Matthew Revord – Senior Vice President, Chief Legal Officer, General Counsel and Secretary Aylwin Lewis – Chairman, President and Chief Executive Officer Charles Talbot – Senior Vice President and Chief Financial Officer.

Nicole M. Miller Regan – Piper Jaffray & Co Jonathan R. Komp – Robert W. Baird & Co., Inc. .

Good afternoon and welcome to Potbelly’s Q2 2014 Earnings Call. The call will begin with prepared comments by management, followed by a question-and-answer session. Today’s call is being recorded. (Operator Instructions) I would now like to turn the call over to Matthew Revord, Potbelly’s Chief Legal Officer. Please go ahead, sir..

Good afternoon, everyone and welcome to our second quarter earnings call. Before we get started, I’d like to note that certain comments made on this call will contain forward-looking statements regarding future events for the future financial performance of the company.

Any such statements, including our outlook for 2014 should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance and also they have relied upon representing management views as of any subsequent date.

Forward-looking statements involve significant risks and uncertainties and events or results could differ materially from those presented due to a number of risks and uncertainties.

Additional detailed information concerning these risks regarding our business and the factors that could cause actual results to differ materially from the forward-looking statements and other information that we are giving today can be found on our most recent annual report on Form 10-K under the headings risk factors and MD&A and in our subsequent filings with Securities and Exchange Commission, which are available at sec.gov.

Our presenters today are Aylwin Lewis, our Chairman and Chief Executive officer; and Charlie Talbot, our Chief Financial Officer. Aylwin will begin with his perspective on the second quarter performance and discuss some recent developments, by providing discussion of our ongoing strategic initiatives.

Charlie will then review our financial results and future outlook in more detail before we open the call up to your questions.

Aylwin?.

Aylwin Lewis:.

our comp store sales, our base business economics and the productivity on those economics and our profitable new units. Two to three of these components continue to deliver our expected results. The obvious opportunity for us is we gain our comparable same-store sales momentum.

We believe coming out of Q1, which is a very difficult quarter that our trends would rebound likely they’ve typically done in past. We moved up our flats roll out to May, because we thought that would help us overcome the first quarter sales shortfall.

While flats have had a good impact on the business has not driven significant, meaningful, incremental sales traffic, which is unexpected. We still believe that we’re in good shape when you talk about our base unit and their productivity around the profit piece in the new unit development. These are still very good strengths for our company.

Our current comp sales growth is a major gap to our growth model. We’re working hard and fast to close this gap for the near-term and for the long-term. In past few years, we spent a lot of organizational – a lot of time building the organizational muscle around our ops excellence, our development activities and our neighborhood margin activities.

We look forward in the near future, we’re going to spend some time on how do we grow traffic in our business. So what’s our problem? I think our number one problem is, how do we find a way to message outside the four walls that augments to neighborhood approach and we will explore digital, social and mobile tactics to solve this problem.

We’ve identified our transition issues as eight to 10 transactions per day per shop, nearly one per hour, per shop each day. This is a gap we know we can close, but being smart and being diligent, and we are very poised to do that. Our sales pyramid is constantly enforced by those shops. It is a sizable number in our fleet.

They’ve grown their business at least 3% annually the last several years. These shops comprised the basis of the sales pyramid, which is strong operational efforts, be in the best place for launch driving back line, low turnover, low managed return.

So what are the solutions we are working on from an operation perspective, it increased our training efforts for our shift leads by district managers. Shift leads of future managers as we grow our district manager’s influence, our business in many neighborhoods in their district, got increase and focused on throughput at peak.

the single key opportunity for us to drive the business is throughput at peak. We’ll continue to invest in technology, in equipment and in staffing to reinforce throughput a key. In a high growth environment, we’ve got a better job with managing, General Manager turn. We use existing GMs to open new shops.

Obviously, when you make that change, relationships that establish in neighborhoods can be separate. To keep that, we’ve got to find a way to make those relationships more tied to the shops versus shifts to GM.

We will be testing this month in several shops, a new service model, essentially putting someone in the dining room during peak in a way to save customers that walk in and make be alive and walk out, performing table touches of our existing customers, and just spreading that Potbelly magic inside the dining room doing lunch.

From a margin perspective, we’re conducting research to update our customer segmentation work, foundation of how we target messages around customer segment. We’ll be testing new menu innovations, proteins and other items that can help us grow. We will test drive in our business using our promise.

That’s our promise to the customer be fresh, fast and friendly. We’ll use digital message help us drive this message. We’ve added breakfast menu in a number of shops that can sell breakfast in a profitable fashion. We are content testing products that will help us grow at two to five date part that we believe is an opportunity for us.

We are even going to try some promotional items and promotional messages and serve certain markets. The goal is to have short-term and long-term solutions to our current growth situation.

Additionally, continued focus on the pipeline, in Q4, we will release our newest flat sandwich, which is the Turkey Bacon Cheddar and continue to focus on the pipeline. There’s no staple bullets that can help us improve our comp trend.

We have to work on several things over time to recapture that magic, what we are – is very committed to find the solutions in the short-term and long-term to address the issue. I’ll turn it over to Charlie now to give you the details of the quarter.

Charlie?.

Thanks, Aylwin. Good afternoon, everyone. I’ll walk down the P&L and give you some of the highlights. Total revenue increased 7% in the quarter to approximately $84 million driven by new unit openings partially offset by a decrease in company operated comparable store sales of 1.6%.

Adjusting for the Easter shift in the second quarter comparable store sales would decline $0.9%. So to reiterate, as we move down to the first quarter we felt better about our underlying traffic trends. However, our business did not get the bounce we had expected after Easter holiday in May and June.

As we mentioned in the June 9 prerelease, comparable store sales growth improved as we move throughout the quarter. However, it was driven more from comparison easing versus traffic trends improving. Our most difficult comp month of the year was April driven by lapping our successful Buffalo Chicken Sandwich promotion in 2013.

Just to further update this year, our July comps were flat, reflecting expected sequential improvements from Q2. Again this was driven primarily by using comparisons.

Our average check growth for the quarter was around 1.5%, driven roughly 1% from pricing from the increase we took in the middle of the first quarter with the remaining from menu mix growth. Mix was strong related in the quarter from our flat central and our Bigs rollout in the North East during May.

The reception of our new platform and Bigs central in the North East is going to really strong mixing both our internal expectations. And the customer feedback has been really, really positive.

So as a result, we are seeing flat become a really healthy mix of our menu, we feel really good about the platform and how this sets us the growth as we move forward. As we stated in our prerelease, our updated full-year comp guidance is flat to negative low single-digits.

Comparable store sales growth, which assumes current traffic trends for the balance of the year. We anticipate comparable store sales to improve in the second half compared to the first half driven from comparisons and some modest pricing taking in the third quarter. In total, we anticipate pricing to be roughly 2% in the second half versus last year.

Moving down to P&L, shop one profit margin for the quarter was 20.5%, a decline of a 160 basis points from prior year. The decrease was primarily driven by deleverage of the fixed expenses across our P&L due to decline in comparable store sales and new units opening later in the quarter.

Cost of goods sold as a percentage of net sandwich shop sales decreased in the quarter to 28.7% down 50 basis points from prior year driven primarily by a modest commodity cost deflation in addition to lower levels of ways to shop.

The deflation in the quarter was a result of a number of key products locked into through the second quarter favorable pricing terms. But despite this deflation in the first half of the year, we still expect roughly 1% to 2% inflation for the full-year, driven by higher levels inflation over the balance of the year.

Our food cost basket is roughly 90% to 95% locked for the full-year and the sequential step up in project inflation is being driven primarily by beef and fork costs. Moving to labor, as a percent of net sandwich shop sales labor increased in the quarter to 28.1%, an increase of 90 basis points from prior year.

This was driven primarily by deleverage of fixed and labor expenses in addition to the timing of seven company operated shops opening in Q2, which we mentioned or back weighted in the quarter.

Looking forward, embedded in our projection is the impact from the Washington D.C., Minnesota, and Michigan minimum wage increases effective in the third quarter. It’s also important to note that labor dollars may fluctuate in the third and fourth quarter based on the sales seasonality and timing of new unit openings.

And again we expect the remaining units to be more heavily weighted in the fourth quarter, which we’ll cover later in the discussion.

Operating expenses as a percentage of net sandwich shop sales increased in the quarter to 10.4% up 30 basis points from prior year and occupancy expenses increased in the quarter to 12.2%, up 90 basis points from prior year. Both driven primarily by deleverage of fixed expense nature of these lines.

General and administrative expenses were approximately $8.9 million during the second quarter, an increase of approximately $1 million from prior year. The increase written expenses driven primarily by $400,000 increase in advertising expense from prior year associated with the rollout of our flats platform in May.

In addition, public company related costs were $1 million for the quarter, which is roughly $800,000 higher than last year, excluding the $100,000 of one-time IPO expenses in the second quarter of last year.

The public company cost were higher than anticipated in the second quarter driven by higher levels of stock compensation associated with board members stock grant. Given the higher level expenses in quarter two, we now believe total public company cost for the year will be at the high end of the $2 million to $2.5 million range previously provided.

When excluding the public company cost and advertising the SG&A was down roughly $200,000 from the quarter versus prior year. As we move forward, we anticipate Q3 and Q4 total G&A spend to be in the $8 million, which is consistent with previous guidance.

Our adjusted net income for the second quarter was $2 million or $0.07 per diluted share, which is a decline of $850,000 and roughly $0.02 from prior year, when using comparable dilutive share counts. The decline is driven from lower comparable store sales, higher advertising expense and the cost associated with being a public company.

For a reconciliation of our reported adjustment net income please refer to the reconciliation table included in our second quarter earnings release. Now turning to development, during the quarter we opened seven new company operated shops and one domestic franchise shop for a total unit growth of 13.4%.

The majority of the shops opened in June also more than a half of the new company operated shops open today in our legacy markets. The legacy to new market opening mix will vary year-to-year as moving forward, but we’ll target our new unit development to be split evenly between new and legacy markets over time.

Now, I’d like to discuss full-year outlook that we’ve included in the July 9th prerelease. We expect adjusted net income per diluted share of approximately $0.18 to $0.20 flat to negative low single-digit comparable store sales and effective tax rate just made it to be approximately 39.5% and 40 to 48 new shop openings.

We anticipate a consistent level of new unit openings for the third quarter as we had in the second quarter with the remaining units opened in the fourth quarter. Also, worth mentioning is our effective tax rate outlook assumes certain federal tax credits that are currently expired will be retroactively renewed by the government.

In addition, we still expect capital expenditures of $30 million to $35 million and shares outstanding between 30 million and 32 million shares for the year. And this excludes any share buyback influence.

It’s important to understand the updated guidance is predicated on our current business trends and expectations for the remainder of the fiscal year. The primary drivers are the lower guidance beyond Q2 results are on comparable store sales assumptions and the projected timing of our new unit openings.

As we discussed above the new unit outlook is now more quarter flow weighted, which brings more inefficiencies into the model during the year. The rest of the business is pretty much in line with previous expectations.

So we’ve talked about this in the past event, I think it’s important to break down how we think about our financial model relative to growth. Our financial model is predicated on growing comparable store sales at a low single-digit level.

Operational productivity to maximize the flow through of those incremental sales and opening possible new units and leveraging our fixed costs, if anyone expected our models below expectations given our size and leverage, it’s difficult to hit our targets.

In Q2 specifically, there was a decline in comparable store sales and public company related G&A expenses running higher. More broadly, it’s our comparable store sales challenges that we’ve already discussed that we’re working really hard to rectify during – driven from a number of initiatives Aylwin has already mentioned.

So with that, I’m going to turn it back over to Aylwin for summary remarks..

So in summary, I’m not happy to be in the position of reporting results below our expected growth levels. I take it very personally, it’s my accountability. I will remind you in the early stages of being a public company. So why we’re disappointed with by no means desperate.

We have strong fundamental in this business, we continue to demonstrate the ability to grow new shops, we got to view 200,000 units. We’ve identified the scope of our current sales issue. It is literally 8 to 10 daily transactions for shop per day, one per hour. But we are aware of external factors that maybe impacting this industry.

We are similarly focused internally to fix our problems, to menu innovations, research, service improvement, staffing, and then messaging, our final way to drive the message outside the four walls, strategically, mobile and social. So we believe in building this business when they look at the time.

The relations based, experience based, and excellent operational based performance. We know that drives loyalty, loyalty drives efficacy by our customers. And put a word of mouth is how we’re trying to build this business. We may need a little bit more to get our message down in an efficient and effective way and we’ll explore that.

We also should be noted that we’re using our strong balance sheet to buyback stock because we believe stock is buoyant at this level. So I thank you for listening today. And we’ll open it up for questions..

Thank you. (Operator Instructions) Your first question comes from the line of Nicole Miller with Piper Jaffray..

Good afternoon.

I have certainly clarity on the share repurchase, is that in the guidance or would that be incrementals that you execute on it?.

Yes, the – Nicole, this is Charlie. How are you doing? The guidance that we gave does not really include any impact from share repurchases, based on that fact with the timing and the amount will be – is to be determined. We do have authorization about the $35 million, and shares, and we’ll do that kind of appropriately..

Thank you.

And from a regional perspective, can you talk about trends? I think maybe there has been Mid-Atlantic issues, do you see maybe specifically issues, where do you stand today, third quarter to date, are you seeing those improved?.

We typically don’t talk about specific markets of regions, but – and we typically don’t update numbers, but I thought it was important to let people know how we’re doing through the month of July. and as I explained, we’re on trend with where we expected to be for the first part of Q3..

Thank you..

Your next question comes from the line of Joseph Buckley with Bank of America..

Hey, it’s Gregg on for Joe. I do have a couple of questions. one, can you just say what you were seeing I guess in the test markets for flats, or maybe didn’t translate when you roll that out more broadly and why, what changed, or what you saw differently, when you roll that out..

We saw really a great acceptance, when we tested it. we did research in front of light and non-Potbelly users, and put the product in front of them and they gave big thumbs up, we did it once and got remarkable results and we did it second time to those, we didn’t believe that remarkable results and it came back.

The mix is great, if you told me that at this mix, there would not be incremental, I would have lost a lot of money. So we’re surprised by the first roll out as just the introduction. so it’s functional around the features and benefits. We will start using it for further development, which was always our plan.

we do see this as a food carrier for us, it’s a different eating sensation, and we’ll have a new recipe in about four weeks and we’ll see what happens..

And I think just to elaborate, we didn’t see anything different really and the only thing we saw that different was it’s mixed higher across the system that it did in the test market, a part of that is simply because the test markets we have very, very limited messaging outside the shop.

and so it’s the times we can expect that, but we’re – if anything we’re surprised by the level of acceptance as Aylwin mentioned, once we rolled it beyond our test markets..

Okay, that makes sense. And then just I think you said, you expect 2% pricing in the back half, because you’re taking modest pricing in 3Q.

I guess what sort of how are you thinking about that and is it food inflation in guidance is driven by that or what’s the main driver there?.

Of course, two things, one is we first cover inflation. and so, as we’ve known our long back half inflation was going to be a little bit higher than the first half based on what we have locked in. the other thing that’s just really happening here is, as we think ahead about pricing in our menu, we would like to maintain relationships across the menu.

so a part of what we’re doing today is resetting those relationships for the future pricing activities. So we don’t have to change everything on the menu once if you will. So think of it, there’s a couple of different ways, one is recognizing additional inflation in the second half, which we kind of expected.

And then second is just making sure relationships across the menu or in order. So as we move forward, we can – we’re pretty flexible with the pricing activities..

Okay.

And then I guess finally, could you give a little color on how the new units are performing, and what you’re maybe seeing in some of your specific markets, maybe in New York, Boston, and some of the other areas?.

Yes. I mean I’ll start and then all I can comment. We’re happy with the unit performance, they continue to evolve and grow. So I mean I think that you have a number of different markets that we’ve gone into, New York and Boston being two of them.

And I think we’re pretty satisfied with the way things are playing out, both operationally from a consumer standpoint. and so I would say that our – as we’ve talked about our development engine is doing fine and we expect that to continue..

Okay. Thank you..

(Operator Instructions) Your next question comes from the line of Jonathan Komp with Robert Baird..

Hi, thank you. Good afternoon. Charlie, first if I can just clarify the comments on the pricing..

Yes..

Could you maybe just clarify when the pricing – the incremental pricing might be rolling in, and I guess maybe if you could, or just clarifying that flat July comp so far, what the traffic and check component of that might be. .

Well, we typically don’t break down the traffic and check that what I will pay it’s – like I said, it’s on trend from Q2. The numbers are getting a little bit easier to roll over. and so that’s all we want to just reiterate that piece of it. The pricing moved in through the month of July. So call it mid-July is when that really took effect.

and again, it’s roughly 1%, it is the incremental type pricing, we’re going to be taking for the back after the year..

Okay, great. That’s helpful. And then to be a bigger picture question for Aylwin, only initiatives that you mentioned I’m trying to reignite the sales trends. You mentioned a lot of different categories and maybe a lot of different initiatives.

so, maybe just from a higher level picture, which are the different initiatives do you see is maybe having the biggest opportunity you’re – maybe the greatest potential to turn the sales trends around?.

Well, it starts with the excellent operations. So, figure it out how to manager turn and a high growth situation is important for us. And that’s long-lasting and that’s very impactful.

So every time, you turn a manager like I said, we’re seeing sovereign those relationships in the neighborhood, which is very important to marking that, or so that’s very big. The continued focus on transactions during our peak, it’s another thing we have to do and we can’t lose side of that and we got to continue to invest there.

Then I think from a messaging standpoint, figuring out how you augment this word of mouth, high experience, high loyalty model that we have, with messaging outside the four walls effectively and efficiently is important to us.

So that’s why mobile, digital, and social are things that we’re exploring, we’ll be testing something, now if we could find a solution there.

I think it would have tremendous potential because it would be effective in those venues, you have to be authentic, and to be authentic is kind of one of the things we really hold our hands on in terms of our food, our experience with our people. So those are the three things that we are looking and other situations like this was unexpected.

Quite frankly, you are trying to separate anecdote from what you see in here to that. And so we are exploring lot of thing.

I don’t want to give people in pressure that is periodic and we are just going step across on the wall to see what’s fixed to be in very methodical product, but we want to be broad region because we want short-term, a long-term solutions. We don’t want – we don’t believe this thing has broken.

We think its tweeting and redirecting, how we allocate resources that would taking apart look at, so that kind of what we’re doing. So I hope that kind of long winded answer bit, as completed I can make..

No, that’s very helpful, much appreciate it. Maybe just a follow-up, you mentioned some aspects related to the marketing and messaging I talked in the prepared remarks you also.

And then, maybe tactics some promotion, so just wondering there is any – that imply change in the competitive environment recently aware is that just an opportunity you see for the brand, your respect of the competition..

Yes. So you got to be aware of stuff that going on, we never been, we are trying to build a company where, we are very focused on bringing our best everyday to the marketplace.

So in this effort to be very thoughtful and very thorough we are doing somethings that maybe out of care, so we got tested when you sitting here disappointing our investors would disappoint ourselves, we don’t leave any stones on turn. We are not going to become a transaction high promotional house.

We are doing, Charlie always looks me like when I do stuff like this is a motion inflated to body. But again, they just trying to be thorough, and just trying to test the limit, push the limit, which possible out there. That’s would that’s about it, its very targeted, very focused and is being done when I toward profitable sales growth..

Great. And then, maybe just one more from on the development outlook for this year, just given that it’s a little more back weighted now, is there any risk to some of those opening in progress looking into next year or what is the degree of confidence of getting all that to targeted unit openings this year..

That’s what you do Ray, just and obviously, absolutely the back end when you are dealing with the new construction and dependent on landlords to delivery business, that is the risk. Fortunately, we believe those stores are still be in the fleet if they laid a month that’s fine. The goal is to open profitable stores and successful stores.

We can do everything on a power to hit the range that we talk about. And so, we are still within that 48 and we are going to work to make sure that happen. But we want to do anything bullish and want to open a store the last week of January just to make the number..

Got it, it makes sense. Thank you very much..

Thank you. At this time, there are no further questions. I would like to turn it back to Aylwin for any closing remarks..

No. Listen, we are disappointed not desperate. We are going to do everything possible to get our sales back on track and we feel very good about this company and our prospects. So thank you for your participation. Thank you for your interest and go buy sandwich to night. Thank you..

Thank you. This does conclude today’s conference call. You may now disconnect..