Q3 2019 Earnings Call
Good afternoon, everyone and welcome to Potbelly corporations third quarter fiscal 2019 earnings conference call.
At this time all participants are in a listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad.
As a reminder, this conference is being recorded.
I would now like turn call over to Mr., Matt Revord Potbellys Chief Legal Officer. Please go ahead Sir.
Good afternoon, everyone and welcome to our third quarter earnings call.
Before we get started I'd like to note that certain comments made in this call contain forward looking statements regarding future events for future financial performance of the company.
Any such statements, including our outlook for 2019 or any other future periods should be considered forward looking statements. The meeting of the private Securities Litigation Reform Act 1995.
These forward looking statements are not guarantees of future performance, nor should they be right upon as representing management's views as with 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.
No detailed information concerning these risks regarding our business and the factors that could cause actual results could differ materially the forward looking statements and other information will be good today.
Can be found our most recent annual report on Form 10-K .
Headings risk factors and Mdna ending or subsequent filings with Securities Exchange Commission, which are available that's easy dot Gov.
Our presenters their Alan Johnson, our Chief Executive Officer, and topics Gerald our Chief Financial Officer.
After our prepared remarks, well open the call for your questions I'll now turn the call around.
Thank you match.
Good afternoon, everyone and thank you for joining us today.
I got to spend some time discussing how a strategic efforts to reposition the company outperforming.
And then Tom will provide more specific details on <unk> third quarter results.
I'll get started with a few high level results for the quarter.
Same store sales were down 3% as we could traffic trends persisted throughout the quarter.
All strategic initiatives are showing positive results.
As this is the second quarter going to write offs sequential improvement and we are seeing a continuation of that trend through the first few weeks the fourth quarter.
However, these initiatives have not been enough to offset the impact of weaken traffic.
And so we all got each you talk today about all planned to accelerate action around progress.
First I want to update you on all four strategic pillars.
One on menu optimization, if it's continued to drive positive results as they have helped grow well average check by 580 basis points year over year.
Two.
Sales for off premise and digital channel up 18% in the quarter.
Driven by the door Dash national rollout that took place in early July .
And as you saw last week, we recently announced a new nationwide partnership with Grubhub.
We see this is an important step as we expand on delivery reach and digital brand awareness.
If premise in digital sales represent 21.6% overall Q3 sales.
Which is an all time high for potbelly.
Three as we shared on all lost pool retention is critical to all success and we remain committed to building brand awareness and all creating a simpler potbelly pigs program that we plan to rolled out in 2020.
All.
We continue to evaluate the right mix of message media and create just to grow all share of the market.
As we communicated you didn't know law school, we have paid down on marketing spend as they're all components of our business that still needs to be fixed before on marketing if its can reach the full impact.
Switching gears.
To walk through a few strategic strategic decisions that we have made.
First.
We have a 50 p. halted the company owned shopped roads until we see more positive traction you know traffic trends.
The exceptions would be where we need slots to further refine shopper the future concept always see opportunistic and highly profitable locations like it.
This will have a positive impact on all cash flow by reducing of Capex spend for new shops, and will lead to lower capex in 2020.
Well context, we spent $7 million in new store skeptics in 2018.
And anticipate spending 2 million in 2019.
We need to keep 100% of a focus on turning around all business specific improving traffic and continuing to accelerate franchise shop right.
Our franchising strategy has been a big win for us this year.
We signed deals for more units in the first half of the yet then we have in the last eight years.
We have a robust pipeline of highly qualified franchise candidates and we are excited about the momentum we have in this business.
Last leap.
We want to make clear.
We also opened to re franchising opportunities.
There are certain cool markets that we would likely not for me franchise.
But that is a much shorter list than the list of markets that we are willing to me franchise.
While we aren't in a position to talk specifics about those markets, we want to make it clear that pop Bailey is open to re franchising opportunities in the majority of all markets.
And just stepped back and look at the progress we have made over the last 18 months I feel encouraged.
We have consistently been testing and learning and these results have been informed our initiatives thus fall.
We have significantly changed all corporate culture leadership, and the way we do business.
Well a lot of progress has been made.
We'll still looking for that exact blocked formula.
It's clear to us that we need to gain for the insights into consumer needs and trends in order to food the shopping our brand position and competitiveness.
Therefore, we decided to bring in a top tier consulting firm in June that has a proven track record of helping other companies enough space to the final corner.
We felt we needed an outside in perspective.
Developed the fact based consumer insights that create a winning strategy.
In working with the spend over the past 16 weeks.
I've been fundamentally addressing the strategic question of where are we going to play and how are we going to win.
This project is all about topline profitable growth.
The consulting companies quantitative research method is proven in the restaurant space and what's the catalyst.
I'll be successful turnaround to several false casual and QSR concepts.
Typically these larger restaurant companies did not disclose that the head to gauge and management consulting firm to do this type of work.
However, given its impact on LPN LDL C is approximately $3 million, we felt it was important to communicate on this call.
Looking forward, we do not anticipate any significant ongoing costs for consulting work for this project beyond Q4.
This has been a collaborative if it and needless to say well very excited about the opportunity in front of us.
We plan to launch a couple of law upscale tests in the first half of 2020 and roll out the successful elements in the second half of the a 12 company operated and expanding franchisee base.
These tests are designed to bring the strategy to life.
Building on what's already working well in our business like off premise in digital and menu optimization.
This initiative is 100% focused on delivering sustainable and consistent profitable same store sales growth.
There are two things that I am willing to share with you today as it relates to this project.
First.
This strategy will leverage the cool strains of what the Potbelly brand represents.
It is not a radical departure, but it's clear that all brand is not as differentiated as it needs to be.
Taken this project includes significant competitive benchmarking.
Suffice to say that we identified some opportunities to improve the in shop customer experience.
We have rallied operators to address these gets by focusing on the fundamentals to improve the customer experience.
We believe this will improve customer satisfaction positively impact traffic and retention and complement the results we have already accomplished with all four pillars.
This will lay the foundation for the strategic changes that followed in 2020.
Beyond those two things, we're not going to elaborate further on this strategy or any of the initiatives today.
We will provide updates once we have results from the various tests.
In the meantime, we're going to continue to operate would talk DNA management focus on the fundamentals and gear up for the tests, we have planned in 2020.
With that I will now turn the call over to Tom who will walk us through all financial performance in the third quarter.
Great. Thanks, Ellen and good afternoon, everyone.
I'll walk through our financial performance and then briefly discuss our 2019 outlook.
Before handing the call back to Alan for his closing remarks.
All comparisons are versus the comparative prior year period.
Unless otherwise stated.
Now before I get into all of the financial information for the quarter I want to step back to the bigger picture for Q3.
As we've communicated in the past Q3 of 2018 was one of the strongest quarters in recent memory in terms of traffic.
Where same store traffic was virtually flat to Q3 of 2070.
That was the first time, we experienced a flat traffic quarters since Q4 2050.
The traffic improvement improvement last year was the result of very high levels of discounting coupled with very high level of advertisings bed compared to our typical spend on advertising.
This year going into Q3, we made a conscious decision to pull back on both the level of discounting.
And the level of advertising spend based on what we've learned in the first half of this year.
As a result gross margin comps were negative 2.9% in Q3.
That's 230 basis points better than the result in the first half of 29 team.
That improvement coupled with the reduction in advertising versus last year spending levels resulted in an adjusted EBITDA decline of 11% year over year in Q3 compared to the 44% drop in adjusted EBITDA that we reported in the first half of the year.
That was an important test for the business as we seek to become less promotional and more focused on driving more sustainable and profitable results.
Now, let me turn it back to the financial review starting with the top line total revenues decreased 2.6% to 104.2 million in the third quarter driven predominantly by 3% decrease for our company operated shops.
Breaking down the same store sales our average check grew by 5.8% driven by a combination of to price and mix and our traffic declined 8.3%.
Our third quarter costs increased 100 basis points compared to the second quarter of this year.
And our to your comp Stat also increased 100 basis points compared to the second quarters two year stack.
Our same store sales gap to black box narrowed.
To 210 basis points. The best result, this year.
As Alan said, our four strategic pillars are clearly, having a positive but.
As we expected same store traffic fell by 240 basis points compared to the second quarter of this year, but our to your traffic stack.
Increased by 80 basis points versus the second quarters, two year stack for traffic.
In the quarter, we opened one new shop, which was the U.S. franchise shop, we closed two company owned shops for a total of 11 year to date.
And our last international franchise shop was also closed.
Our shop level margin for the third quarter was 14.9% of company operated sales as compared to 16%.
Cost of goods sold as a percentage of sales was 26.6% in third quarter, a decrease of 20 basis points.
For the quarter Labor was 31.3% an increase of roughly 80 basis points, driven by wage inflation and sales de leverage.
Occupancy expense was 14.3% in the third quarter, an increase of 10 basis points.
Other operating expenses were two point were 12.8% in the quarter, an increase of 20 basis points due to expenses related to third party delivery.
Our general and administrative expenses were approximately 11.3 million in the third quarter or 10.8% of total revenue.
An increase of 100 140 basis points.
The increase was driven primarily by an increase in consulting fees.
Adjusted Gionee.
Which excludes store closure costs CEO transition costs restructuring cost proxy related costs and the consulting fees for the project Ellen mentioned.
In which we believe is the best indication of the core DNA expenses in our business was 8.7 million in the third quarter and 8.3% of total revenue.
Adjusted DNA was down 0.4 million in absolute dollars relative to last year, primarily due to the pullback in advertising.
Our adjusted EBITDA was 7.8 million for the third quarter compared to 8.8 million.
During the quarter, we had income tax expense of 0.1 million.
Adjusted net income for the quarter was 0.9 billion or four cents per diluted shares compared to adjusted net income of 2.4 billion or nine cents per diluted share.
In the third quarter, we repurchased approximately 162000 shares of Potbelly common stock in the open market for a total of roughly $750000.
At the end of the third quarter, we had 37.9 million available from our board authorized program for repurchases.
Our capital expenditures came in at approximately $4.3 million in the quarter and our balance sheet remained strong.
Well the cash balance of $15.8 million that the ended the third quarter and zero debt.
We are comfortable with balance sheet and are focused on maintaining ample cash and liquidity to fund the turnover.
Now moving to our 2000 2019 outlook, we are reiterating our same store sales and adjusted EBITDA guidance.
We anticipate coming in at the low end of both ranges based on how results have come in for the first nine months of the year.
For 2019, we currently expect flat to low single digit decrease in company operated comparable store sales.
Adjusted EBITDA between 25.0, and $30.0 million, including the impact of eight see 842.
Cost of goods sold to be between 26.7% and 27.3% and labor as a percentage of sales to be between 31.0 and 32.0%.
In terms of adjusted <unk> expense, we are lowering that by a couple of million dollars and now forecasted to rain forecasted to be in the range of $40.0 million to $42.0 million.
While we're still expecting to close 15 to 22 total shops, including nine to 12 company operated shops, we're slightly lowering our outlook for total shop openings from 10 to 15 to 18 to 30.
We also expect two to three company operated shop openings. This year a reduction from our previous from the previously communicated four to five.
As the result of lower shop openings, we're reducing our capex guidance from 19 to 22 million to what is now $17 million to $19 million.
I will now I'll turn the call back over to Alan for his closing remarks.
Thanks, Tom.
Before I turn the call over for questions I want to provide a brief updates on our shop with a future.
We opened office shop in the future on the corner of Logan and Elsztain in Chicago, just a few weeks ago.
As a reminder, all shop with a future is being completely redesigned from the bottom up.
And we will help improve the ordering prices and the overall customer experience.
In addition, the new design will reduce the capital investment by flux must be 25% and reduce the payback period for new company shop or franchisee by approximately one year.
We invite everyone to stop by and see the new shop.
In closing we've taken aggressive steps over the last 18 months to reposition this business for a return to growth and we believe that additional support we brought in last quarter to sharpen all brand focus is helping Essen show that we know we want to play and how we will win.
Supported with consumer insights and competitive benchmarking, we can now but just in shopping all brand position menu offering and overall experience to put us on a path to delivering sustainable positive traffic and comp growth.
We look forward to sharing additional details with you on all progress in 2020.
With that I would like to conclude our prepared remarks, and turn the call over to the operator for Q and I.
Thank you at this time, we will be conducting a question and answer session. If you'd like to ask the question. Please press star one on your telephone keypad confirmation tomo indicate your line is in the question Q you May press star to if you'd like to remove your question from the Q for participants using speaker equipment, it may be necessary to pick.
Up your handset before pressing the star Keith one moment, please why we poll for questions.
Yes.
First question comes from a line of Joshua long with Piper Jaffray. Please proceed with your question.
Hi, great. Thanks for taking my question wanted to see if you might be able to talk about how trends progressed through the quarter I think Alan during your comments you mentioned, how some of that momentum had been carried into Fourq. You. So appreciate the year over year context in terms of maybe comps are still down but were more profitable as we're not discounting we're not spending as much on average.
Hi thing, which is exciting but was hoping you might be able to parse out some of the core underlying momentum and kind of how we should think it'd be be thinking about that for fourq you.
Yeah, Hey, Josh it's Tom Thanks for the question.
We typically don't break it out, but it's sort of directionally comps got better in or through the quarter, particularly in a in a in the p. nine.
The final period of the quarter.
Then as Alan said, we're continuing to see the similar trend going into.
Q4, the first month Q4 was similar.
A slightly better in fact in where P. nine was so that's where we got comfortable staying in the range that we had guided to want to full year basis, although being clear about that we'll be at the lower end of that range.
And I'll just add something to think about as you saw the press release Josh.
On our Grubhub national rollout always see that impacted just a small part of Q3 and we'll have the full impact of both door dash and grubhub in the full full quota.
Great. Thanks for that and then thinking about that digital off premise sales category. Some really nice growth. There can you talk about what you've learned from the consumers have you thought you know coming through that channel either through data or purchase a pattern behavior and then how you think about utilizing that going forward.
It seems like your product travels well and really lends itself to two this channel and so curious on how you're thinking about that is that the longer term opportunity, while still acknowledging that there's a lot of upside opportunity and work to be done.
Yes. Thanks, let me address that if you recall is three parts of that business is the catering business is the delivery business and then is the pick up and go interesting enough. All three of those are a convenience play right.
The consume is desperate for more and more convenience. The great news is that all three component parts of a dead off premise business catering delivery and pick up all positive and contributing towards.
Being 21.6% about business and bear in mind that debt wasn't a that long ago that it was around 17%. So with old premise. We've had 15 consecutive quarters of positive comp growth. So that's not flash in the pad.
And I'll take you back a year ago.
Remember, we said we were making investments spends in this area and we're now bearing the fruit of those investments spins every single component part of the premise business is vastly different than it was one year ago.
It is a dedicated catering website, we now offer delivery in every single shop every single day every single our that we all I've been that was not the case.
At this time last year and then lastly, we have picked up shells that you can order using all app on the website in every single one of our shops across the entire system.
Great that's helpful and I know a piece of.
A large piece of that what's driving all of the the work even though maybe it gets off to use gated by some of their numbers as you put a lot of investment in process isn't team members and really built out or your executive team and their their associated team. So honestly, if you might be able to update us there in terms of our we now through that do we have everybody that we need to have from a crew.
It is [noise].
Human capital perspective are there more investments here needed as you go through the rest of this consulting project, what what else is really needed there too.
And that traction then really realize division that you guys have been 2020 and beyond.
Yes from a leadership we're done.
From a cultural change I will never be done.
But we needed to.
My quantum shift and we also need to change how we would do business. If you remember correctly were very insulated we were a an inside looking inside the company with not outside to stick to that Swatch was absolutely critical at this point that we take an outside perspective from a top tier consulting firm with.
Proven track record in all space that also.
Yes. It was one of the catalyst behind successful turnarounds to help us understand all position in the market and for the first Tom I'm Deluxe exercise an organization that we booked consumer insights in fact based based competitive benchmarking that is driving all strategy. So yeah. This now.
Now just to be heck of a lot more focus on all brand position on menu offerings and the experience that we offer is now aligned to the needs of the consumer. So yeah. I think this success is that we've enjoyed.
Around the things that all working off premise and menu optimization to good examples allows us to sort of.
Build on those successes, but also build on our core strength. So I'm very excited with the direction that this has put us on and we look forward to delivering sustainable positive shop.
For the is to come.
Great. Thank you.
Your next question comes from line of Gregory Francfort with Bank of America. Please proceed with your question.
This is actually John might go on for Greg.
Just wanted to ask on the store portfolio, where it stands today and given where sales are if you're considering a broader at certain review and then I'm Refranchising I think you've been talking about doing refranchising kills for a while now where do you stand on that or you just get a little bit more color in terms of the timeline.
And then maybe where you stand in terms of determining valuations are finding the right partner.
Yes, so why don't I address the Refranchising and then Tom can address the second part of your question.
I think suffice to say weve depend on the mid swung we fold that halted all company does this might that very clear other than the ought exception great.
Airport location makes itself available, we'll certainly consider that but.
On that front, we've focused on fixing the traffic focused on franchise growth and no bid.
Example of the fruits of all labor is in the last six months, we've done more shop deals that we've done in the last ideas and that was the I'll have line the Soc test to the.
Quality of the topline and I'm very encouraged with that.
On the re franchising front, we are open to re franchising in the majority of our markets. We're taking a very strategic approach to it in the coal markets, it's not blockley and that will re French odds in those markets, but that's a very small list a in all the noncore markets. It's a much longer list and were absolute got them to re franchising.
Yeah. It's important for you to also remember that all the deals that we've done the four deals that make up I think it's 42 shops in the last six months old deals in Virginia, New markets territory. So there was no re franchising opportunity in those markets that's not that.
We didn't want to Refranchise, there just wasn't an existing portfolio of upsides today.
And for sure let me be yeah, we're not gonna give away the business. Just so we can say we've done a re franchising deal.
No deal as you have better than a bad deal, but we'll evaluate every.
Opportunity on its merits and so forth I think Jeff and his team have I'm really turned the corner and now a full throttle on making sure that we attract quality franchisees.
And Tom could you want to address yeah. I think I think you also asked about valuation, which Alan covered Jon Michael but just as just to put of another point on it we adjust our expectations on those valuations based on the market.
And I think we're being aggressively realistic for like a better way of saying that.
And yeah, what we're really wanted somebody who will take the market and build it out further and not just do the initial transaction obviously.
In terms of the the assets that we have.
You know as we've said, we and you saw that we closed another shop, we continue to.
Use our internal team as well as an external resource to try to get out of the shops that we.
The that are that are Ah.
That are losing money and that we don't see a reversal in there and their economic ER physician.
Having said that the vast majority of them when we think about our sort of bottom 25.
All of them the loss is less than the occupancy costs. So it makes sense to run them and we don't have the ability and all of them to just accident go dark.
So it makes sense to run them it but also to be very.
Very active in the discussions and negotiations to to get out of them and we've we've written some pretty large Texas your to do so and we'll continue to do so but.
When when the deal makes sense and not when it doesn't.
Got it. Thank you and then a skin to ask on the updated DNA guidance, how much of that reduction is I'm on the lower advertising expectation.
Oh, that's a that's a big piece of it but we also you know as Alan said continue to tighten our belts here and make sure that that were you know frugally managing the business appropriately managing the business given where we are.
And I would say reallocating some of our costs and resources to make sure. We can spool up to test that we want in the first half of the year.
That that goes to the strategy in the work that Alan mentioned without it being an incremental spend.
Got it. Thank you very much you bet, Thanks, Joel Marcus.
At this time there are no other questions in queue I'd like to turn the call back to Alan Johnson for closing remarks.
Thank you picked up thank you again for your time today and your continued support I look forward to updating you on our progress have a great evening.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.