PBPB 10-Q Quarter ended June 29, 2014

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended June 29, 2014

OR

For the Transition Period from to

Commission File Number: 001-36104

Potbelly Corporation

(Exact name of registrant as specified in its charter)

222 Merchandise Mart Plaza, 23rd Floor

Chicago, Illinois 60654

(Address, including Zip Code, of Principal Executive Offices)

Registrant’s telephone number, including area code: (312) 951-0600

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 ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Common stock, $0.01 Par Value – 29,477,677 shares as of August 1, 2014

Table of Contents

POTBELLY CORPORATION

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

2

Table of Contents

ITEM 1. FINANCIAL STATEMENTS.

POTBELLY CORPORATION AND SUBSIDIARIES

(amounts in thousands, except share and par value data, unaudited)

See accompanying notes to the unaudited condensed consolidated financial statements.

3

Table of Contents

POTBELLY CORPORATION AND SUBSIDIARIES

(amounts in thousands, except share and per share data, unaudited)

See accompanying notes to the unaudited condensed consolidated financial statements.

4

Table of Contents

POTBELLY CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Redeemable Convertible Preferred Stock and Equity (Deficit)

(amounts in thousands, except share data, unaudited)

See accompanying notes to the unaudited condensed consolidated financial statements.

5

Table of Contents

POTBELLY CORPORATION AND SUBSIDIARIES

(amounts in thousands, unaudited)

See accompanying notes to the unaudited condensed consolidated financial statements

6

Table of Contents

POTBELLY CORPORATION AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

(1) Organization and Other Matters

Business

Potbelly Corporation (the “Company” or “Potbelly”), through its wholly owned subsidiaries, operates Potbelly Sandwich Works sandwich shops in 22 states and the District of Columbia. As of June 29, 2014, the Company had 312 company-operated shops. During the 26 weeks ended June 29, 2014, the Company opened 16 new company-operated shops and closed no shops.

The Company also sells and administers franchises of new Potbelly Sandwich Works sandwich shops. The first domestic and international franchise locations administered by the Company opened during February 2011. As of June 29, 2014, 13 franchised shops were in operation in domestic locations and 13 franchised shops were in operation internationally.

Basis of Presentation

The unaudited condensed consolidated financial statements and notes herein should be read in conjunction with the audited consolidated financial statements of Potbelly Corporation and its subsidiaries and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 29, 2013. The unaudited condensed consolidated financial statements included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the SEC regarding interim financial reporting. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to the SEC’s rules and regulations. In the opinion of management, all adjustments, which are of a normal and recurring nature (except as otherwise noted), that are necessary to present fairly the Company’s financial position as of December 29, 2013 and June 29, 2014, its statement of operations for the 13 and 26 weeks ended June 30, 2013 and June 29, 2014 and its statement of cash flows for the 26 weeks ended June 30, 2013 and June 29, 2014 have been included. The consolidated statements of operations for the interim periods presented herein are not necessarily indicative of the results to be expected for the full year.

The Company does not have any components of other comprehensive income (loss) recorded within its consolidated financial statements, and, therefore, does not separately present a statement of comprehensive income (loss) in its consolidated financial statements.

Principles of Consolidation

The unaudited condensed consolidated financial statements include the accounts of Potbelly Corporation; its wholly owned subsidiary, Potbelly Illinois, Inc. (“PII”); PII’s wholly owned subsidiaries, Potbelly Franchising, LLC, Potbelly Sandwich Works, LLC (“LLC”) and 17 of LLC’s wholly owned subsidiaries, collectively, the “Company.” All significant intercompany balances and transactions have been eliminated in consolidation. For the Company’s consolidated joint venture, non-controlling interest represents the non-controlling partner’s share of the assets, liabilities and operations related to the joint venture investment in Potbelly Airport II Boston, LLC, related to one shop located in the Boston Logan International Airport. The Company owns a seventy-five percent interest in this consolidated joint venture.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions, primarily related to long-lived assets, income taxes, stock-based compensation and common stock equity valuations, that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Fiscal Year

The Company uses a 52/53-week fiscal year that ends on the last Sunday of the calendar year. Approximately every five or six years a 53rd week is added. Fiscal 2013 and 2014 each consist of 52 weeks. The fiscal quarters ended June 30, 2013 and June 29, 2014 each consisted of 13 weeks.

7

Table of Contents

POTBELLY CORPORATION AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

(2) Fair Value Measurements

The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and all other current liabilities approximate fair values due to the short maturities of these balances.

The Company assesses potential impairments to its long-lived assets, which includes property and equipment, whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. Shop-level assets are grouped at the individual shop-level for the purpose of the impairment assessment. Recoverability of an asset is measured by a comparison of the carrying amount of an asset to its estimated undiscounted future cash flows expected to be generated by the asset. 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 exceeds the fair value of the asset. The fair value of the shop assets was 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. 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 first fiscal quarter of 2014, it was determined that indicators of impairment were present for certain shops as a result of continued underperformance of shop profitability. We performed an impairment analysis related to these shops and recorded an impairment charge of $0.8 million related to the excess of the carrying amounts recorded on our balance sheet over the identified shops’ estimated fair values as of March 30, 2014. As of June 29, 2014, no additional indicators of impairment were noted.

(3) Earnings per share

Basic income (loss) per common share attributable to common stockholders is calculated using the weighted average number of common shares outstanding for the period. For the 13 and 26 weeks ended June 30, 2013, diluted (loss) per common share attributable to common stockholders was computed by dividing the (loss) allocated to common stockholders utilizing the two-class method by the weighted average number of fully diluted common shares outstanding. In periods with net income attributable to common stockholders, the Company’s redeemable convertible preferred stock were all considered participating securities requiring the two-class method to calculate basic and diluted earnings per share. However, in periods of a net (loss) attributable to common stockholders, the redeemable convertible preferred stock were excluded from the computation of basic earnings per share due to the fact that they are not required to fund losses and the redemption amount is not reduced as a result of losses. For the 13 and 26 weeks ended June 30, 2013, the dilutive securities did not include stock options awarded to employees that had a performance condition requiring the completion of an initial public offering of common stock, as that performance condition was not satisfied at the reporting date and the holders of these options had no rights in our undistributed earnings until that time. On October 9, 2013, the Company completed an initial public offering. Effective upon the closing of such offering, all of the shares of preferred stock and non-voting common stock converted into common stock. As a result of the conversion, for subsequent reporting periods, the Company no longer utilized the two-class method in its calculation of diluted income (loss) per common share attributable to common stockholders. For the 13 and 26 weeks ended June 29, 2014, diluted income (loss) per common share attributable to common stockholders was calculated using income available to common shareholders divided by diluted weighted-average shares of common stock outstanding during the period.

8

Table of Contents

POTBELLY CORPORATION AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

For the 13 and 26 weeks ended June 30, 2013, the Company’s potential common stock instruments such as common share options and warrants were not included in the computation of diluted (loss) per common share as the effect of including these shares in the calculation would have been anti-dilutive. For the 13 and 26 weeks ended June 29, 2014, 242,636 common share options were not included in the computation of diluted income per common share for the respective periods, as the effect of including these shares in the calculation would have been anti-dilutive.

9

Table of Contents

POTBELLY CORPORATION AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

(4) Income Taxes

The Company recognized income tax expense of $1.2 million on pre-tax income of $2.9 million, or an effective tax rate of 41.5%, for the 26 weeks ended June 29, 2014, compared to income tax expense of $1.9 million on pre-tax income of $4.7 million or an effective tax rate of 40.3%, for the 26 weeks ended June 30, 2013. The difference between the statutory rate and the effective tax rate is primarily attributable to state income taxes offset by certain federal and state tax credits. The increase in the effective tax rate primarily relates to the expiration of certain federal income tax credits for 2014 that were available in prior years.

(5) Capital Stock

On October 9, 2013, the Company completed an initial public offering. Effective upon the closing of such offering, all shares of preferred stock and non-voting common stock converted into common stock. The terms of the non-voting common stock provided that all shares of non-voting common stock would convert into voting common stock on a 1:1 basis immediately prior to the closing of an underwritten IPO or sale of the Company. The redeemable convertible preferred stock included down-round provisions which would adjust the conversion price for any additional stock issued without consideration or for a consideration per share less than the respective conversion price for one or more of the series of preferred stock in effect immediately prior to the issuance of such additional stock. Each share of common stock has the same relative rights and was identical in all respects to each other share of common stock. Each holder of shares of common stock is entitled to one vote for each share held by such holder at all meetings of stockholders.

(6) Stock-Based Compensation

During the first quarter of 2014, the Company issued 247,767 stock options under the 2013 Long-Term Incentive Plan to eligible employees and key executives. The fair value of the options was determined using the Black-Scholes option pricing model. The Company used the following assumptions for purposes of valuing these option grants: common stock fair value of $20.53 per share; expected life of options – seven years; volatility- 49.61%; risk-free interest rate – 1.13%; and dividend yield – 0.00%. The Company used the simplified method for determining the expected life of the options. Due to the lack of historical data as a newly public company, the Company calculated the specific stock price volatility using a blended volatility rate based on comparable publicly traded companies.

A summary of activity for the 26 weeks ended June 29, 2014 is as follows:

In May 2014, the Company issued 25,663 shares of unrestricted common stock to certain non-employee members of its Board of Directors. The unrestricted stock had a weighted average grant-date share price of $15.60 upon issuance. The Company recorded $0.4 million in stock-based compensation expense, with a corresponding increase to additional paid-in capital, related to the issuance of common stock.

10

Table of Contents

POTBELLY CORPORATION AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

In accordance with ASC Topic 718, Compensation—Stock Compensation , stock-based compensation is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the requisite employee service period, which is generally the vesting period of the grant, with a corresponding increase to additional paid-in-capital. For the 13 and 26 weeks ended June 29, 2014, the Company recognized $1.0 million and $1.4 million, respectively, which includes $0.4 million related to the May 2014 unrestricted common stock grants. For the 13 and 26 weeks ended June 30, 2013, the Company recognized $0.4 million and $1.1 million, respectively. As of June 29, 2014, the unrecognized stock-based compensation expense was $6.6 million, which will be recognized through fiscal year 2018. The Company records stock-based compensation expense within general and administrative expenses in the consolidated statements of operations.

(7) Subsequent Events

On August 1, 2014, the Company’s Board of Directors authorized a share repurchase program of up to $35.0 million of the Company’s common stock. With this authorization, repurchases may be made at management’s discretion from time to time on the open market.

11

Table of Contents

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 29, 2013. This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and involves numerous risks and uncertainties. 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” 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. 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 29, 2013, for a discussion of factors that could cause our actual results to differ from those expressed or implied by forward-looking statements.

Overview

Potbelly is a fast-growing neighborhood sandwich concept offering toasty warm sandwiches, signature salads and other fresh menu items served by engaging people in an environment that reflects the Potbelly brand. Our combination of product, people and place is how we deliver on our passion to be “The Best Place for Lunch.” Our sandwiches, salads and hand-dipped milkshakes are all made fresh to order and our cookies are baked fresh each day. Our employees are trained to engage with our customers in a genuine way to provide a personalized experience. Our shops feature vintage design elements and locally-themed décor inspired by the neighborhood that we believe create a lively atmosphere. Through this combination, we believe we are creating a devoted base of Potbelly fans that return again and again and that we are expanding one sandwich shop at a time.

We believe that a key to our past and future success is our culture. It is embodied in The Potbelly Advantage , which is an expression of our Vision, Mission, Passion and Values, and the foundation of everything we do. Our Vision is for our customers to feel that we are their “Neighborhood Sandwich Shop” and to tell others about their great experience. Our Mission is to make people really happy, to make more money and to improve every day. Our Passion is to be “The Best Place for Lunch.” Our Values embody both how we lead and how we behave, and form the cornerstone of our culture. We use simple language that resonates from the frontline associate to the most senior levels of the organization, creating shared expectations and accountabilities in how we approach our day-to-day activities. We strive to be a fun, friendly and hardworking group of people who enjoy taking care of our customers, while at the same time taking care of each other.

13 Weeks Ended June 29, 2014 Compared to 13 Weeks Ended June 30, 2013

The following table presents information comparing the components of net income for the periods indicated (dollars in thousands):

12

Table of Contents

Revenues

Total revenues increased by $5.4 million, or 7.0%, to $83.6 million during the 13 weeks ended June 29, 2014, from $78.2 million during the 13 weeks ended June 30, 2013. The increase in revenues primarily consisted of an increase of $6.5 million in sales from shops not yet in our company-operated comparable store sales base, $0.1 million increase in franchise revenues, partially offset by a $1.2 million, or 1.6%, decrease in company-operated comparable store sales. The decrease in company-operated comparable store sales resulted from a reduction in entrée counts, which were impacted by reduced traffic as well as a shift of the Easter holiday from the first fiscal quarter to the second fiscal quarter, partially offset by certain menu price increases and mix.

Cost of Goods Sold

Cost of goods sold increased by $1.2 million, or 5.2%, to $23.9 million during the 13 weeks ended June 29, 2014, compared to $22.8 million during the 13 weeks ended June 30, 2013, primarily due to the increase in revenues. As a percentage of revenues, cost of goods sold decreased to 28.6% during the 13 weeks ended June 29, 2014, from 29.1% during the 13 weeks ended June 30, 2013, primarily driven by lower commodity costs.

Labor and Related Expenses

Labor and related expenses increased by $2.2 million, or 10.4%, to $23.4 million during the 13 weeks ended June 29, 2014, from $21.2 million during the 13 weeks ended June 30, 2013, primarily due to new shop openings. As a percentage of revenues, labor and related expenses increased to 28.0% during the 13 weeks ended June 29, 2014, from 27.1% during the 13 weeks ended June 30, 2013, primarily driven by deleveraging of the fixed component of these expenses as a result of lower company-operated comparable store sales.

Occupancy Expenses

Occupancy expenses increased by $1.4 million, or 15.6%, to $10.2 million during the 13 weeks ended June 29, 2014, from $8.8 million during the 13 weeks ended June 30, 2013, primarily due to new shop openings. As a percentage of revenues, occupancy expenses increased to 12.2% during the 13 weeks ended June 29, 2014, from 11.3% during the 13 weeks ended June 30, 2013, due to deleveraging of the fixed component of these expenses as a result of lower company-operated comparable store sales as well as increases in other occupancy-related costs.

Other Operating Expenses

Other operating expenses increased by $0.8 million, or 10.0%, to $8.7 million during the 13 weeks ended June 29, 2014, from $7.9 million during the 13 weeks ended June 30, 2013, primarily due to new shop openings and higher neighborhood marketing expense in our shops, among other costs. As a percentage of revenues, other operating expenses increased to 10.4% during the 13 weeks ended June 29, 2014, from 10.1% during the 13 weeks ended June 30, 2013, primarily due to deleveraging of the fixed component of these expenses as a result of lower company-operated comparable store sales as well as increased marketing expenses, among other costs.

13

Table of Contents

General and Administrative Expenses

General and administrative expenses increased by $1.1 million, or 13.3%, to $8.9 million during the 13 weeks ended June 29, 2014, from $7.8 million during the 13 weeks ended June 30, 2013, driven by an increase in advertising expense of approximately $0.4 million related to the launch of the new Flats platform in late May in addition to approximately $0.8 million higher public company related expenses, which includes $0.4 million related to the May 2014 unrestricted common stock grants. As a percentage of revenues, general and administrative expenses increased to 10.6% during the 13 weeks ended June 29, 2014, from 10.0% during the 13 weeks ended June 30, 2013, driven by public company related expenses and advertising expense during the 13 weeks ended June 29, 2014 as compared to the 13 weeks ended June 30, 2013.

Depreciation Expense

Depreciation expense increased by $0.3 million, or 7.7%, to $4.8 million during the 13 weeks ended June 29, 2014, from $4.5 million during the 13 weeks ended June 30, 2013, primarily due to a higher depreciable base related to new shops. As a percentage of revenues, depreciation remained consistent at 5.7% during the 13 weeks ended June 29, 2014 and June 30, 2013.

Pre-Opening Costs

Pre-opening costs decreased by $0.1 million, or 36.4%, to $0.3 million during the 13 weeks ended June 29, 2014, from $0.4 million during the 13 weeks ended June 30, 2013, primarily due to fewer new shops opened during the 13 weeks ended June 29, 2014 compared to the 13 weeks ended June 30, 2013.

Interest Expense

Interest expense decreased by $82 thousand, or 67.2%, to $40 thousand during the 13 weeks ended June 29, 2014, from $0.1 million during the 13 weeks ended June 30, 2013, primarily due to repaying the $14.0 million outstanding under the senior credit facility on October 24, 2013. Interest expense for the thirteen weeks ended June 29, 2014 is attributable to interest on the note payable, unused commitment fees and deferred financing fees.

Income Tax Expense

Income tax expense decreased by $0.5 million, or 24.7%, to $1.4 million for the 13 weeks ended June 29, 2014, from $1.9 million during the 13 weeks ended June 30, 2013. For the 13 weeks ended June 29, 2014, our effective tax rate was 41.2%, compared to 40.3% for the 13 weeks ended June 30, 2013. The increase in the effective tax rate primarily relates to the expiration of certain federal income tax credits that were available in prior years.

26 Weeks Ended June 29, 2014 Compared to 26 Weeks Ended June 30, 2013

The following table presents information comparing the components of net income for the periods indicated (dollars in thousands):