Papa John's International Inc (PZZA) 2006 Q2 法說會逐字稿

Good morning. My name is Lakisha and I will be your conference operator today. At this time, I would like to welcome everyone to the Papa John's Second Quarter 2006 Conference Call. [OPERATOR INSTRUCTIONS] Mr. Flanery, you may begin your conference.

Thank you, Lakisha. Good morning. With me on the call today are our CEO and President, Nigel Travis; our Executive Chairman, John Schnatter; President of USA, Bill Van Epps, and other members of our executive management team. After a brief financial update, Nigel will have comments about our business and 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 very pleased with the continued sales momentum we saw in the second quarter and the financial results driven by this sales performance. We reported earnings per share $0.46 for the quarter versus $0.32 last year. However, the consolidation of the BIBP cheese purchasing entity increased the second quarter 2006 earnings per share by $0.12 and had no impact on the second quarter 2005 earnings per share results. Excluding BIBP, current year EPS for the quarter was $0.34, as compared to $0.32 for the prior year.

All of the following financial results we will discuss are prior to the impact of the consolidation of BIBP. Our Perfect Pizza operations in the United Kingdom were sold during the first quarter of 2006 and have been classified as discontinued operations in our financial statements. Earnings from continuing operations, excluding BIBP, were $0.34 per share for the current year quarter versus $0.31 last year.

Domestic system-wide comparable sales for the quarter increased 4.7%, with very consistent results between company-owned and franchised restaurants. We're especially pleased with these results given that we were going over a 6.1% comparable sales increase in the second quarter of last year. We're also pleased that our sales momentum continued into period seven, with domestic system-wide comparable sales up 4.4% consisting of a 3.1% increase at company-owned restaurants and a 4.7% increase at franchise units. The strong sales results for the quarter drove improved financial results at both our domestic company-owned and franchise business segments, with operating income from company-owned restaurants up approximately $2.1 million, and from franchising up approximately $500,000 over the prior year amounts. Increased support cost related to the previously announced reorganization of our operations management structure partially offset the sales-driven royalty increases for our franchising business unit.

Our domestic commissary segment reported an operating income increase of $2.1 million, as the favorable impact of increased sales volumes on margin more than covered substantial increases in fuel costs. A portion of the increase in commissary sales and margin is a result of the sponsorship arrangements with Six Flags, which was implemented during the quarter. Total system-wide international sales for Papa John's branded units increased 23.2% for the quarter. However, operating income for the international business segment was approximately $1.7 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 franchised restaurants in the United Kingdom, Mexico, and potentially and in other international markets as well.

Additionally, we incurred approximately $470,000 of cost during the quarter related to the management reorganization in the United Kingdom. Although we elected to expense options several years ago as a result of the vesting provisions of stock options and restricted shares awarded in 2005 and 2006 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 equity-based compensation programs was approximately $900,000 higher in the second quarter of 2006 than in the same period of the prior year. This is a major component of the $2 million increase in unallocated corporate expenses for Q2 versus the same period last year. Additionally, fees related to our sponsorship arrangement with Six Flags and certain marketing-related consulting services incurred during the quarter combined for an additional $1 million in year-over-year cost increases for the quarter.

Cash flow from continuing operations for the first six months of the year, excluding BIBP, decreased approximately $12.8 million as compared to the same period last year, primarily as a result of unfavorable working capital changes related to accounts receivable and income taxes. The unfavorable change in accounts receivable was related to a significant improvement in 2005 from 2004 levels and is not an indication of deterioration in 2006. Additionally, approximately $4.5 million of excess tax benefits related to the exercise of non-qualified stock options were classified as a financing activity rather than an operating activity in the statement of cash flows, as a result of the adoption of FAS 123R.

We repurchased approximately 928,000 shares of stock during the second quarter and approximately 273,000 shares were issued pursuant to option exercises during the quarter. We have continued our share repurchase program subsequent to quarter-end and to date have repurchased a total or approximately $555 million of stock against our current Board authorization of $575 million. It should be noted that even with the substantial share repurchase activity during the quarter, our cash flow was sufficient to also reduce outstanding debt levels from the prior year, leading to an approximate $700,000 reduction in year-over-year net interest expense for the quarter.

We're 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 do not immediately receive the benefit of reduced cheese prices in our company-owned restaurant segment results. However, the current market prices have resulted in an accelerated reduction in the BIBP deficit that could lead to reductions in year-over-year restaurant costs for the last two quarters of 2006 and into 2007. The BIBP pre-tax deficit improved from approximately $14 million at the end of first quarter to approximately $8 million at the end of the second quarter.

As far as the outlook for other commodities and operating costs for the remainder of 2006, there is upward pressure on flour costs due to the wheat market, and it is anticipated there will be pressure on tomato sauce for the 2006 pack that begins later this month. Energy costs also continue to be at historically high levels across the board. We also are closely monitoring proposed legislation relating to the national minimum wage, although any final actions in this area would not likely impact 2006 results.

We're updating our earnings guidance range for 2006 excluding BIBP from $1.40 to $1.46 per share to $1.42 to $1.46 per share. This guidance anticipates that third quarter earnings per share will increase slightly on a year-over-year basis. And, as a reminder, approximately $0.07 of the projected full-year earnings are expected to result from the additional week of operations in 2006 included in our fourth quarter results.

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 $2.8 million higher for full-year 2006 as compared to 2005 as a result of the same factors as previously noted for the Q1 and Q2 increases. Second, the sale of Perfect Pizza in Q1 of '06 will reduce year-over-year net income by approximately $0.04 per share. And finally, international losses are expected to continue to exceed prior levels throughout the remainder of 2006, as we continue to build infrastructure in support of our growth plans including the development of both Company-owned and franchised Papa John's restaurants in the United Kingdom, Mexico, and possibly other markets.

We attempt to balance our earnings growth by making strategic investment decisions that may dampen or offset core business growth to some degree in the near term. Our goal is to generate appropriate current return levels by building a strong foundation to ensure continued earnings growth well into the future. I'd now like to turn the call over to Nigel Travis, our CEO and President. Nigel?

David, thank you very much and good morning everyone. Our second quarter results were very pleasing, driven by excellent sales momentum and numerous other initiatives. Comparable sales increases of 4.7% for the quarter continued our industry-leading performance, as we have beaten the average results for the QSR Pizza category in 48 of the last 52 weeks and have reported positive comparable sales nearly every week for the past six quarters. I'd like to publicly congratulate all of our team members and franchisees for this great performance.

So that poses the question how are we achieving this performance level in the face of a tough category and strong competition. We believe the answer is straightforward. We believe our quality positioning and our ability to execute operationally against that positioning is the primary key to our success. Consumers appreciate the difference made by our better ingredients, better pizza promise. That's why the highlight of our second quarter was our seventh consecutive win in the prestigious American Customer Satisfaction Index conducted annually by the University of Michigan's School of Business. Not only did we improve our score over the prior year with 79, but we came in ahead of Starbucks, a newcomer to the survey in 2006 and a company we all have tremendous respect for as a quality brand and as a company.

I believe so strongly in the importance of our overall leadership position and the attributes that make up this index that I've challenged our team to improve in the 2000 survey to an overall score of 80 plus, a breakthrough level of performance for a QSR company. Of course, we still need to develop compelling products to take full advantage of our better ingredients positioning and consistently strong operational execution. I've been very pleased with both the quality and depth of our new product pipeline and our disciplined product development methodology, which includes very rigorous consumer testing.

During 2006 alone, we've introduced our Sweetreat dessert pizza, promoted a Kong sized meat pizza in connection with the release of the movie King Kong on DVD, and offered consumers their choice of steak or chicken fajita pizza with a recently concluded limited-time offer promotion. And while we don't discuss future promotional plans, we believe that our calendar for the remainder of 2006 will continue to drive results even in the face of what we are sure will be a very intense competitive environment.

In addition to the need for an ongoing pipeline of exciting new products, we are constantly challenged to find more creative ways to compete with the much larger marketing and advertising budgets of our two key competitors. One way we've done this is through a substantial increase in our public relations activities, especially surrounding new product introductions. For example, we had a comprehensive PR campaign around the launch of our Papa's Perfect Pan last fall that features a Time Square press conference with Dan Marino, the ultimate go-deep quarterback as our celebrity spokesperson. This campaign included a series of football-themed, local market, national promotional activities supporting the product launch including an online contest conducted in partnership with ESPN.com. And teaming with Universal to promote the DVD launch for the movie King Kong allowed us to extend our marketing budget by taking advantage of the extensive promotional campaign conducted by Universal. Both parties were really pleased with the results of this collaboration and you might expect that we'll look for further opportunities to be involved in similar types of campaigns.

We believe another important way to increase our brand awareness outside of our marketing budget is to more aggressively focus on non-traditional unit development. For example, we are delighted with the early results from our sponsorship arrangement with Six Flags that we announced last quarter. There are approximately 60 Papa John's sites in 17 Six Flags spots around the country selling Papa John's pizza, with each spot counting as one unit for purposes of our development number, regardless of the number of sites within the park. As we've previously stated, while this arrangement provides essentially break-even direct financial results, we see the true value as a mega taste test of Papa John's product with the roughly 25 million Six Flags annual guests. Additionally, we have really excellent signage and other branding within the parks to further support awareness, which is particularly valuable in those parks in regions of the country where our restaurant penetration is currently low.

And currently, our arrangement, of course, the distribution of promotional materials to Six Flags' guests in an effort to bounce them back to their local Papa John's restaurant for future business. We have over 1,100 Papa John's restaurants within 150 miles of a Six Flags park, an area from which they draw the majority of their guests. When I look at the arrangement overall, I really do believe that Papa John's has already contributed to making Six Flags much more family friendly. We're also very excited about the recent opening of two non-traditional sites in Houston/Bush Airports. We took over sites from another pizza brand and have more than doubled sales on a combined basis from these locations.

So, we have a franchisee that's very pleased with their financial results and we have the added value of what I call the billboard effect of having our units and their signage very visible to the thousands of passengers passing through the airport weekly as an awareness and brand building benefit. We're also continuing to identify ways to press our advantage in the area of online ordering. As the only company that can offer a national online ordering capability, we want to continue to improve both the appearance and functionality of our site and we have a dedicated team of marketing and systems experts focused in this area. We continued to see higher ticker averages and increased frequency from our online customers as compared to those who order by phone and we are committed to driving even more of our existing and new customers to this system.

So from all this you can see that we placed a lot emphasis on continued topline sales growth and have numerous initiatives in place to support this objective. One key benefit we expect to realize from our topline sales momentum is improved domestic unit development. We believe we could add up to an additional 1,000 new traditional units in the US and another 500 non-traditional, or some people call it institutional units, to add sites like Six Flags and the Houston Airport units in the US. So that's a total of 1,500 new units potential in the US.

We view 2006 as a transitional year of rebuilding the development pipeline, with unit growth expected to improve beginning in 2007 and beyond. Our goal this year is to increase net unit openings worldwide in the range of 135 to 170 and moving that next year to a range of 225 to 250 net units. We're already seeing some exciting developments in this, area as over 75% of our new traditional domestic developments agreements have been signed with existing Papa John's franchisees, which I believe is an excellent indication of the financial health and the confidence of the franchise community.

The franchisee satisfaction with and confidence in the system was also evident in the very positive results of a recent survey we conducted. We're pleased to say that we believe our overall relationship with our franchisees is excellent at this time and this will help support increased levels of future unit development. With further support in unit development and particularly greater levels of penetration in our underdeveloped markets with our buy and build program. During late 2005 and early 2006, we acquired 15 units in the Philadelphia market from franchisees and plan to open an additional 20 or more units over the next few years in order to achieve market penetration.

Our results to date with the units we acquired are ahead of plan. As a result, we have planned to execute this buy and build program in other underpenetrated markets where opportunities may exist. We also announced last week our acquisition of 43 franchise units in Arizona. While the Phoenix and related markets were already well penetrated, there is an opportunity that we see for additional unit growth due to the exceptional population trends in this region of the country. We believe we can improve upon the already solid operational and financial performance of these restaurants and increased unit sales volumes in addition to adding new units.

I'd now like to turn to our international business segment. We're very pleased with the 23.2% increase in total system-wide unit sales in the second quarter on a year-over-year basis in international. We have generated a 26% increase in year-over-year revenue during the quarter, excluding the impact of the Perfect Pizza discontinued operations. Now, we do not disclose international comps, but it is worth noting that we've been beating our expectations. This is important. Because as in the US, international will only be successful on the back of growing and profitable franchisees. We continue to focus on several key countries where we believe our opportunities for successful growth are the greatest. Let me briefly review these.

Korea hit a real milestone during the quarter as our first international market to reach 50 units solely from organic development. This level of penetration allowed them to run their first television advertising with a very successful campaign tied to the World Cup featuring the former coach of the 2002 Korean national soccer team. We opened our first two units in Delhi, India during the quarter and received some excellent media coverage surrounding the grand opening of the unit in Noida. The North India franchise has a development agreement for 100 units in total to be opened over the next 10 years. We're also very close to finalizing development agreements for 75 in the South and West India.

We've begun building activities in Mexico after the termination of our former master franchisee and the closure as a result of 34 units during the first six months of 2006. We acquired the [QTC] in Mexico City to stabilize the supply chain for the restaurants and we also recently acquired three units in Mexico City. We intend to develop up to 25 additional company-owned units in Mexico City to provide a leadership platform from which to grow the brand. We're also pursuing development agreements with highly qualified franchisees in Mexico City and other regions of the country.

At the end of the second quarter, we had 33 restaurants in China, with development targets of adding 14 more units during the remainder of 2006. Our South and East China franchisee has a development agreement for a total of 365 units to be developed over the next eight years. And as we're currently working closely with our North China franchisee to determine the best of course of action for the Beijing [Taijing] region. This may include our own capital investment to support unit development. As I've said before, we believe the opportunities we have in China are enormous.

Russia, which currently has a total of seven units open in three markets, has the highest PSAs of any international market. Our Russia master franchisee has entered into a creative turnkey agreement with a real estate company to support site development going forward. And there are plans to develop an additional five units during the second half of 2006.

As you all know, the United Kingdom has been an issue for us. And Bill Van Epps and I are spending plenty of time on it. We therefore are very pleased that Ian Saunders has agreed to join as Managing Director of our UK operations. Ian has the operational background to provide solid leadership as we work with our existing Papa John's franchisees and also strive to attract new franchises for unit growth to increase our awareness and move our UK business forward. We know from the success of the competition that the UK holds great opportunities and as such, we are determined to be successful there.

International as a whole offers us enormous future opportunities but it will take plenty of hard work. One area that is critical to our growth is to ensure that our quality is maintained while also ensuring that our food costs are at an economically accessible level to our franchisees. I'm therefore delighted that Alice LeBlanc has joined us from Yum! as Vice President, Strategic Supply Chain. Her experience, both domestically and internationally, will help us tremendously and improve in all aspects of our international supply chain.

In conclusion, I would like to reiterate what David said about our intention to balance current earnings growth from our core business units with appropriate levels of investment spending in various initiatives to build a foundation to support future growth. International is a primary area of investment spending although there are certain domestic initiatives such as the buy and bill strategy that will also be more long-term in nature so far as the return on our investment is concerned.

In making these investment decisions, we will continue to be very disciplined to ensure that each investment is consistent with our brand positioning, supports the growth of the brand, and thirdly, provides returns consistent with our overall financial objectives. We intend to take full advantage of our business model, which creates very strong levels of cash flow in order to support our basic goal of 10% to 12% annual growth in earnings. And we're very optimistic about the outlook for the balance of 2006, even in light of the very competitive environment, we will almost certainly see as we continue to lead the category in sales momentum and market share growth. And now, we will be pleased to take your questions. So, back to David.

Thanks, Nigel. Lakisha, if you would now like to open it up for the Q&A portion of the call.

[OPERATOR INSTRUCTIONS] Your first question comes from Mark Smith with Sidoti.

Hi, guys. Just a couple of real quick questions. First, kind of housekeeping on guidance. Are you still comfortable with your 35 to 40 million CapEx guidance?

Yes, Mark, we are.

Okay, great. And then, if you can just give -- any more color you can give on this recent acquisition. Is this part of the buy and build strategy? And then also, if you can discuss kind of your long-term plans for these restaurants? Is this something that you may look long-term down the road at refranchising?

Okay, Mark, good morning. And we're pleased with this acquisition in Phoenix and it's not specifically part of the buy and build strategy. I'm going to ask Bill Van Epps to talk about it. He was very instrumental in making this acquisition. He knows Phoenix very well. We believe it's a very attractive market. So, Bill, please tell Mark some more.

Okay. Mark, we look at the Phoenix market as being the highest growth market in the United States, with significant household growth over the next five years. We also see an opportunity in leveraging the existing approximately 50 restaurants in the DMA, leveraging the marketing spend in that market. And we think we can add between six and 10 units over the next couple of years to the market, increasing our marketing spend, increasing our market share in that market.

And long-term plans, is it too far out to even think about possibly refranchising these things down the road?

I think what I would say, Mark, is we've got a goal -- if you take our current footprint of getting up to about 25% Company stores, we've talked about that before on these calls. So, at the moment, we're below that. It does not mean that we won't refranchise elements of the country if the right opportunity occurs. But at the moment, we want to build up our Company base. As we grow, we may decide that 25% is not the appropriate number because obviously 25% of a much bigger number gives you a different answer. So, I wouldn't rule it out down the road but, at the moment, we see a lot of opportunities, as Bill said, to grow the market, to grow the base. It's being very well run. We think we can run it even better. As I said in my remarks, we're very excited about it. So I wouldn't see any refranchising taking place in the next few years.

And then last question, two parts here. On your share repurchases, I think you got about 20 million left in your authorization. First, do you see having any problems upping that authorization from your Board? And second, will we see this kind of trend of 20 million spent on share repurchases during a quarter decrease over the next two quarters?

Mark, what we'll look at for the remainder of the year is probably using up most of that authorization in the last two quarters of the year. Looking at our -- the Phoenix acquisition and some other opportunities, CapEx for the first six months of the year was 14 million, a little over 14 million, and so that will increase the back half of the year. So, we'll probably spread that $20 million over Q3 and Q4. But historically, certainly, our Board has been very willing to increase the authorization as we've reached the end of a current level.

Great. Thank you very much.

Thanks, Mark.

Your next question comes Mark Kalinowski with Buckingham Research.

Hi. Just wanted to chat about the operations of the stores. Shooting for a 80 or better in the Michigan Consumer Index sounds like an admirable goal, but I wanted to dive down a little bit further to the Company's own internal trackings. What are you seeing there? What are your goals for the next year or two, et cetera? Thanks.

Well, Mark, that's a fairly detailed question. But it does, I think, demonstrate the kind of focus we have on quality. One of the things that I think -- what I probably didn't realize when I came onboard was just the depth of how this quality culture goes right through the Company. I mean, this morning, I was speaking to a group of community leaders here and I think even the building speaks quality and I said that to that group. John set up an unbelievable system for managing quality and quality to us is both product and customer service. We don't go into everything we do, except we measure just about every element of our business. And John employed experts to set up the system and I have to say, I think, it's incredible. And if ever I left here and went anywhere else, I would take that system with me because it's simply the best system I've seen in any company. So that means we really do focus on the delivery of our products and the delivery of customer service. We measure, as I say, absolutely everything. We get feedback from our customers and we take it onboard, we discuss it seriously, and we do that for the whole world. It's not just the US, it's for the whole world.

I'm delighted that John, at my request, has stayed very involved in managing quality. I know that he's excited about the results. And I think we're on track for the 80 next year because we've seen internal improvements even since the ACSI results. It's something we talk about daily and in fact, John and I were talking about it as recently as this morning. John, have you got any comments you would like to add to that?

No, I thought that was well said. What's amazing with this management team is the measurements have gotten better since Nigel took over and I thought we were pretty good when he came aboard. So as you can see from our results, the business is run quite exceptionally by Nigel and his team. But even the part that I'm very passionate about, which is the customer experience, they've gotten head and shoulders better. For example, [over our] pizzas for franchisees show a 35% improvement. Those are incredible improvements. It's like that in car toppers, it's like that in answering the phones, it's like that --so, they've really embraced the better ingredient, better pizza positioning and they've taken it, Nigel and the leadership have just taken it to a whole another level that's exceeded my expectations.

I think what I would is the reorganization that we did last year that we talked about, I think on about three calls now, has helped level the playing field in terms of quality because we have senior managers now running small parts of the country and they are responsible for looking after both franchise and Company stores. And I think lessons are passed from franchise to Company, Company to franchise. Mike Cortino, who leads the US operations, does a great job. He's on top of it all the time. So, there are so many aspects to this Mark. I could probably talk for the next two hours about what we're doing, but we're very excited about the progress. And I really think that goes right to the heart of our prompt success.

Thank you.

Your next question comes from Fitzhugh Taylor with Banc of America Securities.

Hi, guys. Would you mind kind of going into a little more of what's involved in the international investment spending and maybe talk about how it, without giving explicit guidance, talk about how that kind of affects -- or how that goes into 2007, obviously with growth that doesn't stop. But you kind of mentioned this being the transitional year. Should the next year be back to more normalized levels?

Fitzhugh, good morning. I'm going to kick off and then pass this over to David because David has been running international, as you all know, for the past several months. This is a very important area for us. We see this as the real growth vehicle for Papa John's going way into the future. These investments that we're making are very strategic. So David, do you want to go through them in detail?

Yes. Fitzhugh, we've talked specifically about Mexico and the fact that we want to establish a leadership position there with our Company-owned operations. And obviously, as we do that, there will be some start-up costs involved and some ramping up. We would expect some early operating losses from some of the Company-owned units that we will open up in Mexico City as they ramp up and as we get better awareness. We've not specifically talked about other countries although we, in general, have said that we're not opposed to other capital investment of this type and we've specifically mentioned China as an opportunity. So, you might just stay tuned, I guess, is the best thing we can say there. But again, it would be the same sort of approach where, if we are going in and putting our capital in and trying to establish a beachhead of really solid Company-owned operations, you could expect some early operating losses as you develop a certain market. And those are a couple of areas we've specifically talked about.

Thanks. And secondly, just on the performance comp, I was kind of under the impression that you'd get a little more leverage this year after last year's ramp up and some of the performance comps. Now, looking at it correctly, have some things changed from kind of the earlier in the year outlook?

When you say performance comp, are you just meaning overall margin improvement, Fitzhugh?

Exactly.

Okay. I think what we've said and we've said it for second quarter and also to project it out for the balance of the year, that we really are balancing some very improved performance at our core business units like Company-owned restaurants and commissaries and our franchising segment with the investment spending that we've been talking about, particularly in international. And then, we also have things like our equity compensation year-over-year increase that's working to dampen that a little bit. So, I do not think we've changed what we said throughout the year on that. We have been pretty consistent in saying we'll try to balance those two activities.

I think it's worth adding, if you look that -- and this is actually spelled out in our 10-Q, which was issued last night as well. Our Company restaurant operating margins was 23.3% for Q2 as against 20.1 for Q2 last year. And so, we certainly got leverage there. And I think, it's a real demonstration of what our system can achieve and we'll continue to push for leverage. But as David said, when you look at it right at the consolidated bottom line, we're managing the exceptional results and they really are very good results against the long-term investments that we're making.

Fitzhugh, the only other point I'll make too is, and we've briefly talked about this. But we aren't -- if you exclude the consolidation of BIBP in all of our numbers, which is certainly the way we think you ought to look at it, we're not getting the same current benefit from the very low cheese prices because of the way BIBP works. So, we will have some good margin improvement to look forward to relative to cheese. Now, clearly, there are some other commodities that may go the other direction, but we definitely, as we spell out in our Q, believe that cheese pricing will start declining year-over-year, beginning a little later this year and certainly into 2007.

I think it's also worth adding, we're making the investment in the WOW! ovens and we have now got way over 100 of those ovens. And there's been various predictors about what's happening to natural gas prices, but there's a big article in, I think, it was the Financial Times yesterday showing the natural gas prices are actually going up when everyone was expecting them to go down. So, that now seems to be a very good investment. It's going to have a small impact on our P&L. But over time, we're very convinced that the 25% energy saving that we talked about previously is going to be a really beneficial thing for all the stores that take those WOW! ovens.

Great. Thanks for those responses guys.

[OPERATOR INSTRUCTIONS] Your next question comes from Barry Stouffer with BB&T Capital.

Good morning, gentlemen.

Good morning, Barry.

I had two questions. I wonder if you could share any valuation metrics with us for the acquisition in Phoenix?

Barry, this is David. We've announced the price, so you can get a -- you can determine a price per store. Clearly, we look at things from a valuation point of view as EBITDA multiples and so on. But we're not going to disclose specifics on that.

Didn't think so, but thought I would try.

Nice try though.

Along that same line, any commentary you can share with us on your same-store sales in second quarter about pricing versus transactions?

Again, nice try, but we'll be consistent in our position of not specifically talking about pricing versus transaction, Barry.

That's all I had. Thank you.

Sorry.

Your next question comes from Patrick Stowe with Priority Capital.

Hi guys, congratulations. Wondering if maybe -- this might be in the Q. I apologize, I hadn't gotten to that yet. But can you give us an idea of maybe the potential magnitude of the effect of lower cheese costs? Maybe what percentage of COGS is cheese in a Company-owned store?

Yes, Patrick. And if you go out and look in the Q, I'll give you a quick highlight of that, but cheese is anywhere from 35 to 40% of the food cost of a pizza. And we actually have a section in our Q, it's on Page 26 of the print out that I've got, I don't know how that may show up on EDGAR or whatever. But, basically, in the first two quarters of '06, the price per pound that our restaurants, corporate and franchise restaurants, had to pay as a result of our pricing mechanism was $1, I'll round this off, $1.55 and $1. 48 a pound, when the real market price was $1.27 and $1.18 a pound during those two time frames. Our projections right now -- and again, they are projections based upon the milk futures market. So, one thing you can be sure of is that they'll be wrong but directionally they should be correct. And that is, for the first two quarters of 2007, those two numbers should be about $1.34 a pound.

Okay.

So, there will be some good opportunity for year-over-year improvement there.

And when do you guys be -- is there a certain time when you reset the prices through the BIBP arrangement?

Yes. And that's actually the major benefit of the program, is we set the prices six weeks ahead of each quarter and then they are fixed to the stores for a full quarter. So, that gives them a lot of good visibility over their food cost, how to set their promotional pricing, and so on.

I think it's worth saying, Patrick, I think just before the last call, we asked the franchisees for their view on this mechanism which of course was set up before I came, and they were unanimous that this was the best way for them to manage their P&L because it gave them certainty for the quarter.

Yes, I think it makes a lot of sense. I just wanted to make sure I remember how it will flow through the P&L. I guess relative to that, are the projections on those cheese costs maybe better as you look into the second half and the first half of next year? Are the projections better now than, say, three months ago or six months ago in terms of, as you project in budget costs for Company stores?

Patrick, I guess they're better to the extent that the CME Milk Futures outlook is more accurate than it was looking ahead nine months versus now maybe only looking ahead three or six months. But, it's still a futures market and certainly subject to volatility. But at least the timeframe is shorter now. So, if you want to say that that's a little more visibility then, yes, probably. But, it's still a futures markets.

Right. I guess in terms of the guidance to the 8.3 to 8.7% operating margins, can you give us an idea of how that compares to what was built in the guidance in previous quarters? And is that about in line? Is that better than you were expecting?

I think, Patrick, that that's pretty much in line. And again, what we've seen is kind of a trade-off between very good performance in our core operating units and some additional, I'll call it investment spending, but some additional expense related to, again, primarily international. But on a net basis, it's fairly consistent.

Okay. That was the sense I got, certainly a lot of moving pieces for now.

Yes.

Maybe one last one on just the cosmetics of the guidance. Are the future share repurchases that you've talked about a little bit built into that guidance or not?

To some degree, yes, they are. As we looked out at what we would take into account for the remainder of the year. And you kind of either did it one way or the other, it either reflects an interest expense or share repurchase. So, it's kind of in there one way or the other.

All right, okay. Well, thanks for your time. Good luck.

Thank you.

Thanks, Patrick.

Your next question comes from Jennifer Milan with Ryan Beck.

Hi. Just wondering if you've implemented the guaranteed lunch program in those stores that have the new ovens. And if so, if you have seen any lift to lunch volumes from that? And also, hoping you could comment a little bit more about opportunities that you see for non-traditional stores?

Okay, Jennifer, good morning. Firstly on lunch, the answer is, we haven't implemented it as yet. We're trying to build out markets where we can cover markets and test it appropriately, but we still are very excited about the concept. And we believe that the WOW! oven will certainly support us, getting a fresh pizza out within 10 minutes. In terms of non-traditional, I think this is a very exciting area. It's an area that really hasn't been an area of focus for Papa John's in the past. It's something which a number of us who have got a lot of experience, just looking around the room here, we've got Mike Cortino, who runs the US operations, Bill Van Epps and myself have all been very involved in either institutional or non-trad, call it what you like. And certainly, talking from my own experience, when I ran Burger King, Europe, Middle East and Africa, I think the key to our success in the early '90s there was the fact that because the brand wasn't known, we managed to get the brand known very quickly through non-traditional units in airports, in motorways, which are really turnpikes here in the US, train stations, and that was a very successful approach.

So, we are excited about the, as I called it in my remarks, the billboard impact. We're very excited about what has happened at Six Flags. And by the way, I just want to reiterate, Six Flags has proved to be a very good partner to us and we feel we've been equally a good partner to them. And non-traditional is very much about partnership because you're dealing with a franchisee, usually a fairly large franchisee. So, partnership is important. So we see lots of opportunity there. It's an area that we've not really had much experience as Papa John's in the past but we see it as a growth area. We do have to be sensible though because if you take airports, there's usually a pipeline of people ready to go into an airport. So it's not as easy as just saying we're going to go into 70 airports. You have to sometimes wait your turn. But we think Papa John's with our quality advantage will be attractive for all these places. We've got a number of people focused on it. We're learning lessons from Six Flags and the Houston Airport all the time. So,we see this as a growth vehicle, which again is just part of the equation that builds up the goal of next year to get into net openings of 225 to 250.

Thanks, Jennifer.

Thank you.

[OPERATOR INSTRUCTIONS] And your next question comes from David Goetz with The Courier-Journal.

Hi, can you hear me?

Hey, David, good morning.

Hi, how are you?

I'm good. How are doing?

I think David Novak last week was quoted as or told analysts, he thought the pizza category as a whole was contracting. I wonder if you agree with that? And if so, how Papa John's is positioned in that kind of an environment?

Having listened to David's remarks, I think he was saying that, based on the numbers that they saw the pizza category has declined some. And there's certainly some evidence to support that. But clearly, we've gone the opposite direction. So I assume we've picked up share as a result of our numbers. I think that gets into the whole issue about what's happening in the economy. There's theories that people are trading now, going from high-end to the casual dining and then down into other categories such as pizza. We think -- and I think David also said on the call that pizza kind of fell into the broader casual dining category.

So I think it's very difficult to say what's actually happening out there. We've actually seen some evidence as recently as this week that shows consumer confidence seems to be higher. But, I think the two big impacts that we see are gas prices, which clearly over $3 a gallon are very high and probably makes it difficult for people to travel out of their homes, which should be a good thing for us. And then, you've got the whole housing impact. You got interest rates rising, they seem to have gone up something like 1% over the past year. And, obviously, a number of people are having their interest rates suddenly changed. So, we think that is going to be, if you like, a dampener, which probably has not really impacted yet. But we believe that people will be attracted to pizza. So we remain bullish.

So, overall, I do accept that the pizza market may have, let's say, plateaued over the last couple of quarters, but it has been good for Papa John's. We continue to be very bullish about the sector. We see a lot of growth as I've said before in the US. And we'll continue to be extremely aggressive and let's say creative, in terms of our promotional and other offerings because we're determined to keep ahead. I mean, as David said on the call, they never consider that you've had a good quarter one year, you should go down the same quarter the following year. We support that philosophy. So, when we're tracking very good numbers from last year, we're determined to find a way to go even higher. And we'll continue to do that all the way through this year as we're going against some very high numbers from last year.

Are the non-traditional units, are they a response in part to the market segment's conditions?

I'm sorry, David. Could you repeat that again please?

Yes, the non-traditional units, are they at least in part a response to the situation in the market now?

Absolutely not. As I explained in my previous comment and previous questions, we see this as a real growth opportunity. We would be doing this if the industry was going up 10%, or going down 10%. This is a real growth area that we want to explore. And we think it's not only domestic, because you're obviously talking primarily about the domestic market. We think non-traditional could be a big opportunity for us internationally.

Thank you.

And at this time, there are no further questions.

Lakisha, thank you.

Thanks. I was just going to say to everyone thanks for you interest and thanks for you support to Papa John's.

Thank you.

Thank you. And this concludes today's conference call. You may now disconnect.