Potbelly Corporation
Q4 2020 Earnings Call Transcript

Published: 11 Mar 2021

[Operator:]

Good afternoon everyone. And welcome to the Potbelly Corporation’s Fourth Quarter and Full Year 2020 Earnings Call. As a reminder this conference is being recorded. It is now my pleasure to turn the call over to Ms. Adiya Dixon, Potbelly's Chief Legal Officer. Ms. Dixon, please go ahead.

[Adiya Dixon:]

Good afternoon, everyone, and welcome to our fourth quarter and full year 2020 earnings call. Our presenters today are Bob Wright, our President and Chief Executive Officer; and Steve Cirulis, our Senior Vice President and Chief Financial Officer. After our prepared remarks, we'll open the call for your questions. I'll now turn the call over to Alan.

[Bob Wright:]

Thank you, Adiya. Good afternoon everyone. And thank you for joining us today. I hope you and your families have remained safe and healthy since our last update. Let's start on Slide 3 and I'll provide a quick overview of last year. 2020 tested everyone around the world and the restaurant industry was obviously significantly impacted. I joined Potbelly in the midst of the pandemic just a few months ago, and I can tell you that great teams and great people rise to the challenge in the face of adversity. And I'm extremely proud of every team member of this organization for what we have collectively accomplished last year. Together, we demonstrated that resiliency, persistence, dedication, and creativity that made Potbelly truly unique. As we begin to pivot from being reactive and protecting our brand to being proactive and more deliberate in our efforts to drive profitable growth, it's those exact attributes and teamwork that will help us thrive. Clearly our financial performance suffered in 2020, but we prioritize the things that were within our control, enabling us to respond and right-size the business throughout the crisis. This included aggressively controlling our costs, protecting our cash position and prioritizing safety for both our employees and our customers. It also involved a significant pivot in the way that we service those customers as we focused on our digitally driven off-premise options like delivery pickup, as well as drive through.

[Steve Cirulis:]

Thanks, Bob. And good afternoon, everyone. Please turn to Slide 6 of the presentation where you can see the progression of our same-store sales and average weekly sales for 2020 and year-to-date through the beginning of March, 2021. Starting with Q4, company-operated same-store sales declined by 19.7%. This was a 130-basis points improvement as compared to Q3, clearly positive momentum, despite the nationwide resurgence we saw in COVID-19, which particularly impacted the month of November results. Breaking down same-store sales, our average check fell by seven tenths of 1% on a sales per entree basis. And traffic improved quarter-over-quarter by three percentage points. We've experienced steady improvement in comparable sales since May. And December was particularly strong with solid holiday traffic. Excluding November slight step back, we saw sequential improvement over seven of the last eight months of 2020, which is a clear demonstration of the resiliency of the business and our ability to pivot to rapidly changing market conditions. In terms of volumes and average weekly sales per unit, we saw a consistency throughout the second half of 2020, despite a strong surge in COVID-19 cases in Q4. Turning into performance so far in 2021, as you can see from the chart, we saw improvement in January, the same-store sales down just 15% followed by softer-than-expected performance in February, which was down 22.4%, mainly due to severe weather impacts throughout the U.S. and in our markets in particular. The data for March so far is encouraging and shows meaningful improvement from February tracking down 10.7% through March 7. Importantly, our shop average weekly sales volume while lower in January compared to the second half trend in 2020 due to seasonality, is now accelerating. In fact, March to date volumes are trending ahead of the Q1 2020 previous high point on this chart.

[Bob Wright:]

Thanks, Steve. Please turn to Slide 12, where you'll see our brand position again. I shared this with you last quarter, and I think it's important that you understand what a great deal of work has gone into this. One of the best ways to summarize our brand position is by recounting the numerous conversations I've had with many of you, our investors. Those of you that aren't fortunate enough to live in an area with the Potbelly shop have often said to me, "Potbelly is on my list of must stops every time I visit Chicago." It's how many of you found our story as an investment, too. And that sentiment is really embodied in our brand positioning, great, craveable, high-quality food served to you in a location you enjoy going to. In other words, in a place with the good vibes of a first-class dive. We're excited about this brand position, and we believe it will resonate both with our loyal and prospective customers as we move forward. Next, on Slide 13, I'll review our traffic-driven profitability strategic focus, which has its foundation in our brand position. Our strategy quite simply is to bring to life the very best attributes of the Potbelly brand represented by our five pillars with a unifying objective of traffic-driven profitability. We shared this with you last quarter as well and implementation has already begun for most of the initiatives with acceleration over the course of the year. There are five core pillars to our strategy, as you can see on the slide. But what I'd like to share with you today are how some of the more detailed initiatives that we're executing are coming to life under each pillar. So please turn to Slide 14. Before I get into the details, I'd like to note that while there are investments associated with many of these initiatives, we built our plan with a focus on lower-cost and higher-profit impact ideas this year. For competitive reasons, we won't be able to go into a lot of detail on the locations and/or the timing of the various testing, but we expect to leverage nearly all of these initiatives in the second half of 2021. Our first pillar is cravable quality food at a great value. We have great food, but to be successful in this highly competitive environment we're in, innovation and adaptability to consumer trends and feedback will remain critical. One of the first things we're doing here is continuing to simplify our menu. Through this work, we will continue to enhance our brand perception, achieve better throughput and make for an easier customer experience, all of which should lead to improved traffic retention. This will include consolidating menu boards and fixing value with a wider price ladder. It will also include other product enhancements like offering smaller sandwiches and half salads outside of the Pick Your Pair promotion. We’re testing larger-sized options with more meat, cheese and toppings as well. While there are a number of new ideas, we also expect fewer SKUs, making for a more efficient system and faster customer experiences. These ideas are already in the beta market testing phase, and with continued success, we have a plan to be live in the second half of the year. Moving to our second pillar, people creating good vibes. As I said last quarter, people are at the heart of this business and create the unique experience our customers expect at Potbelly. We must continue to embrace our hire for attitude and train for skills mantra to bring in people who offer good vibes and love great food. But we also need to manage our labor more optimally and incentivize our people to align personal and team success with that of our own. To do so, we'll be shifting to a modern labor model with hours-based management to improve deployment planning for real-time performance monitoring and management. This platform is already through the testing phase, and we expect it to be fully live across all shops by the end of the first quarter. Our goal in this labor optimization effort is to deliver better customer and employee experiences while also reducing costs. On the incentive front, we have a number of new ideas, including the transformation of our bonus program to motivate top talent and drive performance. We're also creating ways to identify and develop instant win recognition to both motivate our shop-level associates and to share new ideas across the organization. We've implemented a balanced scorecard at the shop level that aligns our incentives around driving traffic and profitable growth, including a share of the wealth component to the plan. We believe we can significantly enhance our field leaders and their employees' careers with the organization, while, at the same time, better tying these successes with that of the organization and its goals. Both the field and the support center bonus programs incentivize traffic, top line growth and profitability and ensure our teams win when we win. Moving to our third pillar, customer experiences that drive traffic growth. With our new COO, Adam Noyes, leading the effort, we are improving the customer experience while also building stronger unit-level economics and shop margins. First, we've created cross-functional teams to identify a pipeline of savings ideas with an objective to improve shop-level margins by 50 basis points without any negative effect on the employee or the customer experience. Importantly, the balanced scorecard I mentioned measures operations standards and customer satisfaction drivers across each service channel, along with employee engagement metrics at every shop, driving a focus on repeat customer traffic. This brings us to our fourth pillar, which is directly connected to the third and is focused on digitally driven awareness, connection and traffic. Our relaunched and simplified Perks program was a huge success in the second half of 2020, but there remains significant opportunity to better leverage this data and better understand our customers, increase their awareness of Potbelly offerings and ultimately drive traffic to our shops through targeted promotional activity. Therefore, we are currently redeveloping our app and our web interface to improve the customer experience, allow for easier reordering and better tie in our Perks loyalty program. This new experience is easier and more flexible for our customers and supports frictionless operations execution as we fulfill the customer's order, regardless of how they order or where they might choose to enjoy their meal. This is a huge step for Potbelly and is only the beginning of the journey as we more fully leverage technology to drive traffic, create efficiencies, enhance rewards and grow our loyal customer base. We look forward to unveiling our new web and app to customers across the system in Q3. Lastly, our fifth pillar is focused on the next leg of our journey, and that's franchise-focused development. 90% of our shops are owned by Potbelly today, and as I said last quarter, that is a tremendous advantage when you're turning around the business and positioning it for strong profitable growth. But we are significantly underpenetrated across most of the United States despite having such a recognized and high-quality brand. We can leverage what works to generate growth across both company and franchise platforms. Our recent slate of franchisees remain active and committed to developing over the next few years as originally planned. As the pandemic continues to wane, we expect the next wave of growth to come from leveraging Potbelly's operations, marketing and shop-level economic model to create a competitive advantage against the other franchising options. We'll welcome three to five new franchise shops in 2021 and expect to see significant annual growth in that number as we work through 2022 and beyond. So as you can see, the strategic initiatives that support our five pillars show a thoughtful plan that will leverage our core capabilities and enhance our future performance by focusing on proven traffic-driven profitability strategies. We're excited to share our journey with all of you and see our momentum build throughout 2021. With that, I will now turn the call back over to the operator so we can address your questions. Operator?

[Operator:]

Thank you. Our first question today is coming from Joshua Long from Piper Sandler. Your line is live.

[Joshua Long:]

Great. Thank you for taking the questions and for the update today. I had a couple of questions. Particularly, I want to start with the momentum that you've seen through the back half of 2020 and here into the first part of 2021. Exciting to see that and then, also, when you pair that up against what you've been able to do in terms of steady cost management there at the shop level. I was curious if you might be able to calibrate that as we've seen improvement from 4Q level that – kind of that just under down 20% to something now in the down mid-teens percent on a same-store sales basis. What does that look like at the shop level? I know you talked about getting to profitability in the first half of the year within some upside in the second half. But just from a modeling perspective, just trying to see kind of where maybe some of those pivot points are as sales start to improve.

[Steve Cirulis:]

Yes, sure. Thanks for the question, Josh. The momentum we're seeing is very exciting. And despite the slight step back there in our second period, seeing the way the business is moving in the third period here is great for all of us. And as it relates to shop-level kinds of things that drive profitability, I mean, what we're obviously taking advantage of here as the top line improves is some of the occupancy leverage from some of that work that we did in the end of 2020. We still will have some work to do on COGS. I think Bob mentioned that Adam is working hard on continuing to find efficiencies everywhere we look. And so some of those things are in place, some of those things are still to be built. We also, however, understand as we look at the shop that we've got labor efficiencies that we're building to. We have a new labor model that's in place, and we're already seeing – we are seeing some benefit from that. As an example, we saw some weeks in period one where we had significantly lower volume, but we're using basically the same amount of labor that we're now using in P3 as a result of that model being deployed because it wasn't deployed in the first period. So we're seeing some benefit from that, or we should see some benefit from that. On the other operating expense area, that one is going to move, I think, as it relates to COVID as a part of it, right? So we still have COVID costs that are in there. We had a lot of additional costs on things like PPE gloves and so forth that got really expensive there towards the back half of the year of 2020. And obviously, one of the things that also hits that line is third-party delivery fees for us. So we are – we expect to get some leverage from sales through some of those things, and we still have some additional work to do.

[Bob Wright:]

Yes. Josh, I'll add to that. I think that the first part of your comment about the sales trajectory is the one that continues to excite us. And so we mentioned during the call, we really do kind of see this as a story of two halves. So we've got the underlying recovery that we think is obviously going to drive some of the business for the industry as a whole. And then some of those initiatives, obviously, we started working on towards the end of last year. There is a balance of top line-driving initiatives, and we're seeing some success with those. Those are included in the operational drivers as well as some of the marketing and the reopening of our shops that have been temporarily closed. But we see the lion's share of the activity, especially against the strategy, really come to life in the second half. And so when you look at this kind of head start coming out of winter and into March, it definitely feels like things are headed in the right direction and something we can be very excited about for some of the numbers we've been sharing with how we think the year shapes up.

[Joshua Long:]

Thank you for that. And then thinking about the cost management side, particularly the G&A savings that you called out, should we be thinking about you reinvesting against some of those? I think you called $3.5 on a run rate basis. Are you going to reinvest against some of those so that we end up with something in line to slightly higher on a 2021 dollar basis when we get to the end of the year? Or do we look at that as really pulling costs out of the business such that we've created a new base, a new lower dollar base from which we can think about modeling 2021 and then out into 2022?

[Bob Wright:]

No. Thanks for the chance to clarify. Yes, that is – we intended to restructure to create a G&A burden on the business that was lower than it was traditionally had been. And that's a net savings. One of the things we're excited about is, as you heard us discuss some of the incentives that we put in place, things that go into taking care of and exciting the team that we have. Fully funded bonus programs at the shop level, at the support center level, those are some of the things that have been reloaded into our plan, still achieving that annual savings. So the short answer to your question is, no, we were looking for a reset. We wanted to get the G&A on our business more in line with the first or second best quartile of performers in this space versus down at the bottom end in the third or fourth quartile where we were maybe even back as late as 2019.

[Joshua Long:]

Great, thank you. I’ll pass along and then hop back in the queue.

[Bob Wright:]

Great thanks.

[Operator:]

Our next question today is coming from Matt Curtis from William Blair. Your line is now live.

[Matt Curtis:]

Hi, good afternoon.

[Bob Wright:]

Hi, Matt.

[Matt Curtis:]

Hi. Just getting back to Joshua's first question. Given that you'll have the inflection into profitability mostly in the second half of the year, can you talk about maybe what level of average weekly sales or comps that you need to actually get back into profitability?

[Bob Wright:]

Yes. I'll let Steve dig into some of the more detailed numbers, but yes, we think that our average sales volume down around, I'll call it, 25%, 35%, range, or sorry, up 25% to 35% gets us into that target range where we're looking for that shop level profitability to build on and then get to the earnings for the company as a whole. And then, I think that if you look at what it takes to be up over 2020, of course, some of these numbers are numbers we've not seen any industry ever. But the mid-double-digit range gets us to that that inflection point at the company breakeven adjusted EBITDA breakeven level.

[Steve Cirulis:]

Yes.

[Matt Curtis:]

Okay. So just to be clear, you said average weekly sales up 25% to 30% or so that's year-over-year and then in the double-digit range, positive on comps.

[Steve Cirulis:]

Yes, so at the shop level, we would need to see comps kind of in the low-double-digits to 20s would be in that zone.

[Matt Curtis:]

Okay.

[Steve Cirulis:]

That revenue range puts us between, let's say $125 million and $175 million on revenue. And these are first half numbers, by the way, because as Bob described, we're looking at the year that way, right. We still have some of the pandemic to run out and the strategic initiatives really start to lay her in, in the back half as well. So that's how we tend to view these kinds of things.

[Matt Curtis:]

Okay. Got you. And then just turning to the lease renegotiations, it seems like you've made some more progress on that front. I mean, in the release, it says you have about 320 total leases renegotiated now. That’s up from, I think, it was something like 280 last time we heard from you. So, could you maybe give us an update on the total amount of annual savings going forward you're going to get from this?

[Steve Cirulis:]

Yes, sure. I think we are almost done with all of that work. There's still a few handful. I think there's about seven or so on leases that of the 300, some odd that we touched here. So, it was a big effort. And we are excited for the results. On a basis related to the closures, right, we will save about $4 million in annual occupancy costs from closing those 28 shops. The lease savings kind of varies because in some of those negotiations, right, we extended term. And we did some other things in there. But it also helps us in terms of abating our – I should say, avoiding some loss shop losses. It's about $15 million in shop losses that we will avoid as a result of going through all of those lease actions.

[Matt Curtis:]

Okay. Got it. Thanks very much for your time.

[Adiya Dixon:]

Thank you. We reached the end of our question-and-answer session. I'd like to turn the floor back over to Bob for any further or closing comments

[Bob Wright:]

Well, thanks everyone for your time today. We really appreciate you joining the call. We're excited about the future here at Potbelly. And hopefully you can hear that we believe we're just at the beginning of what the company can do to reach its full potential. Our team is motivated, we're committed and we will achieve success. And we're confident that we've got the right team and the right strategy to make that a reality. Looking forward to providing you with more regular updates, especially on those various initiatives as we move forward. And most of all, we appreciate your interest and your support for the brand. Have a great day everyone.

[Operator:]

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.