POTBELLY CORP - Quarter Report: 2022 September (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________________________________________
FORM 10-Q
______________________________________________
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
For the Quarterly Period Ended September 25, 2022
OR
| o | 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 325 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 x No o
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 x No o
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 | o | Accelerated filer | x | |||||||||||
| Non-accelerated filer | o | Smaller reporting company | o | |||||||||||
| Emerging growth company | o | |||||||||||||
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. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No x
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 o
As of October 23, 2022, the registrant had 28,812,262 shares of common stock, $0.01 par value per share, outstanding.
Potbelly Corporation and Subsidiaries
Table of Contents
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Potbelly Corporation and Subsidiaries
Condensed Consolidated Balance Sheets
(amounts in thousands, except par value data, unaudited)
| September 25, 2022 | December 26, 2021 | ||||||||||
| Assets | |||||||||||
| Current assets | |||||||||||
| Cash and cash equivalents | $ | 9,506 | $ | 14,353 | |||||||
Accounts receivable, net of allowances of $32 and $27 as of September 25, 2022 and December 26, 2021, respectively | 8,317 | 6,032 | |||||||||
| Inventories | 3,660 | 3,491 | |||||||||
| Prepaid expenses and other current assets | 4,225 | 4,178 | |||||||||
| Total current assets | 25,708 | 28,054 | |||||||||
| Property and equipment, net | 44,665 | 49,805 | |||||||||
| Right-of-use assets for operating leases | 162,086 | 166,084 | |||||||||
| Indefinite-lived intangible assets | 3,404 | 3,404 | |||||||||
| Goodwill | 2,222 | 2,222 | |||||||||
| Deferred expenses, net and other assets | 3,470 | 3,668 | |||||||||
| Total assets | $ | 241,555 | $ | 253,237 | |||||||
| Liabilities and equity (deficit) | |||||||||||
| Current liabilities | |||||||||||
| Accounts payable | $ | 10,229 | $ | 8,140 | |||||||
| Accrued expenses | 28,307 | 30,859 | |||||||||
| Short-term operating lease liabilities | 28,066 | 28,548 | |||||||||
| Current portion of long-term debt | — | 2,333 | |||||||||
| Total current liabilities | 66,602 | 69,880 | |||||||||
| Long-term debt, net of current portion | 10,100 | 17,517 | |||||||||
| Long-term operating lease liabilities | 162,101 | 166,291 | |||||||||
| Other long-term liabilities | 1,843 | 1,966 | |||||||||
| Total liabilities | 240,646 | 255,654 | |||||||||
| Commitments and contingencies (Note 11) | |||||||||||
| Equity (deficit) | |||||||||||
Common stock, $0.01 par value—authorized 200,000 shares; outstanding 28,791 and 28,380 shares as of September 25, 2022 and December 26, 2021, respectively | 384 | 380 | |||||||||
| Warrants | 2,566 | 2,566 | |||||||||
| Additional paid-in-capital | 455,012 | 452,570 | |||||||||
Treasury stock, held at cost, 9,924 and 9,785 shares as of September 25, 2022, and December 26, 2021, respectively | (115,331) | (114,577) | |||||||||
| Accumulated deficit | (341,571) | (343,261) | |||||||||
| Total stockholders’ equity (deficit) | 1,060 | (2,322) | |||||||||
| Non-controlling interest | (151) | (95) | |||||||||
| Total equity (deficit) | 909 | (2,417) | |||||||||
| Total liabilities and equity (deficit) | 241,555 | 253,237 | |||||||||
See accompanying notes to the unaudited condensed consolidated financial statements.
3
Potbelly Corporation and Subsidiaries
Condensed Consolidated Statements of Operations
(amounts in thousands, except per share data, unaudited)
For the Quarter Ended | For the Year to Date Ended | ||||||||||||||||||||||
| September 25, 2022 | September 26, 2021 | September 25, 2022 | September 26, 2021 | ||||||||||||||||||||
| Revenues | |||||||||||||||||||||||
| Sandwich shop sales, net | $ | 116,449 | $ | 100,996 | $ | 328,873 | $ | 275,274 | |||||||||||||||
| Franchise royalties and fees | 1,200 | 698 | 2,950 | 1,974 | |||||||||||||||||||
| Total revenues | 117,649 | 101,694 | 331,823 | 277,248 | |||||||||||||||||||
| Expenses | |||||||||||||||||||||||
| Sandwich shop operating expenses, excluding depreciation | |||||||||||||||||||||||
| Food, beverage and packaging costs | 34,814 | 28,225 | 94,952 | 76,035 | |||||||||||||||||||
| Labor and related expenses | 36,031 | 33,087 | 105,405 | 93,662 | |||||||||||||||||||
| Occupancy expenses | 13,559 | 13,437 | 41,209 | 40,598 | |||||||||||||||||||
| Other operating expenses | 19,743 | 17,466 | 56,977 | 47,039 | |||||||||||||||||||
| Franchise marketing expenses | 115 | 94 | 361 | 213 | |||||||||||||||||||
| General and administrative expenses | 9,554 | 7,260 | 26,899 | 23,106 | |||||||||||||||||||
| Depreciation expense | 2,922 | 3,610 | 9,089 | 12,337 | |||||||||||||||||||
| Impairment, loss on disposal of property and equipment and shop closures | 1,616 | 1,118 | 3,980 | 4,497 | |||||||||||||||||||
| Total expenses | 118,354 | 104,297 | 338,872 | 297,487 | |||||||||||||||||||
| Loss from operations | (705) | (2,603) | (7,049) | (20,239) | |||||||||||||||||||
| Interest expense, net | 354 | 241 | 1,037 | 713 | |||||||||||||||||||
| Gain on extinguishment of debt | (10,191) | — | (10,191) | — | |||||||||||||||||||
| Income (loss) before income taxes | 9,132 | (2,844) | 2,105 | (20,952) | |||||||||||||||||||
| Income tax expense (benefit) | (4) | 16 | 148 | 230 | |||||||||||||||||||
| Net income (loss) | 9,136 | (2,860) | 1,957 | (21,182) | |||||||||||||||||||
| Net income attributable to non-controlling interest | 107 | 88 | 267 | 119 | |||||||||||||||||||
| Net income (loss) attributable to Potbelly Corporation | $ | 9,029 | $ | (2,948) | $ | 1,690 | $ | (21,301) | |||||||||||||||
Net income (loss) per common share attributable to common stockholders: | |||||||||||||||||||||||
| Basic | $ | 0.31 | $ | (0.10) | $ | 0.06 | $ | (0.78) | |||||||||||||||
| Diluted | $ | 0.31 | $ | (0.10) | $ | 0.06 | $ | (0.78) | |||||||||||||||
| Weighted average shares outstanding: | |||||||||||||||||||||||
| Basic | 28,726 | 28,264 | 28,563 | 27,395 | |||||||||||||||||||
| Diluted | 28,867 | 28,264 | 28,947 | 27,395 | |||||||||||||||||||
See accompanying notes to the unaudited condensed consolidated financial statements.
4
Potbelly Corporation and Subsidiaries
Condensed Consolidated Statements of Equity (Deficit)
(amounts and shares in thousands, unaudited)
| Common Stock | Treasury Stock | Warrants | Additional Paid-In- Capital | Accumulated Deficit | Non- Controlling Interest | Total Equity (Deficit) | ||||||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | |||||||||||||||||||||||||||||||||||||||||||||||||
| Balance at December 27, 2020 | 24,323 | 339 | (113,266) | — | 438,174 | (319,477) | (275) | $ | 5,495 | |||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | (14,472) | (2) | (14,474) | ||||||||||||||||||||||||||||||||||||||||||
| Shares issued under equity compensation plan | 63 | 1 | — | — | (1) | — | — | — | ||||||||||||||||||||||||||||||||||||||||||
| Issuance of common shares and warrants, net of fees | 3,250 | 32 | — | 2,566 | 12,342 | — | — | 14,940 | ||||||||||||||||||||||||||||||||||||||||||
| Contributions from non-controlling interest | — | — | — | — | — | — | 136 | 136 | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | — | 193 | — | — | 193 | ||||||||||||||||||||||||||||||||||||||||||
| Balance at March 28, 2021 | 27,636 | 372 | (113,266) | 2,566 | 450,708 | (333,949) | (141) | $ | 6,290 | |||||||||||||||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | — | — | (3,881) | 33 | (3,848) | ||||||||||||||||||||||||||||||||||||||||||
| Shares issued under equity compensation plan | 535 | 6 | (685) | — | (6) | — | — | (685) | ||||||||||||||||||||||||||||||||||||||||||
Proceeds from exercise of stock options | — | — | — | — | 219 | — | — | 219 | ||||||||||||||||||||||||||||||||||||||||||
| Issuance of common shares and warrants, net of fees | — | — | — | — | (101) | — | — | (101) | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | — | 655 | — | — | 655 | ||||||||||||||||||||||||||||||||||||||||||
| Balance at June 27, 2021 | 28,171 | $ | 378 | $ | (113,951) | $ | 2,566 | $ | 451,475 | $ | (337,830) | $ | (108) | $ | 2,530 | |||||||||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | — | — | (2,948) | 88 | (2,860) | ||||||||||||||||||||||||||||||||||||||||||
| Shares issued under equity compensation plan | 198 | 2 | (560) | — | (2) | — | — | (560) | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | — | 640 | — | — | 640 | ||||||||||||||||||||||||||||||||||||||||||
| Balance at September 26, 2021 | 28,369 | $ | 380 | $ | (114,511) | $ | 2,566 | $ | 452,113 | $ | (340,778) | $ | (20) | $ | (250) | |||||||||||||||||||||||||||||||||||
| Balance at December 26, 2021 | 28,380 | $ | 380 | $ | (114,577) | $ | 2,566 | $ | 452,570 | $ | (343,261) | $ | (95) | $ | (2,417) | |||||||||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | — | — | (7,913) | 26 | (7,887) | ||||||||||||||||||||||||||||||||||||||||||
| Shares issued under equity compensation plan | 81 | 1 | (279) | — | — | — | — | (278) | ||||||||||||||||||||||||||||||||||||||||||
| Distributions to non-controlling interest | — | — | — | — | — | — | (120) | (120) | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | 675 | — | — | 675 | |||||||||||||||||||||||||||||||||||||||||||
| Balance at March 27, 2022 | 28,461 | 381 | (114,856) | 2,566 | 453,245 | (351,174) | (189) | (10,027) | ||||||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | — | 574 | 134 | 708 | ||||||||||||||||||||||||||||||||||||||||||
| Shares issued under equity compensation plan | 235 | 2 | (325) | — | (3) | — | — | (326) | ||||||||||||||||||||||||||||||||||||||||||
| Distributions to non-controlling interest | — | — | — | — | — | — | (56) | (56) | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | — | 820 | — | — | 820 | ||||||||||||||||||||||||||||||||||||||||||
| Balance at June 26, 2022 | 28,696 | $ | 383 | $ | (115,181) | $ | 2,566 | $ | 454,062 | $ | (350,600) | $ | (111) | $ | (8,881) | |||||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | — | 9,029 | 107 | 9,136 | ||||||||||||||||||||||||||||||||||||||||||
| Shares issued under equity compensation plan | 95 | 1 | (150) | — | (1) | — | — | (150) | ||||||||||||||||||||||||||||||||||||||||||
| Distributions to non-controlling interest | — | — | — | — | — | — | (147) | (147) | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | — | 951 | — | — | 951 | ||||||||||||||||||||||||||||||||||||||||||
| Balance at September 25, 2022 | 28,791 | 384 | (115,331) | 2,566 | 455,012 | (341,571) | (151) | 909 | ||||||||||||||||||||||||||||||||||||||||||
See accompanying notes to the unaudited condensed consolidated financial statements.
5
Potbelly Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(amounts in thousands, unaudited)
| For the Year to Date Ended | |||||||||||
| September 25, 2022 | September 26, 2021 | ||||||||||
| Cash flows from operating activities: | |||||||||||
| Net income (loss) | $ | 1,957 | $ | (21,182) | |||||||
| Adjustments to reconcile net income (loss) to net cash used in operating activities: | |||||||||||
| Depreciation expense | 9,089 | 12,337 | |||||||||
| Noncash lease expense | 19,511 | 19,199 | |||||||||
| Deferred income tax | 14 | 14 | |||||||||
| Stock-based compensation expense | 2,446 | 1,488 | |||||||||
| Asset impairment, loss on disposal of property and equipment and shop closures | 3,980 | 3,944 | |||||||||
| Gain on extinguishment of debt | (10,191) | — | |||||||||
| Other operating activities | 205 | 232 | |||||||||
| Changes in operating assets and liabilities: | |||||||||||
| Accounts receivable, net | (2,286) | (1,378) | |||||||||
| Inventories | (169) | (197) | |||||||||
| Prepaid expenses and other assets | (491) | 626 | |||||||||
| Accounts payable | 1,352 | 1,206 | |||||||||
| Operating lease liabilities | (21,163) | (24,932) | |||||||||
| Accrued expenses and other liabilities | (3,236) | 1,505 | |||||||||
| Net cash provided by (used in) operating activities: | 1,018 | (7,138) | |||||||||
| Cash flows from investing activities: | |||||||||||
| Purchases of property and equipment | $ | (4,914) | $ | (7,543) | |||||||
| Net cash used in investing activities: | (4,914) | (7,543) | |||||||||
| Cash flows from financing activities: | |||||||||||
| Borrowings under revolving credit facility | $ | 30,550 | $ | 28,000 | |||||||
| Repayments under revolving credit facility | (30,300) | (28,486) | |||||||||
| Payment of debt issuance costs | (176) | (195) | |||||||||
| Proceeds from issuance of common shares and warrants, net of fees | — | 14,839 | |||||||||
| Proceeds from exercise of stock options | — | 219 | |||||||||
| Employee taxes on certain stock-based payment arrangements | (702) | (1,122) | |||||||||
| Contributions from non-controlling interest | — | 136 | |||||||||
| Distributions to non-controlling interest | (323) | — | |||||||||
| Net cash provided by (used in) financing activities: | (951) | 13,391 | |||||||||
| Net decrease in cash and cash equivalents | (4,847) | (1,290) | |||||||||
| Cash and cash equivalents at beginning of period | 14,353 | 11,126 | |||||||||
| Cash and cash equivalents at end of period | $ | 9,506 | $ | 9,836 | |||||||
| Supplemental cash flow information: | |||||||||||
| Income taxes paid | $ | 139 | $ | 185 | |||||||
| Interest paid | 662 | 482 | |||||||||
| Supplemental non-cash investing and financing activities: | |||||||||||
| Gain on extinguishment of debt and accrued interest related to PPP loan | $ | 10,191 | $ | — | |||||||
| Unpaid liability for purchases of property and equipment | 573 | 599 | |||||||||
| Unpaid liability for employee taxes on certain stock-based payment arrangements | 52 | 124 | |||||||||
See accompanying notes to the unaudited condensed consolidated financial statements
6
Potbelly Corporation and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (unaudited)
(1) Organization and Other Matters
Business
Potbelly Corporation (the "Company", "Potbelly", "we", "us" or "our"), through its wholly owned subsidiaries, owns and operates 388 company-owned shops in the United States. Additionally, Potbelly franchisees operate 46 shops in the United States.
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 our Annual Report on Form 10-K for the year ended December 26, 2021. The unaudited condensed consolidated financial statements included herein have been prepared by us 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 our balance sheet as of September 25, 2022 and December 26, 2021, our statement of operations for the quarter and year to date ended September 25, 2022 and September 26, 2021, the statement of equity for the quarter and year to date ended September 25, 2022 and September 26, 2021, and our statement of cash flows for the year to date ended September 25, 2022 and September 26, 2021 have been included. The condensed consolidated statements of operations for the interim periods presented herein are not necessarily indicative of the results to be expected for the full year.
Beginning in the first quarter of 2022, we reclassified certain advertising and marketing expenses within the condensed consolidated statement of operations. Refer to discussion of the Potbelly Brand Fund in the paragraphs below. These reclassifications had no impact on our results of operations, financial position, or cash flows.
We do not have any components of other comprehensive income recorded within our consolidated financial statements and therefore, do not separately present a statement of comprehensive income in our condensed consolidated financial statements.
COVID-19
On January 30, 2020, the WHO announced a global health emergency because of COVID-19 and the risks to the international community as the virus spreads globally. On March 11, 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally. The COVID-19 pandemic significantly impacted economic conditions in the United States where all our shops are located during portions of 2020 and 2021. The availability of COVID-19 vaccines and lifting of local restrictions has resulted in an improvement to our sales since the beginning of the pandemic. We have returned nearly all of our shops to our pre-pandemic operating hours. To the extent there is a resurgence of COVID-19 cases, we will follow guidance from local authorities in determining the appropriate restrictions to put in place for each shop, including mask mandates, hours of operation, and the suspension or reduction of in-shop dining, which could result in lower in-shop dining revenue or higher operating costs.
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 (“PSW”); seven of PSW’s wholly owned subsidiaries and PSW’s six joint ventures, collectively, the “Company.” All intercompany balances and transactions have been eliminated in consolidation. For our six consolidated joint ventures, "non-controlling interest" represents the non-controlling partner’s share of the assets, liabilities and operations related to the joint venture investments. Potbelly has ownership interests ranging from 51-80% in these consolidated joint ventures.
Fiscal Year
We use 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 2022 and 2021 both consist of 52 weeks. The fiscal quarters ended September 25,
7
2022 and September 26, 2021 each consisted of 13 weeks. The year to date periods ended September 25, 2022 and September 26, 2021 each consisted of 39 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.
Potbelly Brand Fund
We maintain the Potbelly Brand Fund (the "Brand Fund") for the purpose of collecting and administering funds to be used for advertising, customer research, marketing technology, agencies, and other activities that promote the Potbelly brand in order to deliver sales at our shops. Company-operated and franchised shops both contribute to the Brand Fund based on a percentage of sales.
Beginning in the first quarter of fiscal year 2022, we manage these advertising and marketing expenses through the Brand Fund using the funds contributed by our shops. We manage these funds separately from our general operating expenses, but we are not obligated to maintain the funds in separate accounts or entities. We may spend more or less in any fiscal period than the amounts contributed to the Brand Fund, and we may choose to roll over any unused contributions to the following fiscal period or return them to our shops. Cash held related to the Brand Fund is not considered to be restricted cash as there are no restrictions on the use of the funds.
Brand Fund contributions made by company-operated shops are eliminated from the consolidated financial statements. Franchisee contributions are included within franchise royalties and fees in the condensed consolidated statements of operations.
Expenses incurred by the Brand Fund are allocated to company-operated and franchised shops based on their relative contributions. The allocation of company-operated Brand Fund expense is included within other operating expenses in our condensed consolidated statements of operations. The allocation of franchisee Brand Fund expense is presented as franchise marketing expenses in our condensed consolidated statements of operations. Prior periods have been reclassified to conform to the current presentation of these expenses.
Recent Accounting Pronouncements
We reviewed all recently issued accounting pronouncements and concluded that they were either not applicable or not expected to have a significant impact to the condensed consolidated financial statements.
(2) Revenue
We primarily earn revenue at a point in time for sandwich shop sales, which can occur in person at the shop, over our online or app platform, or through a third-party platform. Sales taxes collected from customers are excluded from revenues and the obligation is included in accrued liabilities until the taxes are remitted to the appropriate taxing authorities. We have other revenue generating activities outlined below.
Franchise Revenue
We earn an initial franchise fee, a franchise development agreement fee and ongoing fees for royalties and Brand Fund contributions under our franchise agreements. Initial franchise fees are considered highly dependent upon and interrelated with the franchise right granted in the franchise agreement. As such, these franchise fees are recognized over the contractual term of the franchise agreement. We record a contract liability for the unearned portion of the initial franchise fees. Franchise development agreement fees represent the exclusivity rights for a geographical area paid by a third party to develop Potbelly shops for a certain period of time. Franchise development agreement fee payments received by us are recorded in the consolidated balance sheets as accrued expenses or other long-term liabilities, and amortized over the life of the franchise development agreement. Royalties and Brand Fund contributions are based on a percentage of sales and are recorded as revenue as they are earned and become receivable from the franchisee.
8
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 ("breakage"), which is recognized 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. We recognize gift card breakage income within net sandwich shop sales in the consolidated statements of operations.
We recognized gift card breakage income of $0.4 million and $0.1 million for the year to date ended September 25, 2022 and September 26, 2021, respectively, which is recorded within net sandwich shop sales in our condensed consolidated statements of operations.
Loyalty Program
We offer a customer loyalty program for customers using the Potbelly Perks application at the point of sale. The customer will typically earn 10 points for every dollar spent, and the customer will earn a free entrée after earning 1,000 points. We defer revenue associated with the estimated selling price of points earned by Potbelly Perks members towards free entrées as each point is earned, and a corresponding liability is established in deferred revenue. The deferral is based on the estimated value of the product for which the reward is expected to be redeemed, net of estimated unredeemed points. Once a customer earns a free entrée, that entrée reward will expire after 30 days. Any point in a customer’s account that does not go toward earning a full entrée will expire after the customer's account has been inactive for a year. The breakage amount recognized is estimated based on a historical data analysis of loyalty reward redemptions and is recognized in net shop sandwich sales in the consolidated statement of operations. When points are redeemed, we recognize revenue for the redeemed product and reduce accrued expenses.
For the year to date ended September 25, 2022 revenue recognized from all revenue sources on point in time sales was $330.6 million, and revenue recognized from sales over time was $1.2 million. For the year to date ended September 26, 2021, revenue recognized from all revenue sources on point in time sales was $276.8 million and revenue recognized from sales over time was $0.4 million.
Contract Liabilities
We record current and noncurrent contract liabilities in accrued expenses and other long-term liabilities, respectively, for initial franchise fees, gift cards, and loyalty programs. We have no other contract liabilities or contract assets recorded.
The opening and closing balances of our current and noncurrent contract liabilities from contracts with customers were as follows:
Current Contract Liability | Noncurrent Contract Liability | ||||||||||
| (Thousands) | (Thousands) | ||||||||||
Beginning balance as of December 26, 2021 | $ | 6,533 | $ | 1,428 | |||||||
Ending balance as of September 25, 2022 | 6,146 | 1,289 | |||||||||
| Decrease in contract liability | $ | (387) | $ | (139) | |||||||
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The aggregate value of remaining performance obligations on outstanding contracts was $7.4 million as of September 25, 2022. We expect 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 | Amount | |||||||
| 2022 | $ | 4,171 | ||||||
| 2023 | 1,382 | |||||||
| 2024 | 394 | |||||||
| 2025 | 349 | |||||||
| 2026 | 155 | |||||||
| Thereafter | 984 | |||||||
| Total revenue recognized | $ | 7,435 | ||||||
For the quarter and year to date ended September 25, 2022, the amount of revenue recognized related to the December 26, 2021 liability ending balance was $0.4 million and $2.2 million, respectively. For quarter and year to date ended September 26, 2021, the amount of revenue recognized related to the December 27, 2020 liability ending balance was $0.2 million and $1.1 million, respectively. This revenue is related to the recognition of gift card redemptions and upfront franchise fees. For the year to date ended September 25, 2022 and September 26, 2021, we 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 book value of the long-term debt under the Credit Agreement, subsequently amended most recently as of September 23, 2022 and further discussed in Note 7, is considered to approximate its fair value as of September 25, 2022 as the interest rates are considered in line with current market rates.
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.
We assess potential impairments to our 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. After performing a periodic review of our shops during the quarter and year to date ended September 25, 2022, it was determined that indicators of impairment were present for certain shops as a result of continued underperformance, primarily related to the impacts of COVID-19. We performed an impairment analysis related to these shops and recorded an impairment charge of $1.0 million and $3.0 million for the quarter and year to date ended September 25, 2022. The ultimate severity and longevity of the COVID-19 pandemic is unknown, and therefore, it is possible that impairments could be identified in future periods, and such amounts could be material.
(4) Earnings (Loss) Per Share
Basic and diluted income (loss) per common share attributable to common stockholders are calculated using the weighted average number of common shares outstanding for the period. Diluted income (loss) per common share
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attributable to common stockholders is computed by dividing the income (loss) 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 quarter and year to date ended September 26, 2021, we had a loss per share, and therefore potentially dilutive shares were excluded from the calculation.
The following table summarizes the loss per share calculation:
| For the Quarter Ended | For the Year to Date Ended | ||||||||||||||||||||||
| September 25, 2022 | September 26, 2021 | September 25, 2022 | September 26, 2021 | ||||||||||||||||||||
| Net income (loss) attributable to Potbelly Corporation | $ | 9,029 | $ | (2,948) | $ | 1,690 | $ | (21,301) | |||||||||||||||
| Weighted average common shares outstanding-basic | 28,726 | 28,264 | 28,563 | 27,395 | |||||||||||||||||||
| Plus: Effect of potentially dilutive stock-based compensation awards | 141 | — | 329 | — | |||||||||||||||||||
| Plus: Effect of potential warrant exercise | — | — | 55 | — | |||||||||||||||||||
| Weighted average common shares outstanding-diluted | 28,867 | 28,264 | 28,947 | 27,395 | |||||||||||||||||||
| Income (loss) per share available to common stockholders-basic | $ | 0.31 | $ | (0.10) | $ | 0.06 | $ | (0.78) | |||||||||||||||
| Income (loss) per share available to common stockholders-diluted | $ | 0.31 | $ | (0.10) | $ | 0.06 | $ | (0.78) | |||||||||||||||
| Potentially dilutive shares that are considered anti-dilutive: | |||||||||||||||||||||||
| Shares | 2,620 | 1,888 | 647 | 1,994 | |||||||||||||||||||
(5) Income Taxes
The interim tax provision is determined using an estimated annual effective tax rate and is adjusted for discrete taxable events that occur during the quarter. We regularly assess the need for a valuation allowance related to our 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 our deferred tax assets will not be realized. In our assessment, we consider recent financial operating results, projected future taxable income, the reversal of existing taxable differences, and tax planning strategies. We recorded a full valuation allowance against our net deferred tax assets during the first quarter of 2019, resulting in a non-cash charge to income tax expense of $13.6 million. We continue to maintain a valuation allowance against all of our deferred tax assets as of September 25, 2022. We did not provide for an income tax benefit on our pre-tax income (loss) for the quarter and year to date ended September 25, 2022 and September 26, 2021. We assess the likelihood of the realization of our deferred tax assets each quarter and the valuation allowance is adjusted accordingly.
On August 16, 2022, the Inflation Reduction Act ("IRA") was signed into law. We do not expect the IRA to have a material impact to our condensed consolidated financial statements and we will continue to monitor the potential impacts of the IRA to our business.
(6) Leases
We determine if an arrangement is a lease at inception of the arrangement. We lease retail shops and warehouse and office space under operating leases. Our leases generally have terms of ten years and most include options to extend the leases for additional five-year periods. For leases with renewal periods at our option, we determine the expected lease period based on whether the renewal of any options are reasonably assured at the inception of the lease.
Operating leases result in the recording a right-of-use asset and lease liability on the consolidated balance sheet. Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease assets and liabilities are recognized at the lease commencement date, which is the date we take possession of the property. Operating lease liabilities represent the present value of lease payments not yet paid. Operating right-of-use assets represent the operating lease liability adjusted for prepayments or accrued lease payments, initial direct costs, lease incentives, and impairment of operating lease assets. In determining the present value of lease payments not yet paid, we estimate our incremental secured borrowing rates
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corresponding to the maturities of our leases. We estimate this rate based on prevailing financial market conditions, comparable company and credit analysis, and management judgment.
Our leases typically contain rent escalations over the lease term and lease expense is recognized on a straight-line basis over the lease term. Tenant incentives used to fund leasehold improvements are recognized when earned and reduce right-of-use assets related to the lease. The tenant incentives are amortized through the right-of-use asset as reductions of rent expense over the lease term.
We elected a short-term lease exception policy, permitting us to not apply the recognition requirements of ASC 842, Leases, to short-term leases (i.e. leases with terms of 12 months or less) and an accounting policy to account for lease and non-lease components as a single component for certain classes of assets.
During the quarter and year to date ended September 25, 2022, we terminated 1 lease and 2 leases, respectively. We did not incur any lease termination fees related to these leases for the year to date ended September 25, 2022. Upon termination of these leases during the quarter and year to date ended September 25, 2022, we derecognized ROU assets of $0.2 million and lease liabilities of $0.3 million that resulted in a net gain of $0.1 million that is recorded in impairment, loss on disposal of property and equipment and shop closures.
Operating lease term and discount rate were as follows:
| September 25, 2022 | September 26, 2021 | ||||||||||
| Weighted average remaining lease term (years) | 6.77 | 7.33 | |||||||||
| Weighted average discount rate | 8.17 | % | 7.93 | % | |||||||
Certain of our 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:
| For the Quarter Ended | For the Year to Date Ended | |||||||||||||||||||||||||
| Classification | September 25, 2022 | September 26, 2021 | September 25, 2022 | September 26, 2021 | ||||||||||||||||||||||
| Operating lease cost | Occupancy and General and administrative expenses | 10,043 | 10,310 | 30,440 | 31,017 | |||||||||||||||||||||
| Variable lease cost | Occupancy | 3,251 | 3,090 | 10,509 | 9,565 | |||||||||||||||||||||
| Total lease cost | 13,294 | 13,400 | 40,949 | 40,582 | ||||||||||||||||||||||
Supplemental disclosures of cash flow information related to leases were as follows:
| For the Quarter Ended | For the Year to Date Ended | ||||||||||||||||||||||
| September 25, 2022 | September 26, 2021 | September 25, 2022 | September 26, 2021 | ||||||||||||||||||||
| Operating cash flows rent paid for operating lease liabilities | 10,254 | 11,688 | 31,179 | 36,739 | |||||||||||||||||||
| Operating right-of-use assets obtained in exchange for new operating lease liabilities | 7,361 | 2,302 | 17,537 | 6,958 | |||||||||||||||||||
| Reduction in operating right-of-use assets due to lease terminations and modifications | 84 | — | 1,347 | 4,140 | |||||||||||||||||||
As of September 25, 2022, we had no real estate leases entered into that had not yet commenced.
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Maturities of lease liabilities were as follows as of September 25, 2022:
| Operating Leases | |||||
Remainder of 2022 | 10,575 | ||||
| 2023 | 41,879 | ||||
| 2024 | 39,269 | ||||
| 2025 | 36,276 | ||||
| 2026 | 32,632 | ||||
| 2027 | 27,139 | ||||
| Thereafter | 63,374 | ||||
| Total lease payments | 251,144 | ||||
| Less: imputed interest | (60,977) | ||||
| Present value of lease liabilities | 190,167 | ||||
(7) Debt and Credit Facilities
The components of long-term debt were as follows:
| September 25, 2022 | December 26, 2021 | ||||||||||
| Revolving credit facility | $ | 10,100 | $ | 9,850 | |||||||
| Paycheck Protection Program loan | — | 10,000 | |||||||||
| Less: current portion of long-term debt | — | (2,333) | |||||||||
| Total long-term debt | $ | 10,100 | $ | 17,517 | |||||||
Revolving credit facility
On August 7, 2019, we entered into a second amended and restated revolving credit facility agreement (the "Credit Agreement") with JPMorgan Chase Bank, N.A. ("JPMorgan"). The Credit Agreement amends and restates the revolving credit facility agreement, dated as of December 9, 2015, and amended on May 3, 2019 (collectively, the "Prior Credit Agreement") with JPMorgan. As disclosed in our Annual Report on Form 10-K for the fiscal year ended December 26, 2021, we subsequently amended the Credit Agreement during fiscal years 2020 and 2021. The Credit Agreement provides for a revolving credit facility in a maximum principal amount of $25 million.
On January 28, 2022, we entered into Amendment No. 6 (the "Sixth Amendment") to the Credit Agreement. The Sixth Amendment, among other things, (i) extended the maturity date under the Credit Agreement from January 31, 2023 to May 31, 2023, (ii) changed the benchmark interest rates under the Credit Agreement for borrowings from the London Interbank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (SOFR) subject to certain adjustments in the Sixth Amendment, (iii) increased the interest rate margin by 75 basis points with respect to any CBFR Loan (as defined in the Credit Agreement), (iv) sets the interest rate margin at 600 basis points with respect to any Term Benchmark Loan (as defined in the Credit Agreement), (v) amended certain financial covenant testing levels, and (vi) amended the definition of subsidiary to exclude the Potbelly Employee Relief Fund NFP, an Illinois not-for-profit corporation.
On May 31, 2022, we entered into Amendment No. 7 (the "Seventh Amendment") to the Credit Agreement. The Seventh Amendment, among other things (i) extended the maturity date under the Credit Agreement from May 31, 2023 to August 31, 2023 and (ii) amended certain financial covenant testing levels.
On September 23, 2022, we entered into Amendment No. 8 (the "Eighth Amendment") to the Credit Agreement. The Eighth Amendment, among other things (i) extended the maturity date under the Credit Agreement from August 31, 2023 to December 31, 2023 and (ii) amended certain financial covenant testing levels.
As of September 25, 2022, we had $10.1 million outstanding under the Credit Agreement. As of December 26, 2021, we had $9.9 million outstanding under the Credit Agreement. We are currently in compliance with all financial debt covenants.
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Paycheck Protection Program Loan
On August 10, 2020, PSW, an indirect subsidiary of the Company, entered into a loan agreement with Harvest Small Business Finance, LLC in the aggregate amount of $10.0 million (the "Loan"), pursuant to the PPP under the CARES Act. The Loan was necessary to support our ongoing operations due to the economic uncertainty resulting from the COVID-19 pandemic and lack of access to alternative sources of liquidity.
The Loan was scheduled to mature five years from the date on which PSW applies for loan forgiveness under the CARES Act, bears interest at a rate of 1% per annum and is subject to the terms and conditions applicable to loans administered by the U.S. Small Business Administration ("SBA") under the CARES Act. The PPP provides that the use of the Loan amount shall be limited to certain qualifying expenses and may be partially or wholly forgiven in accordance with the requirements set forth in the CARES Act. We used all of the PPP proceeds toward qualifying expenses and pursued forgiveness of the full Loan amount.
On July 12, 2022, we received notification from Harvest Small Business Finance, LLC that the SBA approved our loan forgiveness application for the entire outstanding principal and accrued interest under the Loan equaling $10.2 million, which we recognized as a gain on extinguishment of debt during the third fiscal quarter in our condensed consolidated statement of operations.
(8) Restructuring
On November 3, 2020, as part of our COVID-related cost reduction efforts and to better align our general and administrative expenses with future strategy, we made the determination to reorganize and restructure our corporate team. The restructuring plan implemented resulted in general and administrative expense savings in 2021 and 2022. This was accomplished through corporate expense optimization, consolidating our shop support services, and through other expense and staff reductions. As a result, we reduced corporate employment levels by approximately 35 employees in the fourth quarter of 2020. We substantially completed our planned restructuring actions during 2020, but we will continue to evaluate our cost structure and seek opportunities for further efficiencies and cost savings as part of our ongoing strategy.
During the first quarter of 2022, we fully paid our remaining obligations as a result of the restructuring plan implemented in the fourth quarter of 2020.
| Total | |||||
| (Thousands) | |||||
Balance as of December 26, 2021 | $ | 122 | |||
| Charges incurred | — | ||||
| Payments made | (122) | ||||
Balance at September 25, 2022 | $ | — | |||
(9) Capital Stock
On May 8, 2018, we announced that our Board of Directors authorized a stock repurchase program for up to $65.0 million of our outstanding common stock. The program permits us, 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 quarter and year to date ended September 25, 2022, we did not repurchase any shares of our common stock under the stock repurchase program. We do not have plans to repurchase any common stock under our stock repurchase program at this time.
On February 9, 2021, we closed on a Securities Purchase Agreement (the "SPA") for the sale by us of 3,249,668 shares of our common stock at a par value of $0.01 per share and the issuance of warrants to purchase 1,299,861 shares of common stock at an exercise price of $5.45 per warrant for gross proceeds of $16.0 million, before deducting placement agent fees and offering expenses of approximately $1.0 million. The warrants are initially exercisable commencing August 13, 2021 through their expiration date of August 12, 2026. The proceeds received from the SPA were allocated between
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shares and warrants based on their relative fair values at closing. The warrants were valued utilizing the Black-Scholes method.
On November 3, 2021, we entered into a certain Equity Sales Agreement (the "Sales Agreement") with William Blair & Company, L.L.C., as agent ("William Blair") pursuant to which we may sell shares of our common stock having an aggregate offering price of up to $40.0 million (the "Shares"), from time to time, in our sole discretion, through an "at the market" equity offering program under which William Blair will act as sales agent. As of September 25, 2022, we have not sold any shares under the Sales Agreement.
(10) Stock-Based Compensation
Stock options
We have awarded stock options to certain employees including the senior leadership team. The number of options and exercise price of each option is determined by an independent committee designated by our Board of Directors. The options granted are generally exercisable over a 10-year period from the date of the grant. Outstanding options expire on various dates through the year 2028. The range of exercise prices for the outstanding options as of September 25, 2022 is $9.47 and $20.53 per option, and the options generally vest in one-fourth and one-fifth increments over and five-year periods, respectively.
A summary of stock option activity is as follows:
| Options | Shares (Thousands) | Weighted Average Exercise Price | Aggregate Intrinsic Value (Thousands) | Weighted Average Remaining Term (Years) | ||||||||||||||||||||||
Outstanding—December 26, 2021 | 538 | $ | 12.03 | $ | — | 2.35 | ||||||||||||||||||||
| Granted | — | — | ||||||||||||||||||||||||
| Exercised | — | — | ||||||||||||||||||||||||
| Canceled | (43) | 9.14 | ||||||||||||||||||||||||
Outstanding—September 25, 2022 | 495 | 12.28 | $ | — | 1.71 | |||||||||||||||||||||
Exercisable—September 25, 2022 | 495 | $ | 12.28 | $ | — | 1.71 | ||||||||||||||||||||
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. We did not recognize stock-based compensation expense related to stock options for the quarter ended September 25, 2022. For the year to date ended September 25, 2022, we recognized stock-based compensation expense related to stock options of less than $0.1 million. For the quarter and year to date ended September 26, 2021, we recognized stock-based compensation expense related to stock options of less than $0.1 million. As of September 25, 2022, we do not have unrecognized stock-based compensation expense related to stock options. We record stock-based compensation expense within general and administrative expenses in the condensed consolidated statements of operations.
Restricted stock units
We award restricted stock units ("RSUs") to certain employees and certain non-employee members of our Board of Directors. Prior to 2021, the Board of Director grants had a vesting schedule of 50% on the first anniversary of the grant date and 50% on the second anniversary of the grant date. Beginning with the annual grant made in the second quarter of 2021, the Board of Director grants fully vest on the first anniversary of the grant date, or upon termination from the Board of Directors for any reason other than for cause, a pro rata portion of the shares vest on the termination date. The employee grants vest in one-third increments over a three-year period.
A summary of RSU activity is as follows:
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| RSUs | Number of RSUs (Thousands) | Weighted Average Fair Value per Share | ||||||||||||
Non-vested as of December 26, 2021 | 1,151 | $ | 4.87 | |||||||||||
| Granted | 497 | 6.11 | ||||||||||||
| Vested | (664) | 5.80 | ||||||||||||
| Canceled | — | — | ||||||||||||
Non-vested as of September 25, 2022 | 984 | $ | 4.29 | |||||||||||
For the quarter and year to date ended September 25, 2022, we recognized stock-based compensation expense related to RSUs of $0.8 million and $2.1 million, respectively. For the quarter and year to date ended September 26, 2021, we recognized stock-based compensation expense related to RSUs of $0.6 million and $1.0 million, respectively. As of September 25, 2022, unrecognized stock-based compensation expense for RSUs was $5.0 million, which will be recognized through fiscal year 2024.
Performance stock units
We award performance share units ("PSUs") to certain of our employees. The PSUs have certain vesting conditions based upon our stock price and relative stock performance.
Because these PSUs are subject to service and market vesting conditions, we determine the fair market value of each grant using a Monte Carlo simulation model. Participants are entitled to receive a specified number of shares of our common stock contingent on achievement of a stock return on our common stock. For the quarter and year to date ended September 25, 2022, we recognized stock-based compensation expense for PSUs with market vesting conditions of $0.2 million and $0.4 million, respectively.
A summary of activity for PSUs with market vesting conditions for the year to date ended September 25, 2022 is as follows:
| PSUs | Number of PSUs (Thousands) | Weighted Average Fair Value per Share | ||||||||||||
Non-vested as of December 26, 2021 | 130 | 8.43 | ||||||||||||
| Granted | 145 | 10.15 | ||||||||||||
| Vested | — | — | ||||||||||||
| Canceled | — | — | ||||||||||||
Non-vested as of September 25, 2022 | 275 | 9.34 | ||||||||||||
(11) Commitments and Contingencies
We are 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. We accrue for such liabilities when it is probable that future costs will be incurred and such costs can be reasonably estimated. Such accruals are based on developments to date, our estimates of the outcomes of these matters and its experience in contesting, litigating and settling other similar matters. In the opinion of management, the amount of ultimate liability with respect to those actions should not have a material adverse impact on our financial position or results of operations and cash flows.
Many of the food products we purchase are subject to changes in the price and availability of food commodities, including, among other things, beef, poultry, grains, dairy and produce. We work with our suppliers and use a mix of forward pricing protocols for certain items including agreements with our supplier on fixed prices for deliveries at a time in the future and agreements on a fixed price with our suppliers for the duration of those protocols. We also utilize formula pricing protocols under which the prices we pay are based on a specified formula related to the prices of the goods, such as spot prices. Our use of any forward pricing arrangements varies substantially from time to time and these arrangements tend to cover relatively short periods (i.e., typically twelve months or less). Such contracts are used in the normal purchases of our food products and not for speculative purposes, and as such are not required to be evaluated as derivative instruments.
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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 26, 2021. 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, our ability to grow our brand in new and existing markets, and the implementation and results of strategic initiatives, including our "Traffic-Driven Profitability" 5-pillar strategic plan. 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, the potential future impact of COVID-19 on our business and results of operations; compliance with covenants in our credit facility; competition; general economic conditions including any impact from inflation; our ability to successfully implement our business strategy; the success of our initiatives to increase sales and traffic, including the success of our franchising initiatives; changes in commodity, energy, labor and other costs; our ability to attract and retain management and employees and adequately staff our restaurants; 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 26, 2021, 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.
Business
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 owns and operates Potbelly Sandwich Shop concepts in the United States. We also have domestic franchise operations of Potbelly Sandwich Shop concepts. Potbelly’s chief operating decision maker is our Chief Executive Officer. Based on how our Chief Executive Officer reviews financial performance and allocates resources on a recurring basis, we have one operating segment and one reportable segment.
We strive to be proactive and deliberate in our efforts to drive profitable growth in our existing business. Our "Traffic-Driven Profitability" 5-pillar strategic plan includes a prioritized set of low-cost strategic investments that we believe will deliver strong returns. The 5 pillars are:
•Craveable Quality Food at a Great Value
•People Creating Good Vibes
•Customer Experiences that Drive Traffic Growth
•Digitally Driven Awareness, Connection and Traffic
•Franchise Focused Development
Our shop model is designed to generate, and has generated, strong cash flow, attractive shop-level financial results and high returns on investment. We operate our shops successfully in a wide range of geographic markets, population densities and real estate settings. We aim to generate average shop-level profit margins, a non-GAAP measure, that range from the mid to high teens. Our ability to achieve such margins and returns depends on a number of factors. For example, we face increasing labor and commodity costs, which we have partially offset by increasing menu prices. Although there is
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no guarantee that we will be able to maintain these returns, we believe our attractive shop economics support our ability to profitably grow our brand in new and existing markets.
We are actively executing against our Franchise Growth Acceleration Initiative which includes the goal of refranchising approximately 25% of our company units over the next three years and executing area development agreements with franchisees to develop additional Potbelly shops in specific markets.
The table below sets forth a rollforward of company-operated and franchise operated activities:
| Company- Operated | Franchise- Operated | Total Company | |||||||||||||||
| Shops as of December 27, 2020 | 400 | 46 | 446 | ||||||||||||||
| Shops opened | — | 3 | 3 | ||||||||||||||
| Shops closed | (3) | (3) | (6) | ||||||||||||||
| Shops as of September 26, 2021 | 397 | 46 | 443 | ||||||||||||||
| Shops as of December 26, 2021 | 397 | 46 | 443 | ||||||||||||||
| Shops opened | — | 1 | 1 | ||||||||||||||
| Shops closed | (9) | (1) | (10) | ||||||||||||||
| Shops as of September 27, 2022 | 388 | 46 | 434 | ||||||||||||||
Impact of COVID-19 on Our Business
On January 30, 2020, the WHO announced a global health emergency because of COVID-19 and the risks to the international community as the virus spreads globally. On March 11, 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally. The COVID-19 pandemic significantly impacted economic conditions in the United States where all our shops are located during portions of 2020 and 2021. The availability of COVID-19 vaccines and lifting of local restrictions has resulted in an improvement to our sales since the beginning of the pandemic. We have returned nearly all of our shops to our pre-pandemic operating hours. To the extent there is a resurgence of COVID-19 cases, we will follow guidance from local authorities in determining the appropriate restrictions to put in place for each shop, including mask mandates, hours of operation, and the suspension or reduction of in-shop dining, which could result in lower in-shop dining revenue or higher operating costs.
The situation surrounding the COVID-19 pandemic continues to change and we cannot determine the extent of the pandemic on our operations and financial results. We have and could continue to experience macroeconomic impacts arising from the COVID-19 pandemic, including but not limited to, commodity inflation, disruption in our supply chain, and labor availability challenges at certain shops. We have increased, and plan to continue to increase, menu prices as necessary in order to offset additional costs as a result of a higher inflationary economic environment in the U.S. These price increases may not be sufficient to mitigate additional unexpected higher costs and further increases may negatively impact consumer behavior and purchases. We will continue to actively monitor the evolving situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, franchisees, stakeholders and communities.
Key Performance Indicators
In assessing the performance of our business, we consider a variety of performance and financial measures. The key measures for determining how the business is performing are comparable store sales, number of company-operated shop openings, shop-level profit margins, and adjusted EBITDA.
Company-Operated Comparable Store Sales
Comparable store sales reflect the change in year-over-year sales for the comparable company-operated store base. We define the comparable store base to include those shops open for 15 months or longer. As of the quarters ended September 25, 2022 and September 26, 2021, there were 382 and 365 shops, respectively, in our comparable company-operated store base. Comparable store sales growth can be generated by an increase in number of transactions and/or by increases in the average check amount resulting from a shift in menu mix and/or increase in price. This measure highlights
18
performance of existing shops as the impact of new shop openings is excluded. For purposes of the comparable store sales calculation, a transaction is defined as an entrée, which includes sandwiches, salads and bowls of soup or mac and cheese.
Number of Company-Operated Shop Openings
The number of company-operated shop openings reflects the number of shops opened during a particular reporting period. Before we open new shops, we incur pre-opening costs. Often, new shops open with an initial start-up period of higher than normal sales volumes, which subsequently decrease to stabilized levels. While sales volumes are generally higher during the initial opening period, new shops typically experience normal inefficiencies in the form of higher cost of sales, labor and other direct operating expenses and as a result, shop-level profit margins are generally lower during the start-up period of operation. The average start-up period is 10 to 13 weeks. The number and timing of shop openings has had, and is expected to continue to have, an impact on our results of operations.
Shop-Level Profit (Loss) Margin
Shop-level profit (loss) margin is defined as net company-operated sandwich shop sales less company-operated sandwich shop operating expenses, excluding depreciation, which consists of food, beverage and packaging costs, labor and related expenses, occupancy expenses, and other operating expenses, as a percentage of net company-operated sandwich shop sales. Other operating expenses include all other shop-level operating costs, excluding depreciation, the major components of which are credit card fees, fees to third-party marketplace partners, marketing and advertising, shop technology and software, supply chain costs, operating supplies, utilities, and repair and maintenance costs. Shop-level profit (loss) margin is not required by, or presented in accordance with U.S. GAAP. Potbelly believes shop-level profit (loss) margin is important in evaluating shop-level productivity, efficiency and performance.
Adjusted EBITDA
Potbelly defines adjusted EBITDA as net income before depreciation and amortization, interest expense and provision for income taxes, adjusted for the impact of the following items that we do not consider representative of ongoing operating performance: stock-based compensation expense, impairment and shop closure expenses, and gain or loss on disposal of property and equipment as well as other one-time, non-recurring charges, such as CEO transition costs. Adjusted EBITDA is not required by, or presented in accordance with U.S. GAAP. Potbelly believes that adjusted EBITDA is a useful measure of operating performance, as it provides a picture of operating results by eliminating expenses that management does not believe are reflective of underlying business performance.
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Quarter Ended September 25, 2022 Compared to Quarter Ended September 26, 2021
The following table presents information comparing the components of net loss for the periods indicated (dollars in thousands):
| For the Quarter Ended | Increase (Decrease) | Percent Change | |||||||||||||||||||||||||||||||||||||||||||||
| September 25, 2022 | % of Revenues | September 26, 2021 | % of Revenues | ||||||||||||||||||||||||||||||||||||||||||||
| Revenues | |||||||||||||||||||||||||||||||||||||||||||||||
| Sandwich shop sales, net | $ | 116,449 | 99.0 | % | $ | 100,996 | 99.3 | % | $ | 15,453 | 15.3 | % | |||||||||||||||||||||||||||||||||||
| Franchise royalties and fees | 1,200 | 1.0 | 698 | 0.7 | 502 | 71.9 | |||||||||||||||||||||||||||||||||||||||||
| Total revenues | 117,649 | 100.0 | 101,694 | 100.0 | 15,955 | 15.7 | |||||||||||||||||||||||||||||||||||||||||
| Expenses | |||||||||||||||||||||||||||||||||||||||||||||||
| (Percentages stated as a percent of sandwich shop sales, net) | |||||||||||||||||||||||||||||||||||||||||||||||
| Sandwich shop operating expenses, excluding depreciation | |||||||||||||||||||||||||||||||||||||||||||||||
| Food, beverage and packaging costs | 34,814 | 29.9 | 28,225 | 27.9 | 6,589 | 23.3 | |||||||||||||||||||||||||||||||||||||||||
| Labor and related expenses | 36,031 | 30.9 | 33,087 | 32.8 | 2,944 | 8.9 | |||||||||||||||||||||||||||||||||||||||||
| Occupancy expenses | 13,559 | 11.6 | 13,437 | 13.3 | 122 | 0.9 | |||||||||||||||||||||||||||||||||||||||||
| Other operating expenses | 19,743 | 17.0 | 17,466 | 17.3 | 2,277 | 13.0 | |||||||||||||||||||||||||||||||||||||||||
| (Percentages stated as a percent of total revenues) | |||||||||||||||||||||||||||||||||||||||||||||||
| Franchise marketing expenses | 115 | NM | 94 | NM | 21 | 22.3 | |||||||||||||||||||||||||||||||||||||||||
| General and administrative expenses | 9,554 | 8.1 | 7,260 | 7.1 | 2,294 | 31.6 | |||||||||||||||||||||||||||||||||||||||||
| Depreciation expense | 2,922 | 2.5 | 3,610 | 3.5 | (688) | (19.1) | |||||||||||||||||||||||||||||||||||||||||
| Impairment, loss on disposal of property and equipment and shop closures | 1,616 | 1.4 | 1,118 | 1.1 | 498 | 44.5 | |||||||||||||||||||||||||||||||||||||||||
| Total expenses | 118,354 | 100.6 | 104,297 | 102.6 | 14,057 | 13.5 | |||||||||||||||||||||||||||||||||||||||||
| Loss from operations | (705) | (0.6) | (2,603) | (2.6) | 1,898 | NM | |||||||||||||||||||||||||||||||||||||||||
| Interest expense, net | 354 | 0.3 | 241 | 0.2 | 113 | 46.9 | |||||||||||||||||||||||||||||||||||||||||
| Gain on extinguishment of debt | (10,191) | (8.7) | — | NM | (10,191) | NM | |||||||||||||||||||||||||||||||||||||||||
| Income (loss) before income taxes | 9,132 | 7.8 | (2,844) | (2.8) | 11,976 | NM | |||||||||||||||||||||||||||||||||||||||||
| Income tax expense (benefit) | (4) | NM | 16 | NM | (20) | NM | |||||||||||||||||||||||||||||||||||||||||
| Net income (loss) | 9,136 | 7.8 | (2,860) | (2.8) | 11,996 | NM | |||||||||||||||||||||||||||||||||||||||||
| Net income attributable to non-controlling interest | 107 | NM | 88 | NM | 19 | 21.6 | |||||||||||||||||||||||||||||||||||||||||
| Net income (loss) attributable to Potbelly Corporation | $ | 9,029 | 7.7 | % | $ | (2,948) | (2.9) | % | $ | 11,977 | NM | % | |||||||||||||||||||||||||||||||||||
| For the Quarter Ended | |||||||||||||||||||||||||||||||||||||||||||||||
| Other Key Performance Indicators | September 25, 2022 | September 26, 2021 | Increase (Decrease) | ||||||||||||||||||||||||||||||||||||||||||||
| Comparable store sales | 15.0 | % | 33.7 | % | (18.7) | % | |||||||||||||||||||||||||||||||||||||||||
Shop-level profit margin(1) | 10.6 | % | 8.7 | % | 1.9 | % | |||||||||||||||||||||||||||||||||||||||||
Adjusted EBITDA(1) | $ | 4,677 | $ | 2,677 | $ | 2,000 | |||||||||||||||||||||||||||||||||||||||||
(1) - Reconciliation below for Non-GAAP measures
"NM" - Amount is not meaningful
20
Revenues
Total revenues increased by $16.0 million, or 15.7%, to $117.6 million during the quarter ended September 25, 2022, from $101.7 million during the quarter ended September 26, 2021. This increase was primarily driven by the sustained recovery of our shops in central business district and airport locations, improved performance of our catering channel, successful marketing programs, and increased prices to offset cost inflation. Company-operated comparable store sales resulted in an increase in revenue of $15.2 million, or 15.0%. The increase in revenue also included sales from shops that were temporarily closed in 2021. Additionally, revenue increased due to reductions in sales and promotional discounts during the quarter ended September 25, 2022 in comparison to the quarter ended September 26, 2021. These increases were partially offset by a decrease in sales from shops that have permanently closed during the third quarter of 2022. Additionally, revenue from franchise royalties and fees increased by $0.5 million, or 71.9%.
Food, beverage, and packaging costs
Food, beverage, and packaging costs increased by $6.6 million, or 23.3%, to $34.8 million during the quarter ended September 25, 2022, from $28.2 million during the quarter ended September 26, 2021. This increase was primarily driven by an increase in shop sales volume and increased costs of our food and paper supplies, specifically proteins and bread. As a percentage of sandwich shop sales, food, beverage, and packaging costs increased to 29.9% during the quarter ended September 25, 2022, from 27.9% during the quarter ended September 26, 2021, primarily driven by increased costs as noted above partially offset by increased menu prices.
Labor and Related Expenses
Labor and related expenses increased by $2.9 million, or 8.9%, to $36.0 million during the quarter ended September 25, 2022, from $33.1 million for the quarter ended September 26, 2021, primarily driven by an increase in shop sales volumes and higher shop labor wage rates as a result of labor availability challenges in certain restaurants. As a percentage of sandwich shop sales, labor and related expenses decreased to 30.9% during the quarter ended September 25, 2022, from 32.8% for the quarter ended September 26, 2021, primarily driven by sales leverage in certain labor related costs not directly variable with sales.
Occupancy Expenses
Occupancy expenses increased by $0.1 million, or 0.9%, to $13.6 million during the quarter ended September 25, 2022, from $13.4 million during the quarter ended September 26, 2021, primarily due to an increase in variable lease expenses. As a percentage of sandwich shop sales, occupancy expenses decreased to 11.6% for the quarter ended September 25, 2022, from 13.3% for the quarter ended September 26, 2021, primarily due to increased sales leverage in certain occupancy related costs which are not variable with sales, as well as the impact of lease concessions and restructurings over the last year.
Other Operating Expenses
Other operating expenses increased by $2.3 million, or 13.0%, to $19.7 million during the quarter ended September 25, 2022, from $17.5 million during the quarter ended September 26, 2021. The increase was primarily related to an increase in marketing and advertising spend, utilities and certain items variable with sales, including fees to third-party delivery partners and credit card fees. Marketing and advertising expenses included in other operating expenses were $1.7 million and $1.2 million as of the quarter ended September 25, 2022 and the quarter ended September 26, 2021, respectively. As a percentage of sandwich shop sales, other operating expenses decreased to 17.0% for the quarter ended September 25, 2022, from 17.3% for the quarter ended September 26, 2021, primarily driven by sales leverage in operating expense items that are not directly variable with sales.
Franchise marketing expenses
Franchise marketing expenses increased by $21 thousand to $115 thousand during the quarter ended September 25, 2022 compared to $94 thousand during the quarter ended September 26, 2021, driven by increased marketing and advertising expenses allocated from the Brand Fund to franchised shops.
General and Administrative Expenses
General and administrative expenses increased by $2.3 million, or 31.6%, to $9.6 million during the quarter ended September 25, 2022, from $7.3 million during the quarter ended September 26, 2021. This increase was primarily driven by an increase in payroll costs and bonus accrual expense. As a percentage of revenues, general and administrative
21
expenses increased to 8.1% for the quarter ended September 25, 2022, from 7.1% for the quarter ended September 26, 2021, primarily driven by an increase in certain costs not directly variable with sales.
Depreciation Expense
Depreciation expense decreased by $0.7 million, or 19.1%, to $2.9 million during quarter ended September 25, 2022, from $3.6 million during the quarter ended September 26, 2021. The decrease was driven primarily by a lower depreciable base related to a decrease in the number of company-operated shops and impairment charges taken in prior periods. As a percentage of revenues, depreciation was 2.5% during the quarter ended September 25, 2022 and was 3.5% for the quarter ended September 26, 2021.
Impairment, Loss on Disposal of Property and Equipment and Shop Closures
Impairment, loss on disposal of property and equipment and shop closures decreased by $0.5 million, or 44.5%, to $1.6 million during the quarter ended September 25, 2022, from $1.1 million during the quarter ended September 26, 2021.
After performing a periodic review of our shops during the quarter ended September 25, 2022, it was determined that indicators of impairment were present for certain shops as a result of continued underperformance, primarily related to the impacts of COVID-19. We performed an impairment analysis related to these shops and recorded an impairment charge of $1.0 million for the quarter ended September 25, 2022. The ultimate severity and longevity of the COVID-19 pandemic is unknown, and therefore, it is possible that impairments could be identified in future periods, and such amounts could be material.
During the quarter ended September 25, 2022, we did not incur any lease termination fees.
Interest Expense, Net
Net interest expense was $354 thousand during the quarter ended September 25, 2022 compared to $241 thousand during the quarter ended September 26, 2021, as a result of higher interest rates on our revolving credit facility agreement.
Income Tax Expense
We recognized an income tax benefit of $4 thousand for the quarter ended September 25, 2022. We recognized income tax expense of $16 thousand for the quarter ended September 26, 2021.
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Year to Date Ended September 25, 2022 Compared to Year to Date Ended September 26, 2021
The following table presents information comparing the components of net loss for the periods indicated (dollars in thousands):
| For the Year to Date Ended | Increase (Decrease) | Percent Change | |||||||||||||||||||||||||||||||||||||||||||||
| September 25, 2022 | % of Revenues | September 26, 2021 | % of Revenues | ||||||||||||||||||||||||||||||||||||||||||||
| Revenues | |||||||||||||||||||||||||||||||||||||||||||||||
| Sandwich shop sales, net | $ | 328,873 | 99.1 | % | % | $ | 275,274 | 99.3 | % | $ | 53,599 | 19.5 | % | ||||||||||||||||||||||||||||||||||
| Franchise royalties and fees | $ | 2,950 | 0.9 | $ | 1,974 | 0.7 | 976 | 49.4 | |||||||||||||||||||||||||||||||||||||||
| Total revenues | 331,823 | 100.0 | $ | 277,248 | 100.0 | 54,575 | 19.7 | ||||||||||||||||||||||||||||||||||||||||
| Expenses | |||||||||||||||||||||||||||||||||||||||||||||||
| (Percentages stated as a percent of sandwich shop sales, net) | |||||||||||||||||||||||||||||||||||||||||||||||
| Sandwich shop operating expenses, excluding depreciation | |||||||||||||||||||||||||||||||||||||||||||||||
| Food, beverage and packaging costs | 94,952 | 28.9 | 76,035 | 27.6 | 18,917 | 24.9 | |||||||||||||||||||||||||||||||||||||||||
| Labor and related expenses | 105,405 | 32.1 | 93,662 | 34.0 | 11,743 | 12.5 | |||||||||||||||||||||||||||||||||||||||||
| Occupancy expenses | 41,209 | 12.5 | 40,598 | 14.7 | 611 | 1.5 | |||||||||||||||||||||||||||||||||||||||||
| Other operating expenses | 56,977 | 17.3 | 47,039 | 17.1 | 9,938 | 21.1 | |||||||||||||||||||||||||||||||||||||||||
| (Percentages stated as a percent of total revenues) | |||||||||||||||||||||||||||||||||||||||||||||||
| Franchise marketing expenses | 361 | 0.1 | 213 | NM | 148 | 69.5 | |||||||||||||||||||||||||||||||||||||||||
| General and administrative expenses | 26,899 | 8.1 | 23,106 | 8.3 | 3,793 | 16.4 | |||||||||||||||||||||||||||||||||||||||||
| Depreciation expense | 9,089 | 2.7 | 12,337 | 4.4 | (3,248) | (26.3) | |||||||||||||||||||||||||||||||||||||||||
| Impairment, loss on disposal of property and equipment and shop closures | 3,980 | 1.2 | 4,497 | 1.6 | (517) | (11.5) | |||||||||||||||||||||||||||||||||||||||||
| Total expenses | 338,872 | 102.1 | 297,487 | 107.3 | 41,385 | 13.9 | |||||||||||||||||||||||||||||||||||||||||
| Loss from operations | (7,049) | (2.1) | (20,239) | (7.3) | 13,190 | NM | |||||||||||||||||||||||||||||||||||||||||
| Interest expense, net | 1,037 | 0.3 | 713 | 0.3 | 324 | 45.4 | |||||||||||||||||||||||||||||||||||||||||
| Gain on extinguishment of debt | (10,191) | (3.1) | — | NM | (10,191) | NM | |||||||||||||||||||||||||||||||||||||||||
| Income (loss) before income taxes | 2,105 | 0.6 | (20,952) | (7.6) | 23,057 | NM | |||||||||||||||||||||||||||||||||||||||||
| Income tax expense (benefit) | 148 | NM | 230 | NM | (82) | (35.7) | |||||||||||||||||||||||||||||||||||||||||
| Net income (loss) | 1,957 | 0.6 | (21,182) | (7.6) | 23,139 | NM | |||||||||||||||||||||||||||||||||||||||||
| Net income attributable to non-controlling interest | 267 | NM | 119 | NM | 148 | 124.4 | |||||||||||||||||||||||||||||||||||||||||
| Net income (loss) attributable to Potbelly Corporation | $ | 1,690 | 0.5 | % | $ | (21,301) | (7.7) | % | $ | 22,991 | NM | % | |||||||||||||||||||||||||||||||||||
| For the Year to Date Ended | |||||||||||||||||||||||||||||||||||||||||||||||
| Other Key Performance Indicators | September 25, 2022 | September 26, 2021 | Increase (Decrease) | ||||||||||||||||||||||||||||||||||||||||||||
| Comparable store sales | 18.5 | % | 29.1 | % | (10.6) | % | |||||||||||||||||||||||||||||||||||||||||
Shop-level profit margin(1) | 9.2 | % | 6.5 | % | 2.7 | % | |||||||||||||||||||||||||||||||||||||||||
Adjusted EBITDA(1) | $ | 8,199 | $ | (2,036) | $ | 10,235 | |||||||||||||||||||||||||||||||||||||||||
_____________________________________
(1) - Reconciliation below for Non-GAAP measures
"NM" - Amount is not meaningful
23
Revenues
Total revenues increased by $54.6 million, or 19.7%, to $331.8 million during the year to date ended September 25, 2022, from $277.2 million during the year to date ended September 26, 2021. This increase was primarily driven by the sustained recovery of our shops in central business district and airport locations, improved performance of our catering channel, successful marketing programs, and increased prices to offset cost inflation. Company-operated comparable store sales resulted in an increase of $50.7 million, or 18.5% for the year to date ended September 25, 2022. The increase in revenue also included sales from shops that were temporarily closed in 2021. These increases were partially offset by a decrease in sales from shops that have permanently closed during the last year. Additionally, revenue from franchise royalties and fees increased by $1.0 million, or 49.4%.
Food, beverage, and packaging costs
Food, beverage, and packaging costs increased by $18.9 million, or 24.9%, to $95.0 million during the year to date ended September 25, 2022, from $76.0 million during the year to date ended September 26, 2021. This increase was primarily driven by an increase in shop sales volume and increased costs of our food and paper supplies, partially due to commodity inflation. As a percentage of sandwich shop sales, food, beverage, and packaging costs increased to 28.9% during the year to date ended September 25, 2022, from 27.6% during the year to date ended September 26, 2021, primarily driven by increased costs as noted above partially offset by increased menu prices.
Labor and Related Expenses
Labor and related expenses increased by $11.7 million, or 12.5%, to $105.4 million during the year to date ended September 25, 2022, from $93.7 million for the year to date ended September 26, 2021, primarily driven by an increase in shop sales volumes and higher shop labor wage rates as a result of labor availability challenges in certain restaurants. As a percentage of sandwich shop sales, labor and related expenses decreased to 32.1% during the year to date ended September 25, 2022, from 34.0% for the year to date ended September 26, 2021, primarily driven by sales leverage in certain labor related costs not directly variable with sales.
Occupancy Expenses
Occupancy expenses increased by $0.6 million, or 1.5%, to $41.2 million during the year to date ended September 25, 2022, from $40.6 million during the year to date ended September 26, 2021, primarily due to an increase in variable lease expenses. As a percentage of sandwich shop sales, occupancy expenses decreased to 12.5% for the year to date ended September 25, 2022, from 14.7% for the year to date ended September 26, 2021, primarily due to increased sales leverage in certain occupancy related costs which are not variable with sales, as well as the impact of lease concessions and restructurings over the last year.
Other Operating Expenses
Other operating expenses increased by $9.9 million, or 21.1%, to $57.0 million during the year to date ended September 25, 2022, from $47.0 million during the year to date ended September 26, 2021. The increase was primarily related to an increase in marketing and advertising spend, utilities and certain items variable with sales, including fees to third-party delivery partners and credit card fees. Marketing and advertising expenses included in other operating expenses were $5.4 million and $2.7 million as of the year to date ended September 25, 2022 and the year to date ended September 26, 2021, respectively. As a percentage of sandwich shop sales, other operating expenses increased to 17.3% for the year to date ended September 25, 2022, from 17.1% for the year to date ended September 26, 2021, primarily driven by increased marketing and advertising expenses as noted above, partially offset by sales leverage in operating expense items that are not directly variable with sales.
Franchise marketing expenses
Franchise marketing expenses increased by $0.1 million to $0.4 million during the year to date ended September 25, 2022 compared to $0.2 million during the year to date ended September 26, 2021, driven by increased marketing and advertising expenses allocated from the Brand Fund to franchised shops.
General and Administrative Expenses
General and administrative expenses increased by $3.8 million, or 16.4%, to $26.9 million during the year to date ended September 25, 2022, from $23.1 million during the year to date ended September 26, 2021. This increase was primarily driven by an increase in payroll costs and stock-based compensation expense. As a percentage of revenues,
24
general and administrative expenses decreased to 8.1% for the year to date ended September 25, 2022, from 8.3% for the year to date ended September 26, 2021, primarily driven by increased sales leverage.
Depreciation Expense
Depreciation expense decreased by $3.2 million, or 26.3%, to $9.1 million during year to date ended September 25, 2022, from $12.3 million during the quarter ended June 27, 2021. The decrease was driven primarily by a lower depreciable base related to a decrease in the number of company-operated shops and impairment charges taken in prior periods. As a percentage of revenues, depreciation was 2.7% during the year to date ended September 25, 2022 and was 4.4% for the year to date ended September 26, 2021.
Impairment, Loss on Disposal of Property and Equipment and Shop Closures
Impairment, loss on disposal of property and equipment and shop closures decreased by $0.5 million, or 11.5%, to $4.0 million during the year to date ended September 25, 2022, from $4.5 million during the year to date ended September 26, 2021.
After performing a periodic review of our shops during the year to date ended September 25, 2022, it was determined that indicators of impairment were present for certain shops as a result of continued underperformance, primarily related to the impacts of COVID-19. We performed an impairment analysis related to these shops and recorded an impairment charge of $3.0 million for the year to date ended September 25, 2022. The ultimate severity and longevity of the COVID-19 pandemic is unknown, and therefore, it is possible that impairments could be identified in future periods, and such amounts could be material. During the first quarter of 2021, we amended the lease for our corporate Support Center office in Chicago to relocate to a different office space. As a result of this relocation, the leasehold improvements of the original office space were disposed, resulting in a loss on disposal of $2.5 million.
During the year to date ended September 25, 2022, we did not incur any lease termination fees.
Interest Expense, Net
Net interest expense was $1.0 million during the year to date ended September 25, 2022 compared to $0.7 million during the year to date ended September 26, 2021, as a result of higher interest rates on our revolving credit facility agreement.
Income Tax Expense
We recognized income tax expense of $0.1 million for the year to date ended September 25, 2022 compared to expense of $0.2 million for the year to date ended September 26, 2021.
25
Non-GAAP Financial Measures
Shop-Level Profit (Loss) Margin
Shop-level profit (loss) margin was 10.6% and 9.2% for the quarter and year to date ended September 25, 2022. Shop-level profit (loss) margin is not required by, or presented in accordance with U.S. GAAP. We believe shop-level profit (loss) margin is important in evaluating shop-level productivity, efficiency and performance.
| For the Quarter Ended | For the Year to Date Ended | ||||||||||||||||||||||
| September 25, 2022 | September 26, 2021 | September 25, 2022 | September 26, 2021 | ||||||||||||||||||||
| ($ in thousands) | ($ in thousands) | ||||||||||||||||||||||
| Income (loss) from operations | $ | (705) | $ | (2,603) | $ | (7,049) | $ | (20,239) | |||||||||||||||
| Less: Franchise royalties and fees | 1,200 | 698 | 2,950 | 1,974 | |||||||||||||||||||
| Franchise marketing expenses | 115 | 94 | 361 | 213 | |||||||||||||||||||
| General and administrative expenses | 9,554 | 7,260 | 26,899 | 23,106 | |||||||||||||||||||
| Depreciation expense | 2,922 | 3,610 | 9,089 | 12,337 | |||||||||||||||||||
| Impairment, loss on disposal of property and equipment and shop closures | 1,616 | 1,118 | 3,980 | 4,497 | |||||||||||||||||||
| Shop-level profit (loss) [Y] | $ | 12,302 | $ | 8,781 | $ | 30,330 | $ | 17,940 | |||||||||||||||
| Total revenues | $ | 117,649 | $ | 101,694 | $ | 331,823 | $ | 277,248 | |||||||||||||||
| Less: Franchise royalties and fees | 1,200 | 698 | 2,950 | 1,974 | |||||||||||||||||||
| Sandwich shop sales, net [X] | $ | 116,449 | $ | 100,996 | $ | 328,873 | $ | 275,274 | |||||||||||||||
| Shop-level profit (loss) margin [Y÷X] | 10.6 | % | 8.7 | % | 9.2 | % | 6.5 | % | |||||||||||||||
Adjusted EBITDA
Adjusted EBITDA was $4.7 million and $8.2 million for the quarter and year to date ended September 25, 2022. Adjusted EBITDA is not required by, or presented in accordance with U.S. GAAP. We believe that adjusted EBITDA is a useful measure of operating performance, as it provides a picture of operating results by eliminating expenses that management does not believe are reflective of underlying business performance.
| For the Quarter Ended | For the Year to Date Ended | ||||||||||||||||||||||
| September 25, 2022 | September 26, 2021 | September 25, 2022 | September 26, 2021 | ||||||||||||||||||||
| ($ in thousands) | ($ in thousands) | ||||||||||||||||||||||
| Net income (loss) attributable to Potbelly Corporation | $ | 9,029 | $ | (2,948) | $ | 1,690 | $ | (21,301) | |||||||||||||||
| Depreciation expense | 2,922 | 3,610 | 9,089 | 12,337 | |||||||||||||||||||
| Interest expense | 354 | 241 | 1,037 | 713 | |||||||||||||||||||
| Income tax expense (benefit) | (4) | 16 | 148 | 230 | |||||||||||||||||||
| EBITDA | $ | 12,301 | $ | 919 | $ | 11,964 | $ | (8,021) | |||||||||||||||
Impairment, loss on disposal of property and equipment, and shop closures (a) | 1,616 | 1,118 | 3,980 | 4,497 | |||||||||||||||||||
| Stock-based compensation | 951 | 640 | 2,446 | 1,488 | |||||||||||||||||||
| Gain on extinguishment of debt | (10,191) | — | (10,191) | — | |||||||||||||||||||
| Adjusted EBITDA | $ | 4,677 | $ | 2,677 | $ | 8,199 | $ | (2,036) | |||||||||||||||
______________________________
(a)This adjustment includes costs related to impairment of long-lived assets, loss on disposal of property and equipment and shop closure expenses.
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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 our revolving credit facility. In the short term, Potbelly’s primary requirements for liquidity and capital are existing shop capital investments, maintenance, lease obligations, working capital and general corporate needs. Potbelly’s requirement for working capital is not significant since our 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 we need to pay our suppliers for such items. Company shops do not require significant inventories or receivables.
The COVID-19 pandemic’s impact on our operations and revenues had significantly affected our ability to generate cash from operations in 2020. To preserve financial flexibility, we have utilized our revolving credit facility to fund operations.
We ended the quarter ended September 25, 2022 with a cash balance of $9.5 million and total liquidity (cash plus amounts available under our committed Revolving Credit Facility, which is further described in the section below) of $23.7 million compared to a cash balance of $14.7 million and total liquidity of $26.9 million at the end of the previous quarter. We believe that cash from our operations and borrowings under our revolving credit facility will be able to provide sufficient liquidity for at least the next twelve months (cash plus amounts available under our committed revolving credit facility, which is further described in the section below).
Cash Flows
The following table presents summary cash flow information for the periods indicated (in thousands):
| For the Year to Date Ended | |||||||||||
| September 25, 2022 | September 26, 2021 | ||||||||||
| Net cash provided by (used in): | |||||||||||
| Operating activities | $ | 1,018 | (7,138) | ||||||||
| Investing activities | (4,914) | (7,543) | |||||||||
| Financing activities | (951) | 13,391 | |||||||||
| Net increase (decrease) in cash | $ | (4,847) | $ | (1,290) | |||||||
Operating Activities
Net cash provided by operating activities increased to $1.0 million for the year to date ended September 25, 2022, from cash used in operating activities of $7.1 million for the year to date ended September 26, 2021. The $8.2 million change in operating cash was primarily driven by an increase in income from operations compared to the prior year. This was partially offset by the timing of payment for certain accrued liabilities.
Investing Activities
Net cash used in investing activities decreased to $4.9 million for the year to date ended September 25, 2022, from $7.5 million for the year to date ended September 26, 2021. The $2.6 million decrease was primarily due to a decrease in capital expenditures. Capital expenditures consist primarily of ongoing investment in our company-owned shops and investment in digital technology. No new company shop construction is currently planned.
Financing Activities
Net cash used in financing activities decreased to $1.0 million for the year to date ended September 25, 2022, from net cash provided by financing activities of $13.4 million for the year to date ended September 26, 2021. The $14.3 million change in financing cash was primarily driven by net proceeds from the SPA in 2021.
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Revolving Credit Facility
On August 7, 2019, we entered into a second amended and restated revolving credit facility agreement (the "Credit Agreement") with JPMorgan Chase Bank, N.A. ("JPMorgan"). The Credit Agreement amends and restates the revolving credit facility agreement, dated as of December 9, 2015, and amended on May 3, 2019 (collectively, the "Prior Credit Agreement") with JPMorgan. As disclosed in our Annual Report on Form 10-K for the fiscal year ended December 26, 2021, we subsequently amended the Credit Agreement during fiscal years 2020 and 2021. The Credit Agreement provides for a revolving credit facility in a maximum principal amount of $25 million.
On January 28, 2022, we entered into Amendment No. 6 (the "Sixth Amendment") to the Credit Agreement. The Sixth Amendment, among other things, (i) extended the maturity date under the Credit Agreement from January 31, 2023 to May 31, 2023, (ii) changed the benchmark interest rates under the Credit Agreement for borrowings from the London Interbank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (SOFR) subject to certain adjustments in the Sixth Amendment, (iii) increased the interest rate margin by 75 basis points with respect to any CBFR Loan (as defined in the Credit Agreement), (iv) sets the interest rate margin at 600 basis points with respect to any Term Benchmark Loan (as defined in the Credit Agreement), (v) amended certain financial covenant testing levels, and (vi) amended the definition of subsidiary to exclude the Potbelly Employee Relief Fund NFP, an Illinois not-for-profit corporation.
On May 31, 2022, we entered into Amendment No. 7 (the "Seventh Amendment") to the Credit Agreement. The Seventh Amendment, among other things (i) extended the maturity date under the Credit Agreement from May 31, 2023 to August 31, 2023 and (ii) amended certain financial covenant testing levels.
On September 23, 2022, we entered into Amendment No. 8 (the "Eighth Amendment") to the Credit Agreement. The Eighth Amendment, among other things (i) extended the maturity date under the Credit Agreement from August 31, 2023 to December 31, 2023 and (ii) amended certain financial covenant testing levels.
As of September 25, 2022, we had $10.1 million outstanding under the Credit Agreement. As of December 26, 2021, we had $9.9 million outstanding under the Credit Agreement. We are currently in compliance with all financial debt covenants.
Paycheck Protection Program Loan
On August 10, 2020, PSW, an indirect subsidiary of the Company, entered into a loan agreement with Harvest Small Business Finance, LLC in the aggregate amount of $10.0 million (the "Loan"), pursuant to the PPP under the CARES Act. The Loan was necessary to support our ongoing operations due to the economic uncertainty resulting from the COVID-19 pandemic and lack of access to alternative sources of liquidity.
The Loan was scheduled to mature five years from the date on which PSW applies for loan forgiveness under the CARES Act, bears interest at a rate of 1% per annum and is subject to the terms and conditions applicable to loans administered by the U.S. Small Business Administration ("SBA") under the CARES Act. The PPP provides that the use of the Loan amount shall be limited to certain qualifying expenses and may be partially or wholly forgiven in accordance with the requirements set forth in the CARES Act. We used all of the PPP proceeds toward qualifying expenses and pursued forgiveness of the full Loan amount.
On July 12, 2022, we received notification from Harvest Small Business Finance, LLC that the SBA approved our loan forgiveness application for the entire outstanding principal and accrued interest under the Loan equaling $10.2 million, which we recognized as a gain on extinguishment of debt during the third fiscal quarter in our condensed consolidated statement of operations.
Stock Repurchase Program
On May 8, 2018, we announced that our Board of Directors authorized a stock repurchase program for up to $65.0 million of our outstanding common stock. The program permits us, 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 quarter ended September 25, 2022, we did not repurchase any shares of our common stock under the
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stock repurchase program. We do not have plans to repurchase any common stock under our stock repurchase program at this time.
Equity Offering Program
On November 3, 2021, we entered into a certain Equity Sales Agreement (the "Sales Agreement") with William Blair & Company, L.L.C., as agent ("William Blair") pursuant to which we may sell shares of our common stock having an aggregate offering price of up to $40.0 million (the "Shares"), from time to time, in our sole discretion, through an "at the market" equity offering program under which William Blair will act as sales agent. As of September 25, 2022, we have not sold any shares under the Sales Agreement.
Critical Accounting Estimates
Our discussion and analysis of the 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. Actual results could differ from those estimates. Critical accounting estimates 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. We base our 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. We have made no significant changes in our critical accounting estimates since the last annual report. Our critical accounting estimates are identified and described in our annual consolidated financial statements and related notes.
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 26, 2021. Our exposures to market risk have not changed materially since December 26, 2021.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief 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 September 25, 2022. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of September 25, 2022, 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 Chief 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 quarter ended September 25, 2022 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information pertaining to legal proceedings is provided in Note 11 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 26, 2021. There have been no material changes to our Risk Factors as previously reported.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
The following table contains information regarding purchases of our common stock made by or on behalf of Potbelly Corporation during the year to date ended September 25, 2022 (in thousands, except per share data):
| Period | Total Number of Shares Purchased (1) | Average Price Paid per Share | 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) | ||||||||||||||||||||||
| December 26, 2021 - January 23, 2022 | 3 | $ | 5.65 | — | $ | 37,982 | ||||||||||||||||||||
| January 24, 2022 - February 20, 2022 | 3 | $ | 5.54 | — | $ | 37,982 | ||||||||||||||||||||
| February 21, 2022 - March 27, 2022 | 41 | $ | 6.11 | — | $ | 37,982 | ||||||||||||||||||||
| March 28, 2022 - April 24, 2022 | 6 | $ | 6.62 | — | $ | 37,982 | ||||||||||||||||||||
| April 25, 2022 - May 22, 2022 | 29 | $ | 6.42 | — | $ | 37,982 | ||||||||||||||||||||
| May 23, 2022 - June 26, 2022 | 18 | $ | 5.15 | — | $ | 37,982 | ||||||||||||||||||||
| June 27, 2022 - July 24, 2022 | 3 | $ | 6.35 | — | $ | 37,982 | ||||||||||||||||||||
| July 25, 2022 - August 21, 2022 | 3 | $ | 6.58 | — | $ | 37,982 | ||||||||||||||||||||
| August 22, 2022 - September 25, 2022 | 22 | $ | 5.51 | — | $ | 37,982 | ||||||||||||||||||||
| Total number of shares purchased: | 128 | — | ||||||||||||||||||||||||
(1)Represents shares of our common stock surrendered by employees to satisfy withholding obligations resulting from the vesting of equity awards.
(2)On May 8, 2018, we announced that our Board of Directors authorized a stock repurchase program for up to $65.0 million of our outstanding common stock. The program permits us, 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. Due to the COVID-19 pandemic, we do not have plans to repurchase any common stock under our stock repurchase program at this time. See Note 9 for further information regarding our stock repurchase program.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
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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 | ||||||||
| 31.1 | ||||||||
| 31.2 | ||||||||
| 32.1 | ||||||||
| 101.INS | Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because XBRL tags are embedded within the Inline XBRL document. | |||||||
| 101.SCH | Inline XBRL Taxonomy Extension Schema Document | |||||||
| 101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document | |||||||
| 101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document | |||||||
| 101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document | |||||||
| 101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document | |||||||
| 104 | Cover Page Interactive Data File (embedded within the Inline XBRL document) | |||||||
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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: November 3, 2022 | By: | /s/ Steven Cirulis | |||||||||
| Steven Cirulis | |||||||||||
| Chief Financial Officer | |||||||||||
| (Principal Financial Officer) | |||||||||||
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