals or meet construction schedules. Any of these problems could slow our growth from franchise operations and reduce our franchise revenues. Additionally, financing from banks and other financial institutions may not always be available to franchisees to construct and open new shops. The lack of adequate financing could adversely affect the number and rate of new shop openings by our franchisees and adversely affect our future franchise revenues.

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:

 

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

 

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

 

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

 

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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;

 

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

 

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

 

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

 

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changes in accounting principles;

 

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litigation and governmental investigations;

 

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

 

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a food-borne illness outbreak;

 

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natural disasters and other calamities; and

 

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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:

 

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our board initially will be classified into three classes of directors with only one class subject to election each year, with the classified board being phased out by our fifth annual meeting of stockholders following the completion of this offering;

 

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

 

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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;

 

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

 

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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;

 

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

 

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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 June 30, 2013 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 regular 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, except for the previously-declared cash dividend payable on shares of our common and preferred stock outstanding on the day immediately prior to the closing date of this offering, 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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Our principal stockholders and their affiliates own a substantial portion of our outstanding equity, and their interests may not always coincide with the interests of other holders.

As of June 30, 2013, beneficial owners of 5.0% or more of our outstanding shares owned in the aggregate shares representing approximately 82% of our outstanding voting power, assuming the conversion of all outstanding shares of all series of our preferred stock into, and the exercise of all outstanding Series F warrants for, shares of our common stock. Persons associated with certain of these stockholders currently serve and, following the offering, will continue to serve on our board of directors. In particular, after the offering Maveron Equity Partners 2000, L.P., Maveron Equity Partners III, L.P. and their affiliated funds (the “Maveron Entities”) will beneficially own, in the aggregate, shares representing approximately     % of our outstanding voting power. If the underwriters exercise their over-allotment option in full, after this offering the Maveron Entities will beneficially own, in the aggregate, shares representing approximately     % of our outstanding voting power. As a result, the Maveron Entities, together with certain other stockholders, could potentially have significant influence over all matters presented to our stockholders for approval, including election and removal of our directors and change in control transactions. The interests of such stockholders may not always coincide with the interests of the other holders of our common stock.

A majority of the proceeds we receive in this offering will be paid to related parties and our management will have broad discretion over the use of the remaining proceeds and might not apply those proceeds in ways that increase the value of your investment.

We intend to use approximately $49.9 million of the net proceeds we receive in this offering to pay a dividend to the holders of our capital stock outstanding on the day immediately prior to the closing date of this offering, leaving us with net proceeds of approximately $        . Our executive officers, directors, beneficial owners of 5.0% or more of our outstanding shares of capital stock, and affiliated entities, will receive approximately $43.0 million, or 86.2%, of such dividend amount. As a result, a majority of the net proceeds we receive in the offering will not be available to us to use to grow our business or for other uses beneficial to the company. Our management will have broad discretion to use the remaining net proceeds from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds.

 

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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 and secure 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;

 

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•

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

 

•

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 approximately $49.9 million of the net proceeds to pay a previously-declared cash dividend on shares of our common and preferred stock outstanding on the day immediately prior to the closing date of this offering, leaving us with net proceeds of approximately $        . Our executive officers, directors, beneficial owners of 5.0% or more of our outstanding shares of capital stock, and affiliated entities, will receive approximately $43.0 million, or 86.2%, of such dividend amount. We intend to use the remaining net proceeds from this offering for working capital and general corporate purposes, such as to continue to maintain our existing shops and to support our growth, primarily through opening new shops. Pending such use, we may use such net proceeds to temporarily reduce borrowings under our credit facility, which expires in September 2017. As of June 30, 2013, we had $14.0 million outstanding under the credit facility with a weighted average interest rate of 1.35%. 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

Our board of directors declared a cash dividend in an aggregate amount of approximately $49.9 million, which is payable on shares of our common and preferred stock outstanding on the day immediately prior to the closing date of this offering and will be paid out of a portion of the net proceeds of the offering. The dividend will not be paid on any shares purchased in this offering.

Other than the dividend described above, we do not currently intend to 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 June 30, 2013:

 

•

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 Series F warrants for, common stock immediately prior to this offering and our board of directors’ declaration of a cash dividend to holders of our common and preferred shares to be paid from the net proceeds of the initial public 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,” including the payment of the previously-declared cash dividend on shares of our common and preferred stock outstanding on the day immediately prior to the closing date of this offering, as if the events had occurred on June 30, 2013.

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 June 30, 2013
		Actual				Pro Forma (1)				Pro Forma As Adjusted (1)
		(in thousands)
Cash and cash equivalents		$	21,746			$	21,747
Long-term debt, including current portion:
Credit facility		$	14,000			$	14,000
Note payable			1,132				1,132
Total long-term debt			15,132				15,132
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 10,000,000 shares authorized and no shares issued and outstanding on a pro forma as adjusted basis			260,644				—
Equity (deficit):
Common stock, $0.01 par value—35,500,000 shares authorized and 4,248,360 issued and outstanding on an actual basis; 35,500,000 shares authorized and 20,631,941 shares issued and outstanding on a pro forma basis; and 200,000,000 shares authorized and              shares issued and outstanding on a pro forma as adjusted basis			42				206
Warrants			1,474				908
Additional paid-in-capital			—				211,194
Accumulated deficit			(176,822	)			(176,822	)
Total stockholders’ equity (deficit)			(175,306	)			35,486
Non-controlling interests			211				211
Total equity (deficit)			(175,095	)			35,697
Total capitalization		$	100,681			$	50,829

 

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(1)

Assumes the effect of our board of directors’ declaration of a cash dividend to holders of our common and preferred shares to be paid from the net proceeds of the initial public offering and conversion of all outstanding shares of all series of our preferred stock into, and the exercise of all outstanding Series F warrants for, an aggregate of 16,383,581 shares of common stock immediately prior to the completion of this offering, and excludes, as of August 26, 2013, outstanding options to purchase 4,748,737 shares of our common stock at a weighted average exercise price of $8.99 per share, of which options to purchase 4,249,257 shares at a weighted average exercise price of $8.62 were vested as of such date, and an exercisable warrant to purchase 241,704 shares of our common stock at a price of $8.16 per share. See “Executive and Director Compensation” and “Related Party Transactions.”

 

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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 June 30, 2013 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 Series F 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 Series F 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 June 30, 2013 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 June 30, 2013		$
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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The following table sets forth, as of June 30, 2013, 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 Series F warrants for, an aggregate of 16,383,581 shares of common stock immediately prior to the completion of this offering and excludes, as of August 26, 2013:

 

•

outstanding options to purchase 4,748,737 shares of our common stock at a weighted average exercise price of $8.99 per share, of which options to purchase 4,249,257 shares at a weighted average exercise price of $8.62 were vested as of such date, and an exercisable warrant to purchase 241,704 shares of our common stock at a price of $8.16 per share; and

 

•

1,500,000 shares of our common stock reserved for future grants under our 2013 Long-Term Incentive Plan, including options to purchase 395,000 shares of our common stock with exercise prices equal to the initial public offering price to be granted effective 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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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 30, 2012 and December 25, 2011 and for each of the two fiscal years in the period ended December 30, 2012 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 26, 2010, December 27, 2009 and December 28, 2008 and for the fiscal years then ended have been derived from our audited consolidated financial statements for such years, all of which are not included in this prospectus, except for the consolidated statement of operations for the fiscal year ended December 26, 2010. The selected consolidated interim financial data as of and for the 26 weeks ended June 30, 2013 and for the 26 weeks ended June 24, 2012 have been derived from the unaudited condensed interim consolidated financial statements included elsewhere in this prospectus. 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, December 26, 2010, December 27, 2009 and December 28, 2008 all had 52 weeks. The fiscal year ending December 30, 2012 had 53 weeks.

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																				26 Weeks Ended
		December 28, 2008				December 27, 2009				December 26, 2010				December 25, 2011				December 30, 2012				June 24, 2012				June 30, 2013
		($ in thousands, except per share data)
Consolidated Statements of Operations Data:
Total Revenues		$	207,686			$	214,733			$	220,573			$	237,966			$	274,914			$	131,537			$	146,930
Expenses:
Sandwich shop operating expenses:
Cost of goods sold, excluding depreciation			62,612				61,700				63,009				68,491				79,847				38,151				42,753
Labor and related expenses			66,756				63,939				63,506				67,036				77,479				36,841				40,995
Occupancy expenses			23,429				25,574				25,238				26,511				32,016				14,750				17,530
Other operating expenses			22,752				22,373				22,620				24,095				28,119				13,449				15,112
General and administrative expenses			30,785				27,840				26,563				26,911				29,624				15,668				16,005
Depreciation expense			17,599				17,586				15,647				14,838				16,219				7,553				8,824
Pre-opening costs			1,887				95				267				1,521				2,051				1,130				719
Impairment and loss on disposal of property and equipment			2,852				5,511				2,952				365				994				78				79
Total expenses			228,672				224,618				219,802				229,768				266,349				127,620				142,017
Income (loss) from operations			(20,986	)			(9,885	)			771				8,198				8,565				3,917				4,913
Interest expense (income)			681				828				519				495				541				251				233
Other expense			20				4				9				1				6				—				2
Income (loss) before income taxes			(21,687	)			(10,717	)			243				7,702				8,018				3,666				4,678
Income tax expense (benefit) (1)			121				219				773				537				(15,994	)			682				1,886
Net income (loss)			(21,808	)			(10,936	)			(530	)			7,165				24,012				2,984				2,792
Net income (loss) attributable to non-controlling interests (2)			—				—				—				—				(34	)			(39	)			15
Net income (loss) attributable to Potbelly Corporation		$	(21,808	)		$	(10,936	)		$	(530	)		$	7,165			$	24,046			$	3,023			$	2,777
Accretion of redeemable convertible preferred stock to maximum redemption value			8,814				(14,568	)			(45,992	)			(17,410	)			(10,495	)			(8,342	)			(10,301	)
Net income (loss) attributable to common stockholders		$	(12,994	)		$	(25,504	)		$	(46,522	)		$	(10,245	)		$	13,551			$	(5,319	)		$	(7,524	)

 

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		Fiscal Year Ended																				26 Weeks Ended
		December 28, 2008				December 27, 2009				December 26, 2010				December 25, 2011				December 30, 2012				June 24, 2012				June 30, 2013
		($ in thousands, except per share data)
Net income (loss) per common share attributable to common stockholders (3):
Basic		$	(4.40	)		$	(5.13	)		$	(9.34	)		$	(2.35	)		$	0.72			$	(1.34	)		$	(1.77	)
Diluted		$	(4.40	)		$	(5.13	)		$	(9.34	)		$	(2.35	)		$	0.66			$	(1.34	)		$	(1.77	)
Weighted average shares outstanding:
Basic			4,960,984				4,975,511				4,978,621				4,359,930				4,013,414				3,972,873				4,241,752
Diluted			4,960,984				4,975,511				4,978,621				4,359,930				4,388,822				3,972,873				4,241,752
Statement of Cash Flows Data:
Net cash provided by (used in):
Operating activities		$	5,195			$	11,277			$	18,780			$	20,121			$	25,085			$	12,050			$	13,755
Investing activities			(24,856	)			(4,385	)			(6,243	)			(17,758	)			(25,936	)			(12,790	)			(14,411	)
Financing activities			21,219				5,152				(4,382	)			(7,197	)			(700	)			173				(193	)
Selected Other Data:
Total company-operated shops (end of period)			214				213				218				234				264				247				280
Change in company-operated comparable store sales			(4.3	)%			(2.4	)%			1.8	%			1.7	%			3.4	%			4.8	%			1.5	%
Operating income margin (4)			(10.1	)%			(4.6	)%			0.3	%			3.4	%			3.1	%			3.0	%			3.3	%
Shop-level profit margin (5)			15.5	%			19.2	%			20.9	%			21.6	%			20.7	%			21.3	%			20.5	%
Capital expenditures		$	24,856			$	4,398			$	6,243			$	17,758			$	25,936			$	12,790			$	14,411
Adjusted EBITDA (6)		$	4,038			$	15,732			$	21,052			$	26,752			$	31,451			$	14,907			$	16,183
Adjusted EBITDA margin (6)			1.9	%			7.3	%			9.5	%			11.2	%			11.4	%			11.3	%			11.0	%

 

		December 28, 2008				December 27, 2009				December 26, 2010				December 25, 2011				December 30, 2012				June 30, 2013
		($ in thousands)
Balance Sheet Data:
Cash and cash equivalents		$	8,781			$	20,825			$	28,980			$	24,146			$	22,595			$	21,746
Working capital (deficit)			(4,142	)			6,014				14,764				16,490				15,170				14,490
Total assets			107,440				101,976				98,424				99,110				126,699				132,560
Total debt			13,440				13,544				9,313				15,243				15,169				15,132
Total redeemable convertible preferred stock			167,983				182,551				228,544				239,848				250,343				260,644
Total equity (deficit)			(105,859	)			(124,712	)			(169,643	)			(185,302	)			(168,728	)			(175,095	)

 

(1)	The fiscal year ended December 30, 2012 included a $16.9 million tax benefit related to the release of a valuation allowance against substantially all of our deferred tax assets.

(2)

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.

(3)

Net income (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. Except for 2012, 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.

(4)	Income (loss) from operations as a percentage of total revenues.

(5)

Shop-level profit is not required by, or presented in accordance with, U.S. generally accepted accounting principles, or GAAP, and is defined as income (loss) from operations less franchise royalties and fees, general and administrative expenses, depreciation expense, pre-opening costs and impairment and loss on disposal of property and equipment. Shop-level profit is a supplemental measure of operating performance of our shops and our calculation thereof may not be comparable to that reported by other companies. Shop-level profit margin represents shop-level profit expressed as a percentage of net company-operated sandwich shop sales. Shop-level profit and shop-level profit margin have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. Management believes shop-level profit margin is an important tool for investors 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 at our shops, to evaluate our shop performance across periods and to evaluate our shop financial performance compared with our competitors. See “Management’s Discussion and Analysis of Financial Condition and Results of

 

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Operations” for a discussion of shop-level profit margin and other key performance indicators. A reconciliation of shop-level profit to income (loss) from operations and a calculation of shop-level profit margin is provided below:

 

		Fiscal Year Ended																				26 Weeks Ended
		December 28, 2008				December 27, 2009				December 26, 2010				December 25, 2011				December 30, 2012				June 24, 2012				June 30, 2013
		($ in thousands)
Income (loss) from operations		$	(20,986	)		$	(9,885	)		$	771			$	8,198			$	8,565			$	3,917			$	4,913
Less: Franchise royalties and fees			—				—				—				503				844				343				463
General and administrative expenses			30,785				27,840				26,563				26,911				29,624				15,668				16,005
Depreciation expense			17,599				17,586				15,647				14,838				16,219				7,553				8,824
Pre-opening costs			1,887				95				267				1,521				2,051				1,130				719
Impairment and loss on disposal of property and equipment			2,852				5,511				2,952				365				994				78				79
Shop-level profit [Y]		$	32,137			$	41,147			$	46,200			$	51,330			$	56,609			$	28,003			$	30,077
Total revenues		$	207,686			$	214,733			$	220,573			$	237,966			$	274,914			$	131,537			$	146,930
Less: Franchise royalties and fees			—				—				—				503				844				343				463
Sandwich shop sales, net [X]		$	207,686			$	214,733			$	220,573			$	237,463			$	274,070			$	131,194			$	146,467
Shop-level profit margin [Y÷X]			15.5	%			19.2	%			20.9	%			21.6	%			20.7	%			21.3	%			20.5	%

 

(6)

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, provision for income taxes and pre-opening costs, adjusted to eliminate the impact of other items set forth in the reconciliation below, including certain non-cash as well as certain 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																				26 Weeks Ended
		December 28, 2008				December 27, 2009				December 26, 2010				December 25, 2011				December 30, 2012				June 24, 2012				June 30, 2013
		($ in thousands)
Net income (loss) attributable to Potbelly Corporation		$	(21,809	)		$	(10,936	)		$	(530	)		$	7,165			$	24,046			$	3,023			$	2,777
Depreciation expense			17,599				17,586				15,647				14,838				16,219				7,553				8,824
Interest expense			681				828				519				495				541				251				233
Income tax expense (benefit)			121				219				773				537				(15,994	)			682				1,886
Impairment and closures (a)			3,343				6,824				3,344				672				1,181				265				87
Pre-opening costs (b)			1,887				95				267				1,521				2,051				1,130				719
Stock-based compensation (c)			2,216				1,116				1,032				1,524				2,825				1,893				1,142
Costs associated with an initial public offering (d)			—				—				—				—				582				110				515
Adjusted EBITDA		$	4,038			$	15,732			$	21,052			$	26,752			$	31,451			$	14,907			$	16,183

 

(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.

(d)	Includes costs associated with legal, accounting and other costs associated with the initial public offering that are not directly related to our registration statement.

 

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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 included elsewhere in this prospectus. 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 2012, 2011 and 2010 are references to fiscal years ended December 30, 2012, December 25, 2011 and December 26, 2010, respectively. Fiscal year 2012 included 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 toasty warm sandwiches, signature salads and other fresh menu items served by engaging people in an environment that reflects the Potbelly brand. Our combination of product, people and place is how we deliver on our passion to be “The Best Place for Lunch.” Our sandwiches, salads and hand-dipped milkshakes are all made fresh to order and our cookies are baked fresh each day. Our employees are trained to engage with our customers in a genuine way to provide a personalized experience. Our shops feature vintage design elements and locally-themed décor inspired by the neighborhood that we believe create a lively atmosphere. Through this combination, we believe we are creating a devoted base of Potbelly fans that return again and again and that we are expanding one sandwich shop at a time.

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

 

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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 combination of excellent product, people and place. The following competitive strengths provide a platform for us to achieve continued growth:

 

•

Simple, Made-to-Order Food. Our menu features items made from high quality ingredients such as fresh vegetables, hearth-baked bread, and all-natural chicken (without preservatives or artificial flavors). Our sandwiches are made fresh to order and served toasty warm on our signature multigrain wheat or regular bread which is delivered to our shops. Our menu also features a variety of cookies baked fresh daily in each shop, and our hand-dipped shakes, malts and smoothies are made from real ingredients. We believe the unique Potbelly experience encourages repeat customer visits and drives increased sales.

 

•

Differentiated Customer Experience That Delivers a Neighborhood Feel. We strive to provide a positive customer experience that is driven by both our employees and the atmosphere of our shops. We look to hire employees that are outgoing people and train them to interact with our customers in a genuine way while providing fast service. We believe our atmosphere is enhanced by live, local musicians that perform at least three times per week in the majority of our shops. Every Potbelly location strives to the “The Neighborhood Sandwich Shop,” creating devoted fans who tell others about their experience.

 

•

Attractive Shop Economics. Our shop model is designed to generate, and has generated, strong cash flow, with above 20% shop-level profit margins, a non-GAAP measure, and targeted cash-on-cash returns, on new company-operated shops, above 25% after two full years of operation. We have achieved these targets in 2010, 2011, 2012 and the 26 weeks ended June 30, 2013. Our ability to maintain such margins and returns depends on a number of factors. For example, we face increasing commodity costs, which we have partially offset by increasing menu prices. Although there is no guarantee that we will be able to maintain these returns, we believe our shop economics support our ability to profitably grow our brand in new and existing markets.

 

•

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 17 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 experienced 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. We believe our culture is a key to our success. It is embodied in The Potbelly Advantage, which is an 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 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.”

 

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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.

Company-Operated 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, December 25, 2011 and December 30, 2012 and the 26 weeks ended June 24, 2012 and June 30, 2013, there were 211, 211, 227 and 214 and 239 shops, respectively, in our comparable company-operated 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. Entrees 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. Shop-level profit margin is not required by, or presented in accordance with, GAAP. 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.

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.

 

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

 

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26 Weeks Ended June 30, 2013 Compared to 26 Weeks Ended June 24, 2012

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

 

		26 Weeks Ended
		June 24, 2012				% of Revenues				June 30, 2013				% of Revenues				Increase (Decrease)				Percent Change
Revenues
Sandwich shop sales, net		$	131,194				99.7	%		$	146,467				99.7	%			15,273				11.6	%
Franchise royalties and fees			343				0.3				463				0.3				120				35.0
Total revenues			131,537				100.0				146,930				100.0				15,393				11.7
Expenses
Sandwich shop operating expenses
Cost of goods sold, excluding depreciation			38,151				29.0				42,753				29.1				4,602				12.1
Labor and related expenses			36,841				28.0				40,995				27.9				4,154				11.3
Occupancy expenses			14,750				11.2				17,530				11.9				2,780				18.8
Other operating expenses			13,449				10.2				15,112				10.3				1,663				12.4
General and administrative expenses			15,668				11.9				16,005				10.9				337				2.2
Depreciation expense			7,553				5.7				8,824				6.0				1,271				16.8
Pre-opening costs			1,130				0.9				719				0.5				(411	)			(36.4	)
Impairment and loss on disposal of property and equipment			78				0.1				79				0.1				1				1.3
Total expenses			127,620				97.0				142,017				96.7				14,397				11.3
Income from operations			3,917				3.0				4,913				3.3				996				25.4
Interest expense			251				0.2				233				0.2				(18	)			(7.2	)
Other expense (income)			—				*				2				*				2				100.0
Income before income taxes			3,666				2.8				4,678				3.2				1,012				27.6
Income tax expense			682				0.5				1,886				1.3				1,204				176.5
Net income			2,984				2.3				2,792				1.9				(192	)			(6.4	)
Net income (loss) attributable to non-controlling interests			(39	)			*				15				*				54				(138.5	)
Net income attributable to Potbelly Corporation			3,023				2.3				2,777				1.9				(246	)			(8.1	)
Accretion of redeemable convertible preferred stock to maximum redemption value			(8,342	)			(6.3	)			(10,301	)			(7.0	)			(1,959	)			23.5
Net loss attributable to common stockholders		$	(5,319	)			(4.0	)%		$	(7,524	)			(5.1	)%		$	(2,205	)			41.5	%

 

*	Amount is less than 0.1%

Revenues

Revenues increased by $15.4 million, or 11.7%, to $146.9 million during the 26 weeks ended June 30, 2013, from $131.5 million during the 26 weeks ended June 24, 2012. Company-operated non-comparable store sales contributed $13.4 million, or 87.0%, of the total revenue increase, company-operated comparable store sales contributed $1.9 million, or 12.0%, of the total revenue increase, and franchise shops contributed $0.1 million, or 0.8%, of the total revenue increase. Comparable store sales increased 1.5% as a result of a 2.6% increase in average check, due to a menu price increase and shift in menu mix, and a 1.1% decrease in entree counts.

 

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Cost of Goods Sold

Cost of goods sold increased by $4.6 million, or 12.1%, to $42.8 million during the 26 weeks ended June 30, 2013, compared to $38.2 million during the 26 weeks ended June 24, 2012, primarily due to the increase in revenues. As a percentage of revenues, cost of goods sold increased slightly to 29.1% during the 26 weeks ended June 30, 2013, from 29.0% during the 26 weeks ended June 24, 2012, primarily driven by higher commodity costs.

Labor and Related Expenses

Labor and related expenses increased by $4.2 million, or 11.3%, to $41.0 million during the 26 weeks ended June 30, 2013, from $36.8 million during the 26 weeks ended June 24, 2012, primarily due to new shop openings. As a percentage of revenues, labor and related expenses decreased to 27.9% during the 26 weeks ended June 30, 2013, from 28.0% during the 26 weeks ended June 24, 2012, primarily due to sales leverage (i.e., the ability to spread certain expenses over a higher revenue base).

Occupancy Expenses

Occupancy expenses increased by $2.8 million, or 18.8%, to $17.5 million during the 26 weeks ended June 30, 2013, from $14.8 million during the 26 weeks ended June 24, 2012, primarily due to new shop openings. As a percentage of revenues, occupancy expenses increased to 11.9% during the 26 weeks ended June 30, 2013, from 11.2% during the 26 weeks ended June 24, 2012, due to more shops in higher rent markets, specifically New York City and Boston. There were 19 company-operated shops in New York City and Boston as of June 30, 2013, compared to ten company-operated shops as of June 24, 2012.

Other Operating Expenses

Other operating expenses increased by $1.7 million, or 12.4%, to $15.1 million during the 26 weeks ended June 30, 2013, from $13.4 million during the 26 weeks ended June 24, 2012, primarily 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, other operating expenses increased slightly to 10.3% during the 26 weeks ended June 30, 2013, from 10.2% during the 26 weeks ended June 24, 2012, primarily due to the increase in credit card usage and production timing of in-shop marketing promotion materials.

General and Administrative Expenses

General and administrative expenses increased by $0.3 million, or 2.2%, to $16.0 million during the 26 weeks ended June 30, 2013, from $15.7 million during the 26 weeks ended June 24, 2012. The increase was primarily due to an increase of $0.1 million for our General Manager conference in Chicago and an increase from initial public offering planning costs, partially offset by a decrease of $0.8 million in stock compensation expense primarily related to warrants issued during the 26 weeks ended June 24, 2012. As a percentage of revenues, general and administrative expenses decreased to 10.9% during the 26 weeks ended June 30, 2013, from 11.9% during the 26 weeks ended June 24, 2012, primarily due to lower stock compensation expense and sales leverage (i.e., the ability to spread certain expenses over a higher revenue base).

Depreciation Expense

Depreciation expense increased by $1.3 million, or 16.8%, to $8.8 million during the 26 weeks ended June 30, 2013, from $7.5 million during the 26 weeks ended June 24, 2012, primarily due to a higher depreciable base resulting from new shops. As a percentage of revenues, depreciation increased to 6.0% during the 26 weeks ended June 30, 2013, from 5.7% during the 26 weeks ended June 24, 2012, primarily due to a higher depreciable base resulting from new shops in markets with higher build-out costs such as New York City.

 

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Pre-Opening Costs

Pre-opening costs decreased by approximately $0.4 million to $0.7 million during the 26 weeks ended June 30, 2013, from $1.1 million during the 26 weeks ended June 24, 2012 primarily due to opening one company-operated shop in higher rent markets, specifically New York City, during the 26 weeks ended June 30, 2013, compared to four new company-operated shop openings in higher rent markets, specifically New York City, during the 26 weeks ended June 24, 2012.

Impairment and Loss on Disposal of Property and Equipment

Impairment and loss on disposal of property and equipment remained consistent at $0.1 million during the 26 weeks ended June 30, 2013 and June 24, 2012, respectively.

Interest Expense

Interest expense remained consistent at $0.2 million during the 26 weeks ended June 30, 2013 and June 24, 2012, respectively.

Income Tax Expense

Income tax expense increased by $1.2 million to $1.9 million during the 26 weeks ended June 30, 2013, from $0.7 million during the 26 weeks ended June 24, 2012 due to higher pre-tax income and an increased effective tax rate as a result of the Company recognizing federal tax benefits as a result of the release of a valuation allowance against substantially all of our deferred tax assets in the fourth quarter of 2012. In the fourth quarter of fiscal 2012, we determined that it is more likely than not the deferred tax assets will ultimately be realized. Prior to this period, our income tax expense represented our cash income taxes payable to various states and local jurisdictions. In determining the likelihood of future realization of the deferred tax assets as of December 30, 2012, we considered both positive and negative evidence and weighted the effect of such evidence based upon its objectivity. As a result of our analysis of both positive and negative evidence, we believe that the weight of the positive evidence, primarily related to the cumulative income in the most recent three years and achievement of a sustained level of profitability, was sufficient to overcome the weight of the negative evidence, primarily related to continued uncertainty in the condition of the macro-economic environment. For the 26 weeks ended June 24, 2012, our effective tax rate was 18.6%, compared to 40.3% for the 26 weeks ended June 30, 2013.

 

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Fiscal Year 2012 (53 Weeks) Compared to Fiscal Year 2011 (52 Weeks)

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

 

		Fiscal Year
		2011				% of Revenues				2012				% of Revenues				Increase (Decrease)				Percent Change
Revenues
Sandwich shop sales, net		$	237,463				99.8	%		$	274,070				99.7	%			36,607				15.4	%
Franchise royalties and fees			503				0.2				844				0.3				341				67.8
Total revenues			237,966				100.0				274,914				100.0				36,948				15.5
Expenses
Sandwich shop operating expenses
Cost of goods sold, excluding depreciation			68,491				28.8				79,847				29.0				11,356				16.6
Labor and related expenses			67,036				28.2				77,479				28.2				10,443				15.6
Occupancy expenses			26,511				11.1				32,016				11.6				5,505				20.8
Other operating expenses			24,095				10.1				28,119				10.2				4,024				16.7
General and administrative expenses			26,911				11.3				29,624				10.8				2,713				10.1
Depreciation expense			14,838				6.2				16,219				5.9				1,381				9.3
Pre-opening costs			1,521				0.6				2,051				0.7				530				34.8
Impairment and loss on disposal of property and equipment			365				0.2				994				0.4				629				172.3
Total expenses			229,768				96.6				266,349				96.9				36,581				15.9
Income from operations			8,198				3.4				8,565				3.1				367				4.5
Interest expense			495				0.2				541				0.2				46				9.3
Other expense			1				*				6				*				5				500.0
Income before income taxes			7,702				3.2				8,018				2.9				316				4.1
Income tax expense (benefit)			537				0.2				(15,994	)			(5.8	)			(16,531	)			(3,078.4	)
Net income			7,165				3.0				24,012				8.7				16,847				(235.1	)
Net income (loss) attributable to non-controlling interests			—				*				(34	)			*				(34	)			(100.0	)
Net income attributable to Potbelly Corporation			7,165				3.0				24,046				8.7				16,881				(235.6	)
Accretion of redeemable convertible preferred stock to maximum redemption value			(17,410	)			(7.3	)			(10,495	)			(3.8	)			6,915				39.7
Net income (loss) attributable to common stockholders		$	(10,245	)			(4.3	)%			13,551				4.9				23,796				232.3

 

*	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 $36.9 million, or 15.5%, to $274.9 million for fiscal year 2012, from $238.0 million for fiscal year 2011. Company-operated non-comparable store sales contributed $28.7 million, or

 

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77.8%, of the total revenue increase, company-operated comparable store sales contributed $7.9 million, or 21.2%, of the total revenue increase, and franchise shops contributed $0.3 million, or 0.9%, of the total revenue increase. Comparable store sales increased 3.4% as a result of a 3.2% increase in average check, due to a menu price increase and a shift in menu mix, and a 0.2% increase in entree counts.

The impact in 2012 of an additional operating week was approximately $3.4 million in total revenue.

Cost of Goods Sold

Cost of goods sold increased by $11.4 million, or 16.6%, to $79.8 million for fiscal year 2012, compared to $68.5 million for fiscal year 2011, primarily due to the increase in revenues. As a percentage of revenues, cost of goods sold increased to 29.0% for fiscal year 2012, from 28.8% for fiscal year 2011, primarily driven by higher commodity costs.

Labor and Related Expenses

Labor and related expenses increased by $10.4 million, or 15.6%, to $77.5 million for fiscal year 2012, from $67.0 million for fiscal year 2011, primarily due to new shop openings. As a percentage of revenues, labor and related expenses remained consistent at 28.2% for fiscal year 2012 and 2011, respectively.

Occupancy Expenses

Occupancy expenses increased by $5.5 million, or 20.8%, to $32.0 million for fiscal year 2012, from $26.5 million for fiscal year 2011, primarily due to new shop openings. As a percentage of revenues, occupancy expenses increased to 11.6% for fiscal year 2012, from 11.1% for fiscal year 2011, due to more shops in higher rent markets, specifically New York City and Boston. There were 16 company-operated shops in New York City and Boston as of December 30, 2012, compared to five company-operated shops as of December 25, 2011.

Other Operating Expenses

Other operating expenses increased by $4.0 million, or 16.7%, to $28.1 million for fiscal year 2012, from $24.1 million for fiscal year 2011, primarily 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, other operating expenses increased slightly to 10.2% for fiscal year 2012, from 10.1% for fiscal year 2011, primarily due to the increase in credit card usage.

General and Administrative Expenses

General and administrative expenses increased by $2.7 million, or 10.1%, to $29.6 million for fiscal year 2012, from $26.9 million for fiscal year 2011. The increase was primarily due to an increase of $1.3 million in stock compensation expense related to warrants and stock option grants, in addition to investments made to support new shop growth. As a percentage of revenues, general and administrative expenses decreased to 10.8% for fiscal year 2012, from 11.3% for fiscal year 2011, primarily due to sales leverage (i.e., the ability to spread certain expenses over a higher revenue base).

Depreciation Expense

Depreciation expense increased by $1.4 million, or 9.3%, to $16.2 million for fiscal year 2012, from $14.8 million for fiscal year 2011, primarily due to an increase in the number of shops open from 234 shops as of fiscal year-end 2011, compared to 264 shops as of fiscal year-end 2012. As a percentage of revenues, depreciation decreased to 5.9% for fiscal year 2012, from 6.2% for fiscal year 2011, primarily due to certain assets primarily related to leasehold improvements at legacy shops with a higher build-out cost being fully depreciated.

 

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Pre-Opening Costs

Pre-opening costs increased by approximately $0.5 million to $2.0 million for fiscal year 2012, from $1.5 million for fiscal year 2011. The increase was due to 31 new company-operated shop openings during fiscal year 2012, compared to 21 new company-operated shop openings during fiscal year 2011.

Impairment and Loss on Disposal of Property and Equipment

Impairment and loss on disposal of property and equipment increased by $0.6 million to $1.0 million for fiscal year 2012, from $0.4 million for fiscal year 2011, primarily due to a $0.8 million charge related to the disposal of assets as a result of damage from Hurricane Sandy.

Interest Expense

Interest expense remained consistent at $0.5 million for fiscal years 2012 and 2011, respectively.

Income Tax Expense (Benefit)

Income tax expense decreased approximately $16.5 million in fiscal year 2012, from $0.5 million in fiscal year 2011, due to a benefit from the release of the $16.9 million valuation allowance against our deferred tax assets in the fourth quarter of 2012. In the fourth quarter of fiscal 2012, we determined that it is more likely than not the deferred tax assets will ultimately be realized. Prior to this period, our income tax expense represented our cash income taxes payable to various states and local jurisdictions. In determining the likelihood of future realization of the deferred tax assets as of December 30, 2012, we considered both positive and negative evidence and weighted the effect of such evidence based upon its objectivity. As a result of our analysis of both positive and negative evidence, we believe that the weight of the positive evidence, primarily related to the cumulative income in the most recent three years and achievement of a sustained level of profitability, was sufficient to overcome the weight of the negative evidence, primarily related to continued uncertainty in the condition of the macro-economic environment.

 

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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

 

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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.

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 a reduction in depreciation expense for certain underperforming shops where we recorded impairment charges in fiscal year 2010, offset by an increase in depreciation related to new shops opened. The number of shops open as of fiscal year-end 2010 was 218 shops, compared to 234 shops as of fiscal year-end 2011. As a percentage of revenues, depreciation decreased to 6.2% for fiscal year 2011, from 7.1% for fiscal year 2010, primarily related to leasehold improvements at legacy shops with a higher build-out cost being fully depreciated.

 

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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 $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 consistent 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. In fiscal years 2010 and 2011, 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 fiscal quarter during fiscal year 2012 and each of the first two fiscal quarters during fiscal year 2013. 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												For the 14 Weeks Ended				For the 13 Weeks Ended
		March 25, 2012				June 24, 2012				September 23, 2012				December 30, 2012				March 31, 2013				June 30, 2013
		(unaudited; dollars in thousands)
Total Revenues		$	62,381			$	69,156			$	69,869			$	73,508			$	68,744			$	78,186
Income from operations			1,592				2,325				2,817				1,831				152				4,761
Net income attributable to Potbelly Corporation (1)			1,274				1,749				2,548				18,475				18				2,759
Adjusted EBITDA (2)		$	6,564			$	8,342			$	8,034			$	8,511			$	5,791			$	10,392
Total company-operated shops (end of period)			239				248				257				264				269				280
Change in company-operated comparable store sales			6.4	%			3.3	%			2.2	%			2.0	%			(0.3	)%			3.0	%

 

(1)	The 14 weeks ended December 30, 2012 included a $16.9 million tax benefit related to the release of a valuation allowance against substantially all of our deferred tax assets.

 

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(2)

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 5 to the table included in “Selected Consolidated Financial and Other Data.”

 

		For the 13 Weeks Ended												For the 14 Weeks Ended				For the 13 Weeks Ended
		March 25, 2012				June 24, 2012				September 23, 2012				December 30, 2012				March 31, 2013				June 30, 2013
		(unaudited; dollars in thousands)
Net Income (loss) attributable to Potbelly Corporation		$	1,274			$	1,749			$	2,548			$	18,475			$	18			$	2,759
Depreciation expense			3,837				3,716				4,080				4,586				4,380				4,444
Interest expense			128				123				176				114				111				122
Income tax expense (benefit)			206				476				84				(16,760	)			17				1,869
Impairment and closures			93				171				—				916				26				61
Pre-opening costs			537				593				630				291				290				429
Stock compensation			470				1,423				427				506				708				434
Costs associated with an initial public offering			19				91				89				383				241				274
Adjusted EBITDA		$	6,564			$	8,342			$	8,034			$	8,511			$	5,791			$	10,392

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.

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. 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):

 

														26 Weeks Ended
		2010				2011				2012				June 24, 2012				June 30, 2013
														(unaudited)
Net cash provided by (used in):
Operating activities		$	18,780			$	20,121			$	25,085			$	12,050			$	13,755
Investing activities			(6,243	)			(17,758	)			(25,936	)			(12,790	)			(14,411	)
Financing activities			(4,382	)			(7,197	)			(700	)			173				(193	)
Net increase (decrease) in cash		$	8,155			$	(4,834	)		$	(1,551	)		$	(567	)		$	(849	)

 

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Operating Activities

Net cash provided by operating activities increased to $13.8 million for the 26 weeks ended June 30, 2013, from $12.1 million for the 26 weeks ended June 24, 2012, primarily due to a $2.1 million increase in shop-level profits.

Net cash provided by operating activities increased to $25.1 million for fiscal year 2012, from $20.1 million for fiscal year 2011, primarily due to a $5.3 million increase in shop-level profits.

Investing Activities

Net cash used in investing activities increased to $14.4 million for the 26 weeks ended June 30, 2013, from $12.8 million for the 26 weeks ended June 24, 2012. The increase was primarily due to construction costs for 17 new company-operated shops opened during the 26 weeks ended June 30, 2013, compared to 14 new company-operated shops opened for the 26 weeks ended June 24, 2012, as well as capital expenditures for future shop openings, maintaining our existing shops and certain other projects.

For fiscal years 2012, 2011 and 2010, purchases of property and equipment were $25.9 million, $17.8 million and $6.2 million, respectively. Each year, new company-operated shop development accounted for the majority of the expenditures. The increase in 2012, as compared to 2011, and the increase in 2011, as compared to 2010, were driven by an increase in the number of company-operated shop openings. We estimate that total capital expenditures for fiscal year 2013 will be approximately $29.0 million to $31.5 million, with 32 to 35 new company-operated shop openings planned.

Financing Activities

Net cash used in financing activities was $0.2 million for the 26 weeks ended June 30, 2013, compared to net cash provided by financial activities of $0.2 million for the 26 weeks ended June 24, 2012.

Net cash used in financing activities was $0.7 million and $7.2 million during fiscal years 2012 and 2011, respectively. The decrease in net cash used in fiscal year 2012 as compared to fiscal year 2011 was primarily due to $13.5 million of common and preferred share repurchases that were partially offset by $6.0 million of net borrowings from our senior 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. We will be entitled to incur additional incremental increases in the revolving credit facility of up to $25.0 million that will be included in the credit facility if no event of default exists and certain other requirements are met. 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 credit facility also limits the restricted payments (primarily distributions and equity repurchases) that we may make, unless we obtain certain waivers or amendments from our lender. We were in compliance with these restrictions and conditions as of June 30, 2013. 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 June 30, 2013, we had $14.0 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.”

 

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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 30, 2012 (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)		$	15,169			$	79			$	1,090			$	14,000			$	—
Interest on long-term debt (a)			898				189				378				331				—
Operating leases (b)			183,972				27,552				52,530				40,890				63,000
Capital leases			201				27				60				71				43
Total		$	200,240			$	27,847			$	54,058			$	55,292			$	63,043

 

(a)

On September 21, 2012, we entered into a five-year revolving credit facility agreement that will expire 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. Interest on the credit facility is variable and is included in the table above utilizing an interest rate of 1.35% that applied as of December 30, 2012. Interest expense on the credit facility in 2012 was $0.5 million. Long-term debt also includes a note payable with $1.1 million outstanding as of June 30, 2013. As of December 30, 2012, scheduled principal payments on the note payable were $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%.

(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

 

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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 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 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 30, 2012, 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 $2.9 million, $0.4 million and $0.2 million for the fiscal years 2010, 2011 and 2012, respectively, and $0.1 million and $0.1 million for the 26 weeks ended June 24, 2012 and the 26 weeks ended June 30, 2013, respectively, which is included in impairment and loss on disposal of property and equipment in the consolidated statements of operations. As a result of Hurricane Sandy, we recorded a charge of $0.8 million related to the disposal of assets damaged by the storm.

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

 

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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. Prior to our fiscal quarter ended December 30, 2012, we determined that more likely than not our deferred tax assets would not be fully realizable based on a history of operating losses incurred and established a full valuation allowance in accordance with ASC Topic 740. Throughout fiscal 2012, we evaluated evidence to determine if releasing the valuation allowance is appropriate and concluded in the fourth quarter of fiscal 2012 that it was more likely than not the deferred tax assets will ultimately be realized. In determining the likelihood of future realization of the deferred tax assets as of December 30, 2012, we considered both positive and negative evidence and weighted the effect of such evidence based upon its objectivity. As a result of our analysis of both positive and negative evidence, we believe that the weight of the positive evidence, primarily related to the cumulative income in the most recent three years and achievement of a sustained level of profitability, was sufficient to overcome the weight of the negative evidence, primarily related to continued uncertainty in the condition of the macro-economic environment, and recorded a $16.9 million benefit to release the full valuation allowance against our deferred tax assets in the fourth quarter of 2012.

Stock-Based Compensation

Our 2001 and 2004 Equity Incentive Plans (the “Plans”) permit the granting of awards to employees and nonemployee officers, directors, 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 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 stock options with these performance conditions has been recognized through June 30, 2013. We have estimated the potential compensation cost to be recorded upon consummation of an initial public offering associated with vested options is approximately $7.2 million as of the date of this filing, which excludes charges related to the transactions described below under “Common Stock Equity Valuations.” We will recognize non-cash stock compensation expense with respect to these options in the period in which the offering is consummated. 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 optio