Papa John's International Inc (PZZA) 2006 Q1 法說會逐字稿

Good morning. My name is Kristen, and I will be your conference operator today. At this time I would like to welcome everyone to the Papa John's First Quarter Earnings Conference Call. [OPERATOR INSTRUCTIONS] Mr. Flanery, you may begin your conference.

Thank you, Kristen. Good morning. With me on the call today are our CEO and President, Nigel Travis; our Executive Chairman, John Schnatter; Chief Operations Officer, Bill Van Epps; and other members of our Executive Management Team. After a brief financial update, Nigel will have comments about our business and our planned initiatives. 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're pleased to report a very good start to the year with strong first quarter sales results. We're also pleased with the overall margin improvement driven by those sales results. All of the financial results we will discuss are prior to the impact of the consolidation of the BIBP cheese purchasing entity. The BIBP consolidation increased first quarter 2006 earnings per share by $0.10, and reduced the first quarter 2005 earnings per share by $0.03. Excluding BIBP, current year EPS for the quarter was $0.37 as compared to $0.33 for the prior year. The prior year quarter included a $0.02 per share charge related to the closing of a commissary facility. The Perfect Pizza operations were sold during the quarter, and have been classified as discontinued operations in our financial statements. Earnings from continuing operations for the quarter, excluding BIBP, were $0.36 as compared to $0.31 for the prior year. Our board declared a two-for-one stock split in December effected in the form of a stock dividend distributed in January, and all reported share and per share amounts have been adjusted to reflect the impact of the split. Our first quarter financial results were driven by continued strong sales as company-owned restaurants led the way with a 6.1% comparable sales increase, and franchise units recorded a solid 3.7% increase for a domestic system-wide increase of 4.2%. We are especially pleased that our sales momentum continued into period four, sparked by our very successful Kong-Sized meats pizza promotion. Domestic system-wide comparable sales were 3.8% for period four, consisting of a 4.4% increase at company-owned restaurants and a 3.6% increase at franchise units. And these period 4 results include an approximate 1% unfavorable impact from the timing of the Easter holiday weekend in 2006 as compared to the prior year. The strong sales results for first quarter drove improved financial results at both our domestic company-owned and franchise business segments, with operating income from company-owned restaurants up approximately $4.7 million and from franchising approximately $200,000 over the prior year amount. The results for company-owned restaurants are even more impressive when you consider that the 2005 results were also substantially better than the previous year. Increased support costs related to the previously announced reorganization of our operations management structure partially offset the sales-driven royalty increases for our franchising unit.

Our domestic commissary segment reported an operating income increase of $400,000 as the favorable year-over-year impact of the prior year charge related to the closing of the commissary facility was substantially offset by increased distribution costs attributable to significantly higher fuel prices. The commissary team did a very nice job in achieving these results in spite of the challenges of the higher fuel prices during Q1, and unfortunately these challenges have only worsened during Q2 thus far. Total system-wide international sales for Papa John's branded units increased 29.1% for the first quarter. However, after excluding the impact of the discontinued Perfect Pizza operation, operating income for the international business segment was approximately $1.5 million less than the same quarter in the prior year. This decline was primarily due to increased support structure costs for our international operations, including infrastructure required to support the development and operation of both company-owned and franchise restaurants in the United Kingdom and potentially in other international markets as well.

As a result of the vesting provision of stock options awarded in late first quarter of 2005, and the impact of both share price performance and the layering effect of performance units awarded in both 2005 and 2006, the total expense recognized related to these two equity-based compensation programs was approximately $1.1 million higher in the first quarter of 2006 than in the same period of the prior year. Cash flow from continuing operations for the quarter, excluding BIBP, was approximately $20.3 million, substantially flat on a year-over-year basis. However, the current year results have been reduced by $2.6 million of stock option related tax benefits that are now classified as a financing activity rather than an operating activity in the statement of cash flow, as a result of the adoption of FAS 123-R. A result of the strong cash flow was a reduction in our line of credit borrowings from $49 million at the end of 2005 to $20 million at the end of the first quarter. We repurchased approximately 716,000 shares of stock during the first quarter, and approximately 437,000 shares were issued pursuant to option exercises during the quarter. We have continued our share repurchase program subsequent to quarter end, recently completing our initial $525 million authorization.

And just last week our board authorized a $50 million increase in such repurchase authorization to $575 million through the end of the year. We are very pleased with the continued favorable price trends in the cheese market. It should be noted that because of the BIBP cheese pricing mechanism, we will not immediately receive the benefit of reduced cheese prices in our company-owned restaurant segment results. However, the current market prices should result in an accelerated reduction in the BIBP deficit that could lead to a small reduction in restaurant-level pricing later in the year, as compared to our initial projections. The BIBP pretax deficit improved from approximately $19 million at the end of 2005 to approximately $14 million at the end of the first quarter. We are updating our earnings guidance range for 2006 from the initial $1.38 to $1.46 per share, excluding BIBP, to the updated $1.40 to the $1.46 per share. As a reminder, approximately $0.07 of these projected earnings are expected to result from the additional week of operations in 2006 to be reported in the fourth quarter.

The expected improvement in performance of our domestic operating units on a year-over-year basis throughout the remainder of 2006 will be mitigated by three specific factors. First, total equity-based compensation expense is expected to be approximately $4.2 million higher for full year 2006 as compared to 2005 as a result of the same factors previously noted for the Q1 increase. Second, the sale of Perfect Pizza in Q1 will reduce year-over-year net income by approximately $0.04 a share. And finally, international losses are expected to continue to exceed prior year levels throughout the remainder of 2006 as we continue to build infrastructure in support of our growth plan including the development, as previously mentioned, of both company-owned and franchised Papa John's restaurants in the United Kingdom and possibly other countries.

In addition to these specific year-over-year factors, fuel costs appear to set new highs nearly every day and natural gas continues at historically high levels. So while we are extremely pleased with the Q1 financial results and the period four sales results, we remain cautious with our guidance for the remainder of 2006. I'd now like to turn the call over to Nigel Travis, our CEO and President. Nigel?

David, thank you very much. As David said, we are extremely pleased with our first quarter results driven by excellent sales momentum and a lot of activity on many fronts. Comparable sales increases of 4.2% for the quarter continued our industry-leading performance, as we beaten the average results for the QSR Pizza category in 46 of the past 52 weeks and have reported close to comparable sales nearly every week for the last five quarters. The Kong-Sizes meats pizza promotion we ran in period four continued to drive results with a 3.8% comparable sales, which is especially good considering the approximately 1% negative impact of the timing of the Easter holiday. Creating a unique product offering tied to the release of the Box Office hit movie, King Kong, on DVD proved to be a winning combination to provide our customers with both great value and also procure solid sales results. This is particularly true in that we were comping against the spicy meat ball pizza promotion from a year ago and that generated comp sales increases of 8.6%. At the start of the year, internally we saw periods three and four as major challenges to overcome, with strong numbers from last year. So we are especially pleased to have jumped that hurdle. There were factors that contributed to our consistent sales performance. We believe it is a combination of initiatives, but always anchored by a compelling product of the highest quality.

Like John Schnatter before me, I am obsessed with the quality of our food and service, and we constantly push ourselves to do even better. Also, when I first came to Papa John's just over a year ago, I challenged our marketing and R&D groups to develop a 18-month pipeline of new products that have been fully consumer and operations tested. I'm very pleased to say that they have exceeded my high level of expectations. For example, since the beginning of 2005, our product offerings have included various pizzas, Sicilian meats, the spicy meatball, the barbecued chicken, Hawaiian barbecued chicken, spicy Italian, chicken bacon ranch and, of course, the huge introduction and very successful introduction of Papa's Perfect Pan. We've also had the introduction of our Sweetreat dessert pizza and our recent Kong-Sized meats pizza. And I believe the products we have coming out for the remainder of our 2006 promotional calender will perform as well as these successful products. Another factor impacting our sales performance is our emphasis on alternative marketing methods. Our two primary competitors in the pizza category have much larger marketing funds than we do. So we have to find ways to compete, other than relying on national television campaigns.

Our first quarter Armchair Quarterback and the Perfect Bracket challenge campaign, teaming with partners like Circuit City and SportingNews, are examples of the more creative methods we need to utilize to compete for share of the consumers' attention. Our agreement with Six Flags is another way we can compete by tapping into the Six Flags customer base to grow our awareness throughout numerous markets. Approximately 50% of our restaurants are within the key 100-mile radius that Six Flag focuses on in attracting consumers to their parks. In fact, I call our arrangement with Six Flags a mega taste test because we've always found one of the most effective ways to build sales is to generate trials. Our product really is our very best marketing asset. In addition to the in park product trial that will be generated with the 25 million or more Six Flags customers, we will also have the ability to contact a large number of Six Flags customers with special offers subsequent to their in-park experience. We have found that properly designed e-mail offers can drive transactions, especially when coupled with our online ordering capabilities. And speaking of online ordering. We continue to improve our site, and the portion of our business coming through our online system continues to grow at a rapid pace.

Among the recent site improvements have been the expansion of plan ahead ordering to 24-hour by 7 days a week basis. So that means you can actually order 21 days in advance, every day, all through the night. We've also added the repeat last order function, and the recent introduction of product graphics to the menu portion of the site. We will continue to improve the online ordering experience for our customers, as we believe online has become a major driver of customer loyalty for us. Finally, with respect to factors we believe are helping drive our business forward. We are really starting to see the benefits from the merging our company-owned and franchise restaurant support organizations. The communication with our franchisees have increased significantly and our field teams are truly functioning as advisors in sharing best practices and helping our franchisees manage their businesses. We believe that these activities will help narrow the performance gap between the company-owned and franchised restaurants over time. And perhaps the April comparable sales results were an initial step in this direction.

All these factors are important, but what is even more important going forward is that we do not become complacent. This category is fiercely competitive, and we must remain alive to the strengths of the other three major competitors. Now I'd like to turn briefly to the financial impact of our sales performance. The great thing about our unit economics model is that there is potential for substantial margin improvement with consistently positive sales results. The pretax margin for our continuing operations, excluding the BIBP impact, increased from 6.6% in the first quarter of 2005 to 8% this year. During the first quarter, we were able to translate those improved unit economics into consolidated margin improvement even while overcoming the increase in equity compensation expense that David talk about, the international investment spending, and the significantly higher distribution costs for our commissary business unit that David referred to in his remarks.

One important point related to margins that I'd like to reiterate is that on a segment reporting basis, which means excluding the effects of the consolidation of BIBP, that cheese price for our restaurants in the first quarter of 2006 was actually slightly higher than for the same period in the prior year. Even though the actual block market price of cheese was substantially lower on a year-over-year basis in Q1. As the BIBP deficit continues to be paid down, this year-over-year trend should begin to reverse thus improving margins somewhat later in 2006 and on into 2007. An added benefit to improve restaurant level sales and margins is the impact on the overall health of our franchisees. Franchisee profitability is at all-time highs through our system, and we are beginning to see this lead to increased unit development activity by existing franchisees. While we still have a relatively small number of underperforming franchisees, we believe we may begin seeing reduced unit closures as unit level performance continues to improve. And since underpenetration [inaudible] are the primary reasons with our underperforming markets, as we've previously reported, we have developed a buy and bill strategy that we believe will help accelerate the development of certain underpenetrated markets. We've begun the execution of this strategy in the Philadelphia market, and now have completed the acquisition of 15 franchise units in this market. We will be opening an additional five units in Philadelphia in 2006, and we expect to build 20 or more corporate stores there over the next four to five years. Early results are encouraging, and if ultimately successful in the Philadelphia market, we would likely pursue this strategy in other underpenetrated markets over time.

An exciting development that we believe will help drive sales, in addition to protecting margins, is our recently announced agreement with The Middleby Corporation to purchase their next generation WOW! 770 ovens on an exclusive basis over the next two years. The ovens reduce cook time by two minutes. That's taking it down 6.5 to 4.5 minutes. But also, they reduce energy usage by approximately 25% as compared to the current technology ovens. So we will be able to improve -- to provide improved service levels to our customers, especially for carry out customers that we would market to our lunch day part, but in addition to migrating the impact of anticipated continued increases in natural gas prices on margins. But I want to make three things clear here. One. Well before my time here at Papa John's, the management team under John's leadership recognized the benefits of a faster bake time and energy savings. They approached Middleby Corporation about their ideas and, through a joint approach, the new oven was developed. Two. We are in the very early days of the agreement and very few stores have the oven. And thirdly, the energy savings are part of a plan that we've been working on to improve the energy efficiency of our company during these times when energy costs are escalating at such a rapid rate.

I'd now like to turn to international. While we work very hard to actively support all our international franchisees, we've identified six countries that we believe give us significant opportunities for growth. They are China, South Korea, the United Kingdom, Mexico, India and Russia. Each of these countries has its own uniquely opportunities and challenges. But we believe we are now well-situated to see each market through to successful growth. Shortly after our last earnings call, we announced the sale of the Perfect Pizza brand in the United Kingdom. We saw this as a necessary step to ensure that we could focus our management attention on building the Papa John's brand successfully in that market. In fact, today we have the U.K. management team here in Louisville to discuss in great deal what action and investments we need to make in order for that to happen. Turning now Mexico. We have a renewed sense of commitment for the market including the decision to invest our own capital in that market.

We're still in the very early stages of development for Russia where we only have seven stores, and India where our first store opened just a couple of weeks ago. Pizza is relatively new in both of these markets and we intend to establish the Papa John's brand as the market place is emerging. Early unit level results in Russia are particularly encouraging, as it appears pizza as a food product and its delivery are both well-accepted by the Russian consumer. The South Korean market is closest to critical mass of the remaining international focus markets, with 45 units currently open. It is a highly competitive market where pizza is well established and our franchisee there has done an excellent job of building market share in this tough environment. China is by far the highest potential international market given the pace of growth of its consumer population and their economic capabilities. We're really excited by the fact that even though we have been in the market a very short time compared to our number one competitor, their market share lead is by no means insurmountable. We are reviewing opportunities to further accelerate our development in China with a potential joint venture or other arrangements. We have more to report on these initiatives as they unfold.

Personally ,I intend to support the international business as much as I can because I believe the international business has such long-term potential. I recently visited Russia and the U.K. and shortly I will visit India, and have return trips to Korea and China. With David Flanery and I spending more time on international, I'm very happy to report that Bill Van Epps has been appointed President of U.S.A. Bill has been a really great help to me in the last year, and his contribution to our business is seen through the great U.S. results in the past 17 months. I'd now like to address the recent action by our board to increase our share repurchase authorization by 50 million.

We have several investment opportunities under consideration, including potential capital investments in China and Mexico and the potential acquisition of additional franchise units domestically. We will also be invested in the previously noted WOW! ovens for our company-restaurants, and are evaluating opportunities to increase company-owned unit development beyond current levels including in the United Kingdom. However, because of our very strong cash flow and underleveraged balance sheet, management and the board were comfortable with an increased share repurchase authorization even in light of these potential investment opportunities. We believe that returning excess cash flow to our shareholders through a continued expansion of our share repurchase program, while still investing in growth initiatives, will provide us the proper balance in achieving our targeted 10% to 12% annual increase in earnings-per-share. In conclusion, the quarter and period four were both very encouraging, but we will not rest of our laurels. The second and third quarter offer more challenges to overcome and, as always, we will not hesitate to make the investments needed to build a stronger business for the long-term. And now we will be delighted to take your questions, and I'm passing it back to David.

Thanks, Nigel. Kristen, we're now read for the Q&A session.

[OPERATOR INSTRUCTIONS] Your first question comes from Barry Stouffer.

Good morning, gentlemen. I have two questions. Can you hear me?

Yes, Barry. Barely. Speak up please.

Is that better?

Yes, it's a little better.

Sorry, I was trying to be polite and use my headset. Sometimes it doesn't too good. I have two questions. First -- In the first quarter, can you share with us how much of the same-store sales increase for company stores would have been transactions versus pricing?

Barry, in following with kind of our established policy, we don't break down ticket versus transactions. So we really don't give specifics on that.

You did give some sense the last half of last year that you were seeing some transaction increases. Would you at least give us a hint on the first quarter?

Well we're not going to give you a hint, Barry, despite all your valiant efforts. And I compliment you for always asking the same question, but we are pleased with the trend. Transactions has, let's just say, an upward slope to it over a fairly long period. We're delighted with the progress we're making, but I think it's important to state the pizza category at the end of last year and even this year hasn't seen a lot of transaction growth. So I think what we can clearly say is we've taken some additional share. We're pretty sure of that. Obviously we haven't seen one of our competitors' results, but based on what we hear we've taken extra share. So hopefully that gives you some indication.

Okay. I was a little bit confused about your commentary about food costs. In general, I was wanting to know what would explain the significant decrease in cost of sales for corporate stores in the quarter and I thought I heard that price -- cheese price charged to the system in the quarter was actually slightly above the prior year.

Yes, Barry. This is David. That's a little confusing. If you look at our restaurant segment, which was up $4.7 million over the prior year, that segment is presented on an internal basis. So the cheese price -- The current market cheese price is not reflected in there. However, if you look at our income statement, because we do have to consolidate BIBP, you're exactly right. The cost of sales has a little over 1% of lower food costs because of the lower cheese prices on the income statement. So it's just a matter of which of those you look to.

Now I'm thoroughly confused. What I was referring to is on the income statement you have cost of sales listed as 19.6% of sales versus 22.5% in the prior year.

Right. That -- On the income statement, that has the current market price of cheese in it which is, indeed, lower on a year-over-year basis.

Okay, and how much of that decrease in cost of sales would be attributable to cheese alone?

About -- A little over 1%.

Okay, thank you.

Yes.

Your next question comes from John [Marzolo].

Hi. Yesterday the Company announced a rollout of a new oven for the company-owned restaurants. When will this start and what impact will this have on your capital expenditures and budget going forward?

Okay so -- John good morning. I'll start off by this. Firstly, we're very pleased with this initiative, and we're going to answer this question in a couple of bits. I'm going to pass, firstly, to David just to talk about the impact on capital expenditure, briefly. Then I thought it would be useful to give a little bit of history on this. I'm going to ask Executive Chairman and Founder, John Schnatter, to talk about it. David, do you want to cover the capital?

Yes, Nigel. John, because of the way it's going to be rolled out, it'll probably have about a $5 million impact on our CapEx for '06. We aren't changing full guidance for the year at this time because after one-quarter -- We usually wait until after second quarter to do that. Our full year guidance is $35 to $40 million of CapEx. At the end of second quarter as some of these other initiatives perhaps acquisitions and so on, come more into light, we could update our guidance at this time. But the $5 million, at this point, we can pretty much just absorb into our existing guidance.

As I briefly pass over to John to answer the first, we've got very few WOW! ovens out there. Just over double digit, and it will slowly build up as the year progresses. John.

Yes,John. John Schnatter. Three years ago, when the Irishman, Tim O'Hern, and I sat with Selim Bassoul at Middleby, I felt like energy prices were going to soar. So just a lucky guess on the part of the founder. A year ago when Nigel came aboard, as what is typical with Nigel and his leadership team, they took the simple idea of the oven, multiplied it by five fold with other initiatives and now we sit here way ahead of the game on energy costs and new technology and being more efficient on cook times.

I hope that answers your questions.

It does, thank you.

Your next question comes from Charles [Timell].

Good morning, gentlemen. Good quarter. This question is more for John. Yesterday on Cramer, somebody was talking about one of your more prominent competitors and, without naming names, said that they were a better company than Papa John's. I guess, John, you're the one with the longest sort of view on this. I was wondering if you even saw it and if you -- How do you respond to something like that?

What exactly did he say, Charlie?

He was basically saying that this prominent competitor was a better company than Papa John's, and he listed a bunch of things. Let's sort of leave it as a general better company, sort of versus one of your very prominent competitors who has very much a menu -- Sort of an offering such as yours.

Well, I mean, if you're a better company, I'm not sure you got to go out and say you're a better company. With that being said, I think our competitors, Independent all the way up -- Domino's Pizza are excellent. Charlie, you've got to be very good in this business just to say even. As I'll pass it over to Nigel, our results are superb because our product quality is superb. We keep winning these contests and these surveys. I think our leadership, Nigel and the team are superb. I think our leverage of our technology, we're way ahead of everybody on technology. We're way ahead of everybody on database marketing. So if I had a little bit more specifics -- I would like to hear it because, if anything we're not better than the best, we want to know about it because I know Nigel will be all over it. And this team will get ahead of what they're doing. So if you have something more specific -- But I can't think of anything that this team is not doing better than the other guys.

I didn't actually see it, but as I follow the Internet very closely, I've read the remarks. I also -- I mean, we actually had an interesting day with Jim Cramer yesterday. We had the remarks that Dave made. He also said nice things about me being a Englishman that seemed to have become Americanized. Now I'm not sure if that's a compliment or not, but anyway he said that. But I echo what John says. I've got enormous respect for Dave Brandon. I think he's done a great job at Domino's. I actually think we're taking a kind of leadership position in pizza -- in the pizza industry. It was interesting. When I came here, a lot of people said don't go into the pizza category. All that happens is that market share moves from place to the other. I really do think with the technology lead we've got and some of the other things we're doing like the WOW! oven, we're beginning to reinvent the industry. So we're excited about the future. Like John, please give us a list of where we need to improve. Because, you know I've only been here a year and a half, and we've got a strategic session tomorrow. I'd love to have that list to make sure that we improve in all those areas. So please send them to us.

Thank you, gentlemen, and good quarter.

Thanks, Charlie.

[OPERATOR INSTRUCTIONS] There are no questions at this time.

Thank you, Kristen. Thanks, everyone.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.