Greetings and welcome to the Potbelly Corporation Fourth Quarter and Full Year 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It's now my pleasure to introduce your host Matt Revord, Potbelly's Chief Legal Officer. Please go ahead, sir..

Good afternoon everyone and welcome to our fourth quarter earnings call. Before we get started, I'd like to note that certain comments made on this call will contain forward-looking statements regarding future events or future financial performance of the company.

Any such statements, including our outlook for 2020 or any other future periods, should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are not guarantees of future performance nor should they be relied upon as representing management's views as of any subsequent date. Forward-looking statements involve significant risks and uncertainties and events or results could differ materially from those presented due to a number of risks and uncertainties.

Additional detailed information concerning these risks regarding our business and the factors that could cause actual results to differ materially from the forward-looking statements and other information will be given today, can be found in our most recent report on Form 10-K under the heading Risk Factors and MD&A and in our subsequent filings with the Securities and Exchange Commission, which are available at sec.gov.

Our presenters there are Alan Johnson, our Chief Executive Officer; and Will Atkins, VP and Controller. After our prepared remarks, we'll open the call for your questions. I'll now turn the call over to Alan..

Thank you, Matt. Good afternoon everyone and thank you for joining us today. This afternoon, I want to discuss the progress we made in 2019 particularly in the fourth quarter and how that momentum is carrying into the early part of Q1.

Additionally, I would like to provide a number of insights into the next phase of our turnaround strategy, which is designed to compliment and accelerate our hard work to-date and we look to build a sustainable platform for growth for 2020 and beyond.

The bottom line is our strategy is working and the effort our team put into transforming our company last year is showing up in the results. Fourth quarter, same-store sales were nearly flat at 0.1% negative, driven by improved traffic trends and our menu optimization and off premise and digital efforts.

The fourth quarter marks our strongest same-store sales comp in three years and represents the third consecutive quarter of improved comps. While traffic trends aren't where we want them to be yet they are improving.

According to Black box data, we outperformed our industry peers in both traffic and same-store sales comps in seven of the last eight weeks of the fourth quarter. In fact, we have extended that trend to 11 of the last 13 weeks to-date shifting holidays accounting for the only two misses. Simply put, we are gaining share.

It is critical to understand that we achieve this with a low advertising spend and the lowest rate of discounting this year. I'm also excited to report that this momentum as carried into the first quarter of 2020. A healthy majority of our markets are running at positive comps through the first half of Q1.

And we are confident that Potbelly will deliver the first positive quarterly same-store sales comp in over three years for the first quarter. Most importantly, we expect to deliver positive same-store sales comp in fiscal 2020 as well, the first time in over three years. 2019 was an important year for Potbelly.

Let me spend a few minutes reviewing some of our successes during the year. First, as a quick reminder, we rolled out our mini optimization initiative in February last year, which included pick your pay and meal deal option. As of Q4, these options are now enjoyed by one in four customers.

For the year, we grew our average check by 410 basis points and we picked up momentum as the year progressed as the fourth quarter saw a 670 basis point increase compared to Q4 2018, based on a combination of pricing mix and significantly less discounting.

In early 2019, we identified off-premise as an opportunity where we needed to significantly invest. We substantially improved our delivery business by launching delivery partnerships with DoorDash and Grubhub in the second half of the year. Q4 was the first quarter encompassing the impact of both partnerships.

At the beginning of 2019, some of our shops delivered some at the time. Now all of our shops deliver all of the time. To improve the customer experience for our online order and pickup channels, we invested in pickup reps for all of our shops.

All of this culminated in record annual growth for off-premise and digital channel which moved from 19.4% of sales in Q4 2018 to 24.4% in Q4 2019. Additional investments we made in our digital assets are also set clearly paying off. The Potbelly is now one of the highest rated app in our space at 4.8 stars.

We refreshed our catering website which also contributed to our off-premise growth instantly. Finally, our franchising business gained significant momentum throughout 2019 as we signed deals in the last 12 months for 42 new units nearly doubling our current number of franchise shops, which is expected to open in the next five to seven years.

While the previously mentioned efforts helped establish the right trajectory, we recognize that our pace of change needed to intensify. Beginning in the second half of the year, we challenged our team to make a year's worth of progress in just a few months.

To compliment our internal efforts, we brought in a top tier consulting firm in the third quarter who had helped many of our peers accelerate their turnaround. This firm helped us build a state of powerful tech based consumer insights. Those insights revealed Potbelly is well-equipped to win and provides a solid runway for organic growth.

It's critical for our investors to understand that this is not a radical departure from what makes Potbelly so loved by our loyal customers. We will leverage the core strength of the Potbelly brand along with building on what's already working in our business like many optimization off-premise and digital. We call this effort project Aurora.

Whilst it includes several new initiatives, it is largely a compliment to an extension of our existing strategy. We firmly believe that it will help us accelerate the pace of our turnaround. We have acted with urgency and already begun deploying some of the Aurora's elements across our shop base in the fourth quarter.

For example, we changed our promotional message away from discounting towards talking more about a warm toasted sandwiches and focusing on getting critic for our high quality ingredients like our bacon and the freshly sliced avocado. The current BLTA is a perfect example of this change. We know its working.

We can see it in our numbers as the add on incidents of bacon for example, is up noticeably since the introduction of the BLTA and this new approach. Other elements of Aurora will require additional testing, which we had been preparing for throughout the last few months and we'll be rolling them out next week across 52 shops in multiple models.

First, we'll be building on our learnings from the 2019 menu optimization initiative. Second, we will continue to improve and build on the quality of our toasted sandwiches. Chef Ryan has looked at every recipe to see how we could make each component better.

Lastly, we'll be testing some new awareness and strategic advertising focused on driving stronger traffic. I say strategic as our overall advertising budget for the year is still expected to be fairly flat against 2019.

To summarize, these are only a handful of examples of things we'll be testing and while many of them seem somewhat modest individually, taken together, they will represent a meaningful alignment of our customer's needs.

We are making changes in multiple dimensions of the customer experience and expect the cumulative effect to have a substantial impact in a way that is not capital intensive and impacts the entire system. These tests will last for a minimum of three months, we have a disciplined track record of test, learn and rollout.

We will follow the same cadence here, analyzing every aspect we can and then using the data to inform our next step. As we said in our last call, the first half of the year we will be spent testing and in the second half, we will analyze and roll out the statistical components.

We expect that with the momentum we carrying into 2020 coupled with the insights we gained from our Aurora test, we will produce sustainable positive comps. We also stick to these efforts to continuously improve traffic trends and put us on a path to grow adjusted EBITDA in the not too distant future.

We are excited to launch these tests and look forward to updating everyone on our progress. We are acting with urgency and it already implemented many of the strategic insights and they are beginning to show up in our results. We believe the hard work that has already been done will serve as a perfect launching pad for project Aurora.

For competitive reasons and to ensure, our Aurora test are positioned for success, I'm not going to provide any further details on these initiatives. With that, I'll now turn the call over to Will, who will walk us through our financial performance in the fourth quarter and full year..

Thanks, Alan, and good afternoon. I will walk through our financial performance for the fourth quarter and full year. All comparisons are versus the comparative prior year period unless otherwise stated. Starting with the top-line, total revenues decreased 0.6% to $101.8 million in the fourth quarter driven predominantly by shop closures in 2019.

Company operated same-store sales were nearly flat at minus 0.1% in the fourth quarter, which represented a 290 basis point improvement from the third quarter. Breaking down same-store sales, our average check grew by 6.7% offset by a traffic decline of 6.4%.

For the full year, total revenues decreased 3.1% to $409.7 million driven predominantly by a 3% decrease in company operated same-store sales and shop closures. Our average check grew by 4.1% offset by a traffic decline of 6.9%.

During the fourth quarter, we opened two new shops including one company operated shop and one franchise shop and we did not close any.

In the year, we opened nine new shops including two company operated and seven franchise and we closed 21 shop including 11 company operated shops, two domestic franchise shop and our eight remaining international franchise shop. Our shop level profit margin for the fourth quarter was 15% of sandwich shop sales as compared to 15.7% in the prior year.

Cost of goods sold as a percentage of sandwich shop sales was 26.3% in the fourth quarter, a decrease of 60 basis points driven primarily by a lower discount rate, menu price increases and mixed shift. For the quarter, labor was 31.5% an increase of roughly 40 basis points driven by wage inflation and sales deleverage.

Our shop level profit margin for the year was 15% as compared to 16.7% in the prior year. Cost of goods sold as a percentage of sandwich shop sales was 26.6% in the year, an increase of 10 basis points driven primarily by product inflation partially offset by menu price increases, lower discounting and mix shifts.

For the year, labor was 31.6% an increase of roughly 110 basis points driven by wage inflation and sales deleverage. Occupancy expense was 14.4% in the fourth quarter, a decrease of 40 basis points due to favorable adjustments in occupancy accrual.

Other operating expenses were 12.8% in the quarter, an increase of 130 basis points due primarily to third-party delivery fee. For the year, occupancy expense was 14.5% an increase of 20 basis points due to sales deleverage. Other operating expenses were 12.3% for the year, an increase of 30 basis points due primarily to third-party delivery fee.

Our general and administrative expenses were approximately $10.1 million in the fourth quarter or 10% of total revenue decrease of 90 basis points. The decrease was primarily driven by a pullback in advertising spent.

For the full year, our general and administrative expenses were approximately $47.9 million or 11.7% of total revenue, an increase of 60 basis points.

This increase was driven by $3.1 million of consulting fees related to project Aurora that we previously reported offset by decreases in restructuring costs, stock-based compensation and performance-based incentive compensation.

Adjusted G&A, which excludes store closure costs, CEO transition costs, restructuring costs, proxy-related costs and consulting fees for project Aurora and which we believe is the best indication of the core G&A expenses in our business was $9.1 million in the fourth quarter or 9% of total revenue, which was down $0.5 million in absolute dollars relative to last year primarily due to the pullback in advertising.

For the full year, adjusted G&A was $40.2 million or 9.8% of total revenue, which was down $0.3 million in absolute dollars relative to last year. We continue to tightly manage and control our G&A expense. Adjusted EBITDA was $7 million for the fourth quarter compared to $7.2 million.

Adjusted EBITDA was $25.5 million for the year compared to $35 million and came in at the lower end of our guidance range as we forecasted last quarter. The decline was driven by lower sales from company operated shops and inflation of cost of goods sold and labor.

During the quarter, we had income tax expense $0.3 million, during the year, we had income tax expense of $14.2 million, which includes $13.6 million in tax valuation allowance charges that were recorded in the first half of the year.

During 2019, we purchased approximately 648,000 shares of Potbelly common stock in the open market for a total of roughly $4.2 million. At the end of 2019 we had $37.9 million available from our board authorized program to repurchases. We ended the fourth quarter with a cash balance of $18.8 million and zero debt.

We remain comfortable with our balance sheet and are focused on maintaining ample cash and liquidity to fund our strategic initiatives. I will close my prepared remarks today with a review of our outlook for 2020.

For the full year, we currently expect 0.5% to 2% increase in company operated same-store sales with the momentum our strategic initiatives have shown through Q4 and into Q1 coupled with our project Aurora efforts. We are confident to say we expect comps to be positive for fiscal 2020.

Inherent in our guidance is an assumption that we can produce a low single digit increase in revenue which allows for the investments we are making. Adjusted EBITDA is expected to range between $20.5 million and $25.5 million.

Top-end of our adjusted EBITDA range is flat to last year, so we're leaving in some room in case we decide to accelerate certain project Aurora elements depending on results of the test. Cost of goods sold are projected to range between 26.7% and 27.3% which is similar to last year.

We expect a slight up tick in our total cost of goods sold driven by the investments I mentioned earlier. Additionally, we just renegotiated a new five-year contract with our main food supplier and expect a slight increase in distribution costs.

However, you'll notice that with the low single-digit revenue growth we are expecting this should keep our guidance on cost metrics similar to the guidance ranges we gave last year. Labor as a percentage of sales is expected to be between 31% and 32%. We expect a slight increase in our labor costs as a result of wage inflation.

Adjusted G&A expense is expected to range between $44 million to $46 million. Included in our adjusted G&A guidance, it's higher bonus and stock compensation. Of note, we expect our advertising expense to be between $3 million and $5 million depending on certain elements of [indiscernible].

Specifically, we expect a sequential up tick in advertising spending Q1 and Q2, but again, I'd like to point out that this guidance is fairly in line with last year, but we will remain disciplined in our marketing approach. We currently expect 8 to 10 total shop closures, all of which are strategic closures of company operated shops.

We project 12 to 13 total shop opening including four company operated shop openings, the four company operated shop opening for a carry over from our 2019 shop plan, three of which are already open and the last one will be opened by the end of Q2.

As we said last quarter, we did not currently have plans to open any other company operated shops unless a unique location like an airport becomes available. And as previously discussed, we remain open to refranchising opportunities in select markets. Lastly, our capital expenditures are expected to be between $16 million and $18 million.

I'll now turn the call back over to Alan for his closing remarks.

Alan?.

Thanks, Will. Before I turn the call over for questions, I want to briefly update everyone on a few other strategic initiatives as we look ahead to 2020. Our first shop of the future opened in Chicago last October and the initial results were positive.

This was our first shop with the new design and like everything else in our business, we will continue to tweak and test new elements as part of our continuous improvement process. We are conducting post opening consumer research to aid in these efforts and we'll likely incorporate learnings from Aurora into shop of the future along the way.

The learnings flow in both directions. For example, the consolidated menu being tested in our Aurora efforts was first conceived and executed in our shop the future. The search process for our new Chief Financial Officer is underway and progressing as expected.

We will provide more updates on our search when necessary, but until then Will and the team have a strong finance organization are doing a great job keeping us on track.

In closing, we entered 2020 with positive momentum and we're excited to get moving on the Aurora test, which we expect with significantly accelerate our pace of change and become a multiplier on our strategic action that we've already taken to-date.

I think it is critical for our business to understand that our plan is aggressive, well-informed, and capital light. Our confidence is bolstered by very clear evidence that our strategy is working and the momentum we built in the fourth quarter has clearly carried over into Q1.

In 2020, we will post our first year of positive same-store sales comps since 2016 starting with Q1. We will significantly improve traffic trends and we will put the company on a sustainable path to long-term growth. That concludes our prepared remarks and I will now turn the call over to the operator for Q&A..

[Operator Instructions] Our first question today is coming from Joshua Long from Piper Sandler. Your line is now live..

Congratulations on the quarter and the momentum to date. All very exciting.

When we think about the opportunity for positive comps in 2020, could you provide some context around the cadence that you're looking at? Looking at your performance on a two year basis, you've improved nicely here through 4Q '19, if we assume that that were to continue here in early '20, that shows some nicely positive comps in the low single digits.

So curious, if you could either comment on that, provide some color on where you're running year-to-date and/or provide just on first half, second half commentary and what you're expecting that in that momentum, given that you have a lot of strategic initiatives still in play..

Hey Josh, thank you for the question. Yes. So let me start with Q4, the best comp in three years at a 0.1 negative. That momentum has continued into 2020. As I look at Q1, we're seven, eight weeks into it and I feel very confident in telling you that this would be the fourth sequential quarter of improved comps.

So with that, I believe that we'll get to the end of the first quarter and report the fact that we delivered the first positive comp in over four years. I think that's real progress. It's been driven by off-premise.

We hit record growth, record mix, some of the strategic decisions we made a year ago and made big investments in off-premise, whether that's upgrading the app, whether that's investing in the website, whether that's investing in partners a lot of the growth has come from that, but it's not the only place where we've seen growth.

Menu optimization has been a huge success for us. And then, it's important as I look at the business, for me to be this confident, I need to see that most of the markets are showing positive comp and that is indeed correct. And then, often eye on what's happening in the market and Black box data would confirm that we are achieving market share.

And then, all of this is done through the prism of also sort of spending less on discounting and very modest advertising. For sure, we've got things to learn and that's why, I said in the last earnings call, the first half would be spent testing and the second half would be spent analyzing and deciding what to roll.

And that's why the Aurora test is very important and this team is acting with urgency none more urgent than the fact that this -- the Aurora test launches next week and we're very excited and confident that this accelerates and builds on what is already working because I see it a steady improvement throughout the year in all metrics and we're off to a good start..

Great. Thank you for that.

And following up in your commentary where you mentioned the majority of the markets were running positive, but certainly exciting to hear as you go through and think about the trends by market or by geography, however, that stacked up, what are you learning about those markets that are maybe still probably improving, but maybe struggling a little bit to get to that positive comp territory.

Is that a site selection, dynamic, is that -- it may be a vintage or are those more competitive trade areas? Anything you could share there would be helpful..

Yes. I'm going to limit how much detail I provide here. Its suffice to say, it's broad and wide and we look at 22 markets and the vast majority of them are positive. And the great news is the handful that aren't over the course of the last several months have shown significant improvement and on their way to positive.

So, that's one of the reasons why we feel confident with our guidance for 2020 to deliver the first year of same-store sales comping over four years..

Great. Thank you.

And then following up on your commentary around the Potbelly app, how is that trending in terms of users overall and now that it's been in place for a little while, I imagine that you've had some opportunity to really dig in and get to know your guests better in terms of what they -- what resonates with them, how to communicate them with better.

I imagine that you want to keep a lot of that under wraps in the testing process.

But what high level commentary you share about what you've learned about your guests now, how are you going to engage with them versus prior periods since joining the company?.

Yes. The good news is, we've seen over the course of the last 12 months just under 40% growth in the perk membership going topping 1.7 million and it's now about 17% of our business. So I've seen dramatic growth there.

We've also invested a lot of money in not only the app, but the website and functionality that we've added, which I think is also helping to drive both menu optimization and off-premise. We've added functions like easy access to your past orders, click and pay, pickup in the shop delivery and we've streamlined the whole order process.

So I think that those were good investments and paying a dividend. Also, the checkout process now encourages you to add items, if you've only added a sandwich and you've got to check out, we will remind you to add cookies.

And the decision we made on bundling I think has been a huge success, no better measurement than approximately one in four customers now enjoying a pick your pay and meal deals. So that's first of many. What have we learned from our perk members? You'll see a good sense of that very shortly.

I mentioned in my last earnings call that we were going to launch a new perks program, which was still on track to do that. That'll be in the second half of the year. I'm not going to say too much about that, but suffice to say that it will be a simpler, easier to understand, have more stickiness, focus very heavily on retention and frequency.

And we know that when we focus on those things that will lead to positive comps..

Great. Thank you for that. And one last housekeeping item before I pass the lungs. The average check was very strong in the quarter that's great to see.

Could you provide some context around with the price mix components where there and what your outlook in terms of a pricing would be for this year, or do you expect that to kind of be a back half weighted decision based on what your tests and research show?.

So let's deal with the Q4 and I'm going to limit my comments just to Q4. Best comp in three years, third sequential quarter. You did see a 670 basis point increase in the average check, the four big things leading to that are bundling, which is the meal deal and pick your pay, one in four customers taking advantage of that.

The significant off-premise growth remember the customer uses off-premise, spends significantly more and all three parts of that off-premise business are delivery pickup and catering are all contributing towards that growth and materially we did this with the lowest discount rate for the year at 3.7, which is significant.

There's a lot of flow through and you're not having to discount. And then the menu pricing was simply in line with competition, we didn't take any more than that. So those are the key big drivers.

As far as traffic goes, I will note despite the reports that we read about the fourth quarter being a very soft traffic comp quarter, we improved our traffic comp by 190 basis points, Q3 on Q4 with less advertising, less discounting and beating Black box in the last, seven out of eight weeks of the quarter.

So I think those results are something to be proud of..

Thank you. Our next question is coming from Gregory Francfort from Bank of America. Your line is now live..

Hey, this is actually JonMichael on for Greg. Thanks for taking the question. I was wondering if you could expand on the thinking behind shift in marketing to a more product focused away from discounting.

And is that related to also what you're seeing from competitors or peers sort of eating off of the discounting or is it more the same?.

Hey, JonMichael, thank you for the question. Yes. So, for us this is a big shift. The focus is on warm toasty sandwiches and the quality ingredients.

And what we were testing a large part of the back end of 2018 and into '19 was there -- an used promotion as a way to get the traffic moving in the right direction? And it's certainly didn't work particularly well in Q3, but of last year, but sorry, '18, but it wasn't sustainable.

High discounting and high advertising at the same time, whilst that produced flat traffic, it wasn't sustainable. So, one of the things that we've learned is one, there's a large and growing space here that I think Potbelly is well-equipped to win and it's not a radical departure from what we've been doing before, but the messaging certainly is..

Got it. Thank you for that. And then, are there any more details you could provide on the four franchise deals that you signed? I know it's the longer term, but are these specific geographies that you're looking at and just anything around those deals would be helpful..

Sure. With pleasure. So we did four deals and 42 shops, Vegas, Tampa, Carolina, and there was a few miscellaneous which had four shops, but in total 42 shops, nearly doubling the current footprint that we have in franchising..

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

Thank you guys for your time today and for your continued support. 2020 is a critical year for Potbelly. Our strategy is working and we have plans to accelerate our progress, and I thank you for your interest and look forward to updating you on the next earnings call. Have a great evening..

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