Papa John's International Inc (PZZA) 2004 Q4 法說會逐字稿

At this time I would like to welcome everyone to the Papa John's 2004 fourth quarter earnings 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] Thank you. Mr. Flanery, you may begin your conference.

Thank you, operator. With me on the call today are John Schnatter, Founder and Chairman; Bill Van Epps, Chief Operations Officer; and other members of our executive management team, including our incoming CEO, Nigel Travis. After a brief quarter and full-year financial update, Bill will provide an operations and marketing update; followed by remarks from John and some initial observations from Nigel. The management team will then 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 website.

We reported earnings per share of $0.55 for the quarter and $1.33 for the year, as compared to $0.46 for the fourth quarter of 2003 and $1.86 for full year 2003. The fourth quarter 2004 results included an $0.11 per share loss related to the consolidation of the BIBP cheese purchasing entity and a $0.07 per share charge related to the cumulative catch-up adjustment for lease and leasehold expense recognition; as I'll more fully discuss in a moment. The full year 2004 results included an $0.84 per share loss related to BIBP and a $0.06 per share cumulative lease adjustment charge.

We have completed a comprehensive review of our accounting for lease expense recognition and leasehold depreciation expense in response to recent public announcements by several restaurant companies and emerging technical accounting guidance and interpretations in this area. We recorded a total adjustment of 1.9 million, $0.07 per share, in additional expense during the fourth quarter related to the cumulative prior period correction in the recording of straight-line lease expense, leasehold depreciable lives and tenant improvement allowances. Approximately 1.6 million of this adjustment, $0.06 per share, related to years prior to 2004. We have concluded, based on our analysis, that the required adjustment was not material for restatement of any prior-year financial statement results and our auditors are in agreement with this conclusion.

Revenues were up 3.6 percent for the quarter and 2.7 percent for the full year in 2004 versus the same periods in the prior year. The second quarter consolidation in accordance with FIN 46, of the operating results of four franchise entities representing 33 restaurants, added approximately $4.4 million of revenues to the quarter and $14.4 million of revenues to the full-year results. Additionally, the favorable impact of higher cheese costs and the sale of promotional items on 2004 revenues in our commissary business segment, more than offset the negative impact of lower commissary volumes resulting from reduced restaurant transactions. These increases in revenues were partially offset by the reduction in 2004 company-owned restaurant sales as a result of the closing of 22 restaurants in late 2003.

System wide comparable sales increased 0.7 percent for the fourth quarter and 0.1 of a percent for full year 2004. Ticket averages for both company-owned and franchise units increased in 2004 in response to our strategic efforts to reduce discount levels and, in some cases, increase menu prices. However, this means that restaurant transactions lagged comparable sales results for the quarter and year, leading to the reduction in commissary sales volumes as previously noted.

Although new domestic restaurant openings increased substantially from 66 in 2003 to 103 in 2004, net unit growth continues to be challenging domestically as domestic closings were also substantially higher; increasing from 77 in 2003 to 112 in 2004, primarily as a result of the termination of a large franchisee in the Chicago market during the second quarter of 2004. Internationally both unit openings and net unit growth are up in 2004 versus 2003. We opened 37 and closed 28 Papa John's units internationally in 2003 but opened 70 units as compared to only 23 closings in 2004.

Excluding the impact of consolidating BIBP pre-tax income was $18.1 million in the fourth quarter of 2004 as compared to 13.2 million for the same period in 2003, and 60.6 million for full year 2004 as compared to 54.4 million for full year 2003. The 2003 results included $1.1 million of expenses in the fourth quarter and $5.5 million of expenses in the full year related to the closure or impairment of certain company-owned restaurants. Additionally fourth quarter and full year 2004 costs related to insurance reserves for the franchise insurance program were substantially higher in 2003 as predictability of the claims loss reserves appeared to stabilize somewhat in 2004. The previously noted fourth quarter 2004 lease accounting adjustment also impacted the comparability of operating results between years, as did certain additional items as described in the release.

Margins for company-owned restaurants were comparable to prior-year results for both the quarter and full year, excluding the impact of the consolidation of BIBP. Increases in certain costs, primarily higher cheese costs from BIBP, were offset by labor reductions due to staffing efficiencies and leverage on the higher ticket averages due to the previously noted reductions in discounting and pricing increases. Commissary and other margin was approximately 1 percent lower for the quarter and full year in 2004 as compared to the prior year periods, primarily as a result of the negative impact on cost of sales of higher cheese costs, since cheese has a fixed dollar rather than a fixed percentage mark-up; and higher sales of lower margin promotional items, basketballs in the first quarter of '04 and DVDs in quarters 2 through quarter 4. These items were partially offset by the positive impact on other operating expenses of reduced costs related to the claims loss reserves of the franchise insurance program previously noted.

As previously announced, effective October 1 of 2004 a third-party commercial insurance company began offering fully-insured coverage to franchisees participating in the Papa John's franchise insurance program. We are pleased to note that this new arrangement eliminates the Company's risk of loss for franchise insurance coverage written after September of 2004.

General & administrative expenses increased $500,000 for the quarter and $5.3 million for full year 2004, as compared to the prior year. These increases were primarily due to the impact of the previously-noted lease accounting adjustments, costs of stock options awarded late in 2003 that vest and are expensed over a 12-month period throughout 2004, increased bonuses for corporate and restaurant management to achieve specific performance goals, increased administrative costs related to supporting our domestic franchise sales efforts, severance and other costs associated with the previously announced Q4 staffing reductions, and administrative costs associated with the consolidation of the variable-interest entities in 2004. These increases were partially offset by savings related to various administrative efficiencies implemented throughout the year.

The major components of other general expenses for both the fourth quarter and full year '04 and '03 are discussed in the earnings release. Both recurring and non-recurring items are included in this caption, and the 2004 net costs are approximately $900,000 less than 2003 on a full-year basis, reflecting the favorable impact on 2004 of a $550,000 gain on the sale of unused property and the unfavorable impact in 2003 of $346,000 of restaurant relocation costs.

Net interest expense decreased $300,000 for the quarter and $1.6 million for full year 2004 as compared to the same periods in the prior year, due to lower-- lower average debt outstanding throughout 2004 ; and a $625,000 benefit recorded in the second quarter of '04, reducing interest expense pursuant to FAS 150 related to a change in a joint venture operating agreement.

We repurchased $68.9 million of Company stock during 2004, including $10.9 million during the fourth quarter, while receiving total proceeds of 21.1 million for option proceeds and tax benefits from the exercise of stock options during the year. Additionally, subsequent to year end, we have repurchased and additional $12.8 million of Company stock thus far in 2005. The Board has authorized share repurchases of $450 million, and to-date we have repurchased a total of 433.4 million. There are 16.5 million actual shares outstanding as of this date and approximately 16.7 million on a fully-diluted basis.

Our line of credit balance was 78.5 million at year end and has decreased to $74.2 million to-date, even in view of the additional share repurchase activity. We continue to consider share repurchases as an appropriate use for free cash flow and/or increased leverage taking various economic and industry factors into consideration.

As previously discussed, we were required to consolidate the operating results of BIBP beginning in 2004. BIBP is the franchisee-owned entity conducting the cheese purchasing program for the Papa John's system. Fourth quarter '04 pre-tax income was reduced $3 million, or $0.11 per share, and full-year pre-tax income was reduced 23.5 million, or $0.84 per share, from the consolidation of BIBP. This consolidation could also have a significant impact on operating income in future periods due to the volatility of cheese prices. Based upon current milk futures prices, we project the consolidation of BIBP will increase the Company's operating income by $3.6 million during 2005.

Beginning in the second quarter of 2004 we were also required to consolidate the operating results of four franchise entities representing 33 Papa John's restaurants. As expected, the consolidation of these entities did not significantly impact fourth quarter or full-year results and we do not expect any significant impact in future periods.

Finally, we are reaffirming our 2005 earnings guidance range of $2.27 to $2.35 per share. Specific assumptions underlying this guidance were included in our December 15, 2004 press release, available on our website. And now, before I turn the call over to Bill, I'd like to take just a moment to thank John Black for his many contributions to Papa John's during his career here heading up our IS department, as he transitions to retirement later this year. I'd also like to welcome Glenn West as our new Vice President of Information Services and eCommerce. Glenn has nearly 25 years of restaurant systems experience and is working closely with John Black to ensure a smooth transition. And now I'd like to turn the call over to Bill Van Epps, our Chief Operations Officer, who will discuss our operational and marketing efforts in more detail. Bill?

Thanks, David. We've said for some time now that we've been pleased with our improvements in operational execution that we've seen from both our company-owned and franchise restaurants. While we can always strive to do better, the quality and consistency of our product and service are back in line with where they were in the mid '90s when we were gaining market share and growing into the world's third largest pizza company. We spent a lot of time and money developing and implementing the performance monitoring systems to ensure we maintain this level of performance going forward. We believed all along that if we could achieve these improvements in operational execution our sales results would stabilize and start growing again. However, just as our sales results didn't immediately turn downward when our execution began to slide in the late '90s, we realized the improved execution would not immediately translate into improved sales results.

We are hopeful that our sales results in the last half of 2004 and for the first two months of 2005 are an indication that we're starting to see some positive momentum in response to our efforts. In fact, January and February, 2005 represent the first time since early 2001 that we have achieved two consecutive months of positive system-wide comparable sales while also comping over positive results from the prior year. And we're also encouraged that we have achieved positive system-wide comparable sales results for 16 of the most recent 22 weeks.

In addition to the operational improvements, we've undertaken several strategic initiatives during the last several months that we believe have contributed to our recent sales momentum. Our creative is focused on the food with extensive product shots, upbeat music and the customers enjoying the fun of eating a delicious Papa John's pizza with friends and family. We've implemented a 12-inch medium pizza throughout most of our system to allow us to compete for the more price-conscious consumers without overly discounting our signature 14-inch product. And we've increased our new product news by rolling out new menu items such as the Spinach Alfredo Chicken Tomato specialty pizza and our new Papa's Wings Spicy Buffalo and Mild Chipotle barbeque chicken wings.

But even as we roll new products we continue to challenge the level of operational complexity to ensure that we can deliver consistently high-quality products to our customers.

We have additional store level initiatives underway for 2005 centered on our direct interaction with our customers, both from a marketing and an operational execution point of view. We've decided to shift more of our marketing efforts back to the local store and local market levels, where we were best able to compete with our two larger national competitors. We'll also continue to drive new product news throughout 2005 with our current Sicilian Meats specialty pizza promotion, representing our first new product of the year. Now, that we stabilized our operational execution and are beginning to see topline sales momentum, we want to focus once again on net unit growth.

We're pleased to welcome Tim O'Hern back as Papa John's new Senior VP of Development. Tim has a lot of success in the past getting new units opened during his previous stint overseeing domestic development, and we're very confident that he can once again drive successful new restaurant openings as we work to penetrate the remainder of the United States.

We're also very pleaded to welcome Grant Miller as Managing Director of International. We expect that Grant will be able to build on the solid international infrastructure we now have in place and lead the ramp up in international development that we believe we're well positioned for. We currently have over 700 units in the international development pipeline including 435 restaurants to be built in China. We expect this to be a key growth area for our company in 2005 and for many years to come.

Now, I'd like to turn over the call to our Founder and Chairman, John Schnatter, for his remarks. John?

Thanks, Bill. I also want to thank John Black and the entire IS team for a job well done. They've put a tremendous platform in place and I think Nigel and the leadership team will be able to really leverage, i.e. database, database marketing, internet sales and maybe potentially a one number system. So, thank you, John Black.

As I've harped on the last three years and we've talked about on these calls time and time again, it takes time and money to build the demonstrable value, the DV, of a brand. With our brand promise of better- better ingredients, better pizza and with us straying off course in the late '90's on the fundamental attributes of our brand: product, service, phone courtesy; i.e. the overall customer experience, we knew it would take time and money to recover from our past sins and right the ship. Over the last 36 months that's exactly what we've done. Like a persistent, annoying, leaky faucet we have relentlessly invested in the three things that matter most to our customers and to our business: a superior quality product, our people and our service. Our DV operational fundamental improvements by both our corporate and franchise operators over the last three years have been nothing short of outstanding.

From 2002 to 2004 we reduced general manager turnover at our corporate restaurants from about 60 percent to just above 30 percent. We've improved our internal product quality scores from a 5.3 to a 9.0 on our ten-point perfect pizza scale, a 70 percent improvement. And we've significantly improved our service to our customers, reducing the number of pizzas that get to our customers over 54 minutes, from 22.5 percent of the orders to 9.8 percent of the orders; a 56.5 percent improvement. And, as of the last six months, this number has improved to less than 5 percent of our corporate restaurants. Congratulations to Mike Rotino and his team for making us extremely competitive with the fastest pizza delivery company in the world.

These are huge wins to our system. Consumers recognize these improvements with Papa John's receiving the highest rating among all national pizza chains in the American Customer Satisfaction Index for each of the last five years, us winning this award. We were ranked number one among the national pizza and delivery takeout chains in the prestigious Restaurants and Institution Consumers Choice in Chains the last two out of three years, and we continue to win best pizza awards in local markets throughout the country; which is where I feel the rubber meets the road. I'm pleased to report that these DV improvements, as Bill alluded to, are starting to translate into improved sales.

While our system was slightly positive for all '04, it was one percent positive for the last six months of the year. In December we ran 2.3 percent positive comps, and 2005 is off to a great start with our system running 2 percent comps in both January and February. And with our March promotion off to an outstanding start, it feels as though as we've got some traction from these DV improvements; creating some wind behind our sails.

In closing want to thank the Board of Directors of Papa John's International, leadership, franchisees and our shareholders for hanging in with me and management for these long three years as we've implemented these fundamental improvements throughout our system. We know there's no silver bullets in this business or any other business. We stuck to our guns, we did it the hard way, and we did it the right way and I thank everybody in all the disciplines for their loyal support. It took longer than any of us would liked-- would have liked, but I believe our efforts are just beginning to pay off.

With the fundamentals of our product and service now as good as I can ever remember, there's no better time to now welcome Nigel Travis as our new CEO. Nigel has my full support and the full support of our Board of Directors and our leadership team as he leads Papa John's to the next level of excellence. Thanks. And with this I'll now turn it over to Nigel.

John, thank you very much and good morning, everyone. Firstly, I'd like to say I'm very happy to be here, both in Louisville and particularly at Papa John's. This is a real opportunity for me as both the consumer and franchise relationships are at the center of my past experience. I've often described it as the sweet spot in my experience. A key factor in my decision to accept the CEO position here was the strength of the brand with consumers, even in--even in the face of two larger competitors with much greater marketing resources.

One of my highest priorities, and one I'm already working on, is to build on that brand strength by recruiting a world-class chief marketing officer as soon as possible. I really do believe a strong CMO can help take advantage of the numerous opportunities that exist in marketing to consumers and a new area, the area of partnership marketing, with strategic business partners.

Turning to another area and that's the international opportunities that exist for Papa John's brand are also an important part of my decision to join the Company. Under Bill Van Epps' leadership and with the recent addition of Grant Miller, Papa John's has gone from very little executive management experience in the international arena, as recently as four years ago, to now having three senior executives, including myself, with over 90 years, yes, 90 years of international restaurant and retail experience. I plan to focus a great deal of attention on our international growth potential from day one. I really think it's a real opportunity.

Another factor that appealed to me about Papa John's was the existing systems infrastructure. As the only chain with a common proprietary point-of-sale system in all units and nationwide-- and nationwide online ordering capabilities, we should be able to identify and drive competitive advantages in serving and marketing to our customers. The Papa Card gift card, for example, is an outstanding back-to-school or holiday gift idea, but we haven't focused any significant marketing attention or dollars to supporting this product or exploring additional retail channels for its distribution.

And while we have substantial growth opportunities in the U.S., the key to getting our franchisees excited about adding new units will be a continued focus on improving unit economics. While our average unit economics are still acceptable, we have too much disparity between the higher performing units and the lower performing units. We'll continue to look for every opportunity to drive investment and operating costs out of our stores, but I've found the best and most exciting way to improve unit economics is to consistently deliver topline sales increases, which is why hiring a CMO is such a high priority for me.

Now, I spent my first few weeks on a part-time basis meeting with members of the management team, meeting with some franchisees and generally learning about the business, and that's a process I'll continue until I'm fully onboard in April; but my current observation is that we're really building positive momentum. You've heard that from John and you've heard it from Bill.

Once I've gotten fully up to speed on the business and our challenges and opportunities going forward, I'm looking forward to an increased dialogue with the investment community to review our progress and lay out our longer-term vision for the Company. Once again, ladies and gentlemen, I'm really pleased to be here, I really feel already part of the Papa John's team, and with that I'll turn the call back to David for Q&A.

Thanks, Nigel. Operator, we're now ready to open the lines up for the Q&A session.

[Operator Instructions] Barry Stouffer, BB&T Capital.

I was hoping you might be able to elaborate a little bit more on the change in transaction counts in the fourth quarter and '04?

Hi, Barry, this is David. You know, we've consistently stayed away from giving any specifics on pricing versus transactions. I think what we could say and we-- we said this in the release that, yes, it's-- our transactions are still lagging comps but we are pleased with the trend we're seeing and we'll probably just leave it at-- at that level of detail.

Yes, Barry. This is John Schnatter. The transactions, like the comps the last couple weeks, have been positive. With that being said, one of the things that Gary Langstaff did that was really good is, he-- he-- he taught us we could get full price for the pizza. So, whereas we did lose a little bit of transaction momentum last year, we were able to get a premium for our product and when you own the quality in your category we think that's where we needed to be. So, we intentionally gave up a little transaction growth in order to get a little bit more for the pizza and what that's done that's forced some of the bigger players to do 3, 4, $5 pizzas. Whereas we've been able to get $1 to $1.50 more for our pizzas, which has really helped franchisee and corporate margins.

I remember a number used for, I think, 2003 something like average selling price was 25 percent off of full menu price. Can you give a number like that for '04?

While David and Bill are getting -- this is John again -- while David and Bill are getting the specifics on the number, I didn't mean we could completely ignore the value-minded consumer. We are seeing that there is a consumer that will pay up for a high quality Papa John's pizza. The reliable chain user demands that you have a good pizza with good service. And the variety seeker, some of the new products we're putting out, while I think Dana Tilley and her team have done an outstanding them, they are very picky about what they eat.

With that being said, we've-- our numbers say 30-35 percent of the people buy on deal. Pizza Hut numbers say they're 50 percent, but you pick the number. What Papa John's is trying to do is make sure we don't dilute the people that really want a high quality pizza with the cheap eaters. So we've segmented those two in two distinctly different groups and we market and attack to those completely differently.

Barry, this is David. I'll just add briefly to John's point. The menu price in the pizza category honestly, you know, often doesn't mean a lot because so many people do buy on some sort of deal or coupon, but the numbers you were quoting for '03 probably were fairly consistent in '04 as far as the amount of discount off of menu. It's in that 25 percent range. And we probably made a little progress, as John noted, shrinking that number in '04 at the expense of-- of some transactions.

Can you comment about how much menu prices were actually raised last year?

Again, we've not really given specifics on that and our franchisees certainly have all of the freedom to set their own pricing, so we probably wouldn't want to comment specifically on that.

Okay. And any comments on your thoughts regarding continuing the DVD program in '05?

We'll continue to evaluate-- this is Bill Van Epps. We'll continue to evaluate the strategy going forward, but we have made no commitments that this stage.

Okay. And then do you have a CapEx number for '05?

Yes, Barry, I think it was out in that December 15th release; but we said, basically, CapEx would be in the 18 to $20 million range which is kind of our run-rate, maintenance CapEx number.

[Operator Instructions] Mark Regenbaum (ph), Helios Partners.

In terms of what Nigel said, I was just wondering if you could elaborate a bit more on your plans of getting the Papa John's story out to the investor and the analyst community? And in terms of that, are you planning on participating in any upcoming conferences and other events?

Well, as I said it's early days, but David and I did have a fairly lengthy discussion about this a couple of weeks as part of my induction to the Company; and we fully expect to get out and go around the analysts and conferences in the next few months. I think I'm targeting to get out by early June. I'm looking forward to meeting everyone, but I think it's important I spend time focusing internally. Really at getting to understand the business. Understanding the many opportunities that I think we have and then I can come out and put a coherent story. So I think it'd be June, Mark, before I'm out there fully.

Mike O'Keevey, Two Rivers Capital Management.

A quick question. Do you have any information regarding market share of-- of food away from home? I noticed that, like last--like past cycles, the share of food away from home now has started to rise again after a period of, you know, flatness in the 2001 recession and such. As that has begun to tick up, is pizza maintaining their market share within all the categories?

This is John Schnatter, Mike. I'll comment, I some saw research last night that 86 percent of the deliveries at home are pizza. So then I'll let Bill and David jump in in a little bit. But pizza is holding its own. I do think as other concepts deliver more food, and that was a point of the article, maybe Outback starts delivering, I do think that that may erode a little bit. But you're still going to have an 80/20 rule where I think pizza dominates the home delivery segment. And all the research we're getting from Kolke or McKenzie or Crest suggests that the home is where you want to be.

We have information from Sales Track Weekly, NPD Foodworld that indicates that QSR pizza has improved and it has been since let's say October in the 2 to 7 percent positive range and we have been, as John mentioned, positive as well.

Mike Smith, Oppenheimer.

Yes, a couple of questions. One, I notice that you're pretty close to your current authorization in terms your buyback. John, do you think it likely that the Board will increase that in the near future?

Mike I'm going to let Nigel kind of really answer the question because he's got some ideas on where he wants to take the brand. The reason I haven't spend a lot of time out in the investment community because the story's been simple. I'm going take as much operating income as possible to help make the franchisees healthy and fix-- fix the brand, fix the fundamentals. And that's not -- fundamentals are not a fun story to tell.

Now that John Ishmael and Mike and the franchisees and corporate restaurants are fundamentally sound, by the way I've hidden behind stock repurchase, as you know, to take money out of the Company to protect the shareholders in order to fix the brand. Not a lot of fun, but that's the way we went about it. I think there is a healthier use for capital. I think there is a more sophisticated, healthier use for capital and I'm not saying we don't buy any stock back, but I think we need to find other ways to grow revenue. Nigel?

I think it's an interesting question, Mike. And I think-- I thought by looking at the category, and it was interesting listening to what Bill and John were saying about some of the trends, and some of that information is-- early in my tenure is new to me as well. But one thing I would say is, coming into this category from video rental where most people thought the business was dead but it managed to survive and, indeed, grow over a ten-year period; I think this may be a mature category, but I think I've demonstrated in the past by the companies in which I've been involved, particularly Blockbuster, that often you can get tremendous out of very, very mature industries. So I see plenty of opportunities here.

In terms of the share buy backs, I have not been to a Board meeting yet. I attend my first one in the next couple of weeks. But I think my comments will be, I see growth opportunities in international, I see growth opportunities that we could take advantage of here in the U.S. I see growth opportunities with products and technology and that may mean capital. Now, I have not evaluated these yet. We've not as a management team sat down and come up with a strategic plan. That's why, I said earlier, I want to wait for a couple of months until I go out to the investment community, but I see plenty of opportunities. And as John said, whether it is share buybacks or investing more in growing the business, we've not yet gone through the decision, but I have to say I think my inclination is to grow the business because there are plenty of opportunities.

Is your international growth primarily franchise?

Yes, it is.

I heard you mention, John, local marketing as opposed to national marketing during your prepared remarks. Did I get that right? What does that mean?

I'm sorry, Mike, it wasn't me. I think it was Bill Van Epps.

Yes, we have shifted a point from national to-- back to local, effective in 2005.

So that means -- does that mean less media?

No, just shifting the media from national to local. We don't see any reduction in weight against the consumer. It’s going to be spent differently than we spent it in the past. And to go back to your question about international, while the majority of the development has been franchise we are looking at other alternatives going forward. We see tremendous growth in the international arena and we want to take advantage of it.

At this time you have no further questions.

Thank you, operator. Bye, everyone.

Thank you for participating in today's conference call. This concludes today's conference call. You may now disconnect.