Matthew J. Revord - Senior Vice President, Chief Legal Officer, General Counsel and Secretary Aylwin B. Lewis - Chairman, President & Chief Executive Officer Michael W. Coyne - Chief Financial Officer & Senior Vice President.

Sharon M. Zackfia - William Blair & Co. LLC Joshua C. Long - Piper Jaffray & Co. (Broker) Sam J. Beres - Robert W. Baird & Co., Inc. (Broker) Karen Holthouse - Goldman Sachs & Co. Gregory Paul Francfort - Bank of America.

Greetings, and welcome to the Potbelly Corporation First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. I would now like to turn the conference over to your host, Mr. Matt Revord. Thank you, you may begin..

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

Any such statements, including our outlook for 2016 or other future periods, 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, nor should they be relied upon as representing management's 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 we're giving today can be found in our most recent Annual Report and Form 10-K under the headings Risk Factors and MD&A and in our subsequent filings with the Securities and Exchange Commission, which are available at sec.gov.

Our presenters today are Aylwin Lewis, our Chairman and Chief Executive Officer; and Mike Coyne, our Chief Financial Officer. Aylwin will begin with his perspective on the first quarter performance and provide discussion of our ongoing strategic initiatives.

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

Aylwin?.

Thanks, Matt. Good afternoon, everyone. Thanks for joining the call. We had a good start to the year as the positive momentum we experienced throughout 2015 continued into the first quarter. We generated revenue of $96 million, an increase of roughly 12% driven by company operating comparable same-store increase of 3.7%.

We opened seven shops, five company-operated shops, and two franchise shops. Adjusted EBITDA was $9 million, an increase of 9.2%, and our adjusted net income was $1.1 million, an increase of 34%, and a $0.04 per diluted share. Mike will discuss these results in greater detail later on the call.

I would like spend the next few minutes to review our main value drivers. As I have outlined in prior calls, the three things at the core operating value for our business are, a strong GM in every shop, driving sustainable same-store sales growth, and opening new units with a high rate of return. First, strong GM in every shop.

We hosted our GM and Franchise Conference during the first quarter, where we reinforced the Potbelly Advantage, introduced several new operational tools and recognized our best operators. This was an incremental expense this year versus 2015. Mike will discuss that in more detail later. It's essential that we continue to make investments in our people.

We believe the investment at this conference specifically will result in reduced turnover and training costs, and will ultimately lead to better run and more profitable shops.

Relative to same-store sales growth, we remain focused on driving sales through four key elements; menu innovation, throughput at peak, back line sales, and investment in our media of digital, social, and mobile strategies. Part of our menu innovation is a commitment to best ingredients. It's a focus and a passion.

We insist upon ingredients that are fresh. Fresh is also part of our brand promise, which is posted in our shops (04:12). And over past several years, we've done a lot to upgrade our core ingredients, for instance we upgraded our tuna to albacore. We added an all-natural white meat breast chicken. We upgraded to new (04:27) applewood smoked bacon.

Last year, we added fresh avocado. By the middle of this year, we'll implement reduced sodium in our major proteins in our bread. The best ingredient emphasis will continue in our company.

In April, we launched our Power Protein Salads, which feature our all-natural grill chicken over a fresh bed of spinach, topped with some of your favorite toppings, including egg, avocado, hummus and tomatoes.

Our salads provide a different alternative to those who are looking for non-sandwich entrée, and it's important that we continue to develop this platform now and in the future. Our back line business which includes catering, delivery and pick up grew in the mid-single-digits during the first quarter.

This continue to be a huge part of our growth story today, and in the future. We will continue to modify our approach to that client, so it can remain a growth driver, for instance we'll have more catering kitchens. We're starting back line business earlier in our new shops, week one versus week eight.

We've begun this year to execute our in-shop new back line Leadership Program, and lastly, we got to execute more robust digital marketing around our catering business. We remain committed to investing in our digital, mobile and social advertising strategies to grow brand awareness, drive reach and continue to build loyalty to our customer base.

During the second quarter, we expect to sign agreements with two new technology vendors to upgrade our mobile app, and our website. This investment will improve our customers' experience by providing ordering, pay and engagement options. This should drive our front line and back line business over time.

This investment will be done within the current CapEx range. Turning now to our new unit development, during the first quarter, our total net year-over-year growth was 12%, which again surpassed our stated long-term development target of 10% annual new unit growth.

We expect our shop openings this year to be between 45 to 50 company-operated shops and 10 to 15 franchise shops for a total of 55 to 65 shops. Company openings will be heavily back-weighted into the third quarter, and fourth quarter of this year.

In summary, we are pleased with our solid start to the year; however, we recognize we have some work to do as we overlap our pipeline success from last year.

Going to have continued intense focus on the value drivers of a strong GM in every shop, growing same-store sales through throughput, back line, menu innovation, digital marketing and build great shops at a terrific return.

We expect tougher mix comparisons in the second quarter and the rest of the year as we lap our successful Avocado and Mac & Cheese campaigns in 2015. And in reality, we were negatively impacted by the cold weather in Chicago at the start of second quarter, we well as the recent floods in Houston and Central Texas.

As we look ahead to the balance of Q2, and all of 2016, we think it's prudent to narrow the range of our comparable same-store sales guidance from 3.5% to 4.5% to 3.5% to 4%, but we remain committed to delivering our adjusted net income growth of at least 20%, as well as our other financial targets.

Now, Mike, will go through the details of the P&L for the first quarter, and our expectations for the remainder of 2016 in greater detail.

Mike?.

Thanks, Aylwin, and good afternoon, everyone. Thank you all for joining us today and for your interest in the Potbelly story. I'll review the P&L, and give you some of the highlights associated with our first quarter results. I will also provide an update on our full-year 2016 outlook.

Starting with the top line, total revenue increased about 12% to $96 million in the first quarter, driven by our company-operated same-store sales of 3.7%, and our new unit growth. Breaking down same-store sales, our average check grew approximately 4.5% driven by our price increases and the mix increase from menu and add-on growth initiatives.

As Aylwin mentioned, we are pleased with our same-store sales growth in the first quarter. However, for the reasons previously mentioned, we have revised our full-year sales guidance for the same-store sales growth to 3.5% to 4.0%.

Moving down to shop P&L, shop-level margin for the quarter was 18.6% of company-operated sales, an improvement of 50 basis points from the prior-year quarter. Across our goods sold as a percent of company-operated sales in the first quarter was 27.5%, an improvement of 100 basis points to the prior-year.

We still expect modest COGS inflation as we move through the year, but lower than we originally planned, and therefore we improve our guidance to be near the lower end of the previously communicated 28% to 29% range for the full year.

Labor was 29.5% for the quarter, which was an increase of about 70 basis points from the prior-year driven primarily by inflationary headwinds due to the continuing impact of minimum wage increases that were mandated in 2015 and 2016.

We like others in the industry remain extremely focused on managing our labor expense through continued efforts and investments to improve our labor productivity, as well as through targeted price increases. For the year, we continue to expect labor as a percent of sales to be in the 29% to 30% range.

Occupancy expense as a percentage of company-operated sales was 13.4% in the first quarter, an increase of 10 basis points as compared to the prior-year, and operating expenses as a percent of company-operated sales was 11.1% in the first quarter, an improvement of 20 basis points as compared to the prior-year period.

Our general and administrative expenses were approximately $10.5 million in the quarter, or 11% of total revenue, an increase of 70 basis points compared to the prior year. The increase in G&A was primarily driven by costs related to our GM Conference in January. We did not hold the GM Conference during the first quarter of 2015.

As Aylwin stated, the GM Conference is a key contributor to our goal of having a strong GM in every shop, and will result in better run and more profitable shops. For the year, we continue to expect our G&A to range between $40.5 million to $41.5 million.

Our adjusted EBITDA was $9 million for the quarter, which is an increase of 9.2% over the prior year. Our adjusted net income for the first quarter was $1.1 million or $0.04 per diluted share, an increase of approximately 34% from $821,000 or $0.03 a share in the prior-year. Now, an update on our share repurchase program.

During the first quarter, we repurchased approximately 334,000 shares of Potbelly common stock in the open market for a total of approximately $4.4 million. At the end of the first quarter, we had $15.7 million available from our board authorized program for repurchases.

Our cash balance at the end of the quarter was $33.5 million, and we have zero debt.

To summarize our full-year outlook for fiscal 2016, we expect comparable sales growth of 3.5% to 4%, 55 to 65 total new shops, $38 million to $40 million in CapEx, and effective tax rate in the range of 39% to 40%, adjusted net income growth of at least 20%, and adjusted diluted earnings per share in the range of $0.36 to $0.38.

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

Aylwin?.

Thanks, Mike. We're pleased with the first quarter results. However, we recognize there are lot of work to do to achieve our goals for the year. We believe our strong culture and our core values provide us with the foundation to effectively execute our growth strategies, leverage our top line, trends and increase flow through to the bottom line.

Fundamentals of the business are strong and are reflected in our results, we feel very good about the business over the long-term.

As such, we remain very committed to our stated long-term growth targets, which include total new unit shop growth of at least 10% low to mid-single-digit comparable same-store sales growth, shop level margin of at least 20%, annual adjusted net income growth of at least 20%, return on new shop investment of 25% or greater.

Thank you all for your time today. We appreciate the efforts of the men and women at Potbelly Nation! Thanks for being on the call, I'll turn it over to the operator, and we'll open it up for questions..

Our first question comes from Sharon Zackfia of William Blair. Please state your question..

Hi, good afternoon.

I guess, a quick question on the narrowing of the comp guidance, it's kind of unusual since you're within the range for the first quarter, and I don't know if you're trying to send a message that comps in the second quarter are going to be below the full-year guidance range or kind of what was the takeaway from that today?.

Yeah. Hey, Sharon, it's Mike, I'll start. What Aylwin was referencing was the – some of the challenges we finished Q1, and got in the start of Q2, whether that the weather related from the floods in Houston to the snows in Denver to the unseasonally cold temperatures here in Chicago, that coupled with – and we knew this is going in.

It did some very tough comps for us in this quarter, given the very successful launch last year of the avocado, which did very well. So yes, trying to signal that, we've had a softer start in this quarter, and wanted to provide as much transparency that as we could..

Okay. And then a separate question on the Power Protein Salads, I think that might be the highest price point I've ever seen at Potbelly for an item.

So I guess, I'm curious as to what that's teaching you about kind of how high you can take individual item prices at Potbelly, how the consumer reaction has been?.

So we do direct price comparisons four times a year. And quite frankly, with our direct sandwich competitors we are good 15% to 20% below their average check. Power Protein Salads are at $7.95 in most of the shops, so that's a high-price point.

But we think the price value is good considering you get avocado, you get hummus, you get the all-white natural chicken plus spinach, which is higher than our romaine mix. So – and we talk to customers before we put anything out in the marketplace. And all the research we got that said, the price value was very strong.

So I don't think it's function of price at all, and we still have a lot of room to price overall and with specific products. I do think it's tough to sell salads in Chicago when its 35 to 40 degrees, and so I think that's part of what we run into.

But we're not giving up on the quarter, we're not giving up on the year, in fact we're doing some contingency stuff that we'll have in the marketplace by next week. So, but that's my answer, I think our pricing is right spot-on, I think the price-value of the salad is spot-on..

That's great. Thank you..

Our next question comes from Joshua Long of Piper Jaffray. Please state your question..

Okay, thank you. I wanted to see if you might be able to provide some added context on how trends performed through the quarter. You did mention and you maintained that strength coming from 4Q to 1Q. It seems like increased competition across the environment has been increasingly focused on here of late.

So just curious on any sort of additional trends you could provide on how your performance moves through the quarter? And then I have a follow-up as well..

It was pretty consistent throughout the quarter. We had shift of Easter in the last period, but then you got that back this quarter, but fairly consistent performance across the quarter..

Okay, great. Thank you.

And then in terms of the first quarter same-store sales, how much price was in place in the menu?.

About high-3%s; about 3.8% (18:21) or so on price, so of that check number that I mentioned of 4.5%; about 3.8% is price and $0.07 mix (18:30)..

Got it. Okay.

And then as we think about that going forward for the rest of the year, you're going to be lapping some of those introductions in the back half of the year, so just curious on how you manage that, check building within also just maintaining the strong value in the menu, do you really kind of see that as a mix opportunity with your salad or is there an opportunity maybe later in the year to take some menu price increases given the labor inflation that you're looking at?.

At this point, we have projected any additional pricing. We always leave that option open, but we haven't made that decision, and we believe the menu innovation we have the back half of the year will drive check number one, and hopefully drive traffic and they line up very well against the menu items from last year..

Great, thank you..

Our next question comes from Sam Beres with Robert W. Baird. Please state your question..

Hi, good afternoon.

Thanks for taking the questions, maybe first a couple of clarifications, Mike, first on Q1 comps, could you quantify what the impact of the Easter shift was in Q1, and then maybe what you expect it to be in Q2?.

Yeah, I think the one is the flipside of the other, so it's a matter of a few (19:51)..

Great, that's helpful.

And then in terms of the incremental spending for the GM Conference in January, how much was that year-over-year?.

Yeah, so we didn't see a dollar amount, but when we talk about what that increase in G&A was as a percent of revenue, what I would say is that, the primary driver to that difference was the GM Conference, a little bit from a couple other items including some additional spend on advertising, both in terms of (20:22) and little bit as a percent of sales, so that's really the story..

Great. Thanks, that's helpful.

And maybe kind of thinking about margin going forward, what type of labor inflation did you see in Q1, and maybe what's embedded in that 28% to 29% labor ratio guidance for the full year? And I think you've talked about continuing to manage labor well and being productive there, so maybe an update on what you're seeing and what you're doing at the shop level to make sure you come in within that full year range?.

You saw in Q4 of last year, a really strong labor management, that's continued, that's just daily focus.

We're working on the labor management tool that we'll implement later this year, but we're in the process of developing that and we took pricing early this year to try to anticipate the inflation that's going to occur in labor to balance half of the year.

So, on the range that we gave, we're very confident in our margin projections, our cost projections and we gave visibility in the sales number (21:29) because we thought that was the right thing to do.

But we're very confident in this year, and our ability to hit what we've stated, and we feel very strong about our cost control efforts, and we got beat up a lot last year about flow through, like we demonstrated solving that by having the shop margin up, 0.5% in the first quarter, which historically is on our tougher quarters in terms of volume..

And our guidance then changed from the beginning of the year based with a mid-single-digit inflation, expectation..

Great. Thank you..

Our next question comes from Karen Holthouse of Goldman Sachs. Please state your question..

Hi, thanks for taking the question.

Great to hear that there is progress on the website and the app front, and if contracts are signed in the second quarter, what sort of under a best case scenario, the earliest that this could relaunch? And maybe just sort of remind us of the key upgrades or capabilities that you hope to improve by switching to a new platform? Thanks..

Yeah. So contracts gets signed this quarter, development, in fact, team's working Thursday and Friday with all of the suppliers that we've engaged. We anticipate starting – rolling-out, we're doing it in phase, so first phase will be an update on the website followed closely by an update on the mobile app.

And then, the goal then is to drive all the bells and whistles that a lot of competitors does have.

So the ability to pay, the ability to do geo-targeting, the ability to engage either around messaging or surprising, delighting our customers through specific items that's relevant to them, ability to order online with catering, repeat order having a single button to push if you want to replicate your order, and giving you the time to pick up, giving you the shop you can pick up.

So we – by this time next year, we'd anticipate the thing to be fully implemented, and really using it to drive the business. It's just essential if you're going to compete in today's environment to have a very robust mobile app first, and your desktop should mirror what you're doing on the mobile app..

Okay, thank you..

Our next question comes from Joseph Buckley of Bank of America. Please state your question..

Hey guys, this is a Greg on for Joe. I have a few questions, just first, could you give any color geographically in terms of how you're approaching, given wage inflation market-by-market.

How you're approaching pricing market-by-market, and maybe what you're seeing your competitors do as well?.

Like I say, generally 15% to 20% below our competitors, we put in a new pricing approach beginning this year. So we have price tiers by market based on competition, based on our pricing model that allows us more flexibility around pricing as opposed to nationwide pricing, that's definitely smart way to go.

Lot of our competitors are franchise businesses, so it's hard to get a read on nationwide, what they're doing. So all pricing becomes local, and that's the approach we've taken, and we'll continue to take that approach. We're not line item yet, but we're still fast causal pricing by categories or couple of categories.

Eventually over time, we may get to line item, but we have about 40 of those shops in the marketplace. So we kind of understand how they perform.

But very different approach to pricing, all local based on competition and based on, in my mind, I think about pricing, I think there's an invisible, somebody gives me $10 for lunch, I love would to give them meaningful change back, and we're kind of guided by that right now, so....

That's helpful. And then – I think you mentioned with the catering kitchen just, maybe a change there or opening some more.

Could you dive into what you're doing in the back line, and then maybe how many catering kitchens you have today, and like where you could see that going as we go forward?.

Officially, we have one in Chicago, two in New York, and eventually we would love to have catering kitchens in almost all of our major markets.

We think it's – in order to get to the growth rate of our back line business, we're going to have to scale the business at a greater level, and we definitely think catering kitchens attached to call center is just kind of way to go. As well as that we'll be expanding our sales – catering Sales Managers. We have eight now.

Eventually, we'll have a Sales Manager in each major market to help drive that business. We have updated the leadership model and duties tied to shop. We've implemented that in about 30% of the shops.

By the end the year, we'd like to be in 80% of our shops, and it's upgraded duties particularly outside the four walls, engaging customers as a way to drive the business..

And then just two housekeeping questions. One, and you guess talked about the cadence of unit openings with really heavily weighted to the back half of the year.

Does that – I suggest that 2Q should be, maybe more like 1Q in terms of the open accounts or maybe more like last year?.

Yeah. I think you should continue to think that they are very back-end loaded quarter-by-quarter, and even more so than last year is how we described in last call, and that's true yet again for this year..

Got it, got it.

And then on the commodity inflation, what was commodity inflation in the quarter, and then in the 28% to 29%, or I guess the bottom end of 28% to 29% range, did that suggest potentially deflation for the year?.

We haven't said that. We said in the last call, we expected modest inflation and we're still saying there's a little bit of inflation – a point or less in the first quarter. There are certain categories for sure where we're getting the benefit of some deflation, but overall still what I'd call very modest inflation going forward..

Okay. Thanks a lot, guys. Appreciate it..

Thank you..

There are no further questions. I'd like to turn the call back over to Aylwin Lewis for closing comments..

Yes. Thank you, we're here. So thank you for your interest. Thanks for the questions. Listen, I think a good start to the year. I want to thank the efforts of the men and women of Potbelly Nation! for driving those efforts.

It's going to take all that and more for the rest of the year, but I want to be clear, we're reaffirming our EPS target for the year, reaffirming our net income, adjusted net income growth target of at least 20%, reaffirming the new unit count, although it's extremely back loaded into the third quarter and fourth quarter year.

And we'd have one change, and we thought it was prudent to do. So we've moved the same-store sales from 3.5% to 4.5% range to 3.5% to 4%. Feel very good about where the business is. We'll continue to deliver and drive value for our shareholders and our customers, and we will talk to you in a quarter..

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation..