UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2019
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
Commission File Number: 001-36104
Potbelly Corporation
(Exact name of registrant as specified in its charter)
Delaware
36-4466837
(State or Other Jurisdiction of
Incorporation)
(IRS Employer
Identification Number)
111 N. Canal Street, Suite 850
Chicago, Illinois
60606
(Address of Principal Executive Offices)
(Zip Code)
Registrant’s Telephone Number, Including Area Code: (312) 951-0600
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 par value
PBPB
The NASDAQ Stock Market LLC
(Nasdaq Global Select Market)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☒ No ☐
As of July 28, 2019, the registrant had 23,768,375 shares of common stock, $0.01 par value per share, outstanding.
Potbelly Corporation and Subsidiaries
Table of Contents
Page
PART I.
FINANCIAL INFORMATION
Item 1.
Financial Statements
3
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Operations
4
Condensed Consolidated Statements of Equity
5
Condensed Consolidated Statements of Cash Flows
7
Notes to Condensed Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
16
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
23
Item 4.
Controls and Procedures
PART II.
OTHER INFORMATION
Legal Proceedings
24
Item 1A.
Risk Factors
Unregistered Sale of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
25
Signature
26
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(amounts in thousands, except share and par value data, unaudited)
June 30,
December 30,
2019
2018
Assets
Current assets
Cash and cash equivalents
$
18,066
19,775
Accounts receivable, net of allowances of $131 and $113 as of June 30, 2019
and December 30, 2018, respectively
4,545
4,737
Inventories
3,357
3,482
Prepaid expenses and other current assets
8,182
11,426
Total current assets
34,150
39,420
Property and equipment, net
81,628
87,782
Right-of-use assets for operating leases
216,540
—
Indefinite-lived intangible assets
3,404
Goodwill
2,222
Deferred income taxes
13,385
Deferred expenses, net and other assets
6,898
7,002
Total assets
344,842
153,215
Liabilities and Equity
Current liabilities
Accounts payable
4,222
3,835
Accrued expenses
21,303
25,029
Short-term operating lease liabilities
29,126
Accrued income taxes
162
Total current liabilities
54,813
29,026
Deferred rent and landlord allowances
22,905
Long-term operating lease liabilities
210,898
Other long-term liabilities
6,255
5,751
Total liabilities
271,966
57,682
Commitments and contingencies (Note 9)
Equity
Common stock, $0.01 par value—authorized 200,000,000 shares; outstanding
23,768,375 and 24,142,586 shares as of June 30, 2019 and December 30,
2018, respectively
331
330
Additional paid-in-capital
434,407
432,771
Treasury stock, held at cost, 9,291,732 and 8,801,154 shares as of
June 30, 2019, and December 30, 2018, respectively
(111,874
)
(108,372
Accumulated deficit
(250,394
(229,558
Total stockholders’ equity
72,470
95,171
Non-controlling interest
406
362
Total equity
72,876
95,533
Total liabilities and equity
See accompanying notes to the unaudited condensed consolidated financial statements.
(amounts in thousands, except share and per share data, unaudited)
For the 13 Weeks Ended
For the 26 Weeks Ended
July 1,
Revenues
Sandwich shop sales, net
104,801
109,381
202,059
211,628
Franchise royalties and fees
829
966
1,658
1,636
Total revenues
105,630
110,347
203,717
213,264
Expenses
Sandwich shop operating expenses
Cost of goods sold, excluding depreciation
28,264
28,639
54,242
55,275
Labor and related expenses
32,114
32,412
64,087
63,991
Occupancy expenses
15,230
14,985
29,607
29,711
Other operating expenses
11,816
12,793
23,961
25,293
General and administrative expenses
13,843
13,440
26,552
25,628
Depreciation expense
5,585
5,858
11,121
11,684
Pre-opening costs
68
10
136
Impairment and loss on disposal of property and equipment
246
2,057
328
4,081
Total expenses
107,098
110,252
209,908
215,799
Income (loss) from operations
(1,468
95
(6,191
(2,535
Interest expense
35
28
67
55
Income (loss) before income taxes
(1,503
(6,258
(2,590
Income tax expense (benefit)
302
13,865
(202
Net loss
(1,749
(235
(20,123
(2,388
Net income attributable to non-controlling interest
117
125
182
166
Net loss attributable to Potbelly Corporation
(1,866
(360
(20,305
(2,554
Net loss per common share attributable to common
stockholders:
Basic
(0.08
(0.01
(0.85
(0.10
Diluted
Weighted average shares outstanding:
23,908,095
25,551,386
24,020,567
25,348,121
(amounts in thousands, except share data, unaudited)
For the 13 weeks ended:
Common Stock
Treasury
Additional
Paid-In-
Accumulated
Non-
Controlling
Shares
Amount
Stock
Capital
Deficit
Interest
Total Equity
Balance at April 1, 2018
25,286,229
321
(85,441
424,771
(222,874
556
117,333
Net income (loss)
Stock-based compensation plans
625,063
6
4,483
4,489
Repurchases of common stock
(259,339
(3,386
Distributions to non-controlling
interest
(256
Stock-based compensation expense
1,389
Balance at July 1, 2018
25,651,953
327
(88,827
430,643
(223,234
425
119,334
Balance at March 31, 2019
24,038,211
(109,541
433,400
(248,528
427
76,088
82,694
1
(350,659
(2,323
(177
Contributions from non-controlling
39
Treasury shares used for stock-based
plans
(1,871
(10
1,005
Balance at June 30, 2019
23,768,375
For the 26 weeks ended:
Balance at December 31, 2017
24,999,688
318
(85,262
421,657
(219,990
515
117,238
Cumulative impact of Topic 606
(690
925,375
9
6,735
6,744
(264,339
(3,449
(8,771
(116
2,251
Balance at December 30, 2018
24,142,586
Cumulative impact of Topic 842, net
of tax of $196
(531
116,367
172
173
(485,659
(3,467
(4,919
(35
1,464
(amounts in thousands, unaudited)
Cash flows from operating activities:
Adjustments to reconcile net loss to net cash provided by operating activities:
Noncash lease expense
13,826
Deferred income tax
13,790
(150
Asset impairment, store closure and disposal of property and equipment
433
4,221
Other operating activities
18
311
Changes in operating assets and liabilities:
Accounts receivable, net
192
(822
263
Prepaid expenses and other assets
3,322
(924
303
676
Operating lease liabilities
(15,281
Accrued expenses and other liabilities
(2,202
2,745
Net cash provided by operating activities:
6,988
17,867
Cash flows from investing activities:
Purchases of property and equipment
(5,230
(11,614
Net cash used in investing activities:
Cash flows from financing activities:
Proceeds from exercise of stock options
Employee taxes on certain stock-based payment arrangements
(512
Treasury stock repurchases
Distributions to non-controlling interest
Contributions from non-controlling interest
Net cash (used in) provided by financing activities:
2,527
Net increase (decrease) in cash and cash equivalents
(1,709
8,780
Cash and cash equivalents at beginning of period
25,530
Cash and cash equivalents at end of period
34,310
Supplemental cash flow information:
Income taxes paid
180
244
Interest paid
48
38
Supplemental non-cash investing and financing activities:
Unpaid liability for purchases of property and equipment
583
1,299
See accompanying notes to the unaudited condensed consolidated financial statements
Notes to Unaudited Condensed Consolidated Financial Statements (unaudited)
(1) Organization and Other Matters
Business
Potbelly Corporation (the “Company” or “Potbelly”), through its wholly owned subsidiaries, owns or operates more than 400 company-owned shops in the United States. Additionally, Potbelly franchisees operate more than 40 shops domestically.
Basis of Presentation
The unaudited condensed consolidated financial statements and notes herein should be read in conjunction with the audited consolidated financial statements of Potbelly Corporation and its subsidiaries and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 30, 2018. The unaudited condensed consolidated financial statements included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”) regarding interim financial reporting. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to the SEC rules and regulations. In the opinion of management, all adjustments, which are of a normal and recurring nature (except as otherwise noted), that are necessary to present fairly the Company’s financial position as of June 30, 2019 and December 30, 2018, its statement of operations for the 13 and 26 weeks ended June 30, 2019 and July 1, 2018, the statement of equity for the 13 and 26 weeks ended June 30, 2019 and July 1, 2018 and its statement of cash flows for the 26 weeks ended June 30, 2019 and July 1, 2018 have been included. The consolidated statements of operations for the interim periods presented herein are not necessarily indicative of the results to be expected for the full year.
The Company does not have any components of other comprehensive income recorded within its consolidated financial statements and therefore, does not separately present a statement of comprehensive income in its condensed consolidated financial statements.
Principles of Consolidation
The unaudited condensed consolidated financial statements include the accounts of Potbelly Corporation; its wholly owned subsidiary, Potbelly Illinois, Inc. (“PII”); PII’s wholly owned subsidiaries, Potbelly Franchising, LLC and Potbelly Sandwich Works, LLC (“LLC”); seven of LLC’s wholly owned subsidiaries and LLC’s seven joint ventures, collectively, the “Company.” All intercompany balances and transactions have been eliminated in consolidation. For consolidated joint ventures, non-controlling interest represents a non-controlling partner’s share of the assets, liabilities and operations related to the seven joint venture investments. The Company has ownership interests ranging from 51-80% in these consolidated joint ventures.
Fiscal Year
The Company uses a 52/53-week fiscal year that ends on the last Sunday of the calendar period. Approximately every five or six years a 53rd week is added. Fiscal year 2019 and 2018 both consist of 52 weeks. The fiscal quarters ended June 30, 2019 and July 1, 2018 each consisted of 13 weeks.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Significant estimates include amounts for long-lived assets and income taxes. Actual results could differ from those estimates.
Recent Accounting Pronouncements
On December 31, 2018, the Company adopted ASU 2016-02, “Leases (Topic 842),” along with related clarifications and improvements. This pronouncement requires lessees to recognize a liability for lease obligations, which represents the discounted obligation to make future lease payments, and a corresponding right-of-use asset on the balance sheet. The guidance requires disclosure of key information about leasing arrangements that is intended to give financial statement users the ability to assess the amount, timing, and potential uncertainty of cash flows related to leases. We elected the optional transition method to apply the standard as of the effective date and therefore, prior period amounts have not been adjusted and continue to be reported in accordance with our historical accounting under previous lease guidance, ASC Topic 840: Leases (Topic 840). The adoption of Topic 842 had a material impact on the consolidated balance sheets and an immaterial impact on the consolidated statements of operations, consolidated statements of equity and consolidated statements of cash flows.
Our practical expedients were as follows:
Implications as of December 31, 2018
Practical expedient package
We have not reassessed whether any expired or existing contracts are, or contain, leases.
We have not reassessed the lease classification for any expired or existing leases.
We have not reassessed initial direct costs for any expired or existing leases.
Hindsight practical expedient
We have not elected the hindsight practical expedient, which permits the use of hindsight when determining lease term and impairment of operating lease assets.
The impact on the consolidated balance sheet is as follows:
Adjustments Due
to the Adoption of
December 31,
Topic 842
Accounts receivable, net of allowances of $113 as of December 30, 2018
232,477
Deferred income taxes, noncurrent
195
13,580
232,672
385,887
Accrued expenses(1)
(1,124
23,905
28,826
27,702
56,728
Deferred rent and landlord allowances(1)
(22,905
228,406
233,203
290,885
Stockholders’ equity
Common stock, $0.01 par value—authorized 200,000,000 shares;
outstanding 24,142,586 shares as of December 30, 2018
Treasury stock, held at cost, 8,801,154 shares as of December 30, 2018
Accumulated deficit(2)
(230,089
94,640
Total stockholders' equity
95,002
(1)
Adjustment to reclassify deferred rent and tenant improvement allowance to right-of-use assets for operating leases upon the adoption of Topic 842.
(2)
The Company recorded a net reduction of $0.5 million to opening accumulated deficit as of December 31, 2018, due to the cumulative impact of adopting Topic 842.
(2) Revenue
Potbelly primarily earns revenue at a point in time through sales at our sandwich shop locations and records such revenue net of sales-related taxes collected from customers. The payment on these sales is due at the time of the customer’s purchase. The Company also receives royalties from franchisees on their respective sales, which are recognized at the point in time the sale is made and invoiced weekly. Potbelly also records revenue from sales over time related to upfront franchise fees, gift card redemptions and breakage. For the 13 and 26 weeks ended June 30, 2019, revenue recognized from all revenue sources on point in time sales was $105.5 million and $203.3 million, respectively, and revenue recognized from sales over time was $0.1 million and $0.4 million, respectively. For the 13 and 26 weeks ended July 1, 2018, revenue recognized from all revenue sources on point in time sales was $110.2 million and $212.9 million, respectively, and revenue recognized from sales over time was $0.2 million and $0.4 million, respectively.
Franchise Revenue
Potbelly licenses intellectual property and trademarks to franchisees through franchise agreements. As part of these franchise agreements, Potbelly receives an upfront payment from the franchisee, which the Company recognizes over the term of the franchise agreement. The Company records a contract liability for the unearned portion of the upfront franchise payments.
Gift Card Redemptions / Breakage Revenue
Potbelly sells gift cards to customers, records the sale as a contract liability and recognizes the associated revenue as the gift card is redeemed. A portion of these gift cards are not redeemed by the customer, which is recognized by the Company as revenue as a percentage of customers gift card redemptions. The expected breakage amount recognized is determined by a historical data analysis on gift card redemption patterns.
Contract Liabilities
As described above, the Company records current and noncurrent contract liabilities for upfront franchise fees and gift cards. There are no other contract liabilities or contract assets recorded by the Company. The opening and closing balances of the Company’s current and noncurrent contract liabilities from contracts with customers were as follows:
Current Contract
Liability
Noncurrent Contract
(Thousands)
Beginning balance as of December 31, 2018
(2,184
(1,631
Ending balance as of June 30, 2019
(1,687
(1,960
Increase (decrease) in contract liability
(497
329
The aggregate value of remaining performance obligations on outstanding contracts was $3.6 million as of June 30, 2019. The Company expects to recognize revenue related to contract liabilities as follows (in thousands), which may vary based upon franchise activity as well as gift card redemption patterns:
Years Ending
1,250
2020
288
2021
2022
199
2023
Thereafter
1,472
Total revenue recognized
3,647
For the 13 and 26 weeks ended June 30, 2019, the amount of revenue recognized related to the December 31, 2018 liability ending balance was $0.6 million and $1.5 million, respectively. For the 13 and 26 weeks ended July 1, 2018, the amount of revenue recognized related to the January 1, 2018 liability ending balance was $0.6 million and $1.6 million, respectively. This revenue related to the recognition of gift card redemptions and upfront franchise fees. For the 26 weeks ended June 30, 2019 and the 26 weeks ended July 1, 2018, the Company did not recognize any revenue from obligations satisfied (or partially satisfied) in prior periods.
(3) Fair Value Measurement
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and all other current liabilities approximate fair values due to the short maturities of these balances.
The Company assesses potential impairments to its long-lived assets, which includes property and equipment and lease right-of-use assets, on a quarterly basis or whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. Shop-level assets and right-of-use assets are grouped at the individual shop-level for the purpose of the impairment assessment. Recoverability of an asset group is measured by a comparison of the carrying amount of an asset group to its estimated undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of the asset group exceeds its estimated undiscounted future cash flows, an impairment charge is recognized as the amount by which the carrying amount of the asset group exceeds the fair value of the asset group. The fair value of the shop assets is determined using the discounted future cash flow method of anticipated cash flows through the shop’s lease-end date using fair value measurement inputs classified as Level 3. The fair value of right-of-use assets is estimated using market comparative information for similar properties. Level 3 inputs are derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. At transition of adoption to ASC 842, the Company impaired $0.7 million of pre-tax right-of-use assets related to previously impaired shops. This amount is recorded, net of tax, as an opening reduction to retained earnings. After performing a periodic review of the Company’s shops during the 13 and 26 weeks ended June 30, 2019, it was determined that indicators of impairment were present for certain shops as a result of continued underperformance. The Company performed an impairment analysis related to these shops and recorded an impairment charge of $0.2 million for the 13 and 26 weeks ended June 30, 2019. The Company recorded an impairment charge of $2.1 million and $4.1 million for the 13 and 26 weeks ended July 1, 2018, respectively.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Assets recognized or disclosed at fair value on the consolidated financial statements on a nonrecurring basis include items such as leasehold improvements, property and equipment, operating lease assets, goodwill, and other intangible assets. These assets are measured at fair value if determined to be impaired.
(4) Loss Per Share
Basic and diluted income per common share attributable to common stockholders are calculated using the weighted average number of common shares outstanding for the period. Diluted income per common share attributable to common stockholders is computed by dividing the income allocated to common stockholders by the weighted average number of fully diluted common shares outstanding. In periods of a net loss, no potential common shares are included in diluted shares outstanding as the effect is anti-dilutive. For the 13 and 26 weeks ended June 30, 2019, and July 1, 2018, the Company had a loss per share, and therefore potentially dilutive shares were excluded from the calculation.
The following table summarizes the loss per share calculation:
Weighted average common shares outstanding-basic
Plus: Effect of potential stock options exercise
Weighted average common shares outstanding-diluted
Loss per share available to common stockholders-basic
Loss per share available to common stockholders-diluted
Potentially dilutive shares that are considered anti-dilutive:
Common share options
2,376,713
2,557,475
2,381,767
2,829,461
11
(5) Income Taxes
Our interim tax provision is determined using an estimated annual effective tax rate and adjusted for discrete taxable events that occur during the quarter. The difference between the effective tax rate in 2019 and 2018 is the recording of the valuation allowance in the first quarter of 2019.
The Company regularly assesses the need for a valuation allowance related to its deferred tax assets, which includes consideration of both positive and negative evidence related to the likelihood of realization of such deferred tax assets to determine, based on the weight of the available evidence, whether it is more-likely-than-not that some or all of its deferred tax assets will not be realized. In its assessment, the Company considered recent financial operating results, the change in projected future taxable income for fiscal year 2019, the reversal of existing taxable temporary differences, and tax planning strategies. As a result of the changes in projected taxable income for 2019, the Company estimates it will be in a cumulative loss position as of December 29, 2019. Therefore, the Company determined that the negative evidence outweighed the positive evidence and, therefore, recorded a full valuation allowance against its net deferred tax assets during the 13 weeks ended March 31, 2019. The Company recorded a non-cash charge to income tax expense of $13.6 million related to the recognition of the valuation allowance during the first quarter of 2019 and continues to record a valuation allowance against all of our deferred tax assets as of June 30, 2019. The Company did not provide for an income tax benefit on the pre-tax loss recorded for the three and six months ended June 30, 2019. This accounting treatment has no effect on the Company’s ability to utilize deferred tax assets to reduce future cash tax payments. The Company will continue to assess the likelihood of the realization of its deferred tax assets at the end of each reporting period and the valuation allowance will be adjusted accordingly.
(6) Leases
We determine if a contract contains a lease at inception. The Company leases retail shops, warehouse and office space under operating leases. For leases with renewal periods at the Company’s option, the Company determines the expected lease period based on whether the renewal of any options are reasonably assured at the inception of the lease.
Operating lease assets and liabilities are recognized at the lease commencement date. Operating lease liabilities represent the present value of lease payments not yet paid. Operating lease assets represent our right to use an underlying asset and are based upon the operating lease liabilities adjusted for prepayments or accrued lease payments, initial direct costs, lease incentives, and impairment of operating lease assets. To determine the present value of lease payments not yet paid, we estimate incremental secured borrowing rates corresponding to the maturities of the leases. As we have no outstanding debt nor committed credit facilities, secured or otherwise, we estimate this rate based on prevailing financial market conditions, comparable company and credit analysis, and management judgment.
We recognize expense for these leases on a straight-line basis over the lease term. Additionally, tenant incentives used to fund leasehold improvements are recognized when earned and reduce our right-of-use asset related to the lease. These are amortized through the right-of-use asset as reductions of expense over the lease term.
Related to the adoption of Topic 842, our policy elections were as follows:
Separation of lease and non-lease components
We elected this expedient to account for lease and non-lease components as a single component for our entire population of operating lease assets.
Short-term policy
We have elected the short-term lease recognition exemption for all applicable classes of underlying assets. Short-term disclosures include only those leases with a term greater than one month and 12 months or less, and expense is recognized on a straight-line basis over the lease term. Leases with an initial term of 12 months or less, that do not include an option to purchase the underlying asset that we are reasonably certain to exercise, are not recorded on the balance sheet.
Supplemental balance sheet information related to leases was as follows:
Operating Leases
Classification
Right-of-use assets
Short-term lease liabilities
Long-term lease liabilities
Total lease liabilities
240,024
12
Operating lease term and discount rate were as follows:
Weighted average remaining lease term (years)
8.72
Weighted average discount rate
8.03
%
Certain of the Company’s operating lease agreements include variable payments that are passed through by the landlord, such as common area maintenance and real estate taxes, as well as variable payments based on percentage rent for certain of our shops. Pass-through charges and payments based on percentage rent are included within variable lease cost.
The components of lease cost were as follows:
13 weeks ending
26 weeks ending
Operating lease cost
Occupancy and General and administrative expenses
11,611
22,606
Variable lease cost
Occupancy
3,649
7,153
Total lease cost
15,260
29,759
Supplemental disclosures of cash flow information related to leases were as follows:
Operating cash flows rent paid for operating lease liabilities
11,788
23,726
Operating right-of-use assets obtained in exchange for new operating lease liabilities
2,735
3,657
Reduction in operating right-of-use assets due to lease terminations
(1,320
(5,847
As of June 30, 2019, the Company has additional operating lease payments related to shops not yet open of $4.4 million. These operating leases will commence during the next fiscal year with an average lease term of 12 years.
Maturities of lease liabilities were as follows as of June 30, 2019:
Remainder of 2019
23,542
45,919
41,664
36,359
31,492
2024
28,775
135,169
Total lease payments
342,920
Less: imputed interest
(102,896
Present value of lease liabilities
13
As previously disclosed in our 2018 Annual Report on Form 10-K and under the previous lease accounting, maturities of lease liabilities were as follows as of December 30, 2018:
47,918
45,828
41,497
36,120
31,060
138,928
Total minimum lease payments
341,351
(7) Capital Stock
On May 8, 2018, the Company announced that its Board of Directors authorized a stock repurchase program for up to $65.0 million of its outstanding common stock. The program permits the Company, from time to time, to purchase shares in the open market (including in pre-arranged stock trading plans in accordance with the guidelines specified in Rule 10b5-1 under the Securities and Exchange Act of 1934, as amended) or in privately negotiated transactions. The number of common shares actually repurchased, and the timing and price of repurchases, will depend upon market conditions, SEC requirements and other factors. Purchases may be started or stopped at any time without prior notice depending on market conditions and other factors. For the 13 weeks ended June 30, 2019, the Company repurchased 350,659 shares of its common stock for approximately $2.3 million under the stock repurchase program, including cost and commission, in open market transactions. For the 26 weeks ended June 30, 2019, the Company repurchased 485,659 shares of its common stock for approximately $3.5 million under the stock repurchase program, including cost and commission, in open market transactions. Repurchased shares are included as treasury stock in the condensed consolidated balance sheets and the condensed consolidated statements of equity.
(8) Stock-Based Compensation
Stock options
On May 16, 2019, the Company’s stockholders approved the Potbelly Corporation 2019 Long-Term Incentive Plan (the “2019 Plan”) and, in connection therewith, all equity awards made after that date were made under the 2019 Plan. On June 10, 2019, the Company registered 1,200,000 shares of its common stock reserved for issuance under the 2019 Plan. All remaining shares of common stock reserved for issuance under the previous Amended and Restated 2013 Long-Term Incentive Plan (the “2013 Plan”) are available for issuance under the 2019 Plan and no future awards will be made under the 2013 Plan. The fair value of stock options is determined using the Black-Scholes option pricing model. There were no stock options granted during the 13 weeks and 26 weeks ended June 30, 2019.
A summary of stock option activity for the 26 weeks ended June 30, 2019 is as follows:
Options
Weighted
Average
Exercise
Price
Aggregate
Intrinsic
Value
Remaining
Term
(Years)
Outstanding—December 30, 2018
2,150
11.49
378
5.13
Granted
Exercised
(22
7.93
Canceled
(198
13.54
Outstanding—June 30, 2019
1,930
11.32
5.04
Exercisable—June 30, 2019
1,534
11.05
4.15
Stock-based compensation related to stock options is measured at the grant date based on the calculated fair value of the award, and is recognized as expense over the requisite employee service period, which is generally the vesting period of the grant with a corresponding increase to additional paid-in capital. For the 13 weeks and 26 weeks ended June 30, 2019, the Company recognized stock-based compensation expense related to stock options of $0.3 million and $0.6 million, respectively. For the 13 weeks and 26 weeks ended July 1, 2018, the Company recognized stock-based compensation expense related to stock options of $0.3 million and $1.0 million, respectively. As of June 30, 2019, unrecognized stock-based compensation expense for stock options was $1.4 million, which will be recognized through fiscal year 2022. The Company records stock-based compensation expense within general and administrative expenses in the condensed consolidated statements of operations.
14
Restricted stock units
The Company awards restricted stock units (“RSUs”) to certain employees of the Company and certain non-employee members of its Board of Directors. The Board of Director grants have a vesting schedule of 50% on the first anniversary of the grant date and 50% on the second anniversary of the grant date. The employee grants vest in one-third increments over a three-year period. For the 13 weeks and 26 weeks ended June 30, 2019, the Company recognized stock-based compensation expense related to RSUs of $0.7 million and $0.9 million, respectively. For the 13 weeks and 26 weeks ended July 1, 2018, the Company recognized stock-based compensation expense related to RSUs of $1.1 million and $1.3 million, respectively. As of June 30, 2019, unrecognized stock-based compensation expense for RSUs was $2.1 million, which will be recognized though fiscal year 2022.
A summary of RSU activity for the 26 weeks ended June 30, 2019 is as follows:
RSUs
Number of RSUs
Weighted Average
Fair Value per Share
Non-vested as of December 30, 2018
247
11.99
306
7.02
Vested
(93
6.13
(13
8.46
Non-vested as of June 30, 2019
447
8.68
Performance stock units
The Company awards performance share units (“PSUs”) to eligible employees; the PSUs are subject to service and performance vesting conditions. In March of 2019 the Company issued 188,414 PSUs with a grant date fair value of $8.46 per share. The PSUs will vest based on the Company’s achievement of certain targets related to adjusted EBITDA and same store sales goals. The PSUs will vest fully on the third anniversary of the grant date. The quantity of shares that will vest ranges from 0% to 200% of the targeted number of shares. If the defined minimum targets are not met, then no shares will vest. For the 13 weeks and 26 weeks ended June 30, 2019, the expense associated with the PSUs was not material.
(9) Commitments and Contingencies
The Company is subject to legal proceedings, claims and liabilities, such as employment-related claims and slip and fall cases, which arise in the ordinary course of business and are generally covered by insurance. In the opinion of management, the amount of ultimate liability with respect to those actions should not have a material adverse impact on the Company’s financial position or results of operations and cash flows.
In October 2017, plaintiffs filed a purported collective and class action lawsuit (the “Complaint”) in the United States District Court for the Southern District of New York against the Company alleging violations of the Fair Labor Standards Act (FLSA) and New York Labor Law (NYLL). The plaintiffs allege that the Company violated the FLSA and NYLL by not paying overtime compensation to our assistant managers and violated NYLL by not paying spread-of-hours pay. The Complaint was brought as a nationwide “collective action” under the FLSA and as a “class action” under NYLL. Since the filing of the Complaint, the plaintiffs filed a proposed amended complaint removing the NYLL class claim, but adding a proposed Illinois state law class action. In May 2019, the parties participated in a mediation and resolved the claims, subject to court approval. All charges related to the claims are reflected in the statement of operations.
(10) Subsequent Event
On August 7, 2019, the Company entered into a second amended and restated revolving credit facility agreement (the "Credit Agreement") with JPMorgan Chase Bank, N.A. that expires in July 2022. The Credit Agreement amended and restated that certain amended and restated revolving credit facility agreement, dated as of December 9, 2015, and amended on May 3, 2019 (collectively, the "Prior Credit Agreement") with JPMorgan Chase Bank, N.A. The Credit Agreement provides, among other things, for a revolving credit facility in a maximum principal amount $40 million, with possible future increases of up to $20 million under an expansion feature. Borrowings under the credit facility generally bear interest at the Company’s option at either (i) a eurocurrency rate determined by reference to the applicable LIBOR rate plus a margin ranging from 1.25% to 1.75% or (ii) a prime rate as announced by JP Morgan Chase plus a margin ranging from 0.00% to 0.50%. The applicable margin is determined based upon the Company’s consolidated total leverage ratio. On the last day of each calendar quarter, the Company is required to pay a commitment fee of 0.20% per annum in respect of any unused commitments under the credit facility. So long as certain total leverage ratios, EBITDA thresholds and minimum liquidity requirements are met and no default or event of default has occurred or would result, there is no limit on the “restricted payments” (primarily distributions and equity repurchases) that the Company may make, provided that proceeds of the loans under the credit agreement may not be used for purposes of making restricted payments.
15
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 30, 2018. This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995, and involves numerous risks and uncertainties. Forward-looking statements may include, among others, statements relating to: our future financial position and results of operations, estimated costs associated with our closure of underperforming shops, and the implementation and results of strategic initiatives. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and generally contain words such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “intends,” “plans,” “strives,” “goal,” “estimates,” “forecasts,” “projects” or “anticipates” and the negative of these terms or similar expressions. Our forward-looking statements are subject to risks and uncertainties, which may cause actual results to differ materially from those projected or implied by the forward-looking statement, due to reasons including, but not limited to, competition; general economic conditions; our ability to successfully implement our business strategy; the success of our initiatives to increase sales and traffic; changes in commodity, energy and other costs; our ability to attract and retain management and employees; consumer reaction to industry-related public health issues and perceptions of food safety; our ability to manage our growth; reputational and brand issues; price and availability of commodities; consumer confidence and spending patterns; and weather conditions. Forward-looking statements are based on current expectations and assumptions and currently available data and are neither predictions nor guarantees of future events or performance. You should not place undue reliance on forward-looking statements, which speak only as of the date hereof. See “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements” included in our Annual Report on Form 10-K for the fiscal year ended December 30, 2018, for a discussion of factors that could cause our actual results to differ from those expressed or implied by forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.
Overview
Potbelly Corporation is a neighborhood sandwich concept that has been feeding customers’ smiles with warm, toasty sandwiches, signature salads, hand-dipped shakes and other fresh menu items, customized just the way customers want them, for more than 40 years. Potbelly promises Fresh, Fast & Friendly service in an environment that reflects the local neighborhood. Our employees are trained to engage with our customers in a genuine way to provide a personalized experience. Our shops feature vintage design elements and locally-themed décor inspired by the neighborhood that we believe create a lively atmosphere. Through this combination, we believe we are creating a devoted base of Potbelly fans that return again and again.
We believe that a key to our past and future success is our culture. It is embodied in The Potbelly Advantage, which is an expression of our Vision, Mission and Values, and the foundation of everything we do. Our Vision is to create an experience people love to share thanks to our craveable food, quirky personality and amazing people. Our Mission is to help people love lunch again. Our Values embody both how we lead and how we behave and form the cornerstone of our culture. We use simple language that resonates from the frontline associate to the most senior levels of the organization, creating shared expectations and accountabilities in how we approach our day-to-day activities. We strive to be a fun, friendly and hardworking group of people who enjoy taking care of our customers, while at the same time taking care of each other.
The table below sets forth a rollforward of company-operated and franchise operated activities:
Company-
Franchise-Operated
Total
Operated
Domestic
International
Company
Shops as of December 31, 2017
437
492
Shops opened
Shops closed
(6
(1
(7
Shops as of July 1, 2018
436
41
17
58
494
Shops as of December 30, 2018
49
486
(9
(2
(18
Shops as of June 30, 2019
429
44
45
474
13 Weeks Ended June 30, 2019 Compared to 13 Weeks Ended July 1, 2018
The following table presents information comparing the components of net income for the periods indicated (dollars in thousands):
June 30, 2019
% of
July 1, 2018
Increase
(Decrease)
Percent
Change
99.2
99.1
(4,580
(4.2
)%
0.8
0.9
(137
(14.2
100.0
(4,717
(4.3
Sandwich shop operating
expenses
Cost of goods sold, excluding
depreciation
26.8
26.0
(375
(1.3
30.4
29.4
(298
(0.9
14.4
13.6
245
1.6
11.2
11.6
(977
(7.6
General and administrative
13.1
12.2
403
3.0
5.3
(273
(4.7
*
(68
(100.0
Impairment and loss on disposal
of property and equipment
0.2
1.9
(1,811
(88.0
>100
99.9
(3,154
(2.9
(1.4
(1,563
>(100)
25.0
(1,570
Income tax benefit (expense)
0.3
(56
(18.5
(1.7
(0.2
(1,514
Net income attributable to
non-controlling interest
0.1
(8
(6.4
Net loss attributable to
(1.8
(0.3
(1,506
>100%
Amount is less than 0.1%
Total revenues decreased by $4.7 million, or 4.3%, to $105.6 million during the 13 weeks ended June 30, 2019, from $110.3 million during the 13 weeks ended July 1, 2018. The revenue decrease was driven by a $4.3 million, or 4.0%, decrease in sales from company-operated comparable store shops and a decrease in sales of $2.0 million from shops that have closed. These decreases were partially offset by an increase in sales from shops not yet in our company-operated comparable store sales base and shops that opened in 2019.
Cost of Goods Sold
Cost of goods sold decreased by $0.4 million, or 1.3%, to $28.3 million during the 13 weeks ended June 30, 2019, from $28.6 million during the 13 weeks ended July 1, 2018. This decrease was primarily driven by a decrease in shop revenue. As a percentage of revenues, cost of goods sold increased to 26.8% during the 13 weeks ended June 30, 2019, from 26.0% during the 13 weeks ended July 1, 2018, primarily driven by higher discounting and cost inflation in certain products, partially offset by certain menu price increases.
Labor and Related Expenses
Labor and related expenses decreased by $0.3 million, or 0.9%, to $32.1 million during the 13 weeks ended June 30, 2019, from $32.4 million during the 13 weeks ended July 1, 2018, primarily due to a decrease in expense from closed shops and labor management, partially offset by inflationary wage increases in certain states. As a percentage of revenues, labor and related expenses increased to 30.4% during the 13 weeks ended June 30, 2019, from 29.4% during the 13 weeks ended July 1, 2018, primarily driven by inflationary wage increases in certain states and sales deleverage in certain labor related costs, which was partially offset by a decrease in expense from closed shops.
Occupancy Expenses
Occupancy expenses increased by $0.2 million, or 1.6%, to $15.2 million during the 13 weeks ended June 30, 2019, from $15.0 million during the 13 weeks ended July 1, 2018 primarily due to inflation in certain occupancy related costs, including lease renewals, real estate taxes and common area maintenance, partially offset by shop closures. As a percentage of revenues, occupancy expenses increased to 14.4% during the 13 weeks ended June 30, 2019, from 13.6% during the 13 weeks ended July 1, 2018, primarily due to sales deleverage and inflation in certain occupancy related costs, including lease renewals, real estate taxes and common area maintenance.
Other Operating Expenses
Other operating expenses decreased by $1.0 million, or 7.6%, to $11.8 million during the 13 weeks ended June 30, 2019, from $12.8 million during the 13 weeks ended July 1, 2018. The decrease was primarily attributable to a decrease in music, utilities, and supplies, partially offset by an increase in delivery and third-party sales expense. As a percentage of revenues, other operating expenses decreased slightly to 11.2% during the 13 weeks ended June 30, 2019, from 11.6% during the 13 weeks ended July 1, 2018, primarily driven by sales deleverage in operating expense items such as utilities and other expenses not directly variable with sales.
General and Administrative Expenses
General and administrative expenses increased by $0.4 million, or 3.0%, to $13.8 million during the 13 weeks ended June 30, 2019, from $13.4 million during the 13 weeks ended July 1, 2018. The increase was driven primarily by an increase in advertising, professional services, and lease exit costs, partially offset by a decrease in restructuring costs, stock-based compensation expense and performance-based incentive expenses. As a percentage of revenues, general and administrative expenses increased to 13.1% during the 13 weeks ended June 30, 2019, from 12.2% during the 13 weeks ended July 1, 2018, primarily due to an increase in advertising, professional services and lease exit costs, partially offset by a decrease in restructuring costs, stock-based compensation expense and performance-based incentive expenses.
Depreciation Expense
Depreciation expense decreased by $0.3 million, or 4.7%, to $5.6 million during the 13 weeks ended June 30, 2019, from $5.9 million during the 13 weeks ended July 1, 2018. The decrease was driven primarily by a lower depreciable base related to impairment charges taken subsequent to the 13 weeks ended July 1, 2018, as well as lower depreciation associated with longer expected useful lives for leasehold improvements at new shops and leasehold improvements at legacy shops with shorter expected useful lives being fully depreciated. These decreases were partially offset by existing shop capital investments and investments in technology such as the mobile application, which increased the depreciable base. As a percentage of revenues, depreciation was 5.3% during the 13 weeks ended June 30, 2019, and the 13 weeks ended July 1, 2018.
Pre-Opening Costs
Pre-opening costs were $0 during the 13 weeks ended June 30, 2019 and $68 thousand during the 13 weeks ended July 1, 2018. The decrease was due to no new company-operated shop openings in the second quarter of 2019.
Impairment and Loss on Disposal of Property and Equipment and Right-of-Use Lease Assets
Impairment and loss on disposal of property and equipment and right-of-use lease assets decreased to $0.2 million during the 13 weeks ended June 30, 2019, from $2.1 million during the 13 weeks ended July 1, 2018. After performing periodic reviews of Company shops during the second quarter of 2019, it was determined that indicators of impairment were present for certain shops. The Company performed impairment analyses related to these shops and recorded an impairment charge of $0.2 million for the excess of the carrying amount recorded on the balance sheet over the shops’ estimated fair value. The Company performs impairment analyses on a quarterly basis, which involves significant judgment by management including estimates of future cash flows and future growth rates, among other assumptions. Based on the Company’s current projections, no impairment beyond what has already been recorded has been identified. However, given the current challenges facing the industry and our business, future evaluations could result in additional impairment charges.
Interest Expense
Interest expense was $35 thousand during the 13 weeks ended June 30, 2019 and $28 thousand during the 13 weeks ended July 1, 2018.
Income Tax Expense
Income tax expense was $0.2 million for the 13 weeks ended June 30, 2019, compared to expense of $0.3 million for the 13 weeks ended July 1, 2018.
26 Weeks Ended June 30, 2019 Compared to 26 Weeks Ended July 1, 2018
(9,569
(4.5
22
1.3
(9,547
26.6
25.9
(1,033
(1.9
31.5
30.0
96
14.5
13.9
(104
(0.4
11.8
11.9
(1,332
(5.3
13.0
12.0
924
3.6
5.5
(563
(4.8
(126
(92.6
(3,753
(92.0
(5,891
(2.7
(3.0
(1.2
(3,656
21.8
(3.1
(3,668
6.8
14,067
(9.9
(1.1
(17,735
Net income attributable to non-
controlling interests
9.6
Net income (loss) attributable to
(10.0
(17,751
Total revenues decreased by $9.5 million, or 4.5%, to $203.7 million during the 26 weeks ended June 30, 2019, from $213.3 million during the 26 weeks ended July 1, 2018. The revenue decrease was driven by a $9.0 million, or 4.4%, decrease in sales from company-operated comparable store shops and a decrease in sales of $3.9 million from shops that have closed. These decreases were partially offset by an increase in sales from shops not yet in our company-operated comparable store sales base and shops that opened in 2019.
19
Cost of goods sold decreased by $1.0 million, or 1.9%, to $54.2 million during the 26 weeks ended June 30, 2019, from $55.3 million during the 26 weeks ended July 1, 2018. This decrease was primarily driven by a decrease in shop revenue. As a percentage of revenues, cost of goods sold increased to 26.6% during the 26 weeks ended June 30, 2019, from 25.9% during the 26 weeks ended July 1, 2018, primarily driven by higher discounting and cost inflation in certain products, partially offset by certain menu price increases.
Labor and related expenses increased by $0.1 million, or 0.2%, to $64.1 million during the 26 weeks ended June 30, 2019, from $64.0 million during the 26 weeks ended July 1, 2018. As a percentage of revenues, labor and related expenses increased to 31.5% during the 26 weeks ended June 30, 2019, from 30.0% during the 26 weeks ended July 1, 2018. These increases were primarily driven by inflationary wage increases in certain states and sales deleverage in certain labor related costs, which was partially offset by a decrease in expense from closed shops and labor management.
Occupancy expenses decreased by $0.1 million, or 0.4%, to $29.6 million during the 26 weeks ended June 30, 2019, from $29.7 million during the 26 weeks ended July 1, 2018, primarily due to a decrease in occupancy expenses related to closed shops. This decrease was partially offset by inflation in certain occupancy related costs, including lease renewals, real estate taxes and common area maintenance. As a percentage of revenues, occupancy expenses increased to 14.5% during the 26 weeks ended June 30, 2019, from 13.9% during the 26 weeks ended July 1, 2018, primarily due to sales deleverage and inflation in certain occupancy related costs, including lease renewals, real estate taxes and common area maintenance.
Other operating expenses decreased by $1.3 million, or 5.3%, to $24.0 million during the 26 weeks ended June 30, 2019, from $25.3 million during the 26 weeks ended July 1, 2018. The decrease was primarily attributable to items such as music, supplies, utilities and certain other expenses. As a percentage of revenues, other operating expenses decreased to 11.8% during the 26 weeks ended June 30, 2019, from 11.9% during the 26 weeks ended July 1, 2018. This slight decrease was primarily driven by music, supplies, utilities and other expenses not directly variable with sales.
General and administrative expenses increased by $0.9 million, or 3.6%, to $26.6 million during the 26 weeks ended June 30, 2019, from $25.6 million during the 26 weeks ended July 1, 2018. As a percentage of revenues, general and administrative expenses increased to 13.0% during the 26 weeks ended June 30, 2019, from 12.0% during the 26 weeks ended July 1, 2018. These increases was driven primarily by an increase in advertising, professional services, and lease exit costs, partially offset by a decrease in restructuring costs, stock-based compensation expense and performance-based incentive expenses.
Depreciation expense decreased by $0.6 million, or 4.8%, to $11.1 million during the 26 weeks ended June 30, 2019, from $11.7 million during the 26 weeks ended July 1, 2018, driven primarily by a lower depreciable base related to impairment charges taken subsequent to the 26 weeks ended July 1, 2018, as well as lower depreciation associated with longer expected useful lives for leasehold improvements and leasehold improvements at legacy shops with shorter expected useful lives being fully depreciated. These decreases were partially offset by existing shop capital investments and investments in technology such as the mobile application, which increased the depreciable base. As a percentage of revenues, depreciation was 5.5% during the 26 weeks ended June 30, 2019, and the 26 weeks ended July 1, 2018.
Pre-opening costs decreased by $0.1 million, or 92.6%, to $10 thousand during the 26 weeks ended June 30, 2019, from $0.1 million during the 26 weeks ended July 1, 2018. The decrease was driven primarily by fewer shops opened during the 26 weeks ended June 30, 2019 compared to the 26 weeks ended July 1, 2018.
20
Impairment and Loss on Disposal of Property and Equipment
Impairment and loss on disposal of property and equipment decreased to $0.3 million during the 26 weeks ended June 30, 2019, compared to $4.1 million during the 26 weeks ended July 1, 2018. After performing periodic reviews of Company shops during the first and second quarter of 2019, it was determined that indicators of impairment were present for certain shops as a result of continued underperformance. We performed impairment analyses related to these shops and recorded impairment charges of $0.2 million for the excess of the carrying amount recorded on our balance sheet over the shops’ estimated fair value. We perform impairment analyses on a quarterly basis, which involve significant judgment by management including estimates of future cash flows and future growth rates, among other assumptions. Based on our current projections, no impairment beyond what has already been recorded has been identified. However, given the current challenges facing the industry and our business, future evaluations could result in additional impairment charges.
Interest expense was $67 thousand for the 26 weeks ended June 30, 2018 and $55 thousand for the 26 weeks ended July 1, 2018.
Income Tax Expense (Benefit)
Income tax expense increased by $14.1 million, or more than 100%, to $13.9 million for the 26 weeks ended June 30, 2019, from a benefit of $0.2 million for the 26 weeks ended July 1, 2018. The change was primarily attributable to the valuation allowance on deferred tax assets recorded by the Company during the first quarter of 2019, as a result of the changes in projected taxable income for 2019. The Company estimates it will be in a cumulative loss position as of December 29, 2019. Therefore, the Company determined that the negative evidence outweighed the positive evidence and, therefore, recorded a full valuation allowance against its net deferred tax assets. The Company recorded a non-cash charge to income tax expense of $13.6 million related to the recognition of the valuation allowance and did not provide for an income tax benefit on the pre-tax loss recorded for the 26 weeks ended June 30, 2019. This accounting treatment has no effect on the Company’s ability to utilize deferred tax assets to reduce future cash tax payments. The Company will continue to assess the likelihood of the realization of its deferred tax assets at the end of each reporting period and the valuation allowance will be adjusted accordingly.
Liquidity and Capital Resources
General
Potbelly’s ongoing primary sources of liquidity and capital resources are cash provided from operating activities, existing cash and cash equivalents and the Company’s credit facility. Potbelly’s primary requirements for liquidity and capital are new shop openings, existing shop capital investments, maintenance, repurchases of Company common stock, lease obligations, working capital and general corporate needs. Potbelly’s requirement for working capital is not significant since the Company’s customers pay for their food and beverage purchases in cash or payment cards (credit or debit) at the time of sale. Thus, Potbelly is able to sell certain inventory items before the Company needs to pay its suppliers for such items. Company shops do not require significant inventories or receivables. Potbelly believes that these sources of liquidity and capital will be sufficient to finance the Company’s continued operations and expansion plans for at least the next twelve months.
The following table presents summary cash flow information for the periods indicated (in thousands):
Net cash provided by (used in):
Operating activities
Investing activities
Financing activities
Net increase (decrease) in cash
Operating Activities
Net cash provided by operating activities decreased to $7.0 million for the 26 weeks ended June 30, 2019, from $17.9 million for the 26 weeks ended July 1, 2018. The $10.9 million decrease was primarily driven by an increase in loss from operations, as well as timing of payment for certain liabilities.
21
Investing Activities
Net cash used in investing activities decreased to $5.2 million for the 26 weeks ended June 30, 2019, from $11.6 million for the 26 weeks ended July 1, 2018. The decrease was primarily due to fewer shops opened and under construction during the 26 weeks ended June 30, 2019 compared to the 26 weeks ended July 1, 2018.
Financing Activities
Net cash used in financing activities was $3.5 million for the 26 weeks ended June 30, 2019, compared to net cash provided by financing activities of $2.5 million for the 26 weeks ended July 1, 2018. The change in financing cash was primarily driven by $6.6 million decrease in proceeds from the exercise of stock options during the 26 weeks ended June 30, 2019.
Stock Repurchase Program
On May 8, 2018, the Company announced that its Board of Directors authorized a stock repurchase program for up to $65.0 million of its outstanding common stock. The program permits the Company, from time to time, to purchase shares in the open market (including in pre-arranged stock trading plans in accordance with the guidelines specified in Rule 10b5-1 under the Exchange Act) or in privately negotiated transactions. Under the program, for the 26 weeks ended June 30, 2019, the Company repurchased 485,659 shares of its common stock for approximately $3.5 million under the stock repurchase program, including cost and commission, in open market transactions. The number of shares of common stock repurchased in the future, and the timing and price of repurchases, will depend upon market conditions, liquidity needs and other factors. Purchases may be started or stopped at any time without prior notice depending on market conditions and other factors. Repurchased shares are included as treasury stock in the condensed consolidated balance sheets and the condensed consolidated statements of equity.
Credit Facility
On August 7, 2019, the Company entered into a second amended and restated revolving credit facility agreement (the "Credit Agreement") with JPMorgan Chase Bank, N.A. that expires in July 2022. The Credit Agreement amended and restated that certain amended and restated revolving credit facility agreement, dated as of December 9, 2015, and amended on May 3, 2019 (collectively, the "Prior Credit Agreement") with JPMorgan Chase Bank, N.A. The Credit Agreement provides, among other things, for a revolving credit facility in a maximum principal amount of $40 million, with possible future increases of up to $20 million under an expansion feature. Borrowings under the credit facility generally bear interest at the Company’s option at either (i) a eurocurrency rate determined by reference to the applicable LIBOR rate plus a margin ranging from 1.25% to 1.75% or (ii) a prime rate as announced by JP Morgan Chase plus a margin ranging from 0.00% to 0.50%. The applicable margin is determined based upon the Company’s consolidated total leverage ratio. On the last day of each calendar quarter, the Company is required to pay a commitment fee of 0.20% per annum in respect of any unused commitments under the credit facility. So long as certain total leverage ratios, EBITDA thresholds and minimum liquidity requirements are met and no default or event of default has occurred or would result, there is no limit on the “restricted payments” (primarily distributions and equity repurchases) that the Company may make, provided that proceeds of the loans under the credit agreement may not be used for purposes of making restricted payments.
The Prior Credit Agreement provided, among other things, for a revolving credit facility in a maximum principal amount of $50.0 million, with possible future increases to $75.0 million under an expansion feature. Borrowings under the credit facility generally bore interest at our option at either (i) a eurocurrency rate determined by reference to the applicable London Interbank Offered Rate (LIBOR) plus a margin ranging from 1.00% to 1.75% or (ii) a prime rate as announced by JP Morgan Chase plus a margin ranging from 0.00% to 0.50%. The applicable margin was determined based upon our consolidated total leverage ratio. On the last day of each calendar quarter, the Company was required to pay a commitment fee ranging from 0.125% to 0.20% per annum in respect of any unused commitments under the credit facility, with the specific rate determined based upon our consolidated total leverage ratio. As long as the leverage ratios were met, there was no limit on the “restricted payments” (primarily distributions and equity repurchases) that the Company may have made. As of the 26 weeks ended June 30, 2019, the Company had no amounts outstanding under the Prior Credit Agreement.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Significant estimates include amounts for long-lived assets and income taxes. Actual results could differ from those estimates. Critical accounting policies are those that management believes are both most important to the portrayal of our financial condition and operating results and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company bases estimates on historical experience and other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. Potbelly had no significant changes in our critical accounting estimates since the last annual report. The Company’s critical accounting estimates are identified and described in our annual consolidated financial statements and related notes.
Off-Balance Sheet Arrangements
As of June 30, 2019, the Company does not have any off-balance sheet arrangements, synthetic leases, investments in special purpose entities or undisclosed borrowings or debt that would be required to be disclosed pursuant to Item 303 of Regulation S-K under the Exchange Act.
New and Revised Financial Accounting Standards
See Note 1 to the Consolidated Financial Statements for a description of recently issued Financial Accounting Standards.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For quantitative and qualitative disclosures about market risk, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of our Annual Report on Form 10-K for the fiscal year ended December 30, 2018. Our exposures to market risk have not changed materially since December 30, 2018.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of June 30, 2019. Based upon that evaluation, our Chief Executive Officer and Principal Financial Officer have concluded that, as of June 30, 2019, our disclosure controls and procedures were effective in ensuring that information required to be disclosed in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and is accumulated and communicated to our management, including our Chief Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the second quarter ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information pertaining to legal proceedings is provided in Note 9 to the Condensed Consolidated Financial Statements and is incorporated by reference herein.
ITEM 1A. RISK FACTORS
A description of the risk factors associated with our business is contained in Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 30, 2018. There have been no material changes to our Risk Factors as previously reported.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table contains information regarding purchases of our common stock made by or on behalf of Potbelly Corporation during the 13 weeks ended June 30, 2019:
Period
Total Number of
Purchased
Average Price Paid
per Share (1)
Total Number of Shares
Purchased as Part of
Publicly Announced
Program (2)
Maximum Value of
Shares that May Yet
be Purchased Under
the Program (2)
April 1, 2019 - April 28, 2019
95,000
9.03
40,186,965
April 29, 2019 - May 26, 2019
99,900
6.98
39,489,427
May 27, 2019 - June 30, 2019
157,630
4.89
155,759
38,728,687
Total:
352,530
350,659
Average price paid per share excludes commissions.
On May 8, 2018, the Company announced that its Board of Directors authorized a stock repurchase program for up to $65.0 million of its outstanding common stock. The program permits the Company, from time to time, to purchase shares in the open market (including in pre-arranged stock trading plans in accordance with the guidelines specified in Rule 10b5-1 under the Exchange Act or in privately negotiated transactions. No time limit has been set for the completion of the repurchase program and the program may be suspended or discontinued at any time. See Note 7 for further information regarding the Company’s stock repurchase program.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. MINE SAFETY DISCLOSURES
ITEM 5. OTHER INFORMATION
On August 7, 2019, the Company entered into a second amended and restated revolving credit facility agreement (the "Credit Agreement") with JPMorgan Chase Bank, N.A. that expires in July 2022. The Credit Agreement amended and restated that certain amended and restated revolving credit facility agreement, dated as of December 9, 2015, and amended on May 3, 2019 (collectively, the "Prior Credit Agreement") with JPMorgan Chase Bank, N.A. The Credit Agreement provides, among other things, for a revolving credit facility in a maximum principal amount of $40 million, with possible future increases of up to $20 million under an expansion feature. Borrowings under the credit facility generally bear interest at the Company’s option at either (i) a eurocurrency rate determined by reference to the applicable LIBOR rate plus a margin ranging from 1.25% to 1.75% or (ii) a prime rate as announced by JP Morgan Chase plus a margin ranging from 0.00% to 0.50%. The applicable margin is determined based upon the Company’s consolidated total leverage ratio. On the last day of each calendar quarter, the Company is required to pay a commitment fee of 0.20% per annum in respect of any unused commitments under the credit facility. So long as certain total leverage ratios and minimum liquidity requirements, EBITDA thresholds and minimum liquidity requirements are met and no default or event of default has occurred or would result, there is no limit on the “restricted payments” (primarily distributions and equity repurchases) that the Company may make, provided that proceeds of the loans under the credit agreement may not be used for purposes of making restricted payments.
ITEM 6. EXHIBITS
The following exhibits are either provided with this Quarterly Report on Form 10-Q or are incorporated herein by reference.
Exhibit No.
Description
10.1*
Second Amended and Restated Credit Agreement, dated as of August 7, 2019, among Potbelly Sandwich Works, LLC, the other Loan Parties party thereto, the Lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent, and J.P. Morgan Chase Bank, N.A., as Sole Bookrunner and Sole Lead Arranger
10.2*
Potbelly Corporation Non-Employee Director Compensation Plan †
10.3
Potbelly Corporation 2019 Long-Term Incentive Plan (filed as Exhibit 10.1 to Form 8-K (File No. 001-36104) filed on May 21, 2019 and incorporated by reference). †
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Chief Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
Filed herewith.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
POTBELLY CORPORATION
Date: August 8, 2019
By:
/s/ Thomas Fitzgerald
Thomas Fitzgerald
Chief Financial Officer
(Principal Financial Officer)