Papa John's International Inc (PZZA) 2003 Q4 法說會逐字稿

Good morning. My name is Wes and I will be your conference facilitator today. At this time, I would like to welcome everyone to the fourth-quarter and full-year 2003 results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. (Operator Instructions). I would now like to turn the conference over to Mr. Dave Flanery.

Thank you, Wes. Good morning. I am Dave Flanery, Chief Financial Officer. With me on the call today are John Schnatter, Founder and CEO, and the other members of our executive management team.

With the departure of Robert Waddell, former Chief Operating Officer and President of PJ Foodservice, we recently announced certain management changes. Bill Van Epps was promoted to the position of Chief Operations Officer, where he will continue to be responsible for all aspects of international development and operations while adding responsibility for domestic, corporate and franchise operations. Julie Larner was promoted to the position of President of PJ Foodservice and will also oversee our Support Services Group while continuing to be responsible for Information Systems. Gary Langstaff joined the Company in December as Chief Marketing Officer with responsibilities for all aspects of our marketing plus community and public relations, brand menu management and research and development, including new product development. Chuck Schnatter continues in his role as Chief Development Officer, responsible for overseeing all domestic franchising and development activities. I continue to be responsible for all finance an investor relations activities, while adding responsibility for strategic supply chain management.

After a brief financial update, you will hear from Bill and Gary about certain plans and opportunities in their new roles, followed by some closing remarks from John. Then all members of the executive management team will be available for Q&A.

Our discussion today will contain forward-looking statements that involve risks and uncertainties relating to future events. Actual events may differ materially from the projections discussed today. The call is being taped and the replay will be available for a limited time on our Web site.

Several significant items impacted our overall financial results for 2003, as discussed in more detail in the earnings release. Comparable sales decreased 3.5 percent for the year. This decrease, coupled with increased costs, lead to a substantial year-over-year decrease in restaurant margins. The cost increases related to both the overall operating environment and specific restaurant initiatives, such as the restaurant field management realignment and related unit staffing decisions that resulted in a shifting of G&A costs to restaurant labor.

In turn, decreasing restaurant margins tend to reduce the number of unit openings and increase the financial pressures leading to a greater number of unit closings. This produced essentially flat net unit growth during the year.

While the pizza segment continues to struggle with seven consecutive quarters of flat or declining transactions, we are encouraged by our fourth-quarter 2003 and initial 2004 sales results. Fourth-quarter comparable sales increased 7/10 of a percent and including February's positive 2.2 percent results, we have now seen comparable sales increases in four of the last five periods. Gary will share his ideas for continuing and building on this momentum in a few minutes.

These sales and cost factors negatively impacting restaurant margin were somewhat mitigated by reduced commodity costs. Specifically, cheese costs to the Papa John's system were substantially lower in 2003 than in 2002. A table comparing year-over-year equivalent block prices by quarter is included in the earnings release. It is expected that 2004 equivalent block prices will be closer to the 2002 and historical levels of approximately 1.35 per pound, as compared to the unusually low 1.18 per pound for 2003. More on our reporting of cheese costs in a moment.

As a result of declining financial performance throughout 2003, we identified 27 domestic company-owned units to be closed and an additional 25 units requiring an impairment charge. The total charges for these closed and impaired restaurants were $5.5 million for the year net of a $275,000 gain on the sale of seven restaurants in the UK. Total restaurant closure impairment and disposition charges in 2002 were $1.1 million.

One other significant factor negatively impacting 2003 results was the performance of the franchise insurance program. Additional claims loss reserves of $6.3 million were recorded in 2003 for this program above expected claims costs. These additional reserves reflect both increases in general healthcare costs as well as our specific claims loss history for the program. We believe that our current premium rates are sufficient to fund future claims losses at adequate levels, although the actuarial predictability of ultimate claims costs continues to be subject to volatility and uncertainty.

Areas of year-over-year improvement include reductions and G&A costs and the provision for notes receivable collectibility. The G&A decrease was primarily attributable to reductions in corporate and restaurant field management bonuses, in addition to the previously noted restaurant field management realignment and unit level staffing decisions that resulted in shifting of G&A costs to restaurant labor.

Although the 2003 provision for notes receivable collectibility of $1.9 million compares favorably to the $2.8 million provision in 2002, the combination of decreasing sales and reduced restaurant margins continued to impact the financial condition of franchisees to which we have outstanding notes receivable.

At the end of the year, $11.6 million of notes receivable were outstanding net of a $6.4 million reserve for uncollectible amounts. This net amount includes a $1.2 million note receivable from the National Marketing Fund that was repaid during early 2004. Excluding the marketing fund transactions, net principal payments of approximately $2.3 million were received during 2003.

We continue to closely monitor certain work-out loan situations and are cautiously optimistic that overall efforts to increase unit sales and improve restaurant margins will favorably impact the ultimate collectibility of the remaining outstanding Notes Receivable.

The major components of the other general expense line item on the income statement for both 2003 and 2002 are discussed in the earnings release. Both recurring and nonrecurring items are included in this caption and on a full-year basis, these costs are relatively comparable, excluding the favorable impact of the $2 million litigation settlement included in the 2003 amount.

We repurchased approximately $5.0 million of Company stock during the year while receiving total proceeds of $6.6 million from the exercise of stock options.

The majority of free cash flow generated during 2003 was used for $78.6 million in payments on the line of credit resulting in a year-end outstanding balance of $61 million under the line.

The Board recently increased our share repurchase authorization to $400 million and to date, in 2004, we have repurchased approximately 688,000 shares at a total cost of $23.1 million, leaving just over $25 million of repurchase authorization. The outstanding balance under our line of credit has increased to approximately $77 million today as a result of this increased share repurchase activity. We will continue to consider share repurchases as an appropriate use for free -- (technical difficulty) -- and/or increased leverage, taking various economic and industry factors into consideration.

We have previously discussed proposed new accounting guidance related to the variable interest entities and how we believe such guidance would apply to us. Since that time, the Financial Accounting Standards Board issued revisions to its FIN 46 guidance, changing its impact on our financial statements from that as previously disclosed. Under the revised guidance, we have consolidated BIBP Commodities Inc. as of year end. BIBP is the franchisee owned entity conducting the cheese purchasing program for the Papa John's system. A cumulative effect adjustment was not required for BIBP since it had an equity surplus at year end. This equity surplus of approximately $2.4 million is reflected as a minority interest to liability in our year-end balance sheet.

The revised guidance will also require us to consolidate, as of the end of quarter 1, 2004, the financial results of certain franchise entities through which we have extended loans but will not require consolidation of certain related party franchise entities where no such lending relationship or other significant financial commitment exists. A cumulative effect adjustment will not be required for the consolidation of the entities with outstanding loans from us, as the revised guidance requires equity deficits existing upon adoption to be recorded as goodwill. We estimate we will record approximately $3.3 million of goodwill as of the end of Q1 for the consolidation of these entities under the FIN 46 revised guidance.

We do not expect the consolidation of the franchise entities to significantly impact operating income in future periods. However, the consolidation of BIBP could have a significant impact on operating income in future periods due to the volatility of cheese prices. We will fully disclose any operating income impact as a result of the consolidation of BIBP in future periods. However, we expect a break-even impact over time.

Finally, we are reaffirming our 2004 earnings guidance to 220 to 228 per share and we have provided some general guidelines for our expectations related to net unit growth, unit sales growth and earnings growth over the next few years.

Now, I will turn the call over to Bill Van Epps, our Chief Operations Officer, who will discuss our growth efforts in more detail. Bill?

Thanks, David. As we had previously discussed, we spent a great deal of effort over the last two years on numerous restaurant initiatives with the objective of improving the quality and consistency of our operational execution.

Although we can always get better, we are extremely pleased with the improvements we have seen thus far. We were frustrated that these improvements had not translated into increased sales during most of 2003, as the overall restaurant industry, the pizza category and the economy produced very challenging environments. That's why we're very pleased that we have seen comparable sales increases for the last four of five periods. We're hopeful that this is an indication that our operational improvements are starting to generate the sales momentum we expect. Carrie (ph) will have more to say about sales trends in a few moments.

As David noted, corporate restaurant margins decreased substantially during 2003 as sales declines and cost increases combined to produce deteriorating financial results. We know our franchisees also face these margin pressures and we believe that a key requirement to restart our growth in the system is to improve restaurant level margins.

We have also recently begun an initiative to identify opportunities to reduce costs in the procurement, administrative and marketing areas of our business. It is still early in the process but results to date are promising and we will provide more information as cost savings are realized at the unit level in the future.

One indicator of a healthy, vibrant system is net unit growth and we have been fairly stagnant in this area over the past two to three years. However, we have been very busy building our infrastructure and development pipeline internationally that will spur our growth over the next several years.

We have opened Papa John's restaurants in seven new countries during 2003 and ended the year with nearly 600 units in our international pipeline with scheduled opening dates through 2012. We intend to continue growing this pipeline into 2004 and future years.

Our main competitors, as you probably know, are significantly more developed internationally than we are and we believe that this is an area of sizable growth opportunity for us.

On the domestic side, the development pipeline has really deteriorated at the end of 2002. As we saw improvements in operational execution occurring, we brought in John Campbell as VP of Franchise Sales in early 2003 to begin the rebuilding of that pipeline. John and his team have had a great success thus far, even though our 2003 system performance is still somewhat weak.

We entered the year with over 300 units in the domestic development pipeline and we're very encouraged that the improving sales trends and targeted margin improvements will facilitate growing this pipeline further in 2004. These operational improvements should also work to slow the rate of unit closings so that we can achieve meaningful net unit growth in 2004 and for several years thereafter.

In summary, we're committed to improving restaurant margins and we believe this will lead to a return to net unit growth. This growth should provide efficiencies in our PJ Foodservice system and the administrative infrastructures and should also produce greater marketing dollars for our system.

Of course, the easiest way to produce significant margin improvement at the unit level is to generate consistent sales growth. For more on our plans in this area, I will turn the call over to our new Chief Marketing Officer, Gary Langstaff. Gary?

I came to Papa John's but with one charge, and that's to grow the topline revenue. The qualification that I put on it and everybody has endorsed is to do that profitably. It would be easier, obviously, to be able to do this if the pizza segment were growing but the fact that it is not growing is not going to be an obstacle (indiscernible) what we are going to try to accomplish.

How (indiscernible) obviously, for some competitive reasons that are fairly obvious, we're not in a position to be able to reveal the specifics of our plan but we can talk to principles that I think are critical to the success that we have a goal for coming up (sic). First and foremost, our emphasis on restaurant level operational execution must continue. We know we have the best ingredients and we have to continue to deliver high-quality product in an acceptable time to our customers. The opportunity to do that, however, has got to be able to simultaneously address the importance of service and be able to deliver against what we're calling a food experience, which is a combination of foodservice and value. Without that foundation, we do not have - I really don't care how good our marketing might be, it is just not going to be successful in the long run.

Next, we want to tackle the historical dependence of the pizza category on discounting. We are the "Better Ingredients, Better Pizza" company and yet, like our competitors, we have helped educate the consumer that there is always a deal available, so the true worth of our product has diminished. This kind of (indiscernible) an effective tactic. We just want to limit it as an overriding (ph) strategy and we have a pretty fair idea as to how to go about doing that.

As you might well appreciate, we can match the marketing dollar per dollar with our major competitors, so we need to be certain that we're getting the most out of the dollars we have to spend. We have some talented people working on some creative ways of which to make sure that those dollars are working harder for us and against what we hope we are going to be deliver is an ongoing twelve-month marketing plan.

Finally, we have got to break what I'm calling the Cycle of Insanity that's doing the same thing over and over again, expecting different results. We are looking at an increased role for new products in our marketing plan, heavy investment in testing of new products. However, those products not only have to satisfy the criteria of the product quality, but they also have to be able to be absorbed within our operations without impeding our delivery. That is a snapshot, I guess, and I will probably be in a position to be answering some more questions and really will spend my first 7 to 8 weeks on the job -- I'm looking forward to the opportunity of going forward.

I will turn it over to you, John, for any closing comments.

Thanks, Gary. As we talk about our outlook for 2004 and beyond, I also want to take a moment to look back on our business over the last 36 months. In addition to an extremely competitive category in a challenging operating environment, our system was hurting itself at times by not living up to the Better Ingredients, Better Pizza promise. We had lapses in executing the simple fundamentals of our business, i.e. making a superior quality pizza and getting it to the customer in a reasonable amount of time.

At the beginning of 2001, it took us about eight months or so to dive in and fully understand where our greatest challenges were. It took another 10 months or so to gather the financial resources to support improvals we needed to attack the above issues.

Over the last 18 months, our operators have worked extremely hard to fix the problem by going back to the basics of what makes a great restaurant great, a superior quality pizza delivered in a reasonable amount of time by friendly team members.

During this time, we invested heavily in our people, our products and our service, including in our corporate stores alone in 2003 4 to $5 million for increases in base pay and bonus opportunities for our general managers and assistant GMs, 2 to $3 million a year for additional staffing at our restaurants to do better service with our better pizza, keeping the better experience promises, as Gary alluded to -- and 4 to $5 million a year for additional toppings on our core pizza to make sure that the superior ingredients were covered in every single bite the consumer tasted.

Over the last 9 to 12 months, we have seen marked improvements in both quality and service in both our corporate and franchise restaurants. In the beginning of the fourth quarter of '03, we believe these improved restaurant fundamentals have started to translate into better comp sales. We have run now four out of five positive periods. I am extremely proud of both our corporate and franchise operators for biting the bullet and spending the resources needed to turn the tide.

On another positive note, as announced in the Wall Street Journal last week, for the fifth consecutive year, Papa John's has been ranked Number One in Customer Satisfaction among all national pizza chains, as well as among all national fast food restaurants in American Customer Satisfaction Index conducted by the National Quality Research Center at the University of Michigan Business School. What is significant about this rating is not that we led the pizza category in all national QSR restaurants for five straight years; what is significant to us is that we stop the decline in our score, which went from 78 in '01 to 76 in '02. Our repeat score of 76 in '03, while not an increase over last year's score, is a tremendous win for us in stopping the bad momentum.

With our restaurants running good fundamentals, we now have a chance to both improve our rating and hold onto the high ground of quality, which brings me back to Mr. Langstaff. With all of the challenges faced by our system 18 months, a good Chief Marketing Officer at that time very likely would have done more harm than good. That is, even if he or she would have brought more customers in the door with good marketing, we would've chased most of them out the back of the restaurants with poor quality and poor service. With our core business stabilized, the timing is right for Gary joining our company. We look forward to helping him communicate our "Better Ingredients, Better Pizza" message to the consumers and moving the Papa John's brand to the next level.

Thanks and I would be happy or we would be happy to answer any questions.

(Operator Instructions). Barry Stouffer of BB&T Capital Management.

Good morning. I've got two questions. One just concerns the February same-store sales. I'm just wondering if that number is viewed disappointing internally, giving how weak February was last year.

The second question I had -- there was not that much in share repurchases the latter part of '03 and the resumption of share repurchases in '04 -- I'm just wondering if you can shed any light on why it appears that you have resumed purchasing shares after not having done so for quite a while?

Barry, I will start with the share repurchases question first and then we'll get to the February comp. What we said during most of 2003 -- and we got the question a few times -- was that we were going to be pretty conservative with how we used our cash flow, given the overall economic environment, our internal trends and the pizza category trend. So, I think it is safe to say that we are more optimistic now about our own performance, the economy and so on, so that we are comfortable shifting. Plus, we have paid debt down $70 million, so we're much more comfortable shifting cash flow, at this point, back into a share repurchase program, basically trying to increase shareholder value as much as possible.

On the February comp side, I think John will handle that one.

You always like to run positive comps whatever period, but the pizza (indiscernible) introduced in the four-for-one at a $50 million advertising campaign -- I think this is the first time we have ever run positive comps, whether it's a Bigfoot or a Stuffed Crust or a Triple Decker, or whatever the product might be by our largest competitor and we run positive comps. We were delighted that, in spite of them spending huge amounts of money on Super Bowl, ect., mass media, that we were able to pull positive comps out of February. I don't know, Gary, if you want to piggy-back on that?

No, I think if you can hold your own against a $50 million investment and be positive, that is an encouraging sign, especially in a category that is stagnant.

Okay, thank you very much.

Mike Smith of Oppenheimer.

Good morning. I have a couple of questions. One, whoever was talking about tackling the discounting -- and you had some fairly specific ideas. Could you go into what those specific ideas that might help you to change the way pizza is bought?

I think that was you, Gary.

It is, and I'm a little reluctant to go into the specific detail. All I can really ask you to do is to stay tuned. I've done this before in a previous life, both in the hamburger and at Hardy's and at Burger King. I'm pretty confident that we have a (indiscernible) to be able to do it to leverage the quality ingredient and better tasting product that we have but I would just as soon not reveal all of the detail of our plans and how to go about doing that.

Has there been any more difference in your general manager and your assistant general manager turnover as a result of the fact that you're paying them more?

There has been. Let me take you through the specifics. The GM turnover has decreased from 46 percent in December 2002 to 36 percent in '03. Our assistant manager turnover has decreased from 78 percent to 60 percent during the same time. So we've seen a significant reduction in turnover.

Also, Mike Cortino, our Senior Vice President of Operations, is with us, and he might talk about some (indiscernible).

One of the things that we have seen over the past (inaudible) stabilization and production turnover is (inaudible) restaurant going back to what John was talking almost, the quality initiative and seeing the types of improvements that we are seeing in the restaurant. That has filtered all the way down to the team numbers (inaudible) January already out of the box our improvement is significant as well versus last in turnover (inaudible). We're pretty excited about that. We will make some ground in terms of performance with that kind of stability.

As most of you know, we spend a lot of time here in the restaurants and so far this year, we have matured about 80 percent of our corporate restaurants. While there is a renewed enthusiasm throughout the building of what is going on at Papa John's, it is even more so out in the field. The words cannot explain the excitement and the passion and just the caliber of GM and folks that are running our restaurant is night and day from where it was three or four years ago.

One other question -- Gary, you took the work out of it for us by giving us a guidance of 220 to 228. Can you give me the store counts that you were using to come up with those numbers?

The ending store counts -- I think, Mike, if you look at the release, it will tell you our expected opening and expected closings so you can kind of do the math there. We should be in those ranges. We have given the guidance on both domestic and international openings and then expected or anticipated closings.

Okay.

(Operator Instructions). Dennis Joe of Sidoti & Company.

Dennis Joe. Good morning. Historically, you haven't introduced that many new products. How agreeable are the franchisees to the new product line that you are suggesting in '04 and how they might complicate operations?

All I will kind of talk about what I am sensing from the franchisees and then Gary or Bill, if you want to jump in, you can kind of give you point of view. Most of our success the last couple of years has come from new products. If anything, there seems to be a thrust from the franchisees from corporate to do new products, versus we were concerned that they were afraid it would complicate operations but Deena (ph) (indiscernible) and her team have done such a good job of coming up with products that do not complicate operations, and then Julie Larner and Robert and their team have done such a good job deploying it and administering it that the franchisees are actually hungry for new products.

The opportunity for new products, historically within the category, has been really unlimited. New product news is something that the consumer responds to.

The challenge that we had in terms of new products was pretty specific and it was best summarized by an operator out in Denver who said, "Look, if you can put it on the left side of the make-up table and I can take it off on the right-hand side without fouling up my operational procedures, we're willing to work with you and anything that you want to bring to the table." So, that is really kind of the criteria that we looked at, matching our ability to deliver operationally with what we're knowing now and to have a better fix in terms of consumer demand and consumer taste preference.

Could you give us a little bit of color on what your marketing strategy for this year might be and then how many national television campaigns you might be considering?

I can give your a broad stroke. Our intent is to be able to leverage better ingredients better pizza. Our specific objective is to own better. We think we have to be able to deliver that in terms of service, as well as in terms of the product. With the efforts that have been put in place over the last two years to improve not only the quality of product in terms of presentation but also in terms of ingredients and every bite is beginning to pay off. It is being operated correctly now in the restaurant and consumers are beginning to see it.

What we need to do is take advantage of trying to be in front of the consumer on a consistent basis and instead of doing what I referred to as the EKG effect in terms of our marketing effort utilizing broadcast, we're working on a plan by which to be really implementing a 13 period, or if you will, a twelve-month consistent marketing plan. That plan was presented in outline form to the franchisees on the fifth of February. In fact, I'm in New York today visiting with the New York co-op to be able to get the adoption of that plan as we go forward. So, it is not so much individual flights of advertising as the commitment to a consistent schedule over the course of the year.

Okay. One last question -- if cheese prices remain at around $1.35 a pound for the year, when would you expect the IBP's shareholder equity to be a net deficit position?

Thank you, Dennis. A couple of months ago, I think we actually said that, based on the future's market projections at that time, it did not look like we would be in a net deficit throughout all of 2004. The milk market and the cheese market has changed since then for several reasons and it is possible that we could go into a deficit situation in BIBP late first quarter or possibly second quarter if the future's market is accurate in its projections of what will actually happen in true spot market. So, it looks like now it will happen sometime during 2004, which is exactly why BIBP is set up in the first place.

Okay, thank you.

At this time, there are no further questions.

Thank you, Wes. Thanks, everyone.

Thank you. See you all.

That includes the Papa John's fourth-quarter and full-year 2003 results conference call.