Potbelly Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 8, 2024

There are 8 speakers on the call.

Operator

Good afternoon, everyone, and welcome to Potbelly Corporation's First Quarter 2024 Earnings Conference Call. Today's call is being recorded. At this time, all participants have been placed in a listen only mode and the lines will be open for your questions following the prepared remarks. On today's call, we have Bob Wright, President and Chief Executive Officer Steve Sirlis, Senior Vice President and Chief Financial Officer and Adia Dickson, Senior Vice President, Chief Legal Officer and Secretary of Potbelly Corporation. At this time, I'll turn the call over to Adia Dickson.

Operator

Please go ahead.

Speaker 1

Good afternoon, everyone, and welcome to our Q1 2024 earnings call. By now, everyone should have access to our earnings release and accompanying investor presentation. If not, they can be found in the Investors tab of our website. Before we begin our formal remarks, I need to remind everyone that certain comments made on this call will contain forward looking statements regarding future events or the future financial performance of the company. Any such statements, including our outlook for 2024 or any other future periods, should be considered forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Speaker 1

These forward looking statements are not guarantees of future performance nor should they be relied upon as representing management's views as of any subsequent date. Forward looking statements involve significant risks and uncertainties and events or results could differ materially from those presented due to a number of risks and uncertainties. Additional detailed information concerning these risks regarding our business and the factors that could cause actual results to differ materially from the forward looking statements and other information that will be given today can be found under the Risk Factors heading in our filings with the Securities and Exchange Commission, which are available at sec.gov. During the call, there will also be a discussion of some items that do not conform to U. S.

Speaker 1

Generally Accepted Accounting Principles or GAAP. Reconciliations of these non GAAP measures to the most directly comparable GAAP measures are included in the appendix to the press release and investor presentation issued this afternoon, both of which are available in the Investors tab on our website. And now, I'll turn the call over to Potbelly's President and CEO, Bob Wright.

Speaker 2

Thank you, Adia. Good afternoon and thank you for joining our call today. We are proud of our solid start to the year across multiple fronts. In terms of profitability, we successfully managed both restaurant level and corporate costs, driving 150 basis point expansion to shop level margins year over year to 13.5 percent as well as strong corporate profitability with adjusted EBITDA of $5,700,000 This was made possible through the disciplined execution of our team members as we work to achieve our long term sustainable growth. On the development front, our franchise sales team added 32 additional franchise commitments to our pipeline during the quarter, while our franchise development team helped open 3 new shops.

Speaker 2

Importantly, our momentum on both fronts continues into the 2nd quarter. On the top line, we continue to outpace the fast casual segment and once again took traffic share for the quarter. That said, industry trends were marginally softer than we were anticipating, leading our results to be below our expectations and slightly below Q1 2023 comps by 0.2%. As with industry trends, we saw some slight declines in transactions from our more infrequent customers. These customers tend to skew to more in shop visits and slightly less digital.

Speaker 2

Importantly though, as I'll share shortly, our digital marketing and promotional efforts as well as our new Perks loyalty program drove growth. Those elements of our plan that we drive continue to build top line sales, traffic growth and profitability. We believe our less frequent customers will benefit from some additional value support over the coming months. As we look into the Q2, we're back into positive low single digits and we plan to further accelerate traffic driven top line growth leveraging our 5 pillar strategy with particular emphasis on tactics that build on our past success while expanding our appeal. Our focus is heightened in 3 areas.

Speaker 2

First and foremost, Potbelly's great food is the reason our brand is the favorite in so many neighborhoods. We plan to continue to enhance our innovation pipeline of hot toasted sandwiches, hand dipped ice cream shakes and our best in class baked fresh daily cookies. Next, recognizing that the very best Potbelly experience includes access to and the use of our digital assets, we plan to continue to push growth in Perks member acquisition as a way to expose our newer customers to the best experience and value Potbelly has to offer and everyday value. It's clear to us that consumers of all income brackets can use our help managing their budget pressures. Our customers give us significant credit for our everyday value today, including our picture pair combinations and skinny sized sandwiches.

Speaker 2

We've been developing additional ways to deliver value to both in shop customers and those that engage more often with our digital platforms. Our intent with these expanded everyday value options is to provide an additional access point to the brand and build increased frequency. Now turning to the drivers of our business. Let's start with the Potbelly digital experience. For the quarter, our digital business represented approximately 41% of our total SHOP sales, an increase of approximately 200 basis points versus last year, driven in large part by ongoing progress in our Perks loyalty program.

Speaker 2

In January, as we spoke to last quarter, we further strengthened our digital platform with the launch of our enhanced Potbelly Perks loyalty program. The upgraded Perks program celebrates what our customers love the most about Potbelly, great food. Perks members can earn rewards faster than ever before and have more of our menu items available for reward redemptions by using broader range of coins to do so. We're so proud to say that we're seeing the expected customer behavior under the new program and we consider the transition to be a big success. As we've said in recent quarters, we continue to see a shift in our digital business away from third party channels and towards Potbelly's owned app, web and Perks originated orders.

Speaker 2

We continue to view this as a positive shift. We saw strong growth in our Perks sales, orders and active users during the quarter. In fact, Perks active members were up 36% year over year. While the Potbelly digital experience has been a significant area of growth for us in recent quarters years, we are not standing still. When customers utilize our digital platforms, it not only ensures a better experience, but also allows us to more effectively communicate with and market to them.

Speaker 2

We maintain an extensive ramp of digital enhancements aimed at continually improving our Potbelly digital experience to best suit customers' needs, expectations and reduce friction while driving Potbelly brand awareness, customer engagement and business results. Now, delighting customers with great food and good vibes is always the foundation for sales growth. And I'm pleased with our strong shop operations and the continued progress of our marketing initiatives in fueling our traffic driven sales growth strategy. Beginning in the Q2, we introduced the jalapeno popper chicken along with the dulce de leche cookie and the cinnamon churro shake. While the success of each of these promotions to date is encouraging, we're not stopping there.

Speaker 2

As we move through the remainder of the year, you should expect to see additional limited time offers of our hot oven toasted sandwiches, fresh baked daily cookies and hand dipped shakes. In addition, we expect to bring back more underground menu items this year as well. Importantly, we know that today's consumers more than ever are looking for value when they choose to eat out. The first pillar of our 5 pillar strategy has always been great food at a good value and we've taken great care to protect our value position. We enjoy strong value ratings overall as well as from our digital and Perks loyalty members who are among our most frequent customers.

Speaker 2

We believe we can do more. It's clear that less frequent customers are looking for everyday value options to support their pressured wallets. We have the tools and strategies to support this customer group by building on everyday value already in our core menu, meal deal and picture pair options and look forward to expanding on these offerings throughout the year. Now let me update you on our franchise growth acceleration initiative. Our franchising team continues to make great progress building towards our goal of 2,000 units in the U.

Speaker 2

S. And as I mentioned earlier, we are pleased to add 32 franchise shops to the pipeline during the Q1, bringing our total to 642 open and committed shops. To put that in perspective, that equates to 26% growth versus the 5 0 8 open and committed shops in the Q1 of 2023. We believe our ability to consistently attract high quality franchisees has been driven by 3 major factors. One, Potbelly is an incredibly strong brand with 47 years of success with our customers in markets all across the country.

Speaker 2

Yet, we still have significant multi unit market development potential in areas like the South, the Southeast and the West. Number 2, we've invested heavily in our systems and tools that support franchising and franchisees, particularly in the areas of operations, marketing and development. You see franchisees see us as a franchise company through and through. And number 3, last but certainly not least, franchisees are attracted to our strong unit level operating and investment economics led by 2:one sales to investment ratio with our system AUVs of approximately $1,300,000 and an investment cost as low as approximately $650,000 Despite our investment costs already being compelling when compared to the industry, we are never satisfied. Our shops currently average approximately 2,300 square feet and we're excited to announce the introduction of our new prototype shop that is now only approximately 1800 square feet, an average reduction of 500 square feet positively impacting leasing and construction costs of new shops.

Speaker 2

This new prototype is designed to be more digitally centric along with improved customer flows. Bottom line, we believe the new design simultaneously enhances the historic traditional in shop experience and improves the digital experience for our customers and associates alike. Importantly as well, the prototype is flexible to support our growth in the varied lease spaces our franchisees are developing. In partnership with our design and engineering team, our franchisees will be able to fit the new prototype into each location they lease. And as a reminder, PDK or Potbelly Digital Kitchen is standard equipment in all new Potbelly locations as well.

Speaker 2

We believe this new prototype will bring additional flexibility and cost savings to our franchisees as they search for the optimal site to build Potbelly shops. Our brand design team and engineering teams have been working on the new prototype since last year, and we began shifting all our planning and permitting to the new design several months ago. In fact, our first franchise shop with the new design is expected to open this month in Arkansas. As we look at our development pipeline, the Q1 saw the opening of 3 new franchise shops. Importantly, our momentum is building as we expected into the second quarter.

Speaker 2

As we look to the full year, we have 30 units in various stages of the 2024 development cycle. We also have another 10 units in early stages of development that are expected to open in the later months of 2024 or in 2025. With the work of Adam Noyes and his development team, we expect our annualized 4th quarter run rate to put us in a solid position to achieve our long term growth range of low double digit unit growth annually over the coming years. With that, I'll now turn the call over to Steve to detail our financial performance for the quarter.

Speaker 3

Thank you, Bob. Good afternoon, everyone. Revenues in the Q1 decreased approximately 6.0 percent to $111,200,000 majority driven by the short term revenue impact of last year's refranchising transaction. Average weekly sales were approximately $24,250 up approximately 1.6% and system wide sales of $134,200,000 grew by approximately 1.9%. Same store sales were down 20 basis points in the quarter.

Speaker 3

Despite this, we continue to take sales and traffic share from both the broader restaurant industry as well as the fast casual industry during the quarter. Turning to expenses, food, beverage and packaging costs were 27.2 percent of shop sales, a 70 basis point improvement versus the prior year period. Overall Q1 commodity inflation was greatly improved at negative 170 basis points versus last year. Meat, primarily turkey, retreated the most year over year and we saw some relief in our grocery category, which includes produce, soup, condiments and cookies. Labor expenses were 30.0 percent of sales, a 120 basis point improvement versus the prior year period.

Speaker 3

This improvement is primarily attributed to ongoing optimization of our hour space labor guide. Occupancy was 10.9% of sales, a 50 basis point improvement versus the prior year period. The improvement was driven by the refranchising of our New York City market in Q1 last year, which carried higher than average occupancy costs. Other operating expenses were 18.4% of sales, a 90 basis point increase versus the prior year period. This was predominantly due to increased brand fund spend.

Speaker 3

Overall, shop level margins in the 4th quarter were 13.5%, an increase of 150 basis points year over year, inclusive of a one time legal settlement gain that we mentioned last quarter. General and administrative expenses were 8.6% of system wide sales. The year over year increase in G and A was driven primarily by stock compensation and increased payroll costs to fuel our development efforts. 1st quarter adjusted EBITDA was $5,700,000 or 5.1 percent of total revenue. This was approximately flat year over year driven by the impact of refranchising and investments in development G and A mostly offset by 150 basis point improvement in shop level margin.

Speaker 3

Importantly, we saw 40 basis point improvement in adjusted EBITDA margin as we continue our transition to a higher margin franchise business model. We reported a net loss of $2,800,000 for the quarter, majority driven by the accounting treatment of our debt refinancing. We replaced our $25,000,000 term loan with a $30,000,000 revolving credit facility that provides us with ongoing financial flexibility. Adjusted net income was $200,000 a $400,000 decrease versus the prior year period. This decrease was primarily due to similar drivers affecting adjusted EBITDA as well as higher stock comp expense compared to 2023 partially offset by lower interest expense from our refinanced debt.

Speaker 3

Also, I'm pleased to announce that our Board of Directors has authorized a $20,000,000 share repurchase program. This is driven by their confidence in the sustainability of the momentum in our business, our strong balance sheet and the increased predictability of our cash flows as a franchise business model. Given our flexible capital structure, this is an additional tool that management now has to continue to create shareholder value. Finally, I would now like to provide you with the following guidance items. For the full year 2024, we anticipate the following: same store sales growth in the low single digits, unit growth of approximately 10% and adjusted EBITDA growth in the mid to high single digits.

Speaker 3

The adjusted EBITDA growth expectations for 2024 incorporate our slower Q1 performance and overcome the effects of refranchising 33 shops and the 53rd week in 2023. The impact of refranchising on our adjusted EBITDA growth rate is most pronounced in the 1st 3 quarters of 2024 as the majority of our refranchise sales occurred in the second half of twenty twenty three. With the strength of our operating model and management team, we expect to be able to achieve mid to high single digit adjusted EBITDA growth for the year. For the Q2 of 2024, we anticipate the following: same store sales growth of between 0% 2% and adjusted EBITDA of between 7,000,000 dollars $8,500,000 With that, I'll turn the call back over to Bob.

Speaker 2

Thanks, Steve. Despite the macro headwinds during the Q1, we are thrilled with what 2024 has in store for us. 1st, we have an extensive roadmap of digital enhancements that we believe will further strengthen our Potbelly digital experience. 2nd, our marketing initiatives continue to support our traffic driven sales growth strategy. And finally, our franchise growth initiative is progressing very well as we build toward our goal of 2,000 units in the U.

Speaker 2

S, putting us in a position to achieve our long term growth range of low double digit unit growth annually over the coming years. The work our teams have done for the past 2 years have positioned us to capitalize on the opportunities ahead and we look forward to sharing additional updates in coming quarters. In closing, I would like to thank all of our Potbelly team members from our frontline associates to our support center employees and of course our franchisees and their teams for their hard work and commitment to making Potbelly the most loved sandwich brand in every neighborhood. With that, we're happy to answer any questions. Operator, please open the line for questions.

Operator

We will now begin the question and answer session. Our first question is from Mark Smith with Lake Street Capital Markets. Please go ahead.

Speaker 4

Hey, guys. This is Alex Sternix on the line today for Mark Smith. Thanks for taking my questions. First one for me, as we look at consumer behavior throughout the quarter, did you guys see any trends with comp sequentially? And then to add on to that, are you seeing any consumer shifts with different locations, maybe anything from a CBD location to a suburban store standpoint?

Speaker 2

Yes, Alex, thanks for the question. I think that what we saw, first of all, is probably similar to what you're hearing about the weather and could just be more seasonality returning to those consumer behaviors. But February March certainly started to strengthen. And as we mentioned, even into the Q2, we're seeing those positive sales return to us. I think both our internal data that we have with all of our digital business and then the syndicated data that we have access to, Our indication is that there's just a slight pullback in the more infrequent customer and the infrequent consumer.

Speaker 2

To be clear, these are our customers. They're coming to Potbelly, but they're clearly managing their wallet a little bit more maybe than even a year ago. And that's why you heard some of my remarks about how we've got this great everyday value platform we've had at Potbelly all these years really going back to 2021 when we rebuilt the menu. That was a big part of the work we did to work on the menu. But we think we can do more and we think that that's going to be an area of focus for us.

Speaker 2

When you hear all of the numbers that we shared on the digital growth that we had in the quarter, Those are our most frequent consumers. Those are the ones that we can see the data most clearly. It's the reason that we continue to bring people into that frequency funnel, starting off as a customer that begins to visit the shop and then they start becoming a little more frequent, a little more affinity for the brand. We draw them into our digital assets and eventually get them into the Perks membership. And so we think we've analyzed it more as a frequency, a slight shift in frequency that we think we can address.

Speaker 4

Got it. Yes. No, that's helpful. And then last one for me. Could you give any updates on your desire to sell company units or the demand from others to purchase existing company locations?

Speaker 4

I know you previously mentioned being more selective about where and when, but just curious if that has changed at all.

Speaker 2

Yes. Look, I think the strategy is still the same. What you see in the numbers is that, we're deploying the strategy with a little more judiciously than we have in the past. It has always been that we would refranchise to catalyze growth. And what you see with our continuing growing number of open and committed shops and the new commitments that we got in Q1 and what we can see that we obviously haven't announced until each quarter comes along, what we can see in the pipeline.

Speaker 2

We're really pleased with our development efforts. And even if you take the Washington DC market as an example, we did refranchise some locations there, but we're still operating in that market with company units and franchise units. And brands are very comfortable doing that. So I think that continues to be something that we'll do. We'll be a little more careful about it.

Speaker 2

We shared with you last quarter, we thought there'd be a lot fewer of those this year. Out of that 100, roughly a third of them have been sold. And again, we're still willing to go with the rest, but we're in no rush to do that if it isn't a significant part of our growth.

Speaker 4

Thank you for taking my questions today.

Speaker 2

You're welcome.

Operator

Excuse me. The next question is from Jeremy Hamblin with Craig Hallum. Please go ahead.

Speaker 5

Thanks and congrats on the strong results. I wanted to start with the franchise unit development. I think this is kind of a milestone here, if I'm not mistaken, the first time that the ending unit count is up on a year over year basis in like 6 years. So kudos on that. And I wanted to make sure that I heard the details behind the shovels in the ground, so to speak, and units in progress.

Speaker 5

Did you say you had 30 that were in progress today and then 10 that were in the early stages. I wanted to get a sense if you could help us think about the cadence of franchise unit openings this year? And then as a back part of that question, how long does it take once you start in on a unit kind of from getting the first work done to completing the unit and getting it open?

Speaker 2

Yes, Jeremy, thank you. And you're right, we're celebrating that milestone as well. It's really good to be growing again. And obviously, we're in the very, very early innings of delivering those new units. We're really pleased.

Speaker 2

I'll start with the back end because I think it informs the pipeline a little bit. There was a time when it took much longer to develop a potbelly, but today we've got it down to between 11 12 months. We mentioned, gosh, more than a year ago, how we reorganized the development functions, split that between our franchising efforts, all focused on franchise sales and then everything from the real estate all the way to opening and the construction and engineering in between those reports to 2 different leaders on the SLT. As a result, that reengineered timeline means we can from the time we sign a deal, we can open a unit in less than a year. So you can imagine the fact that we just get deeper and deeper into these deals, we have the ability to open units at an ever accelerating rate.

Speaker 2

That does vary a little bit by unit, by location, but that's why our franchisees are working their entire market at one time and not simply looking for one site at a time. You asked about the cadence of opening, that's going to reflect the deal timing that we went through last year. So that's why a lot of our openings are a little more back loaded this year. That's not unusual in the restaurant space anyway. I know you know that, but we're going to continue to see some acceleration and really some quickening, if you will, in Q2.

Speaker 2

But we're still very much a back loaded opening schedule for the 2023 year. And that's why frankly, that's the reason we wanted to give you that exposure to the 30 and the 10. Those 30 are units we can see in every stage of development. That's why we're counting them as in that pipeline for 2024. And then you get a little deeper into that development cadence and you can certainly get them open by the end of the year, but we all know that sometimes something might slip and we wanted to start to separate those into categories.

Speaker 2

I will also tell you that that isn't a full list. There is still time this year to add units to that pipeline and we're working like crazy to do that as well.

Speaker 5

Great. Thanks for that color. I want to come back to the sales trends for a second and get a sense for I think a lot of restaurants have called out that Easter had a bit of a negative impact on the March quarter. I wanted to get a sense for whether or not that you saw that impact, particularly given your exposure in CBD areas. And then as we think about the customer spend, are you seeing any change in terms of the average ticket?

Speaker 5

Are you seeing any check management from your customers?

Speaker 2

Yes. Look, the Easter flip from 1 quarter to the other is always going to affect us a little bit. And we still are more focused on the trends that we see through the quarter, what happened in January and then how we saw February March start to blend together. And there's no question that there was probably a little bit of extra pressure on March because of that shift. But that's not really what we're pointing to because those holidays swing back the other way too.

Speaker 2

And they over the period of a quarter, it's an impact, but it's not one of the biggest ones we wanted to call out. And when it comes to customer spend, we've shared this in past quarters. We're watching those mix numbers as indicators that customers are using our menu in a way that fits their budget. One of the great things about our three sizes is you can move up and down those sizes. And there is some evidence with a little bit of shift from Biggs to Originals or maybe Originals to Skinnys that there's some wallet management going on.

Speaker 2

The great news is we have all of those sizes and people don't have to pull their occasion completely from us if they can move around the menu. But they're not dramatic or significant shifts, but I think they're indicators of where people are feeling some pressure.

Speaker 5

Got it. And then you guys made great progress on the restaurant level margins this quarter, particularly in light of a flat comp, one 150 basis points, that's pretty impressive. The one line item that you saw some deleverage in was your other operating expenses, I think, was down about 90 basis points year over year. And wanted to see if you could provide a bit more color on that. I know that you're making progress on bringing more of the digital orders on through your app.

Speaker 5

So I would think that maybe you would see your exposure to 3rd party delivery down. But any color that you could provide on what was the culprit there on the deleverage on other operating expenses and how we should think about that particular line item the remainder of the year?

Speaker 3

Yes, sure. Hi, Jeremy. Yes, I think we're really proud of the margin expansion that we experienced in the quarter despite some of the consumer changes that we saw. But you'll have to remember within that other operating expenses line for us is our brand fund. And our conversations over the last several quarters, we've talked about how we took last year to ladder up our spend to that 3% of sales.

Speaker 3

And we didn't achieve that until the second half of the year. So lapping Q1 this year, you can see the difference. We have more brand fund expense that sat in that other OpEx line Q1 this year versus what sat in that line last year. So that's really where a lot of it sits. We also have in there obviously our digital fees and so forth.

Speaker 3

And Q1 is interesting because there's always a little bit of a shift around the delivery piece because of the weather and so forth. But nothing that I think would outstrip the brand fund expense. And even though we've got restaurant margins where they are with some expansion, we're ultimately focused on our overall profitability at the corporate level and our ability to offset anything that we see on the restaurant margin line. We work to offset that with some savings at the corporate level, whether that be through corporate costs like G and A or otherwise. So the other thing to mention, I think, which is important as particularly as we think about next year, some of our SHOP margin benefited from the 3rd party settlement that we had as well as that is reflected in this quarter.

Speaker 3

But as we head into quarter 1 next year, we'll have just remember that that was there. But even with that benefit of that settlement sitting in our shop margin, it was still an expansion, still an expanding quarter for us.

Speaker 5

Got it. And then just to clarify, of the 90 basis points, how much of it was due to the brand fund? Was that 50 basis points or more like 75? It

Speaker 3

was more than half of the hit.

Speaker 5

Got it. And then just the 3rd party settlement that the line item that that falls under?

Speaker 3

It got spread across a couple of line items within Scott Margin. It sat within our F and P sorry, it sat within our labor and it sat within our other OpEx. It sat within labor because it affected our ability to schedule properly and so forth. And on the other OpEx line, it affected our ability to really kind of manage some of the details around how we report and some of those fees that come in from 3rd parties and etcetera. So kind of evenly split among those two items.

Speaker 5

Got it. Thanks for taking the questions and good luck this year.

Speaker 2

Thanks, Jeremy. Thanks, Jeremy.

Operator

The next question is from Todd Brooks with The Benchmark Company. Please go ahead.

Speaker 6

Hey, thanks for taking my questions. I would like to lead off, Bob, I was excited to hear about the new work cementing the new prototype, the 1800 square feet. I don't think did you share a new build cost relative to the prior $650,000,000 that you're looking at for the new box?

Speaker 2

We didn't, not in the remarks, but happy to discuss it, Todd. I'll tell you, we're really excited about this. We've been working on it, as I mentioned, since last year and it's not like we've been keeping a secret. We like to talk about things when we're really proud of the work and not before that. But that's an average to an average.

Speaker 2

First of all, let's make that clear, but an average of 500 feet, if you look at today's average lease cost, triple net charges, those are hundreds of basis of points of leasing margin expansion for franchisees that are able to take advantage of that. And so that's where the big win is, is the OpEx side of things. The other thing is, I'm sure you've talked to many restaurant companies, but inflation that hit every bit of the economy hit construction and durable goods pretty hard. And a lot of our $650,000,000 is rooted in some historical costs that go back even before a lot of that inflation hit. So we will keep you posted as we build more of them.

Speaker 2

And the same team that's been extracting costs out of our operating model for these last 3 years is the one that oversees this work. So we're just getting started on building it as efficiently as possible. I will tell you this, while we don't publish their numbers, the more recent franchise openings, while not formally the prototype, we've been bringing some of the elements of that design into some of these more recent openings. We didn't want to go all the way and have to re permit and do redone drawings, but you can get some of the aesthetic elements in those things in there. But our more recent franchise builds have been less than our published average of 650.

Speaker 2

So it's the one of the greatest things about the franchise business is that they're going to help us find ways to improve the investment economics on these builds. And then because we've got the engineering teams and the more contractors we get involved, I think our best days are ahead on the costs.

Speaker 6

That's great. Two follow ups, if I may. 1, in the discussion with potential franchising partners, now that you can point to this prototype, their excitement, just kind of accelerating the whole effort, if you can build the box at 1800 Square Feet, do the same AUVs and do it at a lower cost, How much easier is that making it to sell new units? And then if I think about the work that you do for the franchisees as far as site identification within the market, how much does the 1800 Square Foot footprint open up the number of sites that some of these franchisees to have to choose from in the market as well?

Speaker 2

Yes, both of those are advantages. We've been putting this prototype work in our Discovery Day materials for a couple of quarters now. So we have been seeing the benefit of those franchisees that are interested in signing development deals with us. They've had some exposure to what we've been working on, while we've been getting everything engineered and finalized, and they're very excited about it. And I tried to be careful with what I said in the remarks that our ability to fit their real estate is one of the big things.

Speaker 2

The world I come from in QSR, a prototype was a fixed specific box. It was exactly the same size every time you built it, I mean, down to the inches the counter was from the front door and so on and so forth. Our prototype is a standard build from which you then fit it into a shop. Some of these are a little more square, some are a little more rectangle. We built and designed some recently that are they look a little more triangular than they do.

Speaker 2

And if it needs to be 1500 feet because that's the best location, well then we can work with that. And I think that's what franchisees are the most excited about. We've got this wonderful starting place that's smaller than we used to build, still keeps all of the best aesthetic elements of this classic pot belly in shop experience. We've got plenty of seating for today's mix of digital and dine in. We've reoriented the pickup shelf and some of the other elements of the digital experience, highlighted some things that we thought were flow issues those are the those are the things that excite franchisees.

Speaker 2

And you're exactly right, when you're attacking the market with a master broker and a set of local brokers, knowing that you've got flexibility, but your flexibility begins at 1800 and not 23, 2500, it really opens up the potential for some earlier real estate development. So I think it's one of those that's a win all the way around. And I firmly believe we've not only not compromised the brand experience, we've improved it.

Speaker 6

That's great. Shifting gears, Bob, you talked about maybe the need to for in shop customers, maybe non digital channel customers to try to deliver some more value to them over the course of this year. Can you I'm sure you're not going to walk through specific tactics about how to do that, but can you at least point us in the direction of how you deliver and how you communicate value to that customer where it's fairly over once they walk into the shop?

Speaker 2

Yes, it is an additional layer for us because if you accept the conclusion we've come to, we certainly do, is that this infrequent customer who is familiar with and has affinity for the brand is managing their personal financial situation. And they're just they're pulling back ever so slightly and probably from a lot of places. We're competing with all other restaurants and we're competing with the refrigerator. And when people's entire food budget is under pressure, they don't want to do is start compromising on their meal choices. And at the same time, they'd love to see some everyday options that can work into their mix over the month or over the quarter that they trade with certain restaurants.

Speaker 2

So because the more infrequent consumer for us overlaps with our non digital consumer, Our digital consumers, we've talked very openly about the meaningfully higher frequency rate with Perks members, for example. So it's a little harder to reach those customers. But for us, we still use digital advertising in addition. In fact, that's where the large majority of our effort goes is through their digital advertising efforts. So we want to make sure that we're using that to spread the word to those people are still picking up our digital ads, even if they're not yet part of our Perks program.

Speaker 2

And then, I think you have to do some things in shop too, so that when they do come in and visit because they do skew slightly more in shop that they're seeing those messages and they're remembering those messages, which brings them back and keeps that frequency, Is that a long Is that a long tailed effort

Speaker 6

or can that be delivered at the shop level pretty quickly?

Speaker 2

We can deliver it pretty quickly.

Speaker 3

Yes.

Speaker 6

And then just one quick follow-up for Steve and I'll jump back in queue. Within the guidance for 2nd quarter same store sales at flat to up 2. And I think, Bob, you commented that we're positive low single digit quarter to date. What's the assumption on price mix that's baked into the flat to up to assumption? Thanks.

Speaker 3

Sure. Thanks for the question. I'll just start with kind of the way we've discussed pricing for the last couple of years, which is we'll manage price in order to outrun some of the costs for our inputs, our food and paper and our labor. And the good news is for this quarter, we saw commodity costs actually deflate a little bit. Labor costs kind of stayed in the same zone that low kind of mid lows in the single digits area.

Speaker 3

So that's good for us. And we had a price increase for this quarter, modest like we said, in kind of the low the mid ones. We carried about 3.3 percent of price into the quarter and we netted about 4%, right? And so that's a way of me saying like 4 carrying forward for the year about 2%. So when you see our carrying forward for the year about 2%.

Speaker 3

So when you see our comps right at 0% to 2%, You can understand that we'll bring in some of that price increase to offset perhaps some traffic challenges. But as Bob was describing with all of the efforts on the digital marketing side and the efforts with some of these new value offers that we're going to start to push that our expectations that we'll strengthen traffic and we'll continue to get the benefits from that and that should show up in our ultimately in our same store sales.

Speaker 6

Okay, perfect. Thanks, Steve.

Operator

The next question is from Matt Curtis with William Blair. Please go ahead.

Speaker 7

Hi, thanks. Good afternoon. Bob, I think last quarter you said you have the opportunity to get to a 16% restaurant level margin this year. Is that still in play at this point given the narrowing in full year comp guidance?

Speaker 2

Yes. I think if you take the comments that Steve shared about what we saw in Q1, and you kind of project where that would put us with margin expansion through the year, of course, I think it's going to be tougher for us to get to 16% if we maintain some of this softer sales against what our original plan was, especially with where we were in Q1. But I think the emphasis there is it's still expanding margins and there's still other ways for us to keep expanding those margins. And one of the great things we're talking about with new development, which is where the franchisees care the most about how quickly can they get to those margins is this prototype. That's the kind of margin expansion that just keeps delivering after you build those shops.

Speaker 2

So I think you're right to point that out. What I would tell you is that we recognize with our still significantly majority company owned portfolio that our shop profitability driven by those margins and top line of course is such an important part of our overall adjusted EBITDA for the company for the year. Steve mentioned this already, but we look at our other measures and other opportunities that we have to manage our cost as a corporation and still continue to deliver what we've guided to on that adjusted EBITDA growth for the year in the mid to high single digits. Well, that clearly means you see some savings elsewhere. We're a growth company though, Matt.

Speaker 2

So we can meter some of those investments in things like G and A and still serve the growth, but be the most responsible on our way to building that earnings growth that goes with it. While we're also continuing to expand those shop level margins. So I think that's how those 2 are working together.

Speaker 7

Okay, got it. Thanks for that. And then, I guess the full year comp guidance implies that traffic will be sort of flattish, I guess, for the full year. So assuming that's the case, would you expect that the unit level margin expansion this year would be more driven by levers like supply chain efficiency and labor optimization as opposed to sales leverage?

Speaker 2

Yes, I mean the sales leverage Yes, I

Speaker 3

think that's

Speaker 2

Sorry, Steve, go ahead.

Speaker 3

Sorry, Bob. Yes, I was sorry, Matt. The as we have the plan laid out, right, we're still expecting to expand the margins throughout the year. We expect the sales to help play a role there, perhaps less of a role than we had thought the last time we spoke. But nevertheless, that's going to be a component of it.

Speaker 3

But as we go down kind of the middle of that, a little middle of the P and L, we continue to see some gains. At least we'll see them in the Q1 sorry, the second quarter on some of our commodities that will settle down a bit in the second half as we see some commodity inflation in some areas come back a little bit. But labor is one area where we continue to make strides. Our labor guide, we continue to find ways to pull some hours out of that, which is fantastic. We'll continue to expand our Potbelly Digital Kitchen, through which we see some labor benefits there.

Speaker 3

And also, we continue to kind of marginally tweak our hours of operation, which ends up being a benefit to some of that labor as well. So leverage in that labor line for sure. We also I think see some continued leverage in our occupancy that there's opportunities for us with new leases and so forth to continue to push that even though the sales leverage is not as intense as it would otherwise be. I think we on the other OpEx side, we just talked about a little earlier, we'll still get a little bit of drag from the brand fund lapping in that line until we get to the back half of the year. So that nets out to us.

Speaker 3

We think we can continue to expand margin just the shop level margin. And as Bob said, having the ability to then work the lower elements of the P and L into our favor too in terms of corporate costs. That's why we're confident guiding what we did as it relates to the EBITDA line for the full year.

Speaker 7

Okay, great. That helps a lot. Thanks very much.

Operator

Ladies and gentlemen, we have reached the end of today's question and answer session. I would like to turn the call back over to Mr. Bob Wright for closing remarks.

Speaker 2

Thank you and thank you all for joining us today and especially thank you for the questions. As you heard, we're proud of our quarter and proud of the team, especially grateful to all of our associates and our franchisees, our growing body of franchisees and their employees as well. So thanks again for your time. We look forward to talking to you again soon. Have a great night.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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Earnings Conference Call
Potbelly Q1 2024
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