Good afternoon, everyone, and welcome to Potbelly Corporation’s First Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note this event is being recorded.

And I would now like to turn the conference over to Ms. Adiya Dixon, Potbelly’s Senior Vice President and Chief Legal Officer. Please go ahead..

Good afternoon, everyone, and welcome to our first quarter 2022 earnings call. Our presenters today are Bob Wright, our President and Chief Executive Officer; and Steve Cirulis, our Senior Vice President and Chief Financial Officer. Please note that we have provided a set of PowerPoint slides that will accompany our prepared remarks.

You may access these slides on the Investor Relations section of our website. After our prepared remarks, we’ll open the call for your questions.

I’d like to call your attention to our cautionary statements on Slide 2, and 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 2022 or any 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 that will be given today can be found in our 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.

During the call, there will also be a discussion of some items that do not conform to U.S.

Generally Accepted Accounting Principles or GAAP reconciliations of these non-GAAP measures to their most directly comparable GAAP measures are included in the appendix to the investor presentation and press release issued this afternoon, both of which are available in the Investors tab of our website. I’ll now turn the call over to Bob..

Thank you, Adiya, and good afternoon all. Thank you for joining us today. As always, I would like to begin today’s call by thanking our employees for their continuous hard work and positive energy.

Our people are the heartbeat of our brand, and it is with their dedication that we continue to deliver our craveable quality food and good vibe service to our loyal customers. In a word, we trust them, and we know our customers do as well. I’m so proud of our associates, and I’m grateful they choose Potbelly as the place to grow their careers.

Now let’s begin on Slide 3, where I’ll provide a brief overview of the first quarter 2022. Revenues of $98.2 million increased by 25.8% compared to the first quarter of 2021. And same-store sales increased by 24.4% as compared to Q1 of 2021.

Following Omicron and weather-related headwinds early in the quarter, same-store sales gained momentum at an accelerated pace, and we’re extremely excited to have achieved record AUV performance in the month of March.

This momentum was supported by notable success in our digital channels as well as significant recovery in our airport and CBD shop types. In March, CBD shops delivered their strongest volume and AUV performance since the onset of the pandemic. We’re particularly encouraged by the recovery of these shop types.

Our expectation is that they will serve as a tailwind supporting our broader portfolio as we continue along our path to growth. Our adjusted EBITDA for the quarter was a loss of $2.3 million, which although negative, still represents a significant improvement compared to a loss of $6.6 million for the first quarter 2021.

Turning to Slide 4, I would like to highlight our strategic successes in the quarter.

During the period, we renewed our focus on food innovation and food-focused promotional initiatives, including the rollout of our seasonal red velvet cookie for Valentine’s Day and buy one get one free promotion celebrating our 45th Anniversary and National Meatball Day.

We’ve also seen strong improvements in our catering business following successful promotional activity, including a focus on social catering for occasions such as the Super Bowl and March Madness.

Additionally, we have further invested in our digital marketing and paid social advertising campaigns, which have yielded sizable increases to sales dollars and daily transactions.

Following the rollout of our upgraded tech stack, we also enjoyed continued positive response from our customers as well as increased enrollment and engagement in our Perks loyalty program.

Not only have our digital platform investments, enhanced customer value, but they’ve also driven top line performance through increased check, traffic and accessibility to our shops with the various order and service channels that meet our customers’ needs.

We are diligently aware of and focused on the macro environmental headwinds in our business today, especially the cost, availability and quality of talent necessary to continue growing our brand.

We’ve implemented a number of new initiatives to strengthen the workplace environment for our dedicated associates, thus driving stronger employee satisfaction and retention, which have resulted in continued improvements in overall customer satisfaction. For example, we’ve successfully rolled out our digital tipping in all of our shops.

Our customers now have the ability to demonstrate their appreciation directly to our associates for delivering our special good vibe service. We’ve seen extremely encouraging results from this initiative, including better service for our customers and better pay for our associates.

We will continue to make enhancements in our workplace with balanced goals of driving a positive employee environment and enhanced customer satisfaction. Lastly, we’ve been very active in executing against our Franchise Growth Acceleration Initiative announced last quarter. We’re building our pipeline of multi-unit franchise candidates.

We’ve enhanced our franchising and refranchising market planning as well as sales and marketing tactics. We also continue to develop and implement internal control systems, processes and tools that will strengthen Potbelly as a franchisor of choice.

We look forward to building further relationships with potential franchisees as we move toward our goal of refranchising approximately 25% of our company units over the next three years and sign deals for new shop development area agreements.

I’d also like to briefly highlight that we have aligned the company’s internal controls and expenses with certain digital and marketing expenses now carried at the shop level as we shift to a more franchise-focused organization.

Later in today’s presentation, as we discuss shop level margins, Steve will provide a more detailed explanation of this presentation change. Franchisees and franchise candidates are happy to see us align our shop P&Ls to reflect their business model. I will now turn the call over to Steve to detail our financial performance in the first quarter.

Steve?.

Thank you, Bob, and good afternoon, everyone. Please turn to Slide 5 of the presentation, where we outline the progression of average unit volume, or AUV as well as same-store sales throughout the first quarter of 2022 and the month of April. As you can see, we continue to report steady growth in same-store sales in each period this year.

More important is the evolution of our AUVs. We experienced a drop in AUVs in January from fourth quarter levels due to seasonality, weather and Omicron impact. However, starting in February, momentum in the business accelerated, resulting in record AUVs in the month of March. So far, we are sustaining this momentum into the second quarter.

Turning to Slide 6, I’ll walk you through our income statement and specific financial performance for the first quarter of 2022 compared to the first quarter of 2021. During the first quarter, total revenues were $98.2 million, an increase of 25.8% compared to $78.1 million in the prior year quarter.

This was driven by a combination of increased traffic, improved staffing and customer service, successful marketing and promotions, our new menu launched last year and strategic price increases. While all of our shop types performed well, our previously lagging CBD and airport locations showed notable recovery.

We reported an adjusted EBITDA loss of $2.3 million compared to a loss of $6.6 million in the year ago period. The previously mentioned headwinds and seasonality impacted sales early in the quarter, along with heightened inflation, which placed pressure on margins. That said, we are encouraged by recent trends.

Our G&A costs were $8.5 million or 8.7% of total revenues compared to $7.2 million or 9.2% of total revenues in the first quarter of 2021. The decrease on a percentage basis was largely due to top line leverage.

The increase on a dollar basis was driven primarily by compensation as multiple senior leadership team positions were vacant in Q1 2021, and our CEO is receiving a $1 salary in his first year. As we turn the discussion to the components of shop margin, I want to highlight the accounting reclassification Bob mentioned earlier.

As we continue to pivot our business towards being a franchise-focused organization, we have adjusted our shop level margins to better align with this shift. Shops now carry certain advertising and marketing expenses, including fees to support our scaled media spend based on a percentage of sales. This realignment best allocates shop level costs.

To reflect this adjustment, we will be providing a reclassification of shop level margins for the past four quarters on our Investor Relations website to support easier comparison. The shop margin components reflected here incorporate the reclassification and show up primarily in the other operating expenses line.

To be clear, we are undertaking these changes on a voluntary basis, and they only involve the geography of the income statement to be more consistent with industry practice. Food, beverage and packaging costs or F&P, were $27.3 million or 28.0% of shop sales versus $21.5 million or 27.7% of shop sales in the year ago period.

The increase in F&P on an absolute basis was due to higher volumes and higher input costs, primarily proteins and packaging. As we’ve discussed previously, we are working to mitigate the impact of increased input costs and have optimized our cost-saving actions to drive the greatest value for our customers.

While the inflationary environment is expected to persist, we continue to prioritize our efforts to protect our margins and bottom line. Our 5.4% pricing increase enacted in February help support those objectives. Labor expenses were $33.3 million or 34.1% of shop sales compared to $28.6 million or 36.9% of shop sales in the year ago period.

The increase on an absolute basis is due to an increase in staffing to service higher volumes as well as continued wage increases in line with the broader industry. During the quarter, we saw our average hourly wage increased 14% compared to the year ago period.

Despite these headwinds, we drove labor more than 200 basis points lower year-over-year as a percentage of sales. In an effort to recruit and retain our employees, we’re proud to have implemented new recruiting measures, referral programs and as Bob alluded to our tipping program.

This program has provided over $1 million of additional compensation directly to our employees.

Other operating expenses were $18.1 million or 18.6% of shop sales compared to $14.0 million or 18.1% of shop sales in the year ago period due mainly to the aforementioned increase in and reallocation of certain marketing and advertising expenses to align with the shift to a franchise-focused business as well as an increase in third-party delivery fees.

Shop level margins under our new presentation were 5.0%, a meaningful improvement compared to a negative 0.2% in the year ago period, driven by strong top line performance and cost discipline. It’s also worth noting that just as sales built through the quarter, margin performance was strongest in March as well.

While CBD sales recovery was significant, their overall impact on margin remains a slight headwind. Our liquidity position at the end of the first quarter was $19.5 million, which consisted of $9.5 million in cash on hand and $10.0 million available on our credit facility.

Turning to Slide 7, I will talk you through our same-store sales metrics for each of our shop types versus the year ago period. Each of our shop types, except drive-thrus, delivered growth in same-store sales on a year-over-year basis.

We saw a substantial recovery in our airport and CBD locations with a return to travel and employees coming back to the office. We are excited that our airport and CBD locations are returning to strength. We expect a continued recovery to serve as a meaningful tailwind for Potbelly.

Moving to Slide 8, we illustrate how our channel mix has evolved since the first quarter of 2021. We are pleased to see the percentage of sales attributed to our digital channels increased by 300 basis points in the quarter to 39%.

This reinforces the positive response our customers have had to the functionality enabled by our upgraded tech stack, including app-only promotions and our Perks loyalty program. Additionally, we saw a positive uptick in our catering performance driven by increases in both office and social catering occasions.

While in-shop dining saw a slight step down in contribution sequentially, primarily due to weather and Omicron-related challenges, we are pleased to see our dedicated customers continue to come into our shops at an elevated rate year-over-year.

AUVs for the quarter were slightly below $20,000, which is attributable to the aforementioned challenges in the early parts of the quarter. However, we saw a meaningful rebound in AUVs as the quarter advanced. We are thrilled that momentum continues to build as we work towards our long-term targets.

Before I pass the call back to Bob, I’d like to turn to Slide 9 to discuss our 2022 priorities and guidance. First, we would like to reiterate our commitment to our 2022 priorities that we shared with you on our last earnings call. We are making good progress in the first few months of the year.

We are continuing to execute against our Five-Pillar Strategy and long-term growth driving initiatives, strengthening our market presence and making strategic, disciplined investments in marketing, development and operations.

Additionally, we remain on track to deliver our 2022 guidance of record AUVs, double-digit growth in same-store sales and shop level margins in the low double-digit range.

For the second quarter, we are expecting revenue of between $110 million and $116 million as well as shop-level margins between 9.0% and 11.0%, a notable increase on a sequential basis. With that, I will pass things over back to Bob..

Thanks, Steve. On Slide 10, I’d like to briefly remind everyone of our Five-Pillar Strategy, which continues to serve us well as the foundation for our three-year strategic growth objectives, which we unveiled last quarter. Since establishing our Five-Pillar Strategy, we have enjoyed great success on our path to growth.

Most recently with strong receptivity to food innovation and promotions, digital marketing engagement and ongoing improvements to our staffing and training programs. You’ve seen and will continue to see our strategic initiatives ladder up to these five pillars supporting the achievement of our growth goals.

To wrap up my prepared comments on Slide 11, I’d like to remind you of the 2024 growth targets we unveiled last quarter. Number one, AUVs of $1.3 million achieved through continued shop recovery, customer service and satisfaction and our targeted marketing efforts leveraging digital and our Perks loyalty program.

Number two, shop level margins of greater than 16%, supported by top line leverage and aggressive cost discipline, including labor as well as supply chain and food cost management. Number three, refranchising approximately 25% of our company shops is significant as we move towards a franchise growth company.

And number four, achieving franchise unit growth at a pace of at least 10% through our shop development area agreements or SDAAs. We have and continue to work diligently to expand our franchise marketing and sales tactics as well as the tools to develop our pipeline of multi-unit franchise candidates.

We look forward to building upon the great momentum we achieved in the first quarter as we progress towards our goals. We see our long-term U.S. potential to reach 2,000 units and at least 85% franchise system. As I said last quarter, we have the team, we have the brand and we have the strategy to deliver.

With that, I will now turn the call back over to the operator so we can address your questions.

Operator?.

Thank you. We’ll now begin the Question-and-Answer Session. [Operator Instructions] And the first question comes from Matt Curtis with William Blair. Please go ahead..

Hi, good afternoon. Thanks for taking the question. First one on pricing, I understand from your comments and from your release, you took a 5.4% increase during the quarter in February.

But could you tell us what the cumulative price benefit was in the menu for the full first quarter?.

Sure, Matt, we spent some time, as you can imagine, like most of you thinking about the right way to put pricing in place to accomplish a couple of things, right.

One is to make sure that we continue to have a well-balanced kind of price value equation for our customers, but also to offset some of the inflationary headwinds that we had coming our way. And we didn’t quite outrun it completely in terms of the price increase, we came pretty close. We look at our price increases as not flowing through at 100%.

It’s closer to about 80% flow-through when we put a price increase in place. And we’ve been consistent with not just this past price increase, but with prior price increases that we’ve seen as well..

Okay.

So are you planning any additional price increases right now? And basically, how much the price benefit you expect in the menu going forward?.

Yes, so we are planning two more price increases through the year, but I would emphasize, similar to the thoughtfulness that we put into this past price increase – they’re discretionary to a certain extent, right, as we see the inflationary environment evolve as well as the consumer behavior environment in all evolve.

We want to make sure that we are flexible in determining what at level we want to adjust those prices. I think based on the way we thought about inflation evolving both on the wage side and on the F&P side, the price increases that we considered should net us out pretty close to even in terms of net margin impact.

So that’s inflation versus price increase. That’s what we’re looking at..

Okay. And….

Yes, Matt, if I can add to Steve’s comments on the pricing – and I think you’ll hear a lot of this, this earnings cycle, just a lot of sensitivity to the inflation on the one hand and consumer demand on the other hand, and kind of threading that needle. We do see pricing as a necessary move. We talked about it very openly in first quarter.

As Steve said, we’ve got those two discretionary price increases on our calendar for later this year. We’re going to be really careful about maintaining value.

So we’re looking at a lot of things internally that measure the customers’ perception of value and how they’re reacting to those price increases and ensuring that especially for our loyal customers, as you saw us do things like our BOGO offers, some loyalty Perks promotion activity.

And even we’re – frankly, we’re very excited to continue to see the value of our three size menu were those Skinny sizes gives people our lower price point and the pick-your-pair that they can use.

So our customer reaction to the price increases has been – sure some have noticed it, but we’re really pleased with the flow-through and the persistent consumer demand. And that’s what’s really kind of governed our ability to price out the inflation while still holding on to that consumer demand.

But we think we’ve got all of the right hydraulics in place to balance that out the rest of this year..

Okay, understood. So just to kind of close the loop on the pricing discussion, I guess.

Your full year restaurant level margin guidance as well as, I guess, the guidance for the second quarter you’ve provided, does that include the impact of the two price increases you’re planning or not yet?.

It includes the contemplation of those. Yes, it does, but again, measured and metered based on what we think is appropriate at the time. I think it’s also good to reiterate, as Steve talked about. It also includes the marketing funds that are now in the shop margin. So that’s fully burdened the way that a lot of franchise P&Ls are burdened now..

Okay, understood. Shifting gears to staffing and wages. I guess, first just a basic question. What was your wage inflation in the quarter and how much do you expect wage inflation for the full year? And are you planning any additional wage increases at this point, so I guess we’ll start there..

Yes. I think our – go ahead, Steve..

Sorry, I didn’t – I think just to cater the numbers really quickly. We mentioned in the prepared remarks that we saw wage increases at about 14%, and those are associate wage, so the hourly wage increases for the quarter that’s versus prior year.

And we’ve, I think, seen – somewhat of a flattening of the acceleration that we saw kind of last – end of last year into this year and that’s helpful to us. We mentioned some things that we’re doing to remain competitive in the marketplace as it relates to some of our recruiting.

And as you heard in the prepared remarks, we’ve instituted a tipping program, which has been beneficial to not just recruitment but retainment of our store-level employees..

Okay. And then….

Yes, specifically to your question about planned increases, Matt, we have budgeted relative inflation in wages throughout the year. We are finding that those tips that we mentioned are able to help us mitigate what we had thought we would need in terms of natural wage inflation.

And of course, in those markets, and there are fewer of those this year than last year where there’ll be legislative wage increases. Obviously, we’ll comply with those. But candidly, in many cases, in most cases, we’re well ahead of those legislative numbers anyway because the market drove the wages higher..

Okay. I guess just talking about staffing more generally, how, are your staffing levels right now either relative to 2019or sort of what you would consider to be optimal levels in this environment.

And could you tell us what hourly employee and shop manager turnover trends have been like recently?.

Yes, we don’t share those internal trends, but we are excited to tell you that our shop turnover numbers, both at the associate level and at the manager level are well below the numbers that we get for fast casual as an industry. Of course, fast casual runs a lot lower than QSR. So we’re very pleased with our turnover numbers.

And overall staffing, where I think we talked a couple of quarters ago, it was probably one of the worst environments I’ve seen in over 30 years in the business. It has gotten better for us. We are back to net hiring. So and we’re retaining and hiring more associates and more managers than we’re losing.

So we’re growing our staffing as we head into the busiest season. We can always use more high-quality people, but we’re not in crisis mode and certainly in a much, much better position than we were even six months ago.

Our expectation is that many of the workplace things that we’ve been working on training and staffing and positioning guidelines and the labor guidelines, the management staffing that we’ve done, all of that is beginning to bear more and more fruit for us.

It’s not only showing up in our employee turnover numbers as those, as I said, are proving to be very good. We’re also seeing customer satisfaction scores accelerating in a positive direction as well. And that’s always a reflection of how the staffing environment is going. So we’re very pleased with where we are but not yet satisfied..

Okay, got it. I guess just to talk about your franchising initiatives for a moment.

I mean I know it’s still relatively early days, but what are you specifically working on right now to attract new franchisees to the system? I mean, is it namely just initial outreach efforts or are you a little bit further along in the process where we could potentially expect to hear about some ADAs being signed as soon as later this year or early next year?.

Yes, we are much further along than initial outreach. We’ve got marketing campaigns, outreach campaigns. We’ve got digital marketing campaigns that are underway that have begun to bear fruit for us.

As you suspect, we look forward to making news on any deals that we sign, and we’ll do that when we sign them, much like we did last week when we issued that press release for our Reef partnership for our mobile – our ghost kitchen partnership that we have with Reef.

As we have new deals, whether they’re refranchising deals or new SDAA deals, we’ll make sure that you guys know about them in real time. Suffice it to say, though, that we have active dialogue with multiple candidates not only for refranchising some of the markets that we are refranchising but for new territory and SDAAs as well.

So we’re very comfortable reiterating our three-year goal of 25% of our shops. We still believe that, that will come at a fairly even pace across those three years, including this year. And we’re very pleased with the interest and the response that we’re getting from franchisees..

Glad to hear. Look forward to hearing more about that in the future then. I guess, final question for me is on digital marketing, which is based on my understanding, one of the core components of you’re getting the system to $1.3 million over time.

It sounds like your efforts today are primarily focused around really driving engagement with the current core customer base, to things like leveraging Potbelly Perks, loyalty and so on? I was wondering if I could hear your thoughts on using digital marketing to maybe broaden your reach more to other demographic groups, thinking mainly about outreach to younger customers here..

Yes, thanks for that. You’re right we talk a lot about our FERCs program because those loyal customers are so important and so valuable to us. But much of the spend that we’re investing in that scale media is, in fact, in awareness building.

So its digital advertising placed in social arenas, that allows us to create an outreach campaign, building the brand for people who either have lapsed awareness or have limited awareness of the brand. I think we – as we’ve shared before, we hold ourselves to a very high standard for the returns on those investments.

That’s why we continue to talk about it in a scaled manner. What we look for is overall lift in sales in a group of shops where we make the additional investments.

And unlike a lot of e-commerce where you’re simply tracking the click-throughs and the online purchases, we’re actually measuring pre-post net of control sales lift overall sales lift because we recognize that much of our advertising drives foot traffic into the shops.

And it is that three to one expected return that allows us to continue to incrementally scale that media. As we take each step, we test it. We prove that it works for us. We’re comfortable that the investment is delivering returns, and then we take the next step to expand it a little further.

So in fact, quite a bit of it is awareness building advertising, and we’re very pleased with how it’s working for us..

Okay, sounds good to listen guys. Thanks very much for the time and good luck with the rest of the quarter..

Thanks, Matt..

Thanks, Matt..

We still have time for questions. [Operator Instructions] We have no further questions. So this concludes our question-and-answer session. And I will turn the conference back over to management for any closing remarks..

Thank you, operator, I know our call is crossing over with a lot of reporting today and – so please know that we are looking forward to any follow-up calls and plan to do a lot of those throughout the evening and tomorrow. But for today, I just want to say thank you. Thank you for your time today.

We’re excited about how 2022 has begun and what is in store for the remainder of the year. We believe Potbelly is at the forefront of growth, and we look forward to unlocking the company’s fullest potential. We appreciate your interest in and support for Potbelly.

And we look forward to meeting many of you and many of our investors in the upcoming William Blair and B. Riley conferences that Steve and I will be attending. So have a great night, everyone. Thanks for dialing in..

The conference is now concluded. Thank you for attending today’s presentation and you may now disconnect..