The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes to those statements included in Item 8. The discussion contains forward-looking statements involving risks, uncertainties and assumptions that could cause Potbelly results to differ materially from expectations. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those described in "Risk Factors" in Item 1A and elsewhere in this report. This section of this Form 10-K generally discusses our results of operations and financial condition for the year ended December 26, 2021. For a discussion of similar topics for the years ended December 27, 2020 and December 29, 2019, please refer to "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Form 10-K, filed on March 12, 2021, which is incorporated herein by reference.
Overview
Potbelly Corporation is a neighborhood sandwich concept that has been a much-needed lunch-break escape 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. 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 high teens to above 20%. Our ability to achieve such margins and returns depends on a number of factors, including consumer behaviors, the economy, labor and commodity costs. For example, we face increasing labor and commodity costs, which we have partially offset by increasing menu prices. Although there is no guarantee that we will be able to achieve these returns, we believe our attractive shop economics support our ability to profitably grow our brand in new and existing markets.
The table below shows a breakdown of the business operated by the company and operated by franchisees:
Franchised
Company- Operated Domestic International Total Total Company Shops as of December 30, 2018 437 41 8 49 486 Shops opened 2 7 - 7 9 Shops closed (11) (2) (8) (10) (21) Shops as of December 29, 2019 428 46 - 46 474 Shops opened 5 3 - 3 8 Shops closed (33) (3) - (3) (36) Shops as of December 27, 2020 400 46 - 46 446 Shops opened - 3 - 3 3 Shops closed (3) (3) - (3) (6) Shops as of December 26, 2021 397 46 - 46 443
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. In response to the
pandemic, many states and jurisdictions in which we operate issued stay-at-home
orders and other measures aimed at slowing the spread of the coronavirus,
resulting in significant changes to our operations and a sudden and drastic
decrease in revenues during those periods. While the pandemic continues to have
an impact on our business, the distribution of
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COVID-19 vaccines and lifting of local restrictions resulted in a gradual
improvement to our sales during 2021. Nearly all of our shops have reopened
their dining rooms and are no longer subject to operating restrictions and
capacity limits related to COVID-19. As of December 26, 2021, 5 of our shops
remain temporarily closed. We will continue to 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 if required due to changes in the pandemic response
in each jurisdiction and restaurant operating protocols, which could result in
lower in-shop dining revenue or higher operating costs.
Specifically, COVID-19 has affected our financial results and performance as follows:
•Revenue - Many of our shops, specifically those in suburban and urban residential locations are now operating near or above pre-COVID-19 levels, but other shops, especially those in central business districts, are still operating materially below those levels. While the majority of our shops have reopened their dining rooms and are operating without mandated restrictions, the pandemic has affected consumer behavior including more significant focus on digital sales. As such, we continue to offer convenient off-premise options for customers. Customers can place off-premise orders through Potbelly.com and the Potbelly app, or through DoorDash, Grubhub, Postmates, Uber Eats and other marketplaces nationwide. We also continue to evaluate our product offerings and service methods to ensure we are aligned with the preferences of our customers as the pandemic evolves. •Operating Costs - We implemented measures to reduce operating costs and general and administrative expenses in response to the negative impact the pandemic has had on our business. We continually adjust shop-level labor and inventory to align with current levels of demand. At the onset of the pandemic, we implemented a strategy to reduce costs and preserve cash, and we continue to be thoughtful and judicious regarding our operating expenses during the uncertainty of the pandemic. We negotiated rent abatements, rent deferrals, and other modified lease terms with the majority of our shop landlords in order to preserve liquidity and reduce ongoing occupancy costs. Additionally, we announced and executed a corporate restructuring plan during the fourth quarter of 2020 which reduced annual general and administrative expenses in 2021. The restructuring plan consisted of corporate expense optimization, consolidation of shop support services, and other expense and staff reductions. As a result of COVID-19, during fiscal year 2021, some of our food and paper suppliers have experienced shortages in labor and transportation resources, which in some cases, has resulted in increased costs of our food and paper, which we expect will continue to a certain extent through 2022. We have worked closely with our suppliers to ensure availability of products and, to date, there has been minimal disruption to the availability of our products, though it is possible that more significant disruptions could occur if the COVID-19 pandemic and labor and supply chain availability challenges continue to worsen.
Additionally, in fiscal 2021, we experienced labor availability issues in some workshops. We are managing the impact on labor availability in these restaurants by selectively increasing wages and limiting our hours of operation or closing dining rooms, if necessary.
While we have been able to manage the costs of adhering to our rigorous food safety and quality assurance programs and implementing and maintaining strict sanitation protocols for our stores, as many new requirements or actions are imposed or we deem advisable, we may incur additional costs to comply with such requirements to take such action.
During 2021 we have increased, and plan to continue to increase, menu prices as necessary in order to offset additional costs as a result of COVID-19 and a higher inflationary economic environment in the U.S. These price increase may not be sufficient to mitigate additional unexpected higher costs and further increases may negatively impact consumer behavior and purchases. •Shop Development - We halted capital investment in new company-owned shops, except for shops that were substantially complete, as well as all non-essential capital expenditures. We currently do not have plans to begin construction on any company-owned shops. 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.
Fiscal year
Operating results are reported on a 52-week fiscal calendar, with a 53-week year occurring every five or six years. Our fiscal year ends on the last Sunday of each calendar year. The 2021, 2020 and 2019 financial years were at 52-
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week year. The first three quarters of our fiscal year consist of 13 weeks and our fourth quarter consists of 13 weeks for 52-week fiscal years and 14 weeks for 53-week fiscal years.
Key performance indicators
In assessing the performance of the Company's business, Potbelly considers a variety of performance and financial measures. The key measures for determining how the business is performing are comparable store sales, 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. Potbelly defines the comparable store base to include those shops open for 15 months or longer. As of the fiscal years ended December 26, 2021, December 27, 2020, and December 29, 2019 there were 366, 378 and 423 shops, respectively, in Potbelly's 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 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 entree, which includes sandwiches, salads and bowls of soup or mac and cheese.
Number of company-operated store openings
The number of company-operated shop openings reflects the number of shops opened during a particular reporting period. Before Potbelly opens new shops, we incur pre-opening costs, which are defined below. 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.
Profit (loss) margin at shop level
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. Shop-level profit (loss) margin is not required by, or presented in accordance with 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, gain or loss on disposal of property and equipment, and pre-opening expenses as well as other one-time, non-recurring charges, such as CEO transition costs. 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.
Key financial definitions
Revenue
Potbelly generates revenue from net company-operated sandwich shop sales and
franchise operations. Net company-operated shop sales consist of food and
beverage sales, net of promotional allowances and employee meals.
Company-operated shop sales are influenced by new shop openings, shop closures
and comparable store sales. Franchise royalties and fees consist of an initial
franchise fee, a franchise development agreement fee and royalty income from the
franchisee.
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Food, beverage and packaging costs
Food, beverage and packaging cost components are variable in nature, change with sales volume, are influenced by menu composition and are subject to increases or decreases based on fluctuations in commodity costs .
Labor and related expenses
Labor and related expenses include all shop-level management and hourly labor costs, including salaries, wages, benefits and performance incentives, labor taxes and other indirect labor costs.
Occupancy costs
Occupancy charges include fixed and variable portions of rent, maintenance of common areas and property taxes.
Other operating expenses
Other operating expenses include all other store-level operating costs, excluding amortization, the major components of which are credit card fees, third-party market partner fees, supplies operating costs, utilities, repair and maintenance costs and store-level marketing costs.
Advertising
Advertising costs include production and media costs related to brand advertising which are expensed as incurred and included in the Consolidated Statement of Income.
General and administrative expenses
General and administrative expenses is comprised of expenses associated with corporate and administrative functions that support the development and operations of shops, including compensation and benefits, travel expenses, stock-based compensation costs, legal and professional fees, costs related to abandoned new shop development sites and other related corporate costs.
Depreciation expense
Depreciation expense includes the amortization of capitalized capital assets and leasehold improvements.
Pre-Opening Costs Pre-opening costs consist of costs incurred prior to opening a new shop and are made up primarily of travel, employee payroll and training costs incurred prior to the shop opening, as well as occupancy costs incurred from when we take site possession to shop opening. Shop pre-opening costs are expensed as incurred.
Depreciation, loss on disposal of property, plant and equipment and workshop closures
Potbelly reviews long-lived assets, such as property and equipment, intangibles and lease right-of-use assets, for impairment when events or circumstances indicate the carrying value of the assets may not be recoverable and records an impairment charge when appropriate. The impairment loss recognized is the excess of the carrying value of the asset over its fair value. Typically, the fair value of the asset is determined by estimating discounted future cash flows associated with the asset. The fair value of right-of-use assets is estimated using market comparative information for similar properties. Loss on disposal of property and equipment represents the net book value of property and equipment less proceeds received, if applicable, on assets abandoned or sold. These losses are related to normal disposals in the ordinary course of business, along with disposals related to shop closures and selected shop remodeling activities. Shop closures includes lease termination payments and the derecognition of the associated right-of-use assets and lease liabilities, as well as any other costs directly incurred in the closure of the shop.
Restructuring costs
Restructuring costs include one-time termination benefits and other accrued charges related to approved restructuring plans.
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Interest charges
Interest expense primarily consists of interest and fees associated with our credit facility, including the amortization of debt issuance costs and other miscellaneous interest charges.
Non-majority interests
Non-controlling interests represent non-controlling partners' share of the
assets, liabilities and operations related to seven joint venture investments.
Potbelly has ownership interests ranging from 51-80% in these consolidated joint
ventures.
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Operating results
Fiscal 2021 (52 weeks) versus fiscal 2020 (52 weeks)
The following table presents information comparing the components of net income for the periods indicated (in thousands of dollars):
Fiscal Year
% of % of
2021 Revenues 2020 Revenues 2019 % of Revenues
Revenues
Sandwich shop sales, net $ 377,283 99.3 % $ 289,337 99.3 % $ 406,688 99.3 %
Franchise royalties and fees 2,769 0.7 1,944 0.7 3,019 0.7
Total revenues 380,052 100.0 291,281 100.0 409,707 100.0
Expenses
(Percentages stated as a percent
of sandwich shop sales, net)
Sandwich shop operating expenses,
excluding depreciation
Food, beverage and packaging
costs 105,035 27.8 82,154 28.4 108,326 26.6
Labor and related expenses 127,099 33.7 105,241 36.4 128,403 31.6
Occupancy expenses 53,821 14.3 56,882 19.7 58,977 14.5
Other operating expenses 59,265 15.7 49,054 17.0 50,178 12.3
(Percentages stated as a percent
of total revenues)
Advertising 2,999 0.8 1,020 0.4 4,111 1.0
General and administrative
expenses 33,287 8.8 33,989 11.7 40,720 9.9
Depreciation expense 15,909 4.2 19,830 6.8 22,103 5.4
Pre-opening costs - * 229 * 35 *
Impairment and loss on disposal
of property and equipment 5,125 1.3 12,346 4.2 6,050 1.5
Restructuring costs - * 1,668 0.6 - *
Total expenses 402,540 105.9 362,413 124.4 418,903 102.2
Loss from operations (22,488) (5.9) (71,132) (24.4) (9,196) (2.2)
Interest expense 963 0.3 1,076 0.4 199 *
Loss before income taxes (23,451) (6.2) (72,208) (24.8) (9,395) (2.3)
Income tax expense (benefit) 172 * (6,536) (2.2) 14,190 3.5
Net loss (23,623) (6.2) (65,672) (22.5) (23,585) (5.8)
Net income attributable to non-
controlling interests 161 * (281) (0.1) 407 *
Net loss attributable to Potbelly
Corporation $ (23,784) (6.3) % $ (65,391) (22.4) % $ (23,992) (5.9) %
Fiscal Year
Other Key Performance Indicators 2021 2020 2019
Comparable store sales 30.3 % (24.7) % (3.0) %
Shop-level profit margin 8.5 % (1.4) % 15.0 %
Adjusted EBITDA $ 522 $ (32,684) $ 25,501
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* The amount is less than 0.1%
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This section of this Form 10-K generally discusses our results of operations and financial condition for the year ended December 26, 2021. For a discussion of similar topics for the years ended December 27, 2020 and December 29, 2019, please refer to "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Form 10-K, filed on March 12, 2021, which is incorporated herein by reference.
Revenue
Revenues increased by $88.8 million, or 30.5%, to $380.1 million for the fiscal year 2021, from $291.3 million for the fiscal year 2020. This increase was primarily driven by the easing of the government restrictions previously imposed by federal, state and local governments, as a result of the COVID-19 pandemic, as well as the national rollout of our new menu, which increased traffic and average check during the second half of 2021. This drove an increase of $84.6 million, or 30.3%, in comparable store sales. The increase in sales also included sales of $8.3 million from shops that were temporarily closed in 2020 due to the impact of COVID-19 but have since re-opened. Revenues also increased by $2.4 million from shops which attained comparable status for the first time since opening during this timeframe. These increases were partially offset by a decrease in sales of $6.4 million from the 38 shops that have permanently closed over the last two years. During 2021 we increased, and plan to continue to increase, menu prices as necessary in order to offset additional costs as a result of COVID-19 and 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.
Food, beverage and packaging costs
Food, beverage and packaging costs increased by $22.9 million, or 27.9%, to $105.0 million for the fiscal year 2021, compared to $82.2 million for the fiscal year 2020, primarily driven by an increase in shop revenue. As a percentage of sandwich shop sales, food, beverage and packaging costs decreased to 27.8% for the fiscal year 2021, from 28.4% for the fiscal year 2020, primarily driven by increased menu prices, including differential pricing on third-party delivery marketplaces, partially offset by inflation in certain products. As a result of COVID-19, some of our food and paper suppliers have experienced shortages in labor and transportation resources, which in some cases, has resulted in increased food, beverage and packaging costs, which we expect will continue to a certain extent in the near future. We have worked closely with our suppliers to ensure availability of products and, to date, there has been minimal disruption to the availability of our products, though it is possible that more significant disruptions could occur if the COVID-19 pandemic and labor and supply chain availability challenges continue to worsen.
Labor and related expenses
Labor and related expenses increased by $21.9 million, or 20.8%, to $127.1
million for the fiscal year 2021, from $105.2 million for the fiscal year 2020,
primarily driven by an increase in shop revenue and higher shop labor wage rates
as a result of labor availability challenges and increasing minimum wage
requirements in certain locations. We are managing the labor availability impact
on these restaurants by selectively raising wages and managing labor real-time
according to sales trends, as well as limiting our hours of operation or closing
dining rooms, when necessary. As a percentage of sandwich shop sales, labor and
related expenses decreased to 33.7% for the fiscal year 2021, from 36.4% for
fiscal year 2020, primarily driven by increased sales leverage in certain labor
related costs not directly variable with sales, partially offset by increasing
labor costs.
Occupancy Expenses
Occupancy expenses decreased by $3.1 million, or 5.4%, to $53.8 million for the
fiscal year 2021, from $56.9 million for the fiscal year 2020, primarily due to
a decrease in expenses from shops that have closed and lease concessions. As a
percentage of sandwich shop sales, occupancy expenses decreased to 14.3% for the
fiscal year 2021, from 19.7% for the fiscal year 2020, primarily due to
increased sales leverage in certain occupancy related costs not variable with
sales, as well as the impact of lease concessions and restructurings over the
last year.
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Other operating expenses
Other operating expenses increased by $10.2 million, or 20.8%, to $59.3 million for the fiscal year 2021, from $49.1 million for the fiscal year 2020. The increase was primarily attributable to higher expenses related to third-party delivery partnerships driven by increased sales in that channel. As a percentage of sandwich shop sales, other operating expenses decreased to 15.7% for fiscal year 2021, from 17.0% for fiscal year 2020, primarily driven by increased sales leverage in operating expense items that are not directly variable with sales.
Advertising
Advertising expenses increased to $3.0 million for the fiscal year 2021, from $1.0 million for the fiscal year 2020, as we purposely reduced our advertising spend in 2020 as a result of the COVID-19 pandemic.
General and administrative expenses
General and administrative expenses decreased by $0.7 million, or 2.1%, to $33.3 million for the fiscal year 2021, from $34.0 million for the fiscal year 2020. The decrease was primarily driven by a decrease in payroll costs as a result of the restructuring plan enacted during the fourth quarter of 2020. As a percentage of revenues, general and administrative expenses decreased to 8.8% for the fiscal year 2021, from 11.7% for the fiscal year 2020, primarily driven by increased sales leverage. Depreciation Expense Depreciation expense decreased by $3.9 million, or 19.8%, to $15.9 million for the fiscal year 2021, from $19.8 million for the fiscal year 2020, primarily due to 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 decreased to 4.2% for the fiscal year 2021, from 6.8% for the fiscal year 2020.
Pre-opening fees
No pre-opening costs were incurred for fiscal year 2021. Pre-opening costs were $0.2 million for fiscal year 2020.
Depreciation, loss on disposal of property, plant and equipment and workshop closures
Impairment, loss on disposal of property and equipment and shop closures decreased to $5.1 million for fiscal year 2021, compared to $12.3 million for fiscal year 2020, primarily due to 2020 impairment charges resulting from the expected impact of COVID-19 on future cash flows. The 2021 charges primarily consisted of impairment of certain shop-level assets and a loss on disposal of certain corporate assets as described below. After performing our periodic review of our shops during each fiscal quarter of 2021, it was determined that indicators of impairment were present for certain shops as a result of continued underperformance. We performed an impairment analysis related to these shops and recorded an impairment charge of $2.8 million for the year ended December 26, 2021. 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 within the same building. As a result of the relocation, the leasehold improvements of the original office space were disposed, resulting in a loss on disposal of $2.5 million based on the remaining net book value of those assets.
Restructuring costs
Restructuring costs of $1.7 million were incurred in fiscal year 2020, compared
to no restructuring costs for the fiscal year 2021. 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 resulted
in annual general and administrative expense savings in 2021. 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
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2020. The restructuring charges recognized in the fourth quarter of 2020 consist primarily of one-time termination benefits to employees. 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. As such, we may incur additional restructuring related charges or adjustments to previously recorded charges in the future, however, we are unable to estimate the amount of charges at this time. Interest Expense Interest expense was $1.0 million for the fiscal year 2021 and $1.1 million for the fiscal year 2020, the decrease driven lower average debt balances throughout the year. Income Tax Expense We recognized income tax expense of $0.2 million for the year ended December 26, 2021. We recognized an income tax benefit of $6.5 million for the year ended December 27, 2020, primarily due to a discrete tax benefit recorded for the carryback of NOLs and a refund of prior AMT credits allowed under the CARES Act. Non-GAAP Financial Measures
Profit (loss) margin at shop level
Shop-level profit (loss) margin was 8.5% for the fiscal year 2021. Shop-level
profit (loss) margin is not required by, or presented in accordance with GAAP.
We believe shop-level profit (loss) margin is important in evaluating shop-level
productivity, efficiency and performance.
Fiscal Year Ended
December 26, December 27, December 29,
2021 2020 2019
($ in thousands)
Income (loss) from operations $ (22,488) $ (71,132) $ (9,196)
Less: Franchise royalties and fees 2,769 1,944 3,019
Advertising 2,999 1,020 4,111
General and administrative expenses 33,287 33,989 40,720
Depreciation expense 15,909 19,830 22,103
Pre-opening costs - 229 35
Impairment, loss on disposal of property and
equipment and shop closures 5,125 12,346 6,050
Restructuring costs - 1,668 -
Shop-level profit [Y] $ 32,063 $ (3,994) $ 60,804
Total revenues $ 380,052 $ 291,281 $ 409,707
Less: Franchise royalties and fees 2,769 1,944 3,019
Sandwich shop sales, net [X] $ 377,283 $ 289,337 $ 406,688
Shop-level profit margin [Y÷X] 8.5 % (1.4) % 15.0 %
Adjusted EBITDA
Adjusted EBITDA was $0.5 million for the fiscal year 2021. Adjusted EBITDA is
not required by, or presented in accordance with GAAP. We believe that adjusted
EBITDA is a useful measure of operating performance, as it provides a picture of
operating results by eliminating expenses that management does not believe are
reflective of underlying business performance.
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Fiscal Year Ended
December 26, December 27, December 29,
2021 2020 2019
($ in thousands)
Net income (loss) attributable to Potbelly
Corporation $ (23,784) $ (65,391) $ (23,992)
Depreciation expense 15,909 19,830 22,103
Interest expense 963 1,076 199
Income tax expense (benefit) 172 (6,536) 14,190
EBITDA $ (6,740) $ (51,021) $ 12,500
Impairment, loss on disposal of property and
equipment, and shop closures (a) 5,125 12,346 6,050
Stock-based compensation 2,137 2,515 2,335
Nonrecurring professional services (b) - - 3,070
CEO transition costs (c) - 769 -
Proxy related costs(d) - 1,039 (127)
Restructuring and other costs(e) - 1,668 1,673
Adjusted EBITDA $ 522 $ (32,684) $ 25,501
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(a)This adjustment includes costs related to impairment of long-lived assets,
loss on disposal of property and equipment and shop closure expenses.
(b)We incurred certain costs in the third and fourth quarter of 2019 for
nonrecurring professional services.
(c)We incurred certain costs related to the transition between the current and
former CEO in 2020. Transition costs were included in general and administrative
expenses in the consolidated statements of operations.
(d)We incurred certain professional and other costs and associated benefits
related to shareholder proxy matters. These costs and benefits were included in
general and administrative expenses in the consolidated statements of
operations.
(e)We incurred certain restructuring costs, primarily related to severance, in
2020 and other business transformation costs in 2019 that were included in
general and administrative expenses in the consolidated statements of
operations.
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Cash 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 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 impact of the COVID-19 pandemic on our operations and revenues significantly impacted our ability to generate operating cash in 2020. To preserve our financial flexibility, we used our revolving credit facility to fund our operations.
We ended the fiscal year 2021 with a cash balance of $14.4 million and total liquidity (cash plus amounts available under our committed Revolving Credit Facility, which is further described in the section below) of $28.8 million compared to a balance of $11.1 million and total liquidity of $44.6 million at the end of fiscal year 2020. The total liquidity was $28.3 million as of September 26, 2021, $35.3 million as of June 27, 2021, 33.5 million and March 28, 2021. On February 9, 2021, we closed on a Securities Purchase Agreement (the "SPA") for the sale 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 were exercisable commencing August 13, 2021 through their expiration date of August 12, 2026. On November 3, 2021, we entered into an Equity Sales Agreement (the "Sales Agreement") with William Blair & Company, L.L.C., as agent pursuant to which we may sell shares of our common stock having an aggregate offering price of up to $40.0 million from time to time, in our sole discretion, through an "at the market" equity offering program. As of March 3, 2022, we have not sold any shares under the sales agreement. We believe that the proceeds from the SPA, cash from our operations, borrowings under our Revolving Credit Facility and sales under our equity offering program will be sufficient to provide liquidity for the next twelve months.
Cash flow
The following table presents summary cash flow information for the periods
indicated (in thousands):
Fiscal Year
2021 2020
Operating activities $ (4,873) $ (11,609)
Investing activities (9,048) (10,920)
Financing activities 17,148 14,849
Net increase (decrease) in cash $3,227 ($7,680)
Operational activities
Net cash used in operating activities decreased to $4.9 million for the fiscal year 2021, compared to $11.6 million for the fiscal year 2020. The decrease in net cash used is primarily driven by a decrease in loss from operations.
Investing activities
Net cash used in investing activities decreased for $9.0 million for the 2021 financial year, from $10.9 million for fiscal 2020. The decrease is mainly due to lower construction costs for new stores.
At the onset of the COVID-19 pandemic, we halted capital investments in new company-owned stores, with the exception of stores that were substantially complete, as well as all non-essential capital expenditures. We have since taken over the capital
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expenses for routine maintenance and repairs in our workshops, but we currently have no plans to begin construction of company-owned workshops.
Fundraising activities
Net cash provided by financing activities increased to $17.1 million for the fiscal year 2021, from $14.8 million for the fiscal year 2020. The increase was primarily driven by the net proceeds from the SPA.
Share buyback program
On May 8, 2018, we announced that its Board of Directors authorized a stock repurchase program for up to $65.0 million of its 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. We did not repurchase any shares of our common stock in the fiscal year 2021. As of December 26, 2021, the remaining dollar value of authorization under the share repurchase program was $37.9 million, which includes commission. Repurchased shares are included as treasury stock in the consolidated balance sheets and the consolidated statements of equity. In light of the COVID-19 pandemic, we do not have plans to repurchase any common stock under our stock repurchase program at this time.
Share issuance program
On November 3, 2021, we entered into an Equity Sales Agreement (the "Sales
Agreement") with William Blair & Company, L.L.C., as agent pursuant to which we
may sell shares of our common stock having an aggregate offering price of up to
$40.0 million from time to time, in our sole discretion, through an "at the
market" equity offering program.
Under the Sales Agreement, we will set the parameters for the sale of shares,
including the number of shares to be issued, the time period during which sales
are requested to be made, the limitation on the number of shares that may be
sold on any trading day and any minimum price below which sales may not be made.
Subject to the terms and conditions of the Sales Agreement, William Blair may
sell the Shares by methods deemed to be an "at the market offering" as defined
in Rule 415(a)(4) promulgated under the Securities Act of 1933, as amended,
including sales made directly on The Nasdaq Global Select Market or on any other
existing trading market for the Shares, and, with our consent, in negotiated
transactions at market prices prevailing at the time of sale or at prices
related to such prevailing market prices. The Sales Agreement may be terminated
by the Company upon five days' written notice to William Blair for any reason.
William Blair may terminate the Sales Agreement upon five days' written notice
to the Company for any reason or at any time under certain circumstances,
including but not limited to the occurrence of a material adverse change in the
Company.
The Sales Agreement provides that William Blair will be entitled to compensation
for its services of 3.0% of the aggregate gross proceeds from each sale under
the Sales Agreement. The Company has no obligation to sell any Shares under the
Sales Agreement and may at any time suspend solicitation and offers under the
Sales Agreement. The Sales Agreement contains customary representations,
warranties and agreements by the Company, indemnification obligations of the
Company and William Blair and other obligations of the parties.
The Shares will be issued pursuant to the Company's effective shelf registration
statement on Form S-3 (File No. 333-255845) (the "Registration Statement"),
declared effective by the U.S. Securities and Exchange Commission (the "SEC") on
May 13, 2021.
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 that certain amended
and restated revolving credit facility agreement, dated as of December 9, 2015,
and amended on May 3, 2019 (collectively, the "Prior Credit Agreement") with
JPMorgan. The Credit Agreement provided, among other things, for a revolving
credit facility in a maximum principal amount $40.0 million, with possible
future increases of up to $20.0 million under an expansion feature. Borrowings
under the credit facility generally bear interest at our option at either (i) a
eurocurrency rate determined by reference to the applicable LIBOR rate plus a
specified margin or (ii) a prime rate as announced by JP Morgan plus a specified
margin. The applicable margin was determined based upon our consolidated total
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leverage ratio. On the last day of each calendar quarter, we were required to
pay a commitment fee of 0.20% per annum in respect of any unused commitments
under the credit facility. So long as certain total leverage ratios, EBITDA
thresholds and minimum liquidity requirements are met and no default or event of
default has occurred or would result, there was no limit on the "restricted
payments" (primarily distributions and equity repurchases) that we may make,
provided that proceeds of the loans under the Credit Agreement may not be used
for purposes of making restricted payments.
As disclosed in our Annual Report on Form 10-K for the fiscal year ended
December 27, 2020, during 2020, we drew on the credit facility to increase our
cash position and preserve financial flexibility in light of the uncertainty
resulting from the COVID-19 pandemic, and we amended the Credit Agreement
throughout fiscal year 2020.
We entered into Amendment No. 5 (the "Fifth Amendment") to the Credit Agreement
on February 26, 2021. As a result of the Amendment (i) the maturity date was
extended from March 31, 2022 to January 31, 2023, (ii) the revolving credit
commitment decreased from $40.0 million to $25.0 million, (iii) the interest
rate margin with respect to any Commercial Bank Floating Rate Loan increased to
2.75%, (iv) the interest rate margin with respect to any Eurodollar Loan
increased to 5.00%, (v) the definition of EBITDA was amended to exclude non-cash
charges/gains in connection with certain equity interests of the Company, (vi)
certain borrowing conditions relating to our Consolidated Cash Balance were
instituted, (vii) we are permitted to repurchase/redeem its equity interests
under certain conditions and (viii) the minimum monthly EBITDA and Liquidity
thresholds we must maintain were revised.
From December 26, 2021we have had $9.9 million unpaid under the credit agreement. From December 27, 2020we have had $6.3 million unpaid under the credit agreement. We are currently in compliance with all financial covenants.
On January 28, 2022, we entered into Amendment No. 6 (the "Sixth Amendment") to the Credit Agreement. The Sixth Amendment, among other things, (i) extends the maturity date under the Credit Agreement from January 31, 2023 to May 31, 2023, (ii) changes 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) increases 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) amends certain financial covenant testing levels, and (vi) amends the definition of subsidiary to exclude the Potbelly Employee Relief Fund NFP, an Illinois not-for-profit corporation.
Paycheck Protection Program Loan
On August 10, 2020, PSW, an indirect subsidiary of ours, 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 is 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 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 have used all of the PPP proceeds toward qualifying expenses and are pursuing forgiveness of the full Loan amount, but we are not able to determine the likelihood or the amount of forgiveness that will be obtained. If the Loan is ultimately not forgiven, we will be required to repay the Loan over 5 years at a 1% interest rate.
We recorded the amount of the loan as long-term debt (current and non-current) in our Consolidated Balance Sheet as of December 26, 2021and the related interest has been recorded in interest expense in our Consolidated Statement of Income for the year ended December 26, 2021.
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
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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. Our significant accounting policies can be found in Note 2 to the consolidated financial statements in Item 8. We consider the following estimates to be the most critical in understanding the judgments that are involved in preparing our consolidated financial statements.
Impairment of long-lived assets
We assess potential impairments to our long-lived assets, which includes
property and equipment and right-of-use assets for operating leases, whenever
events or circumstances indicate that the carrying amount of an asset may not be
recoverable. Assets are grouped at the individual shop-level for purposes of the
impairment assessment because a shop represents the lowest level for which
identifiable cash flows are largely independent of the cash flows of other
assets and liabilities. Recoverability of an asset group is measured by a
comparison of the carrying amount of an asset group to its forecasted shop cash
flows expected to be generated by the asset group. If the carrying amount of the
asset group exceeds its forecasted shop 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 income approach. Key inputs to this approach include
forecasted shop cash flows, discount rate, and estimated market rent, which are
all classified as Level 3 inputs. Level 3 inputs are derived from valuation
techniques in which one or more significant inputs or significant value drivers
are unobservable. We used a weighted average cost of capital to discount the
future cash flows. A 100 basis point change in any of these key inputs would not
have a material impact on the calculation of an impairment charge.
Given the high degree of uncertainty as to whether, when or the manner in which
the conditions surrounding the COVID-19 pandemic will change, including the
timing of any lifting of restrictions on restaurant operating hours, dine-in
limitations or other restrictions that largely limited restaurants to take-out
and delivery sales, customer engagement with our brand, the short- and long-term
impact on consumer discretionary spending and overall global economic
conditions, it is possible that material non-cash impairments could be
identified in long-lived tangible assets in the future. However, the likelihood
or the amount of an additional impairment charge cannot be reasonably estimated
at this time.
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